I’m a proponent of allowing for reforming credit unions’ secondary capital authorities. However, I’m reading through NCUA Board Member Gigi Hyland’s White Paper, and I have to admit that what could happen is mighty scary. NCUA oversees 41 low-income designated credit unions that employ secondary capital; and 83% of those are subject to little or no PCA action. This compares to 97% of the general credit union population. Straight from 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 non-performing loans and poorly performing programs), all of which result in lower than expected returns.

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