Pieces now in Place for Credit Unions to get Much Needed Capital Relief
Sometime next year, when a Financial Accounting Standards Board proposal on mutual business combinations is expected to take effect, credit unions that choose to merge may no longer be able to count the merged institution's retained earnings in their net worth. Without a legislative fix to the statutory definition of net worth, this change in accounting could have a chilling effect on mergers in our industry. Shifting from the "pooling" to the "purchase" method of accounting, as FASB is expected to require, would prohibit a credit union from counting an acquired credit union's retained earnings as its own. This would, in effect, dilute the net worth of the surviving credit union and potentially raise prompt corrective action issues. It would obviously dampen a healthy credit union's desire to merge with another credit union and might, in certain situations, dissuade a healthy credit union from merging with an unhealthy one when NCUA is seeking a healthy merger partner. NAFCU fully recognizes that people may disagree over the long-term implications of consolidation in our industry. Nevertheless, mergers must remain a viable option for preserving and expanding the availability of credit union services to all Americans. In 2004 alone, 310 federally insured credit unions merged. How attractive will it be for healthy credit unions to merge in the future if only one of the institution's retained earnings can be counted as net worth for PCA purposes? What about assisted mergers, where a credit union acquires another credit union in need of a merger? Will credit unions still be willing to participate in these types of mergers? This is not an issue that has snuck up on credit unions. We have known for several years that FASB was considering applying the purchase method to mutual business combinations. NAFCU and others have made every effort to convince FASB to retain the current pooling method for credit unions. Last year, however, it became clear that FASB is not likely to change its mind about ending pooling for mutual institutions, and so NAFCU began to pursue a legislative fix to redefine net worth in the PCA section of the Federal Credit Union Act. NAFCU received written assurances from FASB officials that the accounting board would view this as a solution to our industry's dilemma. We also instituted discussions with NCUA, the Treasury Department and others. After a year of lobbying and working with key legislators, a legislative fix was introduced last month by House Financial Institutions Subcommittee Chairman Spencer Bachus, (R-Ala), Ranking Member Bernie Sanders, (I-Vt.), and 14 of their colleagues in the House. That legislation, known as the Net Worth Amendment for Credit Unions Act (H.R. 1042), has bipartisan support and will be the subject of a hearing this week. It is our hope that the legislation will move quickly and be enacted into law before the FASB changes go into effect in 2006. The Bachus-Sanders bill redefines net worth in the PCA section of the FCUA, which currently equates a credit union's net worth to retained earnings as defined by generally accepted accounting principles. The bill would simply add to that the GAAP retained earnings of any credit union merged with it. Of course, such a legislative fix would not be necessary at all if it were not for the fact that credit unions have their net worth, for purposes of PCA, specifically defined by statute-under the FCUA as amended by the Credit Union Membership Access Act-while the bank and thrift regulators are free to define capital as they see fit for their institutions. Interestingly enough, it is CUMAA's PCA system that has led to another related debate over how well credit unions should be capitalized and how that capital ultimately gets measured. As many in the industry have suggested, credit unions could benefit from a risk-based approach to capital (which the banks have long enjoyed) rather than the current, "one-size-fits-all" standard that treats all capital the same. Such a risk-based yardstick would also give NCUA a safety and soundness tool for better assessing the types and levels of risk credit unions face. NAFCU has long supported such a risk-based approach. The consensus for this approach has been building since late 2003 when NAFCU asked then Treasury Assistant Secretary for Financial Institutions Wayne Abernathy to support a risk-based capital standard. NAFCU also has been working with NCUA, which last fall hosted a Capital Summit. The summit ultimately led to release of NCUA's PCA reform and risk-based capital proposal. In early April, NCUA Chairman JoAnn Johnson sent the agency's final proposal to Capitol Hill, having thoroughly vetted it through Treasury and responded to comments from NAFCU and others. The latest proposal has been endorsed by the NAFCU Board and becomes the starting point for the capital provisions in the soon-to-be-introduced Credit Union Regulatory Improvements Act. NAFCU was pleased that several of the concerns we raised were addressed in the proposal sent to Congress. Chief among these is the treatment of credit unions' 1% deposit in the NCUSIF. That deposit, in keeping with GAAP, is treated as an earning asset on credit union books-a treatment that NAFCU fought successfully to preserve in the face of a 1991 write-down proposal and will continue to defend at all cost. Initially, NAFCU was concerned about the fact that NCUA's proposal excludes the 1% deposit from the net worth calculation for PCA purposes; however, NAFCU is very pleased that both the preface to the final proposal and the section containing the statutory language now make it clear that the agency's treatment of the deposit for PCA "in no way alters its treatment as an asset under generally accepted accounting principles, or NCUA's steadfast support of the mutual, deposit-based nature of NCUSIF." Other issues NAFCU raised have also been addressed, such as the NCUA Board delegating the regional directors the authority to reclassify an insured credit union to a lower net worth level and the treatment of secondary capital maintained by low-income credit unions. NCUA has crafted a thoughtful and workable approach for implementing a risk-based capital system for federally insured credit unions. Add to that the net worth bill introduced by Chairman Bachus, and you have a one-two punch that delivers much needed relief for credit union net worth under PCA.