Just a Member

(part 2 on NCUA’s new capital proposal)

The new capital proposal’s complexity and burden is evidenced in that eight senior staff were required at the board presentation. If the agency needed eight, how many senior credit union employees will have to be involved to respond and implement it?

The new rule is 126 pages on top of the 424 pages of the 2015 RBC rule. 530 pages in total.

This proposal imposes three different plans: the 110-year old simple leverage approach for credit unions below $500 million. For credit unions over $500 million, some will have a choice between the not implemented RBC or the new CCULR. An untold number would not qualify for CCULR under the reg, so they will be forced to use the untried RBC.

Mandating $24 Billion Addition to Restricted Reserves

The CCULR alternative raises the well-capitalized minimum to 9% on Jan 1, 2022, and 10% on Jan 1, 2024. The 117 credit unions below the 9% level would have just months to raise an estimated $3 billion to be at 9% or fall under RBC. No estimate was given for the net worth shortfall for these 117 at the 10% level.

The rule also states: Subordinated Debt would not be eligible for inclusion as capital under the CCULR framework unless the complex credit union is also a low-income designated credit union.

NCUA estimates complex credit unions eligible for CCULR must hold approximately $24 billion more as regulatory capital than the total under the RBC proposal. So why would a credit union not opt for RBC?

Regulatory Coercion

NCUA’s logic is that the “simpler” CCULR calculation will cause credit unions to opt for it since 48% of complex credit unions now have total net worth exceeding 10%.

NCUA offers this regulatory “alternative” for credit unions to avoid the burden and unknowns of RBC. All that is required is to reclassify 3% of assets now in net worth from unrestricted retained earnings to the rule-mandated legal reserves, a 43% increase.

Vice Chair Hauptman explained the tradeoff this way in his opening statement:

. . .all of that (prior wording) is an (admittedly long) way of saying that a simpler-yet-higher capital standard isn’t just useful because it saves time and effort. It’s also a way of protecting the system from the problems inherent in any risk-weighting process.

This is not choice, but regulatory blackmail. Here’s one example of how NCUA says this coercion will be applied:

While a qualifying complex credit union opting into the CCULR framework, is required to have a comprehensive written strategy for maintaining an appropriate level of capital, such strategy may be straightforward and minimally state how the credit union intends to comply with the CCULR framework, including minimum capital requirements and qualifying criteria. In contrast, complex credit unions that do not opt into the CCULR framework will be required to have a more detailed written strategy. The NCUA intends to review the written strategies during the supervisory process.

A Lack of Respect for Process and Credit Unions’ Track Record

Springing a completely new capital requirement to augment one that has yet to be tried with at best a 90-day implementation timeframe, is regulatory autocracy. It shows total disdain for credit unions’ proven record of capital management.

Throughout this rule there are many movable definitions and unexplained criteria. The definition for “complex” has no meaning other than asset size. Even that simplistic approach has moved from $50 million, then $100 million and finally to $500 million to define what “complex” means.

Using this superficial asset criteria, NCUA throws its complex blanket over every large credit union. Even the $5 billion State Farm FCU with minimal products would be included.

The proposal uses two different definitions of net worth in the numerator of the capital ratios: one for CCULR and a different one for RBC. (Page 49 proposal). Net worth means one thing and then another. This overturns GAAP accounting by whatever the regulator puts in rules.

Both capital options provide four ways to calculate average assets. This makes intra-industry comparisons at best uncertain.

Even the illusion of capital choice is incorrect. Credit unions can move from one capital plan to another within the same quarter in one part of the rule. However, in another section, NCUA can stop that. Under a new Reservation of Authority, NCUA can prevent a credit union going from one standard to the other.

Credit Unions’ Capital System Is Fundamentally Different from Banking Options

Banking regulators ended the RBC requirement in 2019. The rule requires only a simple tier 1 leverage ratio which is exactly the historically proven credit union practice for measuring capital adequacy.

NCUA has kept RBC and added another banking solution overlooking fundamental differences when comparing the two systems’ capital options and purpose.

The cooperatively funded NCUSIF can provide capital assistance if that is the best solution to address a problem.

This NCUSIF’s role supporting member owned cooperatives is very different from the FDIC’s. NCUA is authorized and has used capital injections and other support (208 guarantees) to return credit unions to self-sufficiency. The FDIC cannot assist privately owned firms to restore their financial solvency.

Banks have two primary equity sources: share capital and retained earnings. Generally, the two are split about 50/50. Bank equity comes in many forms: preferred shares, subordinated debt, public and private common equity. Moreover, there are different organizational structures: bank holding companies and stand alone to increase capital flexibility.

$1 of Credit Union Capital is Worth More than $1 of Bank Equity

Moreover, $1 of credit union retained earnings is much more valuable than $1of bank earnings. The taxation of bank earnings means that each firm must earn $1.25 to $1.50 to retain $1 in reserves. Also, shareholders expect to be paid dividends on their shares or see appreciation in their stocks’ market value.

Credit union capital is Free in all respects. All sources of bank capital have requirements that do not make them “free” when choosing options.

Action Needed Now

When Board Member Hood asked staff if the majority of credit unions opposed the 2015 final RBC rule, staff replied:

“Yes, a majority of the comment letters opposed the proposal in its entirety, and many suggested the rule be withdrawn.”

So why can this comment outcome be different? I think two factors can lead to the withdrawal of this rule:

1. The rule lacks any data, objective criteria or historical analysis as the rationale for increasing the risk based net worth ratio. There is zero objective evidence for the rule.

When commenting, must show the history of their capital details to demonstrate the credit union’s record in managing risk. Include capital plans and other documents to demonstrate your competence.

1. Hauptman and Hood are open to listening and learning. If they are to object to this dramatic extension of regulatory micromanagement, they must be armed with information to counter the unproven assumption that credit union capital is not sufficient.

Hood closed his Board meeting statement:

The world has changed since 2015. The reality is RBC should be a tool — not a rule. If it is effective in identifying risk, put it in the examiners’ toolbox, but the last thing the NCUA should do is impose it on credit unions as an operating model. The juice just isn’t worth the squeeze for risk-based capital because this is a regulatory burden with limited benefit. Again, we already have a risk-based net worth framework as required by law, so this is not needed.”

I would add one thought, what if there is no juice? How many credit unions faced with a 500-page new capital rule will just give up and close?

Credit unions rarely fail from too little capital. They fail because their leaders’ spirits are broken. This could be the final straw for many boards and managers.

Last Thursday the NCUA board asked for comment on a new capital rule that would:

• Raise the well capitalized threshold from 7% to 10%, a 43% increase, in less than six months;
• Establish three separate, different capital rules and provide NCUA the power to override a credit union’s choice;
• Require credit unions that choose the new 10% option to hold $24 billion more in required regulatory net worth than under the Risk Based version passed in 2015;
• Set 60 days only for comment with implementation of the Board’s decision by Jan. 1, 2022

If approved, the result would significantly undermine credit unions’ ability to serve their members and the system’s financial soundness.

Three Capital Standards

NCUA’s proposal introduces a whole new capital standard alongside RBC. The RBC rule from 2015 has yet to be implemented. There is no actual credit union experience with either RBC or this second higher minimum capital standard called CCULR, or Complex Credit Union Leverage Ratio.

The accelerated, short time frame for this far-reaching change is unnecessary and unwise. In the 8 years since NCUA proposed RBC, banking regulators evaluated their experience and dropped it as a requirement. Now NCUA retains RBC and adds another banking creation without any analysis or data for either option.

The most cogent reaction to this proposal was by Board Member Hood who opened his questions by saying: “Mr. Chairman, after serious study and consideration, my preference would be to table the risk-based capital rule indefinitely—or even repeal it—and fine-tune the risk-based net worth rule as needed.”

The Most Restrictive Rule Since Deregulation

This race to alter credit unions’ proven capital framework will severely lesson the system’s strength and resilience. Both options constrain the most important decisions a CEO and board make about their business model: how much and where to invest in member value versus how much to keep in reserves.

RBC is a regulatory tax on every asset transaction made by a credit union. To avoid this regulatory capital tax credit unions can use CCULR, the new “simpler” option. This would increases a credit union’s restricted earnings by 43% versus the current 7% capital requirement.

The most important operational judgments for members are no longer a credit union’s to determine. Rather, NCUA defines a single definition of balance sheet risks, weighs them, and then sets the minimum capital using an untried formula.

All credit union’s transactions are treated identically for the same asset risk whether located New York, Peoria, or Charleston. This one size fits all denies the objective reality that every credit union’s operating environment is different.

NCUA then reserves the authority to change a credit union’s decision or to modify its weightings, definitions and the required capital minimum at any time. Just as it does in the current proposal!

Existing Capital Approach Has Stabilized Credit Unions for 110 years—Risk Based Net Worth Approved by GAO

The proposition that credit union’s minimum capital standards have not been sufficient is false. NCUA provided not a single example, data or historical event to suggest otherwise.

In 1998 the well-capitalized threshold was raised from 6% to 7% as a political compromise to the suggestion that credit unions expense their 1% underwriting in the NCUSIF. There was no accounting or factual basis for this change.

In 2004, GAO reviewed NCUA’s implementation of this new PCA risk based net worth concept and concluded:

We are aware that NCUA is constructing a more detailed risk-based capital proposal . . .and that any proposal should be based on the premise that risk-based capital be used to augment, but not replace, the current net worth requirement for credit unions. The system of PCA implemented for credit unions is comparable with the PCA system that bank and thrift regulators have used for over a decade. and

. . . available information indicates no compelling need. . . to make other significant changes to PCA as it has been implemented for credit unions.

Credit unions start with no reserve capital. The cooperative approach of reserving from earnings has been sufficient to sustain the industry through both macro events and decades of financial innovation including:

• Introducing share drafts, mortgage lending, member business loans, credit/debit cards;
• Building out distribution capabilities including branches, call centers, Internet Retail services and shared ATM and branch networks;
• Investing in CUSO’s to bring scale and collaborative solutions for member value;
• Incorporating the latest financial tools including ALM risk modeling, derivatives and hedges, and off balance sheet servicing to manage risk;
• Building capital to navigate deregulation and open competition, the FSLIC crisis and ultimate industry shutdown, two FDIC insolvencies, numerous recessions, the Great Recession 2008-2009, and the recent COVID economic shutdown and recovery,

Credit unions have demonstrated the ability to establish appropriate capital levels to meet every risk itemized in the RBC rule plus dozens of other events and changes that no model could incorporate.

Board and management have managed their individual capital levels to correspond to their business plans and the local economy in which they compete. Now NCUA wants to override that proven practice with a rule that treats each asset’s risk the same wherever and however the credit union operates.

Tomorrow’s blog will document the proposal’s unprecedented financial and regulatory burdens.