As Prepared for Delivery on October 21, 2021
Thank you, Vice Chairman Hauptman and Board Member Hood for sharing your views and support for this final rule regarding credit union service organizations, or CUSOs. Specifically, this rule will allow CUSOs to engage in any type of lending permissible for federal credit unions. It will also provide additional flexibilities for the NCUA Board to approve permissible activities and services outside of the standard notice-and-comment process.
It should come as no surprise to anyone who has followed this rulemaking that I strongly oppose the final CUSO rule before us today. And while I will soon outline in greater detail my many concerns about this rulemaking, I will begin by discussing what I like about the rulemaking.
First, I am grateful that my colleagues agreed with me to extend the initial 30-day comment period to 60 days. The matter before us is controversial, and the rulemaking generated considerable comments. In all, we received more than 1,000 letters, one of the largest sets of public comments the agency has ever received. The additional comments we received during the extension allowed the agency to consider a great variety of perspectives on these matters.
Second, I am appreciative that the preamble for this final rule reaffirms the Board’s continuing policy to seek third-party vendor authority from Congress. While I may disagree with moving this rule before the agency has had such statutory powers reinstated, I believe it is important for the Board to express its continued support for this much-needed legislative reform.
That said, there is a classic philosophical difference on this rule. On the one hand, my colleagues believe that the changes contained in this final rule will help small credit unions to compete and remain viable. On the other hand, I believe that unleashing such competition within the credit union system will lead to lower earnings for smaller credit unions because of the earnings that CUSOs will siphon off the top from participating credit unions. This will then lower returns on loans and lower credit union returns on average assets. As a result, this rule in the long run will likely lead to further industry consolidation .
Given the differences in our policy perspectives, we were unable to come to a consensus today. I am nevertheless hopeful that we will reach an agreement on matters like the field of membership shared facility requirements and mortgage servicing rights in the coming months.
Undermining Consumer Financial Protection
Let me start my examination of this rule by focusing on consumer financial protection. CUSOs making loans under this proposal would not be subject to the same loan restrictions as federal credit unions. As a result, they could exceed the limits on maturity, interest rates, and prepayments that federal credit unions must follow. As such, consumer advocates have called on the Board to “abandon this proposal.”
Their concerns are well founded. The final rule would give CUSOs the ability to become indirect auto lenders and payday lenders. Consumer advocates agree that these two consumer financial products carry considerable compliance and reputation risk.
One decade ago, some CUSOs did engage in predatory payday lending. One such CUSO known as NIX had products charging an effective 262 percent annual percentage rate. Another CUSO product, CUonPayday, had true annual percentage rates ranging from 141 to 876 percent. It took the NCUA and the actions of others several years to close down these problematic loan products. With today’s action, however, we will reopen the door to similar predatory scams.
Additionally, during the last decade, the NCUA Board has sought to create an environment in which individuals could obtain safe, affordable, and fair access to short-term credit with its Payday Alternative Loans rule. Yet, this final rule will allow CUSOs to engage in payday lending that exceeds rate caps and without other consumer protection guardrails. That action will set back the agency’s long-term efforts to create access to credit for provident and productive purposes and runs counter to the spirit of the Federal Credit Union Act .
Fostering Regulatory Arbitrage
As stewards of the credit union system, the NCUA Board should act to safeguard consumers and protect the system from sizable losses to the Share Insurance Fund. Because the agency lacks the third-party vendor authorities that the other federal banking agencies and several state regulators have, the NCUA has no power to supervise CUSOs for compliance with federal consumer financial protection laws and regulations and compliance with prudential standards like concentration limits, maximum loan-to-value ratios, and minimum capital levels.
A lack of supervision is a reason for even more guardrails, not fewer. Yet, in adopting the final rule today, we will not be taking substantive action to close these regulatory blind spots. Instead, this final rule will create an unregulated Wild West within the credit union space with little accountability for protecting consumers and credit unions.
The Federal Credit Union Act’s purpose is to promote thrift among credit union members and create a source of credit for provident or productive purposes. In allowing CUSOs to make loans that exceed rate caps and maturity limits, we are evading these statutory obligations. Previously, the courts have affirmed the NCUA’s decision to dissolve a federal credit union on the grounds that it failed to promote thrift as required by its charter. Here, however, we are now allowing CUSOs to make such loans within the credit union system without any authority to shut problematic lending and activities down.
I have spent more than two decades working on financial services issues, and one thing that I have consistently observed is that problems often develop in the areas receiving inadequate oversight and ineffective regulation. Think about the collapse of Enron, the savings-and-loan crisis, and the subprime lending debacle. With this rule, we would be inviting bad actors to come into a lightly regulated space. That is a recipe for disaster.
To paraphrase one commenter on this rulemaking: Why are we providing CUSOs with all the powers of federal credit unions without applying commensurate prudential supervision or consumer safeguards to mitigate risk? That is a very good question that remains unanswered in this final rule.
Likewise, another commenter observed that this rulemaking will likely migrate many existing credit union members from direct credit union services to an outside lender — free of NCUA supervision and examination — to provide the full range of their borrowing needs stripped of the protections afforded under the Federal Credit Union Act and NCUA regulations. Within appropriate levels of risk, we should be acting to protect the Share Insurance Fund from losses. Instead, this rulemaking will likely increase such losses in the years ahead.
CUSO Losses, Members Pay
My fear of future losses to the Share Insurance Fund is not hypothetical. It is a fact. And, when the losses do occur it will be the surviving credit unions and their members who will pay the bill for the misdeeds of others. That deeply troubles me.
According to staff calculations, at least 73 credit unions incurred losses due to CUSOs between 2007 and 2020. Ultimately, the failure of 11 of these credit unions caused $305 million in losses to the Share Insurance Fund. What is more, when combined with the CUSO-caused losses at credit unions which did not fail, the total losses to the system were nearly $600 million.
In an attempt to downplay these past losses, the final rule asserts two points. First, a CUSO must be sufficiently bonded or insured. While such bonds may be useful in covering small losses related to petty thefts, small-time fraud, and other inappropriate management actions, these bonds will not cover large losses. And second, the final rule maintains that a “past pattern of material losses…is not sufficient evidence that the pattern will continue.” These viewpoints are troubling. History may never repeat itself, but it often rhymes. And when it does rhyme, it will be the surviving credit unions and their members who will pay for such losses.
Moreover, we saw what happened when a CUSO focused on business lending ran amok during the Great Recession. The credit union with more than $1 billion in assets which wholly owned the CUSO was placed into conservatorship. And, to protect the system from sizable losses, the NCUA had to provide a $60 million line of credit. Without such section 208 assistance under the Federal Credit Union Act, the credit union would have been insolvent and the credit union’s failure would have created a sizable problem for the Share Insurance Fund at a time when the industry was already coping with the catastrophic losses created by the corporate credit union crisis.
Problematic CUSO activities continue to this day. In fact, earlier this year, the NCUA was forced to liquidate a small credit union because of its troubled mortgage-lending CUSO. With this rule, I fear that we are opening the door for similar situations in the future, but this time in payday and auto lending.
Closing the Regulatory Blind Spot First
Many have recognized the existing CUSO regulatory blind spot within the credit union system. As such, the Government Accountability Office and Financial Stability Oversight Council have repeatedly recommended that the agency have vendor authority to oversee CUSOs and other third-party vendors. And, the NCUA’s own Inspector General has noted that we need such authority to effectively identify and reduce the risks vendor relationships pose to credit unions and protect the Share Insurance Fund from losses.
The first step to providing CUSOs with expanded lending powers should have been the adoption by Congress of vendor authority. With such authority we would have been able to address the risks that arise from vendor relationships and safeguard the Share Insurance Fund .
Instead, this final rule will make the regulatory blind spot even worse. In fact, we know that CUSOs have previously denied NCUA reviews and rejected recommendations to mitigate risks. With the adoption of this final rule, it is only a matter of time before we encounter similar responses from CUSOs making and selling loans under these new authorities.
To divert attention away from this blind spot, the preamble to this final rule notes that the agency could use its broad investigative subpoena authority to compel records and testimony if CUSOs do not allow the NCUA to conduct reviews. This suggestion ignores the difference between a confidential supervisory program and a more adversarial legal proceeding. It is also a hope, not a fact. In reality, the agency has never exercised this authority.
When the Board adopted the CUSO proposal, I expressed concerns that the net result of this rulemaking would be to strengthen CUSOs and weaken the competitive position of many credit unions. Many commenters made similar observations.
For example, Idaho Central Credit Union expressed its strong opposition to the rule in noting that not only does the rulemaking raise safety-and-soundness issues, but it could also damage the relationship credit unions have worked for years to build and develop with car dealers. When implemented, this final rule will make it more difficult for a credit union to maintain the viability of these partnerships. It will also limit the ability of a credit union to control its risk tolerance and look out for the best interests of their members. I very much agree.
Similarly, Unitus Community Credit Union wrote that the proposal’s economic impacts have not been widely discussed and understood by a majority of credit unions, which may have economic service models materially disrupted with the adoption of a final rule. Unitus also observed that there is often a significant discrepancy in transparency of pricing of services offered, which often impacts the small to mid-sized credit unions, especially when governance is controlled by large shareholders.
Further, the credit union observed that the rule would result in the transfer of credit risk to smaller credit unions, while the ancillary income like guaranteed asset protection and credit life auto insurance are generated and retained by the CUSO. While the low margin and credit risk is passed to the credit union, the higher margin income is retained and benefits the largest credit union equity partners of the CUSO.
In that regard, more often than not, credit union ownership of CUSOs is concentrated in the largest credit unions. In fact, for credit unions with an ownership interest in five or more CUSOs, the median asset size is in excess of $1 billion. It is also worth noting that the return on average assets for credit unions with less than $100 million in assets is just 39 basis points, regardless of whether they own and use or just use a CUSO.
In comparison, for credit unions with more than $100 million in assets, the return on average assets is 61 basis points for those institutions with no CUSO ownership interest and 72 basis points for credit unions that own a CUSO. Thus, there is a strong likelihood that larger credit unions owning CUSOs will benefit from this change while smaller credit unions will not receive the benefits.
Incomplete Economic Analyses
Given these competitive concerns, the agency should have conducted in-depth economic analyses before proceeding to the consideration of a final CUSO rule. That said, the NCUA is required to complete two analyses under Regulatory Flexibility Act and the Small Business Regulatory Enforcement Fairness Act. Even these required reviews have fallen short.
The Regulatory Flexibility Act generally requires that, in connection with a final rulemaking, an agency prepare and make available for public comment a final regulatory flexibility analysis that describes the impact of a rule on small entities. For our purposes, we define small entities as credit unions with less than $100 million in assets. That is two out of every three credit unions.
Given their small size, we know that smaller credit unions are more reliant on CUSOs to provide needed services to their members. So, it makes sense that credit unions under $100 million would rely on CUSOs and face new competition for lending, especially in the area of auto loans, under this final rule. Yet, I am unaware of any actual economic analysis conducted on this point. That is a flaw of this rulemaking.
Likewise, the Small Business Regulatory Enforcement Fairness Act of 1996 requires a determination as to whether a regulation is a major rule because it will cause an economic impact of $100 million or more annually. From my discussions with staff, I have learned that there may well be an annual impact exceeding this threshold.
After all, we know that credit unions are heavily involved in auto lending, a market which exceeds $1.2 trillion in loans outstanding. In all, the market share of credit unions is just over 30 percent. Once implemented, it is entirely plausible that CUSOs could capture one percent of the auto market. Under some reasonable assumptions, that could produce an economic impact of $100 million or much more. The agency should have taken the time to calculate this estimate and not rush to finalize today’s rule. Instead, we may well face criticism from the Office of Management and Budget, Congress, and in the courts for short-circuiting these required analyses.
Two Other Concerns
Before closing, I briefly want to discuss two other concerns with this rulemaking. First, this rule is the wrong rule at the wrong time. In the current economic environment, the NCUA Board should be working to adopt rules, protect consumers, and prepare the system for the likely coming credit losses as COVID-19 relief programs come to an end. This rule is not pandemic relief.
And second, the final rule will give the Board additional flexibility to approve permissible CUSO activities and services outside of the standard notice-and-comment process. In the process to allow new CUSO services to get added, the agency is avoiding formal rulemaking when expanding CUSO powers, but it will require rulemaking when limiting CUSO powers. This regulatory approach is lopsided. The agency should have kept the existing process instead to require notice and comment in all instances.
In closing, there is much to dislike in this rulemaking. It will give CUSOs the ability to become indirect auto lenders and payday lenders without applying consumer protection and prudential guardrails. It will also increase a regulatory blind spot and foster regulatory arbitrage.
What is more, the final rule will negatively affect the competitiveness of small credit unions who will make lower earnings on the loans that they will have to buy from CUSOs instead of making such loans directly. Finally, the rule will ultimately lead to losses for the Share Insurance Fund.
We should have taken the time to better estimate the magnitude of such losses and the competitive impacts of this rulemaking.
For each of these reasons, I will oppose this final rule. That concludes my remarks. Is there a motion?