ALEXANDRIA, Va.-NCUA Chairman Dennis Dollar responded recently to questions posed by top financial services lawmakers regarding the problems with the current Prompt Corrective Action system and credit unions' use of secondary capital. House Financial Services Committee Chairman Mike Oxley (R-Ohio), Ranking Member Barney Frank (D-Mass.), and committee member Brad Sherman (D-Calif.) submitted eight questions to Dollar earlier this summer to follow up on his proposed risk-based PCA plan that came up during a hearing on the regulatory relief legislation. Dollar's PCA recommendation would change the denominator in the net worth ratio from total assets to risk weighted assets, allow the NCUA Board to define what assets are risk-weighted, repeal the current PCA law, and allow NCUA to set a minimum requirement for primary capital. "The flaw in the present system of PCA is that it focuses from the outset on all assets, instead of concentrating exclusively on risk assets which is the true source of the risk of loss and more accurately reflects a credit union's ability to manage and absorb risk," Dollar wrote in the question and answer enclosure included with his letter. "Implementation of such a risk-based system would not be uncharted territory for NCUA or federal credit unions," he added. He noted that prior to H.R. 1151, credit unions operated under a similar risk-based approach. In response to the questions, Dollar's letter stated that the economy, as measured by the Gross Domestic Product, does not have a statistical correlation with credit unions' net worth dollars. However, he said it was important to recognize that the economy did not have to endure a period of truly weak growth in the last 10 years. The chairman also pointed out that other external factors, such as the events of September 11, 2001 and the wars in Afghanistan and Iraq, have also affected net worth. Credit unions' net worth grew from $21.1 billion in 1992 to $59.7 billion in 2002 for an increase of 182.9%. On the other hand, the net worth ratio at credit unions increased just 32.5% in the same period, from 8.09% to 10.72%, because of the high level of asset growth, 133.6%, in that stretch. Dollar indicated that a strong correlation does exist between the decline in the S&P 500 over the last few years and credit unions' share growth. However, the correlation to growth in net worth is less conclusive. Of the agency's overall experience with secondary capital, Dollar wrote, "Although there are increased institutional management responsibilities and agency supervisory requirements associated with credit unions receiving secondary capital, there have been few problems that we have not been able to manage through the supervision process." Currently there are 58 low-income credit unions, ranging in size from $537,000 to $172 million in assets, holding secondary capital. The net worth ratio of 21 of these institutions would dip below 7% if they had not issued secondary capital. Regarding secondary capital at corporate credit unions, Dollar wrote, "The supplemental capital introduced into the corporate credit union system has been a key factor in providing a level of stability. The added capital provides corporates a cushion to absorb any initial losses associated with start-up cost of new products and services. Over the past few years, corporate credit unions have introduced numerous innovative services ranging from share draft imaging to e-commerce. These services are essential for corporates to remain relevant in serving the financial needs of their members. The supplemental capital introduced into the corporate system has helped make it possible for the corporates to develop and implement these new services." He explained that NCUA had not yet had a reason to issue regulations implementing the authorized use of secondary capital for a credit union in a prolonged net worth restoration plan. Though NCUA has not turned away any applications for underserved areas under its Access Across America initiative because of inadequate capital, Dollar hinted that it is possible that credit unions decided on their own not to submit an underserved area proposal to the agency because their net worth ratio was too low. CUNA, NAFCU Chime In CUNA Associate General Counsel Mary Dunn provided a ringing endorsement of Chairman Dollar's response to the congressmen. "The chairman's letter is right on track and right on track with what we've been saying," she said. NAFCU Senior Vice President and General Counsel Bill Donovan said he felt that solid communication between the lawmakers and regulator was imperative. "What we've got going on here is very productive.Key members of Financial Services have expressed an interest in an area a number of credit unions have said they want to see addressed," he said. "That means they've heard the voice of their constituents." While secondary capital can be a touchy subject among the credit union community, PCA reform is not. Dunn admitted that not every credit union wants to take advantage of secondary capital, so CUNA had begun looking at alternative solutions to credit unions' difficulties with PCA. This is "clearly a message to Capitol Hill that there are problems with PCA that need to be addressed," she added. Donovan said that NAFCU has been in contact with Sherman but that he has not indicated his intentions regarding PCA reform with them. He added that Dollar's emphasis that secondary capital and risk-based PCA are not mutually exclusive was in line with NAFCU's position. Neither attorney thought credit unions' strong performance and levels of net worth in the current high liquidity environment would affect legislators' perceptions of a need for modifications to PCA. Better yet, Donovan said, they will be "considering it in a hypothetical context without the pressure of urgency." [email protected]