Compliance Update with Amy K
by Amy Kleinschmit
Chief Compliance Officer
10/3/2019

NCUA Final Rules

At the National Credit Union Administration (NCUA) recent board meeting, the board approved the following three final rules: Supervisory Committee Audits, Payday Alternative Loans (PAL II), and FCU Bylaws. The PAL II rule becomes effective 60 days after it is published in the federal register, while the other two are effective 90 days after publication.

Supervisory Committee Audits

With regard to Part 715 Supervisory Committee Audits, the final rule eliminates two audit options, specifically, the Balance Sheet Audit option in §715.7(a) and the Report on Examination of Internal Controls Over Call Reporting in §715.7(b). These were both options for Federally Insured credit unions with assets less than $500 million.

The final rule also removed the 120-day report delivery deadline in §715.9(c)(6) from the required terms for audit engagement letters with outside, compensated persons. As explained by the NCUA, “The Board believes that this amendment will provide enhanced flexibility and potential cost savings, without any adverse impact to the auditing process. Although audit due dates may now vary across the industry, the regulation will continue to require annual audits, which provides substantial uniformity.”

Finally, the final rule removes references to the NCUA’s Supervisory Committee Guide in §715.7 and replaces it with a new appendix covering minimum supervisory committee audit requirements. The NCUA found the Supervisory Committee Guide to be outdated and the minimum areas of review will be now incorporated into the regulation. The NCUA will replace the Supervisory Committee Guide with reference materials on audit procedures to aid in performing the areas of review in the Appendix.

The new appendix – “Supervisory Committee Audit – Minimum Procedures” provides that, “this option may not be adequate for all credit unions as it is designed for smaller, less complex credit unions. The supervisory committee, internal auditor, or other qualified person may also need to perform additional procedures to supplement these minimum procedures if the specific circumstances of a particular credit union so dictate.”

The minimum areas of review include:

  • Review Board of Director minutes to determine whether there are any material changes to the credit union’s activities or condition that are relevant to the areas to be reviewed in the audit;
  • Test and confirm material asset and liability accounts including, at a minimum: Loans; Cash on deposit; Investments; Shares; Borrowings;
  • Test material equity, income, and expense accounts;
  • Test for unrecorded liabilities;
  • Review key internal controls including, at a minimum: Bank reconciliation procedures; Cash controls; Dormant account controls; Wire and ACH transfer controls; Loan approval and disbursement procedures; Controls over accounts of employees and officials; Other real estate owned; Foreclosed and repossessed assets;  
  • Test the mathematical accuracy of the allowance for loan and lease loss account and ensure the methodology is properly applied; and
  • Test loan delinquency and charge-offs.

Payday Alternative Loans II (PALII) 

The NCUA also finalized an additional payday alternative loan rule (PAL II) to allow FCUs to offer an alternative to traditional payday loan products. This rule can be found here. This rule does not replace the first PAL product that was made available to FCUs in 2010. The PALs II final rule retained certain features and modified some features of the PALs I rule to encourage additional FCUs to offer PALs II loans as an alternative to predatory payday loans and to meet the needs of certain payday loan borrowers that may not be met by PALs I loans.

The PALs II allows an FCU to make a PALs II loan for a loan amount up to $2,000 without any minimum loan amount. The PALs I rule currently limits PALs I loan amounts to a minimum of $200 and a maximum of $1,000.

The PALs II loan must carry a loan term of at least 1 month with a maximum loan maturity of 12 months. The PALs I rule currently limits PALs I loan maturities to a maximum term of 6 months.

The final rule also allows FCUs to make a PALs II loan to any member regardless of the length of membership. The PALs I rule currently requires a borrower to be a member of the credit union for at least one month before receiving a PALs I loan.

The final rule adds that FCUs are prohibited from charging any overdraft or nonsufficient funds (NSF) fees in connection with any PALs II loan payment drawn against a borrower’s account. This includes overdraft fees or NSF fees that an FCU could assess against the borrower for paying items presented for payment after the PALs II loan payment creates a negative balance in the borrower’s account.

Some product features from PAL I that were carried forward to PAL II, include the requirement that an FCU may only offer one type of PALs loan to a member at any given time. Prohibition against rollovers, the limitation on the number of PALs loans that an FCU can make to a single borrower in a given period, and the requirement that each PALs II loan fully amortize over the life of the loan.

Another provision in PAL II that is carried over from PAL I is that an FCU may charge a reasonable application fee to all members applying for a new payday alternative loan offered that reflects the actual costs associated with processing the application, but that in no case exceeds $20.

The discussion in the final rule expands on the interpretation of “application fee.” This is important to note, as this comes from Regulation Z and is not limited to the PAL program. As the NCUA explains, “The Board interprets the term ‘application fee,’ as used in the PALs I rule, consistently with that of the CFPB’s Regulation Z. Accordingly, in order to qualify as an ‘application fee’ under the PALs I rule, an FCU must use the charge to recover actual costs associated with processing an individual application for credit such as credit reports, credit investigations, and appraisals. An application fee that exceeds the actual cost of processing a borrower’s application is a finance charge under Regulation Z that must be included in the APR and measured against the usury ceiling in the NCUA’s rules.”

Regulation Z, 1026.4(c)(1) provides, “(c) Charges excluded from the finance charge. The following charges are not finance charges: (1) Application fees charged to all applicants for credit, whether or not credit is actually extended.” Official Interpretation Paragraph 4(c)(1) – “1. Application fees. An application fee that is excluded from the finance charge is a charge to recover the costs associated with processing applications for credit. The fee may cover the costs of services such as credit reports, credit investigations, and appraisals. The creditor is free to impose the fee in only certain of its loan programs, such as mortgage loans. However, if the fee is to be excluded from the finance charge under §1026.4(c)(1), it must be charged to all applicants, not just to applicants who are approved or who actually receive credit.”

The discussion in the final rule goes on to address other concerns of commenters. “Other commenters asked the Board to clarify whether an application fee may reflect staff and technology costs, investing in loan processing automation, third-party service provider costs, and advertising. As noted above, the Board interprets the term “application fee” in the PALs I rule consistently with Regulation Z. An application fee must reflect the actual and direct costs associated with processing an individual application. While certain third-party service provider costs may be included in the application fee, especially if the FCU offers a PALs loan through a third-party vendor and passes any costs associated with using that vendor onto the member borrower, the Board does not believe that other costs, such as investing in loan processing automation or advertising costs, are actual and direct costs associated with processing a borrower’s application. Rather, these costs are general business expenses incurred as part of credit union operations and do not relate to costs specifically incurred processing a borrower’s PALs loan application.”

During the board meeting, the NCUA attorneys presenting this final rule to the Board remarked that if there is no underwriting or application processing there should not be an application fee or it should be commensurate with the minor amount of work done. (NCUA board meeting video, starting at minute 78).

FCU Bylaws

Finally, the NCUA approved a final rule to update, clarify and simplify the Federal Credit Union Bylaws (FCU Bylaws). That final rule can be found here.

As discussed in the final rule, “the new bylaw amendments are simply a resource that is available to all FCUs, regardless of size. Except for newly chartered FCUs, there is nothing prescriptive or mandatory about this final rule. All FCUs are free to adopt the new bylaws, retain their current bylaws, or adopt some combination of the bylaws and their current bylaws.” However, if a FCU chooses a combination of old and new bylaws, proceed with caution and you run the risk of having inconsistent or conflicting provisions. A few of the changes are highlighted below.

The final rule revises Article II. Qualifications for Membership, by adding new Section 5 that defines “member in good standing” which relates to limitation of services policy. As described in the final rule, “A member in good standing retains all their rights and privileges in the credit union. A member in good standing is a member who maintains at least the minimum share set forth in Article III, Section 1 of these bylaws; who is not significantly delinquent on any credit union loan; who has not had any account with this credit union closed due to abuse or negligent behavior; who has not caused a financial loss to this credit union; and who has not engaged in violent, belligerent, disruptive, or abusive activities, such as: (1) Violence, intimidation, threats, harassment, or physical or verbal abuse of duly elected or appointed officials or employees of the credit union, members, or agents of the credit union. This includes actions while on credit union premises and through use of telephone, mail, email or other electronic method. (2) Causes or threatens damage to credit union property. (3) Unauthorized use or access of credit union property. (4) Knowingly disseminating incorrect, misleading, confidential, or proprietary information regarding the credit union. (5) Any actions that may cause material risk or financial harm to the credit union.”

The provision goes on to note, “A credit union may limit services for violent, belligerent, disruptive, or abusive activities only if there is a logical relationship between the objectionable activities and the services to be suspended. In the event of a suspension of service, the member will be notified of what accounts or services have been discontinued.”

Members not in good standing retain their right to attend, participate, and vote at the annual and special meetings of the members and maintain a share account. To expel a member, the FCU must follow the FCU Act and Article XIV of its bylaws. To expel a member, the credit union must call a special meeting of the members; provide the member the opportunity to be heard; and obtain a two-thirds vote of the members present at the special meeting.

However, in the preamble of the final rule the NCUA board clarified that, “it believes that, without question, certain actions warrant immediate limitation of services or access to credit union facilities, such as violence against other credit union members or credit union staff in the credit union facility or the surrounding property. Other actions, such as rude behavior or potential threats of violence, may warrant limitation of services or restrictions on access to credit union facilities based on the specific facts and circumstances. The Board notes that, in addition to the rights granted under Article II, an FCU may immediately take actions such as contacting local law enforcement, seeking a restraining order, or pursuing other lawful means, to protect the credit union, credit union members, and staff. Nothing in the FCU Act or the FCU Bylaws prevents an FCU from using whatever lawful means it deems necessary to address circumstances in which a member poses a risk of harm to the FCU, its members, or its staff.”

The final rule also adopts staff commentary that further expands on this discussion into the model bylaws.

Another change is found under Article III. Shares of Members, the final rule adopted a provision allowing for establishing differing par values for different classes of members or types of accounts (such as students, minors, or non-natural persons), provided this action does not violate any federal, state or local antidiscrimination laws.

The final rule also provides that to establish membership, the member must subscribe to one par value of share. However, the share does not have to be in a regular share account. The board may choose the best account for the characteristics of its membership. The bylaws include two options. One option requires the member to have a regular share account to open membership, and one option allows them to use any other account. The board may select which option to use. If the board does not select an option, the member must have a regular share account to open an account. Please note, if the board selects an account other than the regular share, the requirements of Article III, § 3 still apply. The member must maintain one share to remain a member.

With regard to Article VI. Board of Directors, provisions and staff commentary have been added relating to Director emeritus positions and associate directors’ positions. The decision to establish a director emeritus position and/or an associate director position is within the discretion of the FCU’s board.

As always, CUAD members may contact Amy Kleinschmit with any compliance related questions.

 

 

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