UNITED STATES OF AMERICA
BEFORE THE NATIONAL CREDIT UNION ADMINISTRATION
In the Matter of XXXX
Docket BD – 01 – 18
Appeal of Regional Disapproval of Request to Renew and Extend Nonmember Deposit Exemption
Decision and Order on Appeal
Decision
This matter comes before the National Credit Union Administration Board (Board) as an administrative appeal under 12 C.F.R. Part 746, Subpart B. The appeal concerns the determination by NCUA’s Region I Director to disapprove the request by XXXX (XXXX) for a renewal of an exemption from compliance with the regulatory limits on accepting nonmember deposits.
Background
In 2015, XXXX obtained a two-year exemption from the regulatory limits governing acceptance of nonmember deposits, which permitted it to obtain nonmember deposits in an amount in excess of those limits.1 In July 2017, XXXX requested a two-year extension of the exemption, which was expiring at year-end 2017. The Regional Director denied the request, but instead proposed to extend the exemption through June 1, 2018, to provide XXXX with time to develop a plan outlining how it intended to end its reliance on nonmember deposits as a primary source of liquidity. XXXX has appealed the denial of its request to the Board, and a hearing on the issues was held before the Board on March 14, 2018.
Regulatory text
After first establishing the limit on the amount of nonmember deposits that may be accepted by an insured credit union,2 and then describing what a credit union must develop and submit to the appropriate regional office in seeking an exemption from those limits,3 the rule describes what the regional office should consider in reviewing and acting on any exemption request:
(4) Where the financial condition and management of the credit union are sound and the credit union's plan for the funds is reasonable, there will be a presumption in favor of granting the request. When granted, exemptions will normally be for a two-year period. The Regional Director will provide a written explanation for an exemption that is granted for a lesser time period.4
Standard of Review
In approaching appeals of this nature, which involve the application of a regulation to factual circumstances and the exercise of discretion by the Regional Director, the Board notes, first of all, that the pertinent regulatory language implements §107(6) of the Federal Credit Union Act (FCU Act).5 The statute provides federal credit unions with the authority to accept nonmember deposits, in the form of shares issued to other credit unions or public units, “within limitations prescribed by the Board.” Thus, the FCU Act contemplates that the agency will establish limits on the authority, and the provisions of §701.32 do just that. Where it is clear from the statute that Congress intends for an agency to prepare rules refining and implementing ambiguous statutory text (i.e., in this case, “within limitations”), the agency’s interpretation will typically be upheld against challenge, provided the interpretation is not arbitrary, capricious, an abuse of discretion, or manifestly contrary to law.6 As established by the NCUA’s rule, the limitations are the 20 percent of total deposits or $3 million upper limit on nonmember deposits, together with the “sound financial condition and management” and “reasonable plan” limitations governing the availability of the exemption.7
The rule text itself is not at issue in this case, but rather the interpretation and application of these terms to XXXX’s circumstances. The Regional Director, together with his team of experienced professionals, is the agency’s principal officer responsible for making judgments like the one under appeal in this case. Upon his review and evaluation of XXXX’s request for a renewal of its exemption, the Regional Director determined that a two-year extension of its exemption is not appropriate.
The Board’s review focuses on whether the Regional Director’s determination was arbitrary or capricious, as those terms are typically applied in cases involving judicial review of final agency action.8 Beyond that threshold, however, the Board believes a meaningful review of any matter appealed to it by parties affected by a regional or program office determination requires an independent assessment of the overall correctness of the determination. The Board will not simply substitute its judgment for that of the Regional Director, given the degree of expertise possessed at that level and the depth of knowledge that has been acquired about XXXX through the examination and oversight process. At the same time, the Board will not simply defer to and accept the judgment and conclusions of the Regional Director, without giving due consideration to the arguments that XXXX has put forth.9 Instead, synthesizing the arguments and rationales advocated by both sides, the Board has attempted through this process to arrive at a resolution of the issues that is not only reasonable, but proper and correct.
XXXX’s Arguments
Through counsel, XXXX has outlined three basic arguments as to why the Regional Director’s denial of the extension request was wrong and should be overturned by the Board. Each of these is summarized below.
1. Approval would not harm the National Credit Union Share Insurance Fund.
XXXX argues that it needs the additional liquidity afforded by the nonmember deposits to maintain its operations and manage the difficulties it is confronting due to the upheaval in the taxi medallion business. It asserts that these funds are available to it at a lower cost than from member deposits, which, it claims, are more expensive and have less flexibility. XXXX asserts there would be little benefit, and in fact more downside, to converting its nonmember depositors to members at this stage. XXXX intends to focus its attention during the next two years on diversification of its business and developing new consumer deposits, but argues that this will take time and effort to implement. XXXX asserts that it will become a more member-focused institution as it goes forward, but that it needs flexibility and time that can only be provided with a renewal of the exemption now.
In effect, XXXX asserts that there is a greater risk to the National Credit Union Share Insurance Fund (Share Insurance Fund) if it is not permitted to maintain the exemption while it addresses the difficulties resulting from the dislocation in the taxi medallion market. It acknowledges the need to diversify its business model, but that doing so will take time, which can and should be made available to it through a renewal of the exemption. It notes, however, that it also is pursuing other steps to improve its liquidity position in the meantime, such as by executing a sale and leaseback of its main office location in XXXX, as well as pursuing membership in the local Federal Home Loan Bank. XXXX also has access to credit from Alloya Corporate Federal Credit Union. Despite these resources, XXXX argues that its most efficient and helpful source of funding is through the nonmember deposit route, and the Regional Director’s denial of the exemption renewal request appears vindictive and unnecessary. At the oral hearing, XXXX also asserted that, because its nonmember depositors are insured credit unions, no additional exposure to the Share Insurance Fund is created by its acceptance of those deposits.
2. The Regional Director’s denial of the exemption request was based on misunderstanding and misjudgment.
Here, XXXX focuses on the stated premises articulated in Regional Director Blankenberger’s letter of November 29, 2017, in support of his decision not to renew the exemption for an additional two years. For example, XXXX asserts that it has filled its Chief Financial Officer position with another candidate, after its previous incumbent had abruptly resigned after only a short time on the job, which the Regional Director had noted as a problem. XXXX points out that it has also hired two other senior officers who can help it with addressing its problems. XXXX argues that its short delay in filling the CFO vacancy was not a legitimate basis for the Regional Director’s denial.
XXXX also asserts that its overall composite CAMEL rating of 4 is undeserved, and that the Regional Director’s characterization that XXXX is in “troubled condition” is incorrect and an illegitimate basis for the denial. Even if the composite 4 were correct, XXXX still asserts that granting the exemption and letting it use nonmember deposits as a source of liquidity while it struggles to overcome the disruption in the medallion business is the more prudent decision, both for it and for the Share Insurance Fund.
XXXX also disputes the challenges the Regional Director outlined in his November 29th letter to estimates XXXX identified for overall loss for 2018. XXXX asserts that it relied on outside experts in developing these numbers, and that the work done by those experts was thorough and accurate. XXXX disputes that its estimates were overly optimistic, and it chides the Regional Director for not inquiring as to how these figures were developed. XXXX asserts that its aggressive, realistic assumptions regarding its prospects going forward are well supported and a reflection of its willingness to confront forthrightly the difficulties it faces.
Similarly, XXXX objects to the characterization by the Regional Director that its allowance for loan and lease losses (ALLL) account lacks support in view of market conditions and may even be sufficiently inaccurate as to violate principles of full and fair disclosure. XXXX criticizes the Regional Director for not confronting management with his questions rather than simply rejecting the exemption request, and thus XXXX characterizes the Regional Director’s reliance on this element in terms of his denial as “illegitimate.”
3. Disqualification of Regional Director for retaliation.
Last fall, XXXX filed a complaint with the NCUA Inspector General when the Regional Director issued a Preliminary Warning Letter (PWL) following an unsuccessful attempt by XXXX to appeal certain examination findings. XXXX argued that the PWL was issued in retaliation for its attempt to appeal the exam findings. XXXX argues that, during the pendency of the IG’s investigation of this complaint, it was inappropriate for the Regional Director to have ruled on the exemption request, and has also asserted that the Regional Director’s turndown of its nonmember deposit exemption request is another example of retaliation.10
Regional Director’s response
The Regional Director is not persuaded by these arguments and stands behind his initial decision, which rests principally upon the characterization of XXXX as being in troubled financial condition. Speaking broadly, the Region’s position is that XXXX has been in denial about the scope and depth of its problems and has squandered valuable time over the past two years in which it should have been focusing on diversifying its business model and moving away from reliance on nonmember deposits and the medallion lending business. The Region does not believe XXXX has been sufficiently focused on addressing its problems when it had the time, and that extending the exemption will only prolong the difficulties unnecessarily. Instead, the Region believes the extension it has provided (to June 1, 2018), together with the requirement of submitting a detailed plan by March 31, 2018,11 strikes the right balance in this case.
The Region has made the following specific points in response to XXXX’s arguments. First, despite the assertion to the contrary by XXXX, in fact its cost of funds in obtaining nonmember deposits has been higher than its member shares, as reflected by XXXX’s own call report figures. Second, there are benefits to focusing more on obtaining and growing member deposits, as XXXX claims it wants to do in its strategic plan; continued reliance on nonmember deposits places too much emphasis on a costly, volatile funding source and is inconsistent with XXXX’s strategic plan; it also exposes the Share Insurance Fund to potentially increased risk. Third, XXXX has not shown a sense of urgency in diversifying, which it should have begun before 2017. Instead, regular shares and share draft accounts of members have been in decline since 2013. The Region has been emphasizing the need for XXXX to diversify and migrate away from volatile funding sources since at least 2015.
Aside from these observations, which the Board considers significant, the foundation for the Regional Director’s decision is the conclusion that XXXX is not in sound financial condition. In support of its view, the Region notes that XXXX’s capital has been in a precipitous decline over the past two years and its net worth position does not fully support its current and prospective risk profile. The Region points to XXXX’s significant operational problems, as outlined in the September PWL. The Region defends the composite 4 rating ascribed to XXXX as “well supported,” based on a balance sheet structure that shows extensive losses, continued high delinquency, high loan-to-asset and loan-to-share ratios, and an increasing number of troubled debt restructures. Challenging XXXX’s assertion that its valuation used for the medallions, and therefore its 2018 budget, is based on an accurate “worst case” scenario, the Region notes that XXXX’s budgeted losses for both 2017 and 2016 were both significantly overly optimistic. With nonmember deposits comprising in excess of 30 percent of XXXX’s deposit base, the Region is also concerned about volatility on the liability side of the balance sheet. Finally, despite XXXX’s statement that its ALLL methodology was in full compliance with applicable requirements and therefore an accurate depiction of potential loan losses, the Region has questioned whether this methodology is, in fact, indicative of current market conditions. The Region notes, for example, that XXXX has chosen to use a three-year average of charge off experience in determining its ALLL, even though losses in the most recent year were significantly higher than in prior years.
Conclusion
The FCU Act and applicable NCUA regulations call for the agency to consider the financial condition and plans of an applicant seeking an exemption from the established limits on accepting nonmember deposits. As noted above, in this case, XXXX seeks a renewal of an exemption granted in 2015. The Regional Director has legitimate concerns, well documented in the record, about XXXX’s current financial condition and its future prospects. Equally significant, XXXX’s failure, during the term of its initial exemption, to successfully develop and implement a plan to diversify its business model and de-escalate its reliance on nonmember deposits supports and justifies the Regional Director’s decision. For the reasons summarized below, and as more fully discussed herein and as more fully supported by the record developed by the Regional Director in this case, the Board considers the decision of the Regional Director to be reasonable, proper, and correct:
- XXXX is not in sound financial condition, with capital in steep decline in recent years, a net worth position that does not fully support its current and prospective risk profile, and utilization of an ALLL methodology that may not be indicative of current market conditions.
- XXXX has not demonstrated, during the term of its initial exemption, the ability or the willingness to commit to a plan to diversify its business model and increase its reliance on more stable sources of funding, including in particular deposits established and maintained by members.12
- The Regional Director’s extension of the exemption through to June 1, 2018, together with the requirement that XXXX develop and begin to implement a plan to reduce its reliance on nonmember deposits, is a proper and reasonable response by the Regional Director to XXXX’s exemption renewal request.
At the same time, the Board notes that XXXX has acknowledged the severity of the challenges it confronts and has committed that remedial steps, including specifically a renewed emphasis on cultivating and retaining new members, will be taken. The Board anticipates that significant progress along these lines will have been made by June 1st of this year, the date the current exemption will expire.13 XXXX is free, after that date, to submit another exemption request. The Board anticipates, assuming XXXX has had the type of progress it projects in achieving the objectives of its strategic plan, that the Region will carefully consider that exemption request.
Order
For the reasons set forth above, it is ORDERED as follows:
- The Board upholds the decision by the Region I Director and denies the appeal of XXXX.
- The Board’s decision constitutes a final agency determination and is subject to judicial review in accordance with Chapter 7 of Title 5 of the United States Code.
So ORDERED this 10th day of April, 2018, by the National Credit Union Administration Board.
_____/S/________________________
Gerard Poliquin
Secretary of the Board
1 12 C.F.R. §701.32. The limits set out in this rule are made applicable to federally insured, state-chartered credit unions like XXXX through 12 C.F.R. §741.204.
2 12 C.F.R. §701.32(b)(1).
3 12 C.F.R. §701.32(b)(2),(3).
4 12 C.F.R. §701.32(b)(4). It bears repeating in this case that XXXX is not seeking an initial exemption, but rather the renewal of one previously granted. The regulatory text does not directly address that scenario.
5 12 U.S.C. §1757(6).
6 Chevron U.S.A. Inc. v. Natural Resources Defense Council, 467 U.S. 837 (1984).
7 In 1994, the Board changed the rule by adding a provision that would favor smaller credit unions by permitting them to accept non-member deposits of the greater of 20% of shares or $1.5 million without seeking an exemption (this figure has been increased to $3 million in the current rule). The preamble contains a discussion of the exemption process and the presumption in the context of a renewal of an existing exemption, which is the posture of XXXX. The Board noted that two commenters had requested that an exemption be routinely renewed, if for the same amount and unless an examiner expressed safety and soundness concerns. The Board rejected this approach, saying that it did not favor automatic renewals, which "would make the timeframe meaningless and may tend to actually promote a continuing dependence on nonmember deposits." If anything, therefore, it would seem that there is a presumption against the renewal of an existing waiver, particularly where the financial condition of the credit union has deteriorated. This would appear to be the case with XXXX, which is now rated as composite CAMEL 4. In its appeal materials, XXXX does not assert that the regulation is arbitrary, capricious, an abuse of discretion or manifestly contrary to law.
8 See, e.g., Motor Vehicle Manufacturers Association v. State Farm Mutual Automobile Insurance Co., 463 U.S. 29 (1983) (a case involving judicial review of an agency rulemaking, in which the Court identified some of the criteria to be applied in determining whether the agency meets the arbitrary or capricious standard: has the agency relied on factors which Congress has not intended it to consider, entirely failed to consider an important aspect of the problem, offered an explanation for its decision that runs counter to the evidence before the agency, or is so implausible that it could not be ascribed to a difference in view or the product of the agency’s expertise.)
9 The Board specifically notes the value, in terms of its understanding of the issues in the case, of the oral argument presented by the parties at the hearing before the Board on March 14, 2018.
10 The Board notes that the IG has concluded his investigation and found no basis for the retaliation claim. Accordingly, the Board ascribes no weight to this aspect in its consideration of the appeal.
11 The Board understands that XXXX has submitted such a plan to the Regional Director.
12 The Board notes that XXXX possesses an unusually broad charter that provides it with the theoretical potential to establish and develop a nationwide field of membership. This factor underscores the Regional Director’s frustration that XXXX has not made better progress (indeed, member share and share draft balances have declined) during the term of the initial exemption.
13 The Board notes, in this respect, that expiration of the current exemption does not require the immediate termination of all existing nonmember deposit arrangements on that date. Instead, existing arrangements may be retained through their contractual maturity. The Board understands that approximately half of XXXX’s current nonmember deposit contracts do not mature until sometime in 2021.