BIRMINGHAM, Ala. — With NCUA's proposed new risk-based capital rule due out Thursday, credit unions are anxiously waiting to see if the agency gets it right.
A number of industry executives and insiders are concerned the new rule could restrict growth by penalizing credit unions that carry more risk on their balance sheets without rewarding those that carry less or have proven to manage risk well over the years.
NCUA Chairman Debbie Matz has stated that the proposed rule will
Matz has indicated that only Congress can change the 7% floor ("well capitalized"). She also said that NCUA "strongly" believes that credit unions holding more risk on their books should hold higher amounts of capital, and individual CU risk weighting — determined by the amount of risk on the credit union's books — is needed.
At recent "Town Hall" meetings, NCUA representatives have said that activities such as member business lending, indirect lending, a high concentration of mortgage lending, loan participations and CUSO investments will be primary factors influencing risk weighting, according to people who have attended the events.
But former NCUA Chairman Dennis Dollar, principal at Dollar Associates, noted the new rule will aim at activities that are employed by mostly progressive and fast-growing credit unions.
CUs above $500 million in assets account for the majority of the industry's growth, creating a "Great Divide" among CUs, a subject of ongoing Credit Union Journal reporting. More than 40% of all credit unions (holding 16% of industry assets) reported negative loan growth during between the third quarter of 2012 and the same period last year, including half of all CUs with $50 million or less in assets.
Similarly, more than 80% of loan growth was derived from the 500 largest credit unions — just 7.4% of all CUs. And only 63 CUs in the top 500 (12.6%) reported declines in loan volume.
The 'Generational Issue Of Credit Unions' Today
"Capital reform is the generational issue of credit unions today," said Dollar.
"It is such a critical issue to the future of our movement — How do I survive under the credit union charter with a foundation of a somewhat restricted capital structure only allowing retained earnings to be counted as capital? What is being fashioned by NCUA right now will determine whether or not credit unions have enough capital to invest in their futures and in their members to remain competitive."
If the new rule is not structured correctly, NCUA could add additional capital expectations on those credit unions that are performing and growing the best, according to Dollar. "They do not want to end up penalizing those credit unions building the very capital NCUA wants to see through growth and innovation," he said.
Coming out of an economic crisis, Dollar said he supports NCUA's decision to reform the CU capital system. "Credit union capital requirements should be risk weighted and credit union specific. But there is a difference between those who were able to manage risk during the crisis and those who could not."
Though credit unions with higher risk balance sheets should be expected to hold more capital, there also has to be some reward for those with a low-risk balance sheet and those that have a proven track record of managing risk well, according to Dollar. "It is important that NCUA not come forward with a plan that is all stick and not have some carrot," he added.
Matz previously told Credit Union Journal that the agency is "mindful of the fact we don't want to adversely affect credit unions, impact their innovation and tie their hands unnecessarily. But we are concerned about those credit unions that just have so much risk on their books that they are a threat to the rest of the credit union system."
Gary Easterling, CEO at the $1.6 billion United FCU in St. Joseph, Mich., endorses new capital standards for credit unions and banks that were over-leveraged when the economic collapse occurred, and to prevent over-leveraging in the future.
"For most natural-person credit unions, I don't believe a change in capital requirements is necessary," said Easterling "However, given that the change is inevitable, I would prefer a solution that is not a one-size-fits-all."
Like Dollar, Easterling stressed NCUA has to give some kind of "credit" to CUs doing a good job mitigating risk. He worries that if NCUA applies a "broad-brush rule," it will likely curtail the impact of complex credit unions by requiring them to divert more to capital reserves, force some into an undercapitalized position and simply "create one more headwind for credit unions that are striving to support their membership on the back side of the Great Recession."
The CEO added that he'd prefer NCUA address secondary/supplemental capital at the same time the new capital rule is proposed to provide CUs with a "mechanism to meet elevated capital requirements without impacting members and communities."
Nervous About The Rule
Helen Godfrey-Smith admits she is nervous about the new capital rule and how it could impact her CU, which takes some extra risk to serve low-income communities.
"I have no issues with the overall concept of risk-based capital. But is change pleasant, no? It is frightening," said the CEO of the $101 million Shreveport FCU in Shreveport, La. "We are a credit union that will be high on the radar of risk-based capital. We have extra risk in our loan portfolio but we make a concerted effort to avoid introducing other higher risk components to our balance sheet. We manage the higher risk by using reasonable measurement of the risk and aggressively funding the loan allowance to mitigate the risk."
Godfrey-Smith fears the new rule could require CUs to "fund twice for the same risk. Care should be taken not to penalize credit unions that are willing to take the risk of serving underserved markets... You also don't want credit unions to adopt a strategy of risk avoidance, that will not help the economy."
Tommy Cobb, CEO at the $62 million Tuscaloosa CU in Tuscaloosa, Ala., cautioned that capital standards often can't guard against a financial crisis. "No one saw the corporate crisis coming so we probably won't see the headlights of the next crisis until it's too late. Even if someone foresaw the corporate crisis, there is no capital standard that would have saved them. If NCUA approaches this issue with the same wisdom they used to address potential risks of home-based credit unions, I am confident the issue will be resolved."
Todd Fanning, SVP and CFO at the $2.1 billion University of Iowa Community CU, in Iowa City, emphasized thatcredit needs to be given for historical profitability of the institution along with its history of charged-off loans and delinquencies.
"A framework needs to be established that measures these items against the current capital level in conjunction with the type of assets being held," said Fanning. "In this approach, those institutions that have successfully managed their balance sheets are not penalized. As credit unions are required to hold more capital, they become less likely to grow."
Sources agree that higher capital requirements, and therefore smaller capital cushions, will prompt many credit unions to pull back on growth opportunities like branching or investing in new technology.
Dollar said if a credit union is required to hold more capital but has a track record of managing risk well in areas of higher risk weighting, the CU should know that if it falls below its well-capitalized floor, NCUA's punitive action won't be as harsh as that delivered to institutions that have not managed risk well. The same thinking, he added, should be applied to CUs holding a low-risk balance sheet.
If NCUA balances the risk-based capital proposal — requiring more capital of credit unions with higher-risk balance sheets while using a "less heavy stick" against lower-risk shops — the new rule will encourage growth, giving CUs confidence to be innovative and do things that drive the business, according to Dollar.
BASEL III As 'Baseline'
Sources agree that Basel III, which is bringing higher capital standards to banks, has set in motion NCUA's plan for revised CU capital regulations.
Jim Blaine, president of the $27 billion State Employees' CU in Raleigh, N.C., said he hopes NCUA is using BASEL III as a "baseline for enhancing its current risk-based net worth formula. There is little question that credit unions carry less risk than commercial banks. Hopefully NCUA's new rule will help acknowledge and emphasize that lower credit union risk profile."
Orlando Hanselman, director of education programs for financial and risk management solutions at Fiserv, Brookfield, Wis., recognizes that higher capital requirements are a bigger challenge for CUs. "Credit unions have fewer tools available than banks to readily raise capital."
Hanselman noted that since the majority of CUs don't have access to supplemental capital they have to build capital through retained earnings, often a slow process. "And in times of economic stress, earnings get compressed and that makes the ability to address a capital shortfall much more difficult. That's why stress testing and forecasting of capital is essential for credit unions," he said.
David Proffitt, CEO at the $184 million Alcoa Tenn FCU, Alcoa, Tenn., believes the current capital standards are more than adequate, adding there is merit to risk-based capital for credit unions involved in riskier loans and investments.
"If actual practitioners or analysts with a practical business sense are involved in development of the risk-based standards, it could be a good thing," Proffitt said. "If not, standards will be developed that will restrict loan growth and suppress innovation. I hope [NCUA] does not follow that path, but there is pressure to do that. I hope they can resist it for the good of the credit unions."
But Dollar fears the new rule, unless balanced, could simply be punitive and become a disincentive for CUs to do "the very types of things the numbers clearly show are necessary in order to produce higher earnings.
"This could really impact the middle to larger credit unions, and those guys are the ones that have the challenge to compete toe-to-toe with the big banks," Dollar said. "If their capital ratios are not appropriate to their unique risk management portfolio, they may not have the flexibility to access their capital as needed to offer all of the services to thrive in this challenging marketplace."
