Corporates Submit Risk-Based Capital Study To NCUA; Sign of Change for All CUs?
ALEXANDRIA, Va. - Last week, representatives of the Association of Corporate Credit Unions visited NCUA's headquarters to personally deliver the ACCU's risk-based capital study for corporate credit unions. This project has been almost two years in the making for the ACCU, said Mike Canning, its executive director. Some 15 corporates were represented on five different ACCU committees that worked on the issue. To get an independent, outside perspective, the ACCU commissioned Ernst&Young to complete a white paper on corporates and capital. It was completed by Dr. Balvinder Sangha, a leading Basel expert. The Basel Accord is referred to throughout ACCU's study and Basel principles are held up as what corporates should be following. "While the risk-based capital system of the first Basel Accord has been applied to small community banks in the United States and the advanced credit unions and cooperatives banking systems in much of the remainder of the international community, it seems to have conspicuously by-passed natural person and corporate credit unions in the United States up to this point in time," the study stated. Corporate One FCU CEO Lee Butke has been playing the lead in the ACCU's quest for a risk-based capital system for some time. Butke said the time has come to put in perspective corporates' very low-risk, "vanilla" balance sheets. "Most all corporates invest in AAA asset-backed securities or invest in U.S. government securities which invest primarily in triple AAA securities. Corporates should be rewarded for investing in AAA versus maybe A-. This rewards us for less risky activities," said Butke. Right now everything a corporate does is weighted at 100%, even cash. Under the ACCU's proposal, AAA securities would be weighted at 20%. So in a simplistic example of a $1 billion balance sheet of triple AAA asset-backed securities, it would be risk weighted at $200 million. One byproduct of bringing corporates more in line with other financial institutions for capital measurement is as corporates get more complex and look to go to the capital markets, it will be easier for the rating agencies and others to evaluate their risk profile. For example, in the future more corporates may look to package some credit union loans to be sold off in the capital markets. In the white paper, Sangha highlights the typical low-risk profile of the average corporate. He notes that it was not until 2002 that qualified corporates could hold BBB-rated securities. To date, only a few corporates can do so. Also, only corporates with Part III authority can invest in foreign obligations, those with Part IV authority can engage in derivative activity, and Part V authority gives corporates loan participation authority. Currently, only three corporates have Part III authority, four have Part IV authority, and just one has Part V authority. Corporates are currently required to have a minimum capital ratio of 4%, and 2% reserves, undivided earnings (RUDE). Under the ACCU's proposal, those requirements would be eliminated and replaced with a Tier 1 Leverage Ratio, Tier 1 Risk-Based Capital, and Total Risk-Based Capital, similar to what banks follow. (See chart) Tier 1 Capital is defined as RUDE plus paid-in-capital, with PIC being restricted to an amount equal to 50% of aggregate Tier 1 capital. Total capital is Tier 1 capital plus membership capital shares. "I hope our credit union movement sees this and supports it. From our perspective, to adopt a risk-based capital standard is a goal for the industry. This can be a pre-cursor to what credit unions see," said Butke. Butke believes with risk-based capital in place, corporates will more readily bring on and unload capital as the market dictates. "What's interesting, is this gives us a tool to measure risk," said Butke. Empire Corporate CEO Joe Herbst said the need for membership capital accounts may diminish under a risk-based capital system. "It may allow us to have less membership capital accounts. With the membership capital accounts that corporates have to have now, we're asking our members to put their money at risk to have capital to sustain the corporate." In his white paper, Sangha makes the case for risk-based capital in each of the three tiers of the credit union system. "Having a consistent risk-based capital structure at each tier would result in efficient capital allocation throughout the system, providing risk-reducing incentives for the management," he stated. He notes that NCUA is also moving in this direction with its proposal for a more risk-based prompt corrective action system. "The proposed system was designed to achieve greater comparability with capital standards for FDIC-insured institutions and the new Basel Accord, and to correct the current PCA system's tendency to `penalize institutions with conservative risk profiles'," he wrote. ACCU's Canning is thrilled that the study had such broad support from 29 corporates, all of which are listed at the beginning of the report. (The only corporate absent is EasCorp, which dropped out of ACCU last year.) "An overwhelming working group of corporate CEOs and senior staff worked hard putting this proposal together. Everyone supports opening the dialogue with the agency on capital matters," said Canning. NCUA appears willing to work toward risk-based capital for corporates. "We appreciate the corporate system's diligence and in-depth study on the issue of risk-based capital and the modernization of capital standards. We look forward to delving into the issues and anticipate continued dialogue going forward," said NCUA Chairman JoAnn Johnson. -firstname.lastname@example.org