NCUA Exam Priorities



NCUA EXAM PRIORITIES DISCUSSION – Part 2


Here are highlights of my interview with Subject Matter Experts Steve Farrar and Todd Miller talking about NCUA’s Exam Priority Letter. There are so many priorities this year we broke the interview in two.


Loan Participations:


Mark:


As I've mentioned previously, some topics hit this the NCUA Priority Letter every year. Some topics are new this year and loan participations is a topic that is new this year. Not only is it new this year, going back as far as 2017 loan participations has not been specifically highlighted in this letter as a priority.


The letter states that:

The NCUA continues to encourage credit unions to utilize safe-and-sound practices as they manage their loan participation portfolios, which are often serviced by an outside entity. NCUA examiners will verify that credit unions have evaluated the risk in the loan participation transactions and how that risk fits within the tolerance levels established by the credit union’s board. At a transactional level, each loan participation must have separate and distinct records for individual payments, including principal, interest, fees, escrows, and other information relating to individual loans. While remittances to the credit union may come in a single payment, credit unions must reconcile this information to the servicer’s records and follow prudent third-party due diligence practices when purchasing loan participations.


Steve, Why do you think this is now an exam priority?


Steve:


I'm going to speak to that, issue because I was looking at why, did NCUA put this in the letter? Well, it became real evident to me when I was looking at a financial performance report for the industry which showed that loan participations growth is just much more than it's been any prior years, at 25% annualized through September.


So there's much more activity going on in this area. So essentially NCUA is saying if it's significant growth in that area, let's take a look at it, let’s make sure we understand why its growing and that it's being done in a safe and sound manner. In order for the loan participations to work well, both the parties have to be doing their job well as the originators and the purchasers, and both have their duties that have to be completed well, for this whole item to not become a problem within the industry, Participation loans are well controlled at high level within the regulation, 701.22 that speaks to the requirements of both originators and purchasers. But it really comes down to, originators doing a good job of selling quality loans.


So this one really comes down to The institutions that are purchasers to do your due diligence and make sure that you're very comfortable with and know what you're buying, who you're buying it from. Then once you own it, you need to be able to monitor and control that, so you have to have the structure in place at purchase to monitor throughout the life of those loans.


Mark


Very good points Steve and as I mentioned in part one, if you are going to do it, do it right.

Steve, what you said is spot on. I will say that it's a growing, there are credit unions that have excess demand and there are opportunities out there where credit unions that are smaller that might not have the ability to get loans out can provide some liquidity to the other credit unions that have the loan demand Again, if they do it right, it can be a win-win.


Just like anything, if you do it wrong, it can cause all sorts of challenges for you.

So it's a tool in their toolbox and NCUA just wants to make sure that if you're going to do it, you do it right. And the due diligence that you referenced, there are third party due diligence letters to credit unions that are key in this arena.


FRAUD


Fraud last showed up on the Priority Letter in 2018. let me know your thoughts on fraud, as it relates to this letter to credit unions.


Todd:


this one's interesting. There's just three sentences on this subject, but I'm sure all of us have experience in that. The letter states that:


The offsite posture of many credit unions over the last two years has increased the potential fraud risks. The NCUA will review credit union efforts to deter and detect fraud, including internal controls and separation of duties. Transaction testing will be part of the examination procedures.


The offsite examination procedures at nearly all credit unions over the last two year has increased the potential fraud risk. That's for certainly sure. We talk about increased opportunity for fraud because of the offsite nature and not just offsite exams, many of the audit procedures are offsite. In my experience at credit unions, when I was active in the field we identified fraud or came across fraud in a fair number of institutions that hadn't been identified before.


Steve:


It was always because of something that I observed with generally a staff member, as simple as listening to a conversation of a person really high up in lending function about he was enamored with his fake Rolex. It just struck me that this guy. Some of these things are really overly important to him in terms of status and that I think I'll go make sure that we give his account a close look and sure enough, he was committing fraud in order to be able to support his lifestyle.


Now, if examiners aren't in there and hearing those discussions and observing people, those opportunities for us to identify fraud, aren't there so much. And I'm sure you guys have other experiences be interesting to hear.


Mark


We've all had some interesting challenges in this arena. And especially having spent so much time as special actions,


Todd, anything to add?


Just a couple of Steve mentioned opportunity. If you leave your doors open at home, eventually someone's going to walk in and take something. , I think there's a couple of things with the pandemic. Not only are many credit unions offsite, but they've been working really hard to help their members which kind of lets your guard down a little bit.

I had one person one time alert me to an employee they suspected of fraud I asked why didn't you talk to the supervisory community? Or why didn't he just take this to your CEO? And it's like, well, I've been here five years, the person I've been reporting on or telling you about has been here 25 years, I'll get fired if I report it. So you just tell your examiner. However, with NCUA not onsite, these conversations may not happen.

So we kind of have a trifecta going on here and that, know, we have this economic uncertainty, which leads to increase fraud. we have a greater opportunity for fraud just because of COVID and all the offsite posture auditors are off site examiners are off site. Employees are off site. So it just creates an increased potential for fraud to occur.

And I'm sure some is out there. hopefully they're little ones and they don't impact credit unions significantly. , but you can be sure that fraud is going on and I'm sure it's making NCUA nervous because some of their biggest losses were fraud.


Mark


Yes, a lot of little losses a handful of large ones, but the large ones can take big hit out of the insurance fund.


Todd, you talked about a couple of things. you talked about , the economic pressure leading to more fraud. You talked about the opportunity since credit union staff are not onsite. And since NCUA staff were not on site, the opportunity is greater. And there's the what they call the fraud triangle.


The third leg of the triangle is rationalization. People who feel like maybe they're underpaid compared to their peers or that they have an issue that they need to deal with. When you get rationalization, you get opportunity and you get pressure they call that the fraud triangle, the trifecta, if you will.


That can lead to somebody doing something that they might not otherwise do. I'm sure that NCUA wants to get back onsite. When they can, but in the meantime, I'm sure they're also doing some things to try and get their arms around determining what's going on in this arena.


Exams are not fraud audits. CPA exams are not fraud audits. And then of course there's the whole internal control side of things. So great discussion on fraud, you can tell that gets our juices flowing and reminds us of some war stories, that we've had from the past.


That's a short summary of two topics covered in Episode 3 of my PODCAST With Flying Colors.


You can listen to the entire episode here:

www.withflyingcolors.us


You can find the text to the entire letter to credit unions here:


https://www.ncua.gov/regulation-supervision/letters-credit-unions-other-guidance/ncuas-2022-supervisory-priorities