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What would you think if you learned that Warren Buffet was shorting Berkshire stock? Or Elon Musk prefers driving a Lexus? Or Jeff Bezos doesn’t want to test fly his Blue Origin Space capsule? None of these situations are true because the opposite is the case, observers’ trust in these leaders and their organizations is sustained.

A credit union example

Seven years ago, in October 2015, the NCUA over the objection of board member Mark McWatters, approved a final 424-page Risk-Based Capital (RBC) rule. This was the NCUA’s second attempt to impose this new regulation which was as equally unsupportable as the first. Both attempts were universally opposed by credit unions.

One of the rationales for the rule—stated in the 2014 NCUA Annual Report—was “the issuance in 2013 of new risk-based capital rules by the FDIC, the office of the Comptroller of the Currency and the Board of Governors of the Federal Reserve System.” (page 12)

Certainly, an impressive endorsement by banking regulators. However, in September 2019, the FDIC (with the full concurrence of the Comptroller and Federal Reserve) removed RBC requirements for all community banks under $10 billion. Did the NCUA follow its peer’s decision? No, it plodded on, kicking the can down the road even though one of their primary justifications was gone.

What the rule says about the NCUA’s self confidence

But there is another insight, besides bureaucratic obstinacy, to take from the final proposal.

The agency published a two-page summary—Risk Weights At a Glance—as the final summary of absolute and relative risk of every possible balance sheet asset. Three judgments are illuminating.

Credit unions investing in the capital of the Central Liquidity Facility (CLF) have zero risk. Since the CLF has not made a loan for over a decade, it suggests how the agency is thinking about the CLF’s role assisting credit unions in the future.

The FHLB’s do make loans to credit unions. To qualify for these, a credit union must buy stock in the bank. The NCUA determined these stock purchases should be assigned a 20% risk weighting. Even though no FHLB organization has ever failed, the agency believes there is still a small risk. But it is nowhere near the risk of a credit union investing in a CUSO, which requires a 100-150% weighting.

But the most ominous risk is for credit unions’ 1% capital deposit in the NCUSIF. According to the chart, the 1% deposit cannot even be counted as an asset. It must be subtracted in full from the numerator of the credit union’s net worth and from the denominator’s total of all risk weighted assets.

It is counted as having no value despite having been untouched for almost 40 years. It is an earning asset, withdrawable in a voluntary liquidation or conversion to private insurance. On both credit union and NCUSIF balance sheets it is carried at full value. Multiple national accounting firms have stated this asset “fairly presents” both aspects of this transaction.

What would subtracting this asset mean for the NCUSIF’s Risk Based Capital ratio? If credit unions cannot count this as an asset, how can the NCUA include these deposits in the NCUSIF’s net worth?

One interpretation is that this is just one of many foolish aspects of the final RBC rule which becomes effective January 1, 2022. But there may be more intention than one might think.

A scary thought

This NCUSIF total write-off of the 1%  from net worth, like the hypothetical made up examples first above, points to an uncomfortable reality. This is an agency whose leaders lack confidence when managing the ever-growing resources credit unions provide. And if they lack the understanding of this cooperative fund’s operations, what message is sent to credit union members?

Today, the NCUSIF equity level above the 1% deposit totals over $4.7 billion. Should a loss of that magnitude or more occur, the primary question will not be about the status of the 1% deposit, but where was the regulator?

The cumulative loss rate for the NCUSIF over the past 12 years and two financial crises, is 1.5 basis points. To project a loss at least 20 times this recent real world experience, is deeply troubling. (2,000 percent, i.e. 30/1.5)

That potential accountability is why the agency wants to eliminate the 1% from credit unions’ net worth today. The NCUA wants to avoid explaining how its oversight allowed such a situation to develop.

Now that is a scary thought.