(Dec. 23, 2021) When credit unions open their doors for business on Jan. 3, a revised regulatory landscape will stretch before them with three regulatory changes that took effect Jan. 1: a new “risk-based capital” (RBC) rule, a new “complex credit union leverage ratio” (CCULR), and a new reference rate to replace the then-defunct London Interbank Offered Rate (LIBOR).
The RBC rule was approved by NCUA more than six years ago (and amended more than three years ago). Its aim was to require credit unions taking certain risks to hold capital commensurate with those risks. It restructured the agency’s existing “prompt correction action” (PCA) rules, including by adding a risk-based capital ratio (rather than a risk-based net worth ratio) for federally insured credit unions.
The effective date of the rule was delayed repeatedly by NCUA, as the agency considered (and later made) changes to the asset size for defining a “complex” credit union, which is affected by the RBC rule, and restructured the rule in consideration of recent events.
The agency first issued its risk-based capital proposal for “complex” credit unions – then defined as those with more than $100 million in assets – in 2014, with implementation slated 18 months after the rule would have been finalized. A revised proposed rule was issued in 2015 and finalized that October with an effective date of Jan. 1, 2019. That final rule replaced the risk-based net worth ratio contained in the 2015 rule with a new risk-based capital ratio for federally insured credit unions, which the NCUA called comparable to the regulatory risk-based capital measures used by the federal banking agencies: the Federal Deposit Insurance Corp. (FDIC), Federal Reserve, and Office of the Comptroller of Currency (OCC).
However, in 2018 the NCUA Board revised its definition of “complex” credit unions to include only those credit unions with more than $500 million in assets and delayed the rule’s implementation again, to Jan. 1, 2020. A year later (in 2019) the agency pushed the rule’s implementation date to Jan. 1, 2022. The delay was necessary, the agency said, to review potential changes to credit union capital such as subordinated debt authority; capital requirements for asset securitization; and an option like the community bank leverage ratio (CBLR) that had since been adopted for banks by federal banking agencies.
The board, in fact, addressed all those issues – including, just last week, finalizing the CCULR which it described as an “off-ramp” for eligible complex credit unions from the RBC rule. The rule also took effect Jan. 1; it was approved just last week.
That final rule creates a framework that allows “complex” credit unions opting in to maintain the CCULR instead of risk-based capital. Under CCULR, a complex credit union – one having more than $500 million in assets – may qualify to opt in to the CCULR framework if it has a minimum net worth ratio of 9%. this minimum requirement for a classification of “well capitalized” under the CCULR framework – modeled on federal banking agencies’ community bank leverage ratio (CBLR) – is higher than the 7% minimum ratio required under prompt corrective action (PCA) but lower than the 10% required under risk-based capital. The CCULR final rule also amends provisions of the 2015 risk-based capital final rule. The agency notes that based on June 30, 2021, call report data, about 70% of complex credit unions (down from 90% pre-pandemic) qualify to use the CCULR framework and would be well capitalized under a 9% calibration.
(Also taking effect Jan. 1: changes to NCUA’s rule on subordinated debt, aimed at easing low-income credit unions’ participation in Treasury’s Emergency Capital Investment Program (ECIP), which was created to help communities hard hit economically by the COVID-19 pandemic. The revisions amend the definition of “grandfathered secondary capital” to include any secondary capital issued to the U.S. government or one of its subdivisions under a secondary capital application approved before Jan. 1, 2022, regardless of the date issued. The final rule also extends the expiration of regulatory capital treatment for such secondary capital issuances to the later of 20 years from the date of issuance or Jan. 1, 2042. According to the NCUA, Treasury on Dec. 14 said 85 credit unions will receive about $2 billion in funding that can be used as secondary capital.)
Finally, also effective Jan. 1: LIBOR can no longer be used as a reference rate for a wide variety of financial instruments: from derivative contracts to consumer loans written after Jan. 1 (existing contracts may use LIBOR until June 30. 2023, when LIBOR will be completely phased out). Financial institutions and others will have to use an alternative, which (for derivatives and many other financial contracts) is the Federal Reserve-developed Secured Overnight Financing Rate (SOFR), a broad Treasuries repurchase financing rate.
NCUA has not told credit unions they must use SOFR for their consumer, student, commercial, real estate or other loans with potential LIBOR exposure. Instead, the agency has left that up to each institution to determine for itself (as long as the credit union determines the rate is appropriate for its risk management and member needs).
The agency has also advised that all LIBOR-based contracts that mature after Dec. 31 (one-week and two-month) and June 30, 2023 (one-, three-, six- and twelve-month) should include contractual language that provides for use of a robust fallback rate.