Amanda Parkhill: Good afternoon. Before we get started with the Risk-Based Capital Webinar, we have a few reminders. First, please be sure
that the volume on your computer and on the webinar console is turned up so you can hear the webcast. If you have any trouble viewing the slides, resize the Slides’ window by dragging the bottom corner. Second, please allow pop-ups from the website. Third, set your screen resolution to 1024 x 768 or higher
so that you can see the slides appropriately. Fourth, if you have a question, you can submit it at any time in the Ask A Question box, which you should see in the left area of the console window. We will address your questions at the end of the webcast. Finally, this webinar will be closed-captioned and posted on NCUA’s website within a few weeks.
Now, I will turn it over to Larry. Larry Fazio: Good afternoon, everyone. Thanks for joining us today. I’m Larry Fazio, Director of NCUA’s Office of Examination and Insurance. Joining me today from NCUA staff are Steve Farrar, a Loss Risk Officer in the Office of Examination and Insurance; Tom Fay, a Senior
Capital Markets Specialist also in the Office of Examination and Insurance; Rick Mayfield, a Senior Capital Markets Specialist in E&I; also Justin Anderson, an attorney in our Office of General Counsel. Last Thursday, the NCUA Board approved a Proposed Rule on risk-based capital, which is a
revision of the proposed rule that the Board originally approved last year in January 2014. Today, we’d like to walk you through some of the changes that are included in the Proposed Rule approved by the Board last week. We have a lot of ground to cover, so let’s jump right in. On Slide 2 we have an Agenda.
Since this is our first public webinar on this topic, it’s very important to cover some of the history behind risk-based capital before we dive into the Revised Proposal and the changes we’ve made. This will help you get a better understanding of the whys behind this Proposal. We’ll divide our time up today as follows.
First, we’ll start with some background on risk-based capital, including what risk-based capital is and why we need to update NCUA’s risk-based capital measure now. Then, we’ll explain the process we used to update the Rule. We’ll also go through a high-level overview of this Proposal, including what’s changed and what hasn’t
changed from the original Proposal. We’ll walk through both the numerator and denominator components of the risk-based capital ratio calculation in this Revised Proposal, as well as some other changes like how we define complex and the thresholds for adequate and well capitalized. We’ll provide some information on the net effect and
impact of the Proposed Rule on the credit union industry, before concluding with some comments on the next steps and what you can expect going forward. We’re going to try to get through all the background and major changes somewhat quickly, so that there is time at the end for questions and answers. Let’s get started. With that, I’m going to turn it over the Steve,
who is going to walk us through some of the history on risk-based capital. Steven Farrar: Thanks, Larry. First, some background on risk-based capital. Congress enacted a system of Prompt Corrective Action, or PCA, for banks and thrifts in 1991, following the savings and loans failures in the 1980s. This PCA framework included both a
leverage ratio and a risk-based capital ratio. The Basel II Accord published in 1988 was the basis for FDIC’s capital requirements included in their PCA standard. Credit unions are very familiar with the leverage ratio, or as we call it the net worth ratio, which is capital or net worth
in the case of credit unions divided by the assets. The intent of the PCA framework was to identify a troubled institution in a more timely fashion so that regulators could intervene and prevent them from failing; thus, protecting taxpayer exposure to paying for deposit insurance system losses. The PCA framework
for both banks and credit unions also had an additional measure built as an extra safeguard. This measure was the risk-based capital component whose purpose was to account for risks where the leverage ratio may not be sufficient. The leverage ratio is the function of all assets together regardless of their quality or
credit risk. Leverage ratio for well-capitalized banks was set at 5% of assets and 4% for adequately capitalized level. The risk-based capital ratio for well capitalized was set at 10% and 8% for adequately capitalized. In 1997, the U.S. Treasury issued a report on credit unions that
included a number of recommendations. Of note are the recommendations to Congress to establish a system of PCA for credit unions. As you will see on this slide, the report had a number of recommendations. The first was to require a system of Prompt Corrective
Action designed to ensure credit unions correct net worth deficiency expeditiously. The second was to raise the reserve target to 7% of total assets, which was a 1% increase in the reserve target that approximates the 1% deposit in the Share Insurance Fund. The third was to deduct from
reserves some portion of corporate capital. The fourth one was to require NCUA to develop an appropriate risk-based net worth requirement for large, more complex credit unions to supplement the simple net worth requirement and to take account of risk, such as off balance risk or interest rate risk. For
example, as listed in the report, a large mortgage portfolio. With that I’m going to turn it over to Tom. Tom Fay: In 1988, Congress placed a similar PCA framework for credit unions as part of a Credit Union Membership Access Act requiring NCUA to adopt PCA regulations. PCA imposed a
minimum leverage, or net worth ratio in addressing many of the recommendations of the 1997 U.S. Treasury study. The framework established higher than the corresponding bank leverage requirement; 7% versus 5%. The Treasury also noted most credit unions already saw the benefit
of holding more capital over the 7% leverage ratio even before a PCA system was put in place. For complex credit unions defined at this time as credit unions with assets over $10 million, Congress prescribed that NCUA develop an additional risk-based capital measure for what Treasury called “a small subset of credit
unions,” where the 7% leverage ratio may not be sufficient to support their balance sheet risks. Note, that this risk-based capital measure, which is at the discretion of NCUA to design and update over time, does not replace the 7% leverage ratio which is statutory and which NCUA cannot change. The key
difference is the leverage ratio tends to be a lagging indicator, while a risk-based capital ratio is more forward-looking, taking into account the inherent riskiness of assets. In 2000, the NCUA Board implemented a first PCA rule, Part 702 of the NCUA Rules and
Regulations. That rule included a risk-based capital measurement, which is still in place today. Consistent with the 1998 framework, the rule requires a minimum net worth ratio. The total asset threshold, however, moved from $10 million to $50 million in 2013, in
conjunction with the definition change of a complex credit union. It’s important to note that under the current Risk-Based Capital Rule only 2 credit unions of the 6,400 credit unions operating today failed the risk-based capital requirement. As we roll forward to 2014, it should be noted
that a number of regulatory capital standards for depository institutions continued to evolve and modernize; most notably in the context of the Basel Capital Standards. Other banking agencies revised capital standards implementing Basel in September 2013. Congress specifically put
language into the Federal Credit Union Act saying that NCUA needed to maintain comparability as other regulators updated their capital standards. Given these changes in US and international regulatory capital standards, the GAO study, reports by our Office of the Inspector General and the lessons
learned from the credit union failures during the recent financial crisis, NCUA staff had been working on updating our risk-based capital measurement as part of PCA framework as early as 2011. In January 2014, now one year ago, the NCUA Board approved a Proposed Risk-Based
Capital Rule. A Risk-Based Capital Rule is necessary for the continued safety and soundness of the credit union system. NCUA believes that the credit union industry on a whole is very strongly capitalized today, just as the industry was back
in 1997 when Treasury issued its report. The intent is not to require the system as a whole to hold more capital, but to identify outlier credit unions that hold insufficient capital for the risk on their balance sheets. There are some outlier credit unions that do not
hold sufficient capital commensurate with the risks that they take and our almost 15-year-old risk-based capital measure needs to be modernized for the way the credit union industry’s portfolio looks today, which is much larger and much more diverse. For a small group of credit unions
who are outliers, the 7% leverage ratio minimum may not be enough to safeguard the Share Insurance Fund if they were to fail. In fact, in the recent financial crisis as we apply lessons learned, many of the credit unions that ultimately failed had a leverage ratio of over 12% two years before
they failed. The purpose of a well-calibrated risk-based capital ratio is to reflect the riskiness of the assets on a credit union’s balance sheet more so than a leverage ratio can account for. Further, recent reports by GAO and NCUA’s Inspector General both confirm that earlier indicators of
troubled credit unions from within the Prompt Corrective Action framework are needed to prevent future failures and both have directed NCUA to act to update and improve PCA to better detect problems earlier and prevent or minimize failures. Let me add that the purpose of the updated Rule
is not to prevent credit unions from taking risks. It only mandates that if they choose to do so they must also hold commensurate capital in line with their risk profile. I’ll hand it back to Larry to talk about our approach. Larry Fazio: Thank you, Tom. So as you can see on Slide
13, we’ve been involved in a lot of research and analyses related to this new Proposal. In particular, the second Proposal is a culmination of the extensive work we’ve done since the January 2014 Proposal. Additional research, including analyzing the over 2,000 comment letters we’ve received; a significant input
we received during the series of listening sessions that were held throughout the country in the summer of 2014; and then the ongoing consultation with a group of industry practitioners that occurred throughout the latter part of 2014 as well. Some of the guiding principles that drove the thought process behind
this Proposal include: (1) the statutory mandate for maintaining comparability with the other banking agencies; (2) making the risk-based requirement more meaningful and prospective, as Tom had indicated; and (3) responding to recommendations from GAO and our Inspector General’s Office
to improve the PCA system for credit unions. Since 1998 legislation that enacted Prompt Corrective Action standards for credit unions was implemented in 2000, there has been no meaningful update to credit union capital standards. Almost 15 years have passed. The original Proposal in January 2014 was
intended to rectify this and more closely conform NCUA’s risk-based requirement to international and US banking agency risk-based capital standards. It’s necessary to modernize NCUA’s approach to risk-based capital standards also, because the current ones are ineffective. Only two credit unions are currently governed
by the existing standards. Since 2000, there have been two updates to international standards. The other banking agencies updated their risk-based capital standards in 2013. We’ve also learned various lessons during the recent financial crisis that need to be incorporated. As Tom mentioned, we had a completed review
by the GAO in 2012 that made various recommendations about our Prompt Corrective Action system and risk-based capital standards as well as a variety of recommendations in material loss reviews from our Office of Inspector General that also indicated we needed to update capital standards. Consistent
with the Act, which requires NCUA’s PCA requirement to be comparable to the other banking agencies, NCUA largely relied on the risk weights assigned to various asset classes under Basel and the other banking agencies’ risk-based capital rules in this Proposal. NCUA has, however, tailored the risk weights in this Proposal for
certain assets that are unique to credit unions, or where a demonstrable and compelling case exists to differentiate between bank and credit union performance based on contemporary trends, or where a provision of the Act required doing so. Thus, this Proposal provides for even greater comparability to the rules of the other banking agencies. I will now
turn it over to Justin for more detail on the Act’s mandate regarding PCA. Justin Anderson: Thank you, Larry. The next few slides I’ll walk you through the Federal Credit Union Act mandates with respect to PCA and risk-based net worth. Section 216(b)(1) of the Federal Credit Union Act sets out the requirement
for the NCUA Board to create a system of Prompt Corrective Action. Section 216(b)(1)(A) of the Act requires that NCUA’s framework be comparable to Section 1831o, which is the PCA framework laid out in the Federal Deposit Insurance Act. The accompanying Senate
report to the Credit Union Membership Access Act gives us a little bit more detail as to what Congress meant with respect to comparable. Section 216(b)(1)(B) calls for NCUA to take into account credit union-specific characteristics, like the fact that they are not-for-profits
that do not issue capital stock; that they must rely on earnings to build net worth; and that they have boards made up of volunteers. Finally, Section 216(d)(2) states that the risk-based net worth component must take into account any material risks. Again, we look
to the Senate report, which states that “NCUA should, for example, consider whether the 6% requirement provides adequate protection against interest rate risk and other market risks, credit risk, and the risk posed by contingent liabilities, as well
as other relevant risks. ” I’ll now turn it back to Larry. Larry Fazio: Thank you. In addition to staff research, NCUA gathered a lot of input on the January 2014 Proposal. I mentioned earlier we received over 2,000 comment letters. We got a lot of input from the listening sessions
and we consulted with a group of industry practitioners. We listened to this input and made changes to the Proposal where it made sense to do so. I’d like to thank everybody who contributed to this process. In particular, the practitioners we worked with, their willingness to explore with us alternatives of achieving the desired outcomes, along
with their knowledge of the workings of credit unions was very useful. Further, I’d like to thank the numerous agency staff members who worked together to make it possible to present the Proposal that the Board acted on last week. With Board approval to publish the new Proposal for a 90-day comment period, NCUA is actively trying to
help stakeholders understand the Proposal. That is why we are doing this webinar today. We’ve also published a variety of additional background information on our website, which I encourage everyone to take a look at. I’ll now turn it over to Rick to summarize the key changes from the original Proposal. Rick Mayfield:
Thanks, Larry. I will be reviewing some of the key changes to the revised Proposed Rule. The first change I will talk about is the extended implementation period. Many commenters requested this in their comments from the original Proposal. The Proposal has an effective date of January 2019. This will allow both NCUA
and credit unions time to make necessary changes to implement the Rule, including changes to the Call Report. We are targeting to have a new Call Report available the last quarter of 2017 or the first quarter of 2018. This will allow credit unions to transition from the old Call Report to the
new Call Report format before the effective date of the Rule. Work on the new Call Report will start right after the issuance of the Final Rule. Another change to the Proposed Rule is the number of complex credit unions. This reduction was achieved by raising the definition of complex
credit union from $50 million to $100 million. This change decreases the credit unions subject to RBC by about 650. Twenty-two percent of credit unions will be subject to RBC under the Proposed Rule. The revised definition of complex credit union is based on an analysis performed
on the assets and liabilities of credit unions. NCUA found that credit unions with over $100 million in assets were generally involved in one or more complex activities in greater frequency than credit unions with assets under $100 million. NCUA determined that a
dollar threshold of $100 million was appropriate as a simple proxy for complex credit unions. In terms of assets, the 22% of credit unions that would fall under the complex category would represent 89% of assets in the credit union system. For risk-based
capital classifications, NCUA has retained the current PCA classifications that credit unions are already familiar with from the overall PCA framework. However, in this Revised Proposed Rule, we have proposed reducing the threshold for being well capitalized to 10%
rather than the 10.5% originally proposed last January. The Board lowered the threshold, because it simplifies the comparison to FDIC’s threshold by removing the effects of FDIC’s conservation buffer which yielded our original 10.5% proposal. Therefore, it is more
consistent with the total risk-based capital requirement in the FDIC rule, but also reflects credit union performance versus banks. I will now hand it back to Tom. Tom Fay: Moving on to Slide 23, as noted earlier, NCUA is mandated to account for
all material risks in the RBC measure. The Board continues to view IRR, interest rate risk, as a major risk facing credit unions and agrees with commenters, who suggested that measures of IRR or more appropriately based on both assets and liabilities. Accordingly, the
Board is now proposing to exclude consideration of interest rate risk from risk-based capital ratio measures, but specifically requests comments to consider alternative approaches that could be taken in the future to reasonably account for IRR. Those alternative approaches that could be taken
include adding a separate IRR standard as a subcomponent of the risk-based capital ratio measure. Conceptually, a separate IRR standard should be based on a comprehensive balance sheet measure; like for instance NEV, that takes into account offsetting risks between assets and liabilities, including the benefits
of derivatives. The intent of such a measure would be to measure IRR consistently across all asset and liability categories under a stressed interest rate scenario and to supplement the supervisory process to address severe outliers. This approach would also incorporate a forward-looking
proactive measure into NCUA’s capital standards as recommended by GAO. Higher risk weights for concentrations of real estate and NBLs exist in the current risk-based requirement. Eliminating the concentration dimension for risk weights would be a step backward and is inconsistent with
concentration risk concerns raised by GAO, and in material loss reviews conducted by the NCUA Inspector General. In fact, GAO specifically recommended that the Board continue to address concentration risk in the risk-based capital requirement. Accordingly, the Board has included a tiered risk weight framework
for high concentrations of real estate and commercial loans under this Revised Proposal. The Board believes the higher concentration threshold would provide sufficient flexibility for most credit unions to operate at a level where the risk weights are substantially similar to those of other banking
agencies. It is important to remember that the concentration thresholds would not limit a credit union’s lending activity. Rather, they would merely require the credit union to hold capital for the elevated risk. The Board does not believe credit unions will be at a competitive
disadvantage, because most loans will be assigned risk weights similar to those applicable to banks. A note on capital adequacy; Section 702.101(b) is a new addition to this Revised Proposal and reinforces NCUA’s longstanding belief that credit unions should
maintain capital not just at the minimum regulatory levels, but at levels sufficient for the risk of the credit union’s balance sheet. This new provision requires all credit unions to maintain capital commensurate to those risks to which the institution is exposed, to have a process for assessing
its overall capital adequacy in relation to its risk profile, and to develop a comprehensive written strategy for maintaining an appropriate level of capital. While these are regulatory requirements, they will not impact their PCA category. Moving forward the IMCR, the
Individual Minimum Capital Requirement provision, has been removed. NCUA will continue to use supervisory and enforcement processes to address deficiencies in capital levels by reclassifying a credit union, perhaps to a lower capital classification; other
supervisory authorities to address unsafe and unsound conditions; and also compliance with the capital adequacy provision codified under Section 702.101(b). I’ll turn this over to Steve, who will now talk about the ratio calculation. Steven Farrar: Thanks, Tom. As you mentioned, we’re going to start going
through the calculation now. Let’s take a look at the changes of the risk-based capital ratio calculation itself. Let’s start with the risk-based capital ratio numerator and those components that make up capital. As a conceptual point, the numerator accounts for the capital and reserves available to cover
any losses at a credit union. The capital elements consist of equity accounts, such as undivided earnings, other reserves, and equity acquired in mergers. The numerator is more based on GAAP equity by including equity acquired in merger in lieu of the non-GAAP measure of pre-acquisition retained earnings. It
also includes net income, the allowance for loan losses, secondary capital and Section 208 assistance meeting certain requirements and certain appropriation accounts. There are also various accounts like goodwill and intangible assets that are deducted from the numerator when calculating the risk-based
capital ratio. Let’s run through some of the capital elements that have either changed, or received a lot of comment from the original Proposal. The first one would be removal of the cap on the Allowance for Loan Losses. One of the capital elements that received a lot
of comments was the Allowance for Loan Losses account, or the ALLL. The original Proposal’s treatment of the Allowance for Loan Losses mirrored the other banking agency rules, which placed a 1.25% of risk assets cap on the amount of the allowance that could be included in the risk-based
capital ratio numerator. The Board agreed with commenters that the entire allowance balance functions as capital available to absorb losses and should be included in the risk-based capital ratio numerator. This Proposal also clarifies that the entire ALLL can be included in the risk-based capital numerator
only to the extent the credit union is funding its allowance in compliance with GAAP, which includes charging off loans on a timely basis. This treatment will also eliminate any concerns with financial accounting standards boards’ proposed changes to GAAP relating to the Allowance
for Loans Lease Loss accounting guidance that will take effect before the 2019 implementation date. Another topic that was a hot topic was the treatment of supplemental capital. This Revised Proposed Rule consistent with the original risk-based capital proposal and the authority
specifically granted in the Federal Credit Union Act only allows supplemental capital to qualify as risk-based capital for credit unions with a low income designation; that is secondary capital. Members of Congress have introduced legislation in the past that would authorize all federally insured credit unions to accept additional
supplemental forms of capital. At this time, the Board prefers to wait the outcome of the proposed legislation that, if passed by Congress, would expressly authorize supplemental capital as a component of net worth. In addition, such authority would raise a host of other complicated issues that would need to be
addressed through additional changes to NCUA’s regulations, including providing consumer protections, amending the Share Insurance Fund payout priorities, and imposing prudent limitations on the ability of a credit union to offer and include supplemental capital. Another issue is Congress and the NCUA cannot authorize supplemental
capital for state-chartered credit unions, so this authority would be an issue that would have to be covered under state law. The Board, however, does specifically request comment in regard to supplemental capital in this Proposal. Now, let’s talk about the deductions. Under the original Proposal and consistent with the other banking
agencies’ rules, goodwill and other intangible assets would be deducted from both the risk-based capital numerator and denominator because they are not available to cover losses. However, NCUA recognizes that for a small number of credit unions this will have a large impact on their balance sheet and will require
time to adjust. This Proposal includes a 10-year grace period for credit unions with existing goodwill and intangibles directly related to supervisory merger or purchase and assumption. Specifically, this Proposal would exclude from the definition of goodwill, which must be deducted from the risk-based capital numerator,
any goodwill acquired by a credit union in a supervisory merger or consolidation that occurred before publication of this Rule in final form. Under this Proposal, credit unions would still need to account for goodwill in accordance with GAAP, and the amount of excluded goodwill and other intangibles is
based on the outstanding balance of goodwill directly related to supervisory mergers. The Board believes this January 2015 date would allow most, if not all, credit unions to adjust to this change as they continue to value goodwill and other intangibles in accordance with GAAP. This change will
allow affected credit unions time to revise business practices to ensure goodwill and other intangibles directly related to supervisory mergers do not adversely impact their risk-based calculation. The 1% insurance fund deposit is another account that received a number of comments. After consideration of the
comments and further evaluation, NCUA has elected to maintain the treatment of the Share Insurance Fund deposit by deducting it from both the numerator and denominator in this Revised Proposal. As discussed earlier, this treatment is consistent with the 1997 U.S. Treasury Report on Credit Unions.
The Treasury opined the NCUA’s deposit is double counted, because it is an asset on a credit union’s balance sheet and equity in the NCUSIF. The NCUSIF deposit is not available for a credit union to cover losses from risk exposure on its own balance sheet in the event of insolvency. The purpose of the NCUSIF
deposit is to cover losses in the credit union system. The NCUSIF deposit is refundable in the event of voluntary credit union charter cancellation. However, this aspect does not change the unavailability of the NCUSIF deposit to cover individual losses while a credit union is an active going concern, or its risk stature in the event
of major losses to the NCUSIF. Consistent with its exclusion from the risk-based capital numerator, the NCUSIF deposit would also be deducted from the denominator under this Proposal, which would properly adjust the risk-based capital ratio calculation and reduce the impact of the adjustment. The Proposed Rule
does not adjust for the NCUSIF deposit twice and does not put credit unions at a disadvantage in relation to banks, since banks have expense premiums used to build the Deposit Insurance Fund. Now, back to Larry. Larry Fazio: Thanks, Steve. We’re now
going to shift the discussion to the elements of the denominator of the risk-based capital ratio. The various aspects of the denominator we’re going to walk through in a fairly granular fashion; cash, investments, loans and a very other things. Before we do
that, we’ll go ahead and just at a high level talk about how all those changes made in the Proposed Rule relate to how they are risk weighted under the banking agencies’ rules. If we go to Slide 33, you can see on Slide 33 there is a pie chart that has different color codes for
different sections of the pie so to speak. In the blue area, or approximately 78% of assets of complex credit unions represent assets that get a comparable risk weight to the other banking agencies in this Proposal. The vast majority of the assets have very
similar risk-weighting treatment. The green slice of the pie represents secured consumer loans that receive a lower or more favorable risk weight of 75% versus 100% for the other banking agencies. That’s a more favorable treatment and that’s
almost 19% of complex credit union assets. The red portion of the pie represents those asset areas where this Proposal would have a more conservative risk weight. In total, that’s about 3% of complex credit union assets. Most
of that is from the areas where we have concentration risk included in the risk-weighting framework. Finally, the very, very tiny sliver that’s gray represents assets that aren’t really directly comparable to the other banking agencies, those assets held by banks. Predominantly, that’s the Credit Union
Service Organization or CUSO investments and investments consumer credit unions make in corporate credit union capital instruments. That’s a very, very small portion of complex credit union assets. If we turn to Slide 34, that’s a similar representation of the pie chart, but in table format so
that you can actually see the risk weights associated with those different asset classes. Again, secured consumer loans more favorable rate at 75% risk weighting versus 100% in the other banks, so you can see how those compare and contrast on this slide. With that, we’re going to
turn it over to Rick to discuss the cash and investment areas. Rick Mayfield: Thanks, Larry. Consistent with the original Proposal, this Revised Proposed Rule would continue to assign a 0% risk weight for cash, which is made up of the balance of cash, currency and coin,
including vault, automatic teller machine and other teller cash. This Proposal would change how risk weights are assigned for cash on deposit by assigning a 0% risk weight to insured cash on deposit and a 20% risk weight for uninsured cash on deposit. Cash items in
process of collection, which are currently included in cash on deposit, will not be specifically measured or assigned a risk weight of its own. This change is consistent with the risk weights at banks and having two risk weights for cash on deposit is appropriate,
because of the different risk profiles between insured and uninsured deposits. Because the Board has decided to exclude interest rate risk in this Revised Proposal, it was necessary to propose significant changes on how investments are risk weighted. NCUA made major changes
here in response to commenters. If these changes are eventually adopted, this will be one of the areas requiring substantial changes to the Call Report. NCUA listened carefully and agrees with commenters on a more holistic complete balance sheet approach is preferred to
addressing interest rate risk. Weighted average life measurements are taken out of all the risk weights for investments. This Proposal adopts a risk weight framework for investments based largely on the credit risk of the issuer or underlying collateral.
In the Revised Rule, NCUA has in most cases proposed investment risk weights that are equivalent to those FDIC uses to account for credit risk instruments or investments. However, in some instances, we did try to simplify language and methods. But for
the most part, we are almost identical to the FDIC on risk weights for investments. The Rule itself and Preamble provide more detail, but I will make a few points today. First, the Revised Proposed Rule would materially increase the amount of 0% risk-weighted investments.
If an investment is direct and unconditionally guaranteed by the full faith and credit of the United States, we generally gave it a 0% risk weight with few exceptions. This Revised Proposal would lower risk weights of the Central Liquidity Facility stock to a 0%
risk weight. If an investment in a government instrument is not fully guaranteed, including government-sponsored entities, the risk weights are higher. For example, the following exposures would be assigned at 20% risk weight; Farm credit system, Fannie Mae
and Freddie Mac; Federal Home Loan Bank and the Tennessee Valley Authority. Based on June 2014 Call Report data, approximately 93% of investments held by complex credit unions would receive a risk weight of 20% or less, with the majority of the investments receiving a
20% risk weight. The Revised Proposal would also apply a risk weight of 50% to revenue bonds issued by state or political subsidiaries and senior non-agency residential mortgage-backed securities. As you can see in the table, many of the investments that were weighted
by Weighted Average Life in the original Proposal are now assigned 100% risk weight, which is consistent with the FDIC’s approach. Also shown on the table is the risk weight for corporate perpetual capital was lowered from 200% to 150%. Based on June 2014
Call Report data, approximately 96% of investments held by complex credit unions would receive a risk weight of 100% or less. This slide shows investments that have a risk weight of 300% or greater. However, in determining how to apply risk weights
to many of the investments in the risk weight category of 300% and higher, NCUA has allowed for credit unions to use an alternate calculation method. A credit union may get a lower risk weighting if they use the optional approach. I’d encourage those of you interested or
involved in complex investment portfolios to take a close look at the Preamble and the Rule on this topic. Now, I’ll hand it back over to Tom to discuss consumer loans. Tom Fay: Thanks, Rick. Secured and unsecured consumer loans have been a mainstay of credit unions’ lending for some time.
Many commenters pointed out that risk profiles between secured and unsecured consumer loans was different and needed to be reflected to have more precise risk weights. Based on the feedback from commenters and our practitioners’ group, NCUA changed the original Proposal as
follows. The Revised Proposal uses the term “non-current loans” instead delinquent loans when referring to a loan that is past due placed on a nonaccrual status, modified or restructured. Using the terms “current” and “non-current” when referring to loans will eliminate the confusion caused by using the
term “delinquent loan” in reference to regulatory reporting requirements or proper accounting treatment. Under this Revised Proposed Rule, loans are either current or non-current for purposes of determining their appropriate risk weight category. Along with the change in terminology, this Revised Proposal also
amends the threshold for current loans from less than 60 days past due to less than 90 days past due. Non-current loans, which would consist of loans that are past due more than 90 days, would continue to receive a risk weight of 150% consistent with
the original Proposal and other banking agency rules. This Revised Proposed Rule retains a risk weight of 75% for current secured consumer loans, but increases the risk weight for current unsecured consumer loans to 100%. This risk weight for current unsecured consumer
loans takes into account the higher risk from unsecured loans versus secured loans and is consistent with other banking agencies’ rules. Lowering the risk weight for current share secured loans from 75% to 20% reflects the low exposure of these types of loans. With regard
to residential real estate loans we’ve made a number of significant changes to the risk-based capital calculation. First, in the Revised Proposed Rule, one- to four-family non-owner occupied residential real estate loans would now be included in the definition
of either first or junior-lien residential real estate loans and be assigned the applicable risk weight. As you’ll see in a moment when we cover commercial loans, we estimate about 19% or nearly 1 in 5 of all commercial loans fit this one- to four-family occupied
category. With this change in definition all one- to four-family residential loans, whether owner occupied or non-owner occupied, will be risk weighted as real estate loans not as commercial loans. However, and this is important, it
does not change your overall classification as an MBL in regard to the 12.25% cap, which is statutory. But, all of this provides relief for risk-based capital purposes. Additionally, the definition has been revised to clarify that if a credit union
holds the first and junior-liens on a residential real estate loan without an intervening lienholder and the loan otherwise meets this definition, the entire combined balance of the loans would be assigned the risk weight for first-lien residential real estate loans. Second overall,
similar to the banking agencies the real estate portion of the Revised Proposal notes that loan underwriting must meet the ability to repay real estate loan underwriting requirements. But we want to make clear a credit union does not have to write a
qualified mortgage loan to receive the 50% risk weight. Third and lastly, NCUA proposes to risk weight the portion of government guaranteed real estate loans at 20%, rather than the 50% or more. A 20% risk weight is appropriate, because the
government guarantee does come with some operational risks. Please note that a credit union must fully comply with all the terms of the guarantee for it to be effective. If a credit union incorrectly underwrites or services the loan, the guarantee may be void.
Excluding US Government guarantees in risk weighting on real estate loans is also consistent with practice of other federal banking regulators. With regard to concentration thresholds, NCUA with the input of commenters has revisited the original risk analyses in favor of
a more general simplified approach. Rather than multiple step tiers, the Revised Proposal suggests to having one specific tier break at 35% of assets for first-lien real estate, and one tier break at 20% of assets for junior-liens. As discussed
earlier, this streamlined approach fulfills NCUA’s mandate to account for concentration risk. The change to a single higher concentration risk threshold simplifies the risk weight framework and calibrates it to only pick up outliers. This means that most
covered credit unions operate at a level where the RBC risk weight is the same as banks under the FDIC rule. By design, only outlier credit unions will be subject to a higher capital charge. To summarize, NCUA reduced the number of real estate loan concentration thresholds to a single
threshold where we applied risk weights one and a half times higher than the base rate to account for concentration risk as shown in this slide. Let’s look at the graphic on Slide 44. It shows the number of credit unions for
each 5% increment of their percentage of first-lien real estate loans to total assets. The average credit union with over $100 million in assets holds just under 20% of its assets in first-lien mortgages. Approximately 90%
of the complex credit unions operate at levels below the concentration thresholds proposed for first-lien residential real estate loans. The complex credit unions operating above the proposed 35% threshold include 149 as you can see on the bars sliding down
toward the right, which is approximately $59 billion in assets or about 27% of the first-lien residential real estate loans. The chart on Slide 45, here we see that 67 complex credit unions hold junior-lien residential real
estate loans. This is approximately $6.5 billion and they hold loans greater than the 20% proposed asset threshold. Again, most affected credit unions will not be subject to the lower tier risk weights for residential real estate loans, which
are comparable to the FDIC risk weights. It also should be noted that only two credit unions did exceed both of these real estate concentrations. Let me hand it back to Steve who is going to walk you through commercial loans. Steven Farrar: Thanks, Tom. NCUA made a substantial number of changes to the
assignment of risk weights for commercial loans. This Revised Proposal defines the term “commercial loan” for risk-based capital purposes to better capture loans made for commercial purposes that have similar risk characteristics. This Revised Proposal applies risk weights to commercial loans rather than member business
loans. Now, as we just discussed in the real estate section, one to four-family non-owner occupied residential real estate loans will be excluded from the definition of commercial loans. The definition of commercial loans excludes loans that meet the definition of a consumer loan, which would include
vehicles that are generally manufactured for personal use, even if they may be used for business purpose; except for fleet vehicles and vehicles used for fare paying purposes. It is important to remember as we stated, the definition of member business loans for purpose of compliance with Part 723 has
not changed. The amount of a contractual compensating balance associated with a commercial loan and on deposit in the credit union would receive a 20% risk weight and not count towards the 50% of asset concentration threshold, since a credit union has the ability to apply the compensating balance against
the amount owed lowering the potential loss exposure. This provision would be unique to credit unions but appropriatelyreduces the risk weight due to the existence of the compensating balances. The portion of commercial loan that is government insured or guaranteed would be assigned a lower
risk weight of 20% and not count towards the 50% threshold. Lastly, the Revised Proposed Rule includes changes to the concentration threshold and risk weights. As previously discussed, this Revised Proposal reduces the number of commercial loan concentration thresholds
from 2 to 1 with a single concentration threshold at 50% of assets. As you can see, applicable commercial loans less than 50% would be assigned to a 100% risk weight and commercial loans over the thresholds would be assigned a 150% risk weight. Commercial
loans that are not current would be assigned a 150% risk weight. For commercial loans the incremental risk weight increases from 100% to 150% once more than 50% of the credit union’s assets are in commercial loans which produces a
blended risk weight. As Slide 48 shows, only 12 credit unions with total assets greater than $100 million operate with a level of commercial loans that would exceed the 50% of assets and would be assigned to the 150% risk weighting.
This means that over 99% of complex credit unions’ commercial loans will fall into the 100% risk weight category. Also, keep in mind that this graph and our analysis uses MBL data, since that is all that’s available in the Call Report. The number of credit unions that exceed the
commercial loan threshold may be even lower once non-owner residential mortgages, personal vehicles, government guarantees and compensating balances are excluded. I will now turn it back to Tom, who will discuss CUSOs. Tom Fay: Thank you, Steve. NCUA recognizes the value that CUSOs bring to credit unions and to the
credit union system. The Board is proposing the following changes for the CUSO risk weights based on the comments and the further analysis that we’ve done. In this Proposal, CUSO assets are categorized three ways: (1) CUSOs that are consolidated per GAAP on a single credit
union’s balance sheet; (2) equity investments into a CUSO; and (3) loans to a CUSO. For consolidated CUSOs there will be no risk weight assigned to the equity investment in the CUSO or the loan to the CUSO. When CUSOs are consolidated, those loans and equity investments are
eliminated through consolidating accounting entries. The related CUSO assets that are not eliminated are added to the consolidated financial statement and receive risk-based capital treatment as part of the credit union’s statement of financial condition. For equity investments overall into
CUSOs, NCUA proposes lowering the risk weight from 250% to 150%. NCUA recognizes the uniqueness of CUSOs and the support they provide. However, an equity investment in a CUSO is also unsecured, at-risk equity investment for which is analogous to an investment in a
non-publicly traded entity. There is no price transparency and extremely limited marketability associated with a CUSO’s equity exposures. For loans to CUSOs, NCUA proposes to maintain a risk weight of 100%. Loans to CUSOs have a higher payout priority in the event of a bankruptcy
than the equity investment. Because of this a lower risk weight for loans to CUSOs is appropriate. The risk weight of 100% is equivalent to the commercial loan risk weight. As you can see in the table, the risk weights for both loans and investments in CUSOs are more favorable than the equity
risk weights allotted to banks, which can range from 100% to as high as 600%. The Board recognizes the complexity of the FDIC’s approach and continues to believe that a simplified approach is more appropriate given the limited amount of credit union assets in CUSOs and the value CUSOs
provide to credit unions. Moving over to off-balance sheet items, considering the comments received, NCUA took another look at how off-balance sheet items would be treated. The Board agreed that credit unions should only be required to hold capital against the
actual off-balance sheet exposure, which is often much lower than the outstanding balance of loans transferred with recourse. So in this Proposal, credit unions will use the off-balance sheet exposure amount to calculate the credit equivalent amount that will be applied to the risk weight category. While it looks
like the credit conversion factors for loans transferred with recourse went up, in fact the actual risk-based capital requirement is much less than in the original Proposal, because only the credit union’s exposure will be used in addition to lower risk weights for the actual asset type. Additionally,
this Proposal lowers the credit conversion factor for commercial unfunded commitments from 75% as in the original Proposal to 50%. To round off and finish up with assets and other items, we talk about MSAs. NCUA kept the original
proposed risk weight at 250%, which is consistent with the FDIC rule. MSA evaluations are highly sensitive to unexpected shifts and interest rates and prepayment speeds. MSAs are also sensitive to the costs associated with servicing. These risks
contribute to a higher level of uncertainty in regard to realizing value from these assets, especially under adverse financial conditions. With regard to derivatives, after considering the comments and also considering the recent NCUA final Derivative Rule, the Board
broadened the NCUA risk capital regulation to include all potentially used derivative products. They further aligned the revised regulations for clearing and collateral with the other banking agency capital rules. With that, I’m going to turn it over to Larry to conclude
our presentation. Larry Fazio: Thanks, Tom. I’m going to walk through with all that said a couple of ways of thinking about how this Proposal is estimated to affect credit unions that it applies to. As we had indicated at the outset, it would only apply to complex credit unions. There
are 1,455 of those as of year-end 2013. That represents 20% of credit unions approximately, but almost 90% of the assets in the credit union system. As we look at Slide 52 in terms of the distribution of those 1,455 complex credit unions in relation to the estimated
risk-based capital ratios for them, what you can see on the left side of the chart in the shaded area are the 27 credit unions that we estimate would have risk-based capital ratios less than 10%. The 10% is the threshold in this Proposal to be considered well
capitalized under the risk-based requirement. Of those 27 credit unions, I would note that 8 already have net worth ratios below the 7% required to be well capitalized by the statute. Thus, the net projected impact of the Proposal is a downgrade of 19 credit unions’ PCA classification. We
estimate that the full 27 credit unions would need to raise approximately $53 million in capital, assuming no adjustments to the composition of risk assets, to achieve the well-capitalized classification. Finally, what I would note with this slide is that you can see that most credit unions are very well capitalized
in relation to their risk. Most of the distribution is to the far right in terms of the estimated risk-based capital ratios. In fact, the overall estimate is 19.3% on average. Going to Slide 53 this just compares the original January 2014 Proposal to
this Proposal. As we had noted the January 2014 Proposal had the definition of complex at $50 million, so there were about 700 more credit unions that were covered by that rule. We estimated that under that rule’s framework
there would be 199 credit unions that would see a downgrade in their PCA category. Shift forward to this Proposed Rule, we’re looking at 1,455 complex credit unions, again with assets over $100 million and a net 19 of those credit unions being
downgraded based on the Proposal. If we turn to Slide 54, another way to think about this Proposal and capital standards in general, is when you have a complementary set of capital standards, both a net worth or leverage ratio in the banking system and a risk-based
requirement where you have to meet both, the question then arises which one is the one that’s governing? Which one is the binding constraint? Which one is causing a particular institution, credit union or bank to hold more capital than the other? What we can see up here on this slide and what we’ve
estimated based on risk-based capital ratios projected from this Proposal, that the vast majority, almost 1,400 of the credit unions that are complex, would still be governed or bound by the leverage ratio. Meaning, the net worth ratio would still require more capital at 7% of total assets per the statute than
the proposed new risk-based ratio. But, 59 credit unions would be governed by the risk-based ratio, meaning you would require them to hold more capital than the leverage ratio. Those 59 credit unions are the outliers that we’re trying to calibrate this to and those 59 credit unions hold not quite $40
billion in assets. In context, it’s not a lot of credit unions, but it is a fair amount of assets in relation to a $11 billion Share Insurance Fund. This is another way to think about the impact and the estimates from this Proposal on Slide 55. On the left side
of the screen we have the net worth ratio. Again, under the statute 7% of total assets are required to be well capitalized. That’s the dark blue bar. The light blue is 10.7%, which is the average net worth ratio for complex credit unions. Complex credit unions on average
hold about 50% more than the minimum required to be well capitalized under the statute. If you go to the right set of bars, under this Proposal the risk-based capital ratio, the standard would be 10% to be well capitalized; 10% of risk assets I would note. On average a complex credit union
we project would have a 19.3% risk-based capital ratio, so almost double that required under the Proposal to be well capitalized. Finally, I will conclude with two thoughts. One, what were the goals of this Proposal? Then, what are the next steps or what to expect next? The goals of this
Proposal remain the same as the original to be faithful to the Federal Credit Union Act in designing an effective and responsive risk-based requirement. To support the mission of the Agency in protecting credit unions and the Share Insurance Fund by better relating capital to risk in addressing outliers. It’s not the intent to systematically
increase capital levels across the risk system. Credit unions by and large are very well capitalized as we’ve seen. This Proposal is intended to help credit unions that take above-average risks in serving members to be able to better absorb those losses and any losses that come with taking that risk, which would lead to a safer, more resilient,
and more stable credit union system. The Agency wants to ensure that credit unions maintain sufficient capital to continue functioning as financial intermediaries during times of stress without relying on government intervention or assistance. So what’s next on Slide 57? Once the Proposed
Rule is published in the Federal Register, the 90-day comment period will officially begin. We encourage all interested parties to comment. We’ll carefully evaluate all comments and make adjustments when it’s sensible to do so, just like we did with the last round of comments. Under
the assumption that the Board approves the Final Rule sometime around the end of 2015, and we don’t have a timetable for that, but if you accepted that as one assumption, that would leave three years for implementation before the Rule would become effective in January 2019, as this Proposal would call for. We would plan to have
all the corresponding Call Report changes ready by 2018, so credit unions could see their official new ratios before the Rule become effective in January 2019. Again, I’d really like to thank everybody who helped with this process and everyone who took the time to tune in to this webinar. At this time, we’re going to be happy to answer
questions on the Proposal. Kathryn Metzker: The first question is for Steve. How do you envision the Capital Adequacy Provision, which requires having a written policy and maintaining capital sufficient for the risk profile being reviewed by examiners during the examination? Steven Farrar: Thanks for that question. This is interesting
because this is not a new concept. This item in the regulation reinforces longstanding NCUA policy that credit unions should have capital commensurate with the risk it is taking. That has been shared with credit unions in a number of ways. It’s in each of the letters of credit unions that address
the CAMEL rating system; the first in December 2007, I guess that’s the second one; the first one going back as far as 1994. It’s also in the Examiners Guide, so examiners should have been talking to credit unions about this before. Just to quote out of the Examiners Guide: “The credit union board should have a plan for defining and
maintaining inadequate net worth level. ” That’s really what it comes down to is, it’s the board’s responsibility to know and maintain adequate capital. What’s going to be happening at exams should this Rule become final is your examiner would tend to be focused on that you have a process for measuring your capital and that you know how much
capital you have and you have the plan for maintaining capital commensurate with your risk. That’s what’s important there, is the process as the main function. One other thing I will say, if finalized, NCUA will release additional guidance to credit unions and examiners to clarify expectations on this issue. Kathryn Metzker: Thank you,
Steve. I do have another question for you. Would you please discuss the analytics you used to determine how many credit unions would be impacted by the Revised Proposed Rule? Steven Farrar: Sure. As you can see from this Proposal, there are a lot of a new data items that we are now going to be needing to collect to assign
risk-based capital if this Proposal becomes final. As we were trying to do our analysis on this, we did have to make a number of assumptions as to how to deal with the unknowns. So one thing we did try to do consistently was when we were making assumptions we tried to make
them conservatively. A good example is as we’ve discussed, the one- to four-family non-owner occupied residential real estate loans under this Proposal will receive a 50% risk weight. We could not identify what part of the member business loans they were. We estimated it around
19%, but because we could not accurately get that number, we left all of those loans in the commercial loan risk weight. With all that in mind, we tried to conservatively estimate it. Now, certainly individual credit unions will find significant results that are different, and that’s
why we put it on the estimator spreadsheet so that each credit union can on their own and privately enter in their actual numbers and get to see their results and know where they would stand against this Proposal as they prepare their comments. Amanda Parkhill: All right, Larry, we have a question
for you. How did NCUA determine the risk weights for each category? Larry Fazio: I would note again that we have a statutory mandate to maintain a PCA system that’s comparable to that of the other banking agencies. We largely referenced the risk weights that we used in this Proposal off of Basel and the
other banking agencies’ rules. We only really varied from those when we had a demonstrable case that credit union performance was significantly different than banks that are governed by the other banking agencies’ rules, or where we had a statutory mandate to do so. For example, like taking into account interest rate risk.
Most of that, again, is referenced off of the other banking agency rules. Amanda Parkhill: All right, Steve, a question for you. To clarify the commercial loan tiered risk weight, if the commercial loan is say 60% of assets, is the risk weight 100% for the first 50% and then 150% for the
remaining 10%, or is it 150% for the entire portfolio? Steven Farrar: Thanks, Amanda. That one is a good question and one that comes up a lot. It would be a blended rate. The commercial loans that are less than 50% of assets and subject to that measurement they would receive
the 100% risk weight. It’s the amount above that 50% that would receive the additional or the higher 150% risk weight. If you put it all together, you have a blended rate somewhere above 100% if you were over the 50% threshold. Kathryn Metzker: Thank you, Steve.
Rick, we have a question for you. For the SBA guaranteed portion of investments, what risk weight is assigned? Rick Mayfield: For SBA pools and loan participations that are the guaranteed portion they would have a 0% risk weight. This would differ from the risk weighting of a loan
a credit union originates under the SBA program, which would be a conditional guarantee, so that would have a higher risk weight. Kathryn Metzker: Thank you, Rick. Steve, we have another question for you. Does the goodwill exclusion pertain to only goodwill and intangibles acquired in a supervisory merger only, or
does it apply to other types of acquisitions as well? Steven Farrar: The exclusion that is written in this Proposal does only apply to goodwill and intangibles directly associated with supervisory mergers and we have defined that rather carefully in the Rule text. One of the reasons
that we did that is it is more likely in those situations with the troubled credit unions to produce goodwill and intangibles in those equations that would be more substantial than in a normal arm’s-length combination. One of the items we looked at in that is certainly
the additional longer implementation period does allow credit unions that might have engaged in some of the non-supervisory mergers time to look at the impact that will have. Maybe even over the short period of the implementation, that impact would be much less with the longer implementation
period. Really, extended implementation for the supervisory or merger goodwill is like we said in the presentation, our hope is or our expectation is most of that would have been eliminated from the balance sheet prior to that ending date. Amanda Parkhill: All right, Steve,
here’s another one for you. How is the 35% of assets concentration threshold determined for the first-lien real estate loans? Steven Farrar: The process that we used for determining the concentration levels was the same for both first-lien residential real
estate loans, junior-lien residential, and commercial. What we did is we looked at the items that you saw on the chart that had the distribution of credit unions. It had different percentages of each of those assets. As you saw in the chart with the first-lien residential
mortgages, we had basically 10% of the institutions that would be subject to the Rule, and really those came to about two standard deviations from the average. That’s why you end up with roughly 90% of credit unions not subject to those. When it came to the commercial
loan one, we went substantially higher. With only 12 credit unions applied we are at like the 99th percentile, because we saw that by using that and putting it in place those risk weights, the higher risk weight applying to the amount above the 50% of assets, we ended up
with a capital expectation very close to the current capital that those credit unions would currently be required to hold for those commercial portfolios. In the upshot, the concentration risks are two standard deviations from the average or higher. Kathryn Metzker: Thank you, Steve.
We have a question for Larry. Will NCUA develop a calculator for the website similar to the one that was available during the last version of this Rule? It was nice to simply have an easy means to determine. Larry Fazio: Thank you. We will not be developing a calculator
for the website like we did last time. We do have on our website what’s called a Risk-Based Capital Estimator that a credit union can download and fill out itself with its more precise data. We didn’t do the calculator this time because the alignment of the data we have on the Call Report, the existing data
with this Proposal, is not as good as it was with the original Proposal. So, we didn’t feel like it would be a good idea to put that information out publicly, because while in the aggregate we’re confident that the results and our analysis are solid, individual credit unions could still somewhat
significantly vary in their results if they use more precise data. In this case for this go-around, we’re providing a spreadsheet that credit unions can download to fill out to accurately calculate it for them individually. Kathryn Metzker:
Thank you, Larry. How do these proposals differ from the RBC guidelines for banks and banking holding companies? Larry Fazio: This is Larry. I guess I’ll take a crack at that. I think it was Slides 33
and 34 of the webinar, we went through it at least at a high level the key places where the risk weights lined up with the other banking industry rules and where they differed. I’m just going to just sort of quickly summarize those and these are the bigger ones. We did take advantage of a
lot of opportunities in the Rule to vary a little bit from the other banking agencies’ rules with the goal of trying to simplify the Proposal a little bit and make it a little bit more straightforward, but still maintain equivalency. There’s a lot of nuance there, but in terms of the big ticket items, secured consumer loans is
one. In fact, the fact that we differentiated between consumer loans is a big sort of divergence. The other banking agencies’ rules just lump all consumer loans into one bucket and risk weight them at 100%. We actually break them out into three fully share secured, which
gets a lower risk weight of 20%. Secured consumer loans, which gets a lower risk weight of 75%. Then, unsecured consumer loans would get the 100% risk weight. That’s one big area where we varied. Another area not so significant, but it is a variation. Where we’re a little bit more conservative is having the
concentration risk framework in our Proposal, which exists in the current Rule, not just in the last proposal and this Proposal. It’s a construct that is in place today. Those are mainly three types of loans. It is three types of loans; first-lien residential, junior-lien residential and commercial
loans. So that’s where that shows up. While we’re talking about commercial loans, we match up with the other banking agencies on one- to four-family non-owner occupied residential property. We made that adjustment with this Proposal. But
where we vary a little bit in a favorable way for credit unions is we do allow credit unions to offset that commercial loan risk weight with a lower risk weight if they have any contractual compensating balances associated with that loan on deposit with the credit union.
That portion that would be backed by contractual compensating balances would get a lower risk weight of 20%. We made some other adjustments in how we define commercial loans to deal better with how we define commercial loans and differentiate a little bit from the MBL cap. Finally, related to commercial loans
where we got a little bit more favorable, we separate out a commercial loan that’s backed by a vehicle that would be generally manufactured for personal use. Take for example a small farmer who buys a Ford pickup truck and, of course they use it as part of the farm. They drive it around and
use it for farming. Technically, that’s a business purpose loan and if it’s over $50,000 would meet the definition of a member business loan for purposes of the cap. But for risk weighting purposes, we’re risk weighting that as a secured consumer loan, because it is
essentially a pickup truck that’s for personal and not commercial design use. That’s another area where we vary a little bit. Again, I’ve kind of covered the bigger ticket items. There’s a very comprehensive comparison form on our website. If you go to our website, there
are various materials that are associated with this Proposal. One actually shows line by line where we varied from the other banking agencies’ rules in a very detailed way. Kathryn Metzker: Thank you, Larry. We’re receiving a lot of questions with regard to the estimator. JeanMarie, do you think you could give us an idea of
where we could find this and when it might be available? JeanMarie Komyathy: Sure. We’ve placed a Risk-Based Capital Resources page on the NCUA website. All of our information, for example the Risk Weights At A Glance Sheet that Larry was just speaking about with the differences in risk weights, as well as the Estimator page is on that Resource page.
It’s available now. There are links to the Proposed Rule. There are links to other information. The slides from today’s webinar will be available on that website Resource page as soon as the webinar is done. Those things are available now and you can go directly to NCUA’s website at www. ncua. gov
and find a link to the Risk-Based Capital Resources’ page. Kathryn Metzker: Thank you very much, JeanMarie. I have a question for you, Larry. Under the FDIC rules, investments that are less than 10% of a bank’s capital are risk weighted at 100%,
credit unions have very low investments in CUSOs. Why aren’t credit union investments in CUSOs risk weighted at 100% as FDIC’s approach? Larry Fazio: That’s a great question. It’s true how the FDIC and other banking agencies’ rules work. What they do is they have the bank look across
all of its equity exposures, not just for example CUSO investments. So a bank would have to look across all its equity exposures, add those all up and, if in total those are less than 10% of the bank’s qualifying capital, then because it’s considered de minimis then they can
all be risk weighted at 100%. However, at the point at which it exceeds the 10%, they can no longer get that treatment. All of the equity exposures have to go through a fairly complex formula to determine the risk weights that run a minimum of 250% all
the way to deducting some or all of the investment from the calculation. So, it added a lot of complexity to the process and we chose to go with a simpler approach in this Proposal of a loan at 100%, which syncs up with the commercial loan risk weighting and 150% for the equity portion
of the CUSO investment, which matches up with the corporate capital. But, that’s a good observation and we did look at it. We did make that decision consciously, but if commenters think that we should look at a more complicated approach like the other banking agencies, we are certainly willing to entertain that as part of the comment process.
Amanda Parkhill: Thank you. I’m not sure who this goes to, but how was the credit union practitioners’ group used in developing the Revised Proposal? Larry Fazio: I’ll take that one. We formed a group that helped us think through different aspects of the Proposal. In fact, we had several meetings with them. What we did is we took
all the comments. Once we had the comments summarized, we categorized them into related areas like real estate, commercial loan, investment, and what have you. Then we did a series of meetings with the practitioners to walk through the comments and options on how we might proceed with this new Proposal,
like in terms of calibrating risk weights, calibrating concentration thresholds, making adjustments. In fact, several of the recommendations made by the practitioners’ group were incorporated and adopted in this. If I’m not mistaken and I’m looking at Steve, one was the fully share secured loans I think was one. Steven Farrar: Shared
secured and compensating balances for the commercial loans were two that specifically come to mind. Larry Fazio: So, we bounced pretty much all of the different thoughts we had off of them and gave them an opportunity also to give us any of their unique or innovative thoughts that they had. So it was a great discussion and dialogue and
we valued it and appreciated it very much. Kathryn Metzker: Thank you, Larry. We have another question. What happens if a credit union falls below the 10% capital requirement? Larry Fazio: The same as what happens now if they’re not considered well capitalized. We do not change the PCA
categories with this Proposal. They are still well, adequate, significantly under and critically under. Of course, what happens now is for the net worth ratio if they’re below 7%, they’re adequate. If they’re below 7% but above 6%, they’re adequate. If they’re below 6%, they’re under and so forth. With
this Proposal for the risk-based requirement if they fall below 10%, but stay above 8%, they would be considered adequately capitalized. If they fall below 8%, they would be considered undercapitalized, and undercapitalized is the lowest that a credit union can fall in terms of its PCA
classification under the statute. The most that it will fall to is undercapitalized if it fails to meet the risk-based requirement. Then what happens, the consequences with those PCA classifications are identical to what they are today. While there are no restrictions if you’re adequate, it’s under the statute
merely an earnings’ retention requirement of 10 basis points a quarter. Then of course, undercapitalized involves some mandatory and discretionary supervisory actions, the most noteworthy of which is a requirement to submit and have approved a net worth restoration plan. Kathryn Metzker: Thank you again, Larry. I believe
we have time for one more question. Are there any potential changes to 723 to reconcile risk weighting with the MBL definition? For instance, a pickup truck is risk weighted as a consumer loan rather than a commercial loan, but rated as it has the risk of a commercial loan? Larry Fazio: I would
say yes to that without giving away too much, but yes, we’ve been looking at that. The Chairman has indicated we’ve been looking at the MBL rule and this is one of the things that we are looking at. JeanMarie Komyathy: We’ve run out of time for questions today, so we’d like to thank everybody for joining
us for our webinar. As I mentioned earlier, we do have the Resources page on the NCUA website. We will have the updated slides from today’s webinar available there shortly. The entire webinar will be available through archive once closed captioning is done within a few weeks. Thank you
for listening and for participating in our webinar and we appreciate your interest. JeanMarie reviewed for herself and Larry.