ALEXANDRIA, Va.–In an effort to make it easier for credit unions to partner with fintechs and CUSOs, the NCUA board has voted 3-0 in favor of putting out for comment a proposal that would amend the agency’s rule regarding the purchase sale and pledge of eligible obligations, including notes of liquidating credit unions, as well as its rules on non-participations and lines of credit to members.
The proposal—which NCUA Vice Chairman Kyle Hauptman said is aimed at addressing the fact credit unions are the “left-handers” of the financial services market--seeks to clarify that credit unions that acquire loans through an indirect lending relationship, such as from fintechs, could qualify as the originating lender and be eligible to participate the loan to other institutions.
Currently, the agency’s loan purchasing regulations only allow a federal credit union to purchase the loans of its members from any source up to 5% of the purchasing federal credit union’s unimpaired capital and surplus, with some exceptions Board Member Rodney Hood called “cumbersome to understand.”
According to NCUA, the goal of the proposed rule—which has been long championed by Hood—is also to provide “additional flexibilities” to credit unions to manage their balance sheets, including the ability to customize loan purchase programs.
Agency staff said that includes providing credit unions with expanded abilities to use emerging technologies, such as fintechs, in order to give CUs the ability to appropriately address emerging and innovative technologies.
Officially, the proposal is Proposed Rule, Parts 701 and 714, Financial Innovation – Loan Participation, Eligible Obligations, and Notes of Liquidating Credit Unions, and is aimed at taking more of a “principals-based approach” to rules, according to the agency.
It is now out for 60-day comment.
What’s Being Proposed
According to agency staff, the proposal would, among other things:
- Narrow the 5% limit to apply only to notes purchased from a liquidating credit union
- Would provide federal credit unions greater capacity related to the aggregate amount of the eligible obligations of members that may be purchased from any source
- Define the term liquidating credit union to be consistent with the terms used and other part of the NCAA's regulations and clarify the specific point in time when a credit union meets the definition of a liquidating credit union for the purposes of the 5% limit. Staff noted the term liquidating credit union is used but not defined in the current rule under the proposed rule.
“The 5% limit would apply only to notes purchased from a liquidating credit union, making it important for examiners and federal credit unions to know the specific point in time when a credit union meets the definition of a liquidating credit union,” agency staff said.
- Remove certain prescriptive limitations from the eligible obligations rule related to a federal credit union's purchase of certain non-member loans from other federally insured credit unions. Specifically, the proposed rule would remove the prescriptive requirements in the current eligible obligations rule that a FCU must receive a composite CAMELS rating of one or two for the last two full examinations and have maintained a capital classification of well capitalized under part 702 of the NCAA regulations for the six immediately preceding quarters in order to participate in purchasing and holding certain obligations.
- Set forth principals-based requirements to be addressed in an FCU’s loan purchases policies.
Harper: ‘We Have Met the Goal’
Harper noted that the focus on credit unions and fintech has been a priority for Board Member Rodney Hood, who led the creation of the NCUA’s Office of Financial Technology and Access. Harper credited both Hood and Hauptman for their roles in getting the financial innovation proposal in front of the board.
“The NCUA included in its 2022 Annual Performance Plan the strategic objective of evaluating and addressing barriers to adopting emerging financial technology by credit unions,” said Harper. “As a measure of success, the Annual Performance Plan had the metric of issuing at least one regulatory action related to financial technology and guidance about distributed ledger technology, which the agency issued in May. With today’s consideration of this proposed rule, I can officially say we have met that goal.”
Harper said information technology is found in all aspects of the financial services sector, including even small CUs, and that fintechs have led to new partnerships for loan participations and purchases, avenues to reach potential members, and new sources of liquidity.
“Since the 2013 loan participation final rule went into effect, the NCUA has received several inquiries from federal credit unions, fintech companies, and other parties expressing confusion about how to interpret the rule. This confusion has led to inconsistent reporting of loan interests by federal credit unions and uncertainty about which sections of regulations apply to certain transactions,” said Harper. “The fintech proposed rule before us today would clarify the NCUA’s current regulations to address these and other concerns. It would also provide flexibility for credit unions to take advantage of the benefits and opportunities provided by fintech firms.
“Specifically,” added Harper, “the proposal would remove current limits on purchases of eligible obligations and qualifying criteria for federal credit unions to purchase non-member loans from other credit unions. This would provide federal credit unions with expanded authority and autonomy to transact business with fintech companies and other institutions that offer services associated with the origination and sale of loans made to members of federal credit unions.”
Harper said the proposed changes bring the agency’s regulations into more of a principles-based approach, similar to its recent efforts related to derivatives.
“With this proposal, the prescriptive limits found in Section 701.23 of the NCUA’s regulations would be replaced with policy, due diligence, and risk management requirements that can be tailored to match the risk and planned activity,” the chairman said. “As I have emphasized before, credit unions should recognize and harness the potential opportunities fintechs may offer them. However, we must also acknowledge the potential risks they pose to credit unions, their members, and the system and develop appropriate guardrails. This proposed rule strikes that balance.”
Hauptman: CUs are the ‘Left-Handers of the World’
Hauptman called the proposal “ambitious.”
“My interest in credit union innovation is rooted in the belief that businesses must innovate to stay relevant,” Hauptman said. “Plus, credit unions are not top of mind for most fintechs, so anything their regulator can do to improve the process of working with them is critical. At the very least, we do not want fintechs – or any service provider – choosing not to work with credit unions because their regulator makes it unnecessarily difficult.”
Noting credit unions only hold about 10% of America’s insured deposits, the rest being in banks insured by the FDIC, Hauptman said it’s an “issue” because products marketed at banks sometimes need to be tweaked in order for credit unions to utilize them.
“Banks are 90% of the market, while credit unions are only 10%,” Hauptman said. “Credit unions are the left-handers of the world, if you will; the market focuses on the 90%, not the 10%. I think this is the frame we need to use when considering the costs and benefits of innovative technology.”
Much-Needed ‘Clarity’
Hauptman suggested the “clarity” intended by the proposal will help both NCUA and credit unions.
“In addition, the proposed changes are intended to give flexibility to credit unions that want to engage in lending activities related to financial technology companies, including loan participations and eligible obligations,” he said. “With greater flexibility, more credit unions will have the option to work with these lenders. Credit unions that may not have had the resources to manage the challenges around the current prescriptive rules will be able to tailor their programs to reflect their policies and goals.”
Hauptman called on those who plan to comment on the proposal to be as specific as possible with suggestions and concerns.
Hood: Pushes for Clarity on Several Issue
Hood noted in his comments that the proposed rule began under the premise fintech companies are originating significant numbers of consumer loans—and gaining share--and that credit unions want to effectively reach borrowers digitally by utilizing fintech.
“Are there ways the NCUA could provide additional clarity? The answer is yes, there are. Today’s proposed rule is the NCUA’s response,” Hood said.
He then posed a larger question moving forward: “How large is the loan participation market for credit unions and how has it grown over the last several years?”
In response, agency staff said loan participations purchased by credit unions stood at $59.7 billion as of Sept. 30, 2022, up from $20 billion on September 2015. Loan participations grew by 12% during 2020, 31.5% in 2021 and 20% in 2022, staff added.
Support for Call Report Changes
Hood said he supports making any additional changes to the call report that would “modernize it even further to address the changes that fintech is rapidly making to the industry. I think this also is imperative for us to have these data as a safety and soundness regulator. We may be surprised to learn how quickly the industry is evolving with more data.”
Hood called the need for credit unions to integrate fintech tools a “strategic imperative.”
“Fintech is particularly important when it comes to attracting a new generation of credit union members who are younger, more mobile, and more online,” Hood said. “Moreover, I believe fintech can be tremendously beneficial in terms of financial inclusion, to help us to extend financial services more broadly to underserved communities.”
Losing Marketshare
Hood said credit unions are currently losing market share to fintech companies, citing TransUnion data showing fintech loans comprise 41% of all unsecured personal loan balances, up from 5% of outstanding balances in 2013. During that same period, Hood said, the credit union market share for unsecured personal loan balances declined from 31% in 2013 to 21% in 2021. He added that preliminary research suggests fintechs are beginning to make significant inroads in mortgage and small business lending.
“These loans are mostly to previously underserved borrowers – lower conventional credit scores for consumer loans and zip codes with higher bankruptcy and unemployment rates for small business loans,” he said. “Part of this is traceable to creative use of alternative data in underwriting.”
A Needed Clarification
Hood said the agency’s current regulations have prescriptive limits for credit unions that have stymied CUs in working with fintechs.
“Today’s proposed rule…would clarify that credit unions that acquired loans through an indirect lending relationship, such as from fintechs, could qualify as the originating lender and be eligible to participate the loan to other institutions in an elegant way. This is important because one of the biggest and growing sources of loans in the financial marketplace is fintech originated loans.”
Hood said NCUA has heard from some who have expressed concern that eliminating the limits in the regulation and the requirement to be a well-run credit union causes safety and soundness concerns.
“This is particularly important in this regulation since a credit union can materially change its balance sheet structure in a very short period of time,” Hood said, before asking agency staff to outline steps being taken to minimize the risks.
Staff said the proposal seeks to provide a balance between risk and safety and soundness.
Clearer Definition
Hood also asked staff about the definition of terms.
“While we have a clear definition in this proposed rule for loan participation, we say in this rule an eligible obligation is essentially anything else that is not a loan participation. Can you discuss why it was drafted like this?” Hood asked.
In response, staff said they believe it is particularly important to hear from credit unions and other interested parties about the changes being proposed in this area, noting the market has expanded substantially and there seems to be “growing confusion” about when transactions involve purchases of loan participations or purchases of parts of eligible obligations.
“To address this issue and to maintain the full extent of authority allowed for under the Act, the proposed rule would make a number of carefully crafted changes to the current rules,” staff told the board. “Those changes include the amendment you mentioned to the definition of the term eligible obligation, as well as several changes to the introductory paragraphs for sections 701.22 and .23 regarding the scope and applicability of those sections. While the proposed rule would not amend the definition of the term loan participation, we believe the other proposed changes make the distinction between loan participations and eligible obligations more clear.”