CUNA Comment Letter

NCUA's Proposed Rule on Prompt Corrective Action

August 31, 1999

Ms. Becky Baker
Secretary to the Board
National Credit Union Administration
1775 Duke Street
Alexandria, VA 22314-3428

RE: NCUA's Proposed Rule on Prompt Corrective Action

Dear Ms. Baker:

The Credit Union National Association appreciates the opportunity to comment on the National Credit Union Administration's proposed rule to establish a system of prompt corrective action (PCA) as required by the Credit Union Membership Access Act (the Act). The proposal appeared in the Federal Register May 18, 1999. By way of background, CUNA represents about 90% of the nation's 11,000 state and federal credit unions, which serve approximately 78 million members.

Before addressing the proposal, we would like to stress that an area of critical importance for credit unions is how growth may be accommodated under PCA. The PCA system was designed to require NCUA to address quickly safety and soundness deficiencies for weakening credit unions that have decreasing net worth. However, the PCA provisions must be read in the context of the Act, the fundamental purpose of which is to facilitate member access to credit unions.

Some credit unions that have strong earnings and excellent management may nonetheless experience declining net worth ratios due solely to member share growth, which the credit union did not encourage. Our letter addresses this issue further below and urges NCUA to use its regulatory authority to allow mechanisms for credit unions to build net worth or join forces with CUNA to support other options.

In the meantime, the NCUA Board should provide a clear indication now that it is deeply concerned about this issue. NCUA should confirm that it plans to work with the credit union system to ensure credit unions which are experiencing share growth they did not aggressively solicit need never turn away members, or their funds, or otherwise be penalized by PCA.

We would also like to point out that one of the most troubling aspects of PCA for certain credit unions is the uncertainty regarding how the risk-based net worth requirements for "complex" credit unions will be implemented. That subject is not part of this proposal, but will be addressed in a separate document issued for comments later this Fall. CUNA is developing further analysis regarding the definition of complex credit unions and a proposed framework for risk-based net worth requirements, which we plan to share with senior agency staff in the next several weeks.

Summary of CUNA's Recommendations

CUNA's positions were developed by its Examination and Supervision Subcommittee, which is chaired by Gary Wolter, President of the Alabama Credit Union League. Our views regarding the agency's proposal are summarized below.

Implementation of PCA

Credit Union Growth

Net Worth And Related Issues

Discretionary Sanctions

Net Worth Restoration Plan

PCA For New Credit Unions

PCA Appeals Process

Board Review

Consultation with State Regulators

Details of CUNA's Recommendations

Implementation of PCA

CUNA has been very encouraged by NCUA Board members' statements regarding the implementation of PCA. Those statements have indicated the Board intends examiners to be reasonable in imposing regulatory directives under PCA, without comprising legal requirements.

These statements are indeed commendable, but we encourage the agency to take steps to ensure examiners are also aware of the Board's approach and will act in conformance with it. We strongly recommend that the Board incorporate in its examiner training the clear message from the Board that PCA must not be used in an arbitrary manner and that Congress did not intend for the agency to use PCA as a device for micro-managing credit unions.

CUNA also supports the view that PCA could be a useful tool for the agency in determining the allocation of its resources. Credit unions that are well capitalized or adequately capitalized should require only limited on-site scrutiny from examiners. In fact, the majority of the agency's resources should be directed to overseeing credit unions that are significantly undercapitalized and critically undercapitalized. We believe this framework would allow NCUA to focus more staff and funding to problem areas, consistent with the goals of PCA and the agency's primary mission of supervising for safety and soundness.

We believe there is a pervasive concern among credit unions regarding PCA and how it will be carried out. To address this concern, CUNA is establishing a Credit Union PCA Council, comprised of a small number of credit union officials from state and federal credit unions, as well as league representatives. We envision that the group will serve as a collecting point for concerns credit unions would like to raise anonymously regarding the enforcement of PCA. We believe the Council will provide meaningful input to the Board, to the Treasury Department and to Congress regarding PCA for credit unions. It will also allow credit unions to voice their concerns without being identified to their examiner or regional office. We look forward to meeting with the Board members, once the Council is formed, to provide their input and share information.

Credit Union Growth

One of the gravest concerns CUNA has about the implementation of prompt corrective action is how it will impact credit union growth. More specifically, we do not believe that prompt corrective action was intended to penalize credit unions that are well-managed and not paying excessive rates on savings but are nonetheless experiencing growth because new and/or existing members are making substantial deposits in these credit unions.

Several options have been discussed within the credit union system to allow a credit union to build net worth. One mechanism would be a cooperative fund to which credit unions could make contributions for use by other credit unions in need of capital to boost their net worth ratios. The funds would be used strictly for improving net worth.

A form of "paid-in capital" that has received attention in the context of PCA is the concept of uninsured membership shares. In our view, NCUA has the authority to permit credit unions to offer uninsured membership shares and allow them to be included in a credit union's equity, which would be reflected in a credit union's net worth ratio.

Under the proposal, NCUA would be allowed to adjust a credit union's net worth ratio to take into account certain equity adjustments, such as the gains and losses in the fair market value of securities held for sale. Obviously, NCUA is of the opinion that it has the authority under the Credit Union Membership Access Act to include such adjustments in the net worth ratio, even though they are not part of "retained earnings," which are defined as a credit union's net worth under the Act.

Based on our analysis of the statute, we believe that if NCUA has the authority to adjust net worth ratios to incorporate unrealized gains or losses on AFS securities, then it also has the authority to permit uninsured membership shares. Likewise, if NCUA feels it does not have the authority to allow uninsured membership shares, then we question whether it has the authority to adjust net worth ratios for gains or losses on AFS securities.

In any event, we call upon NCUA to work with us and the credit union system to help devise a creative solution that does not contravene PCA, does not mask problems that are meant to be addressed by PCA, but does allow credit unions to grow safely and soundly without incurring PCA sanctions.

If NCUA is of the opinion that under current law it cannot permit such capital-contribution mechanisms, then we urge the agency to join CUNA and other groups to pursue other options for boosting credit unions' net worth ratios.

Discretionary Actions

NCUA's proposal would establish an elaborate system for imposing a range of discretionary actions on credit unions that are undercapitalized. These discretionary powers go beyond those established by the Federal Deposit Insurance Corporation. In addition, the FDIC generally confines the use of more stringent discretionary powers to institutions that have capital of no more than 4%. NCUA, however, would be able to apply harsh discretionary powers to credit unions that are below 6% in net worth.

The statutory PCA system provides NCUA with considerable tools to address net worth concerns for credit unions with net worth ratios below 6%. The broad discretionary powers NCUA is proposing are unjustified for credit unions with net worth above 4%, given the other mechanisms NCUA and the state regulators have at their command.

In particular, the harshest of the discretionary powers are the ones which allow NCUA to "improve" management, including ordering a new election, dismissing directors or senior executive officers, or employing qualified senior executive officers. With the possible exception of a credit union that consistently refuses to comply with material requirements of a net worth restoration plan or that repeatedly refuses to make a required earnings transfer, these actions are not appropriate as discretionary tools for credit union with net worth above 4%. The boards of directors of credit unions are democratically elected and are unique among financial institution directors in that they are public-spirited volunteers who are not financially motivated. These facts dictate that NCUA should show exceptional restraint in penalizing or removing such boards and the management officials they appoint. We urge NCUA to amend the proposal to reduce the scope of the discretionary powers that may be applied to a credit union with net worth above 4%.

We also urge NCUA to provide guidance to credit unions regarding the application of the discretionary actions so there is less room for arbitrary application and more certainty for credit unions as to when they might be subjected to such actions.

Credit unions otherwise well-managed but that have a net worth ratio which has dropped below 6% due to growth in member shares do not pose a threat to safety and soundness - either to their members or to the National Credit Union Share Insurance Fund. Thus, we urge NCUA to make a distinction for purposes of PCA between such credit unions and others that are not properly managed.

More specifically, the statute affords NCUA the latitude to determine how to apply its discretionary actions when a credit union's net worth is below 6%. Nothing in the Act requires NCUA to impose discretionary sanctions on credit unions that are undercapitalized simply because of members' share growth.

NCUA should clarify that it will not impose any discretionary sanctions on a credit union with a net ratio between 4% and 6% that has experienced a decline in its net worth ratio solely attributable to an appreciable increase in share deposits, as long as the credit union's other financial indicators, such as earnings, are strong, and its management is capable.

The proposal provides that NCUA must not order a new election, dismiss directors or senior officers or employ qualified officers unless it has first taken one of the other discretionary actions or "determines that none of those actions would further the purpose of this part."

Our view is that NCUA should not take any discretionary actions until the statutory ones have had a chance to work. We believe that credit unions should first be allowed to implement their net worth restoration plans and that additional sanctions should only be applied if the credit union needs further incentives to address PCA concerns. If additional problems arise, then those concerns should be addressed as modifications to the net worth restoration plan which both the credit union and NCUA approve, rather than subjecting the credit union to discretionary sanctions.

The PCA statutory provisions provide credit unions with considerable leeway to develop net worth restoration plans to address inadequate capital and corresponding issues. The statute also grants NCUA wide latitude to work with credit unions to develop plans that are no more stringent than is necessary to improve the net worth ratio over a reasonable period of time.

We do not believe credit unions that are undercapitalized due solely to share growth they did not aggressively solicit should be required to develop extensive net worth restoration plans. Also, they should be given considerable time to allow the net worth restoration plan to work before NCUA places further PCA requirements on the credit union.

Net Worth And Related Issue

In adopting the PCA provisions of the Act, Congress repealed the section of the Federal Credit Union Act requiring Federal credit unions to establish a regular reserve account (12 USC 1762). However, the proposal would maintain the regular reserve as a separate capital account, ostensibly to facilitate compliance with the earnings retention requirement for credit unions that are not well-capitalized (12 USC 1790d(e)).

We do not agree that federal credit unions need a regular reserve account, particularly since the express authority for the account has been removed by Congress. We recommend that the requirement for the account be eliminated from the proposal as unnecessary.

NCUA is required to develop PCA regulations for credit unions that contain requirements comparable to those of Section 38 of the Federal Deposit Insurance Act. The FDIC and the other financial regulators direct their institutions to determine their net worth ratios based on their quarterly Call Reports and such institutions have notice of their capital category as of the due date of the Call Report. However, NCUA's proposal does not allow the use of Call Reports, because credit unions that have assets below $50 million file semi-annually.

The system NCUA has devised for notice to credit unions of their net worth category is more stringent than the simpler method allowed by the bank regulators. Under NCUA's system, a credit union is deemed to have notice of its net worth ratio and category "coinciding with the end of the credit union's quarterly dividend period or every monthly dividend period, as the case may be."

If after determining its net worth ratio, a credit union finds itself in a lower net worth category, the credit union must notify NCUA within 15 days. An undercapitalized credit union would have then have 45 days from the time it has notice of its category, to file a net worth restoration plan with NCUA, unless the agency provides a different time frame to the credit union. For credit unions, the filing period could begin at the end of the month or the quarter, depending on their dividend periods. Banks also have 45 days to submit their plans, but the clock doesn't begin ticking for them until the end of the quarter.

We believe there is no statutory basis for NCUA to require credit unions to determine their net worth categories and ratios more frequently than quarterly or semi-annually in the case of the smallest credit unions.

Further, we do not believe this change would create any safety and soundness problems, but would simply conform the requirements for net worth determinations and notice more closely to those for banks and thrifts. We urge the Board to change the notice framework it is proposing and facilitate the net worth determinations for credit unions as the other agencies have done.

The proposal provides that NCUA may reclassify a credit union for an unsafe and unsound condition or practice. While NCUA's authority for reclassifications on these bases are statutory, the agency does have flexibility in how they are applied.

We urge NCUA to amend the proposal to state that such reclassifications will not occur if a credit union is making good faith efforts to comply with all material aspects of its net worth restoration plan. Further, rather than downgrading the credit union, NCUA and the credit union should work together to modify the net worth restoration plan to address the condition or practice. We believe this approach is fairer to credit unions, is consistent with safety and soundness and with NCUA's authority to implement the reclassification provisions under the Act.

Credit unions still remember when, in the late 1980's and early 1990's, examiners required them to make considerable transfers to their Allowance for Loan Loss Accounts, despite the affect of the transfer on their net worth. CUNA urges the Board to consider amending the proposal to provide that if such a directive would appreciably decrease a credit union's net worth, then the transfer requirement is automatically stayed, pending a review of the need for the transfer. Such a challenge could be appealed to the Regional Director and to the PCA ombudsman, discussed below in this letter.

Net Worth Restoration Plan

CUNA supports the provisions in the proposal regarding net worth restoration plan. However, we encourage NCUA to clarify in the supplementary information accompanying the final rule that the agency intends examiners to use the plan to work with credit unions to overcome capital deficiencies and not as a mechanism to intrude needlessly in the operations of the credit union.

PCA For New Credit Unions

The statute creates a separate PCA system for new credit unions and those with less than $10 million in assets. In general, the alternative system appears reasonable and CUNA supports most of these provisions.

However, we do have some concerns about the effect of the provisions on community development credit unions. One concern relates to below market nonmember deposits, which community development credit unions use to build capital. However, such credit unions may be forced to stop accepting nonmember deposits because the deposits could have a negative effect on their capital ratios. We encourage NCUA to consider allowing these deposits to be risk-weighted or excluding them from the asset base so they will not affect the net worth ratio.

The proposal would allow NCUA to restrict principal and dividend payments on uninsured secondary capital for community development credit unions that are critically undercapitalized, which would discourage nonmember deposits for affected credit unions. We encourage NCUA to allow such credit unions that are solvent to continue to be able to pay dividends on those funds.

We are also concerned that PCA may disproportionately affect community development credit unions. We urge NCUA to be as flexible as the law permits to work with these credit unions to develop net worth restoration plans that are reasonable both to fulfill the purposes of PCA and to accommodate the credit unions' operations.

PCA Appeals Process

One of the ongoing issues credit union management officials, particularly those from smaller credit unions, have raised with CUNA's Examination and Supervision Subcommittee is that they are fearful of reprisals if they question an examiner's finding or directive.

If PCA is to become an effective safety and soundness tool, then it is important that credit unions support its use. One important means for helping to relieve credit unions' anxieties about PCA implementation would be for NCUA to develop a meaningful appeals process under which credit unions could appeal any material issue relating to PCA to the NCUA Board or delegated official that reported to the Board for purposes of PCA appeals.

We believe it would be extremely useful if the Board appointed a PCA ombudsman to handle appeals and report to the Board. In addition to encouraging credit unions to communicate to NCUA or their state regulator regarding concerns, the ombudsman should be required to contact all credit unions with net worth ratios at 4% or below to ensure their rights of due process are upheld in the PCA process. The ombudsman should also be required to submit a report in writing to the Board on a periodic basis regarding the effectiveness of the appeals process.

Board Review

The NCUA Board has determined that because of the scope and significance of its Chartering and Field of Membership Manual, the agency will review the manual within a year of its adoption. We hope the agency will conduct subsequent periodic studies of its FOM policies.

The PCA rules are no less important than the field of membership policies and apply to all federally insured credit unions. We strongly encourage the Board to adopt a similar approach to PCA and agree to review the PCA rules, including the ones it is developing for "complex credit unions," one year after their adoption and periodically thereafter.

As part of the process, we recommend the Board solicit input from examiners as well as credit unions and their representatives. This process could be very beneficial for the agency and help it to ascertain whether PCA is accomplishing its statutory purposes. It could also be useful to credit unions by providing them an opportunity to share input with NCUA on how well they believe PCA is being implemented. It would also provide to credit unions a level of reassurance that the agency will be monitoring the enforcement of PCA and fine tuning the system should the need arise.

On May 12, the Office of the Comptroller of the Currency published in the Federal Register an advance notice of proposed rulemaking regarding initiatives to reduce the regulatory burden on small community banks. (FR CITE) The notice requested commentors to suggest "a different, simpler overall approach to measuring capital adequacy for community banks." It is unclear what the OCC intends. However, we urge NCUA to discuss with OCC what it is planning and adapting any changes OCC makes to streamline PCA wherever appropriate for credit unions.

Consultation with State Regulators

Throughout the development of the statutory PCA provisions, CUNA advocated that the legislation include requirements that NCUA consult with state regulators before PCA sanctions are applied to a state chartered credit union. We support NCUA's efforts to work with state regulators to ensure the concept of dual chartering is not jeopardized by PCA.

**

In closing, CUNA appreciates that NCUA did not seek PCA authority in the statute and that many of the provisions in the proposal were explicitly required by the statute, leaving the agency little room to minimize their impact on credit unions. We also want to commend agency senior staff for their efforts to draft a proposal that comports with the statute, while taking into consideration the operational needs of credit unions.

However, we feel that there are areas in which NCUA has greater authority than the proposal exercises to facilitate compliance with PCA for credit unions. More specifically, we believe NCUA has considerable authority to allow a form of paid-in capital for credit unions, minimize the scope of the discretionary powers particularly for credit unions that are undercapitalized solely due to growth in shares, and restructure the net worth ratio determination and notice mechanism.

Prompt corrective action has the potential to become a very useful tool for NCUA. At the same time, however, it raises the specter that some credit unions may be unduly restricted in their ability to serve their members in order to conform to numeric standards of safety and soundness that may not present the complete view of the credit union's condition. To allow this to happen would frustrate the very purpose of the Act that created PCA for credit unions.

We urge NCUA to incorporate the changes we recommend which will support credit unions in their efforts to comply, without jeopardizing the statutory directives of PCA. Thank you for the opportunity to present our views. If you have any questions, please do no hesitate to contact me or CUNA's General Counsel Eric Richard, Chief Economist Bill Hampel or Associate General Counsel Mary Dunn at 202-682-4200.

Sincerely,
/S/
Daniel A. Mica
CUNA President and CEO