Corporate Credit Union Capital: Back to the Future

Reading NCUA’s Chairman Fryzel’s testimony on May 20th before the House Financial Services subcommittee was like engaging in time travel without the flux capacitor to circa 2001 and 2002.

Many of the recommendations posed by Chairman Fryzel in his testimony were exactly what NCUA had contemplated in the earlier part of this decade. But credit union industry opposition largely short-circuited these reforms.

In his testimony, Fryzel stated “it is my intent that NCUA will revise the capital standards corporates are subject to, ensuring they are consistent with capital and prompt corrective action standards for all other federally insured financial institutions.”

NCUA is contemplating the following elements as part of any capital rule it proposes:
• A minimum leverage ratio of core capital;
• A requirement that a percentage of total core capital included in the leverage ratio must be retained earnings;
• A minimum risk-based capital ratio, based on Basel standards; and
• A requirement that all capital instruments qualify as capital under the Basel standards.

In justifying a minimum retained earnings requirement, Chairman Fryzel cautioned that it is bad policy to have the capital base of a corporate credit union consist entirely of contributed capital, because contributed capital results in the downstreaming of corporate credit union losses to natural person credit unions.

This is exactly what happened with the NCUA’s seizure of Western Corporate FCU, which resulted in approximately $1.14 billion of contributed capital of member credit unions being wiped out.

As an editorial note: rather than requiring a minimum retained earnings ratio, I prefer Treasury’s 1997 recommendation which would require credit unions to deduct their contributed capital in corporate credit unions when calculating their net worth ratio for prompt corrective action purposes as a vehicle for limiting losses at corporate credit unions from cascading to natural person credit unions.