Other Supervisory Committee Audit Minimum Procedures Guide Addendum

January 2024

Table of Contents

• Foreword
• Key Terms and Definitions
• Procedures
  • Investments
    • Allowance for Credit Losses on Investments
  • Reserving for Loan Losses
    • Allowance for Loan and Lease Losses
    • Allowance for Credit Losses on Loans and Leases
  • Allowance for Credit Losses on Off-Balance Sheet Credit Exposures
  • Income & Expense

Foreword

This addendum to the Other Supervisory Committee Audit, Minimum Procedures Guide, dated January 8, 2020, replaces procedures based on recent changes in accounting standards from the Accounting Standard Codification No. 326, Financial Instruments—Credit Losses, referred to as Current Expected Credit Losses (CECL). Together, the guide and addendum provide the minimum procedures to perform when a supervisory committee is permitted to choose the Other Supervisory Committee Audit option for completing its annual audit requirement under NCUA regulation § 715.7, Supervisory Committee audit alternatives to a financial statement audit.^{1, 2} These procedures are designed to assist the supervisory committee, internal auditor, or other qualified person in completing the areas of review outlined in NCUA regulation part 715, Appendix A, Supervisory Committee Audit—Minimum Procedures.³

The sufficiency of the procedures, judgments about materiality, and any need for additional or expanded procedures, remains the responsibility of the supervisory committee.⁴ The supervisory committee, internal auditor, or other qualified person may need to perform additional procedures to supplement these procedures, based on the credit union’s risk profile and on products and services offered.

The supervisory committee uses judgment in determining the necessary procedures to meet the requirements in NCUA regulation part 715, Appendix A, Supervisory Committee Audit—Minimum Procedures. All test procedures must be done using balances and samples for the audit period under review. Anytime the test or confirmation procedures include using a sample or selections, the Other Supervisory Committee Audit report should describe the method of selection and the number of selected items.

The Other Supervisory Committee Audit option may not be adequate for all eligible credit unions. In such cases, the supervisory committee should consider an opinion audit of the financial statements performed by a licensed individual.

When a supervisory committee engages external accountants, it must agree to the procedures and acknowledge that the procedures performed are appropriate for the intended purpose of the engagement prior to the issuance of the independent accountant’s report.⁵ In an agreed upon procedures engagement, an independent accountant licensed to perform audits by the State or jurisdiction in which the credit union is principally located takes no responsibility for the appropriateness of the procedures. Therefore, the independent accountant may need to consult with the supervisory committee about the number of items selected for testing and the selection criteria.

The Other Supervisory Committee Audit report should document the testing dates and any exceptions to procedures noted.

Key Terms and Definitions

The following terms are added or updated from the original Other Supervisory Committee Audit Minimum Procedures Guide for use only in this addendum.

Allowance for Credit Losses on Loans and Leases—A valuation account used to estimate credit losses under a CECL methodology, which includes consideration of historical information, current conditions and reasonable and supportable forecasts to develop an estimate of lifetime credit losses. This account may also include individually evaluated loans and other problem loans. The allowance applies CECL to all credit unions $10 million and over in assets and to credit unions under $10 million in assets that have elected to adopt CECL.

Allowance for Loan and Lease Losses—A valuation account used to record management’s estimate of potential loan losses that may occur in the collection of outstanding loans. The estimate includes a historical reserve amount based on the past history of experienced loan losses, as well as the individual classification of delinquent or other problem loans. The allowance applies the incurred loss methodology and follows Accounting Standard Codification Subtopic 450-20 Loss Contingencies and Accounting Standard Codification 310-10 Loan Impairment. This allowance applies to credit unions under $10 million in assets that have not elected to adopt CECL.

Charge-off—A loan that has been deemed uncollectible and is charged-off against the related loan allowance account. Refer to NCUA’s letter to credit unions 03-CU-01, Loan Charge-off Guidance, which also includes suggested policy guidance.

Debt Securities—Any security representing a creditor relationship with an entity. The term of debt security also includes the following: a) U.S. Treasury securities; b) U.S. government agency securities; c) Municipal securities; d) Corporate bonds; e) Commercial paper; f) All securitized debt instruments, such as collateralized mortgage obligations and real estate mortgage investment conduits; and g) Interest-only and principal-only strips. The term of debt security excludes all of the following: a) Option contracts; b) Financial futures contracts; c) Forward contracts; d) Lease contracts; e) Trade accounts receivable; and f) Loans from consumer, commercial, and real estate lending by financial institutions.

Exception—A result that deviates from the procedure requirement.

Testing Period—The period of time that the procedures cover, usually starting from the date of the last Supervisory Committee Audit; for example, a calendar year.

Procedures

The following procedures replace the Allowance for Loan and Lease Losses (ALLL) procedures starting on page 12 of the Other Supervisory Committee Audit, Minimum Procedures Guide, dated January 8, 2020, for all credit unions that have adopted CECL.

Investments

For credit unions that have adopted CECL, credit losses shall be recognized on available-for-sale (AFS) Debt Securities, as applicable, and on held-to-maturity (HTM) Debt Securities.

AFS Debt Securities are required to be evaluated individually for impairment when the fair value is less than the carrying amount and the entity:

1. Intends to sell the security;
2. Is more likely than not to be required to sell the security; or
3. Does not expect to recover the amortized cost basis.

If a credit loss event exists, a credit loss would be calculated using a discounted cash flow approach and recognized as an allowance. Favorable and unfavorable changes in cash flows should be adjusted through a valuation allowance.

For HTM Debt Securities, securities with a net realizable amount less than its amortized cost are assessed to determine estimated credit losses. If a credit loss event exists, a credit loss would be calculated consistent with the same model used for loan portfolios.

Allowance for Credit Losses on Investments

• Confirm that the credit loss measurement methodology agrees to the methodology in the policy.
• Obtain the schedule that lists the Allowance for Credit Losses on Investments.
• Confirm output of methodology agrees to the general ledger.
• Obtain a listing of all Debt Securities.
• On a sample basis, agree whether each selected security on the listing of Debt Securities to the schedule listing the Allowance for Credit Losses on Investments is properly included or excluded.

Note: For Debt Securities where expected non-repayment is zero, a credit loss allowance is not needed. Examples include U.S. Treasury securities and Government Sponsored Enterprises securities. (FASB Accounting Standard Codification (ASC) 326-20-30-10).

Measure credit losses on investments in certificates of deposit for amounts above the financial institution’s deposit insurance coverage.

Reserving for Loan Losses

Though NCUA’s regulation uses the term Allowance for Loan and Lease Losses (ALLL), the intent also applies to the Allowance for Credit Losses on Loans and Leases (ACLLL).

Allowance for Loan and Lease Losses

All credit unions with assets of $10 million and more are required to adopt CECL for financial reporting after December 15, 2022.

Credit unions with total assets less than $10 million do not have to comply with CECL due to the de minimus exception (12 U.S.C. §1782(a)(6)(C)(iii)), unless expressly required by State Supervisory Authorities under state law governing federally insured, state-chartered credit unions.

Under the NCUA’s CECL Transition Rule, federally insured credit unions with assets of less than $10 million are generally not required to implement CECL. For credit unions below this threshold, the rule requires “any reasonable reserve methodology (incurred loss), provided it adequately covers known and probable loan losses.” The incurred loss method is the application of ASC Subtopic 450-20 (loss contingencies) and ASC 310-10 (loan impairment). Federally insured, state-chartered credit unions should refer to state law on Generally Accepted Accounting Principles (GAAP) requirements and CECL standard applicability, as those requirements may be more restrictive.

Federally insured credit unions with less than $10 million in assets that have not adopted CECL should use the ALLL procedures as outlined below:

Obtain the following documents from the credit union:

• Schedule of the ALLL for the testing period which includes beginning balance, provision for loan losses expense, charge-offs, recoveries and ending balance.
• Detailed listings of charge-offs and recoveries by month.
• Management’s support of the ALLL calculation, which typically includes a listing of impaired and classified loan reserves.
• Board of Directors’ approved ALLL Policy.

Perform the following:

• Agree the required ALLL amount according to the schedule to the amount reported on the general ledger.
• Agree the beginning balance, ending balance and provision expense from the schedules provided to the general ledger.
• Agree the totals on the detailed listings of charge-offs and recoveries to the schedule of the allowance activity.
• Mathematically check the schedules for accuracy.
• Confirm that the credit union’s Board of Directors approved ALLL Policy includes, but is not limited to, the following:
  • The requirement that the calculation use the incurred loss methodology per NCUA regulations § 702.113(d)(2).⁶
  • The roles and responsibilities of the credit union’s departments and personnel who calculate and review the ALLL calculation, including:
    • the lending function
    • credit review
    • financial reporting
    • internal audit
    • senior management
    • supervisory or audit committee
    • board of directors
    • others, as applicable
  • The credit union’s accounting policies for loans and loan losses, including the policies for charge-offs and recoveries and for estimating the fair value of collateral, where applicable.
  • The internal control system for the estimation process for the ALLL.
  • The primary elements of the incurred loss methodology.
  • Determining and measuring impairment under GAAP as codified at ASC 310-10-35.
    • A loan is evaluated using ASC 310-10-35 when it is considered impaired, meaning the credit union expects that it will not realize, or receive, full repayment of the loan. The ALLL reserve calculated for an individually impaired loan is the amount of loss that can be reasonably estimated. There are three methods to evaluate impairment:
      • Fair market value of collateral, used primarily for collateral-dependent loans like vehicle loans and mortgage loans. The amount of ALLL reserve needed is the amount the credit union expects to recover (fair market value of the collateral), minus any liquidation costs such as selling costs, transfer taxes, legal fees, or maintenance costs. A current appraisal should be used to estimate the value of the collateral.
      • Present value of future cash flows may be used when there is some expectation of cash payments. The evaluation should use the effective (original, contractual) interest rate as the discount rate for the cash flows. The total impairment reserved in the ALLL is calculated by subtracting total expected cash flows from the total recorded investment.
      • Loan pricing, though this is rarely used by credit unions.
• Confirm that loans with similar characteristics are grouped and evaluated for impairment (in other words, homogeneous pools).
• Confirm that Qualitative and Environment Factors appropriately adjust loss rates or other loss measurements. Qualitative and Environment Factors may include, but are not limited to, the following:
  • Trends in nature and volume of financial assets.
  • Existence and effect of any concentrations of credit.
  • Volume and severity of past due financial assets.
  • Changes in value of underlying collateral.
  • Changes in lending strategies, policies, and procedures.
  • Quality of credit review function.
  • Experience, ability, and depth of lending staff.
  • External factors—competition, technology, natural disasters.
  • Changes to the general market conditions of local area.
  • Changes to local business conditions.

Allowance for Credit Losses on Loans and Leases

Federally insured credit unions with more than $10 million in assets and credit unions with less than $10 million in assets that have adopted the CECL methodology should use the procedures for ACLLL, as outlined below.

Obtain the following documents from the credit union:

• Schedule of the ACLLL movements, for the testing period which includes beginning balance, total credit loss expense, charge-offs, recoveries and ending balance.
• Detailed listings of charge-offs and recoveries by month.
• Management’s support of the ACLLL calculation.
• Board of Directors approved ACLLL Policy.
• CECL Model—The Simplified CECL Tool, third-party CECL Tool, or internally developed models for the periods under audit.
• CECL Model documentation—Documents the major assumptions, inputs, and outputs of the CECL Model. This documentation should include model validation and may also include model backtesting.

Perform the following:

• For the ACLLL Policy,
  • Confirm that management has taken responsibility for determining whether the CECL methodology (for example, expected loss rate, discounted cash flows, regression) is appropriate given their institution’s unique facts and circumstances.
    • For credit unions that use the Simplified CECL Tool, management would confirm the appropriateness of using this methodology. Criteria used to evaluate the appropriateness includes, but is not limited to, credit union size and the complexity of products in its loan and investment portfolios.
  • Confirm the ACLLL Policy is approved by the Board of Directors.
  • Inspect the ACLLL Policy for management’s assertions (existence, rights and obligations, completeness, valuation, and allocation); the required policy components include, but are not limited to, the following:
    • Statement that the allowance calculation complies with GAAP.
    • Description of the roles and responsibilities of the credit union’s departments and personnel (including the lending function, credit review, financial reporting, internal audit, senior management, supervisory or audit committee, board of directors, and others, as applicable) who calculate and review the ACLLL calculation.
    • The accounting policies for loans and loan losses, including the policies for charge-offs and recoveries and for estimating the fair value of collateral.
    • Description of the internal control system, highlighting key controls, for monitoring the quality of the ACLLL value.
• For the Schedule of the ACLLL, agree the following to general ledger.
  • To the ACLLL general ledger accounts, agree the Beginning balance, Total charge-offs, Total recoveries, and Ending balance.
  • To the Credit Loss Expense general ledger accounts, agree the amount that adjusts to period-end ACLLL balance.

For the CECL model, the following procedures are divided into three basic categories. Credit unions that use:

1. The Simplified CECL Tool;
2. An internally developed model; and
3. A third-party developed model.

Based on the type of model, perform the associated procedures, below.

1. For the Simplified CECL Tool:
   • Confirm that the version of the Tool corresponds to the period end (For example, the December 2023 Tool version is used for the period ended December 31, 2023).
   • For Tab 0 – Input; agree input amounts to source documents.
   • For Tab 2 – Individual Basis; see Testing Individually Evaluated Loans, below.
   • For Tab 4 – Adjustments; qualitative adjustments are supported, this includes assessments for current conditions and reasonable and supportable forecasts.
   • For Tab 7 – Checklist; confirm management has completed all items and documented results, including any exceptions.
   • Scan the Tool’s worksheets for any obvious formula errors (For example, cutting and pasting cells may break formulas).
   • For Tab 1 – Summary; agree output (Total Loans and Leases, cell E16) to general ledger.
2. For internally developed models:
   • Agree input to source documents (See Testing Model Input, below).
   • Mathematically check for accuracy, as applicable.
   • Confirm that an independent validation is performed by individuals who do not have a role in determining the ACLLL value. This validation can be performed by individuals internal or external to the credit union. Independent parties should have appropriate knowledge, technical expertise, and experience with credit loss estimation processes.
   • Confirm that the credit union’s management and board of directors have reviewed and approved the independent validation report and addressed recommendations, if any.
   • Confirm that qualitative adjustments are supported, including assessments for current conditions and reasonable and supportable forecasts.
   • Agree output to general ledger.
3. For third-party models:
   • Agree input to source documents (See Testing Model Input, below).
   • Obtain SOC 1 and SOC 2 reports, as available; confirm management has documented their understanding of the SOC testing results and has implemented mitigating controls, if necessary.
   • Obtain external validation of third-party model and documentation of management’s review and approval.
   • Confirm that qualitative adjustments are supported, including assessments for current conditions and reasonable and supportable forecasts.
   • Agree output to general ledger.

For all CECL Models:

Confirm that management has grouped loans with similar characteristics and have evaluated them for impairment (homogeneous pools). ASC 326-20 requires an entity to measure expected credit losses on a collective (pool) basis when similar risk characteristics exist. Pools should be reassessed each reporting period. Risk characteristics to consider include, but are not limited to the following:

• Internal or external (third-party) credit score or credit ratings.
• Risk ratings or classification.
• Financial asset type.
• Collateral type.
• Size.
• Effective interest rate.
• Term.
• Geographical location.
• Industry of the borrower.
• Vintage (origination period).
• Historical or expected credit loss patterns.
• Reasonable and supportable forecast periods.

For Expected Loss models, including the Weighted Average Remaining Maturity (WARM), confirm that major components of the estimate are accurate, such as loss rates and WARM factors.

Testing Individually Evaluated Loans (when applicable):

• Confirm that loans are properly segregated from pools due to different risk characteristics.
• On a sample basis, select loans to confirm the valuation process including outstanding balance, estimation process of amount to be collected (and use of practical expedient if applicable), and loan is not previously written-off.

Testing Model Input:

• On a sample basis, select loans to confirm accuracy of input including outstanding balance, appropriate inclusion in its pool, etc.
• On a sample basis, trace relevant modeling data for accuracy such as loss rates and qualitative factors.

CECL Adoption, if applicable:

• Obtain the calculation of the cumulative-effect adjustment to opening retained earnings (undivided earnings) made to adopt ASU 2016-13.
• Scan calculation for mathematical errors.
• Trace entry to recording in the general ledger.
• Report on any variances noted.

Allowance for Credit Losses on Off-Balance Sheet Credit Exposures

Federally insured credit unions with more than $10 million in assets and those with less than $10 million in assets that have adopted the CECL methodology should use the procedures for the Allowance for Credit Losses on Off-Balance Sheet Credit Exposures, as outlined below.

Obtain the following documents from the credit union:

• Schedule of the movements, for the testing period which includes beginning balance, total credit loss expense, charge-offs, recoveries and ending balance.
• Detailed listings of charge-offs and recoveries by month.
• Management’s support of the calculation.
• Board of Directors approved Policy.
• CECL Model—Third-party CECL Tool or internally developed models for the periods under audit.
• CECL Model documentation—Documents the major assumptions, inputs, and outputs of the model. This documentation should include model validation and may also include model backtesting.

Perform the following:

• Confirm the appropriateness of the credit loss measurement methodology.
• Obtain management’s documentation evaluating financial assets and off-balance sheet credit exposures that fall within the scope of Subtopic 326-20.
• Obtain the schedule listing the Allowance for Credit Losses on Off-Balance Sheet Credit Exposures.
• Confirm output of methodology agrees to the general ledger.
• Obtain a list of all loan commitments and other commitments.
• On a sample basis, agree whether a commitment from the obtained list of all loan commitments and other commitments to the Allowance for Credit Losses on Off-Balance Sheet Credit Exposures is properly included or excluded.

Note: For commitments that are unilaterally cancelable, an allowance is not required.

Income & Expense

Credit Loss Expense

Federally insured credit unions with more than $10 million in assets and credit unions with less than $10 million in assets that have adopted the CECL methodology should perform the following procedures to trace the credit loss expense into the income statement. The values, when applicable, come from documents previously obtained.

Agree the credit loss expense to support for:

• Loans and leases.
• Available-for-sale Debt Securities.
• Held-to-maturity Debt Securities.
• Off-Balance Sheet Credit Exposures.