NASCUS Comments: OTR Methodology

 August 29, 2017
Mr. Gerard Poliquin
Secretary to the Board
National Credit Union Administration
1775 Duke Street
Alexandria, VA 22314

Re: NASCUS Comments on OTR Methodology

Dear Mr. Poliquin:

The National Association of State Credit Union Supervisors (NASCUS), the professional association of the state credit union regulatory agencies and the nation’s state credit union system, submits the following comments in response to the National Credit Union Administration's (NCUA's) request for comments on the methodology used to establish the Overhead Transfer Rate (OTR). NASCUS and its members have long held concerns regarding the OTR methodology and NCUA’s management of its complex role as both the chartering authority of federal credit unions (FCUs) and as the administrator of the National Credit Union Share Insurance Fund (NCUSIF). We commend NCUA for publishing a revised OTR methodology for formal notice and comment. The revised OTR methodology, as laid out in the current proposal, is a marked improvement over the flawed current methodology.1

There is a lot to commend in NCUA’s proposed OTR methodology, and NASCUS supports many of the changtes.

The proposed OTR methodology is an indication that NCUA gave serious consideration to the forty (40) comments the initial request for comments published in 2016. That NCUA received so many comments on such a complex and technical issue is testament to how important the OTR is to the credit union system in general and state system in particular. After all, NCUA is well aware of the credit union system’s desire for regulatory relief, yet the agency received only 28 comment letters in response to four separate notices for comment related to the Economic Growth and Regulaory Paperwork Reduction Act (EGRPRA) process. 2

While NASCUS supports the proposed changes to key components of the methodology, we have identified further refinements that would improve the proposal consistent with the wording and spirit of the Federal Credit Union Act (FCUA). Our recommendations are discussed in more detail below.

Regrettably, NCUA’s proposal is accompanied by a narrative that tempers our enthusiasm for the proposed changes and curtails our confidence that the proposed improvements to the methodology will be finalized in an equitable manner. Our comments address those issues as well.

  • Background

NCUA is both the chartering authority for FCUs and the administrator of the NCUSIF. As it performs these two functions, (Title I and Title II) NCUA incurs costs that it allocates by charging operating fees to federal credit unions for expenses related to its chartering responsibilities and by allocating expenses to the NCUSIF for expenses related to the administration of the fund. It is the NCUSIF allocation (the OTR) that has been the subject of debate within the credit union system for many years. Specifically, many stakeholders observed that the current OTR methodology was inequitable and inconsistent with the FCUA because it imposed a disproportionate burden on state chartered credit unions and, thus, threatened the dual chartering system.
 
The NCUSIF was created by an act of Congress in 1970 and, as NCUA notes in the preamble of its proposal, the OTR methodology originated as a result of the 1972 Government Accountability Office (GAO) report recommendation that NCUA create a better system to match expenses to its Title I chartering and Title II NCUSIF activities. 3 For the first thirty (30) years of the NCUSIF’s expense allocation, the OTR never exceeded 50%. In 2000, the OTR increased from 50 to 66.7%. Since 2009, the OTR has remained inequitably high, increasing nearly every year until 2017.

Overhead Transfer Rate History (1986-2017) 4

Year

OTR

 

1986-2000

50%

=

2001

66.7%

2002

62%

2003

62%

=

2004

59.8%

2005

57.0%

2006

57.0%

=

2007

53.3%

2008

52.0%

2009

53.8%

2010

57.2%

2011

58.9%

2012

59.3%

2013

59.1%

=

2014

69.2%

2015

71.8%

2016

73.1%

2017

67.7%

 

  • NCUA’s Safety and Soundness Responsibility as Chartering Authority of Federal Credit Unions

The primary source of contention for the state system with the prior OTR methodology was that it failed to recognize (and account for) NCUA’s safety and soundness responsibility as the FCU chartering authority.  The prevailing assumption under the prior methodology was that all safety and soundness related costs were exclusively “insurance-related.” That assumption was inconsistent with the FCUA, the NCUA’s own regulatory history, and with the regulatory practice of the other federal financial regulators.

As our previous comments filed in response to the 2016 ANPR on the OTR methodology discussed, and NCUA acknowledges in this proposal, other bank regulators that are not deposit insurers view their primary examination responsibilities to be that of safety and soundness. In fact, the GAO also shares this common understanding of the responsibility of the chartering authority.

The occasion for the 1972 GAO report was the completion of its first congressionally mandated audit of NCUA’s financial statements. Throughout the report, GAO references NCUA’s roles as both the chartering authority of FCUs and the administrator of the NCUSIF. On page 1, GAO characterizes NCUA’s objectives to “to promote a national system of cooperative thrift and credit organizations which are financially sound” (chartering) and then distinctly to provide share insurance. GAO goes on to say in the next paragraph that NCUA “administers its insurance functions under a share insurance function” and then distinctly “administers its functions of chartering, supervising, and examining credit unions under an operating fund.” On page 8 of its report, GAO states that the “regular examination is the principal method the Administration uses to supervise each Federal credit union. The information obtained also helps to determine if the credit union continues to qualify for share insurance.” GAO is distinguishing examination as a chartering/supervisory function distinct from share insurance.

NCUA’s repeated assertions that it has no Title I safety and soundness responsibilities and hence very few limitations on its discretion to shift FCU examination costs to the NCUSIF remain unconvincing. As has been stated many times, by many different stakeholders, to accept NCUA’s proposition that ALL of its safety and soundness examination work is Title II is to accept the proposition that were the NCUSIF to be folded into the Federal Deposit Insurance Corporation (FDIC) NCUA would not bother examine its charters for financial stability. It is even more dubious that any board exercising true fiduciary duty to the insurance fund would allow the chartering authority to shift all of its examination costs to the share insurer.

For all of these reasons, the NCUA is to be credited for acknowledging in the current proposal that it also has safety and soundness responsibilities for FCUs in its role as the prudential regulator.  This is a major step forward in establishing an equitable and workable methodology.

That recognition is also central to the shift to a “principles-based” approach that allocates the NCUA’s examination time and costs evenly between its chartering and insurance-related responsibilities.  The adoption of a principles-based approach will help reduce the complexity of the OTR methodology and the 50 percent rule makes intuitive sense because it is modeled after and reflects the likely allocation using alternating examination schedule. 

NASCUS accepts the adoption of this principles-based approach and the allocation of the examination time and costs of FCUs as 50 percent chartering and 50 percent NCUSIF-related as a workable approximation for purposes of the OTR.

Accepting as a working rule that 50 percent of the costs of FCU examinations is insurance-related is a compromise by the state system. The most accurate calculation of costs would be for the NCUSIF to accept Title I exams in their entirety for a majority of FCUs.  The NCUSIF should cover only the resources needed to review those exams or conduct its own insurance reviews for due diligence or material risk - just as it does with respect to FISCUs.  That is why the NCUA’s budgeted workload hours for FISCUs is substantially lower than the workload hours attributable to FCUs.   Nevertheless, the adoption of a principles-based rule that allocates 50 percent of the FCU examination time and cost to the NCUSIF is a significant improvement.  We urge NCUA to hold fast to the proposal’s acceptance of Title I responsibilities. Backsliding from this position  would undermine the principles-based approach espoused by the Board and render the remainder of the proposal unacceptable.

  • NCUA Program Offices and Elements of the Proposed Methodology

The new proposal is predicated on four underlying principles. Principle (1) is that 50% of NCUA’s time spent examining federal credit unions is allocated as Title I chartering. As discussed above we support this new classification. We note that a case could easily be made that a 50% allocation to Title I is too modest, but for the sake of simplicity we can accept the 50% allocation.

Principle (2) is that all time and costs NCUA spends supervising or evaluating the risks posed by FISCUs or other entities NCUA does not charter or regulate is allocated as 100% insurance related. NCUA gives as examples of non-regulated entities CUSOs and third party service providers. We agree that NCUA oversight of FISCUs is 100% insurance related. However, we do not agree that 100% of the time and costs associated with NCUA’s supervision of CUSOs and third parties is insurance related.

NCUA justifies the 100% insurance allocation of its 5,000 hours for CUSO or service provider oversight by noting that it does not charter or supervise those entities. 5 While that is true, it is not entirely the point. NCUA has taken steps to assert supervisory authority over such entities out of concern for the safety and soundness of its federal charters as well as the FISCUs it insures. As we have established that safety and soundness concerns for FCUs is partially allocated to Title I, it would follow that some of NCUA’s workload hours in CUSOs and third parties reflect NCUA’s safety and soundness responsibility as charterer/prudential regulator. Additionally, NCUA’s chartering rules limit the services that an FCU’s CUSO may provide and to whom it may provide them. These are not materially safety and soundness issues, they are compliance issues. Likewise ensuring FCU CUSO mortgage loan originator registration in compliance with the SAFE Act is a regulatory, not supervisory issue.

  • We recommend that NCUA allocate 25% of its CUSO and third party workload hours to Title I.

Principle (3) is that the time and costs related to NCUA’s role as charterer and enforcer of consumer protection and other noninsurance based laws governing credit unions are allocated as 100% Title I. We agree.

Principle (4) is that NCUA’s hours administering the NCUSIF is 100% insurance related. We agree.

NCUA’s proposal allocates 13% of the office of Consumer Financial Protection and Access (OCFPA) to the NCUSIF. However, NCUA has recently proposed a reorganization that would change this office and its mission and create a new program office. 6

  • We request clarification on how changes to the OCFPA and the creation of the Office of Credit Union Resources and Expansion would affect the proposed methodology.

The proposed changes make significant improvements in the allocation of costs, but further refinements can and should be made.  For example, the costs for “all other offices” still represent approximately one-third of NCUA’s total operating budget - this includes the Board, the Executive Director, the General Counsel, the Chief Financial Officer, the Chief Information Officer, the Chief Economist, the Human Resources, the Office of Examination and Insurance, the Inspector General, the Office of Minority and Women Inclusion, the Public and Congressional Affairs Office, and the Office of Continuity and Security Management.

The current proposal uses a weighted-average of other cost centers to designate 60% of the costs as insurance-related.  This is an improvement over the prior methodology which allocated approximately 90% of the costs as insurance-related, but the notice fails to justify the current allocation.  The notice acknowledged that “improvements can be made in allocation methods involving non-field offices.”  Further review of allocation decisions for other cost centers (Regional costs, Small CU Office costs, etc.) is warranted. 7    

We understand NCUA’s premise that leads it to the 60% threshold, but we question the logic from an enterprise wide perspective. Just because NCUA is willing to shift 50% of its examination costs of FCUs to the NCUSIF, it does not follow that 50% of everything else it does with FCUs is insurance related for purposes of calculating the expense allocation for each program office.

NCUA’s Human Resources (HR) office is but one example. Were NCUA to be formally divided into its NCUSIF and chartering functions, the NCUSIF would need far fewer examiners for performance of its insurance functions because rather than performing 50% of FCU examinations, it would be accepting Title I examinations for review and only examining troubled institutions or sampling healthy institutions for due diligence. NCUA as chartering authority on the other hand would need to increase its funding to support a majority of its current existing examination force. Therefore to suggest that a majority of the HR function is NCUSIF is a flawed premise.

Likewise, we believe that at a minimum, the NCUA board’s expenses be allocated as only 50% NCUSIF related.

  • We recommend that NCUA use a 50% allocation for its HR and board functions. We are willing to accept the 60% allocation for the other program offices as a compromise designed to balance the OTR. NCUA should revisit these initial allocations in the future.

NCUA’s proposal would eliminate calculating and crediting the imputed value of state regulator work and the related cost savings. For this year the imputed value of state regulator work is $50.8 million. 8 This is value paid for by FISCUs that accrues to the benefit of all insured credit unions by reducing the workload, and expenses, of the NCUSIF. Backing the imputed value out of the total OTR under the existing methodology was an understandable, if imperfect, means for the NCUSIF to recognize those costs borne directly by the state system. Within the context of this proposed OTR methodology, eliminating the imputed value seems consistent with the underlying principles of the new formula. However, should NCUA decide to not finalize the proposed methodology changes, the imputed value should be returned to the state system. The most workable way to return the imputed value to the state system is not by backing it out of the OTR, but rather by paying the imputed value back to the state system.

In its proposal, NCUA details the complexities in attempting to determine the exact value provided by each individual state. We concede determining the precise value in any given year of a particular state’s contribution to the OTR would be complex. However, calculating precise value is by no means the exclusive mechanism by which the NCUSIF can return the imputed value to the states. NASCUS is willing to discuss alternative means of recognizing the imputed the value should NCUA decline to move forward with the new methodology.

  • Future Notice and Comment for the OTR Methodology

The notice reiterates NCUA’s position that the OTR methodology is not subject to notice and comment rulemaking requirements under the Administrative Procedure Act.  We continue to think that NCUA is wrong as a matter of law on this issue.

Nevertheless, NASCUS commends the NCUA for committing to: (1) seek comment through the Federal Register on the OTR methodology every three years; (2) to hold annual public board meetings on the OTR and to post all related materials on the NCUA website; and (3) for all future rulemakings to identify and seek comment on whether the proposed regulation is being issued pursuant to NCUA’s regulatory authority or its role as the administrator of the NCUSIF.9

These are important procedural safeguards that help ensure transparent and accountable processes, will result in increased stakeholder input and, ultimately, better informed decision making by the agency.

As we have previously written, NCUA is required to provide an opportunity for notice and comment for its rulemakings 10 unless otherwise exempted. 11   Because the OTR methodology is an NCUA Board statement of general applicability and future effect designed to implement and interpret FCUA it clearly falls within the scope of the APA. 12 In fact, it is telling that the NCUA Board itself characterized the OTR as a rule and procedure at the very Board meeting where this proposal was approved for publication. 13  

Another issue to consider with respect to NCUA’s proposed notice and comment is the criteria triggering Federal Register publication. As currently proposed, NCUA would seek comment at least every three years and whenever the methodology changed. Given that dramatic changes in interpretations, or organizational structure, could have a significant impact on the OTR, public comment should also be sought any time the OTR changes by more than 2% points in any given year. This recommendation accounts for the fact that the new methodology as proposed may not in fact be the methodology going forward. Under the old methodology where controversial categorization of rules as insurance or chartering can dramatically swing the OTR, it is prudent for NCUA to seek stakeholder input to ensure equitable allocation of agency expenses.

  • We recommend that public comment on the OTR is sought at least every three years, whenever the methodology is changed, and any time the OTR changes by more than 2% (in either direction) in any given year.
  • Absorbing the Costs of Losses to the NCUSIF

While NASCUS advocates on behalf of the state credit union system, we are also staunch defenders of the dual chartering system. NASCUS remains the only national credit union organization that explicitly recognizes the need for a strong dual chartering system in its mission statement. Our commitment to dual chartering was evidenced by our unwavering support for H.R 1151 in 1998, legislation that was critical to fix the federal charter’s field of membership, while subjecting state chartered credit unions to  member business lending restrictions and prompt corrective action. 14 We recognize the credit union system as a whole, regulators and industry, are stronger together.

Likewise, state regulators understand that task of balancing supervision with providing credit unions flexibility to manage their affairs necessitates that supervisory mistakes will be made, things will be missed, and credit unions (like all financial institutions) will suffer some failures among their ranks. Pointing fingers among regulators in such circumstances is rarely productive.

Over the course of the discussion of the OTR, certain memes continue to be repeated that disparage the state system and mischaracterize the mutual share insurance within the credit union system operates. This meme can best be summarized by the odd (and unfounded) notion that either state regulators have no “skin” in the game or that somehow the state system does not pay for losses. Both suggestions could not be further from the truth.

Of course the agency that charters a financial institution has a stake in the financial health and well-being of its charters. In particular, state regulators are not just supervising a corporate entity, they are supervising institutions in their communities entrusted with the financial means of their fellow citizens. The failure of a financial institution in a specific community is not reduced to the dispassionate calculation of a balance sheet at a far-away agency, but rather represents an economic blow with far reaching consequences to the lives of not just the depositors/members, but to the community as a whole. Those costs accumulate at the state level and are felt by state government, of which our state regulators are, obviously, a part. That state regulators maintain a robust examination of even their most modestly sized credit unions in the face of a curtailed small credit union examination program from the deposit insurer stands as further testament to this fact.

Even harder to reconcile is the suggestion that the state system should pick up the cost of the failure of any state chartered credit union in that state. In point of fact they already do.

The losses sustained in the failure of a federally insured credit union are borne by the NCUSIF and all related supervisory and share deposit costs are passed to the NCUSIF. This is reflected in NCUA’s allocation of the entire costs of its Asset Management Assistance Center (AMAC) as 100% insurance related 15 . The cost of the actual losses in the failed credit union is charged t0 the NCSIF, of which FISCUs contribute nearly 50% of the assets although making up less than 40% of the “units.” Whether a failed credit union is an FCU or SCU, the costs of that failure goes to the NCUSIF and is shared by the remaining credit unions by way of lost equity in the fund. Therefore state charters do cover the costs resulting in the failures of other state charters, just as they participate in the losses of FCUs. A review of NCUA’s Office of Inspector General (OIG) Material Loss Reviews (MLRs), Semi Annual Reports to Congress, and news reports bears out that both FCUs and state charters have caused losses to the NCUSIF that are in turn shared by the remaining federally insured credit unions. 16 In fact, losses to the NCUSIF tend to be cyclical. Federally insured credit union failures from 2010 to the present have seen more losses attributable to FCUs. Were the timetable to be extended to 2006 to the present, then more losses are attributable to state charters.

The larger point is that it seems hardly productive, and less germane, to imply one charter, or one regulator, is responsible for more losses to the NCUSIF and the credit union system caused by natural person and corporate credit union failures. The question presented is not about losses, but rather about the responsibility of the chartering authority to examine its credit unions. Suggestions that the nearly 500 dedicated state regulatory personnel and the 2,153 FISCUs somehow don’t contribute to the financial soundness of the credit union movement speaks less to the issue at hand of the proper OTR methodology and more to the state system’s need to ensure the NCUSIF has state regulatory experience in its official governance.

  • The OTR Methodology’s Inverse Impact on FCU Operating Fee

As a rule, NASCUS does not comment on NCUA’s overall budget. We believe a regulatory agency is generally best suited to understand its funding needs. Therefore, we have historically limited our comments to the expense allocation of the OTR. However because the possible increase in FCU operating fees was emphasized at the June 23, 2017 NCUA board meeting, we offer the following comments on the matter. 17

We recognize that there is an inverse relationship between the OTR and the FCU operating fee and understand that if the OTR is adjusted to become more equitable NCUA might have to increase its operating fee accordingly. But increasing the FCU operating fee is not NCUA’s only option. Increases in the operating fees paid by FCUs could be tempered by reductions in NCUA’s overall budget. In fact, in June of this year NCUA announced a 2% overall budget savings equaling over $5 million.

Another issue to note is that while the OTR has risen steadily in the past years, the opposite inverse reaction has been occurring. Over the past decade, the FCU operating fees decreased by nearly 30%. The only year it increased during that span was in 2013 when it increased by .24% to offset NCUA eliminating any operating fee for FCUs with less than $1 million in assets.  

History of NCUA FCU Operating Fee (2009 – 2016)

 

OTR

 

Δ FCU Operating Fees

 

2009

53.8%

-6.77%

2010

57.2%

-1.58%

2011

58.9%

-2.86%

2012

59.3%

-0.90%

2013

59.1%

=

+0.24%

“↑”

2014

69.2%

-18.4%

2015

71.8%

-0.90%

2016

73.1%

-0.47%

 

 

 

 

 

 

 

  • Conclusion

We thank NCUA for the opportunity to provide formal comment on the methodology used to determine the Overhead Transfer Rate. The proposed revisions to the methodology evidence a commitment within NCUA to develop an equitable and understandable basis for allocating the combined expenses of the agency’s dual mission. NASCUS, state regulators, and the state credit union system remain committed as well to forging a balanced partnership with NCUA that contributes to a vibrant credit union system into the future.

NCUA, and the work it does, is a vital component of that future. Neither NASCUS, nor its members, have ever suggested otherwise. Likewise, we have never downplayed the benefit to the state system provided by the NCUSIF’s support of state examination programs. We have however insisted that the administration of the NCUSIF treat state charters and national charters the same in terms of recognizing the benefits it provides, as well as the benefits it receives. The state system works hard to safeguard the credit union system, and the NCUSIF. For example, while the states benefit from NCUSIF funded training, the state agencies budget to provide their own training to their examiners as well: the result of which benefits the NCUSIF at no cost to the fund. But the larger point is that whatever benefit the NCUSIF is providing states, it provides to the federal system as well. 18

We would welcome the opportunity to discuss our comments and recommendations in detail with NCUA. We also resubmit for the record and for further consideration of the revised methodology, our 2016 comment letter that addresses many of the fundamental underlying issues with the existing OTR process. That letter is incorporated as Appendix A to our comments.

 

Sincerely,

- signature redacted for electronic publication -

Lucy Ito
President & CEO

APPENDIX: NASCUS 2016 Comments on OTR Methodology

cc:       SSAs
            NCUA Chairman McWatters
            NCUA Board Member Metsger
           


1. See Appendix A NASCUS Comments OTR Methodology, (April 26, 2016). Also available at https://www.ncua.gov/Legal/CommentLetters/bc-otr-2016421LIto.pdf.

2. Another benchmark might be NCUA’s annual Regulatory Review process. Unfortunately, NCUA does not publish those comments so the number of comments submitted is unknown to the public although it would be safe to wager less than forty letters were filed  this year.

3. http://www.gao.gov/assets/210/203181.pdf

4. Data based on NASCUS analysis of NCUA budget documents.

5. Table 1, Allocation of Workload Hours, Request for Comments Regarding Revised Overhead Transfer Rate Methodology, 82 Fed. Reg. 29944 (June 30, 2017).

6. NCUA Press Release (July 21, 2017). Available at https://www.ncua.gov/newsroom/Pages/news-2017-july-ncua-plans-restructuring.aspx.

7. Request for Comments Regarding Revised Overhead Transfer Rate Methodology, 82 Fed. Reg. 29943 (June 30, 2017).

8. Request for Comments Regarding Revised Overhead Transfer Rate Methodology, 82 Fed. Reg. 29941 (June 30, 2017).

9. Request for Comments Regarding Revised Overhead Transfer Rate Methodology, 82 Fed. Reg. 29948 (June 30, 2017).

10. Under the APA, a rulemaking is defined as “an agency process for formulating, amending or repealing a rule, (5 U.S.C § 551(5).

11. 5 U.S.C. § 553.

12. Legal Analysis of the Administrative Procedure Used By The National Credit Union Administration To Adopt The Overhead Transfer Rate (Report to the National Association of State Credit Union Supervisors), Schwartz & Ballen, LLP, page 16 (June 2015).

13. “NCUA's Overhead Transfer Rate methodology is probably the most misunderstood of all of our rules and procedures based on history.” Comments of NCUA Board member Rick Metsger, NCUA Board meeting, June 23, 2017 (Online transcript at p. 13). Available at https://www.ncua.gov/Pages/exitdisclaimer.aspx?externalURL=http://tinyurl.com/NCUA1446771.

14. Of course, HR 1151 gave those regulatory burdens to FCUs as well, but it did provide a needed fix to FCU FOM. State charters received only burden.

15. Request for Comments Regarding Revised Overhead Transfer Rate Methodology, 82 Fed. Reg. 29945 (June 30, 2017).

16. While publically available data is incomplete, in the past 10 years NASCUS identified approximately $822 million in losses to the NCUSIF with approximately 56% of those losses attributable to FISCUs. These losses do not include the over $5 billion in losses incurred by the failure of the 5 federal corporate credit unions.

17. See transcript of June 23, 2017 NCUA board meeting. Available at https://www.ncua.gov/Pages/exitdisclaimer.aspx?externalURL=http://tinyurl.com/NCUA1446771.

18. For example, the proposal notes that NCUA budgeted $1.4 million for training of state examiners. However, the $1.4 million for state training is only part of $10 million training and development budget which presumably is benefitting the chartering authority as well.