(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.
(Dec. 10, 2021) Minimizing the risk of disruptive litigation and adverse economic impacts associated with the transition away from the LIBOR reference rate is the aim of legislation passed by the House Wednesday.
The Adjustable Interest Rate (LIBOR) Act of 2021 (H.R. 4616), passed on voice vote, was sponsored by Rep. Brad Sherman (D-Calif.). In addition to minimizing litigation and economic risks, supporters say the bill will encourage a fair transition for financial contracts that do not consider the permanent cessation of LIBOR by June 2023 in existing contracts, and have no workable fallbacks. LIBOR as a reference rate may no longer be used for new loans or other financial contracts after Dec. 31.
The bill states its intent is to establish a clear and uniform basis nationwide for replacing LIBOR in existing contracts whose terms do not provide for the use of a clearly defined or practicable replacement benchmark rate, without affecting the ability of parties to use any appropriate benchmark rate in new contracts.
The legislation, similar to a statute enacted earlier this year in New York, now heads to the Senate for consideration.
LINK:
H.R. 4616, The Adjustable Interest Rate (LIBOR) Act of 2021
(Oct. 15, 2021) It’s “time to move” from LIBOR now by slowing the use of the reference rate by year’s end to foster a smooth completion of the rate’s overall use, according to a Federal Reserve-sponsored group that has developed an alternative rate.
LIBOR – the London Interbank Offered Rate – is used widely in derivative contracts, and other financial vehicles, as a reference rate. It is also used by many financial institutions as a reference rate for adjustable rate mortgages and student loans (particularly among credit unions).
However, the rate is being discontinued for new contracts after Dec. 31 (and completely defunct for existing contracts after June 30, 2023). “As a result, USD LIBOR’s liquidity and usefulness will likely diminish as new use comes to an end,” the Alternative Reference Rate Committee (ARRC) stated in a press release this week.
NCUA and the federal banking agencies have issued supervisory guidance to credit unions and banks reminding them that LIBOR will be discontinued after year’s end, and that the institutions should take steps to find alternative rates. ARRC said its recommendation is consistent with steps that “it understands a number of firms are already taking to significantly slow new USD LIBOR activity ahead of year-end in order to ensure that they will be in a position to meet the supervisory guidance.”
ARRC has recommended, as an alternative, the Secured Overnight Financing Rate (SOFR), which the group helped to develop. The Federal Reserve has recommended that firms switch to SOFR for such items as derivative contracts but has made no such recommendation for specific use of SOFR for loans (NCUA and the other banking agencies have likewise made no specific recommendation).
LINK:
(Aug. 27, 2021) Concern over reports that nonfinancial corporations are not, in most cases, being offered alternatives to the soon-to-be-defunct LIBOR reference rate was expressed by leaders of agencies overseeing financial markets in a letter released this week.
The letter was signed by Treasury Secretary Janet Yellen, Federal Reserve Board Chair Jerome H. (“Jay”) Powell, Securities and Exchange Commission Chair Gary Gensler, Federal Reserve Bank of New York President and CEO John C. Williams, and Commodity Futures Trading Commission Acting Chairman Rostin Behnam.
The communiqué followed up on a meeting among them and representatives of nonfinancial corporate stakeholders on the transition away from LIBOR, now scheduled for discontinuation at the end of this year (however, existing contracts will be allowed to use LIBOR until June 30, 2023).
“The transition is at a critical juncture, and we were thus concerned to hear your members report that nonfinancial corporations are, in most cases, not yet being offered such alternatives despite the short amount of time left in the transition,” the leaders wrote. “Accordingly, we invite you to continue to share your experiences and views with us as the transition, and the dialogue with your lenders, continues.”
In April, the nonfinancial corporate stakeholders – the Association for Financial Professionals, National Association of Corporate Treasurers, and the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness – wrote of their concern that non-financial corporates (NFCs) were challenged to obtain loan agreements based on alternatives to LIBOR, including the Secured Overnight Financing Rate (SOFR) even after those NFCs had indicated that loan agreements based on SOFR would be their preferred choice.
The group requested a meeting with the federal regulators to express their concerns in person.
(SOFR was developed by a group sponsored by the Federal Reserve the Federal Reserve Bank of New York; the Fed, including Vice Chairman for Supervision Randal Quarles, have said repeatedly that they recommend use of SOFR.)
The regulators agreed that the LIBOR transition presents operational, technological, accounting, tax and legal challenges to Main Street companies, and that firms
“The official sector has consistently supported a transition from LIBOR that leads to a more stable financial system, while also meeting the needs of all the parties who will be impacted by it, including nonfinancial corporate and noncorporate business borrowers, consumers, and investors, as well as financial institutions,” the letter from the regulators stated. “We have stressed the importance of reference rates built on deep, liquid markets that are not susceptible to manipulation.
“Although the official sector is not positioned to adjudicate the selection of reference rates between banks and their commercial customers, borrower preferences and needs clearly have a significant role to play in the selection of such rates,” the regulators wrote.
NCUA, for example, has not endorsed a specific alternative rate to LIBOR, including SOFR. LIBOR is used widely among credit unions for determining rates for adjustable rate mortgages and student loans.
LINK:
Treasury Department Releases Letter to Nonfinancial Corporate Stakeholders on LIBOR Transition
(July 30, 2021) Market participants now “have every tool they need to transition from LIBOR,” the vice chair of the Federal Reserve said this week, as a Fed-backed group developing an alternative to the widely used reference rate announced it had made a formal recommendation for the replacement, the Secured Overnight Financing Rate (SOFR). The recommendation came after a change in interdealer trading conventions that were adopted Monday (July 26), which outlined loan conventions and use cases for how best to use the SOFR. Federal Reserve Board Vice Chair for Supervision Randal Quarles also said that “all firms should be moving quickly to meet our supervisory guidance advising them to end new use of LIBOR this year.” LIBOR will no longer be used for new contracts beginning Jan. 1 and will be discontinued for existing contracts after June 30, 2023. Separately, the federal banking regulators Thursday jointly published FAQs concerning the regulatory capital treatment of capital instruments whose terms reference LIBOR … The Treasury Department and IRS Thursday announced that eligible employers can claim tax credits equal to the wages paid for providing paid time-off to employees to take a family or household member or certain other individuals to get vaccinated, or to care for a family or household member or certain other individuals recovering from the vaccination. Comparable tax credits are also available for self-employed individuals, the agencies said. In April, Treasury and the IRS announced eligible employers, such as businesses and tax-exempt organizations with fewer than 500 employees and certain governmental employers, could receive paid leave tax credits available under the American Rescue Plan Act of 2021 (ARP) for providing leave for each employee receiving the vaccine and for any time needed to recover from the vaccine.
LINKS:
ARRC Formally Recommends Term SOFR
OCC — Libor Transition: Regulatory Capital Rule Frequently Asked Questions
To Enable More Vaccinations, Treasury Expands Paid Leave Tax Credit
The forward motion to officially sideline LIBOR (London Interbank Offering Rate) as a reference rate for such financial products as adjustable mortgages and others continued this week with two top players in the mortgage market taking action.
Banking behemoth JP Morgan Chase unveiled a mortgage based on the new (and Federal Reserve-backed) Secured Overnight Financing Rate (SOFR), an alternative to LIBOR which is scheduled to be completely phased out by the end of next year. Meanwhile, secondary mortgage market giant Fannie Mae issued its first security backed by adjustable rate mortgages that use SOFR as a reference.
Also last week, the Financial Stability Board (FSB, an international group of central bankers and national regulators, which is chaired by Federal Reserve Board Vice Chair for Supervision Randal Quarles) unveiled a “global transition roadmap,” which sets out a timetable for a smooth transition away from LIBOR by year-end 2021. The FSB said the roadmap is intended to inform those with exposure to LIBOR benchmarks of steps they should take now through year-end 2021 to successfully mitigate these risks. “These are considered prudent steps to take to ensure an orderly transition by end-2021 and are intended to supplement existing timelines/milestones from industry working groups and regulators,” the group said.
Clearinghouses this month (and as recently as last week) have already begun making the switch from LIBOR to SOFR or other alternative rates, largely because of the impact on banks trading U.S. derivatives. The change affects trillions of dollars’ worth of transactions.
Last month, the Treasury’s Office of Financial Research (OFR) announced a new data tool focusing on repo data. According to OFR, the collection of repo data is expected to provide “a permanent and expanded source of data to support SOFR and reference rate transition.”
LINKS:
OFR Begins Publishing Repo Data, Unveils Short-term Funding Monitor