How NCUA Can Keep CUSOs Off the Chopping Block
For more than 25 years, Guy Messick has seen firsthand how CUSOs have generated and contributed millions of dollars of net capital per year to the credit union industry.
As an attorney, Messick represents CUSOs and credit unions and serves as general counsel for the National Association of Credit Union Service Organizations and principal in Messick & Lauer P.C. in Media, Pa. When the NCUA delivered what he called a one-two punch to CUSOs in November 2013 and January 2014 with the revised CUSO rule and the proposed risk-rated capital rule, he was more than concerned that the regulator had labeled CUSOs as a systemic risk to credit unions.
“NCUA's rules seem to encourage credit unions to do business with non-CUSO service providers where credit unions do not have to set aside risk based capital for CUSO investments,” said Messick. “Based on NCUA's message, why would a credit union want to invest in a CUSO? The answer is that CUSOs have proven to be one of the most effective means to generate net capital and provide access to critical services.”
Messick ticked off a number CUSOs to prove that point: A credit union that made a $50,000 investment 10 years ago in a title insurance CUSO has earned $11 million to date; another credit union that is a partner with three other credit unions in a compliance services CUSO made back its investment of $250,000 through operational savings in the first year.
In another instance, credit unions that use a CUSO for back office IT support invested $2 million each to form the entity that now saves each credit union $4 million per year through reduced staffing and vendor concessions due to their greater bargaining power, said Messick. Yet another CUSO provides small credit unions with access to core processing and a host of other operational services at affordable costs.
“A penny saved is still a penny earned. I could continue with examples but my point is that these success stories far outweigh the handful of business lending CUSOs that have caused losses to credit unions,” Messick noted.
The new CUSO rule focuses on CUSOs but is silent on non-CUSO service providers, Messick pointed out. Since non-CUSO service providers greatly out-number CUSO service providers, the bulk of the risk to credit unions has not been addressed.
“A much better solution is for credit unions to identify to NCUA the critical third party service providers they use,” Messick suggested. “If NCUA desires to obtain more information from a service provider, NCUA could obtain the information directly from the service provider. CUSO service providers have always cooperated with inquiries from NCUA and will continue to do so.”
Messick said the reason NCUA gives for wanting CUSOs to directly report to the regulator is that credit unions often fail to provide accurate information on their CUSOs –a reason he finds astonishing because they agency is preaching to credit unions the importance of performing due diligence on all its service providers yet it seems willing to give credit unions a pass on their ability to accurately report a small amount of fundamental information about their CUSOs, he noted.
“Even cursory due diligence would enable credit unions to provide the limited information for the direct annual reports required by NCUA,” said Messick. “If it is important for credit unions to manage their service provider relationships, then NCUA should insist that credit unions provide accurate information for all their critical service provider relationships.”
Messick stepped up his concerns about the regulator's proposed risk-based capital rule.
In January, the NCUA proposed the rule that says in order for a credit union to be classified as well-capitalized, it must maintain a risk-based capital ratio of 10.5% or above, and pass both net worth ratio and risk-based capital ratio requirements. Adequately capitalized credit unions would have to maintain risk-based capital ratios between 8% and 10.49% and pass ratio requirements. The threshold for undercapitalized credit unions would fall below 8%.
The CUSO risk rating appears arbitrary when compared to other risk ratings, Messick pointed out. For example, delinquent consumer debt over sixty days is risk rated at 150% and delinquent first lien mortgage debt is risk rated at 100%. Yet investments in CUSOs that have added millions to the bottom line of credit unions are deemed much riskier, he said.
Messick said there is no consideration for what types of services are being provided or whether the investment represents necessary operational expenses that would be otherwise incurred. The NCUA is also not considering 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.
“Even if there is a risk assessment for the initial CUSO investment, there is no reason to continue to have a risk assessment if the amount of the investment has been fully offset by net income or cost savings for the credit union that was generated by the CUSO,” said Messick.
Risk rating investments in CUSOs providing operational services is especially troubling as the money invested is money that would be spent on operational services in any event, said Messick. For example, all credit unions need to spend money for compliance, he explained. If the credit union spends the money internally there is no risk rating for that expense. If the credit union shares the costs of compliance with other credit unions through a CUSO that saves each partner money, the amount invested in a CUSO is risk rated.
“Why should the credit union have to set aside capital in order to save money on operational costs,” Messick asked. “There should never be disincentives for innovations that save money and provide higher levels of service.”
There are only 22 basis points of credit union industry assets invested in CUSOs, less than the aggregate NCUA corporate assessments, said Messick. Each federal credit union may only invest less than 1% of its assets in CUSOs. Credit unions could lose all of their CUSO investments and the loss would not be material yet the upside potential could be very significant, he warned.
Messick is optimistic that with modest adjustments in the CUSO regulation and the proposed risk rating rule, the NCUA could dramatically change how CUSOs are perceived. For one, these changes will encourage credit unions to take their due diligence more seriously, enable the NCUA to identify all critical service providers, give the regulator the ability to approach all service providers for more information as needed, and place a CUSO investment risk rating at a level that will not act as a chilling effect on CUSO investments.
“There is a real sustainability risk in credit unions. We lose 3% of our credit unions every year and that rate could increase when the full impact of the new regulatory onslaught overwhelms smaller credit unions,” said Messick. Credit unions need capital to grow and now need even more capital to set aside as risk based capital.”
Demanding credit unions make more net income and reserve more capital while handcuffing credit unions from the ability to do so is not good policy, said Messick. Instead, a more ideal model would be a regulatory climate that fosters the changes credit unions need to make in order to survive in the 21st century and the broader use of CUSOs is one of those changes.
“The true risk to the long term viability of credit unions is not an investment or loan to a CUSO, rather it is not investing in a CUSO to share risk, reduce costs, increase income and grow capital,” Messick urged.