NCUA last week formally announced long-awaited changes to net worth standards under prompt corrective action (PCA).
Among the proposed changes, which were first proposed by former NCUA Chairman Dennis Dollar and are now championed by Chairman JoAnn Johnson, are a reduction in the standard net worth ratio requirements for credit unions to a level comparable to what is required of FDIC-insured institutions, about two percentage points lower than what is currently required. NCUA is also proposing to tailor the risk-asset categories and weights of BASEL II, as well as related aspects of the FDIC's PCA system, to credit unions.
As was clear in interviews The Credit Union Journal did with credit union CEOs and analysts last week, the issue of capital requirements is at the top of many agendas. The inability to grow capital at a pace matching asset growth has led some credit unions to throw water on growth plans. Meanwhile, credit unions looking to convert to mutual savings bank charters have repeatedly cited capital concerns as their reasons for exiting the credit union charter.
NCUA's move follows by a year a report from the Government Accountability Office (GAO) that found when it comes to capital there is little consensus among credit unions. The issue generates diverse and often contradictory opinions within and outside the movement. Some seek ways to raise alternative capital while others fear a loss of tax-exemption; others say the whole thing is unnecessary.
Among those championing capital alternatives is Jim Blaine, CEO of State Employees Credit Union in Raleigh, N.C., who manages a 7.5% net worth ratio.
"Having the right (to raise alternative capital) would be equivalent to having a spare tire in my car," he said. "A drop below the 7% ratio may mean that regulators may step in and start questioning decisions, and if the drop is steep enough some decisions may be overruled."
Blaine believes credit unions should have the right to raise alternative capital by selling subordinate debt, without voting rights, to current members. Concerns about risk are largely unfounded, he believes.
Some credit union members already face risks as 10% to 15% of deposit accounts exceed the $100,000 insured limit, he noted. Selling a "non-voting" instrument would guarantee freedom from the outside influence that many fear. Furthermore, the right to raise alternative capital doesn't exclude other initiatives to make standards more flexible, he said.
Blaine believes that his credit union may help pave the way into alternative capital.
"We issued alternative capital in 2001 to (Durham, N.C.-based) Self Help Credit Union, a member of our credit union. We wanted to do it as a 'demonstration project.' The (state) regulator approved the $1-million sale. Price Waterhouse Coopers has given an opinion that it is equity shares," he said.
The equity shares pay a yield that is variable and depends on the dividend rate of the mortgage-lender Federal Home Loan Bank in Atlanta, currently higher than 4%.
While the debt is subordinate to all other payments in case of liquidation, the rate is "a good return in this market. They are getting twice the rate compared to shares."
"What we are in the process of doing is submitting a request for a private letter ruling from the IRS (Internal Revenue Service)," Blaine said. "One of the questions that come up is that you may hurt tax-exempt status. So we'll say to them we want your (IRS) opinion that says whether this may impair tax-exempt. If the IRS were to reply to the letter to be sent next month that it may hurt it, we'll return the money."
If the IRS says the transaction doesn't affect it, the reply will be forwarded on to the NCUA, he said.
The funds that he received from the sale are not to be used for capital for regulatory purposes, he said. It is just borrowing from the market.
He said the "equity" sales to raise a maximum of 2% of capital would be a good instrument for the some 15% of credit union deposits that are IRAs. Many credit unions are offering mutual funds to members, he pointed out, which are uninsured investments, as well, he said.
To avoid systemic risk, a cap of 2% on alternative capital could be set, he suggested. This would help a credit union go from a 7% net worth to assets ratio to 9% if needed.
The higher rate would be too expensive an instrument for growth and it will only be a tool to raise needed capital. An institution selling this instrument may serve as a flag to the regulator and the additional "investor" eyes looking at institution would help the overall system's safety, he said. It would help "deal with unexpected situations" and "enhance" safety and soundness, he said.
The View From NASCUS
Meanwhile, in Arlington, Va., the National Association of State Credit Union Supervisors (NASCUS) said it continues to back both the easing of requirements and the allowance for alternative capital. NAFCU said it is taking a more conservative stance and just coming up with a set of principles that it says should guide all PCA-related discussion.
NASCUS' main concern is the growth restrictions.
"With the economic downturn and the flight to safety from the stock market, credit union savings are growing. Members are depositing more with credit unions and many credit unions are reporting a reduced net worth ratio as earnings retention lags growth in assets," said Sandra Troutman, executive vice president-government relations at NASCUS.
"In order to continue offering products and services that meet the financial needs of their members, credit unions need capital to include more than just retained earnings. NASCUS believes state-chartered credit unions should have the means to raise alternative capital. We do not espouse a specific instrument to raise capital. In addition, NASCUS supports risk-based changes that lower capital ratios," Troutman said.
At NAFCU, Chief Economist Dr. Tun Wai believes that "a lot of credit unions have more than enough capital." As of June, of 9,124 federally insured CUs, 8,936 are considered well capitalized.
The approximately 2% of institutions that are not well capitalized "isn't that sizable if you consider that most of those are very small," he said. "We just want to make sure that the nature of credit unions does not change. The nature is the cooperative, not for profit."
To Lower or not to lower
CUNA's Chief Economist, Bill Hampel, noted that efforts to reduce ratios of net worth-to-assets may be most effective. This should help reduce average credit union ratios he said are at levels of about 11%. This is because CU CEOs view 8% or 9% as not enough capital, Hampel observed, noting that one common proposal is to allow the sale of subordinate debt, "the most mentioned form of alternative capital," while another would be to lower requirements. Commercial banks, for instances, are only required a 5% ratio, he said.
But as credit unions meet in Washington this week for CUNA's GAC, Hampel added, "Congress doesn't appear to supportive for secondary capital."
"Most of our attention is trying to come up with some form of reform to lower the 7% and the 6%," he said, referring to provisions of the PCA rules. This would help some 1,500 credit unions that have ratios between 7% and 9%, he added.
"Because of cooperative structure CUs tend to be much more risk-averse than banks" and lowering rations wouldn't hurt system, he said.
Concerns about the rates make CEOs less aggressive when it comes to pricing to attract deposits. "If capital requirements were not as high they would be able to offer their members a better deal," he said.
"On subordinated debt, it could be done to minimize danger. The danger of supplemental capital is introducing a new element that may believe they have a say in the operation," said Hampel.
Dennis Dollar, the former CU CEO and former chairman of NCUA who first began discussions of changes to capital standards, believes the opposite: credit unions shouldn't ask for lowering ratio standards.
"The lowering of the standards option is a non-starter. Congress would not agree," said Dollar, who is now a consultant based in Birmingham, Ala. Dollar believes lowering the standards would also eliminate one of the arguments CUs have against taxation. "The Best option is to go to a risk-based capital," he said.
He said that present rules require the same capital reserves for the cash in the vault as they do for a 30-year, fixed-rate mortgage, with no accounting for the difference. "Risk-based capital has a much broader base of support and may have a better changes" and is already included in the CURIA bill now in Congress.
By basing the 7% on risk-weighted assets credit unions that now fall into the inadequately capitalized bracket may be considered as well capitalized if they have a low-risk profile, he said.
GAO report.
A report by the GAO last year didn't appear to help much the credit union's pleas for changes.
"One credit union CEO, whose institution is one of the largest federally insured CUs, stated that three of the five largest federally chartered credit unions were against allowing credit unions to acquire secondary capital," said the GAO in its report. The report did not identify the CEO. "He countered arguments for changing PCA by citing his credit union's experience with a dramatic influx in shares two years ago. He noted the influx did not trigger PCA because his institution's capital was aggressively managed."
The GAO report continued, "We did not find evidence that the inflow of member share deposits resulted in widespread net worth problems for federally insured credit unions during the period that PCA has been in place...while PCA is intended to curb aggressive growth, our analysis of credit union and bank data indicates that credit unions have been able to grow at a higher rate than banks during the three years that PCA has been in place for credit unions."
While the changes are being discussed CU CEOs will continue waiting for a solution.
Jeff McDaniel, CEO of First Financial CU in New Mexico, said that discussions on alternative capital should go on.
"My credit union doesn't need it but I think it is something that should be available under certain circumstances. I think it is a valuable tool," he said. "I am not sure that we should have alternative capital just for the sake of growth but I think it should be available to use under certain circumstances."
Meanwhle, in Orlando two weeks ago at a PALS Conference hosted by NCUA, Jeff Hendrickson, CEO of Dow Louisiana FCU and a speaker at the meeting, looked at NCUA Board Member Debbie Matz and asked, "Please help us with capital."
