The secondary capital debate draws deep-seated philosophical arguments from both sides as you've seen in letters to the editor and opinion pieces in this publication and elsewhere, and NCUA Board Member Gigi Hyland's recently released white paper on the subject stirred the pot further.
The issue of secondary capital has many complex aspects in addition to the actual complexity of structure. Less quantifiable, but probably more important, political considerations are at play, too. There are intra-credit union politics pitting opponents against backers that have gotten quite snippy. There are agency and Capitol Hill considerations as well.
While I believe credit union capital can be deployed better at some credit unions, I also do not understand the logic behind denying credit unions even the opportunity to access other sources of capital to help them spread their good deeds. Healthy credit unions that intentionally run at marginally well-capitalized as defined in the prompt corrective action regulation could use alternative sources of capital to further expand their product and service lineup, cultivate membership growth and hedge against inordinate deposit influx. After all, these are the credit unions that are, theoretically, providing the best returns to the membership, which should be a primary mission of credit unions. Secondary capital in particular could help to buffer and finance greater service to those of modest means-that's why low-income credit unions are permitted to use it.
That's a check in the plus column politically. However, by the NCUA Working Group's own admission, the low-income credit unions (which tend to be smaller in assets) have used alternative capital with mixed results. The NCUA oversees 41 low-income designated credit unions that employ secondary capital, and 83% of those are subject to little or no prompt corrective action. This compares to 97% of the general credit union population not subject to PCA requirements. Remember PCA was one of the items credit unions were saddled with in CUMAA negotiations. Straight from the NCUA's report:
"NCUA's supervisory experience with uninsured secondary capital in low-income credit unions has been mixed. As recently as 2006, NCUA addressed a pattern of lenient practices in some low-income designated credit unions that frustrate the good faith use of uninsured secondary capital. These included: (1) poor due diligence and strategic planning in connection with establishing and expanding member service programs such as ATMs, share drafts and lending (e.g., member business loans, real estate and subprime); (2) failure to adequately perform a prospective cost/benefit analysis of these programs to assess such factors as market demand and economies of scale; (3) premature and excessively ambitious concentrations of uninsured secondary capital to support unproven or poorly performing programs; and (4) failure to realistically assess and timely curtail programs that, in the face of mounting losses, are not meeting expectations. These experiences among low-income designated credit unions that accept secondary capital show the danger and consequences of leverage when used by institutions that do not conduct the necessary planning and risk management required to effectively utilize the extra leverage provided by supplemental capital. Lenient practices of this kind contribute to excessive net operating costs, high losses from loan defaults and a shortfall in revenues (due to nonperforming loans and poorly performing programs), all of which result in lower than expected returns."
The other example of NCUA oversight of a similar capital framework is also the third rail of credit union politics-the corporate credit unions with their paid-in capital and member capital shares (or lack thereof). However, as NASCUS President/CEO Mary Martha Fortney pointed out, the PIC and MCS served their purpose of cushioning the NCUSIF, and losses to the fund would have been greater without them. Still mere mention of how something worked at the corporate credit unions raises red flags in the back of minds.
Each of the NCUA Board members have publicly expressed support for supplemental capital, as has NASCUS, which represents the state regulators.
Yet, there are no next steps planned. Why?
In the current climate on Capitol Hill, even among friends, there is a question as to whether supplemental capital is "real" capital. I can't fathom this one. The funds are locked in for a predetermined amount of time. The investor would not be able to withdraw it according to the proposals in the report.
SECU CEO Jim Blaine is one that has been pushing the capital reform issue because the NCUA has yet to release its financial statement from 2008, and secondary capital would provide more protection against what possibly lies ahead in the form of assessments.
The report itself is very prescriptive, like a regulation. According to Chairman Debbie Matz and Board Member Michael Fryzel's statements, there are no next steps for the white paper at this point. Matz sent a letter to Financial Services Committee Chairman Barney Frank, which received no official response, just last December supporting supplemental capital to counterbalance excess deposits on credit union balance sheets.
Right now, unlike capital reform, which could be interpreted as a relaxation of capital, there's an appetite for increasing credit to small business, thus business lending has been a primary focus of the credit union trade associations. CUNA and NAFCU have sworn allegiance to supplemental capital reform, but as a practical matter the business lending issue is leaving the station so it's time to get on board; the two still say they continue to work supplemental capital as well.
Another practical consideration in tough economic times is the ability to raise supplemental capital. The agency would also have to be careful to ensure credit unions don't start investing in other credit unions, defeating the purpose behind the capital cushion effect.
Unrelated, but I would be remiss in not mentioning it: the National Community Reinvestment Coalition President/CEO John Taylor was at it again last week, bashing credit unions at a Community Reinvestment Act hearing on the Hill. How someone with such a vested interest in CRA money has the opportunity to address Congress while credit unions were not invited is beyond reason. His assertions that banks are doing a better job at serving underserved communities are absurd and contrary to his allegedly altruistic motivation. To his credit, Rep. Jeb Hensarling stood up for credit unions.
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