NCUA General Counsel’s Office in a recent letter opinion to James Forney, Superintendent of the Iowa Credit Union Division of the Department of Commerce dated May 1, 2008 (08-0302), stated:
“Generally, there is not an inherent conflict of interest where a credit union uses a CUSO to meet its MBL direct experience requirement, provided the CUSO is independent as to each transaction….Your letter indicates the CUSO “does not participate in any of the funding of the MBL loans or have any interest in the collateral securitizing any of the loans.” 12 C.F.R. §723.5(a), (b). Also, it “is not selling a loan, does not participate in funding the loan, and does not have a security interest in the loan collateral.” Generally, the presence of these factors would enable credit unions to still use a CUSO to meet its direct experience requirement. We noted, however, the CUSO appears to be compensated on a fee basis, collecting fees in connection with origination, servicing, participations, referral and document preparation. Under this fee structure, the CUSO appears to be paid only or primarily when a loan is funded. This situation creates an inherent conflict of interest as the CUSO has a direct interest in recommending a loan be funded and not denied. We recommend you address any questions or concerns regarding the nature of this arrangement or specific transactions with the appropriate regional director. “
This letter has caused consternation among Business Lending CUSOs that charge the majority of their fees only when the loans close, i.e. origination fees and servicing fees. First you have nothing to worry about if your credit union owns a “controlling financial interest in the CUSO as determined under Generally Accepted Accounting Principles.” 723.5(b)(3). NCUA assumes the CUSO would not do its owners wrong. A controlling financial interest could be 20% or even less under some circumstances.
I spoke to the author of the letter and the letter may be more strict then intended. Many CUSOs charge some non-transactional fees but the typical model charges a majority of its fees when the loans are funded and performing. Does this mean that a credit union that does not have a controlling interest in a CUSO can be the victim of a designing CUSO that approves loans just to suck fees from credit unions? Well maybe but that is pretty far fetched in the real world. We are talking about CUSOs here…credit union owners serving credit unions. Are CUSOs being told to approve good loans for the owner credit unions but stick it to the non-owner credit unions? How long does that fairy tale last in the real world? Should it make a difference that the owner credit unions take a loan participation interest in the loan funded by a non-owner credit union? Does that remove the taint of a possible conflict/conspiracy?
An alternative is that the non-owner credit unions have to obtain a second opinion from a qualified credit union staff person or another CUSO whose fee is not dependent on approval of the loan. The economics of the CUSO arrangement can quickly erode. Another alternative is to have the CUSO charge an underwritng fee regardless if the loan is approved. Can this model work?
What do you think? Is this a tempest in a teapot or is this a real concern that the CUSOs could have a conflict of interest in advising non-owner credit unions?
