NASCUS Comments: NCUA Regulatory Review (2022)
NASCUS Comments: NCUA Regulatory Review (2022)
August 15, 2022
Office of General Counsel
National Credit Union Administration
1775 Duke Street
Alexandria, Virginia 22314
Re: Regulatory Review (2022)
To Office of the General Counsel,
The National Association of State Credit Union Supervisors (NASCUS)[1] submits the following comments in response to the National Credit Union Administration’s (NCUA) request for comments on the 2022 Regulatory Review. The 2022 Regulatory Review covers NCUA’s Rules and Regulations Parts 700 through 710. These rules include 17 provisions applicable to federally insured state-chartered credit unions (FISCUs) by way of incorporation by reference in NCUA’s Part 741.
NASCUS appreciates the NCUA Board’s continued efforts in seeking input from stakeholders on its rules and regulations. The one-third review provides an opportunity for stakeholders to proactively address key issues with NCUA’s Rules and Regulations.
Consolidation of NCUA Title II Insurance Rules
As we have noted in previous comments to NCUA, the current organization of NCUA’s rules for FISCUs unnecessarily complicates compliance for both credit unions and examiners because most substantive provisions applicable to FISCUs are scattered throughout NCUA’s rules for federal credit unions. NCUA should reorganize its rules to consolidate and co-locate all National Credit Union Share Insurance Fund (NCUSIF) rules for FISCUs in one section (or series of consecutive sections). Reorganizing the rules in this manner would provide significant regulatory relief to credit unions without increasing risk to the NCUSIF.
§701.21 Loans to Members and Lines of Credit to Members
701.21(c)(8) – Compensation in Connection with Loans to Members and Lines of Credit to Members
In 2019 NCUA issued an Advanced Notice of Proposed Rulemaking (ANPR)[2] specific to 701.21(c)(8) concerning compensation in connection with loans to members. Incentive-based compensation tied to loan production is a complicated matter requiring nuance to balance a financial institution’s need to offer competitive compensation packages for key staff on par and in line with prevailing industry standards and practices against the risk of incentivizing bad loans or encouraging inappropriate risk-taking.
NASCUS continues to support rulemaking that would provide greater flexibility for credit unions to offer compensation packages for loan officers compatible with financial sector practices. We would encourage NCUA to allow state rules regarding compensation practices to vary from NCUA’s. State regulators, most of whom have experience supervising financial services entities that utilize incentive-based compensation are well positioned to administer prudent regulations that balance needed business flexibility with supervisory principles.
Ability of States to Obtain Exemption from the Rule
Part 741.203(a) provides an exemption from §701.21(c)(8) prohibitions for FISCUs “in a given state…if the state supervisory authority…adopts substantially equivalent regulations as determined by the NCUA Board…” To provide for meaningful regulatory and supervisory innovation, the “substantially similar” standard for a state exemption should be modernized and better calibrated to focus on material risk to the share insurance fund and not the proposed state rule’s “similarity” to the existing prohibition.
§702 Capital Adequacy
As the Board recognized in the 2020 final rule, allowing Low-Income Credit Unions (LICUs), complex credit unions, and newly chartered credit unions to issue Subordinated Debt for regulatory capital treatment is an essential means for credit unions to extend financial inclusion to the communities in which they serve as well as deliver products and services to low-income and underserved communities.[3]
NASCUS continues to support NCUA promulgating rules to modernize and expand the acceptable use of subordinated debt and secondary capital. For certainty, a rule of this scope and complexity was going to require amending and re-calibrating after initial implementation.
Prepayment and Pre-approval Process
The final rule retained the provision of receiving prior approval, with a 45-day timeframe for the NCUA to approve the application. While the 45-day approval timeframe is similar to the Secondary Capital rule, the Board eliminated the provision for automatic approval if a credit union is not notified of a decision by the Appropriate Supervision Office within 45 days.
§702.41(b) requires; “Before an issuing credit union can, in whole or in part, prepay subordinated debt prior to maturity, the issuing credit union must first submit to the Appropriate Supervision Office an application that must include, at a minimum, the information required in paragraph (d) of this section and; (c) Before a FISCU may submit an application for prepayment to the Appropriate Supervision Office, it must obtain written approval from its state supervisory authority to prepay the Subordinated Debt it is proposing to prepay. A FISCU must provide evidence of such approval as part of its application to the Appropriate Supervision Office.”
We encourage NCUA to work with state regulators to evaluate whether additional flexibility in prepayment rules would enhance safety and soundness.[4] Furthermore, NCUA, state regulators, and stakeholders should discuss what guidelines, if any, could be published to provide more certainty to institutions regarding the metrics for evaluating applications for prepayment.
Subordinated Debt Policy Requirements
The current rule requires a credit union to submit: A draft written policy governing the offer, and issuance, and sale of Subordinated Debt, developed in consultation with Qualified Counsel, which, at a minimum, addresses:
(i) Compliance with all applicable Federal and state securities laws and regulations;
(ii) Compliance with applicable securities laws related to communications with investors and potential investors, including, but not limited to: Who may communicate with investors and potential investors; what information may be provided to investors and potential investors; ongoing disclosures to investors; who will review and ensure the accuracy of the information provided to investors and potential investors; and to whom the information will be provided.[5]
While NASCUS understands the intent behind a policy addressing the debt instrument we also question the extensive requirements NCUA is imposing in such a policy and have several questions specific to this requirement.
For FISCUs, does this policy requirement mean that a credit union would need to contract with an attorney experienced with state securities laws in each state it operates in? How would smaller credit unions afford an attorney who specializes in securities laws or how would credit unions in rural areas identify an attorney with this expertise? Additionally, there is uncertainty as to whether federal credit unions would be excluded from state securities laws or if they too would need to also comply with state laws.
If NCUA is seeking to alleviate regulatory burden, requiring such extensive policy conditions is moving in the wrong direction. Policies are important; however, they should not be one-size-fits-all. NCUA should provide a more principles-based approach allowing credit unions greater flexibility in creating their policies or NCUA should provide resources for credit unions in developing such policies.
Application Process
The application and approval process in the final rule provided some welcome clarity and transparency, however, NASCUS remains concerned that the application process may stifle the ability of well-managed, modest-sized credit unions to access the traditional secondary capital markets.
Additional clarity and standardization of the preapproval application process is valuable. However, the framework of the standardized application also reflects the use of a single structure for all subordinated debt requests. In many instances, especially for smaller credit unions, the requirements outlined in the final rule may be unnecessary and overly burdensome.
As NCUA looks ahead at future rulemaking, NASCUS highly recommends the agency look to a more “risk-focused” approach in evaluating requests as it does in other areas. The NCUA’s approach to information security evaluation and use of the Automated Cybersecurity Assessment Tool (ACET) is one example of how the agency could look at administering applications for subordinated debt in a manner that scales with the complexity of the credit union and the offering.
§704 Corporate Credit Unions
NCUA’s corporate credit union rule applies in its entirety to state-chartered corporate credit unions by way of reference in §741.206.[6] After the 2008 recession revealed substantial weaknesses in some corporate credit unions, NCUA promulgated a comprehensive overhaul of §704, drastically limiting corporate credit union powers, homogenizing corporate credit union regulations, and imposing a new corporate credit union capital regime.[7] As a result, the corporate credit union system today is far smaller than it was in 2008.[8]
In the years since the recession, and throughout the COVID pandemic, the corporate credit union system has remained stable and a tremendous asset for credit unions. While giving due consideration to the lessons learned from the recession, NCUA should work with state regulators to perform a comprehensive review of Part 704 to identify changes that would help sustain the healthy growth of the overall credit union system. At the same time, NCUA and the states together could identify governance and other areas where NCUA preemption of state rules for corporate credit unions might be dialed back to provide an opportunity for regulatory diversity and corporate credit union innovation as means to further strengthen the corporate credit union system itself.
NASCUS appreciates the hard-learned lessons of the cascading effect weaknesses in the corporate system could have on natural person credit unions. However, we also appreciate that some corporates, operating under the pre-existing more expansive Part 704, weathered the recession without impairing the capital of their natural person credit union members. It is almost important to recognize that for most natural person credit unions, the corporate credit union is a critical source of liquidity and other services.
Weighted Average Life
Today’s corporate system is structurally different than that of the pre-2008 recession. Rather than rely on a single centralized liquidity hub, the eleven remaining corporate credit unions rely on their own balance sheets to generate liquidity and fund operations.
As we have recommended previously, NCUA should re-evaluate whether providing greater flexibility to corporates with respect to Weighted Average Life (WAL) would allow corporates to better manage balance sheets without unduly increasing risk to the share insurance fund.
Non-CUSO Investments
With the amount of innovation occurring outside the traditional financial space, for instance, the area of FinTechs, the NCUA should consider amending part 704 to allow state-chartered corporate credit unions to invest in non-CUSO entities where permissible under state law. Recognizing the need for greater flexibility to engage with emerging technologies, some states have begun to provide natural person credit unions the authority to hold equity investments in non-CUSOs. Allowing state-chartered corporates those same flexibilities would give meaning to recent NCUA moves to allow corporates to invest in natural person credit union CUSOs without the corporate CUSO limitations. NCUA has recognized the value of this. [9]
§708a & §708b Bank Conversion and Mergers; and Mergers of Federally Insured Credit Unions
Since the 1960’s, there has been a trend of consolidation among the credit union industry, state, and federal credit unions alike, that has driven down the number of community-based financial institutions. The consolidation has continued for a multitude of reasons, including perceived economies of scale attendant with larger credit unions; a desire to provide members with a greater range of financial products and services; ongoing regulatory burden; and succession planning. The COVID pandemic has further driven the number of mergers among credit unions of all sizes. [10]
State Law and State Regulation Dictate Merger Processes for FISCUs
With respect to a FISCU, NCUA’s sole concern should be mitigating risk to the National Credit Union Share Insurance Fund (NCUSIF). In the absence of any clear and compelling connection between the activity being regulated and risk to the NCUSIF, NCUA should always defer to laws applicable to each state
When two state-chartered credit unions merge, NCUA’s appropriate role is to ensure the surviving credit union is sufficiently capitalized and managed as to absorb the merged credit union without posing a material risk to the insurance fund. If the surviving credit union is safe and sound, the motive behind the merger should be irrelevant to the NCUA as the share insurer. It is for the state regulators, as the prudential regulator, to decide whether the board of directors’ decision to merge was inappropriately influenced.
As we have noted on numerous occasions, there is abundant transparency in the state credit union system when it comes to compensation. To further add to this point, most states have the ability to collect compensation information, and many, in fact, do collect this information as a requirement in the course of reviewing the merger proposal and application.[11]
NASCUS believes in transparency, but in this instance, disclosure of the compensation to the membership is, again, a governance matter for state law. And, in the case of FISCUs, more compensation data is already publicly available.
Member-to-Member Communication Remains Problematic
The member-to-member communication component of the final rule remains problematic, overly burdensome, and unnecessary. It might help stakeholder evaluation of the efficacy of this rule were NCUA to publish data on the numbers of mergers completed since the implementation of the rule, the total number of members affected, and the total number of members that availed themselves of the portal.
The multitude of mailings the NCUA requires also proves problematic and costly to FISCUs as many states have their own statutory notice and timing requirements for communications. NCUA should NOT require the states, when two FISCUs are merging, to follow the Agency’s notice and timing requirements on top of their own statutory requirements. This imposes double the costs of mailings to the respective institutions and confusion for the membership receiving the communications. We are unconvinced that the difference between NCUA’s timing and a state timing requirement represents any serious risk to the share insurance fund. [12]
To reiterate, NASCUS and state regulators acknowledge, and welcome, NCUA’s role in FISCU mergers as the administrator of the SIF. However, the overreach of the 2018 Merger Rule not only weakens the dual chartering system, but it has also caused real-life complications involving the mergers of FISCUs that continue to frustrate state regulators. Whether the problems arise from a mismatch in state and NCUA timeframes for notices, state and NCUA assessment of the need to pay out net worth to the merging credit union, or any other governance-related issue, the root cause is the same: NCUA’s rule reaches far beyond reasonable safety and soundness risks.
Distribution of Net Worth
When two FISCUs apply to merge and the smaller FISCUs merging has a high net worth, NCUA has often required a dividend be paid out to the membership of the smaller credit union. Again, this should be left to the state regulatory authority and the merging institutions. In a significant number of mergers, a small institution with fewer products and service offerings is merging into that of a larger credit union, with a larger footprint. The larger credit union also has more products and services, home banking options, and more accessibility for membership. Credit unions, as member-owned financial cooperatives, own these products and services. For the smaller credit union merging in, the membership is receiving more benefits than that of a dividend payout. NASCUS strongly encourages NCUA to evaluate the requirements and once again, defer to the state supervisory authority.
Conclusion
We commend NCUA for continuing its tradition of soliciting stakeholder comments on 1/3 of its Rules and Regulations annually. We would encourage the agency to reinstate the practice of issuing a summation of the comments and preliminary indications of which recommendations might be reviewed further for implementation and reasons for declining to pursue other suggestions. So doing would promote transparency in the rule review process and inform stakeholders as to how to think about existing rules for future comment opportunities.
Sincerely,
Sarah Stevenson
Vice President, Regulatory Affairs
[1] NASCUS is the professional association of the nation’s forty-five state credit union regulatory agencies that charter and supervise over 1900 state credit unions. NASCUS membership includes state regulatory agencies, state-chartered and federally chartered credit unions, and other important stakeholders in the state system. State-chartered credit unions hold over half of the $2.2 trillion assets in the credit union system and are proud to represent nearly half of the 129 million credit union members.
[2] Docket NCUA-2018-0041. Fed. Reg. 2018-17087
[3] https://www.ncua.gov/newsroom/press-release/2020/board-approves-final-subordinated-debt-rule
[4] The regulatory structure for banks allows prepayment without OC approval of subordinated debt not included in Tier 2 Capital. Adequately capitalized credit unions should have the same ability to prepay, without regulatory approval, the portion of subordinated debt not included in net worth.
[5] Fed. Reg. Vol. 86, No.34, p.11079
[6] Corporate credit unions are also separately referenced in Part 741.3(b)(3) which cross-references Part 741.206 which incorporates by reference Part 704.
[7] 75 Fed. Reg. 200 (October 20, 2010), p. 64786.
[8] In 2008, there were 27 corporate credit unions with aggregate assets over $85bb. In 2022, there are 11 corporate credit unions.
[9] NCUA has issued guidance to credit unions in the form of letters to credit unions, specifically, LTCU 22-CU-07 and LTCU 21-CU-16, to address the increased use of financial technology by credit unions in their operations and clarify its expectations for credit unions contemplating the use of new or emerging distributed letter technologies.
[10] While NASCUS recognizes a merger may be the only option for credit unions and as credit unions grow, consolidation becomes part of the life cycle. Faced with a trend that the credit union community is not pleased with, it remains perplexing to NASCUS that rather than working to address underlying issues of consolidation (further reducing regulatory burden, scaling regulatory requirements for smaller credit unions, assistance with succession planning, etc.…) the NCUA chose to issue a final rule in 2018 that had the opposite effect and ultimately increased regulatory burdens associated with mergers, particularly for mergers involving two state-chartered credit unions.
[11] All FISCUs must complete annual Internal Revenue Service Form 990 filings. Part VII of those filings is public and requires FISCUs to disclose any compensation paid to directors and officers; the compensation paid to “key employees” (employees earning more than $150,000.00 in reportable compensation; and “highly paid” employees (the top 5 employees earning more than $100,000.00 in reportable compensation).
[12] Much of the rationale behind the NCUA’s timing requirements is for members to provide comments on the proposed merger, however, a review of NCUA’s dedicated website for comments on proposed mergers, identifies an immaterial number of comments on mergers since the rule was finalized in 2018. This begs the question as to whether this is even necessary given the amount of burden it has imposed upon merging credit unions, particularly mergers between two FISCUs.