By Ray Birch
WASHINGTON—One credit union that has successfully submitted a secondary capital plan to NCUA says the agency has not restricted the flow of the funding, and is offering advice to credit unions to avoid road bumps.
The credit union’s CEO is also calling some paths toward secondary capital being recommended to CUs “suicidal.”
Department of Commerce FCU has obtained $4.4 million from a first round of secondary capital funding and is confident its next submission to NCUA for approximately the same amount will proceed without issue.
The news follows a CUToday.info report in which some analysts suggested NCUA is slowing secondary capital funding to credit unions. The agency previously responded to CUToday.info saying that is not the case.
Evan Clark, CEO of the $517-million Department of Commerce FCU here, agrees with NCUA. He emphasized credit unions seeking secondary capital must work closely with their examiners to devise plans that address the agency’s risk concerns, and focus on plans that seek capital to fund sound CU growth plans. Clark also emphasized he believes CUs applying for secondary capital should have a strong ALCO process.
“Credit unions applying for secondary capital have to realize they are playing on NCUA’s court and when you’re playing on their court you have to play by their rules,” said Clark, who explained that before DOCFCU’s fourth submission to NCUA the credit union had worked with third party-advisors on the applications.
The applications were primarily the work of the third-party advisor and they were not approved by NCUA, he added.
NCUA Shares Concerns
“Prior to the fourth application our supervising examiner and our regional capital market specialist came to our credit union and told us what their safety and soundness concerns were. We took loads of notes and then we addressed each one of their safety and soundness concerns in our fourth application,” said Clark. “I wrote the application and our CFO did all of the analytics for it. NCUA had one very minor concern after that application that again we addressed. On the fifth go-round we got approved for $4.4-million in secondary capital. We are in the process of applying for our second round of secondary capital—another $4 million. We will use a format nearly identical to the format we used for our approved secondary capital application.”
Clark believes DODFCU was turned down in its initial bid for secondary capital due to the amount for which it had applied, $15 million. The credit union had planned going to use transitional assets to cover the costs of the secondary capital. Those transitional assets would have been investments that did not contribute to the credit union’s strategic plan of growing member shares and loans, Clark explained.
Clark emphasized its successful application did not request those additional funds. The interest on the secondary capital the credit union raised is being paid for by loans to the credit union’s members.
No Need for Safety Net
"No need for a transitional assets or a safety net or anything of the like,” stated Clark. “We only requested money to fund a really solid growth plan that focuses on what we do well—lending and certificates of deposit. There's some brokerage firms and consultants out there that want credit unions to apply for these massive amounts of secondary capital, beyond what the credit union will be using for its growth plans.”
The brokerage firm will then sell the credit union transitional assets and assets for a safety net, said Clark, who reiterated these assets are not typically part of a credit union’s core business of making loans to its members.
“If the credit union applies for only the amount of capital needed to assist the credit union in growing its core business of increasing member loans and shares, the transitional assets and safety net assets are not necessary,” he said. “The ongoing business of the credit union will pay for the secondary capital. Secondary capital typically has an interest rate around 6.5%.
‘It’s Suicidal’
Evan Clark
“Some of the outside consultants and brokerage firms want credit unions to buy a bunch of assets and build up their balance sheet and leverage Home Loan Bank borrowing, for example,” continued Clark. “And, over time, grow their business and replace these transitional assets with the assets that are growing business. Well, let me tell you, by putting on a bunch of these quote-end-quote transitional assets, it's suicidal, especially in the current rate environment where spreads are so tight. If the projected prepayments or cash flows are off by even a little, the yields on the transitional assets will not be nearly as good as the broker estimated at the time of the sale and the credit union won’t earn enough income from the transitional assets to cover the cost of the excess secondary capital it was convinced by consultants that it needed. And then the credit union will be on its own to figure out how to pay for all this excess capital and figure out how to solve their bottom-line problem.”
Clark contrasted what was recommended by consultants—the additional funds for a safety net and transition assets—with what Department of Commerce FCU is doing today.
“We got $4.4 million dollars of secondary capital at 6.60%. This is expensive money and it's subordinated to everything else on the books,” he explained. “So, that's costing us $280,000 a year to pay for this $4.4 million dollars.”
Revenue to Cover Expenses
But Clark said Department of Commerce FCU will be able to pay for the secondary capital with the revenue from about $10 million of real estate loans. The CU has its own mortgage division and handles its mortgage business in-house.
“We grew our overall loans by 33% last year and this year we’re on about the same track—we’ll grow loans by $65 million,” Clark said.
Clark stressed what he believes NCUA liked about his credit union’s secondary capital plan is that it was straightforward—the money would be used to drive lending growth and the cost of the secondary capital would be paid through the lending expansion.
“We’re not using any of our secondary capital for transitional assets or a safety net of any kind,” Clark said. “It’s cut and dried, nuts and bolts…We’re using the money to organically grow our business, which I believe NCUA likes. We are not using secondary capital for anything that it is not meant to do. Secondary capital is meant to help credit unions grow their business, and in an area of business in which they have strong competency.”
A Reminder
Clark reiterated CUs applying for secondary capital must realize they are “playing by NCUA’s rules.”
“Work with your examiners, find out what their safety and soundness concerns are and make sure you address all of them in your plan,” advised Clark. “And you really need a strong ALCO process at the credit union. I believe that helps with NCUA’s view of your plan. We have a very strong ALCO process at our credit union. If you're having your ALCO done by a third-party vendor that sends you a report twice a year and then you put the reports on a shelf somewhere, that says to NCUA you are not serious about what's going to happen with your secondary capital. In submitting these plans you need a clear, strong plan for growth.”
CEO Welcomes Inquiries
Recently NCUA put out Supervisory Letter no. 19-01 regarding evaluating secondary capital plans. Clark urged credit unions to follow the guidance in this supervisory letter.
“Remember, you’re playing on NCUA’s court.”
Editor’s Note: Evan Clark is encouraging CUs with questions regarding secondary capital applications to contact him if they need advice. Clark can be reached at ECLARK@DOCFCU.ORG or 202-808-3633.