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The leading credit union groups appeared last week to come to a consensus on capital, endorsing NCUA's efforts to convert its current net capital rules under prompt corrective action into a risk-based system of capital.

But agreement remained elusive during NCUA's "Summit" on credit union capital on the issue of secondary, or alternative, capital.

During a morning session at NCUA headquarters, representatives from CUNA, NAFCU, NASCUS, the Association of Corporate CUs and the National Federation of CDCUs agreed that current capital levels in the credit union movement, as a whole, are strong (though the Federation said CDCUs continue to struggle with capital). The groups also agreed that current rules severely constrain credit unions in raising additional capital, a constraint all the more onerous since the enactment of new net capital requirements under PCA. The massive inflow of new deposits over the last three years, which has diluted capital levels, has brought this issue to the forefront.

The PCA rules, which require a minimum of 6% capital for all credit unions, had prompted credit unions to push for alternative methods of raising capital, such as issuing subordinated debt. But while nine states now allow state-chartered credit unions to issue secondary capital instruments, the PCA rules prohibit NCUA from counting it as net capital.

Over the last year the focus has switched to a risk-based capital system, similar to the requirements of banks and thrifts. The brainchild of former NCUA Chairman Dennis Dollar, a risk-based capital system would discount a credit union's holdings based on the risk. For instance, a federal government-guaranteed instrument such as a Treasury bill would have a risk rating of zero, while a mortgage-backed security would have a higher risk-weighting. By all calculations, this would ease the net capital requirements.

"There is agreement in the credit union community regarding development and adoption of a risk-based capital measurement system," said Bradley Beall, president of Nevada FCU, who was representing NAFCU at last week's session.

Both NAFCU and CUNA were reticent to endorse secondary capital at this time, because there is some disagreement in the movement over the issue. Many traditionalists, for example, worry that by issuing secondary capital to parties outside credit unions may run the risk of diluting the ownership rights of regular members.

But the state regulators and state-chartered credit unions have forged ahead on secondary capital, with several state charters already issuing some form of secondary capital. The problem is, they still can't count it has net worth under PCA. Jim Blaine, president of North Carolina State Employees CU, speaking for NASCUS, made just that point to NCUA last week. He explained how his credit union issued a $1-million subordinated note to Self-Help CU, the cutting-edge CDCU, but has been unable to count it as net worth, even though the state regulator and a leading accounting firm has concluded that it should be acceptable.

The groups appeared to reach agreement on another capital issue bearing in on credit unions, that is new accounting rules that will prevent credit unions from "pooling" or aggregating, the capital of both credit unions after a merger. The rues are scheduled to take effect on January 1, 2006.

The Rule's Current Effect

If credit unions are not allowed to count the acquired credit union's capital in a merger every merger would end up diluting the acquiring credit union's net capital, putting more strain on PCA and discouraging mergers. In order to deal with the new accounting rule the credit union lobby has proposed a redefinition of net worth in the PCA law that would allow credit unions to include both retained earnings, as net worth is currently defined, as well as acquired equity. This would allow credit unions to continue counting the capital of both institutions after a merger.

The significance of last week's summit was in reaching a consensus to bring to Congress next year, as all of the proposals-enactment of a risk-based capital system, counting secondary capital as net worth, and redefining net worth-will require an act of Congress.

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