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ALEXANDRIA, Va.-Oct. 19, NCUA held its first Summit on Credit Union Capital at its Alexandria, Va. headquarters and it seemed the consensus was some reform of the current system of capital and Prompt Corrective Action is necessary. “Capital is a critical issue affecting all institutions, and I believe the time has come for action to address these issues,” NCUA Chairman JoAnn Johnson said. “I strongly support a risk-based structure for capital. While legislation is required for certain structure changes, I believe we need to continue to facilitate a safe and sound risk-based approach, wherever possible, within NCUA’s own regulatory authority.” She also emphasized that there is interest in the issue on Capitol Hill as well. “While I welcome thoughtful comments from the industry, we must not lose sight of the fact that any change to NCUA’s capital formula would first take an act of Congress,” NCUA Board Member Debbie Matz said. She added, “Risk-based capital can address some of the concerns we have with PCA while maintaining safety and soundness.” Presenters at the summit were looking for more than meaningful dialogue. Particularly those representing the Association of Corporate Credit Unions, who pointed out that a legislative change was not necessary to establish a risk-based capital system for corporates. “[W]e encourage you to recognize that a risk-based capital system for corporates does not require a legislative solution to implement-unlike natural person credit unions,” Corporate One Federal Credit Union President and CEO Lee Butke said. “It is possible for this summit to be the starting point for a serious and meaningful evaluation of the issue at NCUA of a risk-based capital system for corporate credit unions.” Though he admitted there are risk-weighted components to NCUA’s examination of corporate credit unions, capital adequacy is not one of them. “As the board is aware, regulation is simply one pillar in an effective system of regulatory oversight,” Butke said. “An effective examination system is unquestionably the best method of identifying and addressing safety and soundness concerns, but the NCUA’s Office of Corporate Credit Union’s examination cannot be the only tool to encourage lower risk behavior at corporate credit unions. A capital standard that incorporates risk factors into its regimen is essential to complement a risk-based examination program, risk-based authorization of expanded authorities, and risk-based NEV [Net Economic Value] standards.” He also outlined corporates’ experience with secondary capital, which could serve as an example of how a system could work for natural person credit unions. Butke explained that credit unions purchase Membership Capital Shares and Paid-in-Capital shares in their corporates. There is a designated maturity schedule, the investments are uninsured, have a first loss priority after reserves, dividends are not cumulative and can be waived as necessary, voting rights are not attached, and credit unions receive clear disclosures as to their risk at the time of purchase. U.S. Central Corporate Credit Union Senior Vice President and General Counsel Franois Henriquez, who testified on behalf of NASCUS, employed PIC to illustrate the importance of alternative capital options to credit unions. He explained that PIC is a hybrid capital instrument in that there are no voting rights and there are no purchaser call options, but, at the same time, accountants and auditors count it as GAAP equity because it lacks stated maturity, dividends are non-cumulative, and PIC is uninsured, among other things. So, for natural person credit unions, the question becomes “Why not?” Henriquez said. “We all agree that capital is beneficial to credit unions, their members, and their regulators,” he stated, “However, when it comes to alternative capital, the credit union movement seems to be asking, `Why should we add alternative capital?’ But, given credit unions’ desire to have the flexibility to serve their members better, and credit union regulators’ desire to assure capital adequacy, NASCUS believes the question today should be, `Why shouldn’t we add alternative capital?’ ” Henriquez pointed out that a leverage ratio would work “ in tandem” with a risk-based net worth requirement that is afforded to other U.S. financial institutions. He added that, when properly structured as debt, hybrid capital instruments do not “interfere with the credit union’s operation for mutual purposes and without profit, because all of its net income continue to be given to, or reserved for, its members and not any third parties, including creditors.” Additionally, state-chartered credit unions in 10 states permit their credit unions alternative capital. State Employees Credit Union of N.C. CEO Jim Blaine also testified on behalf of NASCUS. He decried credit unions’ excessive capital retention. “The efficient use and deployment of capital is the basic building block of a capitalistic economy -regardless of whether an organization is operated on a for-profit or not-for-profit basis,” he said. “Just as with labor or raw materials, the use of too much capital in any business venture is inefficient and wasteful.” Credit unions’ current level of over 10% “is excessive,” Blaine stated. SECU, located in North Carolina where state charters are permitted alternative capital, issued its first placement of alternative capital in June 2001 of $1 million in conjunction with Self-Help Credit Union. PCA is a valuable tool, according to CUNA. USA Federal Credit Union President and CEO Mary Cunningham, who testified on CUNA’s behalf, stated during her presentation, “In theory, the value of PCA is that it automatically requires a credit union whose net worth ratio falls toward a dangerous level to take action to reverse that situation. In practice, the problem with the current credit union PCA system is that it actually forces credit unions to take such actions at net worth ratios that are far too high.” She went on to say, “Further, bank regulators have latitude to set capital levels for banks while NCUA must implement statutory benchmarks, despite the fact bank portfolios generally contain a great deal more risk than those of credit unions.” The result is “needless limitations on growth at well-run credit unions.” Bill Raker, president and CEO of US Federal Credit Union who also testified for CUNA, pointed to Basel II, which provides a “substantial reduction in risk-based capital requirements for banks.What is most telling is that the very assets that have had their risk weights lowered are the same assets that comprise virtually all of credit unions’ loan portfolios, like residential mortgages and consumer and small business loans.” He noted that CUNA also supports secondary capital, but acknowledges the road blocks it faces. “Given the unlikely achievement in the reasonably near future of secondary capital in a form that would be generally useful and desirable for all credit unions, considerable attention has been given to other avenues to obtain reform.” Raker said. Melissa Marquez, a loan officer at Genesee Federal Credit Union, and Helen Godfrey, president and CEO at Shreveport Federal Credit Union, testified on behalf of the National Federation of Community Development Credit Unions. They pointed out that low-income designated credit unions already have the ability to raise secondary capital. According to NFCDCU’s written testimony, “Prompt Corrective Action as administered by NCUA is suppressing the expansion and threatening the survival of credit unions that specialize in serving low-income communities. If current trends continue, the outcome will be diminished service to the people whom the credit union industry has a historic and philosophical mission to serve.” NFCDCU argued that NCUA’s aggressive implementation of policies on allowance for loan losses depletes low-income credit unions’ capital and stunts earnings. Additionally, NCUA should improve the secondary capital system to provide greater benefits to credit unions while making it more attractive to investors. NFCDCU complained that the current system discounts secondary capital as net worth by 20% and after reaching less than five years to maturity, the credit union carries the note as a liability. In those last five years, the credit union is burdened with a loan priced above the cost of deposits with no value as net worth, the investors are completely at risk, and the insurance fund continues to benefit from the buffer. NAFCU has consistently supported a system of risk-based capital and provides qualified backing to a secondary capital alternative. “Our suggestion was that we focus on risk-based capital and see if we can move that forward and change the definition of net worth to accept all forms of GAAP equity,” NAFCU Director Brad Beal, president and CEO of Nevada Federal Credit Union, told Credit Union Times following the hearing. However, he said, NAFCU has not given up the search for a form of alternative capital that would meet its seven underlying principles. Beal said that if alternative capital were available, he did not foresee his credit union taking advantage of it right away. Nevada FCU stands at 9.7% net worth and will grow about 18% by year end, he said. However, with risk-based net worth, Beal said he would not be “as worried” about maintaining as high a level of capital. He said risk-based capital “might make us a little more aggressive.” He stated it simply provides a more accurate view of all credit unions’ capital. Sitting on the agency’s side of the table at the summit were Johnson, Matz, Director of Examination and Insurance Dave Marquis, Director of the Office of Corporate Credit Unions Kent Buckham, and Director of the Office of Strategic Program Support and Planning Owen Cole. Professor of Accounting and Information Systems for the Broad Graduate School of Management at the Michigan State University Dr. Harold Sollenberger also testified. The agency is accepting written comments until Nov. 19. [email protected]

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