October 28, 2022
Re: NASCUS Comments on NCUA Staff Draft Budget Justification 2023–2024 (Docket NCUA-2022-0145).
Dear Ms. Conyers-Ausbrooks:
The National Association of State Credit Union Supervisors (NASCUS), on behalf of its regulator members who represent all state agencies that administer a state credit union charter, and state-chartered credit unions across the country, provides the following comments on the NCUA staff draft budget for 2023 and 2024.
A regulatory agency is generally in the best position to know the resources it needs to maintain a safe and sound supervisory program. With respect to the overall expense of NCUA operations in the coming year, NASCUS would expect that NCUA, like many state agencies, will strive to fully maximize efficiencies consistent with safe and sound supervision.
Our comments that follow address NCUA staff’s expense allocations of the cost of its operations, the administration of the National Credit Union Share Insurance Fund (SIF or Fund) and the use of the Overhead Transfer Rate (OTR).
Specifically, NASCUS’s comments address:
- Impact of the State Supervisory Programs on the SIF
- Risk that the OTR Methodology may Inequitably Subsidize FCU Regulatory Oversight at the Expense of the State Systems
- Lack of Independent Review and Transparency of OTR Methodology Primary Inputs
- Counterintuitive Aspects of the OTR Methodology
- Recommendations for Strengthening SIF Governance & OTR Transparency
Impact of the State Supervisory Programs on the SIF
The 45 NASCUS State Regulator members provide oversight to half of the assets and members in the domestic credit union system. NCUA, and the SIF, substantially benefit from the regulatory and supervisory work performed by state regulators. That state supervision is almost exclusively funded by state credit unions; not the SIF, nor NCUA. Based on NCUA’s own public call report data, federally insured state-chartered credit unions reported paying $86.3 million in state operating fees in 2021 to ensure robust, independent oversight of federally insured state credit unions throughout the country. These monies funded thousands of examiner hours and numerous reports that in many cases provide NCUA with the only onsite examination and supervision of a particular federally insured state charter (FISCU) it may see over a period of several years.
The SIF’s reliance on the prudential state regulators for the majority of examination and supervision work in federally insured state credit unions saves the SIF millions of dollars of administrative costs.
We raise this point because NCUA’s budget justification illustrates what it purports to be the relative costs borne by state and federal credit unions (FCUs) to fund supervision without recognition of the savings afforded the NCUA budget by the application of state resources. This is most evident when the budget notes that state credit unions pay only 31.2% of NCUA’s operating budget with only a footnote acknowledging state credit unions pay a supervisory fee to their state regulator. While this is true in the narrow context of NCUA’s budget funding, it does a disservice to the material expense borne by FISCUs to fund supervision relied upon by the SIF and presents a misleading picture of the true expense allocation impacting the fund.
The recognition of the SIF’s reliance on the state supervisory program and the related cost carried by state credit unions takes on added relevance when considered in the context of the Overhead Transfer Rate (OTR) methodology.
Risk that the OTR Methodology may Inequitably Subsidize FCU Regulatory Oversight at the Expense of the State Systems
It can be easy to overlook the OTR as it does not result in an annual expense item carried by credit unions, but rather in lost opportunity cost, both in interest income and capital held, as a result of the diversion of investment income on the deposits held by the NCUA.
However, the fact that the OTR is not accounted for as a direct charge to credit unions does not mean it may not require credit unions to “write a check” to cover the OTR. This is because every dollar transferred from the SIF by the overhead transfer to fund NCUA expenses is a dollar unavailable to cover future losses in the system and unavailable to generate future income to the SIF. At best, credit unions might be denied a distribution from the SIF as the overhead transfer diverts funds that might otherwise have resulted in the SIF exceeding its established Normal Operating Level. At worst, future losses may result in a need for a special assessment to replenish the Fund.
As implied earlier in our discussion of the impact of the state programs on the SIF, the overhead transfer, if not handled prudently and equitably, has the potential to imbalance the dual charter system by artificially reducing the cost of the federal charter while providing no equal benefit to the state charter.
On the state side, the work done by state regulators directly benefits the SIF by reducing its administrative costs and maximizing share insurance funds available. While it is true there are circumstances on the state side where the SIF will absorb the primary cost of an examination of a state credit union and pass that benefit to the state, such circumstances are the exception, not the norm. Through the current overhead transfer methodology however, the SIF will directly bear the primary cost of supervision of nearly half of all FCUs and pass that benefit to NCUA’s Title I operations (reducing the cost of being a FCU) as a norm rather than an exception.
To be clear, costs associated with administering the SIF should be allocated to the fund. That is what Congress intended when it established the SIF. But a plain reading of the Federal Credit Union Act demonstrates that Congress envisioned the SIF maximizing efficiencies gained by relying on examination work conducted by NCUA and the states to the fullest extent possible to reduce the administrative costs borne by the fund.
We would be remiss to not recognize that the OTR declined slightly in the proposed budget justification for 2023. We commend NCUA for taking this step. However, additional work remains to better calibrate the OTR methodology to recognize the savings SSAs provide to the SIF and ensure the SIFs management is equitable to all charters. NASCUS remains committed to working with NCUA to identify improvements to the calibration of the OTR.
Lack of Independent Review and Transparency of OTR Methodology Primary Inputs
Total assets and insured shares of state-chartered and federally chartered credit unions are equal, but the number of charters in each category is materially different:
|Credit Unions||62.7%; 3,042 Units||37.3%; 1,811 Units|
Sources: NCUA 2023 Draft Budget Justification and NCUA 2022Q2 Call Report Data
In its insurance role, NCUA has over 1,000 more FCUs to monitor. Given the equal number of insured shares and assets between federal and state-chartered FICUs, one would expect NCUA’s insurance workload to be significantly higher for FCUs than that of SCUs. Further, one would expect the NCUA’s chartering related work for FCUs would be significantly higher than that of the state agencies related to FISCUs.
However, as the NCUA does not publish its OTR workload analysis, it is not possible to evaluate the intuitive perception that NCUA physically spends far more of its time on FCUs.
Understanding the primary drivers of the OTR is critical because these drivers reflect NCUA’s cost allocations and, more importantly, NCUA’s assumptions in completing its workload analysis. NCUA explains that its OTR “analysis starts with a field-level review of every federally insured credit union to estimate the number of workload hours needed for the current year.…The workload estimates are then refined by regional managers and submitted to the NCUA central office for the annual budget proposal.” However, NCUA’s explanation statements do not provide sufficient detail to enable validation of the assumptions that drive NCUA’s workload analysis.
NCUA’s cost allocation and OTR calculation processes remains too opaque for proper public evaluation of the allocation of costs to administration of the SIF and to the Title I chartering function. l Greater transparency would enhance stakeholder confidence of an equitable balancing of the interests of the state and federal charter.
Counterintuitive Aspects of the OTR Methodology
NCUA’s Conflation of Principle 1 & Principle 2 with Respect to Monitoring Third Party and CUSO Risk
Principles 1 and 2 of the OTR formula read:
- Time spent examining and supervising federal credit unions is allocated as 50 percent insurance related.
- All time and costs the NCUA spends supervising or evaluating the risks posed by federally insured, state-chartered credit unions or other entities that the NCUA does not charter or regulate (for example, third-party vendors and Credit Union Service Organizations (CUSOs)) are allocated as 100 percent insurance related. [NASCUS emphasis.]
The 2022 Overhead Transfer Rate (OTR) Summary reads in footnote 1:
The 50 percent allocation mathematically emulates an examination and supervision program design where NCUA would alternate examinations, and/or conduct joint examinations, between its insurance function and its prudential regulator function.
This assumes that all time examining FCUs is split 50/50 between the operating fee charged to FCUs and the SIF. However, this assessment presumes that the prudential regulator and the deposit insurer functions necessitate the exact same activity levels to be effective in their respective oversight responsibilities. The appeal of the ease of application of a 50/50 split is understandable and we concede the efficiency of maintaining the blended structure of NCUA’s Title I and Title II responsibilities. However, given the plain language of the Federal Credit Union Act and the importance of the dual chartering system, more granular calibrating of Title I and Title II cost allocations is warranted.
The 2023 Draft Budget Justification (page 50) reads:
CUSOs are at times subject to review during the examination of a federally insured credit union. The OTR methodology captures CUSO-related time within the scope of the examination and supervision of federally insured credit unions under Principle 1 for federal credit unions and Principle 2 for federally insured state-chartered credit unions. The time designated for separate, standalone reviews of CUSOs and third-party vendors is accounted for separately in the NCUA’s workload budget and is covered by Principle 2 only. The standalone review of CUSOs and third-party vendors is to identify and address risk to federally insured credit unions. [NASCUS emphasis.]
While NASCUS agrees that appropriate cost allocation is necessary given the lack of separation of NCUA’s regulatory and deposit insurance roles, we do not agree that reviews of CUSO’s or third-party vendors should be allocated 100% to the SIF. Given that NCUA’s supervisory interest in CUSOs and other third-party service providers would include both FISCU and FCU related safety and soundness concerns from a SIF perspective, we would agree that CUSO allocation would be heavily weighted to the SIF. However, to allocate 100% of this work to the SIF is not appropriate. Put simply, to accept that all NCUA CUSO reviews of FCU CUSOs are strictly SIF related and hence 100 percent of CUSO reviews to the SIF is to assert that but for the SIF, NCUA as a chartering authority of FCUs has no interest in its charters’ investments into CUSOs and the associated operational and/or transactional risks. As this is an unlikely proposition, we believe a modest percentage of CUSO reviews are properly allocated as Title I expenditures.
Recommendations for Strengthening SIF Governance & OTR Transparency
Properly evaluating NCUA’s proposed 2023 budget necessitates more that an understanding of the OTR methodology and mechanics, it necessitates an understanding of the underlying data applied to the methodology. In the shared interest of strengthening SIF governance and enhancing the transparency of NCUA’s overall budget process, NASUS makes the following recommendations:
- Provide greater transparency to NCUA’s underlying workload analysis in the aggregate. Providing stake holders more information on the aggregate distribution of supervision hours as well as hours allocated among different agency offices would enhance stakeholder understanding of the respective Title I and Title II costs.
- Reconsider the November 19, 2015, NCUA Board decision to delegate calculation and administration of the OTR to a strictly formula administration. Given the potential for misbalancing the dual chartering system, the NCUA Board should evaluate the need for equity-based adjustments.
- Provide the documentation necessary to support all underlying assumptions utilized in the OTR methodology.
- Amend NCUA Principles 1 and 2, as appropriate based on regular review of the supporting analytics, to assure that NCUA’s treatment of costs associated with FCU insurance activities and third-party vendor and CUSO risk reviews for FCUs is reasonably applied to the SIF.
As already noted, it is difficult to comment on NCUA’s budget without addressing the allocation of expenses and spending that is inextricably tied to the OTR. We encourage NCUA to continue to calibrate the OTR methodology to ensure equitable treatment of both FCUs and FISCUs.
The current OTR methodology marks an improvement over the previous iteration. However, more work is needed to ensure the reasonable distribution of expenses between NCUA’s Title I and Tittle II authorities in the manner intended by Congress. The Federal Credit Union Act (FCUA) clearly contemplates that the SIF should benefit from the exam work NCUA is doing as the Title I administrator of the federal charter. All of NCUA’s various formulas turn this Congressional intent on its head and shift the benefits from the SIF to the NCUA’s Title I chartering functions. application of costs to the SIF.
Our comments herein are made in the spirit of State/Federal regulator collaboration and in support of our shared objectives to foster a vibrant dual charter system that increases consumer access to safe and sound cooperative financial institutions. NASCUS commends NCUA for the agency’s continued willingness to collaborate with stakeholders to better calibrate the agency’s budget and the OTR methodology.
John J. Kolhoff
Senior Vice President, Policy and Supervision
 NASCUS is the professional association of the nation’s forty-five state credit union regulatory agencies that charter and supervise over 1900 state credit unions. NASCUS membership includes state regulatory agencies, state chartered and federally chartered credit unions, and other important stakeholders in the state system. State-chartered credit unions hold over half of the $2.2 trillion assets in the credit union system and are proud to represent nearly half of the 134 million members. The remaining 5 states lack state-chartered credit unions.
 “Staff Draft: 2023-2024 Budget Justification,” p. 50. Available at https://www.ncua.gov/files/publications/budget/budget-justification-proposed-2023-2024.pdf.
 NCUA Staff Draft: 2023 – 2024 Budget Justification, Page 15, available at www.ncua.gov/files/publications/budget/budget-justification-proposed-2023-2024.pdf