1. Federally Insured CU Capital Rules for Coops in Puerto Rico
Bill Hampel
Credit Union Economic Consultant
August 27, 2018

2. AGENDA NCUA’S Prompt Corrective Action Rule How PCA actually works
Puerto Rico’s credit unions under a PCA system:
What counts as capital?
Earnings ability?

3. PROMPT CORRECTIVE ACTION (PCA)
PURPOSE: Minimize losses to the National Credit Union Share Insurance Fund
First ever capital requirement for credit unions, enacted in 1998, implemented in 2000
As net worth ratio falls below “adequately capitalized”, regulator required to act, promptly
Precludes “forbearance” by regulators
Initially a response to the Federal Savings and Loan Insurance Corporation (FSLIC) debacle of the 1980s

4. PCA Driven by Net Worth Ratio
Ratio of net worth (capital)to total assets
Net worth defined as retained earnings
Includes undivided earnings (sobrantes), regular reserves (reserva capital indivisible), and other reserves (otras reservas)
Excludes allowance for loan losses (reserva prestamos incobrables)
Excludes unrealized gains or losses on Available for Sale and Held to Maturity Securities (reserva valorizacion de inversiones)
Secondary capital permitted for “Low Income” credit unions

5. Secondary Capital
Secondary capital is an uninsured account, best described as a subordinated debt or loan. In the event of a credit union’s liquidation, secondary capital claims are subordinate to all other claims on the assets of the credit union, including claims of shareholders, creditors and the National Credit Union Share Insurance Fund. Going concern: Secondary capital must also be available to absorb losses in the event that retained earnings are used up. Depleted secondary capital cannot be later replenished. See Part of NCUA’s Rules and Regulations

6. Secondary Capital: NCUA’s Description
Secondary capital is uninsured and at risk. Each investor must execute a disclosure to this effect.
The credit union must have a written secondary capital plan approved by the Regional Director prior to accepting secondary capital accounts.
There is a minimum five-year term.
The amount of secondary capital that can be counted as net worth declines 20 percent each year for the last five years until maturity.
The portion of secondary capital that no longer counts as net worth may only be redeemed with written approval of NCUA.
Secondary capital can only be accepted from non-natural person (organizations, not a single-individual) members and non-members.

7. PCA Capital Classifications

8. Supervisory Actions: Depend on Capital Classification
Capital classification triggers NCUA’s prompt and corrective actions
Mandatory Supervisory Actions
Begin if not well capitalized
Discretionary Supervisory Actions
Applied at lower capital classifications

9. Mandatory Supervisory Actions
Minimum earnings requirement
(10 bp per quarter)
Net Worth Restoration Plan
Asset growth restriction
Member business loan restriction

10. Discretionary Supervisory Actions
Require prior approval for acquisitions, branches, new lines of business
Restrict transactions with or ownership of a CUSO
Restricting dividends
Prohibit or reduce asset growth
Alter, reduce or terminate an activity
Prohibit non-member deposits
Dismiss director or senior executive officer
Employ qualified senior executive officer
Require election of a new board
Restrict executive compensation
Just about anything else

11. Supervisory Actions: Depend on Capital Classification
Four Mandatory Supervisory Actions
First applied at adequately capitalized (6% to 7%)
Remaining three at inadequately capitalized (less than 6%)
Discretionary Supervisory Actions
Can apply to all undercapitalized < 5%
Can apply to between 5% and 6% if not meeting the four mandatory actions

12. PCA in Practice for Federally Insured CUs
Imposition was preventative rather than remedial
Credit unions were already very well capitalized
Most credit unions maintain large cushions above 7%
Avoid stigma of not being “well” capitalized
Concern about supervisory actions
Sometimes, examiners apply PCA actions to well- capitalized credit unions
Net worth restoration plans
Earnings “suggestions”

13. Net Capital to Assets
PCA Passed
PCA Implemented

14. Current Credit Union PCA Classifications
Net Worth Ratio
PCA Classification
% of CUs
% of
Assets
Over 7%
Well Capitalized
97.5%
99.3%
Over 9%
“Very” Well Capitalized
79.7%
81.1%
7 – 9%
“Merely” Well Capitalized
17.8%
18.2%
6 – 7%
Adequately Capitalized
1.5%
0.3%
4 – 6%
Undercapitalized
0.5%
0.2%
2 - 4%
Significantly Undercapitalized
0.4%
LT 2%
Critically Undercapitalized
0.1%

15. Average Capital Ratios for Puerto Rico’s Cooperativas
% OF ASSETS
SPANISH
FICU English Equivalent
PR Coops
FICUs
1. Acciones
1. Shares
26.2% NA
2. Reserva Capital Indivisible
2. Regular Reserves
3.9%
1.6%
3. Otras Reservas
3. Other Reserves
2.2%
1.5%
4. Sobrantes
5. Undivided Earnings
-0.2%
7.9%
5. Reserva Valorizacion de Inversiones
4. Investment Valuation Reserve
-0.3
-0.3%
: TOTAL DE CAPITAL / TOTAL CAPITAL
31.7%
2+3+4: / RESERVAS Y SOBRANTES / RESERVES AND UNDIVIDED EARNINGS
5.8%
11.0%

16. Average Capital Ratios for Puerto Rico’s Cooperativas
% OF ASSETS
SPANISH
FICU English Equivalent
PR Coops
FICUs
1. Acciones
1. Shares
26.2% NA
2. Reserva Capital Indivisible
2. Regular Reserves
3.9%
1.6%
3. Otras Reservas
3. Other Reserves
2.2%
1.5%
4. Sobrantes
5. Undivided earnings
-0.2%
7.9%
5. Reserva Valorizacion de Inversiones
4. Investment Valuation Reserve
-0.3
-0.3%
: TOTAL DE CAPITAL / TOTAL CAPITAL
31.7%
2+3+4: / RESERVAS Y SOBRANTES / RESERVES AND UNDIVIDED EARNINGS
5.8%
11.0%
NET WORTH FOR PCA

17. Imaginary Net Worth Restoration Plan for PR Coops
Assuming Special Investments at par. ROA = 30 bp
Asset Growth Rate 0% 2% 4%
Years to Well Capitalized (7%) assuming no losses on “special investments” 4 6+ 8
Annual Earnings Drag of Paying
Losses on Special investments During New Worth Restoration Period
50 bp
47 bp
42 bp
Required ROA before Special Investment Write Down to Reach Well Capitalized in 10 Years
62 bp
72 bp
79 bp

18. Conclusion
Operating under Federally Insured Credit Union Capital standards (PCA) would be difficult:
Only primary (retained earnings) capital counted
Would require both replenishing ”special investment” losses and building capital to 7%
Would require several years of very strong net income
Weakened island economy from hurricane damage and fiscal problems make credit union net income more difficult.

19. Capital in the Puerto Rican Coop System
Millions of $
% of Assets
Reserves and Undivided Earnings
$500
5.6%
- Unrealized Losses on Goverment Bonds
$600
6.7%
= Net Position
-$100
-1.1%
+ Target at 6%
$540
6.0%
= Additional Capital Needed
$650
7.14