PCA Alternative is a Capital Idea That Needs to Be Pursued
As children, many of us had to pay for the misdeeds of our siblings. For example, if they stayed out too late, we inherited a strict curfew. Now, as the President of Nevada FCU, I see itsomething very similar happening with credit unions. Prompt Corrective Action (PCA) and its capital requirements as mandated by the Credit Union Membership Access Act (CUMAA) isare a prime examples of credit unions paying for the mistakes of others. PCA was put in place by Congress to deal with the banking agencies' regulatory forbearance of undercapitalized banks and thrifts, which contributed to the closing of 1,600 of those institutions during the 1980s. As we all know, taxpayers were left on the hook for billions of dollars. Credit unions, on the other hand, have never had a significant regulatory breakdown. We have never cost taxpayers one dime! Why is PCA a bad fit? First, credit unions are not structured like banks, and we don't want to be. Second, a single capital standard simply cannot be applied to all credit unions. The concept of "one size fits all" just doesn't work. The minimum capital needed to safely operate varies dramatically among credit unions. Third, unlike banks and thrifts that have multiple choices in raising PCA-eligible capital, credit unions only have one way to grow net worth-through retained earnings. When asset growth outstrips a credit union's ability to generate retained earnings, some credit unions face the unpleasant prospect of dropping below the 7% "well capitalized" PCA minimum-despite the fact that they may be safe and sound and pose virtually no risk of failure. Given the current unprecedented growth in assets, isolated PCA problems today may become more widespread in the future. Several states already allow, or are considering allowing, state-chartered credit unions to supplement their capital by offering alternative capital instruments. Unfortunately, none of the current or prospective plans appears to meet PCA requirements. Essentially, PCA allows only retained earnings to be counted as capital; alternative forms of capital would be excluded from PCA calculations. Really, there is only one way to change the current PCA restrictions, and that is through congressional action. To date, two amendments which that would have permitted alternative capital have been discussed in the House Financial Services Committee, one offered by Rep. Bob Ney (R-Ohio), and the other by Rep. Brad Sherman (D-Calif.). These amendments, however, met with some opposition and were subsequently withdrawn. I was asked by NAFCU Chair Jim Mills to chair a task force to study potential models for alternative capital. Fellow NAFCU Board members Mike Vadala and Bill Cheney also serve on the task force, as well as a number of credit union leaders and other experts from across the nation. The NAFCU Board provided the task force with a set of seven guidelines that we believe must be a part of any viable alternative capital model. These are: They are: * Preserve the not-for-profit, mutual, member-owned and cooperative structure of credit unions and ensure that ownership interest (including influence) remains with the members; * Ensure that the capital structure of credit unions is not fundamentally changed and that the safety and soundness of the credit union community as a whole is preserved; * Provide a degree of permanence such that a sudden outflow of capital will not occur; * Allow for a feasible means to augment capital; * Provide a solution with market viability; * Ensure that any proposed solution applies for PCA purposes (to include risk-based capital as appropriate) or changes the definition of net worth to include other equity capital balances; and * Ensure that any proposed solution qualifies as equity capital balances under GAAP. The task force has considered a number of models, as has the NAFCU Board. One of the primary unresolved questions is whether alternative capital changes the member-owned structure of credit unions. This question and others remain under study. NAFCU greatly appreciates the efforts of some lawmakers to address PCA, as well as NCUA Chairman Dennis Dollar who recently proposed what clearly appears to be a very viable first step if not final solution. Chairman Dollar has suggested that the capital adequacy evaluation of credit unions under PCA be based on the relative risk embodied in their financial condition. One flaw in PCA is that it focuses on all assets, instead of concentrating on those assets that pose risk. Chairman Dollar has suggested that the pre-1998 risk-based formula be utilized as a baseline for future evaluation. That formula defined "risk assets" by excluding assets that posed no risk, such as cash on hand, deposits in federally insured institutions, loans guaranteed by governmental agencies, CLF investments and the 1% NCUSIF deposit. By basing a credit union's net worth ratio on its risk assets, most credit unions would receive an appropriate -and very revealing-boost to their capital ratio. Estimates show that a risk-based capital formula similar to what Chairman Dollar has suggested would raise the average net worth ratio of federally insured credit unions to about 20%. That's almost double the current level. More importantly, it is a substantially more realistic view of each credit union's safety and soundness. This approach will also provide NCUA with another important tool for early identification of potential problem situations. In a June 19 letter, House Financial Services Chairman Mike Oxley, R-Ohio, ranking member Barney Frank, D-Mass., and member Brad Sherman, D-Calif., asked Chairman Dollar to supply information on capital-related issues. We look forward to Chairman Dollar's response and working very closely with him to develop a solution. NAFCU is determined to make PCA a better fit. We are also fully committed to preserving the member-owned and member-controlled structure of credit unions. We are encouraged by the efforts of credit union allies on Capitol Hill, and we believe that Chairman Dollar has us clearly headed in the right direction.