It’s Ten O’Clock. Do You Know What Your CUSO is Doing?

Many have heard that the NCUA is setting its sights on CUSOs because CUSOs are playing a more important and influential role in the credit union industry. You may have read the transcript of Chairman Matz’s testimony before the Senate, or you are experiencing it first hand with a zealous examiner shining his or her magnifying glass on your CUSO. Either way, are you prepared for the potential extra focus on your CUSO and will you be able to quickly answer all questions with the necessary and relevant information, or will you look like a deer in headlights?

As you know, Chairman Matz recently spoke before the Senate Banking, Housing and Urban Affairs Committee and stated that she would like regulatory authority over credit union vendors. She explained that such oversight would likely have stemmed the tide of this financial crisis. Although this is a broad statement, we can surmise that the NCUA may ask Congress for direct supervisory authority over CUSOs in the near future. For years, CUSOs have been serving credit unions in many different capacities enabling credit unions to use innovative ways to better provide services to their members. In addition, credit unions have collaborated within CUSOs to drive down operating costs and increase non-interest income. It has really been a blessing for the industry. CUSOs have saved and made millions of dollars for the credit union industry. The benefits of CUSOs are undeniable.

Now, it would appear that the NCUA would like to provide some closer parental guidance. The fact is that the NCUA already has access to CUSOs right now through their owner credit unions. Under Part 712 of the NCUA regulations, the NCUA may examine the books and records of a CUSO, but only to determine if the CUSO is a legal investment and the effect such CUSO poses to the safety and soundness of its owner credit unions. This means that the NCUA can, through an examination of an owner credit union, review a CUSO. Credit unions need to be prepared to answer examiner questions when they do.

The first and most important point is that most of the information an examiner is trained to request during a CUSO “examination” is not mandated by regulation. The NCUA currently requires credit unions to grant them access to the books and records of a CUSO they own and the examiner is charged with ensuring that the CUSO is sufficiently organized to limit the credit union’s liability exposure to such credit union’s investment. This, ultimately, becomes a question of whether the CUSO is a legal separate entity from the credit union such that if there were claims made against the CUSO, the credit union would not be liable for them. There is also some consideration given to the criticality of the service to the credit union to prevent debilitating effects on the credit unions core services if such CUSO were unable to continue to perform.

Although the NCUA review of a CUSO is limited, this does not mean that a CUSO should stonewall an examiner, but this does mean that an examiner has no authority to directly regulate how a CUSO conducts its business activities. In most instances, you should work with the examiner to explain the permissible services provided by your CUSO. This process should also highlight how your CUSO is helping the credit union owners minimize costs and generate income. You should explain, with confidence, the policies and procedures that your CUSO follows in accordance with the regulations and any applicable state or federal laws.

Often the role of a CUSO is misunderstood by an examiner and you should be in a position to communicate clearly the CUSOs services to assuage any concerns of the examiner. Let me give an example of a misunderstanding that could damage your CUSO’s reputation and potentially handcuff your CUSO’s ability to provide services. Imagine a CUSO that is providing underwriting services for member business loans, where the CUSO is referred applications for a small business loan and the CUSO underwrites that application resulting in a recommendation to the credit union as to whether the loan meets the credit unions pre-approved standards for a similar loan. Now, the examiner steps in and says that the CUSO cannot make such a recommendation because the credit union must make the lending decision. The examiner is correct that a credit union must make the lending decision, but I would ask the examiner if this criticism is rightly placed on the CUSO. A CUSO is permitted to provide underwriting services to credit unions and is permitted to make recommendations to a credit union that a loan meets the pre-approved underwriting standards of such credit union. It is the credit union’s job to have policies and procedures in place to make the lending decision. If you are not prepared for such an explanation, you may find that your CUSO’s credibility is damaged by the examiner’s criticism and that your CUSO is hampered by this arbitrary limitation on the services your CUSO provides.

Often what is underlying the questions and criticisms in an exam is that the examiner simply does not like or understand the services that are being provided. In the above example, it is possible the examiner did not think the underwriting was done well enough. But in the end, an examiner does not have authority to tell a CUSO how to run its business. He or she can only instruct a credit union to make sure the services it receives from CUSOs and other third party vendors conform to credit union policies and procedures. Therefore, the examiner tries to limit the CUSO’s ability to provide services and too often the CUSO conforms without question to the examiners will.

So, what questions should you be asking yourself if, and when, the NCUA focuses on your CUSO? The most important question you should be asking yourself is whether your CUSO is conducting a permissible service. Part 712.5 of the NCUA regulations sets forth the permitted services a CUSO may perform. Many CUSOs started out for one purpose or to provide a particular service but after some time passes this CUSO may be providing completely different services. Maybe you invested in a CUSO that was already in existence and you did so along with the presumption that the current owners determined if the service was permissible. You and your legal counsel should review the services your CUSO is currently providing and determine if those services are permitted under the regulations.

Next, you should have a clear picture of the CUSO clients and ensure that the CUSO is primarily serving credit unions and credit union members. This will involve a summary of the CUSO’s books and records showing that more than 50% of the CUSO’s business is serving credit unions or their members. The means of calculating the customer base is not specifically prescribed by the NCUA; therefore, you could, for example, calculate this by looking at the total number of clients served or by looking at the total gross revenue generated. There may be several ways to determine if the CUSO primarily serves credit unions or their members, but you should be confident in how this calculation is performed before the examination, so you can explain this calculation to the examiner along with why it is the most relevant means to measure the customer base.

Another question you should ask yourself is has your credit union exceeded its statutory limitation on the amount of investments in CUSOs. If the credit union has a federal charter, such credit union cannot invest more than 1% of its paid in and unimpaired capital in CUSOs in the aggregate. Such credit union also cannot loan more than 1% of its paid in and unimpaired capital in CUSOs in the aggregate. You must keep in mind that this limitation can change annually based on the performance of your credit union in the past year, but that this limitation is not affected by any gains or losses on previous CUSO investments.

Finally, you need all your documentation in place. I think it is good practice to have a disk or folder with all the appropriate documentation in one easy to access place. You definitely do not want to be looking for documentation and paperwork while the examiner is standing there. Furthermore, you need to ensure that the documentation matches what actually happens on a daily basis. I cannot tell you how many times I have been asked a question and my response is “what does the agreement say?” which is quickly followed by silence. In preparation for any exam, you need to have all of your paperwork in place and you need to know that its content matches your daily operations.

With the increasing scrutiny on CUSOs from the NCUA, you should do a legal and business audit of your CUSO. This process will provide you with all of the necessary preparations for a CUSO review by the NCUA and give you the confidence you need to communicate with an examiner about your CUSO and the benefits it provides your credit union.

Brian G. Lauer is a partner with Messick & Lauer PC in Media, PA. He can be reached at 610-891-9000 or