NASCUS Comments: NCUA Exam Flexibility Initiative
August 1, 2016
National Credit Union Administration
1775 Duke Street
Alexandria, VA 22314
Re: NCUA Exam Flexibility Initiative
Dear Director Morton,
NCUA’s Exam Flexibility Initiative is a critically important review of all of the agency’s examination and supervision processes, policies, and programs. As you know NCUA’s and the states’ exam programs are inexorably linked. The configuration of NCUA’s examination program for both federal credit unions (FCUs) and federally insured state chartered credit unions (FISCUs) influences and impacts how state regulators (also known as state supervisory authorities (“SSAs”) structure their supervision programs and expend their resources.
In addition to impacting SSAs, NCUA’s share insurance related examination program for FISCUs also directly affects state chartered credit unions and the state credit union system. Of course, as the administrator of the National Credit Union Share Insurance Fund (NCUSIF), NCUA has a duty to supervise FISCUs, including conducting its own share insurance examinations as needed. However, it is also true that FISCUs face a unique burden of having both a state and federal regulator conducting examinations of the institution. To the extent NCUA, and SSAs, can improve their individual efficiencies, and coordinate and harmonize where possible, it will mitigate the regulatory burden on FISCUs and conserve regulatory resources.
At its July 21, 2016 meeting, the NCUA Board approved the agency’s 2017-2021 Strategic Plan, which in turn retired NCUA’s self-imposed requirement to conduct annual examinations of all FISCUs with assets of $250 million or greater regardless of the credit union’s condition or the timing of the last state examination. NASCUS welcomes this change.
An NCUA examination/insurance review of a FISCU generally takes place in the context of a formal joint examination with the SSA. In these instances, the NCUA accompanies the SSA on a regularly scheduled state examination and participates with the state examiners on the state examination. In some cases, NCUA is unable, or unwilling, to synchronize its desired examination schedule for a particular FISCU with the SSA examination schedule. In such cases, NCUA will conduct a stand-alone share insurance examination of the FISCU. It is the policy of many states to accompany NCUA on the stand-alone share insurance examination regardless of how recently the state has conducted its own supervisory examination. Such a redundancy of effort strains state budgets and resources without producing a corresponding supervisory benefit. It also understandably frustrates and burdens FISCUs which must endure a second disruption to their operations as NCUA conducts its insurance review.
Now that NCUA has retired its mandatory annual examination policy, we urge the agency to move expeditiously to a policy that allows discretionary extended examination cycles for all FISCUs, and to adopt a policy of accepting state examinations in lieu of its own examinations for FISCUs regardless of size, consistent with Congress’ statutory mandate to rely on state examinations.1 With respect to FISCUs, there are two issues raised by NCUA’s review of its examination cycle: 1) what is the maximum acceptable exam cycle for FISCUs of a certain risk profile, and 2) must the examination conducted within that examination cycle be one performed by NCUA.
SSA examination cycles vary.2 At least five states conduct examinations on all of their credit unions annually. Most states examine all of their credit unions between every 12-18 months, with a majority of these states conducting annual exams on a majority of their credit unions, while extending some credit unions’ examination cycles out to 18 months. A few states will extend an individual credit union’s examination cycle out to 24 months. In making determinations as to the exam cycle for an individual credit union, SSAs rely on several factors, including, but not limited to, CAMELS ratings (both component and composite); results of the previous examination, balance sheet makeup, offsite monitoring, and regional economic factors. SSAs might also factor in their own internal capacity and resource allocation needs.
NCUA could extend its larger FISCU examination cycle out to 18 months and accept state exams to satisfy that policy without any material increase in risk to the NCUSIF. Setting a more flexible examination cycle would allow states and NCUA to focus resources where most urgently needed. Particularly for SSAs, which not only examine 2,600 state charters, but in some cases CUSOs and other third party service providers as well.3
Extended Examination Cycle Eligibility
In the banking sector, well managed institutions with assets of less than $1 billion and CAMELS composite ratings of 1 or 2 are eligible for 18 month cycles. According to FDIC, nearly 5,000 of its 6,051 insured commercial banks are eligible for the extended examination cycle. NCUA should adopt the same standard for credit unions.
Of the 5,954 federally insured credit unions at end of fourth quarter 2015, all but 266 have less than $1 billion in assets. While this would mean that 95% of credit unions are eligible for extended examinations, we note that approximately 83% of FDIC’s insured banks also qualify for extended examination cycles. These numbers are comparable, especially given the generally more limited nature of credit union powers and authorities.
Once the threshold of CAMELS composite 1 or 2 and less than $1 billion is assets is established for eligibility, NCUA’s policy should explicitly provide for consultation with the SSA in establishing individual examination cycles.
In nearly every state, state chartered credit unions have due process rights to appeal supervisory determinations and enforcement actions. In addition, at the state level, the proximity of regulators, credit unions and policy makers adds another check and balance on the system. In order to foster an environment that provides for enhanced regulatory discretion in supervision at the federal level while maintaining industry’s confidence that decisions are not arbitrary and capricious, NCUA should enhance its supervisory appeal process.
Currently, a FISCUs appeal of a supervisory determination made by NCUA is governed by Interpretive Ruling and Policy Statement (IRPS) No.: 11-1. Pursuant to the IRPS, a credit union may appeal “material supervisory determinations” which are limited to (1) composite CAMEL ratings of 3, 4, and 5 and all component ratings of those composite ratings; (2) adequacy of loan loss reserve provisions; and (3) loan classifications on loans that are significant as determined by the appealing credit union.4 While the appealing credit union has a right to make its case “in-person,” NCUA reserves the right to work out the dispute through teleconference. Much of the appeal function remains shrouded in mystery. For example, NCUA provides no readily available information on how many appeals are filed each year, how many of those appellants were granted in-person appeals, and what were the overall disposition of appeals.
A first step to improve the appeal process would be for NCUA to publish information, in the aggregate, about how many appeals are filed each year, what the subjects of the appeals were, and the dispositions of those appeals. Providing those numbers would allow stakeholders to better evaluate the efficacy of appeals. This in turn could instill greater confidence in the due processes surrounding the supervision program.
A more robust, effective, and transparent appeal process might also alleviate longstanding tensions between regulators and credit unions regarding the citation of guidance and best practices in the examination process. All regulators, state and federal, need discretion to evaluate specific facts and circumstance before them. Without such discretion, regulations would have to be written to the lowest common denominator. Lowest common denominator supervision does not lend itself to a healthy and vibrant system. However, as noted above, credit unions are entitled to the confidence that supervisory discretion is not arbitrary and capricious.
Benefits of a Variable Approach
States and NCUA have joint supervisory authority over FISCUs and must work to coordinate their activities. Much like the interactions between regulators and credit unions, the interactions between NCUA and its state partners must balance consistency with flexibility. NCUA and SSAs should develop standardized protocols to govern the national relationship, but not commit to a rigidity of policy that forecloses the ability to acknowledge that specific circumstances might necessitate a varied approach among the states. NASCUS remains committed to working with NCUA to ensure the proper balance is struck between NCUA and the states.
Use of Technology
We applaud and support NCUA’s continued efforts to leverage technology to improve the examination and supervision process. SSAs also have been working to incorporate technological advances in their state programs. Enhanced leveraging of technology can reduce supervisory burden on credit unions, reduce the wear and tear of examiners’ road time, improve analytical abilities, and preserve limited agency budgets.
The creation of secure portals for transmission of information between credit unions and regulators would allow for increased off-site review. In some cases, centralized specialists could review entire portfolios, providing the analysis to the on-site examiner for validation and follow-up. Not only would this reduce on-site disruption to credit unions, it would likely improve consistency of analysis. Several states have begun development of secure portals, and we urge NCUA to coordinate with states to ensure maximum system compatibility.
In addition to improving the examination process, NCUA should work with states toward the development of enhanced analytics. The Securities and Exchange Commission’s use of aberrational performance inquiry (API) is an example of computerized data mining that could be used to identify attempts to mask fraud or negative performance.
Call Report Reform
Discussions of changes to the examination program are incomplete without discussing a comprehensive overhaul of the 5300 Credit Union Call Report. We understand that NCUA is undertaking an independent review of its 5300 Call Report. NASCUS will submit detailed comments in response to that separate initiative. However we felt it important to note for the record here that decisions related to the structure and scope of NCUA’s examination presence in FISCUs are inexorably linked to off-site monitoring and information gathering. Efficiencies gained in the Call Report process create greater flexibility for regulatory allocation of resources and reduce regulatory burden for credit unions.
We thank NCUA for working with NASCUS’ task force of state regulators on this important initiative. Our comments here serve as a supplement to those detailed discussions. We also commend NCUA for including working groups of credit union stakeholders to ensure robust discussion of the future of the federal supervision program. We would be happy to discuss these comments and recommendations in more detail as the credit union system works together to balance the need for effective supervision with the desire to reduce regulatory burden.
Executive Vice President & General Counsel
2. NASCUS is in the process of aggregating data from its bi-annual survey of SSA practices, powers, and authorities. The survey is compiled and published as the NASCUS Profile of State Regulatory Agencies. Data cited in this letter was collected in 2016.
4. NCUA Guidelines for the Supervisory Review Committee, p. 1. Available at https://www.ncua.gov/Legal/Documents/IRPS/IRPS2011-1.pdf.