the comment period for NCUA's proposed rule to apply the Prompt
Corrective Action (PCA) section of HR 1151 will close. How this
part of the legislation is implemented could be more critical to
credit unions than the rules dealing with field of membership. Those
regulations affect only federal charters. The rules on capital impact
all federally insured credit unions.
threat was that the banker's suit would shut off growth opportunities
by preventing credit unions from taking in new members. The PCA
legislation could result in the same no growth outcome by preventing
credit unions from serving new members in any meaningful way.
Basics in Credit Unions
Until HR 1151, the history of credit unions and capital was that
capital was generated as a flow from income. The regulations required
that a certain percentage of total income be set aside until certain
ratios of capital to risk assets were met. For example, federally
insured credit unions were required to "reserve" 10% of
gross income until the ratio of capital to risk assets reached 4%.
The transfer rate was reduced to 5% at that level.
This regulatory concept was that capital came from revenue over
time, not as a set amount required at a point in time. This approach
has worked. Credit unions' average equity to asset ratio of approximately
11% at June 1999 is higher than any of their depository institution
is the new law does not recognize this "flow" over time
concept. Rather the theory of Prompt Corrective Action is that depository
institutions must maintain a fixed ratio of capital to assets at
every point in time or be subject to regulatory oversight and increased
supervision. The "floor" on this measure is 7%. Anytime
a credit union falls below this, regulatory constraint on its activities
The theory of Prompt Corrective Action comes from the banking industry.
In that world, banks and thrifts have the ability to raise capital
from external sources through sales of stock or subordinated debt
which can provide the needed capital when they are presented with
a crisis or an opportunity. These options do not exist in the current
credit union capital structure. The top of the ratio, capital, comes
only from retained earnings.
At the present time, credit union capital grows about
9.5 to 10% per year (see graph on page 6). That would be the maximum
asset growth that credit unions could support and still retain their
capital ratio. At midyear 1999, new member growth in credit unions
was running over 5%. The cost of funds is about 4%. So if a credit
union just kept up with general market trends, then they would be
using up all of their "capital capacity" before they reach
out for new opportunities.
These new opportunities are certainly there. The restructuring of
the banking and thrift industries where the vast majority of assets
are held by a small number of national or super-regional firms,
is leaving many communities without locally owned options. San Diego,
California; Tampa and Jacksonville, Florida; and San Antonio, Texas
are just some of the communities where credit unions are the largest
local depository institution.
Moreover, the realignment of the financial services industry driven
by the Internet and new competitors is offering growth opportunities
of double digits per month. The growth of home banking accounts
is estimated to be over 65% per year for the next five years. New
products and service options are causing consumers to look for new
solutions. Many credit unions are part of this innovative wave.
Focus on Member Service
Some of the most creative and member service-driven credit unions
have single digit capital ratios in the 7 to 9% range (see table
on page 6). They have dynamic growth opportunities because of their
business leadership and market effectiveness. Their rate of earnings
as measured by ROA is in the upper quartile; their delinquency is
lower than average and their expense ratios are generally less than
their peers. The result of their effectiveness is that their members
want to do business with them often resulting in growth of savings
and loans in the 15 to 25% range. These credit unions are among
the most safe and sound institutions, but their financial dynamics
cause them to have lower capital to asset ratios while they still
produce above average capital growth from earnings. This flow to
retained earnings however, is not as high as the underlying growth
rate of savings and loans in times of great opportunity.
from the System and Cooperatives
Fortunately options for allowing credit unions to meet the new PCA
requirements and fulfill the needs of their members do exist. In
the past five years NCUA has supported alternative capital programs
for corporate and community development credit unions. These alternatives
have included membership shares and term deposits by third parties
that are uninsured. These options recognized that parts of the credit
union system were "capital rich" and that this surplus
could be used to help credit unions that were "capital poor."
The actions were a logical extension of the credit union principles
where those persons with savings help other members who need to
But the options are even broader than membership shares and uninsured
term deposits. In cooperatives and other member-owned firms, capital
has been contributed by members by creating shares or notes that
result from the members use (or patronage) of the cooperative. These
firms have also accessed the markets by creating new forms of capital
that uniquely fit their organization's needs, e.g. trust preferred
shares. There have been original solutions to the capital needs
of organizations from non-profits to mutual firms that do not issue
stock. Credit unions can use these precedents and not compromise
any of their democratic, member-owned governance structure.
Way Forward: Pilots
Market opportunities won't wait because consumers will not continue
to use a second class product when a better alternative exists.
The world of today is very different from just five years ago because
the speed and ubiquity of Internet solutions can cause an enormous
shift of loyalties to occur literally overnight. Traditional solutions
can be threatened by new upstarts in a matter of months. The founder
of Netscape, Jim Clark, describes this New World as similar to riding
a motorcycle. "Stability is a function of momentum. In other
words, move fast, keep going or end up on your butt. In our business
stability and security come from doing things quickly."
Capital is the fuel that enables organizations to act quickly. For
credit unions and NCUA, soundness comes not from the level of capital
but from capital creation and access. To improve access, credit
unions should develop pilot programs that use the best of both credit
union and cooperative examples to expand credit union capital options.
Pilots encourage innovation, can be accomplished without a lot of
administrative bureaucracy and can help identify the best way forward.
Implementing Prompt Corrective Action without capital options will
strangle credit unions sitting on opportunity. These organizations
will have only two choices: slow death or convert to a more flexible
regulatory environment. NCUA has the opportunity to create that
environment, provide credit unions greater flexibility and meet
the legal mandates of 1151. This could be the most important test
of the Agency's responsiveness since deregulation.