The revised NCUA Risk Based Capital proposal’s impact on CUSOs, which was approved at the January 15 NCUA Board meeting on a vote of 2-1, with NCUA Board Member Mark McWatters voting against the revised RBC proposal, are summarized as follows:
• If the CUSO’s financials are consolidated into a credit union’s financial statement under GAAP, there is NO separate applicable CUSO investment or loan risk weight.
• If equity investment in a CUSO is unconsolidated, then risk weight is 150%, an improvement from the 250% in the original RBC proposal, but still unreasonable for CUSOs that pose little risk to their credit union owners.
• Loans to CUSOs are still risk weighted at 100% for unconsolidated CUSOs.
• Non-CUSO equity investments are risk weighted at 300% for publicly traded entities and 400% for non-publicly traded non-CUSO equity investments.
Comments on the revised Risk Based Capital rule are due 90 days after publication in the Federal Register.
Dollar Associates, CUNA and NAFCU have highlighted many of the major provisions regarding the newly proposed second draft of the Risk Based Capital Rule. However, NACUSO would like to give our initial thoughts on the rule from the context of CUSOs. Many aspects of the rule beyond the treatment of CUSO investments and loans to CUSOs affect CUSOs because of the nature of CUSO services, but right now we want to analyze the direct treatment of CUSOs. In the near future, NACUSO will share its thoughts on the entire rule and provide members a copy of our comment letter to the NCUA as well as a sample comment letter for their review. In addition, we will have several representatives of NCUA at the NACUSO Annual Conference in Orlando this April, where this rule will be directly discussed.
Before we strike directly into the CUSO provisions of the rule, let’s highlight the fact that Board Member McWatters made a cogent argument about the statutory authority for even proposing the risk based capital rule in the first place, and he voted against it. Without getting into the thick of this particular issue, there are parallels to the new CUSO rule. First, NCUA admits that it does not have the authority to regulate CUSOs or vendors, yet it proceeded to pass a rule devoted entirely to the “indirect” regulation of CUSOs, mandating CUSOs, not their credit union owners, report to NCUA highly confidential and proprietary information. As we will see later this lack of regulatory authority rears its head again in the risk based capital rule.
The risk based capital rule as proposed this week sets the risk weighting of CUSO assets at 100% of loans to CUSOs and 150% of investments in CUSOs. NCUA describes the different treatment of a loan versus an investment is based on the different treatment of a loan and an investment in the event of liquidation or bankruptcy. Before we address these differences, it is important to note what is not included in these categories. Through the hard work of NACUSO and its members, NCUA agreed to not include loans and investments in CUSOs if those assets were already consolidated into the credit union’s statement of financial condition under generally accepted accounting principles (GAAP). This is a big victory for credit unions and CUSOs.
Overall, NCUA lowered the risk weight for investments to 150% and left the risk weight for loans at 100% for all unconsolidated assets. CUSO loans are tied directly to commercial loans. NCUA states that the 100% risk weight is the same for that of commercial loans. Like our impression of the commercial loan risk weights, this approach does not account for the actual risk associated with the loan and if that loan is secured by any collateral.
CUSO investments are tied to the treatment of equity investments under FDIC rules where, according to NCUA, these types of investments can range from 100% to 600%. Under FDIC rules, investments that are less than 10% of a bank’s capital are risk weighted at 100%. FDIC characterizes such investments as insignificant. Because federal credit unions (and most state-chartered credit unions) can only invest up to 1% of their assets in CUSOs in the aggregate, all or nearly all of a well capitalized credit union’s investments in CUSOs should be considered insignificant and be risk rated at 100% as in the FDIC schema. The insignificance of CUSO investments is further highlighted by the fact that approximately 98% of credit unions are well capitalized at 7% (a much higher baseline than banks) and evidence shows that approximately 22 basis points of industry assets are invested in CUSOs today. While NCUA states that the risk of loss is central to determining the risk weight of an asset and not the size of the exposure, it is unclear how an insignificant investment in a CUSO creates more risk than in the FDIC setting. Furthermore, Congress by statute limited CUSO investments to 1% of assets specifically to limit risk and NCUA already accounts for such risk by requiring all credit unions to obtain a legal opinion confirming that all CUSO investments are limited to the amount invested.
There are two things as referenced above that are used to justify this higher risk weighting of 150% — historical CUSO losses and lack of CUSO/vendor authority. Once again, NCUA turns to these two keystones for the regulatory treatment of CUSOs. Going back to the latest CUSO rule, it was also justified by losses to the share insurance fund. NACUSO continues to question the significance of these losses to the share insurance fund. We have asked and not received any data to back up the claims of significant losses. Yet, NCUA constantly states that CUSOs pose a significant risk to the fund and have contributed to the failure of several credit unions during the financial crisis. Without the ability to see the data that backs up these claims, NACUSO will continue to take the position that any use of this data as justification for any regulation is tautological.
In the same vain attempt, NCUA continues to state that its lack of knowledge about the CUSO industry requires it to over regulate the industry as a whole. NCUA seems to postulate that if it had direct regulatory authority over CUSOs (and vendors which is completely irrelevant to the risk based capital rule yet cited nonetheless) the risk weighting may be different. NCUA further explains, in response to comments about the many different types of services provided by CUSOs and the different level of risk associated with those services, the risk weights for CUSOs may change as NCUA gets more information about CUSOs in accordance with the new CUSO rule. NACUSO continues to see this approach to regulation as over-burdensome where the agency uses fear of the unknown to justify such overreach.
Finally, NACUSO has grave concern about the treatment of investments in CUSOs over time. Under the newly proposed risk based capital rule, credit unions must risk rate for the appreciation of an asset. For instance, if a credit union makes a good investment for $100,000 in a valuable service offering and that investment appreciates to be worth $500,000, the credit union must hold more capital to offset this appreciation. NACUSO is very concerned that this approach to appreciating assets will deter credit unions from making good investments. In fact, credit unions often get involved in valuable service offerings to have some manner of control over the service and its future benefit to the industry. It is not generally a get in and get out approach to investments. NACUSO also fears that this will change the culture of CUSOs and their effect on the industry turning more CUSOs into vendors as it becomes economically infeasible to hold an investment in a CUSO once it becomes too valuable to the industry.
While we are happy that the investment weighting has been reduced and NCUA has accounted for the CUSOs consolidated into a credit union’s books, we also believe there is a lot of work to do on this newly proposed rule. We will continue to push and advocate for better treatment of CUSOs by the regulator. As stated above, we will prepare an official comment to the rule in the coming weeks and share it with our membership. We again encourage you to come to the NACUSO Annual Conference this April in Disney World where you will be able to address your concerns with the NCUA’s proposed Risk Based Capital rule with senior leadership of NCUA at the conference.
