Risk Weighting Called Crippling
With the May 28 comment deadline looming, Jim Blaine is already planning ahead for passage of the NCUA's risk-based capital rule.
If the tenets of the rule go unchanged, in particular what he considers egregious risk-weightings in several key areas, the president/CEO of the $28.3 billion State Employees’ Credit Union in Raleigh, N.C., may ask his board to consider converting to a mutual bank.
“It's like marrying the devil,” Blaine said. “We’re a cooperative, but the board has to look after the best interests of our members. If we can make loans more cheaply as a bank than as a credit union, we’re obligated to look into that.”
SECU is the nation's second-largest credit union. As a bank, it would barely break the Top 40. The largest, JPMorgan Chase, now has assets of $2.4 trillion.
Among the proposed rule's many problems, said the outspoken Blaine, is risk weightings given to specific long-term assets that he said would ultimately penalize institutions holding a cooperative charter.
“If I had to grade the current rule I would give it an F,” Blaine said. “I am very supportive of risk weightings and risk-based capital, but the NCUA's rules appear arbitrary, and that to me is scary.”
Blaine's assessment is echoed in numerous letters and emails received by the NCUA since the proposed rule was announced earlier this year. Despite credit unions’ relatively overall positive performance during the recent recession, they would be required to reserve more capital than banks.
Another outspoken critic of the proposals said any attempt to create a single regulatory profile for all credit unions is not only misguided, but undermines the decision-making authority of credit union boards and management, according to Chip Filson, chair of Callahan & Associates.
“Capital adequacy for credit unions in America is unmatched, but that doesn't mean a one-size-fits-all national formula is going to work,” said Filson, a former NCUA executive staffer who once served as the agency's director of programs and is a former president of the National Credit Union Share Insurance Fund.
“Credit unions make informed decisions every day about the adequacy for reserves and net loss needed to sustain business plans for what they do in their local marketplace,” Filson said. “Neither man nor model can adequately assess given risk and adequate circumstance before the fact.”
Douglas Fecher, president/CEO of the $2.7 billion Wright-Patt Credit Union in Fairborn, Ohio, raised similar concerns.
“The proposed rule will fundamentally change the decision-making process of boards and managers, away from service to members and community and instead towards managing ‘capital at risk,’” Fecher said in an early draft of his letter to the NCUA. “We see no compelling evidence that the proposed rule is better than the current risk-based net worth system, or even necessary.”
A March 17 email to NCUA from a credit union member identified only as “Ken” brought home the point as well.
“What are you doing?” asked Ken. “The credit unions are a great asset to this country and you are trying to kill them, especially the little ones.
“As a consumer in the process of purchasing my retirement home and taking out a mortgage from a credit union, do you expect me to find a CU where MY mortgage isn't going to affect the capital requirements?” continued Ken. “Nope, I’ll go to a bank. If everyone does this what will you have left to regulate?????”
The NCUA's 198-page proposal, which amends seven sections of the Federal Credit Union Act, was introduced Jan. 23 with comments due no later than May 28. The agency also will host listening sessions on June 26 in Los Angeles, July 10 in Chicago and July 17 in Alexandria, Va.
“Listening sessions after the comment period is over means what's discussed doesn't become part of the record,” Blaine said. “It would be a great grace to the industry to put them on the record.”
The rule, which regulators said is designed to make credit union rules consistent with OCC, FDIC, Federal Reserve and corporate capital requirements, replaces existing risk-based net worth requirements with risk-based capital requirements. Once approved, credit unions will have between 12 and 18 months to comply with the new standards.
The change was implemented as part of Chairman Debbie Matz's initiatives to modernize standards established in 2001 after the 1998 passage of the Credit Union Membership Access act, said Larry Fazio, director of examinations and insurance.
“We really haven't updated it since and a lot has happened since 2001,” Fazio said in an agency video about the proposed rule.
According to the video, the new rule will only affect those credit unions considered “complex,” defined as the roughly 2,200 institutions with more than $50 million in assets out of a total of about 6,600 credit unions. Of that number, about 200 credit unions will see a change in their PCA category, according to JeanMarie Komyathy, NCUA's director of risk management.
“About 190 (credit unions) will go from a well-capitalized position to an adequately capitalized position, which means their risk-based capital will be between 8% and 10.49%,” Komyathy told video viewers. “The other 10 or so credit unions will go to an under-capitalized position where their risk-based capital will be below 8%.”
That's just 3% of all credit unions representing only 7% of industry assets, Komyathy said. Those are the credit unions that will have to make choices to either raise more capital or shed some of the long-term assets the agency considers risky to their balance sheets, she added.
The risk-based capital ratio for credit unions currently stands at 7% overall for credit unions. This compares to a 5% ratio for banks as dictated by Basel III, the international banking guidelines that U.S. banks adopted in 2013.
More disturbing to many credit unions, however, are the risk ratings for various long-term assets, including member business loans, certain investments, CUSOs and mortgages, which some larger credit unions have in abundance. Those risk weights would increase based on the percentage of the portfolio that they occupy.
Consider, for example, member business loans under the new proposal. In credit unions where MBLs comprise less than 10% of assets, the risk weight would be 100%. If MBLs comprise 15% to 25% of assets, the risk weight would be 150%, and those institutions with more than 25% of assets devoted to MBLs are facing risk weights of 200%.
Risk weighting for mortgage servicing rights and CUSOs top the list at a whopping 250%. The weighting, at least when it comes to CUSOs, will almost guarantee declines in what otherwise have been profitable collaborative investments, say critics of the rule.
“The new risk-weightings will change credit union balance sheets,” said Mark Starr, president/CEO of $559 million Florida Credit Union in Gainesville, Fla. “It will require credit unions to grow based on assets with lower risk weights so we won't fall out of compliance. We think it will limit us to the point where we won't be competitive in five to 10 years.”
The risk weight is assessed regardless of any qualifying strategy on the part of the credit union itself, which many believe flies in the face of basic credit union management oversight.
The NCUA declined to comment on this or other issues prior to the May 28 deadline for comment letters, according to spokesperson John Fairbanks.
The simplified – and some say simple-minded – one-size-fits-all approach flies in the face of credit union operations and purpose, according to Starr.
“Credit unions are in the risk-management game, not the risk-avoidance game,” Starr wrote in his comment letter. “We must take on risk, get paid for it and manage it effectively in order to be economically viable. For this reason, risk weights must be assigned looking at the entire credit union, its earnings potential and its ability to mitigate losses.”
Next week: Alternatives to NCUA's risk-based capital proposal.