Alternative capital – Be careful what you wish for!
On February 8, 2017, the NCUA issued an advanced notice of proposed rulemaking (ANPR) asking for comments on alternative forms of capital that federally insured credit unions could issue to meet their capital needs. Currently, only low-income designated credit unions can issue secondary capital instruments, which serve to help satisfy their capital requirements. The NCUA is considering broadening the power of credit unions to issue alternative forms of capital and is asking credit unions to comment on this idea.
The NCUA asked for similar commentary as it was drafting the risk-based capital rules that will go into effect in 2019. Many credit unions expressed interest in alternative capital at that time. However, the NCUA did not feel as if the comments then offered specific suggestions, so the NCUA is soliciting additional information now by asking many questions that it groups in six key areas:
- Possible changes in the current secondary capital standards that apply to low-income designated credit unions.
- Current and prospective use of alternative capital, and the effect that broader use of supplementary capital by credit unions might have on the ability of low-income designated credit unions to issue secondary capital.
- The legal authority for supplementary capital, and the implications of supplementary capital on the tax exemption and mutual ownership of credit unions.
- Complications arising from the application of securities laws.
- Other investor considerations such as who should be able to purchase secondary and supplementary capital (e.g., only sophisticated institutional investors, accredited investors, or anyone?), “the extent to which credit unions should be allowed to sell alternative capital with equity like characteristics to nonmembers,” and “what controls are necessary to preserve the mutual ownership structure and democratic governance of credit unions?”
- Standards for issuing and counting alternative capital for prompt corrective action (PCA) purposes.
It is important to note that any supplementary capital that the NCUA might authorize for credit unions other than low-income designated credit unions would be secondary capital and ineligible for inclusion in meeting the net worth ratio requirements of the PCA requirements. The NCUA would only have the authority to allow other credit unions to use the supplementary capital for risk-based capital purposes. Given that the vast majority of credit unions more narrowly meet the net worth ratio requirements rather than risk-based capital requirements, the use of supplementary capital would be of limited value to almost all credit unions. Moreover, just like the membership capital share deposits (MCSDs) that were used by corporate credit unions, the amounts of supplementary capital instruments available for inclusion in risk-based capital ratios would amortize to zero over the last five years of the terms of such instruments. Although a small number of non-low-income designated credit unions would benefit from supplementary capital, the true value of such capital would be quite modest overall.
However, the costs of supplementary capital might be substantial. Preserving differences between credit unions and banks is an important factor in supporting credit unions’ exemption from Federal taxation. The NCUA notes in its request for comment that “the Board is aware that part of the basis for the credit union tax exemption was that Congress recognized most credit unions could not access the capital markets to raise capital.” All but the smallest credit unions would be subject to a tax rate of 34 percent or higher on the majority of their earnings so that losing the tax exemption would dramatically reduce the ability of credit unions to build capital through earnings. Finally, credit unions would need to be very careful in any use of secondary capital to ensure that meeting the objectives of investors in such capital would not erode their ability to meet the needs of members. Finding it necessary to cater to another group of equity holders might divert attention from the members that credit unions were created to serve.
Please take the time to read the NCUA’s ANPR on alternate forms of capital and provide your credit union’s thoughts to the NCUA by the May 9, 2017 deadline. The ability to issue supplementary capital might be an attractive tool for a very limited group of non-low-income designated credit unions today. We need to be certain that the ability to issue such capital would not expose all credit unions to the loss of the tax exemption or sacrifices in meeting their primary goal of serving members.