What’s The Big Idea?

January 24, 2014 at 8:38 am Leave a comment

Yesterday, the NCUA proposed the most far reaching revisions of credit union risk based net worth requirements since they were originally promulgated at the beginning of the last decade. Given the complexity of the issue and the fact that every credit union will be affected differently, it is far too early to give this proposal a thumbs up or thumbs down. But given NCUA’s aggressive use of its authority to create risk-based net worth requirements to deter what it perceives as safety and soundness risks, this proposal will undoubtedly keep more than a few credit union CEOs and CFOs up at night. The changes would take effect 18 months after final approval.

Risk based net worth generally attempts to gauge the stability of a financial institution’s assets by weighting the risk posed to financial institutions in the event of financial trouble. So, for example, cash on hand is not counted against an institution’s strength at all, but member business loans would be. The system is already used by banks and NCUA is putting forward this proposal, in part, to harmonize credit unions with other financial institutions.

First, the good news. This proposal would only affect credit unions with $50 million or more in assets. Second, it is possible that for those of you with a conservative asset composition, the new asset weighting system proposed by NCUA will actually result in your credit unions having to put aside less, not more, capital.

Now for the potentially bad news. As explained by NCUA in the proposal’s preamble, credit unions usually have quality capital; however, the Share Insurance Fund has lost hundreds of millions of dollars due to the failure of individual credit unions holding inadequate levels of capital. According to NCUA, “examiners did warn officials at these credit unions that they needed to hold higher levels of capital to offset the risks in their portfolios, but the credit union officials ignored the examiner’s recommendations, which were unenforceable. This proposal seeks to incorporate the lessons learned from these failures and better account for risks not addressed by the current rule.”

How would the proposal do that? By greatly expanding the use of weightings to better assess the ability of a credit union to absorb potential losses. For instance, NCUA has expressed a concern about excessive concentrations of MBL and mortgage loans on credit union balance sheets, so under the new proposal, credit unions would have to assign a 100% “risk-weight” to member business loans of less than or equal to 15% of assets but a 150% “risk-weighting” to any business loans greater than 15% of a credit union’s assets. For those of you who want to take a closer look, the suggested categories with their accompanying weightings begin on page 138 of NCUA’s draft.

. . . . . . . .

Net worth requirements wasn’t the only issue that NCUA dealt with at its meeting. First, it extended until September 10, 2015 the 18% maximum loan interest rate for federal credit unions. It also finalized a rule permitting credit unions with $250 million or more in assets to apply for authority for limited use of derivatives solely as a hedge against interest rate risk. The rule also permits credit unions under that threshold to exercise this authority with regulatory approval. The final rule expands the number of derivatives originally proposed that can be utilized by credit unions to include, for example, interest rate caps and interest rate floors.

I’m not much for Westerns, but whenever I think of derivatives I think of the movie Shane. Alan Ladd plays a gun slinging good guy who protects the town from a bunch of ruffians while gaining the admiration of an impressionable young boy and his pacifist mother, who despises guns. At one point in the movie Shane explains that a gun is a tool, as good or as bad as the man who uses it. That’s pretty much the way I feel about derivatives. By allowing financial institutions to trade one expected revenue stream for another, derivatives makes sense and actually enhance financial stability if used properly. I’m glad NCUA finalized this proposal and now its up to eligible credit unions not to abuse the privilege.

Happy trails.

Entry filed under: General, Regulatory. Tags: , , , , .

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Authored By:

Henry Meier, Esq., Senior Vice President, General Counsel, New York Credit Union Association.

The views Henry expresses are Henry’s alone and do not necessarily reflect the views of the Association. In addition, although Henry strives to give his readers useful and accurate information on a broad range of subjects, many of which involve legal disputes, his views are not a substitute for legal advise from retained counsel.

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