The Impact of the New CUSO Rule and Proposed Risk Rating of CUSO Investments Guy A. Messick Messick & Lauer PC General Counsel to NACUSO
Credit unions are fenced in by regulations.
WHY CUSOS MATTER
23,866 6,554 3%
Scale Matters
Number of Credit Unions, ROAA and Net Worth by Peer Level Assets ROAA Net Worth >$500 1.02 9.88 $100 - $500 0.68 10.23 $50 - $100 0.45 10.70 $10 - $50 0.30 11.85 $2 - $10 0.06 14.09 <$2 -0.49 17.44
CUSO Formula Scale Access Innovation Net Income More Capital Better Services
Generating Net Income More interest income More non-interest income Reduce operating cost Increase expertise Leverage outside capital
$28 Billion to Trim
Build a Business Model That Will Succeed in Today’s World
Collaboration Works
Examples of CUSO Success Operational CUSOs – Saving Money ◦ Compliance CUSO ◦ Technology Support CUSO ◦ Full Back Office Support ◦ Business Lending CUSO
Examples of CUSO Success Financial Services – Fee Income ◦ Title Insurance CUSO ◦ Broker/Dealer CUSO ◦ Insurance Lending Services – Interest Income ◦ Business, mortgage, student, credit card, indirect auto, time share, & energy improvement loans.
Examples of CUSO Success Access to Services ◦ IT and Back Office Services ◦ Data analysis
HISTORY OF THE CUSO RULE AMENDMENT
The History of the Amendment A proposed CUSO amendment was introduced by NCUA on July 21, 2011. NACUSO, CUNA and NAFCU lobbied hard against the proposed amendment. NCUA received 290 comment letters, almost all against some or all of the proposed amendment.
The History of the Amendment NCUA did not act on the proposed amendment due to lack of consensus on the NCUA Board. NCUA reduced the scope of the proposed amendment and passed it as a final amendment on November 21, 2013.
NCUA Board Commentary on the Changes Made from the Proposal “The Board emphasizes, however, that the final rule is significantly more limited in application than the proposed rule, targeted mainly to CUSOs engaged in more complex or high-risk activates, such as credit and lending, information technology (IT), and custody, safekeeping, and investment management services for credit unions.”
DETAILS OF THE CUSO AMENDMENT
NCUA Power Over CUSOs NCUA acknowledges that it does not have the direct statutory and regulatory authority to regulate CUSOs under the Federal Credit Union Act. NCUA states that it has the power to condition the ability of CUs to invest in CUSOs, e.g. follow GAAP and provide access to books and records. Direct reporting to NCUA is another condition.
CUSO Definition Now covers CUSOs owned by all federally insured credit unions.
Corporate Separateness and Legal Opinion Requirements – Section 712.4 No change in content but now applies to FISCUs too.
Less Than Adequately Capitalized CUs FCUs must obtain NCUA approval to invest if the aggregate cash outlay over the past seven (7) years would exceed the 1% CUSO investment limit. Applies to FISCUs FISCUs must obtain SSA approval and provide notice to NCUA. No discussion of lending power.
CU – CUSO Agreement Per Section 712.3(d)(1) – (3). No change in content: follow GAAP, quarterly and annual financial statements and access to books and records Applies to FISCUs State can have its own version ◦ State must have equal or more stringent authority ◦ NCUA must have access as well.
Direct Reporting Requirement Section 712.3(4) New condition in the CU – CUSO Agreement The commentary has details of the effects of failed CUSOs (not in 2011 proposal). NCUA says it needs direct reporting as the reporting by CUs is often inaccurate and much less efficient. Final rule is more targeted to complex or high risk CUSOs. Applies to FISCUs.
Basic Info for All CUSOs Name Tax ID Number Address, Telephone and Website Primary Contact Services Provided Names and Charter Numbers of CU investors, lenders and clients Parent and subsidiary CUSOs
High Risk / Complex CUSOs Credit and Lending ◦ Origination of business, mortgage, student and credit card loans ◦ Loan support services, including servicing Information Technology ◦ Electronic transactions, record retention, security, disaster recovery, and payroll processing Custody, Safekeeping and Investment Management Services for Credit Unions
Enhanced Reporting List of services provided to each CU client. Investment and loan amounts from each CU. Most recent annual audited financials . Lending CUSOs – For each loan type ◦ Total dollar and total number of loans outstanding ◦ Total dollar and total number of loans granted year-to-date.
Subsidiary CUSOs Reporting requirement a CUSO subsidiary qualifies as a CUSO (providing products and services primarily to credit unions and members). Does not apply to companies the CUSO does business with. No reporting requirement if a CUSO has an ownership interest in a company that is not a CUSO. Applies to FISCUs
Timing of Implementation All changes to CU – CUSO Agreements by June 30, 2014. New annual reports submitted to NCUA by December 31, 2015…yes that is correct…2015.
THE POLITICAL CONTEXT OF THE AMENDMENT
NCUA Wants Vendor Authority “Me too”, the bank regulators have it. CUSOs pose a systematic risk. Congress has not given vendor authority to NCUA other than for a short period during the potential Y2K crisis. No evidence that additional authority was needed by NCUA to thwart CUSO losses. No evidence that banks were safer due to vendor authority.
Need to Obtain CUSO Knowledge The lack of data available at NCUA on CUSOs is embarrassing to the agency when asked by Congress about CUSO losses. Building a database on CUSOs enables NCUA to show they are being diligent to monitor potential areas of risk and show they can responsibly impact CUSOs with the purpose of getting Congress to expand that authority. The tools are already in place to obtain that information.
Concern for High Risk CUSOs Need to know the CU customers of CUSOs and financial info for ‘high risk” CUSOs Potential risk of trade secrets disclosure through FOIA despite Trade Secret Exemption and CU Examination Exemption The information is more secure and the regulatory line is less of an issue if NCUA goes through a CU investor of the CUSO to obtain the same information
Need Direct Reporting for Accuracy NCUA gives credit unions a pass on accurately reporting on CUSOs despite due diligence duties. Additional cost of direct reporting and CUSO reviews are not imposed upon non-CUSO competitors of CUSOs.
Summary of Industry Concerns Has NCUA exceeded its statutory authority? Is there any limit on what information NCUA can demand from CUSOs – de facto regulation of CUSOs? Innovation and risk sharing are not fostered in a regulated environment. How will the cost of NCUA “oversight” impact the competitiveness of CUSOs?
Better Solution Require credit unions to do due diligence on all service providers. Report to NCUA identifying information on all service providers. NCUA can follow up directly with the CUSO and non-CUSO service providers if additional information is needed.
PROPOSED RISK RATING OF CUSO INVESTMENTS
Proposed CUSO Risk Rating 250% for CUSO investments as they are equity interests held in small businesses without a market to sell. Uses bank investment risk ratings. No appreciation of that CUSO investment returns are usually in the form of lower operating costs and fee income.
No Consideration for: What types of services are being provided, Whether the investment represents necessary operational expenses that would be otherwise incurred, Whether the amount invested is material, Whether the CUSO has a history of profitability, or Whether the investment amount has been fully recovered by the credit union through savings or income.
CUSO Investments are Not Material There are only 22 basis points of credit union assets invested in CUSOs industry-wide; less than the annual corporate assessments. Each federal credit union may invest less than 1% of assets in CUSOs and loan less than another 1% of assets.
Comparative Risk Ratings CUSOs – investments 250%; loans 100% Delinquent First Mortgages – 100% Delinquent Credit Card Debt – 150% MBL’s ◦ Up to 15% of assets – 100% ◦ 15% to 25% of assets – 150% ◦ Over 25% of assets – 200%
Other Risk Rating Comments Loans in a CUSO versus in a CU Risk rating on appreciated CUSO value Discretion to change risk ratings History of 7% well capitalized designation
Other Risk Rating Comments Business loans – one size fits all Mortgage servicing rights Supplemental capital Implementation timing
Recommend
More recommend
