Allowing credit unions to raise supplemental capital that iscounted toward net worth requirements is an “appropriate policyconsideration,” as long as there are strong regulatory safeguardsare in place, according to a report issued today by the NCUA'sWorking Group on Supplemental Capital chaired by Board Member GigiHyland.

The report said any capital must adhere to three principles:preservation of the cooperative credit union model, robust investorsafeguards and increased prudential safety and soundnesssafeguards.

Any policy change to allow such capital would have to beapproved by Congress because, the report concludes, the “NCUAcannot count other sources of capital as 'net worth,' byregulation.' When Congress passed HR 1151, it mandated that networth could only come from retained earnings.”

The NCUA plans no discussion or action “at this time,” on thereport, NCUA Chairman Debbie Matz said.

Through a spokesman, Matz added that if “Congress gives NCUAsupplemental capital authority, we will of course act.”

In a letter that Matz wrote to House Financial ServicesCommittee Chairman Barney Frank in December, she encouragedCongress to “consider authorizing qualified credit unions, asdetermined by the NCUA Board to issue alternative forms ofcapital.” Matz did not say what form the alternative capital shouldtake. The Treasury Department hasn't taken a position on thesubject.

Through a spokesman, NCUA Board Member Michael Fryzel declinedcomment.

Several lawmakers who follow credit union issues declinedcomment on the report and lobbyists for CUNA and NAFCU said theyexpect any legislative action would likely come later, rather thansooner.

Hyland said she hopes if Congress takes up the subject, it won'ttie the agency's hands too much.

“I am fearful Congress would put too much in the statute,” shesaid in an interview.

Hyland's report, which was the result of more than a year ofresearch, spells out the three acceptable types of capital:voluntary capital invested by a credit union member; conversion ofthe par value share required for credit union membership to a formof supplemental capital; credit unions issued subordinated debt,subject to standard market practices, with the understanding thatit does not come with voting rights or any other involvement in themanagement of the credit union.

But the report contained several warnings and noted that theagency's supervisory experience with the 41 low-income creditunions (out of 1,102) that receive secondary capital has been“mixed.” It criticized some of those credit unions for poor duediligence and “premature and excessively ambitious concentrationsof uninsured secondary capital to support unproven or poorlyperforming programs.”

The report also noted that the substantial losses at U.S.Central Federal Credit Union and Western Corporate Federal CreditUnion caused the exhaustion of paid-in and membership capital.While the capital served its function-to absorb losses-it issymptomatic of problems with that kind of capital.

“The industry demonstrated a strong unwillingness to use capitalas a reserve of funds to manage the risk of the institutions andabsorb losses. These experiences substantiate the lack ofunderstanding among credit unions about the function of capital andare troubling when contemplating the authorization of a form ofleverage (supplemental capital) that may have less discipline thanretained earnings,” the report said.

While the top regulatory specialists of CUNA and NAFCU praisedthe report for endorsing supplemental capital, both took issue withaspects of it.

CUNA Senior Vice President and Deputy General Counsel MaryMitchell Dunn expressed concern that the agency wants to put toomany regulatory constraints on credit unions that want to raisesecondary capital.

“You want to have rules that are strong enough that you canregulate for safety and soundness but not weigh it down with somany requirements that it serves as a deterrence to credit unionsto participate,” she said. “The key is enough flexibility to makeit work.”

NAFCU Senior Counsel and Director of Regulatory Affairs CarrieHunt said her association is concerned about the possibility ofallowing for capital from outside the credit union system. Thiscould cause undue influence by those that don't have the interestsfrom the credit union in mind, she noted.

“We want to make sure that the executives and the board aren'tsubconsciously making decisions with those [outside institutional]investors in mind,” Hunt said.

NASCUS President/CEO Mary Martha Fortney said she is pleasedwith the report but is frustrated that it may take a while forlegislative action to occur.

She said the timetable is “very hard to predict,” in partbecause nobody on Capitol Hill “has stepped forward to walk thisthe whole way.”

Fortney noted that several states-including California and NorthCarolina-allow state-chartered credit unions to seek secondarycapital, but it isn't counted toward net worth.

State Employees Credit Union President/CEO Jim Blaine said hehopes the report and Matz's endorsement of secondary capital willhelp push the process along for the sake of the health of creditunions.

“The more capital we have, the better off we are,” he said. “Ifwe don't have the option to seek more capital we are driving a boatwithout any life rafts.”

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