Source: https://nascus.org/regulatory-resources/05.09.17%20Comment%20alt%20capital%20anpr.php
Timestamp: 2019-04-23 00:11:51+00:00

Document:
The National Association of State Credit Union Supervisors (“NASCUS”), the professional association of the state credit union regulatory agencies and the nation’s state credit union system, submits the following comments in response to the National Credit Union Administration's (“NCUA's”) Advance Notice of Proposed Rulemaking for Supplemental Capital (“the ANPR”).1 The ANPR addresses issues concerning both low income credit union (LICU) issuance of secondary capital as well as the non-LICU natural person credit union potential use of supplemental capital to meet impending complex credit union risk-based capital requirements. NASCUS appreciates the opportunity to provide our perspective to NCUA on this important rulemaking and submit the following recommendations for the agency’s consideration.
As discussed in detail below, NASCUS supports allowing supplemental capital to contribute toward a portion of a credit union’s risk-based capital ratio. 2 As NCUA implements a more complex regulatory capital framework, the agency should also modernize credit union regulatory capital concepts to match. Including supplemental capital in credit union risk-based capital ratio calculations is well within NCUA’s statutory authority. Furthermore, including supplemental capital in risk-based capital ratio calculations is consistent with the statutory purposes of both state and federal credit unions and is sound public policy. 3 Expanding credit union access to supplemental capital will not impair credit union mutual ownership and governance, nor imperil the credit union tax exemptions.
We also believe that it is essential NCUA take a flexible approach to creating the risk-based supplemental capital framework. To the extent it is determined that credit union specific regulations are needed to safeguard investors, members, and the National Credit Union Share Insurance (NCUSIF), NCUA should look to existing regulation found in state, federal and international regulatory regimes for instruction. However, NCUA’s regulations must provide room for the marketplace to evolve and shape supplemental capital in ways that maximize its utility to credit unions as well as its attractiveness to investors. Essential to that flexible approach will be NCUA allowing state chartered credit unions to raise supplemental capital from both entities or individuals (member and non-member) as permitted by state law or regulation.
Risk-based supplemental capital should adhere to the credit union mutual ownership and governance principles, be available to cover losses, and be subject to prior regulatory approval.
While the statutory basis for low income credit union (“LICU”) designated secondary capital and complex credit union supplemental capital are distinct, NCUA should consolidate rules regarding both. So doing would diminish the potential for confusion among credit unions and the public regarding capital sources beyond retained earnings. In addition, LICUs could benefit from instruments, processes, procedures and disclosures developed by complex credit unions for risk-based supplemental capital.
In 1998, the Credit Union Membership Access Act (“CUMAA”) was signed into law, in part establishing Prompt Corrective Action (“PCA”) for credit unions. 8 The CUMAA amended the Federal Credit Union Act (“FCUA”) to create a net worth ratio requirement for all federally insured credit unions and a risk-based net worth ratio requirement for federally insured credit unions the NCUA Board designates as complex. 9 The net worth ratio is explicitly defined in the CUMAA as a ratio of a credit union’s net worth to total assets with net worth being defined as retained earnings, certain NCUA emergency assistance (Section 208 assistance), and for LICUs, secondary capital. 10 However, the CUMAA did not define the risk-based net worth ratio, granting the NCUA Board discretion in developing a risk-based net worth framework.
In 2015, NCUA promulgated a final risk-based PCA rule that amended Part 702 to replace the risk-based net worth ratio with a two-tiered risk-based capital ratio. 11 As part of that rulemaking, NCUA solicited comments on whether non-LICU natural person credit unions should be allowed to count supplemental capital toward their risk-based capital ratio.
Enhancing credit union ability to access capital, in a manner consistent with their mutual organization and not-for-profit status, would do more than just bring them on par with banks and credit unions worldwide. In addition to helping credit unions meet risk-based capital ratio requirements, supplemental capital can help credit unions meet the needs of their members. Supplemental capital can help credit unions manage growth, support the formation of new credit unions, promote investment innovation, assist in the funding of credit union infrastructure, and help consumers. 14 Increasing access to supplemental capital may also strengthen the system’s cooperative foundation.
Of course, the fact that tens of millions of dollars has been invested in LICU secondary capital demonstrates a market among investors for credit union issuances, as does the fact that credit unions around the world have found investors for their supplemental capital offerings.
The ANPR questions whether the use of supplemental capital by non-LICUs will negatively impact LICUs. 18 We do not think it would. To the extent that some investors in LICU secondary capital have been philanthropic, it is unlikely that non-LICU supplemental capital will dilute those opportunities for LICUs. 19 Of course, not all LICU investors are philanthropic. However, we believe that rather than dilute opportunities for LICU issuances, expanding supplemental capital for complex credit unions will revitalize the market for LICU capital instruments. In particular, this could be the case should NCUA accept our recommendation and expand the LICU eligibility for natural person investors and harmonize LICU and non-LICU supplemental capital rules.
(1) In general.—The regulations required under subsection (b)(1) of this section shall include a risk-based net worth requirement for insured credit unions that are complex, as defined by the Board based on the portfolios of assets and liabilities of credit unions.
NCUA’s approach with respect to risk-based capital calculations is consistent both with the statutory language of the FCUA and that of federal bank regulators. Extending that discretion to include supplemental capital for risk-based capital ratio calculations is well within NCUA’s authority. In fact, failure to include supplemental capital in the complex credit union risk-based calculation could be construed as failing the requirement that NCUA’s regulation be comparable to that of the FDI Act.
NCUA notes that FCUs may need clarified borrowing authority in order to effectively issue subordinated debt. 26 NASCUS offers no opinion on FCU authority to engage in supplemental capital transactions. If changes are needed in statute or regulation to clarify FCU authority, we encourage NCUA to pursue such changes. However, we reiterate, as with FISCUs needing changes at the state level, this rulemaking should advance regardless of whether additional changes to credit union powers must be sought in addition.
NCUA notes in the ANPR that the FCU tax exempt status is derived from the FCUA, in part because FCUs “could not access capital markets to raise capital” while SCUs derive their federal income tax exemption from §501(c)(14)(A) of the Internal Revenue Code. The SCU federal income tax exemption is predicated upon the lack of “capital stock,” and credit unions’ not-for-profit mutual organization and purpose. NCUA expresses concern about the possible effect of credit union access to supplemental capital on the credit union tax exemption. 27 The agency seeks to ensure that supplemental capital authority for non-LICU designated complex credit unions does not negatively impact the tax exemptions.
Concerns regarding the possible effect of supplemental capital on the credit union tax exemptions are legitimate, but hardly insurmountable.
As NCUA notes in its ANPR, the Internal Revenue Service (“IRS”) has not established an official definition of “capital stock.” 28 A few courts addressing similar issues have suggested a lack of certain features tends to make an instrument less like “capital stock” and more like a debt instrument. One of the key features in such determinations is whether voting rights are conferred with the instrument. 29 It will be essential that supplemental capital instruments issued by credit unions do not confer voting rights, and future regulations should so stipulate. Ultimately, it will be the IRS that determines if supplemental capital instruments are consistent with the credit union tax exemptions.
We caution against that approach.
Prudential safety and soundness considerations should be addressed in a credit union supplemental capital rule to protect credit unions, their members, investors, and the NCUSIF from litigation and reputation risk from mismanaged offerings as well as fundamental issues such as concentration and earnings risk.
To allow future marketplace and supervisory adaptation to non-LICU supplemental capital, the initial rulemaking should focus on establishing characteristics consistent with the mutual nature of the credit union system, supervisory safeguards to mitigate risks to the safety and soundness of the participating institution, investor safeguards, and credit union policies and procedures.
As the credit union system gains experience with supplemental capital, NASCUS supports a requirement for prior regulatory approval before issuance.
The business plan submission requirements could contain provisions mandating certification that the credit union’s plan is in compliance with any applicable securities laws, director liability, disclosures and tax laws. 38 As discussed above, credit unions would also submit the legal opinions they obtain regarding the effect of the instrument on their tax exempt status. The business plan would also cover the amount of supplemental capital to be 0ffered, the rates and maturities (if any), and the business reason for the offering.
Once the plan is submitted to NCUA or the state regulator, NCUA and the state should consult on the plan and application to issue the instruments. The regulation should provide that the credit union may deem its plan approved 90 days after its plan is submitted to regulators unless informed that the plan has been rejected. Once a plan is approved, or the 90 day period has run, the rule should give credit unions a set time frame within which to proceed with the issuance. These time frames will provide a degree of certainty to the process. From a credit union’s perspective, establishing a time frame for supervisory approval allows them to move forward or know their plan has been rejected. From a supervisory perspective, requiring the credit union to move forward within a set time after receiving approval helps ensure the credit union’s condition, and other circumstances, can be reasonably expected to be the same as when the supervisory evaluation of the business plan was made.
The supplemental capital rule should also provide for an expedited approval process for credit unions that have been previously approved for similar offerings and/or remain in sound condition.
NASCUS agrees that supplemental capital instruments should be subject to investor suitability safeguards and disclosures. There is no need to reimagine standards from scratch. As a starting point, NCUA may look to existing rules applicable to LICU secondary capital as well as standards for bank supplemental capital as promulgated by the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), and state securities laws. NCUA should consider whether it needs to adopt a “credit union tailored” version of existing rules. An alternative approach could be for NCUA, rather than develop its own rules, to rely on the existing regulatory frameworks by requiring compliance with applicable disclosure rules.
As a starting point, both secondary capital and supplemental capital should be available to natural persons as well as non-natural person investors. 40 The rules should also allow for both member and non-member investors. Such flexibility accomplishes several policy goals, such as increasing the market for secondary and supplemental capital, diversifying the investor pool, providing for investor discipline, and permitting members to contribute additional support for their credit union.
Both the OCC and the FDIC utilize tiered approaches to their disclosures. 41 In these cases, streamlined disclosures are available for non-public offerings, and more detailed disclosures for public offerings. Either of these existing frameworks may be used to tailor appropriate disclosures for credit union supplemental capital offerings.
Supplemental capital regulations should clearly establish the criteria for a credit union seeking approval to make an issuance. Qualifying credit unions should be well run, sufficiently capitalized, and free from material findings in their most recent Report of Examination (ROE). Credit unions classified as troubled, or reasonably at risk for conservatorship, should be ineligible.
Credit unions should be permitted to structure offerings with varying priorities with respect to loss absorption among the offerings themselves. In addition, the regulatory definition of operating losses should include the payment of dividends unless prohibited by order.
NCUA seeks comments on how supplemental capital should be treated for purposes of voluntary mergers. 43 Under current secondary capital rules, LICUs are required to close and pay out secondary capital accounts to investors before a merger with another credit union. 44 Credit unions should be given more flexibility to make a business decision as to the benefits of closing or retaining secondary and supplemental capital accounts during a voluntary merger. It should be the credit union’s choice whether to redeem or carry the alternative capital in the event of a merger.
We do agree that covenants mandating the early redemption of the supplemental capital in the event of a future merger should be prohibited. While as noted above we support the credit union having discretion in this regard, we do not think the decision should be included in a covenant of the issuance. Such a covenant bears similarities to an investor veto of a merger decision, albeit tangentially. Such a covenant obfuscates the issue of ownership and control.
NCUA should move expeditiously to form a working group with state regulators to draft a proposed supplemental capital rule.
In 2010, NCUA’s Supplemental Capital working group identified three base forms of supplemental capital that might be made available to the credit unions system. Mandatory patronage would allow credit unions to convert the member share required to join the credit union into a form of supplemental capital. Voluntary patronage capital would be an instrument available only to members of the credit union, but remain distinct from their member share. The third instrument would be a subordinated debt instrument available to members and non-members both individual and institutional. We note these instruments to illustrate that supplemental capital rules should be flexible and allow for broad development of marketable instruments. We do not think these three options represent the exclusive universe of possibly beneficial supplemental capital instruments that could be developed for the credit union system.
We discourage NCUA from attempting to pre-determine the specific types of instruments that may be offered by credit unions. The rule should focus on the instrument’s attributes and qualifying criteria. In particular, we are intrigued by the possible development of “pooled” supplemental capital instruments that provide cost savings to the issuers and expands access to capital markets for credit unions seeking more limited offerings. 48 CUNA Mutual Group has demonstrated proof of the pooling concept in 2006 when it helped 21 Australian credit unions raise nearly $100 million in subordinated debt and preferred equity in an innovative offering that was named the “Structured Finance Deal of the Year.” 49 Not only would innovative pooled offerings provide efficiencies for the credit union system, it epitomizes the cooperative spirit that founded the movement more than 100 years ago.
Truly comprehensive capital reform for credit unions requires Congressional action. However, that this rulemaking would fall short of comprehensive reform in no way diminishes the important framework it would establish. As discussed throughout these comments, developing a supplemental capital rule for non-LICU natural person credit unions is sound policy.
From a supervisory perspective, in particular a deposit insurer supervisory perspective, more capital, at risk and junior to the share insurance fund, is almost always better than less capital.
In closing, we commend NCUA for its hard work on this important issue. Our comments and recommendation contained herein result from extensive discussions with our members. We would be pleased to discuss these comments in detail at NCUA’s convenience.
1. 82 Fed. Reg. 9291 (Feb. 8, 2017).
2. NASCUS also supports a statutory modernization of credit union capital definitions to permit the use of supplemental capital in net worth calculations for natural person credit unions. However, as the issue presented in The ANPR is limited to risk-based capital ratios so too will our comments be limited to risk-based capital.
3. Some commenters responding to the ANPR have asserted that providing credit unions access to supplemental capital is inconsistent with “the credit union purpose to serve members of modest means.” These comments offer nothing in support of their assertion. Furthermore, they ignore the fact that some credit unions have as their statutory purpose to promote thrift among their members rather than singularly serving members of modest means. Finally, and perhaps most perplexing, they fail to reconcile their assertion with the fact that Congress expressly authorized secondary capital for low income designated credit unions.
4. 61 Fed. Reg. 50696 (Sept. 27, 1996).
5. Williams, Marva. Woodstock Institute. Critical Capital: How Secondary Capital Investments Help Low-Income Credit Unions Hit Their Stride, (May, 2002), p. 6. Available at http://www.woodstockinst.org/sites/default/files/attachments/criticalcapital_0.pdf (viewed March 2017).
7. NCUA, Supplemental Capital White Paper, (April 12, 2010) p. 1. Available at https://www.ncua.gov/Legal/Documents/SupplementalCapitalWhitePaper.pdf.
9. PCA is implemented by 12 C.F.R. §702.
10. 12 U.S.C. §1790d(o)(3); 12 CFR 702.2(g) and (k).
11. 80 Fed. Reg. 66626 (October 29, 2015).
12. NCUA, Supplemental Capital White Paper, (April 12, 2010) p. 5. Available at https://www.ncua.gov/Legal/Documents/SupplementalCapitalWhitePaper.pdf.
13. Id. Citing Filene Research Institute, Alternative Capital for U.S. Credit Unions? A Review and Extension of Evidence Regarding Public Policy Reform, Robert F. Hoel, PhD (2007), p. 2. Available at https://filene.org/assets/pdf-reports/145_Hoel_AltCapital.pdf.
14. Colweel, Theran. (2017, March 1) Ready to Help with Alternative Capital (Editorial) CUToday. Available at http://www.cutoday.info/THE-tude/Ready-To-Help-With-Alternative-Capital.
15. NCUA, Supplemental Capital White Paper, (April 12, 2010) p. 13.
16. Ibid. NCUA does note that supplemental capital is not as effective as retained earnings in covering losses. We agree. However, the question is not whether supplemental capital is better than retained earnings (it is not) but rather, would having supplemental capital in addition to retained earnings increase the buffer for losses. It would. Furthermore, with respect to NCUA’s concern regarding investor litigation, that risk may be mitigated with disclosures comparable to those mandated by other federal bank regulators or state securities laws.
17. Colweel, Theran. (2017, March 1) Ready to Help with Alternative Capital (Editorial) CUToday.
19. Secondary capital investments in LICUs is sometimes driven by philanthropic motives. See NCUA, Supplemental Capital White Paper, (April 12, 2010) p. 11.
20. 12 U.S.C § 1790d(o)(3); 12 CFR 702.2(g) and (k).
21. 12 U.S.C. 1790d(b)(1)(A); see also 12 U.S.C. 1831o.
22. 12 U.S.C. § 1790d(d).
23. 12 C.F.R. § 702.104(b)(1), (2).
24. 2016 NASCUS Profile of State Supervisory Agencies. Available at www.nascus.org/publications.
25. 79 Fed, Reg. 5228 (January 21, 2014).
26. The ANPR, at 9695.
29. See NASCUS, Alternative Capital for Credit Unions…Why Not? (2005), p.4. Available at http://www.nascus.org/publications/AlternativeCapitalForCreditUnionsWhyNot.pdf.
30. See NASCUS, Alternative Capital for Credit Unions…Why Not? (2005), p.7. Available at http://www.nascus.org/publications/AlternativeCapitalForCreditUnionsWhyNot.pdf. As a result, U.S. Central’s independent auditors consistently treated such instruments as equity for GAAP purposes. Today PIC is known as Perpetual Contributed Capital (PCC).
32. The ANPR, at 9696.
34. Hoel, Robert F., Alternative Capital for U.S. Credit Unions? A Review and Extension of Evidence Regarding Public Policy Reform, (Filene Institute, 2007) p. 28. Available at https://filene.org/assets/pdf-reports/145_Hoel_AltCapital.pdf.
35. FCU Ownership of Fixed Assets, 80 Fed. Reg., 45844 (August 3, 2015).
36. Member Business Loans; Commercial Lending, 81 Fed. Reg., 13530 (March 14, 2016).
36. Chartering and Field of Membership Manual, 81 Fed. Reg., 88412 (December 7, 2016); also Derivatives, 79 Fed. Reg. 5228 (January 31, 2014).
38. The ANPR at 9697.
39. NCUA Whitepaper, p. 18.
40. The limitation on secondary capital sales to natural persons is a regulatory construct, not a statutory prohibition. See 12 CFR 701.34(b).
41. 12 C.F.R. § 16.1; and FDIC, Statement of Policy Regarding Use of Offering Circulars in Connection with Public Distribution of Bank Securities, 61 Fed. Reg. 46808, (Sep. 5, 1996).
42. 12 C.F.R §701.34 and 12 C.F.R. §3.22(c)(3).
43. The ANPR, p. 9701.
46. The Credit Union Membership Access Act of 1998, HR 1151, Public Law 105–219, 112 Stat. 913 (1998), stating in §(L) that NCUA shall consult and cooperate with state regulators when implementing the statutory PCA provisions.
47. As just one example, state banks in Georgia report approximately $3.4 billion in Tier 2 capital on their books.
48. Hoel, Alternative Capital for U.S. Credit Unions? A Review and Extension of Evidence Regarding Public Policy Reform, (Filene Institute, 2007) p. 48.
49. “CUNA Mutual Capital Project Named One Of Australia's Best,” Credit Union Times, (October 18, 2006). Available at http://www.cutimes.com/2006/10/18/cuna-mutual-capital-project-named-one-of-australias-best.
50. Much in the same way that an increased member business lending cap is not universally beneficial to all credit unions, nor is an expanded community field of memberships for federal credit unions beneficial to all FCUs.

References: §501
 §702
 §1790
 § 1790
 § 1790
 § 702
 § 16
 §701
 §3