CUNA Comment Letter
NCUAs Proposal on Prompt Corrective Action
Filed via firstname.lastname@example.org
August 5, 2002
Ms. Becky Baker
Secretary to the Board
National Credit Union Administration
1775 Duke Street
Alexandria, VA 22314-3428
Dear Ms. Baker:
The Credit Union National Association appreciates this opportunity to comment on the agencys proposal to revise the Prompt Corrective Action (PCA) rules. The changes are intended to improve and simplify the implementation of PCA. CUNA represents more than 90% of our nations 10,300 state and federal credit unions. Our comments were developed by CUNAs Examination and Supervision Subcommittee, chaired by John Franklin, President and CEO of the South Carolina Credit Union League.
Summary of CUNAs Position
- CUNA strongly supports NCUAs proposed changes to PCA.
- In particular, CUNA endorses the "safe harbor " approach to net worth restoration plans (NWRP).
- Also, CUNA views the amendments to the risk based net worth (RBNW) requirements to allow for risk weighting to reflect loans sold with partial recourse and to allow a credit union to receive a risk mitigation credit prior to when it may fail the RBNW requirement as positive steps in the right direction.
- While CUNA agrees with the changes regarding charges to regular reserves, as far as they go, CUNA continues to encourage the agency to drop the requirement for a regular reserve account as unnecessary in light of the net worth structure under PCA.
- The issue of how NCUA treats member business loans in the risk based net worth calculations is not addressed, although this is an issue of concern to some credit unions. CUNA recommends that NCUA increase the threshold for MBLs, consistent with NCUAs risk assessment for long-term mortgage loans.
- Likewise, the issue of secondary capital is not addressed in this proposal. CUNA continues to support this concept. While the agency has taken the view that secondary capital could not be used to meet core capital requirements unless the PCA statute is changed, we encourage the agency to consider the use of secondary capital for undercapitalized credit unions in some contexts as they endeavor to meet PCA requirements.
- The proposal does not schedule "callable" loans by call date for purposes of calculating risk based net worth. CUNA encourages NCUA to reconsider this issue and allow credit unions to schedule such loans by their call date, rather than by their maturity date or provide a somewhat lower risk weighting for callable loans.
Since its inclusion in the Credit Union Membership Access Act in 1998, PCA for credit unions has been problematic. In many respects, the agency has sought to make the PCA rules as flexibile as possible for credit unions, within the constraints of the Federal Credit Union Act. Two continuing issues of major concern for credit unions are:
- the net worth levels that are statutory and higher than what is required for banks and
- the uncertainty that credit unions face in terms of what remedial actions will be required of them if their net worth should fall below the adequately capitalized level.
It is against this backdrop and in large measure for these reasons, that the possibility of secondary capital has been embraced by a number of credit unions as one resource to help them build net worth. Absent these major concerns about PCA, the need for secondary capital, undoubtedly, could be diminished.
CUNA continues to work diligently to lay the groundwork for improved PCA statutory provisions that would address the net worth levels in the statute and the issue of secondary capital.
In the meantime, we wholeheartedly commend NCUA for its efforts to make changes within its purview that are intended to facilitate PCA compliance. A number of the changes the agency is proposing are in the nature of fine- tuning and we believe they will be helpful to credit unions and the agency alike. CUNA will confine its comments to some of the more significant changes the proposal contains.
Safe Harbor For Net Worth Restoration Plans
NCUA proposes a "safe harbor" for net worth restoration plans. Under the proposal, credit unions that are marginally below the "adequately capitalized" level primarily because of growth would be able to utilize a net worth transfer schedule to meet NWRP requirements. Such a credit union would agree to increase its net worth through quarterly transfers designed to restore the credit unions net worth level to 6%. A plan that meets these standards would "be assured of approval," as the proposal states.
CUNA is a strong proponent of this approach. CUNAs Chief Economist Bill Hampel has developed some further enhancements to this approach, which we urge the agency to adopt. His comments on these changes to the safe harbor concept are attached.
Loan Sold With Partial Recourse
Under the standard calculation of a credit unions risk based net worth requirement, an entire balance of loans sold with recourse is given a single rating of 6%, including those sold with only partial recourse. CUNA and others have maintained that such treatment overstates the risk associated with partial recourse loans.
To address this issue, the proposal would add a fourth alternative component for determining risk based net worth to allow risk weighting to reflect loans sold with partial recourse. The alternative component proposed is the sum of two risk-weighted items. As with the other alternative components, if the component proposed for loans sold with recourse reduced a credit unions RBNW requirement as determined under the standard calculation, the credit union could substitute the alternative component.
CUNA supports this change, which we believe is more consistent with the amount of risk associated with such loans. This approach is also consistent with Reg-Flex and the agencys ongoing efforts under the current Administration to help address regulatory burden.
Risk Mitigation Credit
Some credit unions have sought more flexibility in receiving risk mitigation credit, even before they fail applicable risk based net worth requirements. The proposal would allow credit unions to apply for and receive a Risk Mitigation Credit (RMC) before they fail RBNW requirements. This differs from the current rules that require RBNW failure first.
The rule allows a credit union to apply for an RMC at any time before the next quarter-end effective date if on any of the current or three preceding effective dates of classification it has either failed an applicable RBNW requirement, or met it by less than 100 basis points. A credit union that has met its RBNW requirement by more than 100 basis points in each of the preceding four quarters would not be able to apply for an RMC until it subsequently fails its RBNW requirement or meets it by less than 100 basis points.
We agree with NCUA that the proposed revision will enable some credit unions that are at risk of failing RBNW requirements to seek a mitigation credit that would permit them to retain their current net worth classifications.
Under the Federal Credit Union Act, NCUA may allow a credit union to increase its net worth by less than the required minimum transfer. The proposal sets up a mechanism that will allow NCUA to consider requests to decrease the earnings retention requirement, if they are received no later than 14 days before the quarter-end. A decision to permit a credit union to decrease its earnings retention would remain subject to quarterly review and revocation.
CUNA supports this basic approach but encourages the agency to build some additional flexibility into the process for both the regional offices and credit unions. We recommend that the agency modify this language to provide that verbal applications made closer to the end of the quarter could also be accepted as permitted, on a case-by case basis, by the regional office.
The proposal would make some changes in the area of regular reserves, and we support these amendments, as far as they go.
The proposed rule would allow a federally-insured credit union that has depleted the balance of its undivided earnings and other reserves to authorize losses to be charged to the regular reserve account without regulatory approval if the charges do not reduce the credit unions net worth below "adequately capitalized." The current rule only allows this without regulatory approval if the net worth of a credit union is below the "well capitalized" level. This lowering of the threshold gives credit unions some flexibility in deciding whether to decide whether charge losses when the quarterly earnings transfer would be required.
We support this change but encourage the agency to make a broader change in this area. Since the initial stages of PCA implementation, CUNA has encouraged NCUA to discard the regular reserves account. As credit unions have pointed out, the account is now redundant and unwarranted in light of the net worth requirements under PCA. We urge NCUA to simplify PCA in an even more meaningful way by eliminating the unnecessary requirement that a regular reserves account be maintained.
Treatment of MBLs
The agency has not sought comments on the issue of the treatment of member business loans in the assessment of risk based net worth. Since the proposal of the risk-based requirements, CUNA has maintained that the MBL threshold for calculating RBNW is still artificially low and is based primarily on the arbitrary cap for credit union member business lending of 12.25% in the Federal Credit Union Act. Rather than use this approach, which a number of credit unions think is not consistent with the risks associated with MBLs, we urge the agency to utilize the 25% threshold for mortgage loans, which is more appropriate for the level of risk involved.
Use of Secondary Capital
Despite the failure of a legislative amendment this year to authorize credit unions to have the option of using secondary capital to meet net worth ratios, the possibility of some uses of secondary capital deserve the agencys consideration, in our view.
Under the amendment offered by Rep.Robert Ney (R-OH) to the regulatory relief bill, secondary capital would be:
(ii) subordinate to all other claims against the credit union, including the claims against the credit union, including the claims of creditors, shareholders, and the Fund, and
(iii) no more than 50% of net worth.
In addition, eligible investors would be limited to legal entities within the credit union system, including the credit unions members, individuals or businesses within the credit unions field of membership, other natural person or corporate credit unions, and credit union service organizations. A credit union investing in another credit union under this provision would have been required to deduct the amount of its investment from its net worth.
We believe this model provides a workable approach to secondary capital that could be utilized in some situations under the PCA rules. For example, while secondary capital would not be part of net worth, the presence of such capital could provide a shield for certain undercapitalized credit unions, for example, those with no less than 4% net worth. This would mean that examiners would take the presence of secondary capital into account for a less than adequately capitalized credit union with at least 4% net worth, and mitigate the application of PCA sanctions accordingly.
For credit unions with risk-based net worth requirements, NCUA should allow them to use secondary capital to reduce their RBNW requirements as they are permitted to use the allowance for loan loss accounts.
While the use of secondary capital as outlined above is not a panacea to instantly restore financial health, it is one approach that could be beneficial for some credit unions as they weigh their limited options under PCA.
Foregoing Other Corrective Action for Critically Undercapitalized Credit Unions
Under the proposal, if a credit union is complying with an approved NWRP and achieving its prescribed net worth targets, NCUA may decide not to impose other corrective action on those "critically undercapitalized" credit unions. We strongly agree with this clarification because if a credit union is in compliance with its NWRP, it does not appear that additional corrective actions would be required, in most cases.
Under the proposal, schedule "callable" loans would not be scheduled by call date for purposes of calculating risk based net worth. CUNA encourages NCUA to reconsider this issue and allow credit unions to schedule such loans by their call date, rather than by their maturity date or provide a somewhat lower risk weighting for callable loans.
In closing, CUNA appreciates the opportunity to comment on the PCA proposal. The agency has made a number of solid recommendations that will, in our view, enhance implementation of the regulation. However, we urge the agency to continue its creative thinking, consistent with the Federal Credit Union Act, to enlarge the safe harbor concept, consider secondary capital for NWRPs and make other changes in the PCA rule that will make the proposed revisions even more meaningful.
Mary Mitchell Dunn
Associate General Counsel and Senior Vice President
NCUA Board Chairman Dennis Dollar
NCUA Board Member Deborah Matz
NCUA Board Member JoAnn Johnson
CUNA Examination and Supervision Subcommittee
NCUA General Counsel Robert Fenner
NCUA Deputy Director, Office of Examination and Insurance