Monday, July 18, 2011

Countercyclical Capital

Credit unions may face countercyclical capital requirements as a result of Section 616(c) of Dodd-Frank Act.

Section 616(c) states:

"Each appropriate Federal banking agency shall seek to make the capital standards required under this section or other provisions of Federal law for insured depository institutions countercyclical so that the amount of capital required to be maintained by an insured depository institution increases in times of economic expansion and decreases in times of economic contraction, consistent with the safety and soundness of the insured depository institution."

While this provision addresses insured depositories regulated by the Federal banking agencies, Section 216(c)(2) of the Federal Credit Union Act discusses adjustments in credit union net worth levels. The NCUA Board may adjust the net worth ratio if the Federal banking agencies change the minimum leverage ratio.

In deciding to adjust the net worth level, the NCUA Board must determine, in consultation with the federal banking agencies, that the reason for the change in the required minimum level for the leverage limit also justifies the adjustment in net worth ratios and determines that the resulting net worth ratios are sufficient to resolve the problems of insured credit unions at the least possible long-term loss to the NCUSIF.


  1. It would be helpful if Dr. Leggett would explain how much capital will really be needed by a typical bank to be considered "well capitalized" by the FDIC. I have read several articles and have become confused by some of the terms and how they were applied in the articles. So, please define the following; leverage ratio, common equity, retained earnings, tier 1 and tier 2 capital and how much of these various catagories must be maintained to be well capitalized. Also, please be sure to indicate when any required ratio is a "risk based" vs a true numeric value. In the credit union world we have Net Worth which is made up of required reserves and retained earnings and we must have 7% to be considered well capitalized. We do have a minimum risk based capital calculation on our 5300 report but it rarely figures into anything when looking at the vast majority of CUs. Once we have a better understanding of these issues, we can opine on whether the NCUA should change capital requirements to be considered "well capitalized".

  2. To be well-capitalized, a bank must satisfy three capital ratios -- a total risk-based capital ratio of at least 10 percent, tier 1 risk-based capital ratio of at least 6 percent, and tier 1 leverage ratio of at least 5 percent.

    Tier 1 leverage ratio is the most similar to the credit union net worth leverage ratio.

    FDIC defines Tier 1 capital or core capital as "the sum of common stockholders' equity, noncumulative perpetual preferred stock (including any related surplus), and minority interests in consolidated subsidiaries, minus all intangible assets (other than mortgage servicing assets, nonmortgage servicing assets, and purchased credit card relationships eligible for inclusion in core capital pursuant to § 325.5(f)), minus credit-enhancing interest-only strips that are not eligible for inclusion in core capital minus deferred tax assets in excess of the limit set forth in § 325.5(g), minus identified losses (to the extent that Tier 1 capital would have been reduced if the appropriate accounting entries to reflect the identified losses had been recorded on the insured depository institution's books), and minus investments in financial subsidiaries subject to 12 CFR part 362, subpart E, and minus the amount of the total adjusted carrying value of nonfinancial equity investments that is subject to a deduction from Tier 1 capital as set forth in section II.B.(6) of appendix A to this part."

    Common stockholders' equity means the sum of common stock and related surplus, undivided profits, disclosed capital reserves that represent a segregation of undivided profits, and foreign currency translation adjustments, less net unrealized holding losses on available-for-sale equity securities with readily determinable fair values.

  3. Based on the information provided, it would appear that because credit unions are already better capitalized than their banking counterparts, there is no need for the NCUA to require higher capitalization ratios. On top of that, our loans and investments tend to be less risky than the banks. Maybe the FDIC should make their banks match our capital levels.

  4. The higher net worth requirement for credit unions is actually comparable to the leverage ratio for banks, once you consider that 1) credit unions can only build capital through retained earnings; 2) credit unions have a contingent call on their capital associated with their one percent NCUSIF capitalization deposit; and 3) credit unions have equity investments in their corporate credit unions, which also represents a contingent call on credit union capital or net worth.

    I recommend reading the 1997 Treasury study on Credit Unions, which is responsible for the net worth standards for credit unions.

  5. KL - You mentioned Tier 1 capital does not include intangible assets, but CUs regulatory net worth does include intangibles - right? And some CUs are really loading up on goodwill through mergers. Since intangibles are basically worthless in the event of a failure, it would seem more prudent for the regulator to subtract intangibles from the calculation of regulatory net worth.

  6. the net worth ratio of some CUs is overstated on call reports.
    look at large cu's that are known to have done a merger in recent years. you will see net worth ratios that are grossly overstated when one considers the amount of goodwill that regulators allow as regulatory capital, but in fact is worthless in the event of need.
    the same is/will be true with 208 assistance.
    CUs are well served to strongly reconsider mergers where the reliance on goodwill gives comfort to regulatory capital. goodwill is not real and can be extinguished with the strok of a regulatory pen...just look at what occurred at the end of the thrift crisis.

  7. I don't know for sure but I have been told that goodwill is not included in credit union net worth calculations for regulatory purposes. There may be a few credit unions out there that have significant amounts of goodwill on their books but I don't know of any-----perhaps the responder should ID those credit unions. The mergers I know about seem to come up with valuations of assets and liabilities that mirror the totals of the credit unions that are being combined so there are no overstatements of equity. On the other hand, I do know of numerous banks that had tons of goodwill on their books after they paid significant premiums over book value for bank buyouts and hostile takeovers.
    Keith, would you please address this issue?

  8. FDIC is reporting that banks at the end of the first quarter had approximately $285 billion in goodwill as an asset on their books.

    However, pursuant to section 18(n) of the Federal Deposit Insurance Act (12 U.S.C. 1828(n)), an unidentifiable intangible asset such as goodwill, if acquired after April 12, 1989, cannot be included in calculating regulatory capital.

  9. That's a lot of vaper-value!!! If credit unions have any goodwill on their books, I would bet it is less than $20 million. Still waiting for the answer as to whether goodwill is counted as regulatory net worth (very much doubt it).

  10. According to NCUA data, goodwill was $495.9 million as of March 2011 -- up from $323.4 million a year earlier.

    Goodwill does not count as regulatory net worth for credit unions.

  11. Please check out schedule RC-R of the call report for banks. Goodwill is subtracted out of bank equity capital when calculating tier-1 capital. Credit unions do not make the simil;ar adjustment when calculating their net worth for regulatory capital purposes.

  12. thats correct. this is why regulatory capital in cu's is overstated.
    then, when one subtracts the 1% ncusif deposit out of capital for cu's---capital is substantially overstated.

  13. OK, let's review; if goodwill overstates CU capital, it amounts to about 5-6 basis points and if you substract the 1% deposit at the NCUSIF, where does that leave the CU industry? I believe it still has between 8% and 9% net worth. That compares quite well to the banking world where banks have to have only 5% in real capital (the CU world doesn't get the benefit of risk based capital). On top of having plenty of capital, CU balance sheets reflect better loan quality with lower delinquency and net charge off rates than the banking world. Suggesting that credit unions are not well capitalized is way off base.

  14. The 1% NCUSIF deposit is why the credit union capital requirements were increased to 7% in the Credit Union Membership Access Act of 1998 (HR 1151). That deposit is completely refundable should the state credit union become privately insured or the federally insured credit union becomes a bank.

    Now there is an irony. Credit unions converting to banks becoming FDIC insured and not having to pay anything immediately into the fund with cash returned from the NCUSIF deposit. Talk about the opportunity to "freeload!"



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