Category: NCUA

The process took 23 months.   The appeal required multiple in-person meetings. And oral hearings.  The credit union engaged an attorney. The most senior regional and professional staff at NCUA opposed the petitioner’s request.

In the end, the board exercised common sense.  It adjudicated the appeal in favor of the credit union.  A difference  that, on the record, should have been resolved at agency’s local level.

This event is the first time in a long, long while in which the NCUA board has acted as a true board.   It overturned the actions and judgment of agency senior staff in their most important activity-examinations.   This decision could be a critical turning point in board oversight and staff accountability.

This summary is prepared from the Order published by the agency.

Background Summary

On November 26, the NCUA released a Decision and Order on Appeal of a Region’s and Supervisory Review Committee’s  CAMEL 3 examination rating of a credit union.

The Order provides  dates for the many steps required in this elongated bureaucratic appeal process.  The Order repeatedly presents the explanations for the Regional office’s downgrading  of the examiner’s recommended CAMEL 2 rating to CAMEL 3, and the SRC’s concurrence.

The examination date was December 2019.  The Board released its Order in late November 2021, or almost two years after the exam date.

Reading the agency’s repeated justifications for not correcting a flawed process reminds one of the old joke about NCUA examinations:

Question: What’s the difference between your NCUA examiner and a terrorist?

Answer: You can negotiate with a terrorist!

The Board’s Finding and Conclusion on the Credit Union’s Appeal

 

The Finding by the Board

After a de novo review of the administrative record, and taking both parties’ oral presentations under advisement, the Board finds, by a two to one vote, that the Region erred in assigning Petitioner a composite CAMEL 3 rating, effective December 31, 2019.

The Board notes the record in this case reflects several documented errors on the part of the Region, including miscommunications and breaches of NCUA examination procedures. Notably, the credit union was given an exam report containing composite CAMEL 2 language to support a composite CAMEL 3 rating. In addition, the exam report included DORs that did not cite a specific regulation, in violation of agency policy and regulation.²⁵ Accordingly, the Board considers those DORs²⁶ invalid and they are accorded no weight in this appeal.

Looking purely at the numbers, Petitioner’s ratios appear to be better than, or in line with, the average lowest rated composite CAMEL 2 credit unions:

The Board disagrees with the Region’s Asset Quality rating. The solid performance of Petitioner’s loan portfolio infers that the Region’s rating was based on the quality of the borrowers, rather than the quality of the loans. For example, although the borrowers’ average FICO scores were in the low 600s, delinquencies are very low. The Board notes it is much easier to achieve low delinquencies with borrowers with higher (e.g., 750 – 800) FICO scores.

Further, while the Board is not prepared to overturn the Region’s Capital rating, the Board is concerned that the Region failed to articulate to Petitioner why this credit union’s risk profile demands such high capital levels, especially when capital adequacy is defined by the Federal Credit Union Act (FCU Act).²⁷ Petitioner’s net worth position of XXXX percent is considered well capitalized under prompt corrective action.²⁸ The Board notes XXXX Petitioner’s net worth was still stronger than statutorily required by the FCU Act.

Additionally, the Board disagrees with the Region’s Management rating. XXXX Management understands how best to work with the credit union’s members XXXX.

Conclusion

The Board finds nothing in the record to support this credit union is “less capable of withstanding business fluctuations and [is] more vulnerable to outside influences.”²⁹ Based on the Board’s full and independent review on appeal, the Board finds the Petitioner’s composite CAMEL 3 rating is not justified. Instead, a composite CAMEL 2 rating is appropriate.

Why This Example Is Extremely Important

The agency process for this extended appeal  lacked any semblance of mutual objectivity. Following are the timelines of the exam and appeal process presented in the Order:

Examination data used:  December 31, 2019

Exam began: February 29, 2020

Report released by Region: June 25, 2020 (six months after the exam date)

Credit Union Board met with Regional staff: July 14 2020

Credit union filed request for reconsideration: August 13, 2020

Region reaffirmed the CAMEL 3: September 11, 2020

Credit union letter to appeal Region’s Decision to the SRC: October 8, 2020

Appeal letter opened by SRC 42 days later: November 19, 2020

SRC held oral hearing with credit union: February 2, 2021

SRC affirmed the Region’s CAMEL 3: March 2, 2021

Credit union filed supplemental appeal letter to NCUA: April 14, 2021

Credit union requested an administrative review by NCUA board: granted April 20,2021

NCUA Board oral hearing with credit union: June 10, 2021

Order issued  assigning a CAMEL 2: September 8^th, 2021 (last modified date of November 22, 2021)

For any credit union to persevere during this nearly 23 month gauntlet of appeals and hearings in the face of bureaucratic intransigence is a demonstration of true grit and determination—even courage.

The fact that the Board was willing to listen to the appeal and then reverse the agency’s repeated justifications of its actions, is a noteworthy and critical exercise of Board oversight.  For the Board  directly challenged and changed the Region’s and SCR reasons for assigning specific CAMEL ratings.

Why was the credit union so persistent?  Especially as the standard for appeal to the board is difficult: “the burden of showing an error in a material supervisory determination rests solely with the insured credit union.¹¹”

This criteria means the credit union must show that the agency made a mistake.   Such a finding is contrary to every regulatory impulse that the regional office’s judgments and findings can be incorrect.  It shatters the aura of expertise that is the core of a regulator’s authority.

What the Supervisory and District Examiners Told the Credit Union

The following is from the oral recordings and written transcripts of what the Supervisor and District Examiners told the credit union in assigning a CAMEL 2 rating upon completing the exam:

The Composite CAMEL rating is based on our assessment that you are fundamentally sound. For a credit union to receive this rating, generally no component rating should be more severe than a 3. Only moderate weaknesses are present and are well within the board of directors’ and management’s capabilities and willingness to correct.

While this rating results in an upgrade, as you do not pose material concerns, we have retained a management rating of “3.” This rating indicates some degree of supervisory concern. You will not qualify for an extended exam program and will remain on a 12-month examination supervision schedule.

Bureaucratic Jargon Overrides: “Authorized and Unauthorized Examination Versions”

NCUA Regional staff explained this overruling of the district and supervisory examiner’s CAMEL 2 rating by saying it was an “unauthorized version, erroneously issued.”

The Region’s “authorized exam version” explanation is that upon its review, “the Region found that staff had mistakenly excluded from the examination report closing language that had been approved for release. Noting that the reconsideration determination should be considered an addendum to the examination report, the Region’s September 11 letter indicated that the final paragraph in the Examination Overview that discussed Petitioner’s composite CAMEL 3 rating should have read:        The Composite CAMEL rating is 3”

 “Arbitrary and Capricious”

This overturning of the field examiners’ judgment was the core of the credit union’s appeal.

Petitioner further contends that the Region’s field examiners followed NCUA’s published examination procedure by including their first-hand observations and on-site assessments of the credit union into a draft examination report that concluded a composite CAMEL 2 rating was appropriate, but that same draft examination report was subsequently altered after field staff was “overruled,” to reflect the final composite CAMEL 3 rating that was issued to the credit union. Petitioner argues that “the same set of facts resulting in two different and inconsistent conclusions is by definition arbitrary and capricious and fundamentally lacks a rational and reasoned connection to the evidence.” 

A Credit Union to Be Saluted

We do not know who the credit union is. It takes a special kind of leadership  to challenge regulatory authority when a credit union has been wronged. The process takes time, resources and distracts from the primary job of serving members.  The emotional toll can be telling as well.

Every credit union knows the examiners will be back in another 12 months and the agency is always tempted to prove they were right.   The fact that the board was willing to take this appeal and support the credit union’s position is an important check and balance that has been long absent in NCUA examination and supervisory actions.

A Worrisome Dissent

The dissent by chairman Harper presents interesting logic.  He writes:  “Although the process by which the credit union received its report and rating was inconsistent and flawed,³¹ an inconsistent and flawed process can still produce a reasonable and supportable result.”

An NCUA chairman seeing an “inconsistent and flawed process” should have set off alarm bells about the agency’s entire examination effort, not to mention the internal review process.

Moreover, if the means to an end are found deficient, how does one justify the end result or, in this case CAMEL assignment? That is the arbitrary moment that many credit unions have experienced in examinations.

For data and logic are the way sound judgments are supported.   This is a critical skill for examiner effectiveness in their credit union dialogues.   It should be modeled at the highest levels in the Agency, not asserted using one’s position of presumed authority.

Following are two additional references from the Order presenting the distinction between regulations and guidance,  which were used by Board:

²⁵ NCUA’s regulations, Part 791, Subpart B, reiterates the distinctions between regulations and guidance and prohibits examiners from criticizing (through the issuance of DORs and supervisory recommendations) a supervised credit union for a “violation” of, or “non-compliance” with, supervisory guidance. The NCUA’s National Supervision Policy Manual requires examiners to cite to the specific section of the Federal Credit Union Act, NCUA regulations, Federal Credit Union Bylaws, or other authority and (if the credit union violates more than one) to cite the highest authority.

²⁶ Of the DORs included in Petitioner’s exam report, 2 of 5 DORs included specific regulatory citations, while 3 of 5 included only general or incomplete citations.

 

 

On November 5^th, Pomona Postal FCU, founded in 1964, became NCUA’s  fifth conservatorship of 2021.

The Credit Union Times story contained this standard explanation:

The NCUA issued a media release and other information, showing the agency took possession and control of the insured credit union to conserve its assets, protect the National Credit Union Share Insurance Fund, and resolve operational problems that could affect the credit union’s safety and soundness.

At September 30,  this $4.2 million credit union reported a net worth of 6.86%–down .01bps from a year earlier; an ROA of .48, delinquency of $33,184 covered by an allowance of $41,000.

The Critical Question

This action raises again the ultimate question, Why?  The $20 billion NCUSIF had to be “protected” from the deprecations of this $4.4 million monster disguised in tiny sheep’s clothing?

Or, as typical of other small credit union seizures, will we learn from court records (years from now) that there has been a long, on-going pattern of misdeeds in this two-employee firm, overlooked in multiple past annual NCUA exams?

Or, perhaps it is just examiner and regional office frustration that their supervision has been unable to stabilize a slowly declining financial picture?

Both options are troubling. The failure of NCUA to be transparent in the use of its most absolute authority is itself a symptom of the real issue.

If NCUA is unable to supervise this credit union speck in the $2.2 trillion system, how can anyone have confidence in their oversight of a $40 or $400 million, let alone a $4.0 billion entity.

The irony of NCUA’s explanation is stunning.  For if true that this $4.4 million was taken over to protect the insurance fund, the greatest danger to the system is not from credit union malfeasance or failures; rather it is NCUA’s incompetence.

It is time for the agency to drop the bureaucratic doublespeak and start giving straight talk about its actions. For the issue is not what happened at Pomona Postal but why the agency feels so compelled to cover up its most important responsibility.

 

 

From a retired 30-year CEO commenting on NCUA’s oversight of loans to credit union executives and directors- (2021).

“I hope NCUA has improved their guidance for loans to Management and the Board of Directors.  We merged with a credit union that had a policy that Board members, management and their families could borrow $100,000 each unsecured.  When we merged with them we found the Manager, his wife and two sons each borrowed $100,000 as well as the Asst Manager and two directors.

Each went bankrupt and the loans were never paid. When I challenged NCUA, CUMIS and our lawyers, they all said since they went bankrupt, we could not collect from them as long as the Board approved the policy allowing them to borrow up to $100,000 each unsecured.  NCUA should have a policy that officials cannot have special terms that the members do not have. “

Changing Role of the Regulator: A  Relationship That Should Be Based on Mutual Respect (1984)

“. . . it seemed as though we would never escape the attitude that the regulator knows best. . . A dramatic change has taken place in the last few years.  We now have a federal regulatory agency which openly concedes that credit union people know more about running credit unions than the agency does. . .

The relationship between credit unions and the regulatory agency is one founded on mutual self-respect, and on the realization that both sides share equally in the responsibility for the survival and future development of credit unions. . .

The nature of the federal bureaucracy being what it is. . .there will be a great amount of inertia to cause it to revert a less creative and less cooperative approach to regulating credit unions. 

I would not like to see that happen.”

Frank Wielga, CEO Pennsylvania State Employees credit Union. Source: NCUA 1984 Annual Report

 

In Illinois, the initial state credit union act prohibited officers and directors from borrowing from their own credit union.   The act authorized chapter credit unions  to meet those official’s needs as well as serve members of any groups too small to form their own credit union.

When I became Illinois credit union supervisor in 1977, this restriction had been removed.  However the concept that persons managing money should be subject to special scrutiny remained.   As one colleague noted, one aspect of our job was to keep honest people honest.

Examiner Norman Glazer

Illinois conducted an annual exam of its 1,000 plus charters.   An important part of the onsite visit was reviewing all official family loans, their relatives and the travel and other expenses they charged the credit union.

Examiner Normal Glazer looked like a bookkeeper.  He wore wire rimmed glasses, was slight of stature, talked in subdued tones and was a long-time state employee.   He was  a very thorough examiner, who knew accounting and more importantly, the many ways that humans might conceal wrongdoing.

I asked him how he reviewed the loan and savings verifications looking for fictitious accounts.  It was simple-he selected a sample of each, and then looked up the names in the phone book.  If there was no name, he dug further.

Among Norman’s discoveries was a $1.0 million embezzlement from the Scott Foresman Credit Union where the manager kept a double set of books and accounting ledger cards.  When Norman’s tape of the individual ledger cards did not match the GL total, he sensed something was wrong. He refused to accept the “missing cards” explanation and found a completely separate set of ledgers with which he documented the full amount of the loss.  CUMIS paid the claim he substantiated.

Human Nature Has Not Changed

I cite this Illinois examination practice in support of Board member McWatters and others who have publicly observed that fraud is the most common cause of NCUSIF’s losses.

The historical concern about senior managers and directors engaging in self-dealing has a 5300 call report “echo.”   Account codes 995 and 996 show the number of loans and total dollar amount to this leadership group.   The table below lists the top 20 credit unions by highest average loan balance with total loan numbers and balances as one way of reviewing the data.

This table shows wide variations in this activity even among these 20.  The list by itself might prompt some obvious questions; however, the point is NCUA still believes this is an activity for ongoing monitoring—or is it?

Job # 1

NCUA’s largest budgeted amounts and the majority of its workforce are dedicated to  on-site exams. One assumes all loans, family related transactions and the expenditures charged by senior staff and directors to the credit union would be reviewed as normal exam protocol.

Reporter Peter Strozniak of the Credit Union Times regularly follows NCUA’s legal filings and court documents. From these records he describes the details of these internal thefts and other employee/director wrongdoing, unfortunately years after the credit unions’ failure.  These detailed accounts show that examiners have overlooked extended periods of self-dealing.

A recent example is from the Time’s report of NCUA’s suing CUMIS for recoveries from Melrose Credit Union’s CEO.  His October 15, 2021 story described one NCUA claim:

Prior to his 1998 retirement, Herb Kaufman, Kaufman’s father, was Melrose CEO and served as the board’s treasurer. In May of that year, Herb Kaufman became an independent consultant to Melrose under the terms of what the NCUA described as an unusual three-page agreement, which was signed by only one member of the board who turned out to be a life-long and close friend of Herb Kaufman.

The agreement contained a one-year renewable term that paid Herb Kaufman $5,600 a month for his services.

“Despite his obvious conflict of interest, Kaufman aggregated solely to himself the over site within the Melrose Consulting Agreement with his father,” the NCUA lawsuit reads. “Thereafter for more than 18 years, Kaufman covertly caused the renewal of his father’s Consulting Agreement without ever informing the Melrose board or otherwise bringing its continued existence to the attention of the Board.”

According to the NCUA, Herb Kaufman was paid $1,239,795 over 18 years and failed to generate any business for Melrose or provide any meaningful consulting services to the credit union. What’s more, Melrose also paid Herb Kaufman’s travel expenses of more than $26,000 even though his consulting agreement stipulated the travel expenses were to be paid by Herb Kaufman.

The facts offered by NCUA say the Melrose President paid his father (the retired CEO) for 18 years without a fully approved contract.

Assuming an annual NCUA and state exam, this arrangement went un-noted for almost two decades.  How could this be?  Same last name, monthly checks, a written agreement-it raises the question of what do examiners look at?   And NCUA is asking CUMIS to pay up because the bond company should have detected this?

This is not the first time NCUA has sued CUMIS for credit union failures.

On April 23, 2010 NCUA placed the East Lake, Ohio-based St. Paul Croatian FCU in conservatorship  with an estimated loss of $170 million, or almost the entire amount of insured shares balance. Loan fraud was among the primary reason for the CU’s collapse.

The IG significant loss report stated:

At St. Paul Croatian FCU, examiners didn’t assess the weakness of the credit union’s internal controls and failed to ensure that the credit union took corrective action on document of resolution issues.

How does NCUA atone for its exam failures?  The CU Times report:  The NCUA filed a proof of loss claim with CUMIS for nearly $72.5 million (St Paul Croatian FCU). However, because CUMIS’ fidelity bond has a $5 million coverage limit, the amount of money in dispute would be less than 7% of that figure, said Phil Tschudy, a CUNA Mutual Group spokesman.

Between this 2010 St. Paul failure and the October 2021 CUMIS suit for Melrose recovery, there have been repeated cases of significant examination failures over multiple exam cycles.   Three of these are described in this post.    The information, all from court proceedings, documents CEO embezzlements lasting years.  In the CBS Employees FCU case, the CEO fraud extended for two decades resulting in an estimated $40 million loss to the members.

NCUA’s Two-foldProblem

These recurring, costly examples, suggest that NCUA is not doing well its number one job of examination.  Examiners should be given a whole new process  and trained on reviewing self-dealing activity.

But it is hard for NCUA to fix a problem that is hidden from public scrutiny until years after the fact.

A second challenge is NCUA’s lack of transparency.  It provides no information on its supervisory actions.  The agency has said nothing about its current conservatorships, one of which is over $4billion in assets. But then years later court proceedings show how extensive and elongated the pattern of misconduct and coincident examination shortcomings were.

Generalized IG critiques of exam failures provide no details of the examiner oversights or  any mention of accountability.   The response to IG findings is by the same people responsible for the entire process in the first place.

Accomplishing Job # 1

With all the recent public remarks by NCUA leadership about cyber ransomware, cryptocurrency, DEI, climate change and other current “risk” topics, the agency seems unable to perform its most important, historically necessary, oversight function effectively.

Examinations produce pages of financial statements, ratios and trends, and checked boxes for policy adequacy.  Almost 97% of credit union assets are held by Code 1 and 2 rated credit unions.  The biggest risks are internal, not on the balance sheet.

Examiners should be training for conversations about all forms of self-dealing to see who approved what, when and why.  These discussions should be part of the exam record.  The topics should be raised and documented in the board exit conference.  Without putting these activities in the light of day during exams, everyone presumes it’s OK to keep questionable activities in the dark, and out of the record.

Where is Norman Glazer when credit unions need his sixth sense, or rather common sense?  For example he might look at the table above and ponder why are real estate loans to senior credit union personnel so much larger in the lower priced Midwestern states than in any of the more expensive big city coastal markets?

I know he would have challenged a $35 million dollar sinecure committed to a newly organized non-profit by two merging credit unions to support the “advocacy” activities of the CEO who arranged the merger.

The fiduciary concepts of care and loyalty would appear to have been erased from NCUA’s examination and supervision process a long time ago.

Credit union members pay the costs of these failures. However in the long run its is the public reputation of NCUA and the system that is at risk when examinations miss the obvious.