CUNA Regulatory Comment Call


May 23, 2002

NCUA’s Proposal on Prompt Corrective Action Reforms

EXECUTIVE SUMMARY

The NCUA Board voted unanimously to issue a proposal to revise the Prompt Corrective Action (PCA) rules, which are intended to improve and simplify the implementation of PCA. Comments on these PCA changes are due 60 days after they are published in the Federal Register, which should be within the next few days. The proposed revisions that are mostly technical are listed below, with the exception of the new "safe harbor" that NCUA proposes.

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 union’s net worth level to 6%. A plan that meets these standards would "be assured of approval," according to NCUA. The proposal also:

BACKGROUND ON THE PROPOSAL

The NCUA Board directed a task force to review PCA after a full year of implementation. NCUA implemented PCA, a comprehensive system of prompt corrective action consisting of minimum capital standards for federally-insured credit unions and corresponding remedies for restoring net worth. After six quarters of implementation experience, NCUA requests public comment on proposed revisions and adjustments intended to improve and simplify the system of PCA. The changes in the proposal are the outcome of that review.

To assist credit unions that fall marginally below "adequately capitalized" primarily because asset growth outstrips income growth, the NCUA Board is seeking comment on the concept of creating a safe harbor for approval of an NWRP. According to NCUA, the safe harbor would have certain criteria that would ensure approval of an NWRP if the criteria were met. Only credit unions above a certain minimum net worth ratio would be eligible. Under a safe harbor proposal, an eligible credit union would agree in its NWRP to achieve a minimum quarterly return on assets ("ROA"). This ROA would be set by regulation according to the number of basis points needed to attain a 6 percent net worth ratio. The ROA would have to offset abundant asset growth sufficiently to improve the credit union’s net worth ratio quarterly over the term of the plan. The NWRP must specify the means by which the credit union plans to achieve the minimum quarterly ROA while controlling exposure to interest rate risk and credit risk. If it met these criteria, then NCUA would approve the NWRP. That approval would be revoked automatically if and when the credit union failed either to achieve its quarterly minimum ROA or to improve its net worth ratio, as pledged in the NWRP. This safe harbor would not exempt a credit union from the statutory requirement to comply with the three other MSAs: earnings retention, the freeze on assets, and the freeze on MBLs. NCUA asks for comments regarding whether it should pursue the concept of adding a "safe harbor."

The NCUA Board proposes to add a fourth alternative component that would allow for risk weighting to reflect loans sold with partial recourse. The alternative component proposed is the sum of two risk-weighted items. The first item consists of the amount of loans sold with contractual recourse obligations of six percent or greater and is risk weighted at a uniform six percent. The second item consists of the amount of loans sold with contractual recourse obligations of less than six percent and is risk weighted according to the weighted average recourse percent of its contents, as computed by the credit union. Like the existing alternative components, if the alternative component proposed for loans sold with recourse reduced the RBNW requirement initially determined under the "standard calculation," the credit union could then substitute the alternative component for the corresponding "standard component."

The proposal allows credit unions to apply for and receive a Risk Mitigation Credit (RMC) before they fail the RBNW requirement, unlike the current rules that require 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. The proposed revision will enable credit unions that are genuinely at risk of failing an RBNW requirement to preemptively qualify for and timely receive an RMC that may permit them to seamlessly maintain their initial classification as either "adequately capitalized" or "well capitalized."

This proposal clarifies that it is the dollar amount of net worth that must be set aside when necessary to meet the 7 percent net worth requirement. NCUA proposes to clarify for credit unions that it is the dollar amount of net worth that they must increase by the equivalent of .1 percent of assets per quarter, not the net worth ratio itself, until they meet the 7 percent net worth requirement.

The proposed rule provides that NCUA will consider requests to decrease earnings retention only if they are submitted in writing no later than 14 days before the quarter end. NCUA will be under no obligation to grant applications submitted after the 14-day deadline or after the quarter-end. Furthermore, NCUA is entitled to take supervisory or other enforcement action against credit unions that either decrease their earnings retention without permission, or persist in failing to timely apply for permission. Also, the proposed rule specifies that a decision to permit a credit union to decrease its earnings retention is subject to quarterly review and revocation.

The NCUA Board has determined that the purpose of PCA—building net worth to minimize share insurance losses—is not compromised by declining to impose other corrective action (OCA), under PCA, when a credit union already is complying with an approved NWRP and achieving its prescribed net worth targets. Therefore, NCUA may decide not to impose additional corrective action on those "critically undercapitalized" credit unions that are meeting their NWRP. The proposed rule sets a deadline of ten calendar days in which a credit union may appeal a delegated decision to the NCUA Board. The NCUA Board has in fact delegated to its Regional Directors the authority to impose and renew OCA for credit unions that have assets of less than $5 million.

The proposed rule clarifies that an NWRP need only address whatever DSAs, if any, the NCUA Board already has imposed on the credit union. There is no need for a credit union to explaining how it would comply with future DSAs.

The proposed rule clarifies that publication of a Revised Business Plan for new credit unions is not a prerequisite to enforcing its provisions. Similarly, publication of an NWRP is not a prerequisite to enforcing its provision as authorized. The NCUA Board does not intend to publish NWRPs or RBPs because it believes that publication would expose the credit union to reputation risk that would be contrary to the public interest. As a result, the proposed rule also revises the statute to provide that a civil money penalty may be assessed for failure to implement either plan "regardless whether the plan was published."

The proposed rule would eliminate the perceived disincentive for "new credit unions to become adequately capitalized." To do this the proposal makes all "new" credit unions that have a net worth lower than 7 percent subject to the same earnings retention requirements. All new credit unions would be required to increase net worth quarterly by "an amount" reflected in its approved initial or revised business plan" until it becomes "well capitalized." Before, credit unions that were adequately capitalized had to meet the earning requirements, while other credit unions did not, this created a disincentive for new credit unions that were less than adequately capitalized to become adequately capitalized.

The proposed rule treats all "undercapitalized" new credit unions equally, so that the member business loan (MBL) restriction applies regardless whether a new credit union is operating with no net worth as permitted by its initial business plan or has declined to undercapitalized from a higher net worth category. This alleviates the problems caused in the old rule due to the fact that as a credit union’s net worth improved PCA became more demanding,

The proposed rule puts all new credit unions that must file an RBP in parity. First, it deletes the 90-day filing window for "undercapitalized" credit unions, thereby limiting them to the general 30-day window, once they are required to file an RBP. The proposed rule requires an "undercapitalized" credit union to submit an RBP if it either: fails to increase net worth (i.e., reduce its earnings deficit) as its existing business plan provides; has no approved business plan; or has violated the MSA restricting MBLs.

The proposed rule mandates conservatorship or liquidation of an "undercapitalized" new credit union after a 120- day period, regardless whether an RBP has been approved or rejected. This period combines the 30-day window for submitting an RBP and the original 90-day period allowed for the credit union to avoid conservatorship and liquidation by developing positive earnings. The 120-day period runs from the later of either the effective date of classification as "undercapitalized" or, if a credit union is operating with no net worth in the period prescribed by its initial business plan, the last day of the calendar month after expiration of that period. A section also is added to preserve the exception to mandatory conservatorship or liquidation for a credit union that is able to demonstrate that it is viable and has a reasonable prospect of becoming "adequately capitalized." In addition, the proposal rule clarifies that an "uncapitalized" federal credit union may be placed into liquidation on grounds of insolvency.

The proposed rule eliminates the 90-day filing window for "undercapitalized" credit unions. In addition, the rule applies the 30-day filing window uniformly to all new credit unions classified less than "adequately capitalized" or that have violated the MSA restricting MBLs.

The proposed rule gives new credit unions that fail to meet a quarterly target 60 days following the quarter-end to file an RBP. The 60-day period combines the calendar month that separate the quarter-end from the effective date of classification, with the uniform 30-day filing period that commences on the effective date. The proposed rule further clarifies that, for new credit unions that either have no approved business plan or that have violated the MBL restriction, the effective date of classification as less than "adequately capitalized" triggers the 30-day window for filing an RBP. For new credit unions, a RBPs net worth target will ensure that the credit union will become adequately capitalized when it is no longer "new."

The proposed rule would allow the board of directors of 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 so long as the charges do not reduce the credit union’s net worth below "adequately capitalized" (e.g., 6 percent net worth ratio). The current rule only allows credit unions to do this without regulatory approval if they do not reduce the capital of the credit union below "well capitalized". This lowering of the threshold gives credit unions the flexibility to decide whether charging losses is worth triggering the single MSA that applies to that category—the quarterly earnings retention MSA. The proposal reminds credit unions that they must deplete their undivided earnings balance before making any charge to their regular reserve. Likewise, the proposal lowers to "adequately capitalized" the minimum net worth category in which federally-insured credit unions may pay dividends out of the regular reserve without regulatory approval. This will give credit unions that have depleted undivided earnings the flexibility to decide whether drawing down the regular reserve to pay dividends is worth triggering the quarterly earnings retention requirement that applies to "adequately capitalized" credit unions.

In addition, for state-chartered credit unions, both the appropriate state official and Regional Director must agree before charging losses to the regular reserve account that would cause a decline below the minimum category. Likewise the Regional Director and appropriate state official must agree for a state-chartered credit union to pay dividends out of its regular reserve, when undivided earnings have been depleted. An appropriate state official would retain complete discretion to withhold approval of charges to the regular reserve on grounds that they would violate state law or procedures. The proposed rule clarifies that written approval may consist of an approved NWRP that allows such dividend payments. In addition, the proposed rule inserts the requirement that NCUA must consult the appropriate state official before decreasing a state-chartered credit union’s earnings retention.

The proposal makes a few changes to the definition section: by revising the term "dividend" to include interest paid on deposits by state-chartered credit unions and defining "senior executive officer" in connection with the DSA that permits the dismissal of a director or senior executive officer; by defining "average quarterly balance: as the average of quarter-end balances of the "four most recent calendar quarters"; and by defining "corrected net worth category" as the average of quarter-end balances of the "four most recent calendar quarters"; and by defining the "corrected net worth category" as ‘the date the credit union receives subsequent written notice of a decline in net worth category due to correction of an error or misstatement in the credit union’s most recent Call Report."

QUESTIONS REGARDING THE PROPOSAL

  1. NCUA would create a NWRP safe harbor for when credit unions fall marginally below "adequately capitalized" primarily because of asset. The safe harbor would have certain criteria that would ensure approval of an NWRP if the criteria were met. Only credit unions above a certain minimum net worth ratio would be eligible. Under a safe harbor proposal, an eligible credit union would agree in its NWRP to achieve a minimum quarterly ROA. The NWRP must specify the means by which the credit union plans to achieve the minimum quarterly ROA while controlling exposure to interest rate risk and credit risk. If it met these criteria, then NCUA would approve the NWRP. Do you support the concept of "safe harbor" approval of an NWRP for credit unions that become marginally "undercapitalized" primarily due to asset growth?

    Yes ______ No ______

    Please explain why you support or oppose this provision.













  2. For the "safe harbor" proposal described above only credit union above a certain minimum net worth ratio would be eligible. What do you think the minimum net worth ratio should be and why?













  3. Under a "safe harbor" proposal, an eligible credit union would agree in its NWRP to achieve a minimum quarterly return on assets (ROA). The ROA would be set by regulation according to the number of basis points needed to attain a 6 percent net worth ratio and improve the credit union’s net worth ratio quarterly taking into account the credit union’s growth. The NWRP must specify the means by which the credit union plans to achieve the minimum quarterly ROA while controlling exposure to interest rate risk and credit risk. If it met these criteria, then NCUA would approve the NWRP. The regulation would set the ROA based on to the number of basis points needed to attain a 6 percent ratio and offset growth. Do you agree with this type of approach?

    Yes ______ No ______

    Should the calculation of the necessary ROA take into account other factors?

    Yes ______ No ______

    If so, please explain what other factors or formulas NCUA should consider in setting the ROA?













  4. The safe harbor approval would be revoked automatically if and when the credit union failed either to achieve its quarterly minimum ROA or to improve its net worth ratio, as pledged in the NWRP. Do you agree that the approval should be automatically revoked under these conditions?

    Yes ______ No ______

    If not, please explain how the automatic revocation requirement could be modified?













  5. The NCUA Board proposes to add a fourth alternative component that would allow for risk weighting to reflect loans sold with partial recourse. The alternative component proposed is the sum of two risk-weighted items. The first item consists of the amount of loans sold with contractual recourse obligations of six percent or greater and is risk weighted at a uniform six percent. The second item consists of the amount of loans sold with contractual recourse obligations of less than six percent and is risk weighted according to the weighted average recourse percent of its contents, as computed by the credit union. Like the existing alternative components, if the alternative component proposed for loans sold with recourse reduced the RBNW requirement initially determined under the "standard calculation," the credit union could then substitute the alternative component for the corresponding "standard component." Do you agree with NCUA’s change that allows for an alternative component to take into account loans sold with partial recourse?













  6. Do you believe that NCUA should allow credit unions to apply for and receive a Risk Mitigation Credit prior to when the credit union may fail the RBNW requirement? Please explain.













  7. Do you agree with the change that specifies that NCUA will consider requests to decrease earnings retention only if they are submitted in writing no later than 14 days before the quarter end? NCUA states that it is entitled to take supervisory or other enforcement action against credit unions that either decrease their earnings retention without permission, or persist in filing to timely apply for permission. Please explain your position.













  8. Do you support NCUA’s decision to lower from "well capitalized" to "adequately capitalized" the minimum category in which losses may be charged to the regular reserve account without regulatory approval? Please explain. This also applies to the payment of dividend out of the regular reserve account when undivided earnings have been depleted.













  9. Do you have any other comments on the PCA reforms proposed? Please explain






















Eric Richard • General Counsel • (202) 508-6742 • erichard@cuna.com
Mary Mitchell Dunn • SVP & Associate General Counsel • (202) 508-6736 • mdunn@cuna.com
Jeffrey Bloch • Assistant General Counsel • (202) 508-6732 • jbloch@cuna.com
Catherine Orr • Senior Regulatory Counsel • (202) 508-6743 • corr@cuna.com