WASHINGTON and ARLINGTON, Va. - Extensive trade association comment on NCUA's proposed risk-based net worth (RBNW) requirements rule for "complex" credit unions was submitted by last week's comment deadline with considerable attention being paid to portfolio categories, definitions, and numerical factors constituting "complexity" and RBNW requirements. The proposed rule, required by the prompt corrective action (PCA) provisions of the CU Membership Access Act (H.R. 1151) and passed in a 3-0 NCUA Board vote February 9, establishes CU net worth requirements over and above basic PCA strictures for credit unions whose portfolios represent an increased risk to the share insurance fund. Originally deemed by NCUA to apply to no more than 1,490 federally insured credit unions (FICUs) out of a total of 10,840, the proposed rule cited four relevant categories of CU balance sheet risk-any one of which, depending on its make-up, could qualify the FICU as "complex" and trigger RBNW requirements. They are: long-term (maturity greater than three years), fixed real estate loans comprising more than 25% of the FICU's portfolio; a combination of outstanding member business loans (MBLs) and unused MBL commitments comprising more than 12.25% of portfolio; fixed or variable rate investments with maturities over three years making up more than 15% of portfolio; and off-balance sheet risks in excess of 5% of portfolio. The proposed rule also presented a table ascribing risk weights (RBNW factors) to various exposure/hedging percentages in eight portfolio categories. It was provided to help the FICU self-determine its cumulative RBNW requirement. "CUNA applauds the NCUA and the state supervisors who worked with the agency for the general approach to defining a `complex' credit union and the RBNW requirements," said CUNA President Dan Mica in CUNA's exhaustive comment letter. "We believe the four `risk portfolios' identified in the proposal correctly identify the major sources of material risks against which a 6% net worth ratio (the "adequately capitalized" level) may not provide adequate protection as defined in the Credit Union Membership Access Act." "The proposed method of calculating the risk-based net worth requirement also has considerable merit." "However, we have a number of recommendations to refine and improve the application of the general approach...." "First, the proposal identifies a much larger number of credit unions as complex than we believe should be the case....we do not believe that almost 15% of credit unions present a material level of risk above that which is covered by the 6% net worth standard for capital adequacy...." "Second, we are specifically concerned about the large number of small credit unions identified as complex under the proposal....We believe that the burden placed on them by compliance with the complex portion of the PCA rule far outweighs the minor additional protection for the National Credit Union Share Insurance Fund." "Third, we believe that for the vast majority of cases, the proposal presents a robust approach to identifying potentially complex credit unions and determining the amount of net worth they should hold to be adequately capitalized. However, for a relatively small number of credit unions that are actively engaged in some of the `risk portfolios,' the approach may not be effective." "The proposal does not adequately capture the extent to which a credit union might appropriately manage the risks associated with the risk portfolios." Mica then went on to recommend (and explain) rule changes in 11 major and 15 minor categories, including: * dropping the "pejorative" term "complex" and referring to the RBNW regime as "net worth plus" or "net worth level II"; * tightening the standard for CU "complexity" to require calculated RBNW requirements in excess of 6% in addition to threshold exposures in one of the portfolio risk categories; * exempting FICUs with assets below $20 million from the rule; * permitting FICUs with good risk management characteristics in place to reduce their RBNW requirements by up to 300 basis points; * incorporating into the record a RBNW rule review one year after it becomes effective; * redefining the rule definition "long-term" to exclude closed-end, fixed-rate home equity loans with remaining maturities of seven years or less and mortgages with terms of up to five years; * allowing a risk reduction for fixed-rate, long-term real estate loans commensurate with similarly long-term, fixed rate borrowings from a corporate credit union or Federal Home Loan Bank; * using a single factor of 12% for all long-term, fixed rate mortgages above the threshold; * including long-term, fixed-rate member business mortgage loans with the long-term real estate risk portfolio; * increasing-consistent with the threshold for mortgage loans-the 12.25% MBL threshold to 25%; * excluding the portion of MBLs guaranteed by a government unit from the risk portfolio; * raising the long-term investment threshold for "complexity" from 15% to 25% of assets; * changing from three to four years the threshold for investments considered "long-term"; and * assigning the NCUSIF 1% deposit, cash, and cash equivalents a RBNW factor of 0%. In NAFCU's iconoclastic 32-page comment letter, President Fred Becker, Jr.-under the banner of protecting the federal charter and of opposing overregulation-did not limit himself to fine-tuning the "givens" of NCUA's proposal. Instead, he challenged some of the fundamental assumptions of "complexity" determination. "While we applaud the agency for listening to NAFCU's comments to the advance notice of proposed rulemaking and for making enormous headway into devising a workable definition for complexity," Becker wrote, "NAFCU continues to take issue with the fundamental approach that NCUA has adopted." "From a regulatory perspective, we believe this approach to be inconsistent with the law, therefore resulting in an unnecessarily broad regulation. At the same time, we believe that the approach also conflicts with the fundamental purpose of the regulation, which is to promote the safety and soundness of credit unions." "NAFCU is confident that we have an answer to these problems, and hope that the suggestions included herein are taken into consideration by the agency when drafting the final version of the rule." Becker then went on to say that: * the four, specific portfolio category thresholds constituting "complexity" have little correlation to the overall portfolio risk; * the proposed rule fails to recognize that interest rate risk can be measured only on a portfolio-wide basis; * the eight RBNW-determining risk categories fail to consider risk-mitigating factors or the unique nature of "credit unions' liability structure"; * risk categories are defined too broadly, and the assigned RBNW factors have little relevance to the actual risk of the underlying assets; * the proposed rule assumes extreme rate volatility that is not warranted by the historical evidence; and * a majority of credit unions deemed complex under the proposed rule have actual RBNW requirements lower than 6%, and, therefore, do not pose "material" portfolio risk against which the basic PCA's 6% minimum net worth requirement would be insufficient. Becker therefore explained why NCUA should: * classify an FICU as "complex" only if its RBNW requirements are greater than 6%; * narrow the definitions of proposed rule risk categories and give more credit to risk-mitigating factors; * allow FICUs to use one of three methods in calculating RBNW requirements, including an alternative method based on the "internal risk measurement model"; * allow FICUs to engage in interest rate risk-mitigating strategies such as interest rate swaps and forward rate agreements; and * make future adjustments to RBNW requirement factors in order to allow for greater flexibility in the area. Typical of the "reverse engineering" cast to NAFCU's inquiry, Becker at one point referred to NAFCU calculations that suggested "conflicting and flawed measurements" co-existing in NCUA's proposed rule. "Of the complex credit unions with a net worth ratio of 6% or greater," he said, "only 35 were estimated to fail their RBNW requirement." "Based on these numbers, almost half of the credit unions that are triggering a designation of complexity have portfolios that are so risk-adverse that 6% net worth is more than sufficient to classify the credit union as adequately capitalized....NAFCU believes that this result makes a designation of complex meaningless." The rule becomes final in August. -
gmcorrigan@mindspring.com
