NEW YORK — Peter Duffy contends that NCUA's proposed capital rule could force some credit unions to sacrifice net income and capital to meet the new risk-based standard.
The managing director at Sandler O'Neill, New York, asserts that in an effort to meet the new risk-based ratio CUs have to take several steps, essentially moving out of higher coupon mortgage and higher coupon bonds, and going into lower coupon auto and lower coupon investments.
Duffy explained that Sandler O'Neil is running scenarios with credit unions to see what they need to do to meet the new rule.
"We are helping credit unions look at rotating out of certain asset classes and rotating the funds into RBC-preferred asset classes, such as auto loans and short-duration investments," said Duffy. "What we are finding is that you can get to the RBC number you want, but it is at the cost of net income and capital. The rule actually works against its stated purpose, which is to protect capital."
In sharing a simulated scenario run with a credit union that finds its 250-basis-point cushion above well capitalized now 150 BPs short under the proposed rule, Duffy said it took "material transactions" to get the CU to well capitalized under RBC.
"And that is what we are commonly finding, it takes about a material transaction or two, sometimes more, for a credit union to get back to well capitalized under the new guidelines," said Duffy.
Duffy explained the CU, on paper, took a small amount of non-performing high risk-weighted loans, sold them and took the market value loss.
"That reduces the net worth ratio," he explained. "You are reducing your capital dollars by selling the bad loans. It was a small amount, less than $10 million from a billion-dollar-asset credit union."
Next, Sandler O'Neil modeled selling over $30 million of mortgage loans that were performing so the risk-weight calculation improved under mortgages. The CU's mortgage concentration is above the 25% of assets.
"And still that was not enough," said Duffy. "So then we modeled selling all of its longer-term investments. We calculated the loss on sale of delinquent loans, and the gain on sale on the mortgage loans and long bonds. Then we reinvested all the money into shorter investments, including auto loans."
The net, explained Duffy, is the credit union's net worth ratio went down and it lost $1.5 million in annual net income. "But they barely met their risk-based number to be well capitalized."
