The National Credit Union Administration's new risk-based capital rule has some credit unions saying it's time to consider switching to a bank charter while others applaud the agency's effort.
To be sure, the proposed rule is sparking a wide range of opinions, but one thing everybody agrees on is that now's the time to provide feedback.
The NCUA should expect a letter landslide in the rule's 90-day comment period, say CU executives and analysts, who after having time to dig through the detailed 198-page proposal, stress there are changes that need to be made.
Risk weighting that discourages mortgage lending, duration in the investment portfolio and maybe even mergers are just some of the regulatory aspects drawing attention. But the largest issue, insiders and experts say, is the rule — as written — could have negative effects on members.
NCUA released its new proposed risk-based capital rule at its January board meeting. Federally insured credit unions with assets of $50 million and above, with concentrations in real estate loans, member business loans or delinquent loans, would have to maintain additional capital requirements. Institutions with less than $50 million in assets will follow current capital rules, with the current 7% leverage capital standard remaining the floor.
Under the proposed rule, to be classified as "well capitalized," the impacted institutions must maintain a risk-based capital ratio of 10.5% or higher and pass a net-worth ratio as well as risk-based capital ratio requirements. Adequately capitalized credit unions would be required to maintain risk-based capital ratios between 8% and 10.49% and pass ratio requirements. Undercapitalized institutions would fall under 8%.
Jim Blaine, president of the $27 billion-asset State Employees' CU in Raleigh, N.C., noting that an "elementary and rarely used" risk-based capital formula has been in place for CUs since 1998, said it's "good news" the new risk-based capital rule is finally here.
"We needed an improved risk-based formula," said Blaine. "That said, I think the proposed rule needs a lot of work."
Blaine said he believes that credit unions are now making comparisons to Basel III banking capital regs to see where differences lie. He cautioned that if CUs perceive they are being "penalized on a capital basis," and "penalized for being credit unions," that could be the final straw for many.
"They may see that everything now, except tax exemption, is on the other side of the ledger," said Blaine, adding that some CUs could decide it would be advantageous to convert to a mutual savings bank.
Consider A New Charter?
One credit union executive, asking for anonymity, concurred, saying it's time many in the community consider converting to a bank charter.
He added the new rule is about "risk elimination, not risk management," and that earnings will be on a steep decline if the rule goes unchanged.
But Peter Duffy, managing director at Sandler O'Neill in New York, said that while the new rule will get many CUs to begin discussing a bank charter, he is "not entirely sure that credit unions in any number will want to switch."
Duffy cautioned that any quick moves to change charters based on reaction to the new rule are unwise, as a decision to convert requires a thorough analysis of the new capital rule and its implications on an institution's growth.
"It also requires a thorough analysis of what's expected on the bank side," added Duffy. "It's too early to make a decision about the correct charter."
A source close to NCUA acknowledged that while some credit unions may use this new rule as justification for considering a charter change, not many will follow through since the agency has made conversion challenging.
Evan Clark, CEO of the Department of Commerce FCU in Washington, said the new rule, overall, is a great system.
"The idea of having risk-based capital makes a lot of sense," said Clark, whose $330 million CU has a 15.74% risk-based ratio. "My biggest point of contention is the fact, as with all risk-based capital systems, the regulation only addresses half of the balance sheet. It does not look at the liability side and what credit unions are doing to mitigate risk with their liabilities, because there are enormous things you can do over there."
Rule Change Halfway Through Game
Ron Burniske, CEO at the $2 billion Chartway FCU in Virginia Beach, Va., is not as complimentary, particularly since his 7.34% net worth CU stands at 6.09% under the new risk-based calculation.
"We have made money every year," said Burniske. "And we think 7.34% is well capitalized, especially if our goal is to give back to members as much as we can."
What has dropped the credit union to near 6% risk-based capital is the new rule excluding $70 million in goodwill that is currently included in Chartway's net worth. The new rule excludes goodwill from the risk-based calculation.
Burniske explained in his case, the goodwill appears on the institution's books as the result of Chartway taking over three troubled credit unions in the last 18 months.
"Goodwill truly equals what the market value of those credit unions are," said Burniske. "If we did not get that goodwill, NCUA would have had to eat the loss. We think this part of the rule needs changing, as it impacts a lot of credit unions that have taken on underwater CUs in the last year or two. To me, it's like NCUA changed the rules of the game during the middle of the game."
Former NCUA Chairman Dennis Dollar, who in a previous report (Credit Union Journal, Jan. 22) said he hoped that the new rules would also reward good managers of risk, thinks requiring more capital from those credit unions with more balance sheet risk is a good idea.
"The challenge is what risk weight to give each asset category, how to incorporate a credit union's individual risk management record into the formula and what NCUA's comparative usage of the statutory leverage PCA ratio of 7% will be versus the new risk-based capital ratio," explained the principal at Dollar Associates, Birmingham, Ala. "There are some concerns being expressed strongly by credit unions about each of these areas."
Dollar predicts the comment period on the proposal will likely be the most active in recent years.
"And, from the incredible number of questions we are hearing about this, quite extensive. That will be healthy. This is a huge issue, both for NCUA and credit unions, and there needs to be enough constructive back-and-forth between the regulator and the regulated."
Michael Moebs, economist and CEO at Moebs Services in Lake Bluff, Ill., who stated in 2011 that higher capital standards were coming for credit unions (Credit Union Journal, May 16, 2011), said the NCUA's new rule is a "good step in the right direction."
"The definitions of risk are good but lack empirical measures that would assist credit unions in dealing with examiners and regulators — too much discretion here," he added.
Moebs said that NCUA must be more transparent about how the risk-based capital measures will be treated by examiners at individual credit unions, regarding the "why and how" of calculations.
The $50 million cutoff for the rule is too low, according to Moebs, who said the asset size to remain under the current capital rules needs to be raised to $100 million to help smaller credit unions cope.
"Credit unions from $50 million to $100 million do not have the resources to devote to tackling the risk-based capital requirements as presented," offered Moebs, who like other sources sees the rule as possibly impeding growth.
The bigger issue, say a number of experts, is that the rule affects how credit unions grow. Sandler O'Neill's Duffy emphasized that if the rule remains as written, many CUs will be asking: "'How can I generate the earnings to accommodate growth, still remain well capitalized and have the kind of cushion the board expects?'"
He said questions also will address how the credit union can continue to grow in the ways it has been growing, with the same mix of assets in which it has gained expertise. "For example, I am a good mortgage originator with a good reputation in the market. Do I have to start turning away business because I don't have the same capital cushion anymore?"
At a time when margins are narrowing and non-interest income streams are under attack, Duffy pointed out that earnings are more closely linked to ability to grow under the rule.
"Earnings will face even more pressure, since the rule discourages duration in the investment portfolio while it encourages auto loans, where there is very little spread," he said.
Consumer Lending Concerns
SECU's Blaine sees the new rule stalling mortgage growth at some shops. "The formula may encourage consumer loan growth, but it appears to strongly penalize mortgage lending."
He pointed out the rule applies 75% risk weighting when real estate lending comprises 25% to 35% of the loan portfolio, and 100% weighting above 35%, noting that bank capital regs weight residential mortgages at 50% across the board.
"Why is there a penalty for credit unions to do mortgage lending as opposed to the banking industry?"
Blaine predicted that some credit unions will use the rule as a reason to cut back on non-qualified mortgages. "That means cutting back on mortgages to the young, low-income and others who need these loans from credit unions."
Chartway's Burniske predicted that many CUs will cut back more than just mortgages. "Some credit unions may choose a path to become well capitalized by not lending. If I don't do any lending and just take deposits I will pick up 75% credit."
If the final rule discounts goodwill, to get its risk-based capital in line Chartway plans to reposition its balance sheet. "We can reposition some of our three-to-five year investments to under three and two years and we are there," said Burniske. "We won't, though, be able to grow the business."
Merger plans, too, may be put on hold, added Duffy. Without access to secondary capital, a provision several sources indicated should have accompanied the new rule, CUs will look at mergers with a more "jaundiced eye."
"This is due to the diminution or erosion of capital that comes with the combination of two institutions that both can't raise capital," noted Duffy. "What's more, I have to pay even more attention to the mix of assets of the target. Because if I bring an institution over that puts me into higher risk weighting on mortgages, MBL or investments, I may not like that merger."
Of all the potential effects of the proposed rule, CUs are most concerned about the impact to members. SECU's Blaine, a proponent of keeping capital near 7% to give more back to members, said the rule emphasizes that his CU's philosophy rewards members while ensures safety and soundness. SECU's net worth is 7.40%, while its risk-based capital is 14.38%.
"We'd like to think we have finally clarified to NCUA that we are well capitalized under any circumstance," said Blaine.
Blaine, however, fears that NCUA and the new rule are encouraging CUs to hold too much capital, which will "only take money out of members' pockets."
Chartway's Burniske has a similar view. Saying higher risk weighting will force his CU to charge more for loans. "I'm charging 5% to 6% on a credit card and I have to carry a 75% premium, that takes me to 13% to 14%. A 3.99% auto loan I can't do anymore. Who loses — the member."
Burniske and others plan to send their comments to NCUA, hoping the final rule will better reflect the needs of credit unions and members.
NCUA spokesperson John Fairbanks said the proposed rule is "essential" to the future safety and soundness of the credit union system and "the 96 million members who have placed their trust in credit unions."
He added that the NCUA board wanted to make sure stakeholders had ample opportunity to read the rule and provide comments. "The board will, as always, consider comments very carefully. That is why the comment period was extended to 90 days."
Burniske said he hopes that in the end, CUs and the agency work together to devise a better final rule.
"We have to sit down and understand what the impact of this reg means for credit unions. But more important, what it means for the member. We can't lose sight of the member."
