best frenemies how to manage your relationship with regulatory examiners

How to Manage Your

Relationship with Regulatory Examiners

Valerie Edgington www.linkedin.com/in/valerie1120/

Who and How Often?

Federal Credit Unions:

National Credit Union Administration (NCUA).

State Credit Unions:

Ohio Division of Financial Institutions (ODFI).

12 month exam schedule.

Occur more or less frequently depending on risk profile and other issues.

Who’s In Charge?

Sometimes “joint” exam with federal and state regulators.

State‐chartered federally‐insured credit unions (FISCUs) are subject to NCUA’s examination.

“Document of Cooperation” between NCUA and State Credit Union Supervisors (NASCUS) coordinates NCUA’s and state examiners’ oversight of FISCUs.

“It is recognized and agreed that the regulation and examination of state‐chartered credit unions properly belongs to and is the primary responsibility of the state.”

NCUA will independently perform “insurance review” of FISCUs.

Who’s In Charge?

NCUA will immediately inform state regulators of NCUA’s findings and recommendations as a result of independent insurance review.

NCUA’s policy to hold conference with credit union officials within 30 days of completing insurance review.

NCUA does not discuss with, or disclose to, FISCU officials the CAMEL ratings it examiner assigned to the credit union, which may differ from those assigned by the state examiner.

If state law or regulation does not prohibit a credit union policy or action that NCUA considers unsafe, the NCUA examiner will cite it as a problem in the report to officials and will expect to see corrective action taken.

How Did We Get Here?

The “examiner” was examined by the Government Accountability Office (GAO).

GAO issued report of its findings in 12‐247:

Failures of corporates and credit unions since 2008.

Assessment of NCUA’s response to the failures.

Prompt Corrective Action (PCA).

GAO recommendations.

NCUA’s Response to GAO 12‐247

“NCUA is committed to proactively addressing safety and soundness problems at credit unions.”

“NCUA will continue to build on its current enforcement efforts in requiring credit unions to promptly correct problems at the earliest possible time.”

“Consistent with GAO’s findings, NCUA will also continue to take steps to strengthen the effectiveness of our enforcement program, striving to develop new predictive PCA measures that identify emerging problems earlier and better protect the Share Insurance Fund from losses.”

Examiner Duties

Review of credit union’s financial performance and assess how well the credit union is managing its risks.

Risk‐focused examination program used by NCUA and ODFI.

Key areas of risk review:

Credit Risk Strategic RiskInterest Rate Risk Compliance RiskLiquidity Risk Reputation Risk

Transaction (operational) Risk

2012 Supervisory Focus

NCUA Letter 12‐CU‐01 highlights 2012 supervisory focus.

ODFI focus substantially similar to NCUA.

Focus areas include:

Credit Risk

Interest Rate and Liquidity Risks

Concentration Risks

Required Questionnaires

Minimum Required Exam QuestionnairesBSA – Bank Secrecy Act Interest Rate Risk ‐ A Ln – Participation Loans

5300 Review Interest Rate Risk – B Ln – Controls

SC Audit & Verification Interest Rate Risk – C Ln – Real Estate – IC

SAFE Act Interest Rate Risk – D Ln – Indirect Lending – IC

Red Flag Questionnaire Liquidity ‐ A Ln – Sub‐Prime Lending – IC

Credit CARD Act Liquidity – B Ln – Home Equity – IC

Foreclosure Procedures Liquidity – C Ln ‐ Business Loans – IC

Unlawful Internet Gambling Sh – Controls Ln – SBA – Parts I and II

FFIEC Authentication Sh – Internal Controls IC – Lines of Credit

Third‐Party Relationships IC – Financial Triggers IC – Cash

Examination vs. Audit

Examinations:

Performed by regulator.

Safety & soundness.

Overall controls.

Regulation Compliance.

Recordkeeping.

Audits:

Outside company retained by credit union.

Accuracy of accounting records or procedures & records related to a particular regulation (i.e. BSA).

Internal controls.

Examiner Expectations

Examiners will send the credit union a preliminary notification of information needed for the examination.

Exam notification will indicate:

Date of the exam.

Number of examiners to expect.

Anticipated length of stay.

Documents and reports needed from the credit union by examiner upon arrival.

Examiner Expectations

Accurate and timely financial data.

Management and officials understand risks.

Efficient operations /conservative operating expenses.

Sound internal controls / effective audits.

Detailed written policies that reflect actual practices.

Realistic budget and strategic plan.

Communication.

The Blame Game

When failures or losses occur, everyone points the finger at everyone else:

Auditors.

Examiners.

Supervisory Committee.

Board of Directors.

Manager/CEO.

Credit Union Examination Rights

Credit unions have the right to:

1. Manage risk without being directed by examiners to eliminate it.

NEG Pg. 1‐3: Examiners should not “insist that a credit union eliminate risk but, instead, should ensure that credit unions identify and manage their risks. The desired reward for taking risk is stable profitability and increased net worth. Credit unions must balance risk and reward responsibly.”

2. Respectful conduct from their examiners.

NEG Pgs. 21‐3; 21‐4: Credit unions, as well as regulators, expect examiners to act professionally – which they do most of the time, according to credit unions. However, if a credit union feels that an examiner has stepped over the line in terms of conduct involving the credit union, the credit union should report the incident to the supervisor examiner or regional office, without fear of retaliation.

3. Be examined by well‐trained, competent examiners who understand the unique characteristics of credit unions.



4. Meet and discuss examiner findings, conclusions, directives and administrative actions with the examiner, or privately among themselves without the examiner present. Credit union officials should be able to have management staff present at the officials’ discretion.

NEG Pgs. 1‐11; 1‐15, 21‐2 & 21‐3: According to NCUA’s Examiner’s Guide, examiners are instructed to provide time throughout the examination process for discussion with management and officials regarding developments and findings in the examination. Examiners are encouraged to provide credit union officials with a draft copy of the examination report and give officials sufficient time to review it before the joint conference or exit interview. As the Examiner’s Guide notes, ―Nothing presented at the joint conference, exit interview, or in the examination report should surprise the [credit union’s] officials.‖ It is equally important that credit union officials not surprise examiners and that they take advantage of opportunities to meet with examiners and discuss issues throughout the examination process.


5. Question, and seek corrections to, examiner findings, conclusions and directives.

NEG Pg. 1‐15: Accuracy is an essential component of strong safety and soundness regulation. Examiners are human and all humans make mistakes. It is not only appropriate but very important that credit unions work with their examiner to ensure all reports are as accurate and timely as possible and that all directives are based on accurate information.

6. Provide alternative and/or additional data, conclusions and solutions to address problems indentified by the examiner.

NEG Pgs. 1‐11; 2‐3; 3‐10 & 21‐6: According to the Examiner’s Guide, examiners are not expected to dictate credit union policies but rather should work with credit union officials to reach a favorable outcome. The Examiner’s Guide emphasizes cooperation and coordination between examiners and credit union officials, which should include flexibility for credit union management to provide alternative perspectives and data as well as alternative solutions to problems—as long as such alternatives are factually based and appropriate for the situation.




7. Know the specific authority or legal basis for an examiner’s directive.

NEG Pg. 20‐7: The Examiner’s Guide makes it clear that examiners must be willing and able to provide to credit union officials the legal authority for the action they are suggesting or directing the credit union to take. In addition, examiners do not have flexibility to insist on actions or policies that are counter to or inconsistent withstatutes, agency policy, or GAAP.

8. Receive clearly written examination reports, notices, etc. on a timely basis.

NEG Pg. 20‐1: Credit unions should not be expected to comply with directives that are not in writing. In order for the credit union’s record of performance, including efforts to address problem areas, to be as accurate as possible, directives should be provided in writing to the credit union and included in the credit union’s examination history.

Page 17



9. Receive exam reports, findings, directives, and administrative actions that are based on all relevant facts.

10. Be evaluated on their own strengths and weaknesses and not solely on the basis of regulator concerns about trends.

NEG Pg. 3‐5: While examiners must be mindful of problems and conditions in their regions and even across the country, it is essential for the accuracy of each credit union’s examination report that the examiner’s assessment of a credit union reflects an accurate depiction of the performance and operations of the credit union under review.

11. Be evaluated for progress toward objectives that are realistic and achievable, proportionate to the risk presented.

12. Examination findings and directives that are risk prioritized.



13. Appeal examiner findings, conclusions, or directives without retaliation from their regulator.

It is clear that under the FCU Act, agency policy and practice, credit unions have the right to appeal ―material supervisory determina ons, including decisions to require prompt corrective action‖ to the NCUA Board. As discussed in this Section, matters that may be appealed include, for example, cease and desist orders, removal of officials, and conservatorships. Credit unions also have the right to appeal material examination report findings, conclusions, and directives from the examiner. Documents of Resolu on and LUAs are not generally ―appealable‖ because they are technically voluntary agreements, but the credit union should be able to appeal to the regional director as part of the DOR or LUA negotiation process.



14. Have instructions on how to appeal, detailed on every exam report form provided to credit unions.

NEG Pg. 17‐1: NCUA’s process for allowing an appeal is far from clear. NCUA and state regulators should ensure that all examination report forms which examiners provide to credit unions include sufficiently detailed information as to which issues may be appealed or challenged and the process for making such an appeal. CUNA and the Leagues are pursuing greater transparency in the appeals process.

15. Record meetings with examiners and other agency personnel.

NEG Pg. 21‐2: The Examiner’s Guide states that credit unions often use tape recorders to record their meetings at the joint conference, and that the NCUA examiners usually agree to the request, and may request a copy of the tape or transcript. A recorded meeting provides an objective transcript of the discussion between the examiner and the credit union officials.



16. Have a representative, such as attorney, present during meetings with the examiner and other regulatory personnel.

NEG Pg. 21‐6: The Examiner’s Guide states that credit union officials have the right to invite other persons to the joint conference, and that an examiner will rarely object to the attendance of any outside individual. Proper communication about the attendees in advance will facilitate the meeting.

17. Have any published orders – such as consent orders – address only facts and not conjecture or speculation by the examiner.

18. Have confidential, non‐discoverable communications with their legal counsel regarding examination issues.

19. Develop and use “high‐level” policies, which should be separate and distinct from detailed procedures.



20. Have a lead examiner that is state or federal, consistent with the credit union’s charter type (except with respect to some insurance reviews performed solely by NCUA staff).

NEG Pg. 22‐B3: NCUA appears to be compelled to accompany state regulators during the examination of state‐chartered credit unions, par cularly on federal ―hot button‖ issues such as MBL and indirect lending. Thus, it is important that the lead examiner be comparable to the credit union’s charter type. It is also important that the state regulator—not NCUA—be responsible for assigning the credit union’s CAMEL rating during an examination.

21. Know the timing of when NCUA will publish a Letter of Understanding and Agreement.



22. Defer to their CPA if there is a disagreement between the officials and their regulator regarding issues related to U.S. generally accepted accounting principles.

NEG Pgs. 5A‐4 & 7‐28: Credit unions over $10 million in assets are required to follow GAAP and a credit union’s CPA is responsible for ensuring that the credit union’s activities and financial statements are in compliance with GAAP. Therefore, rather than the regulator becoming involved in the specific accounting issues of numerous credit unions, the examiner should not seek to override the credit union’s CPA when disagreement on accounting issues arise, absent clearly erroneous guidance from the CPA. Such practice will benefit not only the credit union but also the regulator by freeing up its resources.



23. Have communication (i.e., discussion of draft findings) with their examiner prior to final issuance of the examination report.

NEG Pg. 21‐1: The NCUA Examiner’s Guide states that examiners should set aside time periodically to discuss with management and officials developments in the examination.‖ NEG page 21‐1. In addition, an examiner should provide credit union officials and management sufficient time to review it before the joint conference or exit interview.‖ NEG page 20‐1.

24. Have directives from examiners (including verbal and written comments) be consistent with regulatory requirements, policies and Letters to Credit Unions.

NEG pages 3‐1; 6‐15; 6‐16; 6‐20; 7‐35; 9A‐18; & 10‐1 – 10‐14: While this seems like an obvious right, this is frequently raised by credit unions across the country. NCUAexaminers must follow the guidelines in the Letters to Credit Unions. For example, the Examiner’s Guide states that credit unions must follow Letters to Credit Unions in areas such as CAMEL ratings, risk‐based lending, and risk management.

Enforcement Actions

Prompt Corrective Action.

Document of Resolution (DOR).

Letters of Understanding and Agreement (LUAs).

Cease and Desist Orders.

Civil Monetary Penalties.

Removal of Officials/Prohibition Orders.

Termination of Insurance.

Conservatorship.

Revocation of Charter.

Liquidation.

Prompt Corrective Action

Prompt Corrective Action (PCA) net worth categories are based on credit union’s net worth ratio.

Currently, 7% net worth deemed “well‐capitalized.”

Less than 7% net worth subject to increasingly harsh PCA sanctions as net worth declines.

GAO 12‐247 states:

NCUA should consider additional triggers for PCA.

Credit unions that did not fail were more likely subject to earlier PCA action.

PCA Appeals Process

Examiner required to inform credit union of right to appeal “material supervisory determinations.”

May also appeal adequacy of ALLL and classification of any “significant” loan.

Credit union must contact the regional office within 30 days of the examiner’s final determination.

If finding in favor of examiner, credit union may appeal the region’s determination to the Supervisory Review Committee (SRC) within 30 days of region’s decision.

PCA Appeals Process

Credit union may also appeal to the SRC if the regional office fails to respond to its initial appeal within 60 days.

Issue under dispute remains in effect pending the appeal.

SRC makes determination on the appeal within 30 days of receipt or 30 days from date additional requested information (if applicable) received.

Document of Resolution

Document of Resolution (DOR) issued by examiner to document agreements reached with credit union on reducing unacceptable material risks.

Includes persons responsible and timeframes for correction.

DOR should not address minor issues.

Examiners should strive to reach agreements with credit union officials on needed corrective action.

Document of Resolution

If credit union will not agree to DOR, examiner should work with credit union officials to develop alternative solutions or provide additional time to develop acceptable plans of their own.

If credit union officials do not agree to DOR or offer acceptable alternate plans, examiner may recommend administrative action, depending on severity of identified risks.

Do not sign or agree to when first presented.

Terms of DOR can be negotiated.

Letters of Understanding and Agreement

Letter of Understanding and Agreement (LUA) is a more formal supervisory tool.

Negotiated when credit unions have not adequately responded to less severe measures, such as Documents of Resolution.

“Voluntary” contract between NCUA and a credit union and/or its officials, in which the credit union or officials agree to take, or not take, certain specified actions.

Severe consequences for failing to follow and fulfill terms LUA.

Letters of Understanding and Agreement

Review LUA in its entirety; request clarification if needed.

Seek advice from legal counsel.

Make sure goals are realistic and achievable within required timeframes.

Board can refuse to sign LUA, but regulator likely to proceed with more formal administrative actions.

Enforcement difference between “published vs. unpublished” LUA.

Cease and Desist Orders

Cease and Desist (C&D) orders prohibit a credit union from engaging in the activity(ies) described in the order.

May require credit union to take affirmative action to correct condition resulting from the violation.

C&D made by NCUA board after a hearing; can issue Temporary C&D before a hearing can be held in certain circumstances.

Credit union can appeal decision to United States Court of Appeals.

C&Ds can be issued against “institution‐affiliated parties.”

Removal and Prohibition Orders

NCUA can issued “Removal Order” after notice and a hearing to remove members of credit union board and paid staff.

Prohibition Orders are broader and can be brought against institution‐affiliated parties including individuals who are not officials or personnel of the credit union.

Permanently bar a person from serving or being employed by any federally‐insured financial institution.

Can issue immediate Removal or Prohibition Orders if immediate action necessary to protect credit union.

Civil Monetary Penalties

NCUA has authority to assess civil money penalties (CMPs) against a federally‐insured credit union or any institution‐affiliated party.

Three‐tier CMP scheme ranging from $5,000 per day up to $1 million per day.

NCUA required to issue a Notice of Assessment to impose CMP.

Assessed parties have 90 days to pay but may request hearing within 20 days.

May appeal NCUA Board’s decision to U.S. Court of Appeals within 20 days of order.

Conservatorship

Conservatorship allows NCUA Board to take immediate control of a federally‐insured credit union under certain specific circumstances.

No notice or hearing required, however, credit union can seek an injunction within 10 days to set aside seizure.

If a federally‐insured state‐chartered credit union, also requires written approval of state regulatory agency, however, NCUA can place into conservatorship if state withholds approval.

Termination of Insurance

NCUA may terminate an insured credit union’s share insurance based on grounds substantially similar to C&D.

Termination generally reserved for FISCUs.

Notice of Intent to Terminate Insured Status sets out facts and establishes time/place for administrative hearing within 30 to 60 days.

Credit union can appeal to U.S. Court of Appeals but order is effective unless modified by NCUA Board or the court.

Involuntary Liquidation

NCUA Board may liquidate a federal credit union if it is bankrupt or insolvent.

Credit union has no legal authority to seek administrative hearing before closure.

Notice is served on credit union, however, order is effective immediately. Credit union can appeal to U.S. Court of Appeals but order is effective unless modified by NCUA Board or the court.

Involuntary Liquidation

NCUA Board may liquidate any federally‐insured credit union if significantly undercapitalized and has no prospect of becoming adequately capitalized, or the credit union is critically undercapitalized.

Procedure cannot be initiated without recent examination and documentation from the examiner as to the scope of problems and support for the recommended action.

Other Administrative Appeals

Credit unions may also appeal other decisions:

For MBL decisions and waivers and foreign branching, may appeal to NCUA Board.

Freedom of Information Act requests can be appealed to Office of General Counsel.

Appeals of creditor claims in liquidation should following the administrative review process.

NCUA Ombudsman

NCUA Ombudsman office set up to investigate complaints and recommend solutions.

Ombudsman does not make decisions regarding complaints but will help identify options and make recommendations to involved parties.

Issues or complaints must relate to regulatory issues that were first appeals, and were not resolved at the operational and regional levels.

Credit union must submit an Ombudsman Complaint Form.

NCUA Ombudsman

Ombudsman can help explain NCUA’s regulations or help raise systemic or recurring issues.

Ombudsman does not handle matters that are:

Subject to formal review as set forth in NCUA regulations or policies.

Involving an enforcement action where a Notice of Charges has been filed, such as an LUA.

In litigation.

Involving a conservatorship or liquidation.

Within the Inspector General’s jurisdiction.

Small Business Administration Ombudsman

The Small Business Administration has established an SBA Office of the National Ombudsman.

Credit unions with less than $10 million in assets have right to contact the SBA Ombudsman to raise concerns or issues about NCUA compliance matters or enforcement actions.

Credit Union ExaminationBest Practices

1. Understand the scope of the examination. Activities posing the highest risk will receive the highest amount of scrutiny.

2. Use past exams to prepare for future exams. Ensure there has been a resolution of prior exam and audit issues.

3. Ensure credit union officials are fully informed regarding any areas of material weakness at the credit union and the credit union’s risk management program.


4. Ensure the credit union’s policies and practices are appropriate for the credit union’s risk profile, up‐to‐date, and consistent with legal requirements.

5. Work with the examiner to provide necessary financial data and access to personnel on a timely basis.

6. Seek to work with the examiner on a professional basis and be willing to meet and listen to his/her concerns, recommendations and directives.


7. Do not hesitate to provide reasonable supplementary information to the examiner or to seek corrections in examiner reports, findings, or directives that the credit union feels are incorrect.

8. Do not hesitate to point out discrepancies between the examiner’s directives and the regulator’s Examiner’s Guide or legal requirements.

9. Do not hesitate to appeal examiner or regional office decisions on material, supervisory issues that the credit union feels are in error, unrealistic, inappropriate or inconsistent with its regulator’s policies or procedures.


10. Be specific. When an examiner indicates that you must/must not do a specific thing, ask for the specific legal or regulatory citation that is the basis for the recommendation.

11. Use CUNA’s Examination and Supervision Issues Reporting Form after each exam to report on your latest examination experiences.

12. Seek the advice of legal counsel prior to entering into any type of legally binding agreement (LUA, etc.).

13. Maintain open communications with examiner before, during and after the exam.

Responding toEnforcement Actions

1. Make sure credit union responds in timely manner.

2. Make sure board is aware of and understands requirements of the enforcement action.

3. Develop detailed action plan to address each component requirement.

4. Assign someone to track compliance enforcement action and report to board or supervisory committee.

5. Consider using outside assistance.

Resources

CUNA Supervisory Issues and Examinations: Guidance For Credit Unions During the Current Economic Times and Beyondhttp://www.cuna.org/reg_advocacy/member/download/examsuper_issuesguide_2011‐01.pdf

CUNA’s Examination Experience Reporting Form. Click to report on your credit union’s examination experienceshttp://www.cuna.org/initiatives/member/exam_supervisory.html

CUNA’s Examination & Supervisory Resources for Credit unionshttp://cuna.org/reg_advocacy/member/hot_topic/exam_supervisory_resc.html

CUNA’s Due Diligence Resources for Credit Unionshttp://www.cuna.org/initiatives/due_diligence.html

Resources

“Everything You Ever Wanted to Know about Exam Appeals” NCUA’s Newsletterhttp://www.ncua.gov/NewsPublications/News/Newsletters/NCUA_Newsltr_March10_5P.pdf

Guidelines for NCUA’s Supervisory Review Committee (RegFlex), IRPS 02‐1http://www.ncua.gov/Legal/Documents/IRPS/IRPS2002‐1.pdf

Guidelines for NCUA’s Supervisory Review Committee, IRPS 95‐1http://www.ncua.gov/Legal/Documents/IRPS/IRPS1995‐1.pdf

NCUA Examiner’s Guidehttp://www.ncua.gov/Legal/GuidesEtc/Pages/Examiners‐Guide.aspx

Administrative Actions – Chapter 30 of NCUA Examiner’s Guidehttp://www.ncua.gov/Legal/GuidesEtc/ExaminerGuide/chapter30.pdf

NCUA Aires Exam Questionnaireshttp://www.ncua.gov/Resources/CUs/Pages/AIRES.aspx

Thank You!

Valerie EdgingtonSuccess Consortium

www.linkedin.com/in/valerie1120/