ALEXANDRIA, Va.–With one board member saying he was doing so “begrudgingly,” the NCUA board has voted 3-0 to put out for 60-day comment proposed rulemaking around the Complex Credit Union Leverage Ratio.
Casting the “begrudging” vote was Board Member Rodney Hood, who said he would prefer the matter be tabled or even repealed and the focus turned to other areas of capital. To agency staff Hood posed numerous questions, including why CUs that meet the agency’s definition of “well-capitalized” continue to lose members and loans.
The Complex Credit Union Leverage Ratio proposed rule, also known as CCULR, amends the agency’s 2015 risk-based capital rule. Within the proposal NCUA is seeking feedback on a number of issues, including setting minimum capital at 8%, 9% or 10%.
In January the board put out for comment a proposal to raise the definition of a “complex” credit union to $500 million in assets from $50 million for purposes of being required to determine risk-based net worth.
The advanced notice of proposed rulemaking (ANPR) included a comment period that ran through May and which suggested two approaches to simplifying the definition: replacing the risk-based capital rule with a risk-based leverage ratio (RBLR) requirement, which uses relevant risk attribute thresholds to determine which complex credit unions would be required to hold additional capital (buffers); or retain the 2015 risk-based capital rule but enable eligible complex federally insured credit unions to opt-in to a CCULR framework to meet all regulatory capital requirements.
Capital Held Must Be Equal to Risk
Noting he has long held that all financial institutions backed by federal deposit insurance should hold capital equal to the risks held on their balance sheets, NCUA Chairman Todd Harper said in the event of a complex credit union failure, the additional capital buffer provided through a robust risk-based framework would protect surviving credit unions, their members, and the taxpayers who ultimately guarantee the Share Insurance Fund.
When it comes to risk-based capital (RBC), Harper said NCUA has three legal responsibilities, which he summed up in four words: “comparable, consistent, complex, and cooperative.”
Harper said those responsibilities include:
- Standards need to be comparable to the rules developed by the other federal banking agencies and consistent with the requirements of the Federal Credit Union Act.
- Whereas risk-based capital rules apply to all banks regardless of size, NCUA’s rules need only apply to complex credit unions, which the board has currently set at $500 million or more in assets.
- NCUA’s risk-based capital rules must address the cooperative nature of the institutions the agency regulates.
Meeting the Standards
“In my view, the risk-based capital rule approved in 2015 met all those standards. And, once implemented, it will provide the system with greater stability,” Harper said. “We must, however, also recognize several legislative, regulatory, and marketplace developments since the NCUA board approved the final risk-based capital rule in 2015. For example, in 2018, Section 201 of the Economic Growth, Regulatory Relief, and Consumer Protection Act directed the other federal banking agencies to propose a simplified, alternative measure of capital adequacy for certain federally insured banks. The result of that effort became known as the Community Bank Leverage Ratio framework, which became effective in January 2020.”
Harper noted the initial minimum net worth level under the proposed CCULR framework would be 9% on Jan. 1, 2022, and would gradually increase to 10% by Jan. 1, 2024. Using year-end 2020 financial performance data, he said the agency estimates that nearly three-quarters of complex credit unions would initially be able to meet the CCULR’s net worth requirement of 9%.
“While lowering a credit union’s risk-based capital compliance requirements, CCULR actually increases the system’s capital buffer,” Harper said. “Under the 2015 final rule, the total minimum capital for complex credit unions to be considered as well capitalized is estimated at $82 billion. Under the proposed CCULR framework, if all qualifying credit unions opt into the minimum 9% level during 2022, the total minimum net worth required is estimated at $104.6 billion, an increased capital requirement of $22 billion. This additional capital would strengthen the system’s ability to absorb any future financial losses and economic shocks.”
Not Out of the Woods
As he has at other recent meetings, Harper said that while the economy is improving, “we are not out of the woods just yet when it comes to the COVID-19 pandemic,” adding that an uncertain interest rate environment and the potential for continued elevated insured shares also place additional stress on credit union capital levels.
“As such, this proposal is an appropriate measure that provides complex credit unions with a streamlined approach to managing their capital levels while also strengthening the system’s resiliency to economic shocks, Harper said.
Data & The Human Risk
NCUA Vice Chairman Kyle Hauptman said the chief benefit of the proposed CCULR rule is that it allows some credit unions to bypass a risk-based capital approach.
“For me, the point of this simpler leverage ratio is that it protects both credit unions and the Share Insurance Fund from the inevitable problems associated with risk-weightings,” said Hauptman. “As I said in my nomination hearing, capital is the holy grail. When a recession hits, the first thing I’d want to know about any deposit-taking institution is how much total capital they have. However, the problem arrives with implementing risk-based capital, even though we all agree that some assets are riskier than others. In fact, the exact same asset can be riskier in the hands of one credit union versus being held by a different credit union, partly due to differences in loan servicing.”
Hauptman said he believes historical problems with risk-weightings stem from two factors:
- Humans make the risk-weightings, and humans are imperfect, especially when it comes to using the past to predict the future.
- The humans who are doing the risk-weightings. “They are set by political appointees with the best of intentions, while credit unions assess risk every day. The official risk-weights are set in a process that is, by definition, a political process and removed from the day-to-day reality in which credit unions operate.”
‘No Small Matter’
After citing other examples of government attempts to limit risks, such as recommending use of asbestos to prevent fires, Hauptman observed, “All of that is an admittedly long way of saying that a simpler-yet-higher capital standard isn’t just useful because it saves time and effort. It’s also a way of protecting the system from the problems inherent in any risk-weighting process.
“In conclusion, we can argue about exactly how much capital is appropriate for switching to a simpler capital ratio – and I’m aware that is no small matter,” Hauptman said. “But so long as we must prepare for the possibility of a world with risk-based capital (RBC), I encourage everyone to submit comments on today’s proposals, including the issue of how to treat the 1% of credit unions that sit in the SIF.”
Hood Has Questions
NCUA Board Member Rodney Hood, who pressed agency staff for responses to more than a dozen questions he posed, called for repealing the risk-based capital rule and focusing elsewhere.
Hood noted the agency’s core mission is to maintain a safe and sound credit union system and be good stewards of the NCUSIF, reminded that when he was chairman of the agency in 2019 he worked to delay the risk-based capital rule for two years to “holistically evaluate the NCUA's capital standards to ensure they would serve us well in the future.”
Hood said that at that time agency staff told the board there were three main additional considerations that were warranted: subordinated debt, the credit union leverage ratio, and securitization.
“While work remains with securitization, we made some progress in terms of the agency's view of capital compared to where we were two years ago,” Hood said. “However, Mr. Chairman, after serious study and consideration, my preference would be to table the risk-based capital rule indefinitely—or even repeal it—and fine-tune the risk-based net worth rule as needed.”
A ‘Tool, Not a Rule’
Describing what he called a “trip down memory lane,” Hood pointed out the rule that was passed in 2015 will be eight years old by the time it goes into effect.
“The world has changed since 2015,” Hood said. “The reality is RBC should be a tool… not a rule. If it is effective in identifying risk, put it in the examiners’ toolbox, but the last thing the NCUA should do is impose it on credit unions as an operating model. The juice just isn’t worth the squeeze for risk-based capital because this is a regulatory burden with limited benefit. Again, we already have a risk-based net worth framework as required by law, so this is not needed.”
Questions Posed
Hood posed nearly a dozen questions for agency staff, some of which included:
- How does NCUA define risk? Staff: “NCUA defines risk that events expected or unexpected may have an adverse effect.”
- When the RBC rule was finalized in 2015, the vast majority of individual commenters opposed the rule at the time, correct? Staff: “Yes, a majority of the comment letters opposed the proposal in its entirety, and many suggested the rule be withdrawn.”
- Can you tell me what we have learned about risk since the RBC model was finalized? Staff: “I would say the biggest thing we have learned about risk is we don’t always know where it comes from. I think COVID is the best example.”
- How do we explain the fact that many credit unions, all of whom exceed the 7% well-capitalized level and much higher, seem to be losing members and loans and still meet our criteria for being safe and sound? What is missing in the RBC model? Staff: “For some, they may not be missing anything. They may have great portfolio diversification. It’s just that some may have diversification standards that might subject them to a kind of risk they would want to hold capital for. When it comes to losing members or loans, I would have to look at the specific credit union.”
Can’t Be Clairvoyants
Similar to Hauptman’s observations, Hood said macro-risks remain uncertain and the agency cannot be “clairvoyants.”
“So, while RBC may require higher net worth ratios at certain so-called complex institutions over $500 million based on how we risk weigh activities, we cannot assume RBC will prevent a credit union failure and we can't assume, since risk itself evolves, that the risk weights are fixed and set for all of time,” said Hood. “If anything, RBC creates a moral hazard because we as regulators are weighting risks. We are giving a stamp of approval on the weights of risks. We should recognize that since risk evolves, it is not stagnant. And, as we are often reminded, the future, and especially future crises, aren’t predicted with a great deal of precision or accuracy. Risks, like a global pandemic, are impossible to put in a formula. Who on this board was talking about the risks of a pandemic in January 2020?”
Risk Weightings & Medallion Loans
Indeed, said Hood, the agency’s risk-weightings were unlikely to ever have foreseen the threat to taxi medallion loans.
Hood asked staff if any of the taxi medallion credit unions that failed and led to an approximate $750-million loss to the insurance fund had been subject to RBC based on the 2015 rule amended in 2018, what would have been the result?
“With the higher threshold in place, had the 2015 rule been in place, two of the six primary taxi medallion credit unions would have been bound by the new capital standard,” staff responded.
“For the taxi medallion losses, those credit risks were exacerbated because of a new market entrant—ridesharing services—among other factors that actually inflated the value of the underlying asset of the taxi medallion,” said Hood. “Markets evolve with competition. And so does risk. It's important for any agency to be forward thinking. And as we have learned during the taxi medallion crisis and most recently the pandemic, and it bears repeating—the future is hard to predict.”
Future Agency Costs
Also looking to the future, agency staff confirmed the move to the new capital standards will involve costs of approximately $2 million to implement, mostly due to software development, and that the agency will not be adding to its headcount as a result.