NAFCU Compliance Blog

Upcoming NCUA Board Meeting; IRR Webcast; Top of the Mountain

Written by Steve Van Beek

Good morning - it feels good to be back.  I had the pleasure of talking to a large group of wonderful and energetic Directors and Supervisory Committee members last week in Palm Springs, California.  

NCUA Board Meeting.  NCUA has released its agenda for their May Board meeting on Thursday.  Included are the following items:

1. Final Rule – Parts 701, 703 and 7742 of NCUA’s Rules and Regulations, Reg Flex Relief.
2. Final Interpretive Ruling and Policy Statement (IRPS) – 12-1, Supervisory Review Committee.
3. Final Rule – Part 741 of NCUA’s Rules and Regulations, Troubled Debt Restructuring.
4. Quarterly Insurance Fund Report.

***

NAFCU Interest Rate Risk Webcast.  Also on Thursday is a NAFCU webcast on NCUA's new Interest Rate Risk regulation.  The webcast will be broadcast live from NAFCU's headquarters from 2:00 to 3:30 p.m. EDT on Thursday, May 24th.  

Remember, the compliance deadline is September 30, 2012.  If you can't make the live webcast, you can always purchase and view the on-demand webcast at a later date.  

***

And, of course - a picture from Grubb's View at the top of the Palm Springs Aerial Tramway.

NCUA Report; Reg Alerts on Loan Participation & Reg Flex Proposals

Written by Steve Van Beek

Below are a couple of items for your Wednesday.  

NCUA Report - January 2012.  The latest version of the NCUA Report is available.  The following two articles definitely caught my eye:

• A Frequently Asked Questions section on the FFIEC Online Authentication Guidance
• A discussion on What is a Minority Credit Union?

The FFIEC discussion indicates that credit unions should keep an eye out for upcoming FAQs from the Agencies as well as updated examination guidance:

"NCUA and other FFIEC agencies are now developing a set of frequently asked questions and will issue the document when completed. In addition, NCUA will issue a Letter to Credit Unions with updated examination questionnaires covering NCUA’s expectations by customer authentication, layered security, or other controls in early 2012." 

In the discussion on Minority Credit Unions (MCU), NCUA indicates their collection of information via the call report is an interim process until an Interpretive Ruling and Policy Statement (IRPS) is issued and approved:

"NCUA must develop and approve an Interpretative Policy and Ruling Statement before it can implement the MCU Preservation Program. However, using the Call Report enables NCUA to identify potential MCUs so NCUA can assess the characteristics and/or unique structure to consider program and policy development. NCUA plans to disclose a list of all MCUs on its OMWI webpage. This list will enable organizations to initially identify minority owned institutions that they may wish to partner with or establish business relationships. For example, banks can now obtain Community Reinvestment Act credit for investing in minority-owned institutions."

The full NCUA Report is here.

***

NAFCU Members.  Our Regulatory Affairs team has issued Regulatory Alerts on both the Loan Participation Proposal and the Regulatory Flexibility Proposal.  As always, we are eager for your input to help us draft our comments to NCUA.  

NCUA Proposes Changes to Reg Flex Rule; Loan Participations

Written by Steve Van Beek

The NCUA Board had a busy day yesterday with a full agenda.  The results of the Board meeting can be found here.  Additionally, the Board Action Bulletin provides a summary of each item.

The proposed changes to NCUA's Reg Flex rule are summarized in the Board Action Bulletin:

"The proposed rule would eliminate the charitable contributions rule and add relief provisions to rules that apply to eligible obligations, nonmember deposits, fixed assets, and investments. Under the proposed changes, FCUs would no longer have to qualify for a specific “RegFlex” designation. As of June 30, 2011, 60% of FCUs (2,764 of 4,534) were designated as RegFlex FCUs. The proposed changes would extend regulatory relief to the remaining 1,770 FCUs that do not currently have a RegFlex designation.

The RegFlex relief proposed rule has seven components. Specifically, the proposal would allow all FCUs to:

• Make charitable contributions to charities of their choosing;
• Accept non-member deposits, subject to predetermined limits, from local governmental entities or other credit unions;
• Use a six-year time horizon to partially occupy unimproved property they acquire for future expansion;
• Obtain certain exceptions to eligible obligations constraints;
• Enter into borrowing repurchase transactions in which the purchased securities have maturities that exceed the maturity of the borrowing repurchase agreement, provided the investment value does not exceed net worth, and subject to certain mismatch timing constraints;
• Purchase private-label commercial mortgage-related securities, subject to certain net worth constraints and four safety and soundness investment criteria; and
• Invest in zero-coupon securities, subject to certain net worth or investment maturity limits.

The proposal is issued with a 60-day comment period."

The draft version of the proposed rule is here.  It will be published in the Federal Register in the upcoming days.

***

NCUA also proposed a rule on loan participations that would extend the rule to all federally insured credit unions.  Additionally, the proposed rule addresses retention requirements, underwriting and concentration limits.  Here is from the Board Action Bulletin:

"Under the proposed rule, originators would be required to retain 10% of the original loan risk. (FCUs are already subject to this requirement.) Underwriting standards for loan participations must meet or exceed the underwriting standards that each purchasing credit union uses for originating their own loans. Credit unions buying participation interests must establish parameters for reviewing loan documentation, and for performing on-going due diligence on purchased loans.

Buyers would also be protected from acquiring undue concentrations. Loan participations purchased from one originating lender could not exceed 25% of net worth. Participation loans to one borrower could not exceed 15% of net worth. Credit unions could apply to NCUA Regional Directors for waivers of these limits."

***

NAFCU will be producing Regulatory Alerts on both of these proposals.  

Have a great weekend everyone! 

Good Intentions

Posted by Anthony Demangone

You know that saying about how the road to a certain locale is paved with good intentions?  That's been on my mind a lot lately.  Let me just give you two examples.

Fixed Assets.  NCUA decided to remove a number of RegFlex "exemptions" recently.  One of those exemptions dealt with fixed assets.  To make a long story short, federal credit unions may not accumulate fixed assets (think premises, furniture, fixtures and equipment) to the point where those fixed assets are more than five percent of the credit union's shares and retained earnings. Here's the rule.  But for years, if a credit union qualified under the RegFlex program, they did not have to abide by the fixed asset rule limitation.  So, many credit unions legally went far beyond the five percent.  

Fast forward to today. Since NCUA removed that exemption, credit unions over the five percent mark are grandfathered where they are.  But, if their fixed assets drop, so does their "grandfathered" fixed assets level.  So, if a credit union is at 10 percent now, that's fine.  But if their fixed assets drops to 9, they are then stuck at 9.  Keep in mind that a credit union is always free to request a waiver if they think they need to go beyond their allowable fixed asset limit.

On the surface, if one didn't understand how credit unions work, that seems reasonable.  But there was no guidance issued on how NCUA will examine this, nor how a credit union is supposed to manage it.  A fixed assets ratio will go up and down based on a number of factors, including purchases of fixed assets, the amount of shares at the credit union, and the credit union's retained earnings.  If a credit union wants to purchase a new ATM to deal with the new ADA requirements, and that puts it just over its grandfathered level, must the credit union seek a waiver?  Or will NCUA allow minor variances below or above its fixed assets ceiling?  I don't know. There's no clear guidance.  Should credit unions monitor their fixed assets to ensure that they do not go above their allowable limit on a daily, monthly, quarterly or annual basis?  I don't know.  There's no clear guidance. 

We've written to NCUA to voice our concerns on this issue.   I know my opinion isn't worth the price of a cup of coffee, but here's how I would allow credit unions to manage this.

I would require credit unions to maintain a policy and procedures regarding fixed assets.  The fixed assets policy would state what level the credit union plans to maintain, taking into account the credit union's strategic plan.  The fixed assets procedure would simply spell out how the credit union is going to stay within its fixed assets limitations.  I think it's fair for NCUA to require credit unions to measure this quarterly, to coincide with the filing of the 5300.  Credit unions should be able to use an average of their last three fixed assets ratios as reported on their 5300s.  This would balance out seasonal ups and downs.  NCUA should also allow for seasonal variances by giving credit unions a safe harbor of, say 50 basis points, above and below its allowable limit. Once a credit union goes outside of its limit (higher or lower), NCUA would then be able to require the credit union to show them concrete plans on how they'd return to a proper level. If that plan is not executed, the credit union could face administrative action or have their grandfathered fixed assets limit reduced. 

Thoughts?

The Fed's Recent Rule on Appraisals. The Fed recently issued an interim final rule that addresses real estate appraisals.  There are certain provisions that are giving mortgage lenders fits. Not because they don't want to comply. They simply can't come up with a way to comply that doesn't also open up multiple cans of worms.  Here's the provision:

(2) Employees and affiliates of creditors with assets of more than $250 million for both of the past two calendar years. For any covered transaction in which the creditor had assets of more than $250 million as of December 31st for both of the past two calendar years, a person subject to paragraph (d)(1)(i) of this section who is employed by or affiliated with the creditor does not have a conflict of interest in violation of paragraph (d)(1)(i) of this section based on the person's employment or affiliate relationship with the creditor if:    

(i) The compensation of the person preparing a valuation or performing valuation management functions is not based on the value arrived at in any valuation;    

(ii) The person preparing a valuation or performing valuation management functions reports to a person who is not part of the creditor's loan production function, as defined in paragraph (d)(5)(i) of this section, and whose compensation is not based on the closing of the transaction to which the valuation relates; and    

(iii) No employee, officer or director in the creditor's loan production function, as defined in paragraph (d)(5)(i) of this section, is directly or indirectly involved in selecting, retaining, recommending or influencing the selection of the person to prepare a valuation or perform valuation management functions, or to be included in or excluded from a list of approved persons who prepare valuations or perform valuation management functions.

So, the rule states that if you are over $250 million assets, a person will not have a conflict of interest if they meet those requirements.  It creates a "safe harbor."  But it is a very, very costly one. Here's why.  The person who prepares an appraisal or performs "valuation management functions" cannot report to someone who, more or less, works in the credit union's loan production area.  (The general prohibition does have some minor carve-outs, such as when a person is only an underwriter or only closes loans.  But this person could not be supervised by anyone within the loan production area.  Ugh.) The appraisal part is not the end of the world.  Credit unions can simply work with outside vendors who manage the appraisal process, or work with independent appraisals as long as people in the loan production area are not involved in their selection. The problem is the second part.  In order to qualify for that safe harbor, no person directly or indirectly involved with valuation management functions can work in the loan production staff either.  That may sound OK to someone not familiar with the mortgage process, but not to anyone working in mortgages.  Here's why.

First, you have to understand how the process works.  When a credit union obtains an appraisal, they just don't run over and punch in the numbers from the report. Someone has to take a look at the appraisal to make sure there aren't errors or problems.  The definition of "valuation management functions" includes appraisal reviews.  

So, here's the new problem.  In order to qualify for the safe harbor for institutions with more than $250 million in assets, the person who reviews appraisals can't work in the loan production area, or report to anyone who does as outlined in the rule.  So, the credit union has to assign this review process to someone in, say, internal audit.  But here's the rub: that person may know nothing about appraisals. So, the credit union has to send them off for training. But it gets better. Who can review the reviewer's work?  Remember - this person cannot report to anyone in the loan production area.  So the credit union may have to select someone else to review the work of the reviewer, and train that person. All the while, a number of people which in-depth knowledge of appraisals are sitting in the loan production area, waiting for "approved" appraisals to come over.   

Keep in mind that credit unions in excess of $250 million can move outside of the the safe harbor and put together a plan that they think works.  But that increases compliance risk and gives folks like me heartburn.  It really is putting mortgage lenders between a rock and a hard place. 

***

Some folks think I'm anti-CFPB.  That's not a true statement.  I just know how this game works.  Every rule, no matter how artfully crafted, has unintended consequences.  Interchange. Overdraft protection. RESPA. RegFlex.   So when I see a huge new regulator with sharpened pencils and a long list of projects, I get the heartburn I mentioned above.  I understand good intentions, but I spend my day dealing with the confusion and uncertainty of new rules and regulations. Just think about this: these two rules I discussed today are not making national headlines.  But I can tell you this, many credit unions are struggling with them as you read this.  If two "minor" rules can do this, I cringe when I think of the new few years of Dodd-Frank implementation and CFPB rulemaking. What can we do? 

• Read proposals and comment whenever you see a problem.  
• When you meet with NCUA officials, or your elected officials, talk to them about compliance burdens. 
• Stay vigilant.  No one will look out for your interests better than you. 

____________________________________________________________________

Practices and Procedures for Financial Institution Risk Management
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MBL Guarantees

Posted by Anthony Demangone

Since NCUA issued its final rule to whittle down amend its RegFlex regulation, we've received quite a few questions concerning the soon-to-be-gone "principal guarantee" exception.  One of the more common questions is this: Assuming a business is owned by three principals, could we have each principal guarantee just one-third of the loan amount each?  

No, as explained in this legal opinion letter.   Each principal, as outlined in the regulation, would each guarantee the full amount of the loan. Here's a snippet of the opinion letter.

Who is a principal with respect to a limited liability partnership or a limited liability corporation, where the managing partner usually has a minority ownership position but has the authority to borrow and pledge assets?  You further ask whether the managing partner must guarantee the entire amount of the loan or just the managing partner’s pro rata share? 

Natural person partners having a majority ownership interest in a partnership must each guarantee the full amount of a loan to a partnership

***

We now think it is more likely that NCUA's final rule on fiduciary duties will be addressed during the NCUA December board meeting. 

This and That...

Posted by Anthony Demangone

I should have a sign in my office that reads "Things will hopefully slow down tomorrow." If I sold that sign to compliance officers, I might be writing this blog from my boat in the Bahamas. 

Indirect lending.  NCUA Board Member Gigi Hyland announced that NCUA will host a free webinar on indirect lending on Tuesday, November 9.  If you look at the panel of speakers, you'll see that NCUA is having senior members of its staff make the presentation.  They always answer a ton of questions and answers, so these webinars are a good place to measure NCUA's expectations on a topic.

RESPA.  The OCC has updated its RESPA exam procedures. They might come in handy, as RESPA is RESPA is RESPA, no matter if you are a bank, thrift or credit union. 

Fixed assets.  The NCUA is not the only financial regulator to issue material loss reviews.  OTS's inspector general wrote this report looking at the reasons why MainStreet Savings Bank failed.  The reason?  Fixed assets, to a certain degree. It brings home (a bit) at what NCUA may have been worried about regarding fixed assets and its RegFlex rule. (Hat tip to Mr. Clarke.)

The primary causes of MainStreet’s failure were its large investment in fixed assets, high overhead costs, and a very competitive local market. In 1998, MainStreet purchased a $22 million branch office and constructed a $4 million main office, which represented approximately 30 percent of the thrift’s total assets. The occupancy and related personnel expense increased the thrift’s overhead costs significantly and resulted in weak earnings. Management tried to implement a growth strategy in deposits and commercial real estate lending but was unsuccessful due to the highly competitive local market and a low net interest margin. Consequently, MainStreet could not absorb the increased overhead costs and incurred losses in 8 of the previous 11 years. These conditions were exacerbated by the deterioration in the Michigan economy. Loan delinquencies and classified assets increased significantly, which resulted in higher net operating losses that further diminished earnings and capital, and ultimately, led to MainStreet’s failure.

Sleep.  A certain set of twins in Arlington, Virginia seem to think it is perfectly acceptable to get up somewhere between 3:30 and 5 a.m. each morning.  They generally fall back asleep just as their father heads out the door for work.  Their father is not amused, but he is keeping tabs on the behavior and will dock their future allowances accordingly.

 

U.S. Central MLR; Fixed Assets Grandfathering; NAFCU Member Call-In

Posted by Anthony Demangone

Last week, NCUA's Office of Inspector General released a material loss review (MLR) concerning NCUA's conservatorship of U.S. Central Federal Credit Union.  The MLR tries to determine the reason why NCUA had to conserve U.S. Central.  You should read the MLR yourself, but, in short, the MLR found that U.S. Central's management and board failed to adequately manage the risk involved with its investment strategy, partly due to inadequate oversight.  In addition, the report pointed fingers at NCUA, concluding that examination staff failed to hone in on that risk within the investment portfolio.  By the time NCUA saw the risk, it was too late.

Here's one paragraph that caught my eye:

Since 2001, U.S. Central had modest growth and a generally conservative investment strategy. However, in 2006, U.S. Central’s business strategy shifted towards more aggressive growth that was focused on increasing or maintaining market share of the retail corporate credit union balances by offering competitive investment products and rates. U.S. Central’s assets grew to $44.7 billion by December 31, 2007, an increase of 22 percent from December 31, 2005. U.S. Central’s growth was achieved by offering highly competitive rates to its retail corporate credit union members, encouraging these members to invest their liquid funds with U.S. Central.

This paragraph states that in 2006, U.S. Central moved toward a strategy of aggressive growth.  In order to fund the higher returns needed to grow its assets, U.S. Central had to achieve higher returns on its investments. Arguably, that growth strategy is the event that caused the rest of the dominoes to fall. But there was no discussion within the MLR about why U.S. Central changed strategies.  It is food for thought, anyway.

***

In last week's NCUA board meeting, NCUA approved a regulation that ends four RegFlex exemptions. One of the affected areas involved fixed assets. Currently, RegFlex credit unions are exempt from the 5% limitation on fixed assets. The final rule ends that, and the rule will be effective 30 days after it is published in the Federal Register.  I'm sure that last sentence caused a few jaws to drop.  There's good news, of sorts.  There is a grandfather clause.

Credit unions that have already exceeded the 5% limit on the effective date of this rule will be grandfathered at that limit. If their level of fixed assets subsequently trends downward, then so will the level at which they are grandfathered. Grandfathered credit unions are, however, still eligible to apply for a waiver to increase their fixed asset investments. For example, a credit union grandfathered at 8% whose fixed assets trend downward to 6.5% will have a new grandfathered limit of 6.5%. Further, if that same credit union then wishes to increase its fixed assets to 9%, then it may apply for a waiver to do so. 

***

Please join us for our "Year-End Review," a NAFCU member-only conference call on Nov. 18. NAFCU President Fred Becker and the association's senior staff will report on the latest developments in Washington affecting credit unions, as well as the outlook for the economy. NAFCU's Member Call-In is free, but you must register to participate. You can register online or contact our Member Service Center at (800) 344-5580.

NCUA Board Meeting; Shameless Plug

Posted by Anthony Demangone

 Yesterday, NCUA held its monthly board meeting.  The meeting addressed the following issues:

RegFlex. NCUA approved a final rule that ends four RegFlex "exemptions" in the areas of 1) fixed assets, MBLs, stress testing of investments, and discretionary control of investments. The rules go into effect 30 days after the rule is published in the Federal Register.  For a detailed discussion of the rules, please read our NAFCU Today article on the RegFlex changes.

Merger Registry. The NCUA board heard a briefing on its efforts to create a merger partner registry that will help create transparency in the merger process.  Here's a link to the briefing materials.  (PowerPoint presentation.)

PCA.  The board approved an interim final rule that applies a 0% risk weighting to debt instruments that are unconditionally guaranteed by NCUA. This will benefit credit unions that purchase NCUA Guaranteed Notes (NGNs) that NCUA is selling as part of its corporate stabilization efforts. 

Keep in mind that the board discussed other items as well, so please review NCUA's "board actions" website, where you can download all available materials reviewed by the NCUA board at the meeting. 

 ***

Shameless plug alert.

 

At our Compliance Seminar, Steve Van Beek and I did three "Shotgun Compliance" sessions where we covered a ton of ground in roughly 3 hours.  We had quite a few attendees tell us that they wished their coworkers could have seen the presentation, because the sessions highlighted numerous compliance issues and red flags that affected nearly every area of credit union operations.  In addition, they said the sessions would be a nice way to show the credit union's senior management how many regulatory changes were coming down the pike.

With that in mind, NAFCU will offer a webcast on November 3 that tries to boil down our three shotgun sessions into one fast-moving, 90 minute webcast.  And NAFCU's Director of Regulatory Affairs, Carrie Hunt, will moderate! This will be a great opportunity to get the gang together so that everyone will catch a glimpse of major changes that place, and those that will soon be upon us.  In addition, if you couldn't attend our seminar, you'll get a good taste of what we addressed.  Here's what we'll cover in the webcast:

• NCUA Roundup
  • Guidance documents of note
  • Final rules and proposals
  • NCUA's new enforcement stance
  • Material loss reviews
  • Changes within NCUA and the outlook for 2011
• Fed Roundup
  • Final and proposed rules
  • Fed resources
• Dodd-Frank
  • Interchange
  • Mortgage reform
  • CFPA
  • Miscellaneous
• Miscellaneous
  • ADA and ATMs
  • Risk Based Pricing Notices
  • 2010 BSA Manual Update
  • OFAC
  • NCUA National Merger Registry
• How the "Hoo-hoo" are we supposed to keep up with all of this?

The early registration deadline is next Wednesday.  If you are interesting in signing up, go here.   

In any event - have a great weekend! Even you Gopher fans...

Fed Proposal; Other Stuff

Posted by Anthony Demangone

Earlier this week, the Federal Reserve issued a proposed rule designed to (in my own words) shut down a few loopholes found within Regulation Z's rules for credit cards. The rule does three main things.

1. If you waive interest charges, such a practice is deemed to be a promotion and will need to follow promotion requirements.  Some credit card issuers were planning to manage credit risk by charging a member, for example, a 16 percent APR. But as long as the member would pay on time, the issuer would waive 3 percent of the APR.  So, the member would have, in effect, a 13 percent APR credit card. If the member slips up, the issuer would revoke the benefit. This proposal says that such a practice is a promotion, so you have to give them a firm time, not less than six months, for how long the "interest waiver" will be in place, and what the rate will be after that.  You won't be able to end promotions simply because a card holder makes one late payment, for example. In addition, the proposal clarifies that existing balances earned under a waiver promotional program are protected at the lower balance, unless the borrower becomes more than 60 days delinquent.
2. Under the proposal, application and similar fees that a consumer is required to pay before a credit card account is opened are covered by the same limitations as fees charged during the first year after the account is opened. The Fed gives a good example: "Because the total amount of these fees cannot exceed 25 percent of the account's initial credit limit, a card issuer that, for example, charges a $75 fee to apply for a credit card with a $400 credit limit generally would not be permitted to charge more than $25 in additional fees during the first year after account opening." I don't think that this is necessarily bad for credit unions.  This clarification makes it much harder for credit card "sharks" to offer these fee-heavy credit cards.  That makes our credit cards more attractive.
3. Finally, if the proposal goes final in its current form, when you evaluate a consumer's ability to make the required payments before opening a new credit card account or increase the credit limit on an existing account, you'll have to consider information regarding the member's independent, individual income, rather than his or her household income. That shouldn't be a big deal, but it could trigger a change to your policy and procedures.

Finally, here are some other things of note:

• This is a proposal, so these proposals may be tweaked when the Fed issues a final rule.  
• While the proposal tackles the three main issues noted above, it addresses quite a few other issues as well. It clarifies what would be considered a credit card and charge card, and it addresses employee preferential rates.  If your shop offers credit cards, you'll need to work through the whole rule.  NAFCU is preparing a Regulatory Alert on the Fed's proposal, so stay tuned. 

***

Here are some other items of note:

• NCUA holds its NCUA Board Meeting today.  They're addressing their RegFlex regulation and its Merger Partner Registry, among other things.  The draft board items will be available this morning here.
• The Fed's Outlook Live seminar series will be offering a free webinar on HMDA and CRA reporting, to be held November 17th. Hopefully, they'll hit the HMDA stuff first.
• NCUA has issued Legal Opinion Letter 10-0856 to clarify that, for purposes of NCUA's rules and regulations, a CUSO may serve as a loan broker for loans used to finance the purchase of New York City tax cab medallions.  NCUA stresses, though, that other laws and regulations may apply.