The White Paper states that credit unions rely almost exclusively on retained earnings to build capital. Currently, only two types of credit unions can issue supplemental capital – low-income credit unions and corporate credit unions. Congress in 1998 limited credit union net worth to retained earnings as defined by generally accepted accounting principles. Therefore, the Federal Credit Union Act would have to be amended to allow federally-insured credit unions to count supplemental capital as part of their net worth.
“The Working Group concluded that any form of supplemental capital for credit unions should adhere to three key public policy principles: (1) preservation of the cooperative mutual credit union model; (2) robust investor safeguards; and (3) prudential safety and soundness requirements.”
There are two important characteristics associated with supplemental capital – 1) the source of supplemental capital and 2) the equity characteristics of the supplemental capital.
The Working Group identified three alternative forms of supplemental capital that meet the aforementioned principles – Voluntary Patronage Capital (VPC), Mandatory Membership Capital (MMC), and Subordinated Debt (SD).
“ VPC would be uninsured and subordinate to the National Credit Union Share Insurance Fund (NCUSIF), and would be used to cover losses that exceed retained earnings. These instruments are intended to allow members with the financial wherewithal, under strict suitability and disclosure standards, to support the credit union by contributing capital. Purchase of this type of supplemental capital instrument would be optional for natural person members, but not available to institutional members. Voting rights and access to all credit union services otherwise available to members may not be contingent in any way on the purchase of VPC. This type of supplemental capital would function as equity, not debt, as it is a very long term, noncumulative capital instrument. Given its utility as capital, VPC would count toward both the net worth ratio and the risk-based net worth ratio, but subject to certain limits given mutuality and risk considerations.
MMC would function as equity, not debt, as it approximates a perpetual, non-cumulative capital instrument. Purchase of this type of supplemental capital would be a condition of membership for any person or entity eligible to join the credit union. The idea behind this form of capital is to allow credit unions to convert the par value share currently required to be a member of the credit union in good standing to a form of supplemental capital. Specifically, the minimum single par share which a member is required to “purchase” to be a member of the credit union would be uninsured and subordinate to the NCUSIF. Subject to prior regulatory approval, individual credit unions would opt-in to this type of membership structure by adoption of a standard bylaw amendment.
Given its utility as capital, MMC would count without limit toward both the net worth ratio and the risk-based net worth ratio. It is intended to reflect the cooperative “ownership” and voting rights every member of the credit union has, without changing the one member-one vote principle. It more explicitly reflects each member’s ownership stake in the credit union.
SD is the third general category that could satisfy to various degrees the key public policy principles. SD would be uninsured, subordinate to the NCUSIF, and would be used to cover losses that exceed retained earnings and any MMC or VPC capital. It would have a 5-year minimum initial maturity or notice period with no early redemption option for the investor. Credit unions issuing SD would need to be subject to standard marketplace investor suitability standards and disclosures. SD may not convey any voting rights, involvement in the management and affairs of the credit union, or be conditioned on prescriptive measures directing the credit union’s business strategies. This type of supplemental capital would function as a hybrid debt-equity instrument. It is the Working Group’s belief that this type of capital instrument should be limited to institutional investors, regardless of whether such investors are members of the credit union or external. Given the debt characteristics and shorter minimum initial maturity, SD would only count toward the risk-based net worth ratio, and only up to 50% of capital instruments (including retained earnings) counting toward the net worth ratio.”