ALEXANDRIA, Va. –NCUA spent nearly $40 million through year-end 2020 on its new MERIT examination tool, while the agency also has a number of specific statutory changes it would like to see from Congress, according to responses NCUA has provided to a U.S. senator.
As CUToday.info first reported here, Sen. Pat Toomey (R-PA) sent a letter to NCUA Chairman Todd Harper in early March with specific questions related to what is going on with the agency’s Modern Examination and Risk Identification Tool (MERIT), the Virtual Examination Project, and the National Credit Union Share Insurance Fund (NCUSIF).
In his response, Harper said the questions address some of his “top priorities” as chairman, and that NCUA’s “digital efficiency effort is a major part of the agency’s work to ensure effective oversight of the credit union industry.”
Here are the specific questions posed by Toomey and Harpers responses:
Toomey: When does the NCUA plan to officially launch MERIT or will the launch be delayed again?
Harper: The broader deployment of the NCUA’s MERIT program is currently planned for the summer of 2021. Given the state of the pandemic and the agency’s current off-site operational posture, the NCUA is evaluating options for the rollout, including virtual training. While we may need to adjust our training approach for 2021, our current plans are to deploy MERIT this year.
While we did not deploy MERIT fully in 2020 as originally planned, the agency expanded the pilot of MERIT to include more than 100 additional users. To date, more than 80 credit union exams and contacts were created in the MERIT system.
Toomey: How much did the NCUA anticipate this project would cost and has the budget increased since the announcement of the project? If so, why?
Harper: The NCUA’s current examination system, AIRES, is a custom-built system that is over 25 years old and based on outdated technology. Given the age of AIRES and the importance of an electronic examination system to the mission of the agency, priority was given to the development of its replacement, MERIT. The NCUA engaged in extensive market research to estimate the cost of the initial phases of the agency’s modernization efforts, including MERIT.
The research estimated a range of $18.9 to $37.9 million. Total spending through December 31, 2020 is $39.73 million. The costs increased due to higher than anticipated development and training costs, as well as an expansion of the project’s scope to include advanced financial analytics to improve how we efficiently assess the financial condition of the credit unions we supervise and insure. MERIT and the new related systems (new infrastructure and business intelligence analytics) will be continually improved in the operations and maintenance phase during MERIT’s lifecycle.
Toomey: Given the NCUA’s unique budgeting and contracting authority, how was the vendor selected for MERIT?
Harper: Similar to other federal financial services regulatory agencies, while the NCUA is not subject to the Federal Acquisition Regulation (FAR), our practices are based on the FAR and best practices from both the Federal government and non-governmental organizations.
The acquisition strategy for MERIT sought to ensure robust competition while employing Federal procurement best practices and processes. The contracting rules under which the NCUA operates allowed the agency to identify and directly solicit vendors determined to be the most capable of meeting the program objectives. Extensive market research identified more than 20 potential vendors, all of which were sent the Request for Proposal to compete for the project award.
Six vendors submitted written technical proposals to bid on the project. Based on a rigid review of the bid evaluation criteria, the NCUA eliminated bidders that did not meet the established standards and focused on the highest-rated bidders, which were those considered to have a reasonable chance of being selected for award. The NCUA engaged each of those bidders in discussions to address and resolve issues identified during the evaluation. Those bidders were also required to show how their product would perform under different scenarios. These demonstrations provided an opportunity for the NCUA to evaluate proposed solutions against the written proposals.
After reviewing the demonstrations and evaluating the written proposals, a best-value recommendation was made to the senior NCUA official designated to make the final contract award decision.
Toomey: How much of the NCUSIF covers operational expenses of the agency, and how has this evolved since the inception of the NCUSIF?
Harper: After the NCUSIF’s creation in 1971, the Government Accountability Office recommended the NCUA adopt a method for properly allocating Operating Budget costs—that is, the portion of the NCUA’s budget funded by requisitions from the NCUSIF and the portion covered by Operating Fees paid by federal credit unions.
The NCUA has since used an allocation methodology, known as the Overhead Transfer Rate (OTR), to determine how much of the Operating Budget to fund with a requisition from the NCUSIF.
The NCUA uses the OTR methodology to allocate agency expenses between these two primary funding sources. Specifically, the OTR is the formula the NCUA uses to allocate insurance-related expenses to the NCUSIF under Title II of the Federal Credit Union Act. Almost all other operating expenses are funded through annual Operating Fees paid by federal credit unions.
Two statutory provisions directly limit the Board’s discretion with respect to NCUSIF requisitions for the NCUA’s Operating Budget and, hence, the OTR. First, expenses funded from the NCUSIF must fulfill the purposes of Title II of the Federal Credit Union Act, which relate to share insurance. Second, the NCUA may not fund its entire Operating Budget through charges to the NCUSIF. The NCUA has not imposed additional policy or regulatory limitations on its discretion for determining the OTR.
The NCUA conducts a comprehensive workload analysis and reassesses the OTR annually. This analysis estimates the amount of time necessary to conduct examinations and supervise federally insured credit unions to fulfill the NCUA’s dual mission as insurer and regulator. The OTR is designed to cover the NCUA’s costs of examining and supervising the risk to the NCUSIF posed by all federally insured credit unions, as well as the costs of administering the fund. The OTR represents the percentage of the agency’s Operating Budget paid for by a transfer from the NCUSIF. The OTR methodology is approved by the Board, and the NCUA’s practice is to seek comments every three years on its methodology. The result of the annual OTR analysis is included in the NCUA’s annual budget presentation.
The total operating expenses of the NCUSIF were $181.1 million and $191.2 million in 2020 and 2019, respectively. Since the NCUSIF was fully capitalized in the mid-1980s, the OTR has borne between a low of 50.0 percent of the Operating Fund expenses in the mid-1980s, to a high of 73.1 percent in 2016. For 2021, the OTR rate is 62.3 percent.
Another metric by which to gauge the relative impact of operating expenses to the NCUSIF is the percentage of operating expenses over total fund assets. The expense-to-assets ratio for 2020 was 0.95 percent. Over the past decade, it has ranged between the current low of 0.95 percent and a high of 1.63 percent in 2016, with the 10-year expense-to-assets ratio average of 1.3 percent between the years 2010 and 2020. The data supporting this calculation, as well as insurance loss expenses, is published annually in the NCUA’s Annual Report.
Toomey: Likewise, how much covers actual losses of failed credit unions?
Harper: Losses to the NCUSIF vary by year. The average ratio of the insurance losses over total NCUSIF assets is approximately 0.5 percent between 2010 and 2020. The provision for insurance losses represents actual and anticipated losses from the failure of insured credit unions. This is how we report on losses in our financial statements and reflect the total impact that economic activity is expected to have on the NCUSIF. It includes both the reserve expense and a bad-debt allowance for natural person credit unions and corporate credit union asset management estates.
As context, in 2020, the total insurance losses of the NCUSIF were $68.7 million, or 0.4 percent of total assets. Since 2011, the largest insurance losses occurred in 2017 and was a high of $726.3 million. The NCUA provides NCUSIF ten-year trends, including total operating expenses and insurance losses, in its Annual Report.
Regional Directors identify credit unions experiencing financial difficulty through the NCUA’s supervisory and examination process. The estimated losses from these supervised credit unions are determined by management on a specified case basis. Management also evaluates overall economic trends and monitors potential system-wide risk factors such as increasing levels of consumer debt, bankruptcies, and delinquencies.
The NCUA applies a rating system to assess a credit union’s financial condition and operations in the areas of Capital Adequacy, Asset Quality, Management, Earnings, and Asset/Liability Management (CAMEL). The CAMEL Rating System is a tool to measure risk and allocate resources for supervisory purposes. The NCUA periodically reviews the CAMEL Rating System to respond to continuing economic and regulatory changes in the credit union industry.
Toomey: At the NCUA’s February 18, 2021, board meeting, you mentioned that you want to change the NCUSIF and work with Congress to do so. Please provide detail about any statutory changes and actions Congress would need to take.
Harper: At the NCUA’s February Board meeting, I noted that the NCUA’s top priority in 2021 is to ensure that the credit union system and the NCUSIF are fully prepared to weather any economic fallout related to the COVID-19 pandemic. During 2020, the credit union system experienced a dramatic rise in assets, falling loan demand, compressed interest rates, decreased earnings, and subdued consumer confidence.
The system also saw an unprecedented increase in share growth, which caused the NCUSIF’s equity ratio to fall to 1.22 percent as of June 2020. Even after receiving the semi-annual capital deposit adjustments in October, the equity ratio at the end of 2020 was 1.26 percent, less than six basis points away from the statutory floor of 1.20 percent; the year-end equity ratio was about four basis points lower than previously anticipated. It was also 12 basis points under the normal operating level set by the NCUA Board.
The trajectory of the NCUSIF’s equity ratio has been on a downward trend for a number of years. The closure of the Temporary Corporate Credit Union Stabilization Fund and the transfer of its assets to the NCUSIF in 2017 boosted the equity ratio and prevented a premium assessment at that time and resulted in a distribution to credit unions. However, as we have seen, the increase in the numerator of the NCUSIF equity ratio was only temporary.
To protect the NCUSIF and our credit unions, I believe the following statutory changes need to be enacted:
- Increase the NCUSIF’s capacity by removing the 1.5 percent statutory ceiling on the normal operating level.
- Remove the interim limitation on assessing premiums when the equity ratio exceeds 1.3 percent, granting the NCUA Board discretion on the assessment of premiums.
- Provide the NCUA Board with the option to use risk-based premiums and use total assets as the assessment basis, not insured shares.
These changes would allow for an increase in insurance reserves during economic expansions to avoid charging premiums in economic downturns. The revisions would also bring the NCUSIF into greater, although not identical, alignment with the changes to the Federal Deposit Insurance Corporation’s Deposit Insurance Fund enacted by Congress more than a decade ago.
The agency is currently preparing a white paper about this issue, which I will share once completed. The white paper will include greater details, as well as suggested legislative language. I hope this can be one of the first issues upon which we will collaborate.
Regarding the NCUA’s Virtual Examination Project, the pandemic and resulting off-site operational posture resulted in the implementation of virtual processes during 2020 to continue supervision of the credit union industry. This unplanned need provided an incubator and learning environment to identify effective and ineffective strategies for remote or virtual examinations. Based on the lessons we have learned, the agency is studying longer-term strategies to continue a virtual examination program.