SAN DIEGO–With NCUA now wading through more than 800 comment letters following an advance notice of proposed rulemaking (ANPR) on alternative capital for federally insured credit unions, a panel of experts offered insights on what could lie ahead and how CUs might be able to leverage alternative capital.
Offering their perspectives on the issue at the NASCUS Summit here on the issue were Larry Fazio, director of NCUA’s Office of Examination and Insurance; Theran Colwell, VP-lending product management with CUNA Mutual Group, and Eben Sheaffer, CFO/chief investment officer with the National Federation of Community Development Credit Unions.
Here’s a look at what each had to say:
Larry Fazio
Fazio explained the capital standards under which credit unions now operate go back to 1998’s Credit Union Membership Access Act, which defined regulatory capital as net worth, and defined net worth as retained earnings for the most part (the exception is for low-income designated CUs which can also count any secondary capital).
There are now about 2,400 LICUs, 73 of which have outstanding secondary capital representing $181 million in total. About three-quarters of that figure is held by four LICUs, two of which are related, Self Help FCU and Self Help CU.
Fazio reminded that earlier the risk-based net worth requirement is to update in January 2019 and will apply to all CUs of more than $100 million or more in assets.
Regarding the ANPR on supplemental capital sent out by NCUA in January of this year, Fazio noted that the agency cannot do the same for the net worth ratio, as it’s hard-coded in statute. But what NCUA is authorized to do is to change its rules to count alternative capital against the risk-based component of capital.
Secondary capital is available to low-income credit unions (LICUs) only, while supplemental capital would be available to all credit unions but would only count for risk-based capital purposes.
Following NCUA’s ANPR, it received approximately 800 comment letters, 690 of which were form letters from bankers, according to Fazio.
“Secondary capital is for LICUs only, per the FCU Act, and must be subordinate to all other claims on the credit union,” said Fazio. “Practically speaking, what that means is we can’t allow any sort of tranches. Contrast that with supplemental capital for risk-based capital purposes, where there is no such provision, so we could entertain how to structure such capital to appeal to an investor base. The other thing, and this is in the regulation and not in the Act, for secondary capital is we only allow institutional investors to purchase. That is something we could visit if the board so chooses.”
Fazio called supplemental capital a function of the agency’s authority to design the risk-based capital system, “and so while it gives us some flexibility in the types of instruments you might use, the only authority federal credit unions would have to issue supplemental capital is their authority to issue debt. The FCU Act gives pretty broad authority to borrow from any source. What that means practically for FCUs is it would have to be framed up within the debt authority. Federally insured state charters would have to look to state law to see if they could do any form of supplemental capital and what sort of instrument it might be.”
Theran Colwell
Colwell called capital the “bedrock” upon which member value and innovation are built within credit unions, and emphasized it’s critical to respect that when making any changes. Alternative types of capital, he said, are one way to strengthen that bedrock.
“I think there are a great number of advantages,” he told the NASCUS meeting. “At a high level, alternative capital can help a credit union to grow and manage risk.”
Colwell added that going through the process of having an outside investor do its due-diligence before making any investment is also a helpful process for the CU’s management team.
“As we go down this evolution we want to adhere to the spirit of credit unions and not change the ownership structure in any way or risk the tax exemption,” said Colwell, noting there are examples from around the world on doing just that.
Colwell, who authored an op-ed on the issue of capital in CUToday.info here, shared that CUNA Mutual has had experience on several fronts when it comes to alternative capital. In 2006 it worked with 20 Australian CUs that issued approximately $100 million in capital in what he called “a pretty innovative structure.” In the Australian case, the debt was issued as a securitization that was tiered and which had sub-debt and subordinated debt.
“One experience learned from that is there is institutional interest where savvy investors will invest in cooperative institutions,” he said.
Colwell said CUNA Mutual over the past 15 years has also invested millions of dollars in the low-income space in secondary capital and has seen the opportunity there.
In addition, CUNA Mutual in 2010 issued $75 million in sub-debt that counts as capital on its own balance sheet.
“So we have a unique view where we can see this from both the investor and issuer standpoints,” he said.
Among the other lessons Colwell said CUNA Mutual has learned when it comes to alternative forms of capital:
- Took time to educate the market. Credit unions are one of the best kept secrets in the U.S. “It takes time on investor side to educate,” he said, sharing that in meeting with many big banks they had very little understanding of credit unions.
- There is a market out there for this, and a fairly deep market that is untapped. “I think institutional investors can come to understand credit unions and to see there can be fair covenants on both sides.”
- It’s an evolution. “I think it’s critical we start defining terms as NCUA did for supplemental capital vs. secondary capital. It gives credit unions more levers to manage a balance sheet as we look forward at the next 20 or 30 years.”
Eben Sheaffer
Sheaffer noted the National Federation of CDCUs represents 200 community development credit unions. It is also a certified CDFI by Treasury. Of the 73 credit unions that have secondary capital, approximately half are members of the Federation.
Where challenges have been faced is in scaling up the instrument as larger CUs become certified LICUs, according to Sheaffer.
“One of the other big challenges we faced was pricing,” he said. “We were pricing this at 5% when it was a balloon loan. Banks are taking money at anywhere from maybe 5% to the 9%-10%, and part of that is because of the leverage. In order to profitably use secondary capital, an institution needs to lever it and get a good spread. What I’ve seen in the growth in the low-income sector is they are getting more sophisticated managers who understand this.”
What those more sophisticated managers are coming to understand, he said, is that it’s the all-in weighted average cost of capital that management has to look at.
“LICUS can also use non-member deposits and leverage those, and that really is a very effective way to increase the profitability of the institution while also hopefully increasing the community impact they have,” said Sheaffer. “We have seen a lot of positive developments in secondary capital over the last two to three years and I’m looking forward to continuing that progress.”