NCUA Risk-Based Capital Proposal

Executive Summary

 
Credit Union National Association’s Initial Summary of NCUA’s Risk-Based Capital (RBC) Proposal

What NCUA Is Proposing – An Overview

The National Credit Union Administration Board is seeking comments for 90 days on a proposal regarding risk-based capital (RBC) requirements under its prompt corrective action rules. The proposal would:

•  Cover credit unions with assets over $50 million;

•  Restructure NCUA’s current PCA regulation to involve calculation of a capital to risk assets ratio, analogous to Basel III for community banks, although the risk weights would be substantially different;

•  Require a well-capitalized credit union to maintain a 7% net worth ratio (unchanged from the current PCA system) and a new, 10.5% risk based capital ratio;

•  Change many of the effective risk-weights for most of NCUA’s current asset classifications;

•  Set higher risk weights and hence higher capital requirements for credit unions with higher concentrations of assets in real estate loans, member business loans, longer-term investments and some other assets;

•  Authorize the agency to require even higher capital on a case-by-case basis.

•  Set further restrictions on the ability of a credit union to pay dividends.

NCUA has produced a calculator to help credit unions determine how the proposal would affect their net worth (capital), as the bank regulators provided under their Basel III proposal. The proposal has not yet been published in the Federal Register, so a specific comment due date has not been set yet; we will revise this document to include the date when it appears in the Register.

Please submit your comments to CUNA as soon as possible, as we anticipate filing a comment letter to NCUA well in advance of the comment period deadline.

For more information about the proposal, contact Bill Hampel, Mary Dunn or Lance Noggle.


CUNA’s Initial Concerns

We will be updating this document as we continue our review of the 198 page proposal. Initial concerns include the following:

•  NCUA has not justified the need for the rule adequately;

•  NCUA would assume additional authority to impose even higher capital requirements on individual credit unions that could exceed even well-capitalized level requirements;

•  NCUA would require covered credit unions to subtract good will from net worth when calculating their risk based capital requirements (note: this is consistent with Basel III);

•  NCUA would also require the National Credit Union Share Insurance Fund 1% deposit to be ignored in the risk-based capital calculation;

•  More credit unions than NCUA has indicated would be impacted as their net worth would fall to just barely over well-capitalized or adequately capitalized levels;

•  More time is needed for the rule to be phased in;

•  A number of the risk weightings, especially for member business loan and mortgage concentrations as well as for CUSO investments, do not appear to be properly calibrated for credit unions. Using higher risk weights on long-term assets to deal with interest-rate risk is misleading without considering liability maturities.

CUNA’s Plan to Address the Rule’s Deficiencies

CUNA is analyzing all aspects of the proposal, including the agency’s legal authority for the proposal and how it compares with Basel III for community banks.

CUNA staff will be working with our Examination and Supervision Subcommittee and others, such as the CUNA Accounting Subcommittee and the CUNA Councils, to develop our official response in our comment letter. We will be meeting with NCUA Board members and staff as well as reaching out to the credit union system to solicit the views of credit unions and leagues. We will also be talking with outside consultants that have particular expertise on Basel III and discussing aspects of the proposal with bank regulators.

Credit Unions that would be affected by the Proposal

NCUA estimates that over 90 percent of the credit unions with assets over $50 million, if the proposed rule were in effect today, would be meet the minimum risk-based capital requirements. NCUA stated that approximately 2,237 credit unions reported over $50 million in total assets, all of which would be subject to the proposed risk-based capital measures.

However, we are also concerned about credit unions that would fall from being well-capitalized with a healthy margin to those that are just barely above the well-capitalized level.

NCUA estimates that if the proposed risk-based capital requirements were applied today, the aggregate risk-based capital ratio (dollar weighted average) for credit unions subject to the proposed risk-based capital measure would be 14.6 percent and the credit union average risk-based capital ratio would be 15.7 percent. These average numbers are well above the proposed 10.5 percent requirement for classification as well-capitalized. However, many more credit unions will have risk-based capital ratios near 10.5% than currently have net worth ratios close to their risk-based-net-worth requirement.

Based on June 2013 Call Report data, 189 credit unions would experience a decline in their PCA classification from well capitalized to adequately capitalized if the proposal were in effect now and 10 well capitalized credit unions would be downgraded to undercapitalized. In addition, CUNA estimates that a number of credit unions would fall from being comfortably well capitalized under the current system to being merely well capitalized under the proposed system, where the dividing line between these two groups if having a two percentage point buffer above both the net worth ratio requirement and the risk-based capital requirement. (CUNA will update this document with our estimate of how many credit unions would fall from comfortably higher than well-capitalized to barely well capitalized shortly.)

NCUA says that, collectively, the 10 credit unions that would become undercapitalized under the proposal would need to retain an additional $63 million in risk-based capital to become adequately capitalized, assuming no other adjustments are necessary.

Effective Date – Transition Period

NCUA is proposing that the rule would go into effect approximately 18 months after the publication in the Federal Register. This would not give credit unions sufficient lead time to plan for the new risk-based capital ratio requirements and other proposed changes to part 702 and implement them properly. This is particularly important as many credit unions may wish to alter their balance sheet composition in response to the rule. We will be urging a much longer implementation period, particularly in light of the multi-year development and implementation of Basel III for banks. During the 18 month implementation period, credit unions would be required to continue to comply with current part 702.

Capital Categories for Covered Credit Unions

The “risk-based net worth (RBNW) requirement” is replaced with a “risk-based capital ratio requirement.” Whereas the current RBNW requirement imposes different capital requirements on different assets (6% for average risk assets, more or less than 6% for low-risk or high-risk assets) the proposed risk-based capital ratio would assign varying weights to different assets, and then calculate the ratio of net worth to total risk-weighted assets. Unlike the Basel system, which assigns weights exclusively on the basis of credit risk, NCUAs risk weights would cover, in addition to credit risk, interest rate risk, concentration risk and other risks. The statutory Tier I net worth ratios would remain unchanged.

        Well Capitalized (All risk based capital ratios are for covered credit unions only)

        A credit union must maintain a net worth ratio of 7 percent or greater and a risk-based capital ratio of 10.5 percent or greater.

        Adequately Capitalized

        A credit union must maintain a net worth ratio of at least 6 percent and a risk-based capital ratio of 8 percent or greater.

        Undercapitalized

        A credit union with a net worth ratio of 4 percent to 6percent or with a risk-based capital ratio less than 8% if the net worth ratio exceeds 6%.

        Significantly Undercapitalized

        (This is essentially unchanged from the current rule.) A credit union has a net worth ratio of less than 5 percent, and has received notice that its net worth restoration plan has not been approved; (2) the credit union has a net worth ratio of 2 percent or more but less than 4 percent; or (3) the credit union has a net worth ratio of 4 percent or more but less than 5 percent, and the credit union either fails to submit an acceptable net worth restoration plan within the time prescribed in §702.111, or materially fails to implement a net worth restoration plan approved by NCUA.

        Critically Undercapitalized

        (This is unchanged from the current rule.) A credit union is classified as critically undercapitalized if it has a net worth ratio of less than 2 percent.

Calculation of the Current Net Worth Ratio

This is unchanged from the current rule.

Calculation of Capital for the new Risk-Based Capital Ratio

To determine its risk-based capital ratio, a covered credit union would calculate the percentage, rounded to two decimal places, of its risk-based capital numerator as described in the proposal divided by its total risk-weighted assets denominator, also addressed in the proposal.

         Risk-based Capital Ratio Numerator

        This is the sum of:
        • Undivided earnings (includes any regular reserve);
        • Appropriation for non-conforming investments;
        • Other reserves;
        • Equity acquired in merger;
        • Net income;
        • ALLL, limited to 1.25% of risk assets;
        • Secondary capital accounts included in net worth (as defined in §702.2); and
        • Section 208 assistance included in net worth (as defined in §702.2).

        The following Call Report equity items would not be included:
        • Accumulated unrealized gains (losses) on available for sale securities;
        • Accumulated unrealized losses for OTTI on debt securities;
        • Accumulated unrealized net gains (losses) on cash flow hedges; and
        • Other comprehensive income.

        Elements deducted from the sum of the risk-based capital elements are:
        • NCUSIF Capitalization Deposit (which would also be deducted from the denominator);
        • Goodwill;
        • Other intangible assets; and
        • Identified losses not reflected in the risk-based capital ratio numerator.

Total Risk-Weighted Assets, Which Are the Denominator

The proposal assigns higher risk-weights to larger percentages of certain assets such as MBLs and real estate loans. The proposal would require calculation of risk-weighted asset amount for its on- and off-balance sheet exposures. The calculation would be automated as part of the Call Reporting process. The 5300 Call Report would be modified to include all items necessary for the calculation.

Total risk-weighted assets would also include risk-weighted derivatives, minus the risk-based capital numerator deductions mentioned above. Risk-weighted asset amounts for off-balance sheet items would be calculated using a two-step process: (1) multiplying the amount of the off-balance sheet exposure by a credit conversion factor (CCF) to determine a credit equivalent amount, and (2) assigning the credit equivalent amount to a relevant risk-weighted category.

To determine total risk-weighted assets, a credit union would calculate its risk-weighted assets and subtract goodwill and other intangibles, as well as the NCUSIF deposit.

Risk-Weights for On-Balance Sheet Assets

The chart below prepared by NCUA defines the risk categories and risk-weights to be assigned to each specifically defined on-balance sheet asset. Some of these risk weights are equivalent to the factors of the current RBNW requirement, although many are different.

Risk-Weight Categories and Associated Risk-Weights

Risk-Weight

Category

Risk-Weight

Items Included

Category 1

0 percent

• Cash on hand, which includes the change fund (coin, currency, and cash items), vault cash, vault funds in transit, and currency supplied from automatic teller machines.

• NCUSIF capitalization deposit.

• Debt instruments unconditionally guaranteed by the NCUA or the FDIC.

• U.S. Government obligations directly and unconditionally guaranteed by the full faith and credit of the U.S. Government, including U.S. Treasury bills, notes, bonds, zero coupon bonds, and separate trading of registered interest and principal securities (STRIPS).

• Non-delinquent student loans unconditionally guaranteed by a U.S. Government agency

Category 2

20 percent

• Cash on deposit, which includes balances on deposit in insured financial institutions and deposits in transit. These amounts may or may not be subject to withdrawal by check, and they may or may not bear interest. Examples include overnight accounts, corporate credit union daily accounts, money market accounts, and checking accounts.

• Cash equivalents (investments with original maturities of three months or less). Cash equivalents are short-term, highly liquid non- security investments that have an original maturity of 3 months or less at the time of purchase, are readily convertible to known amounts of cash, and are used as part of the credit union’s cash management activities.

• The total amount of investments with a weighted-average life of one year or less.

• Residential mortgages guaranteed by the federal government through the FHA or the VA.

• Loans guaranteed 75 percent or more by the SBA, U.S. Department of Agriculture, or other U.S. Government agency.

Category 3

50 percent

• The total amount of investments with a weighted-average life of greater than one year, but less than or equal to three years.

• The total amount of current and non-delinquent first mortgage real estate loans less than or equal to 25 percent of total assets.

Category 4

75 percent

• The total amount of investments with a weighted-average life of greater than three years, but less than or equal to five years.

• Current and non-delinquent unsecured credit card loans, other unsecured loans and lines of credit, short-term, small amount loans (STS), new vehicle loans, used vehicle loans, leases receivable and all other loans. (Excluding loans reported as MBLs).

• Current and non-delinquent first mortgage real estate loans greater than 25 percent of total assets and less than or equal to 35 percent of assets.

Category 5

100 percent

• Corporate credit union nonperpetual capital.

• The total outstanding principal amount loaned to CUSOs.

• Current and non-delinquent first mortgage real estate loans greater than 35 percent of total assets.

• Delinquent first mortgage real estate loans.

• Other real estate-secured loans less than or equal to 10 percent of assets.

• MBLs less than or equal to 15 percent of assets.

• Loans held for sale.

• The total amount of any foreclosures and repossessed assets.

• Land and building, less depreciation on building.

• Any other fixed assets, such as furniture and fixtures and leasehold improvements, less related depreciation.

• Current non-federally insured student loans.

• All other assets not specifically assigned a risk- weight but included in the balance sheet.

Category 6

125 percent

• Total amount of all other real estate-secured loans greater than 10 percent of assets and less than or equal to 20 percent of assets.

Category 7

150 percent

• The total amount of investments with a weighted-average life of greater than five years, but less than or equal to ten years.

• Any delinquent unsecured credit card loans; other unsecured loans and lines of credit; short- term, small amount loans; non-federally guaranteed student loans; new vehicle loans; used vehicle loans; leases receivable; and all other loans (excluding loans reported as MBLs).

• The total amount of all other real estate-secured loans greater than 20 percent of assets.

• Any MBLs greater than 15 percent of assets and less than or equal to 25 percent of assets.

Category 8

200 percent

• Corporate credit union perpetual capital.

• The total amount of investments with a weighted-average life of greater than 10 years.

• The total amount of MBLs greater than 25 percent of assets, other than MBLs included in Category 3 above.

Category 9

250 percent

• The total value of investments in CUSOs.

• The total value of mortgage servicing assets

Category 10

1,250 percent

• An asset-backed investment for which the credit union is unable to demonstrate, as required under §702.104(d), a comprehensive understanding of the features of the asset- backed investment that would materially affect its performance

Risk-Weights for Off-Balance Sheet Activities

Risk-weighted amounts for all off-balance sheet items would be determined by multiplying the notional principal, or face value, by the appropriate conversion factor and the assigned risk-weight as follows:

        •  A 75 percent conversion factor with a 100 percent risk-weight for unfunded commitments for MBLs.

        •  A 75 percent conversion factor with a 100 percent risk-weight for MBLs transferred with limited recourse.

        •  A 75 percent conversion factor with a 50 percent risk-weight for first mortgage real estate loans transferred with limited recourse.

        •  A 75 percent conversion factor with a 100 percent risk-weight for other real estate loans transferred with limited recourse.

        •  A 75 percent conversion factor with a 100 percent risk-weight for non-federally guaranteed student loans transferred with limited recourse.

        •  A 75 percent conversion factor with a 75 percent risk-weight for all other loans transferred with limited recourse.

        •  A 10 percent conversion factor with a 75 percent risk-weight for total unfunded commitments for non-business loans.

A credit union would calculate the exposure amount of an off-balance sheet component, which is usually the contractual amount multiplied by the applicable credit conversion factor (CCF). This treatment would apply to specific off-balance sheet items, including loans sold with recourse, unfunded commitments for business loans, and other unfunded commitments.

Data Collection – Call Report

The proposed risk-based capital ratio measure primarily uses existing information contained in the Call Report. As compared to the current RBNW measure, the proposed risk-based capital ratio measure would include a greater number of exposure categories for purposes of calculating total risk-weighted assets. Thus, some additional data would need to be collected on the Call Report. This additional data would not, however, represent a material increase to the burden of completing the Call Report, according to the NCUA.

Individual Minimum Capital Requirements

CUNA is extremely concerned about these provisions and will certainly oppose them as proposed. NCUA would be able to require a higher minimum risk-based capital ratio for an individual credit union in any case where the circumstances, such as the level of risk of a particular investment portfolio, the risk management systems, or other information, indicate that a higher minimum risk-based capital requirement is appropriate. For example, NCUA says higher capital may be appropriate for a credit union that has significant exposure to declines in the economic value of its capital due to changes in interest rates.

The following specific situations would allow NCUA to impose higher capital levels when a credit union:
        •  Is receiving special supervisory attention.
        •  Has or is expected to have losses resulting in capital inadequacy.
        •  Has a high degree of exposure to interest rate risk, prepayment risk, credit risk, concentration risk, certain risks arising from nontraditional activities or similar risks, or a high proportion of off-balance sheet risk.
        •  Has poor liquidity or cash flow.
        •  Is growing, either internally or through acquisitions, at such a rate that supervisory problems are presented that are not adequately addressed by other NCUA regulations or other guidance.
        •  May be adversely affected by the activities or condition of its CUSOs or other persons or entities with which it has significant business relationships, including concentrations of credit.
        •  Has a portfolio reflecting weak credit quality or a significant likelihood of financial loss, or which has loans or securities in nonperforming status or on which borrowers fail to comply with repayment terms.
        •  Has inadequate underwriting policies, standards, or procedures for its loans and investments.
        •  Has failed to properly plan for, or execute, necessary retained earnings growth.
        •  Has a record of operational losses that exceeds the average of other similarly situated credit unions; has management deficiencies, including failure to adequately monitor and control financial and operating risks, particularly the risks presented by concentrations of credit and nontraditional activities; or has a poor record of supervisory compliance.

In addition, the following factors that may be considered by NCUA in making its determination:
        •  The conditions or circumstances leading to the determination that a higher minimum capital requirement is appropriate or necessary for the credit union.
        •  The urgency of those circumstances or potential problems.
        •  The overall condition, management strength, and future prospects of the credit union and, if applicable, its subsidiaries, affiliates, and business partners.
        •  The credit union's liquidity, capital, and other indicators of financial stability, particularly as compared with those of similarly situated credit unions.
        •  The policies and practices of the credit union's directors, officers, and senior management as well as the internal control and internal audit systems for implementation of such adopted policies and practices.

All of these factors would be over and above the objective risk-weighting system implicit in the proposed new risk-based capital ratio calculation. As such, NCUA’s determination of whether a credit union would be subject to an individual minimum capital requirement would of necessity be highly subjective.

The proposal would establish a process under which a credit union could challenge the requirement for higher capital. The credit union would be entitled to “reasonable prior notice” from NCUA that would state the levels of capital NCUA seeks to impose and the cause for the extra capital along with a schedule for attaining the higher capital levels. The credit union must respond within 30 days and may file a notice if it objects as well as seek a recommendation from the NCUA Ombudsman. We have many concerns about the adequacy of this process.

Reserves/ Charges for Loan Losses

The proposed rule would eliminate the current requirements regarding earnings transfers to the regular reserve account and the provision which directed that the maintenance of an ALLL does not affect the requirement to transfer earnings to a credit union's regular reserve.

Restriction on Dividends

Currently, credit unions with a depleted undivided earnings balance may pay dividends out of the regular reserve account without regulatory approval, as long as the credit union will remain at least adequately capitalized.

Under the proposed rule, well capitalized credit unions could pay dividends only if their net worth classification does not fall below adequately capitalized unless they receive NCUA approval. The credit union’s request for written approval must include the credit union’s plan for eliminating any negative retained earnings balance. Secondary capital accounts would continue to be excluded as a direct source of dividend payments. Dividends would not be considered operating losses and could not be paid out of secondary capital.

A credit union classified as well capitalized would be prohibited from paying dividend rates that are higher than the prevailing market rates, declaring a non-repetitive dividend, or approving a refund of interest if, after the payment of the dividend, the credit union’s net worth ratio would decline to less than 6 percent in the current quarter.

Subpart B—Alternative Prompt Corrective Action for New Credit Unions

The proposed rule would add new subpart B, which would contain most of the capital adequacy rules that would apply to “new” credit unions, those that have been in operation for 10 years or less, or have $10 million or less in total assets.

Comments Are Urged

CUNA and the leagues urge credit unions to review the proposal in light of its impact on credit union operations and to share their views regarding the proposal with CUNA and the leagues as soon as possible; comment letters to NCUA are also urged, with a copy to CUNA and the credit union’s league. This is a critical proposal and as many credit unions as possible should weigh in with their assessments and concerns.


Questions to Consider Regarding the Proposal
1. Do you agree this new proposal is necessary?
2. How would your credit union be affected by the proposal?
3. Do you agree NCUA should be able to impose higher capital requirements on credit unions on a case by case basis?
4. Do you agree with the risk weightings for these categories?


YesNo
MBLs
Mortgage Loans
Longer-term investments
Consumer loans
CUSOs Investments and Loans
Others (Please identify)
5. Should the NCSUIF deposit be excluded from the calculation of RBC ratios?
6. Should goodwill be excluded from the calculation of the RBC numerator?
7. Do you agree NCUA should be able to restrict dividend payments as the proposal would provide?
8. Do you agree with NCUA’s implementation time line? If not, how much more time should credit unions be provided?
9. Do you have other concerns with the proposal? Please explain.
10. (Optional) What is your credit union's asset size?
11. (Optional) Please provide information about yourself and your credit union.
Thank you for your input and time - CUNA Regulatory Advocacy Team