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Longer exam cycle not trickling down to all eligible credit unions

Not all credit unions that qualify for an extended exam cycle from the National Credit Union Administration are getting it.

That’s according to a recent report from the National Association of Federally-Insured Credit Unions, which found that fewer than half of eligible credit unions are on an extended exam cycle. In 2017, NCUA announced it expected to fully implement extended exam cycles for all qualifying institutions by the close of 2019.

In order to qualify for the transition from a 12-month exam cycle to an 18-month rotation, credit unions must hold less than $1 billion in assets, maintain a Camel code of 1 or 2 in both the composite and management ratings, and be considered well-capitalized. Additionally, credit unions must not hold any outstanding documents of resolution from NCUA related to deficiencies in their recordkeeping. Institutions under enforcement or administrative orders from the agency are also disqualified.

“These findings suggest that the promised efficiencies of virtual examinations and other initiatives have yet to be fully realized,” the NAFCU report reads.

For its part, NCUA says the regulator “fully implemented its extended examination policy in 2019, and the agency retains the authority to make exceptions when necessary.”

So why aren’t all qualifying credit unions receiving the benefits of a longer exam cycle? Carrie Hunt, NAFCU’s EVP of government affairs and general counsel, suggested a confluence of factors. For one thing, since the announcement that some CUs could qualify for longer exam timelines, the agency has undergone a large-scale restructuring effort that included shuttering 40% of its examiner offices. Attempts to increase the use of remote exam technologies have also been implemented, but only in limited amounts.

“I think NUCA's limited resources, to the extent they’re focused on implementing those initiatives, has an impact,” said Hunt.

She added, “NCUA has a very risk-averse approach to what they do. They are a safety-and-soundness regulator and also a functional regulator, but I think they put the safety-and-soundness first, and that represents a very conservative approach.”

Some credit unions who say they should qualify for the new cycle remain stuck on a 12-month rotation.

“I’m told that we qualify for an extended exam, but we have yet to be notified,” said Brian Clark, CEO of Virginia Beach Schools Federal Credit Union.

Examinations have been a long-standing pain point for credit unions involved. They’re often viewed as disruptive, since they can stretch out for weeks and pull resources away from serving members.

“An exam is a pretty hectic event and it takes a lot of time, a lot of preparation, a lot of resources and a lot of manpower,” Clark said. “And if you can do that twice every three years instead of three times every three years, then certainly it will be a help.”

Clark said examiners are typically on-site for about a week.

Making matters worse, NAFCU’s report shows that when exams do happen, credit unions are seeing more examiners in their shops for longer periods of time, regardless of whether those institutions are on a 12- or 18-month timeline.

NAFCU found that the number of on-site examiners rose from 6.5 in 2018 to 6.8 in 2019, a 4.5% increase. Similarly, the average exam length went from from 12.9 days to 13.1 days, a 1.5% lift.

‘Low-hanging fruit’?

Many credit unions previously enjoyed an 18-month exam cycle but NCUA shortened the space between visits to 12 months following the financial crisis. The decision to return to year-and-a-half intervals came on the basis that any safety-and-soundness concerns within the industry were not widespread, and there were no indications of major economic problems on the horizon.

North Jersey Federal Credit Union remains on a 12-month exam cycle, and Chief Financial Officer Luke Zimmerman claimed NCUA is “pulling the low-hanging fruit for those that are performing well and have a vanilla portfolio” for the extended cycles. He added that NCUA may need to sort out other administrative issues before it pivots additional CUs to the 18-month rotation.

The $212 million-asset North Jersey and other credit unions in the wider New York area could be perceived as riskier since they have higher potential for taxi medallion exposure. The credit union declined to comment on the amount of lending it has done in that arena, but representatives emphasized it has not taken on additional medallion loans in recent years.

“We had very limited exposure,” Zimmermann said.

The credit union declined to share its Camel rating and did not confirm if it meets all of NCUA’s criteria to qualify for an 18-month timeline.

While some CUs that qualify for new lengthened exam cycle are still waiting, NAFCU and other groups have begun pressing the regulator to up the threshold from $1 billion to $3 billion, the current benchmark for 18-month exam schedules at banks. While there has been no indication that NCUA is considering that change, Hunt suggested a shift to $3 billion is at least a possibility.

“That was a decision made by a different NCUA board, so there’s an opportunity to have that looked at again,” she said.

Others, however, indicated that a possible economic downturn in the coming years could limit any additional moves to raise the threshold or qualify more institutions. A recession could increase the industry’s risk profile, including a rise in credit risk. Members who fall victim to job losses, layoffs or lower incomes are more likely to have an increase in delinquent loans, which could lead to chargeoffs.

"A recession is the wild card here since ultimately exams are focused on safety and soundness,” said Vincent Hui, managing director at Cornerstone Advisors.

So if a recession is looming, credit unions may not be heading toward an extended exam cycle even if they meet all of NCUA’s criteria.

Credit unions say there is still plenty of room for improvement even if they’re stuck in a 12-month exam cycle.

Virginia Beach Schools FCU’s Clark lamented that in previous years CUs became familiar with their lead examiners over an extended period of time. Now, he said, “it seems like there’s a new lead examiner every year.”

And he said the process has improved overall, in part because additional preparations before exams start have made the visits feel much less intrusive.

“It’s a much less adversarial interaction and more cooperative,” he said. “It used to be that you felt like they were coming in to try and find something – they were coming in and trying to get you.”

Aaron Passman contributed to this report.

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