Article

On Compliance: Complex Credit Union Leverage Ratio vs. Risk-Based Capital Rule

businessman balancing coin stack on wooden beam
Michael S. Edwards Photo
Attorney-at-Law

5 minutes

Affected credit unions should consider whether adopting CCULR would make sense if NCUA finalizes the proposal.

The National Credit Union Administration board has recently proposed the complex credit union leverage ratio as a simplified compliance alternative to the agency’s risk-based capital rule.

If finalized, CCULR will give federally insured credit unions with between $500 million and $10 billion in assets the choice between implementing the agency’s risk-based capital rule or the CCULR. Credit unions will need to do the math to determine whether it makes sense to adopt the simplified CCULR or stay the course with NCUA’s more granular risk-based capital rule.

CCULR is modeled on the Federal Deposit Insurance Corporation’s community bank leverage ratio that is a simplified regulatory capital option available to FDIC-insured banking institutions. Fewer than half of the community banks that are eligible to use the community bank leverage ratio have chosen it over the FDIC’s risk-based capital rules. More than half of eligible community banks appear to have determined that they would have lower capital requirements under the FDIC’s risk-based capital rule than under the community bank leverage ratio, however, many other FDIC-insured banks have decided that the community bank leverage ratio is preferable.

Under NCUA’s CCULR proposal, “complex” federally insured credit unions—which the NCUA defines as those with more than $500 million in assets—that select CCULR instead of the risk-based capital rule would have a minimum 9% leverage ratio requirement in 2022 that would rise to a minimum 10% leverage ratio in 2024.

A credit union seeking to adopt the CCULR would also need to have less than $10 billion in assets, have off-balance-sheet exposures (such as unfunded loan commitments) that are less than 25% of its total assets, have trading assets and liabilities that are less than 5% of its assets, and have “the sum of total goodwill, including goodwill that meets the definition of excluded goodwill, and total other intangible assets, including intangible assets that meet the definition of excluded other intangible assets, of 2% or less of its total assets.”

Eligible “complex” credit unions that decline to adopt the CCULR would follow the NCUA’s risk-based capital rule of a minimum 10% ratio relative to risk-adjusted assets and also be subject to the existing minimum net worth ratio of 7% to be well capitalized.

NCUA first adopted its risk-based capital rule, modeled on the Basel framework, in 2015. The rule is currently scheduled to take effect in January 2022. Under it, most unsecured consumer loans and commercial loans that are not past due, as well as some other types of credit union assets, are weighted at the baseline of 100% of face value, just as they would be treated under the net worth ratio. Many other types of common credit union assets, however, are weighted at less than 100% of their face value, meaning that they are considered less risky and require relatively less risk-based capital to be held against them. NCUA’s reference guide listing its asset risk weights is available here.

Depending on a credit union’s asset composition, its risk-based capital requirement may be less than its 7% net worth requirement, in which case the risk-based capital rule has little practical impact.

Under NCUA’s risk-based capital rule, assets backed by the full faith and credit of the United States and most share-secured loans, for example, would be weighted at 0%, meaning that no risk-based capital must be held against those classes of assets. This means that a credit union which was completely invested in US Treasury securities and share-secured loans with no off-balance-sheet exposures would have a risk-based capital requirement of $0 because 10% of zero is zero.

Similarly, government-guaranteed portions of loans as well as state and local government bonds, Federal Home Loan Bank stock, and most agency and GSE securities will be weighted at 20% of face value, meaning that only 20% as much risk-based capital must be held against those assets compared to the baseline of 100%.

First-lien mortgages are weighted as 50% to 75% of face value. Non-mortgage secured consumer loans, such as auto loans, are typically 75% of face value. Credit unions that are heavily invested in these types of lower-risk assets may have risk-based capital requirements that are less than the amount of capital required by the 7% net worth ratio.

Assets weighted at more than 100% include past-due loans (150% of face value), mortgage servicing assets (250% of carrying value) and subordinated tranches in any investment (1,250% of face value), among other things.

The risk-based capital rule also factors in such off-balance-sheet exposures as unfunded loan commitments and, in many cases, the amount of capital that must be held against off-balance-sheet items can be as low as 5% of the notional value of the exposure. Loans transferred with recourse, however, are weighted at 100% of face value, meaning that they are treated for risk-based capital purposes as though they were still on the credit union’s balance sheet.

Credit unions between $500 million and $10 billion in assets should consider now whether adopting CCULR would make sense for them if NCUA finalizes the proposal. The calculations required under the NCUA’s risk-based capital rule are basic algebra and can be estimated using the Excel spreadsheet that NCUA has made available on its website.

These calculations will likely be largely automated once the rule takes effect, which should help limit compliance burdens. As many community banks have discovered with the community bank leverage ratio, it may be preferable for a federally insured credit union to follow the NCUA’s risk-based capital rule instead of CCULR, especially if its estimated risk-based capital requirement is less than the amount of capital required by the CCULR’s 10% leverage ratio.

Michael S. Edwards is an attorney-at-law with extensive experience representing credit unions, community banks and credit union organizations in the United States and around the world on a wide range of regulatory, compliance and other legal matters. Now with his own law firm based in the Washington, D.C., area, Edwards previously served as SVP/advocacy and general counsel of the World Council of Credit Unions and was senior assistant general counsel in the regulatory advocacy section of the Credit Union National Association.

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