NAFCU Compliance Blog

NCUA's Derivatives Proposal; Can't Help Myself

Written By JiJi Bahhur, Regulatory Compliance Counsel

Today, the NCUA Board issued a proposed rule to provide qualified credit unions limited authority to engage in derivatives activities for purposes of mitigating against interest rate risk (IRR). But, the proposal establishes a “pay-to-play” regulatory scheme for credit unions that are permitted to engage in derivatives activities. I’ll get into that in a moment. 

First, I should probably give some background on what derivatives are and what NCUA is proposing. NCUA has created a Q&A document addressing this, among other things.  From the Q&A document:

“Q.1: What are derivatives? What kinds of derivatives is NCUA proposing to allow for credit unions?

The Commodities Futures Trading Commission (CFTC) broadly defines a derivative as: “A financial instrument, traded on or off an exchange, the price of which is directly dependent upon (i.e., “derived from”) the value of one or more underlying securities, equity indices, debt instruments, commodities, other derivative instruments, or any agreed upon pricing index or arrangement (e.g., the movement over time of the Consumer Price Index or freight rates). They can be used to hedge risk or to exchange a floating rate of return for fixed rate of return. Derivatives include futures, options, and swaps.”

While the term “derivatives” covers a broad spectrum of financial instruments in today’s market, NCUA is only recommending authorizing the use of plain-vanilla, US Dollar-denominated (USD) interest rate swaps and purchased-only interest rate caps. These instruments are widely transacted in today’s capital markets, have deep and transparent pricing and afford end users with strong liquidity and execution. The Bank for International Settlements reports that interest rate swaps are the largest component of the global over-the-counter (OTC) derivatives market.

With regard to interest rate swaps, the NCUA Board is proposing to authorize only standard “pay-fixed/receive-floating” and “pay-floating/receive-fixed” interest rate swaps. It is currently anticipated that most interest rate swaps users would enter into “pay-fixed/receive-floating” transactions to hedge against rising interest rates. This “plain vanilla” interest rate swap affords some protection against the most common interest rate exposure experienced by credit unions with material interest-rate risk (IRR) sensitivity—namely, a balance sheet with an asset portfolio that does not reset to external rate changes as quickly as its liabilities. Most credit unions use non-maturity and other short-term shares to fund longer duration assets, creating an inherent re-pricing mismatch for which pay-fixed/receive-floating interest rate swaps can provide some effective mitigation.”

Eligible credit unions seeking derivatives authority must submit an application for one of two levels of authority.  Level I authority contains more stringent limits, including limits to the notional value of interest rate swaps, aggregate book value of interest rate caps, combined limit of interest rate swaps and caps, and the maximum weighted average life of all derivatives transactions cannot exceed 5 years.  Level II authority has fewer limits, but credit unions that seek Level II authority must show why the Level I limits are not adequate to meet their IRR mitigation needs.

So what’s the catch? You have to “pay-to-play.”  The proposed rule calls for application fees and pretty hefty ones at that.  Level I application processing costs would range from $25,000 to $50,000 and Level II applications would range from $75,000 to $125,000.  If that’s not bad enough, there is an associated fee for every year after that. 

NAFCU has long advocated for expanded investment authorities for credit unions, but the "pay-to-play" proposal raises concerns as this would be the first time “pay-to-play” will be required in the credit union industry. 

The proposal can be accessed here.  NCUA’s Q&A document – which provides an understanding of the rule’s intent and the main contents – can be accessed here.  Also, NAFCU’s Regulatory Affairs team is in the process of drafting a Regulatory Alert (NAFCU Member Log-In required) on this proposal so keep your eyes peeled for that. 

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I just had to share these pictures with you all.  Have a great weekend.

The Three Primary Changes Made by the Final TILA Escrow Rule

Written By JiJi Bahhur, Regulatory Compliance Counsel

As Steve mentioned in Monday’s blog, the CFPB issued a Small Entity Compliance Guide for the Amendments to the Escrow Requirement for Higher-Priced Mortgage Loans.  The purpose of this Guide is to provide the requirements of the Escrow final rule in plain English.  The Guide does a pretty good job laying out what credit unions need to know and do to be compliant with the final rule by June 1, 2013. 

The Small Entity Compliance Guide is broken out into eight main sections:

1. Introduction
2. What is the TILA Escrow Rule
3. What are the important changes in the TILA Escrow Rule compared with existing regulations?
4. What are the exemptions to the TILA Escrow Rule?
5. What definitions do I need?
6. What else do I need to know?
7. Practical implications and compliance considerations
8. Other resources

It’s surprisingly a very easy read, especially because each main section is broken down into smaller compartments (sub-sections) and the index is on-point to what each sub-section contains.  As an example, let’s take a look at section 3 (see above).  The sub-section under section 3 is “What are the three primary changes made by this rule?”  And under that, simplified and in plain English, you find the three primary changes:

“These are the three primary changes this rule makes compared with existing regulations:

1. It lengthens to at least five years the required minimum period most creditors must maintain an escrow account for first-lien higher-priced mortgage loans secured by a consumer’s principal dwelling. You must maintain the escrow account until one of the following occurs: 1) the underlying debt obligation is terminated or 2) after the five-year period, the consumer requests that the escrow account be canceled. However, if you are canceling the escrow account at the consumer’s request, the loan’s unpaid principal balance must be less than 80 percent of the original value of the property securing the underlying debt obligation, and the consumer must not be currently delinquent or in default on the underlying obligation.

2. It clarifies that you do not have to escrow insurance payments for homeowners in common interest communities where the governing body is required to purchase master insurance policies.

3. It exempts from the escrow requirement loans made by certain small creditors that operate predominantly in rural or underserved counties, as long as they are not subject to forward commitments for sale to nonexempt creditors.” 

I have to say, if you haven’t read the final rule, or if you are just struggling with some of the language in the final rule, you definitely want to take a look at this. 

Don't forget to visit NAFCU's Mortgage Rules webpage - a one-stop shop for resources on all of the new mortgage regulations.  Among other related items, you can find NAFCU's article, featured in February's Compliance Monitor, on Escrow Requirements on HPMLs, which includes a detailed run-down of the small creditor exemption (NAFCU log-in required). 

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There are a lot of new rules – the escrow rule being one – that may apply to your credit union so it is important to have a plan of attack.  Don’t let the effective dates creep up on you . . . time will fly!  Speaking of time flying, Kyse and Ava turned 8 months old this past weekend. 

A Final Farewell to the Legacy Forms; eCFR Updated to Reflect ATM Disclosure Amendments; Happy Weekend from the Twins

Written By JiJi Bahhur, Regulatory Compliance Counsel

With April 1 approaching, I thought today would be a good time to remind you all that after March 31, 2013, the legacy reports can no longer be used for filing SARs and CTRs.  Starting April 1, 2013, the new SAR and CTR forms must replace the legacy forms if you have not already said your goodbyes to those forms. 

For more information, check out FinCEN’s guidance on this matter and past blog posts written by NAFCU’s Compliance Team (here, here, and here). 

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In last Friday’s blog post, Steve mentioned that the CFPB issued a final rule requiring the removal of the Regulation E requirement to place ATM fee disclosure language “on the machine.” He also mentioned that the final rule would be effective immediately upon publication in the Federal Register.  Well, as of March 26, 2013, the final rule has been published in the Federal Register.  And on a grander note, the language has already been removed from the Electronic Code of Federal Regulations, thus making everything consistent. 

    “§ 1005.16   Disclosures at automated teller machines.

     (a) Definition. “Automated teller machine operator” means any person that operates an automated teller machine at which a consumer initiates an electronic fund transfer or a balance inquiry and that does not hold the account to or from which the transfer is made, or about which an inquiry is made.

    (b) General. An automated teller machine operator that imposes a fee on a consumer for initiating an electronic fund transfer or a balance inquiry must provide a notice that a fee will be imposed for providing electronic fund transfer services or a balance inquiry that discloses the amount of the fee.

    (c) Notice requirement. An automated teller machine operator must provide the notice required by paragraph (b) of this section either by showing it on the screen of the automated teller machine or by providing it on paper, before the consumer is committed to paying a fee.

    (d) Imposition of fee. An automated teller machine operator may impose a fee on a consumer for initiating an electronic fund transfer or a balance inquiry only if:

     (1) The consumer is provided the notice required under paragraph (c) of this section, and

     (2) The consumer elects to continue the transaction or inquiry after receiving such notice.”

Now when credit unions research Regulation E, the regulation matches the underlying law! Imagine that!

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The twins and I intend to just relax this weekend.  We hope you can do the same!

More Form Changes - The FCRA: Regulation V; The "Real" Deal, as Promised

Written by JiJi Bahhur, Regulatory Compliance Counsel

The Consumer Financial Protection Bureau (CFPB) issued changes to several FCRA forms – which are implemented in Regulation V.  The following forms were affected by these changes:

• Appendix I – Summary of Consumer Identity Theft Rights
• Appendix K – Summary of Consumer Rights
• Appendix M – Notice of Furnisher Responsibilities
• Appendix N – Notice of User Responsibilities.

Of particular importance to credit unions is the “Summary of Your Rights Under the Fair Credit Reporting Act” form (Summary of Consumer Rights), which can be found in Appendix K of the final rule.  Changes to this form included removing the reference to the Federal Trade Commission and replacing it with CFPB instead; updating the addresses for contacting the Assistant General Counsel for Aviation Enforcement and Proceedings and the Surface Transportation Board; and correction of typographical errors in the Spanish language translation at the top of Appendix K. 

Credit unions that use credit reports as part of the hiring, promoting, or firing process (i.e., for an employment purpose) should be cognizant of these changes, as this form must go to employees, or applicants, after the credit union has acquired a consumer report, but before it has taken adverse action based on that report.  Credit unions that use consumer reports for employment purposes should be aware of the requirements, and should have a detailed policy and procedures to ensure compliance. 

Although the effective date of the form changes was November 14, 2012, it looks like the CFPB is giving some leeway on the timeframe to make the changes.  In the meantime, the old model forms will be construed as being in compliance with the FCRA provisions requiring such forms.  From the rule:

“To mitigate the impact of these changes on users of the model forms in the Bureau’s Appendices I, K, M, and N published December 21, 2011, the Bureau will regard the use of those model forms to constitute compliance with the FCRA provisions requiring such forms and will regard those forms to be substantially similar to the corrected forms published today, until further notice. The Bureau anticipates providing that further, notice along with ample time to allow for the orderly discontinuation of the December 21, 2011 model forms, when it issues a final rule to restate Regulation V in 2013.”

That being said, if your credit union uses these forms, it would be a good idea to start taking steps to update to these new forms.  Additionally, it looks like the CFPB has plans to make additional changes to Regulation V in 2013 – so stay tuned.  

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It's a miracle!  The professional photographer was able to catch several photos of all four of us looking at the camera at the same time.  So, as promised, here is the family photo we chose...and of course I had to purchase the rights to all of the pics taken because there were some other memorable photos I just had to have (and I've shared one of those with you all as well).

The CFPB’s Supervisory Highlights from Fall 2012; The Attempted Family Photo

Written by JiJi Bahhur, Regulatory Compliance Counsel

In case you’re looking for something juicy to read, I thought I’d point you to an interesting topic (okay, okay…it’s interesting, but not interesting enough to call it juicy): highly problematic areas that financial institutions are struggling to stay compliant in.  As part of the supervisory authority given to the CFPB through the Dodd-Frank Act, the CFPB released its first issue of Supervisory Highlights, which highlights supervisory actions found between July 21, 2011, and September 30, 2012.  The CFPB’s Supervisory Highlights serve as a means to communicate to the public and financial services industry about its examination process and the kinds of problems CFPB examiners discovered through that process. 

This report can serve as a useful tool for credit unions, as it points to items that the CFPB carefully scrutinized during its supervisory process.  Further, credit unions can see the seriousness of noncompliance for those particular problem areas since the CFPB also goes into the corrective actions and remedies financial institutions had
to take to correct their deficiencies. 

I’ll leave the reading to you.  The report is short and sweet and very well-organized.  But just as a taste, the CFPB broke the deficiencies down into two main categories: (1) Compliance Management Systems and (2) Significant Violations Detected. 

• The CFPB deems a robust and effective compliance management system (CMS) as a critical component of a well-run financial institution.  The CFPB found financial institutions to be lacking across its entire consumer financial portfolio in instances where it failed to adopt and follow comprehensive internal policies and procedures, resulting in a breakdown in compliance and numerous violations of Federal consumer financial law.  Further, it found a CMS to be deficient in situations where there was failure to oversee affiliate and third-party service providers. 

• The CFPB found violations involving credit card, credit reporting, and mortgage origination activities to be significant violations.  Some of these violations resulted in public enforcement actions while others resulted in nonpublic supervisory actions.  At any rate, the discovered violations were of a broad spectrum and financial institutions were required to take corrective action, including but not limited to stopping the illegal practices, adopting effective policies and procedures, implementing robust compliance management programs, and paying out large sums of relief and civil money penalties.

The CFPB also released an appeals policy for supervised institutions as well as an updated version of the CFPB Supervision and Examination Manual, the guide used by examiners during the supervision process.  The appeals policy provides a means for financial service providers to request a review of any adverse findings set forth in its examination report.  The Manual serves as a great indicator of what the CFPB has authority to supervise and what it will be looking for during the examination process.  Even those credit unions under $10 Billion can use this Manual to ensure that it is compliant with Federal consumer financial laws. 

For those of you that are members of NAFCU, you can find a more detailed article on this topic in NAFCU’s January 2013 Compliance Monitor. 

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On an even more interesting note (or at least I’d like to think so), my husband and I made an attempt this past weekend to take a professional family photo with the kiddies.  We decided to go professional when we realized we couldn’t seem to get a good picture where all four of us are actually looking at the camera.  I’m hoping to share the “good” picture with you all once I have access to it, but in the meantime, here is our “nonprofessional” attempt at getting us all in one picture…of course the boys aren’t looking the right way. 

 

Reporting Nonresident Alien Interest in 2013; Meet my Twins

Written By JiJi Bahhur, Regulatory Compliance Counsel

With the New Year right around the corner, I thought it would be fitting to remind you all of the IRS’s Nonresident Alien Interest requirements.  Although the final regulations were effective as of April 19, 2012, the rule applies to payments of interest made on or after January 1, 2013. 

The final regulations require credit unions to report interest of $10 or more in the aggregate, paid to certain nonresident aliens, for that particular year.  That means at the end of 2013, credit unions will be required to report interest paid on or after January 1, 2013.  Credit unions are only required by the regulations to report payments made to residents of countries listed in IRS Revenue Procedures 2012-24, which was published contemporaneously with the final regulations.  However, to alleviate potential burden, credit unions may choose in the alternative to report interest paid to all nonresident aliens rather than just those that are residents of countries found on the list.   

The regulations require that reporting is conducted using the same form that is currently used to report interest payments made to nonresident aliens who reside in Canada.  IRS Form 1042-S, “Foreign Person’s U.S. Source Income Subject to Withholding,” can be located here.   

As mentioned before, the IRS published a list of countries that require reporting to the IRS where the interest meets the $10 or more criteria.  A credit union may rely on the permanent residence address provided on a valid Form W-8BEN to determine the country of residence, unless the credit union knows or has reason to know that the documentation is unreliable.  

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While I was out on leave, I received several emails asking about the birth of my twins – a boy and a girl.  Well, I’d like to introduce them to you all:  meet Kyse (rhymes with rice) and Ava, born August 20, 2012. 

A Whole Lot of FYIs

Written By JiJi Bahhur, Regulatory Compliance Counsel

 

I thought I’d keep it simple today with a couple…okay, a whole lot of…FYIs that you may (or may not) find interesting.

  

CFPB “Sweepstakes” Scam

The CFPB has issued a notice stating that if you receive a call from the “CFPB” in regards to a “sweepstakes” offer, it is a scam. Be careful not to provide any personal, consumer, or commercial information.

 

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FinCEN SAR Activity Review – By The Numbers Issue 17

FinCEN has released its seventeenth issue of The SAR Activity Review – By the Numbers (BTN). The report is only published once a year and provides numerical data on SAR filings from the last 12 months. It is available here.

 

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NCUA’s Office of Minority and Women Inclusion

In April, NCUA filed its first report to Congress on its Office of Minority and Women Inclusion (OMWI) and is expected to issue a proposal for comment in the future on standards for assessing credit unions' diversity policies. NAFCU wrote a letter to NCUA addressing OMWI’s assessment of credit unions’ diversity policy. March 29, 2012 - OMWI Assessment of CU's Diversity Practices.

 

NCUA’s OMWI was created in accordance with the Dodd-Frank Act. Its focus is diversity, civil rights and the promotion of minority and women hiring and contracting practices throughout the credit union industry. 

 

NCUA’s 2011 annual report notes actions taken thus far toward developing standards for assessing the diversity policies and practices of entities it regulates. It also looks at steps taken within the agency to promote diversity in its own hiring and procurement practices.

 

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NCUA’s Plain Writing Act.

If you remember from Steve’s blog post on April 30^th, we were waiting to see NCUA’s Annual Report on the Plain Writing Act. That report is now available on NCUA’s webpage dedicated to the Plain Writing Act.

 

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I could keep going, but I think I’ll stop right there for now. Okay, wait…one more...FYI: I’m having twins (a boy and a girl)!

 

 

Thanks for Everything

Posted by Anthony Demangone

I love my job.  I always have.  But I love NAFCU.  Always have.  Ever since I joined this organization in 2004.  So it is with mixed emotions that I have to tell you that my days as NAFCU's head compliance geek are at their end.  In a few short days, I'll transition into the role of NAFCU's Senior Vice President and Chief Operating Officer.  I'll be replacing Pat Morris, who is moving on to be CEO at the ACA.  That's very good news for a very good guy, and I can safely speak on behalf of NAFCU when I say that we wish him nothing but the best.   

It has been a sincere pleasure working with all of you, and I thank you for allowing me to barge into your office each morning through this blog.  Credit union compliance officers are my kind of people. You stand for the rule of law.  You respect process and procedures.  You bow to internal controls.  You understand that just because you can do something doesn't necessarily mean you may do it, or should.  Your role within an organization should be treasured, nurtured, and respected.  

In my new role at NAFCU, I'll be removed from NAFCU's compliance program.  I'll be in charge of helping my colleagues at NAFCU get what they need so they can do their jobs - which is to serve NAFCU's members.  I'll take with me the respect of risk management, internal controls, and critical analysis that I gained alongside you these past 6-plus years.  I'm humbled and excited at the challenge.

NAFCU's compliance services will still be here, and they'll continue to be great.  And the blog will live on as well.  No one person is indispensable, and that certainly extends to me.  Our compliance services will be headed up by someone else, and that's fine.  NAFCU is busy finding my replacement, but until then Sarah, Steve and Shari are here to help.  

Change is good, and learning new things and challenging yourself is great. Thanks again for humoring me with this blog, and I wish you all the best.

PS: And since I know what you really will miss most, here are a final few pics of Kate and Briggs.

 

NCUA Board Meeting; The Chairman on Comment Letters; Mortgage Doc Prototypes Near?

Posted by Anthony Demangone

Happy Friday, everyone.  We somehow made it through another week as compliance officers!

NCUA. Yesterday, NCUA held its monthly board meeting.  You can access the meeting materials here. It wasn't a huge compliance day, although NCUA did issue rules regarding corporates and they finalized a proposed IRPS that tweaks NCUA's Supervisory Review Committee.  NAFCU Today will provide overview of the meeting here.

Comment letters. NCUA Chairman Debbie Matz gives some great advice on how to write comment letters.  Via this link, you can read a quick overview of the four major areas where she gives advice, as well as watch a 5-minute video on the art of writing comment letters. This clearly is on the Chairman's mind right now, as she covered the same topic in this month's NCUA Report. 

The Mortgage Forms Are Coming.  Reportedly, the CFPB is close to releasing prototype model mortgage disclosure forms.  This will be our first chance to see how they'll handle model forms. 

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As you can see, Kate and Briggs would rather be outside, enjoying springtime.  I hope you follow their lead, and enjoy your weekend!  If you are travelling, be safe.  

Some Thoughts on Regulations; Give Them What They Want

Posted by Anthony Demangone

Yogi Berra is a smart man.  This is one of his best observations.

Baseball is 90 percent mental.  And the other half is physical.

That is actually true, for anyone who has played the game.  I think Professor Berra was on to something. A similar calculation could be used for regulations. 

Ninety-percent of regulatory burden is made up of all the rules and regulations.  The other half is how those rules are written.

One of these days, someone is going to reinvent how regulations are drafted and presented.  If they get it right, I think it will be a win-win.  The regulations will be easier to read and understand.  And that will lead to greater compliance.  Usually, the goal of a regulation is to solve a simple problem.  If regulators can come up with simple, creative ways to solve that problem, everyone will be better off. 

Here are two examples off what I mean. 

1.  The CARD Act and Regulation Z. When the CARD Act became law, it mandated that the Fed issue a number of credit card-related regulations.  Those were issued in three waves.  The first proposal totaled more than 800 pages (ultimately 241 in the federal register) of dense regulatory language.  We spent a lot of resources helping our member figure out how to break the rule down into readable portions. (When someone can add value by helping someone else figure out how to read a regulation you've written, you may have a problem.) Over the course of the next year, additional proposals and clarifications were issued.  

And it continues.  Just last month, the Fed issued another "clarification" to clear up a hand-full of CARD Act-related issues.  The length of that clarification totaled more than 300 pages.  
 

2.  Unnecessary complexity.   MDIA has created an interesting discussion that has reached the level of complexity needed to launch a rocket into space.  What is that issue? If you overstate the loan's APR in your dwelling-secured loan's disclosures, must you re-disclose your MDIA disclosures under Regulation Z?  You'd think this would be a simple question.  But it is not.  I won't bore you with the bloody details.  But if you want to see the complexity - read this article issued by the Fed.   

To paraphrase Allen Iverson, we're talking about an overstated APR.  An overstated APR. A creditor in this situation has disclosed an APR to the member that ends up being higher than what the member will get.  The member will get a lower APR when the loan is consummated. In many cases, the member is no better or worse off - they pay the same amount. But in some cases, the lender must halt the process, re-disclose, and then wait for the necessary time before the loan can move to closing.

This could have been regulated a different way.  How about this general rule? If you overstate the APR, no harm, no foul. No need to re-disclose.  Just let the member know at closing what the new APR is.  If the member proceeds to closing, they surely didn't mind the higher APR.  And for those who think that this creates a perverse incentive to inflate costs to err on the side of overstating the APR, thereby erasing the need for re-disclosure, Adam Smith is rolling over in his grave.   Market pressures will demand that they get that as close as possible.  If it is too high, they'll lose mortgages at the margins to other lenders.

These were just two examples of how the regulatory system seems to be breaking down.  When it takes hundreds of pages to explain one provision of a rule, be it a provision of the CARD Act or MDIA, it may be time to come up with a different rule altogether. 

Here's a thought.  

What if financial organizations could create their consumer disclosures using a risk-based system that is based on their products and services.  The regulation could come up with certain over-arching goals, such as clarity of disclosures, and certain prohibited practices.  But beyond those basic requirements, each organization would have to defend its disclosures and advertisements against basic principles: Is this disclosure or advertisement easy to understand? Does it accurately describe the features and costs of the account or service? Can we say (with a straight face) that it would not mislead or confuse the average consumer. 

What do you guys think?

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Give them what they want?  Well, during compliance school, more than a few of you approached me and said something like this

Yes, we like the compliance stuff...but we really like pictures of your kids.

I understand completely. And with that in mind...

They just had their 2-year check up.  Kate is now 3 foot, one inch tall.  Briggs is a clean three feet.  They both weigh just under 26 pounds.  Kate is in the 99th percentile for height.  Briggs is in the 86th percentile.  Come on, growth!  The Demangone side of the gene pool never saw 6 feet, to the best of my knowledge.  I look forward to when my kids can look down on me.

Have a great weekend, everyone!