National Credit Union Administration Proposed Rule: Capital Adequacy – Complex Credit Union Leverage Ratio

WASHINGTON, Aug. 14 -- The National Credit Union Administration has issued a proposed rule (12 CFR Part 702 and 12 CFR Part 703), published in the Federal Register on Aug. 14, 2021, entitled: "Capital Adequacy: The Complex Credit Union Leverage Ratio; Risk-Based Capital".

The proposed rule was issued by Melane Conyers-Ausbrooks, Secretary of the Board.

DATES: Comments must be received on or before October 15, 2021.

FOR FURTHER INFORMATION CONTACT: Policy and Accounting: Thomas Fay, Director, Division of Capital Markets, Office of Examination and Insurance, at (703) 518-1179; Legal: Rachel Ackmann, at (703) 623-9363 or Ariel Pereira, at (703) 548-2778; or by mail at National Credit Union Administration, 1775 Duke Street, Alexandria, Virginia 22314.

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The NCUA is seeking comment on a proposed rule that would provide a simplified measure of capital adequacy for federally insured, natural-person credit unions (credit unions) classified as complex (those with total assets greater than $500 million).

Under the proposed rule, a complex credit union that maintains a minimum net worth ratio, and that meets other qualifying criteria, will be eligible to opt into the complex credit union leverage ratio (CCULR) framework.

The minimum net worth ratio would initially be established at 9 percent on January 1, 2022, and be gradually increased to 10 percent by January 1, 2024.

A complex credit union that opts into the CCULR framework would not be required to calculate a risk-based capital ratio under the Board's October 29, 2015, risk-based capital final rule, as amended on October 18, 2018.

A qualifying complex credit union that opts into the CCULR framework and that maintains the minimum net worth ratio would be considered well capitalized.

The proposed rule would also make several amendments to update the NCUA's October 29, 2015, risk-based capital final rule, including addressing asset securitizations issued by credit unions, clarifying the treatment of off-balance sheet exposures, deducting certain mortgage servicing assets from a complex credit union's risk-based capital numerator, updating several derivative-related definitions, and clarifying the definition of a consumer loan.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

A. The NCUA's Risk-Based Capital Requirements

B. The Other Banking Agencies' Risk-Based Capital and CBLR Framework

C. The NCUA's Advance Notice of Proposed Rulemaking

II. Legal Authority

III. Proposed Rule

A. Overview of the CCULR Framework

B. Qualifying Complex Credit Unions

C. The CCULR Ratio

D. Calibration of the CCULR

E. Opting Into the CCULR Framework

F. Voluntarily Opting Out of the CCULR Framework

G. Compliance With the Proposed Criteria to Be a Qualifying Complex Credit Union

H. Treatment of a Qualifying Complex Credit Union That Falls Below the CCULR Requirement

I. Transition Provision

J. Reservation of Authority

K. Effect of the CCULR on Other Regulations

L. Illustrative Reporting Forms To Support the CCULR

M. Amendments to the 2015 Final Rule

N. Technical Amendments

O. Illustrative Reporting Forms for Risk-Based Capital

IV. Regulatory Procedures

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

C. Executive Order 13132 on Federalism

D. Assessment of Federal Regulations and Policies on Families

I. Background

A. The NCUA'S Risk-Based Capital Requirements

The NCUA's mission is to ensure the safety and soundness of federally insured credit unions (FICUs), in addition to carrying out other statutory responsibilities. The NCUA performs this function by examining and supervising federally chartered credit unions (FCUs), participating in the examination and supervision of federally insured, state-chartered credit unions (FISCUs) in coordination with state regulators, and insuring members' accounts at all FICUs up to the limits prescribed by statute.

Capital adequacy standards are an important prudential tool to ensure the safety and soundness of individual credit unions and the credit union system as a whole. Capital serves as a buffer for credit unions to prevent institutional failure and dramatic deleveraging during times of stress. During a financial crisis, a buffer can mean the difference between the survival or failure of a financial institution. Higher levels of capital insulate credit unions from the effects of unexpected adverse developments in their financial condition, reduce the probability of a systemic crisis, allow credit unions to continue to serve as credit providers during times of stress without government intervention, and produce benefits that outweigh the associated costs.

Following the 2007-2009 recession, the NCUA substantially reevaluated its capital adequacy standards, which are codified in 12 CFR part 702 (part 702). On October 29, 2015, as amended on October 18, 2018, the Board published a final rule restructuring its capital adequacy regulations (2015 Final Rule).[1] The effective date of the 2015 Final Rule was originally January 1, 2019. The overarching intent of the 2015 Final Rule was to reduce the likelihood that a relatively small number of high-risk credit unions would exhaust their capital and cause large losses to the National Credit Union Share Insurance Fund (NCUSIF). Under the Federal Credit Union Act (FCUA), FICUs are collectively responsible for replenishing losses to and capitalizing the NCUSIF.[2]

The 2015 Final Rule restructured the NCUA's current capital adequacy regulations and made various revisions, including amending the agency's risk-based net worth requirement by replacing a credit union's risk-based net worth ratio with a risk-based capital ratio. The risk-based capital requirements in the 2015 Final Rule are more consistent with the NCUA's risk-based capital ratio measure for corporate credit unions, are more comparable to the risk-based capital measures implemented by the Federal Deposit Insurance Corporation (FDIC), Board of Governors of the Federal Reserve System (Federal Reserve Board), and Office of the Comptroller of Currency (OCC) (collectively, the other banking agencies) in 2013, and consistent with the FCUA.[3]

The risk-based capital provisions of the 2015 Final Rule apply only to credit unions that are complex, which the rule defined as those with total assets over $100 million.[4] On November 6, 2018, the Board published a supplemental final rule that raised the threshold level for a complex credit union to $500 million (2018 Supplemental Rule).[5] Therefore, only credit unions with over $500 million in assets are now subject to the risk-based capital requirements of the 2015 Final Rule. The 2018 Supplemental Rule also delayed the effective date of the 2015 Final Rule for one year (from January 1, 2019, to January 1, 2020).

The effective date was delayed a second time through a final rule published on December 17, 2019 (2019 Supplemental Rule).[6] The 2015 Final Rule is now scheduled to become effective on January 1, 2022. The delay has provided credit unions and the NCUA with additional time to implement the 2015 Final Rule. Further, as explained in the 2019 Supplemental Rule, the delay provided the Board additional time to holistically and comprehensively evaluate the NCUA's capital standards for credit unions.[7] Among a few items that the Board made reference to, the rule highlighted a community bank leverage ratio (CBLR) analogue and the treatment of asset securitizations issued by credit unions as items for possible consideration by the Board during the delay.[8]

B. The Other Banking Agencies' Risk-Based Capital and CBLR Framework

As discussed previously, the other banking agencies adopted a revised risk-based capital rule in 2013, which was designed to strengthen their capital requirements and improve risk sensitivity. These rules, along with subsequent amendments, were intended to address weaknesses that became apparent during the financial crisis of 2007-08 (the other banking agencies' 2013 capital rule).[9] The other banking agencies' 2013 capital rule provides two methodologies for determining risk-weighted assets: (i) A standardized approach; and (ii) a more complex, models-based approach, which includes both the internal ratings-based approach for measuring credit risk exposure and the advanced measurement approach for measuring operational risk exposure.[10] The standardized approach applied to all banking organizations, whereas the internal ratings-based approach applied only to certain large or internationally active banking organizations.

In 2018, section 201 of the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA), directed the other banking agencies to propose a simplified, alternative measure of capital adequacy for certain federally insured banks.[11] On November 13, 2019, the other banking agencies issued a final rule implementing this statutory directive (CBLR Final Rule).[12]

Under the CBLR Final Rule, the CBLR framework is optional for depository institutions and depository institution holding companies that meet the following criteria:

(1) A leverage ratio (equal to tier 1 capital divided by average total consolidated assets) of greater than nine percent;[13]

(2) Total consolidated assets of less than $10 billion;[14]

(3) Total off-balance sheet exposures of 25 percent or less of its total consolidated assets;

(4) Trading assets plus trading liabilities of five percent or less of its total consolidated assets; and

(5) Not an advanced approaches banking organization (advanced approaches banking organizations are generally those with at least $250 billion in total consolidated assets or at least $10 billion in total on-balance sheet foreign exposure, and depository institution subsidiaries of those firms).

The CBLR Final Rule refers to the depository institutions and depository institution holding companies that meet these criteria as "qualifying community banking organizations." Qualifying community banking organizations that opt into the CBLR framework are considered to be in compliance with the other banking agencies' generally applicable risk-based and leverage capital requirements. Further, these qualifying banking organizations will be considered to have met the well-capitalized ratio requirements for purposes of section 38 of the Federal Deposit Insurance Act (FDI Act), which applies prompt corrective action to federally insured depository institutions.[15] Qualifying community banking organizations may opt into or out of the CBLR framework at any time.

The CBLR Final Rule includes a two-quarter grace period during which a qualifying community banking organization that temporarily fails to meet any of the qualifying criteria, including the greater than nine percent leverage ratio requirement, generally will still be deemed well-capitalized so long as the qualifying community banking organization maintains a leverage ratio greater than eight percent. At the end of the grace period, the banking organization must meet all qualifying criteria to remain in the CBLR framework or otherwise must comply with and report under the generally applicable risk-based and leverage capital requirements. Similarly, a banking organization that fails to maintain a leverage ratio greater than eight percent will not be permitted to use the grace period and must comply with the generally applicable capital requirements and file the appropriate regulatory reports.

In March 2020, the CBLR was temporarily set to eight percent by statute.[16] Accordingly, effective the second quarter of 2020, the CBLR requirement was eight percent or greater.[17] At the start of 2021, the CBLR requirement was increased to 8.5 percent or greater and the minimum requirement during the grace period is 7.5 percent.[18] Beginning on January 1, 2022, the CBLR requirement will return to nine percent and the minimum requirement during the grace period will return to eight percent.

C. The NCUA'S Advance Notice of Proposed Rulemaking

At its January 14, 2021, meeting the Board issued an advance notice of proposed rulemaking (ANPR) to solicit comments on two approaches to simplify the 2015 Final Rule.[19] The risk-based leverage ratio (RBLR) is the first alternative to the 2015 Final Rule included in the ANPR, which would replace the 2015 Final Rule with a new capital framework. The RBLR would use relevant risk-attribute thresholds to determine which complex credit unions would be required to hold additional capital buffers above the statutory leverage ratio. The second alternative contemplated in the ANPR is to retain the 2015 Final Rule but enable eligible complex credit unions to opt-in to the CCULR framework.

The ANPR provided for a 60-day comment period that closed on May 10, 2021. The Board received 19 comments. Almost all commenters supported the stated goal of simplifying the 2015 Final Rule. In general, commenters favored the NCUA developing a CCULR complement to risk-based capital rather than adopting a RBLR system of capital adequacy.

Several commenters were opposed to the RBLR framework because it would likely call for higher capital requirements for credit unions holding certain assets compared to the current RBC requirements. Several commenters also stated that introducing a RBLR regime at this point would increase regulatory burden and negate the substantial work complex credit unions have undertaken to achieve compliance with the 2015 Final Rule. Commenters also generally stated that the RBLR would increase transaction costs for complex credit unions as they would be required to invest additional resources to redevelop the processes that have been put in place in anticipation of the RBC requirements. A few commenters also stated that a RBLR framework could result in a capital cliff. These commenters were concerned that a small change in assets could move a credit union to a new buffer, thereby causing a large increase in minimum capital requirements.

Almost all commenters that favored the CCULR framework noted that it is a more flexible framework than the RBLR because complex credit unions have the option of calculating the more complex risk-based capital measure for a more precise and generally lower overall capital requirement. A few commenters noted that a benefit of the CCULR framework, as compared to a RBLR framework, is its similarity to the capital framework of the other banking agencies.

After reviewing the comments received in response to the ANPR, the Board decided to issue this proposed rule to provide a simple measure of capital adequacy for complex credit unions that would serve as a complement to the 2015 Final Rule.

II. Legal Authority

This proposed rule would primarily provide a simple measure of capital adequacy for credit unions classified as complex based on the principles of the CBLR framework. The CCULR would relieve complex credit unions that satisfy specified qualifying criteria from having to calculate the risk-based capital ratio. In exchange, the credit union would be required to maintain a higher net worth ratio than is otherwise required for the well-capitalized classification for risk-based capital purposes. This is a similar trade-off to the decision qualifying community banks make under the CBLR. After the initial phase in period, a qualifying complex credit union that has a net worth ratio of 10 percent or greater will be eligible to opt into the CCULR framework.

A qualifying complex credit union that opts into the CCULR framework and maintains the minimum net worth ratio (both during and after the threshold transition) will be considered well capitalized under the 2015 Final Rule.[20] The proposed rule would also make several amendments to update the NCUA's 2015 Final Rule, including addressing asset securitizations issued by credit unions, clarifying the treatment of off-balance sheet exposures, deducting certain mortgage servicing assets from a complex credit union's risk-based capital numerator, updating certain derivative-related definitions and clarifying the definition of a consumer loan.

The Board is issuing this proposed rule pursuant to its authority under the FCUA. Under the FCUA, the NCUA is the chartering and supervisory authority for FCUs and the federal supervisory authority for FICUs.[21] The FCUA grants the NCUA a broad mandate to issue regulations governing both FCUs and all FICUs. Section 120 of the FCUA is a general grant of regulatory authority and authorizes the Board to prescribe rules and regulations for the administration of the FCUA.[22] Section 207 of the FCUA is a specific grant of authority over share insurance coverage, conservatorships, and liquidations.[23] Section 209 of the FCUA is a plenary grant of regulatory authority to the Board to issue rules and regulations necessary or appropriate to carry out its role as share insurer for all FICUs.[24] Accordingly, the FCUA grants the Board broad rulemaking authority to ensure that the credit union industry and the NCUSIF remain safe and sound.

The FCUA also includes an express grant of authority for the Board to develop capital adequacy standards for credit unions. In 1998, Congress enacted the Credit Union Membership Access Act (CUMAA).[25] Section 301 of CUMAA added section 216 to the FCUA,[26] which required the Board to adopt by regulation a system of prompt corrective action (PCA) to restore the net worth of credit unions that become inadequately capitalized.[27] Section 216(b)(1)(A) requires the Board to adopt by regulation a system of PCA for credit unions consistent with section 216 of the FCUA and comparable to section 38 of the FDI Act.[28] Section 216(b)(1)(B) requires that the Board, in designing the PCA system, also take into account the "cooperative character of credit unions" (that is, credit unions are not-for-profit cooperatives that do not issue capital stock, must rely on retained earnings to build net worth, and have boards of directors that consist primarily of volunteers).[29] The Board initially implemented the required system of PCA in 2000,[30] primarily in part 702, and, as discussed previously, most recently made substantial updates to the regulation in the 2015 Final Rule.

Among other things, section 216(c) of the FCUA requires the NCUA to use a credit union's net worth ratio to determine its classification among five net worth categories set forth in the FCUA.[31] Section 216(o) generally defines a credit union's net worth as its retained earnings balance as determined under generally accepted accounting principles (GAAP),[32] and a credit union's net worth ratio, as the ratio of its net worth to its total assets.[33] As a credit union's net worth ratio declines, so does its classification among the five net worth categories, thus subjecting it to an expanding range of mandatory and discretionary supervisory actions.[34]

Section 216(d)(1) of the FCUA requires that the NCUA's system of PCA include, in addition to the statutorily defined net worth ratio requirement, "a risk-based net worth[35] requirement for credit unions that are complex, as defined by the Board."[36] The FCUA directs the NCUA to base its definition of complex credit unions "on the portfolios of assets and liabilities of credit unions."[37] If a credit union is not classified as complex, as defined by the NCUA, it is not subject to a risk-based net worth requirement. In addition to granting the NCUA broad authority to determine which credit unions are complex, and therefore subject to a risk-based net worth requirement, the FCUA also grants the NCUA broad authority to design a risk-based net worth requirement to apply to such complex credit unions.[38] Specifically, unlike the terms net worth and net worth ratio, the term risk-based net worth is not defined in the FCUA. Accordingly, section 216 grants the Board the authority to design risk-based net worth requirements, so long as the regulations are comparable to those applicable to other federally insured depository institutions and consistent with the requirements of the FCUA.

The proposed CCULR framework is comparable to section 38 of the FDI Act, as implemented by CBLR Final Rule.[39] As discussed previously, section 201 of the EGRRCPA amended part of the other banking agencies' capital adequacy framework to direct the other banking agencies to propose a simplified, alternative measure of capital adequacy for certain federally insured banks.[40] The other banking agencies implemented this requirement, including amendments to their PCA regulations under section 38 of the FDI Act, in the CBLR Final Rule. The Board also notes that the proposed amendments to the NCUA's 2015 Final Rule would make the rule more comparable to the other banking agencies' 2013 capital rules.

In addition to satisfying the comparability requirement in section 216, the proposed CCULR framework also meets the requirements in section 216 for the NCUA's risk-based net worth framework. Section 216 has two express provisions that authorize an NCUA analogue to the CBLR--the definition of complex credit unions and the mandate for the Board to design a risk-based net worth requirement. In designing its CCULR framework, the Board considered both its legal authority to exclude credit unions from risk-based net worth requirements under the definition of complex, and its authority to design a system of risk-based net worth that includes a higher net worth ratio in place of calculating a ratio based on risk-adjusted assets.[41]

The Board considered its express authority under section 216 to define which credit unions are complex, and thus exclude noncomplex credit unions from the risk-based net worth requirement.[42] The express delegation grants the Board significant discretion to determine which credit unions are considered complex. Under this legal basis, the Board would continue to limit the definition of complex to only those credit unions with quarter-end total assets that exceed $500 million dollars. In using asset size as a proxy for complexity, the Board complied with the statutory directive that the definition of complex be based on the portfolios of assets and liabilities of credit unions. Specifically, the Board relied on a complexity index that counted the number of complex products and services provided by credit unions.[43] The complexity index demonstrated that credit unions with greater than $500 million in total assets held complex assets and liabilities as larger share of their total assets than smaller credit unions.[44]

The Board, however, could also propose a definition of complex that, rather than looking at the assets and liabilities of credit unions in the aggregate, looks at the individual portfolios of credit unions with total assets greater than $500 million. This approach is also consistent with the statutory provision that the complex definition should be based on the portfolios of assets and liabilities of credit unions. The Board would use the same qualifying criteria as in the proposed rule, as measures of complexity. If a credit union would otherwise meet the proposed definition of a qualifying credit union, it would be considered not complex, and therefore not subject to risk-based capital, as implemented by the 2015 Final Rule. This alternative approach would create a functionally equivalent requirement to the one set forth in this proposed rule, with the only difference being the technical details of the implementing regulatory text in part 702.

The Board also considered its express authority and mandate to design the CCULR on the basis that the CCULR constitutes a risk-based net worth requirement, as required for complex credit unions in section 216(d). As discussed previously, the FCUA does not define the term risk-based net worth requirement and only sets forth general guidelines for the design of the risk-based net worth requirement mandated under section 216(d)(1). Specifically, section 216(d)(2) requires that the Board "design the risk-based net worth requirement to take account of any material risks against which the net worth ratio required for an insured credit union to be adequately capitalized may not provide adequate protection." Under section 216(c)(1)(B) of the FCUA, the net worth ratio required for a credit union to be adequately capitalized is six percent.

The plain language of section 216(d)(2) supports the NCUA's interpretation that Congress intended for the NCUA to design the risk-based net worth requirement to take into account any material risks beyond those already addressed through the statutory six percent net worth ratio required for a credit union to be adequately capitalized. In other words, the language in paragraph 216(d)(2) simply identifies the types of risks that the NCUA's risk-based net worth requirement must address, that is, those risks not already addressed by the statutory six percent net worth requirement. Notably, the FCUA does not require that the risk-based net worth requirement include risk-adjusted assets as part of its calculation.[45] Instead, the Board interprets "risk-based" to require an accounting for risks in some manner--that is, the measure must be based on a consideration of risks--but not any particular manner of doing so.[46] Therefore, provided the Board determines that the proposed CCULR considers all material risks against which the six percent net worth ratio does not provide protection, then the Board has satisfied the statutory requirements for a risk-based net worth ratio.[47]

The Board believes that both approaches to designing the CCULR framework are supported by the FCUA. The Board, however, has chosen to draft the proposed rule under its authority to design a risk-based net worth requirement. The Board believes that considering the CCULR as an alternative way to calculate a risk-based net worth requirement is more straightforward, consistent with the structure of section 216, and simpler for complex credit unions to implement.

By the National Credit Union Administration Board on July 22, 2021.

Melane Conyers-Ausbrooks,

Secretary of the Board.

[FR Doc. 2021-15965 Filed 8-13-21; 8:45 am]

BILLING CODE 7535-01-P

The document is published in the Federal Register: https://www.federalregister.gov/documents/2021/08/16/2021-15965/capital-adequacy-the-complex-credit-union-leverage-ratio-risk-based-capital

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