Since January 1, 2022, credit unions with total assets of $50 million and above must follow different expectations and frameworks when calculating capital ratios. The new capital adequacy standards from the National Credit Union Administration (NCUA), first issued in October 2015 as a result of the 2009 recession, went through several amendments and implementation delays before taking effect at the start of this year.
After such a long process to develop and implement the new, simplified rule, impacted credit unions may not be aware it is now in effect and that they must follow suit. Let’s take a look at some frequently asked questions about the new capital adequacy standards and the ratios, limits and details involved.
What are capital adequacy standards?
Capital is critical to a credit union’s success. While higher capital better protects a credit union from failure during an economic crisis, the goal is to not be over capitalized. The previous rules (through December 31, 2021) required the calculation of the Net Worth Ratio (NWR) for all credit unions, and the calculation of the Risk-Based Net Worth (RBNW) ratio for all credit unions with total assets greater than $50 million. This approach was limited because RBNW is a historical and lagging ratio. It also does not factor in an asset’s risk level. The NWR is the primary measure of a credit union’s financial strength. Capital serves several purposes, such as protecting the credit union against unforeseen or unusual losses, and investing in future member services. The NWR is calculated by taking the total net worth divided by total assets. We explain RBNW in further detail below.
Why did the NCUA change the standards?
For several reasons. First, the NCUA wanted to address weaknesses observed during the 2007-08 financial crisis. Second, the NCUA wanted to bring capital adequacy standards in line with those of other banking agencies, which amended their capital rules in 2013. Above all else, the NCUA wanted to strengthen capital requirements and improve risk sensitivity.
What changed under the new rule?
As of January 1, 2022, the definition of a complex credit union changed from more than $50 million in total assets to quarter-end total assets of more than $500 million on its most recent Call Report. While all credit unions still have to calculate NWR, only complex credit unions must also perform a second capital calculation, following the Risk-Based Capital (RBC) framework or, if elected and qualified, the Complex Credit Union Leverage Ratio (CCULR) framework.
What are the different capital categories?
What is the Risk-Based Capital ratio?
It is a more complex calculation of a credit union’s capital involving:
|Capital elements with additions and deductions||÷||Risk-weighted on balance sheet assets + Risk weighted off balance sheet exposure|
As the capital elements in the numerator increase, the ratio increases (which is better), but as the risk weighted assets in the denominator increase, the ratio decreases.
Different assets are assigned a specific risk weight. For instance, cash is not risky, so it is assigned a zero percent risk weight. However, mortgage servicing assets are considered risky and assigned a weight of 250 percent. Risk weighting in this way supports the consideration of capital requirements in asset allocation choices before potential losses and declining capital. To be considered well capitalized, a complex credit union must have an NWR of 7 percent or greater, and an RBC ratio of 10 percent or more.
What is the CCULR?
CCULR (pronounced cooler) is modeled after the Community Bank Leverage Ratio (CBLR). The CCULR (and CBLR) dictate that credit unions (and banks) should hold capital equal to the risks on their balance sheets. This risk-based capital helps to minimize the losses when a financial institution fails. The intent is to simplify requirements for eligible complex credit unions, as it eliminates the requirement to calculate the RBC ratio. The trade-off for this simplicity is that the complex credit union would be required to maintain an NWR higher than if they had elected to use the RBC ratio.
Opting in to CCULR is not a lifetime commitment. Institutions can opt in and opt out during any quarter. If a credit union opts in to CCULR and fails to meet the required thresholds, there is a two-quarter grace period to meet the opt-in requirements, which are:
- Be a complex credit union (>$500 million total assets)
- NWR of 9 percent or more
- Off-balance sheet exposures totaling less than 25 percent of total assets
- Trading assets and liabilities that comprise less than 5 percent of total assets
- Goodwill and intangible assets that are less than 2 percent of total assets
What about Member Business Loan limits?
Under NCUA regulations, a federally insured credit union’s net Member Business Loan (MBL) balances must be limited to the lesser of 1.75 times the actual net worth of the credit union, or 1.75 times the minimum net worth required under the Federal Credit Union Act. The CCULR final rule requires an applicable complex credit union to calculate the minimum amount of net worth required by both its NWR and RBC requirement. Here is what that looks like in practice:
- NWR requires a complex credit union to hold net worth (in dollars) equal to 7 percent of its total assets.
- For purposes of computing the MBL cap, the RBC ratio requires a complex credit union to hold net worth (in dollars) equal to 10 percent of the credit union’s risk-weighted assets as calculated under 12 CFR 702.104.
- The complex credit union would then compare these two net worth amounts and take the larger as the minimum amount of net worth necessary to be well capitalized under either NWR or RBC ratio.
- The lesser of the net worth amount calculated above and the credit union’s actual net worth is used to compute the complex credit union’s MBL cap, which would be 1.75 times the lesser of these two net worth amounts.
What’s the bottom line impact on credit unions?
Credit unions with total assets between $50 million and $500 million no longer need to calculate an RBNW ratio. Complex credit unions with total assets greater than $500 million will no longer calculate the RBNW ratio; instead, they will follow the RBC framework, or, if eligible and opted into, the CCULR framework.
All credit unions will continue to calculate their NWR, which will impact the calculation of MBL limits. Credit unions should review how they calculate their MBL limit to ensure they align with NCUA expectations.
While this is a significant change, the impact on the vast majority of credit unions will be less given the increase in the value of the definition of a complex credit union. RKL’s team of industry advisors can answer questions and support credit unions with calculating and applying the new rules. Contact your RKL professional or use the form below to contact us.