The Overcapitalization of the Credit Union System

Twenty-five responses were filed responding to NCUA’s request for comments on the appropriate NOL cap for the NCUSIF.  One provided an insightful context for their remarks.

This excerpt from the Ohio Credit Union League  points out a larger industry bias.  This observation is especially relevant in view of NCUA’s proposal to raise the well capitalized standard for credit unions over $500 million in assets.  This new net worth option called CCULR, would raise the well capitalized compliance standard 43% in two years, from 7% to 10%.

Here is their partial comment:

. . .we wish to register a general objection to the notion of unnecessary over-capitalization of the credit union system wherever such an idea takes root. Except for a relatively small proportion of outliers, where ordinary supervision serves as an appropriate intervention, credit unions themselves are strongly capitalized to the extent that the primary buffer (natural-person credit union capital) against shocks to individual credit unions or the credit union system, is deep and broad.

Prior to the pandemic (December 2019) the average total capital ratios for U.S. and Ohio credit unions were 11.87% and 11.89%, respectively. As the pandemic began receding (March 2021), these metrics remain thoroughly robust (10.51% and 10.53%, respectively) despite the tremendous stresses of a global pandemic, global recession, and stimulus-driven ballooning balance sheets. The abundantly healthy capital levels and ratios in credit unions served the intended purpose quite effectively and in essence, shielded NCUSIF from material impact.

The regulatory process, perhaps beneficially, engenders a bias for more capital at the credit union level (seemingly, ever-stronger balances and ever-higher ratios). Yet this bias must be tempered by business discipline to ensure that capital balances in credit unions and in the NCUSIF remain strong but not excessive, so the various costs of capital are reasonable (even supportable).

To the extent that we witness what appears to be strong NCUA bias for more capital (unnecessarily larger balances and unnecessarily higher equity ratios) and noting the nexus of this concern to NOL strategy, we draw attention to the potential disruptive and costly over-capitalization of the credit union system at the credit union level, in NCUSIF, and particularly in combination. In this context we reiterate our call for the return of the NOL to its previous strong and proven level of 1.30%

Amen

One Reply to “The Overcapitalization of the Credit Union System”

  1. Chip –

    I’d like to bring some specific concerns to the table for discussion.

    The proposed regulation establishes a phased-in 10% net worth floor. We all know that credit unions will carry a buffer to avoid going below the floor – most likely in the 1.0% to 2.0% of assets range. So, the new net worth standard from a practical basis will be 11.0% to 12.0%.

    This creates a huge safety reserve, before any consideration for CECL. Recall that loan loss reserve is effectively net worth too, just specifically earmarked to cover anticipated loan losses.

    For perspective, there are 600 credit unions with assets greater than $400 million that have net worth below 11% as of the 3/31/2021 call report. I specifically included credit unions greater than $400 million because they will have to prepare for the higher capital standards as they approach the $500 million threshold.

    The current low interest rate environment is making it difficult to accrete capital via asset growth. This fact must be considered as part of the discussion.

    Any net worth requirement is a tax on asset growth. Raising the net worth requirement increases the growth tax. For example, a credit union growing 10% per year with an 8% net worth target must produce a ROA (profit taken from members) of 0.80% to maintain its net worth ratio. If the net worth requirement increases to 11%, that same credit union must now produce a 1.10% ROA.

    Credit unions that cannot produce the higher ROA to support the new net worth target will have their ability to grow and serve new members stifled. It will also make it more difficult to invest in the cooperative to maintain market relevance.

    In a perverse twist, credit unions may have to take more risk because of the proposed regulation to produce the higher ROA necessary to maintain net worth.

    Ultimately, a higher net worth requirement harms the people credit unions are designed to serve.

    I am genuinely concerned this regulation is a gift to the competition because it erodes the advantages credit unions currently hold in the marketplace. The concept of evaluating risk to determine necessary reserves, especially in outlier situations, is important, but I agree with Chairman Hood, it should be used as a tool and not a rule.

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