Capital is King

Well-capitalized CUs can weather difficulties and protect the insurance fund from losses.

June 17, 2013

The lesson from the recent financial crisis for all financial institutions is that capital is king.

It’s the first line of defense in protecting federal deposit insurance funds from losses. And it’s in everyone’s best interests to have financial institutions that are well-capitalized and able to weather difficulties.

So given that, why shouldn’t credit unions have access to more capital without disrupting their cooperative structures, but at the same time protecting the credit union difference?

We can see no reason why not, and neither do two of our champions in the U.S. House of Representatives: Peter King, R-N.Y., and Brad Sherman, D-Calif. They’ve introduced HR 719—the Capital Access for Small Businesses and Jobs Act. This bill would strengthen credit union capital, but still be consistent with credit unions’ not-for-profit, cooperative nature.

It can be done—and more important, it must be done.

At the beginning of the Great Recession in 2007, credit union net worth (capital) stood at 11.5%. But by the nadir of the recession—year-end 2009—net worth had dipped to 9.9% as credit unions grappled with a slowing economy and, consequently, lower loan demand and lower returns on investments.

We’ve come back. At year-end 2012, net worth across the board was 10.4%. That’s a remarkable achievement for credit unions, most of which can only build net worth from retained earnings.

But a further comparison shows just how far credit unions still have to come back. The aggregate net worth ratio in 2007 (11.5%) stood more than one percentage point higher than the banking industry’s equity capital ratio at that time.

By year-end 2012, however, this ratio was one percentage point lower than the banking industry’s average.

Still, credit unions are doing quite well. CUNA economists estimate that, by the end of next year, the overall credit union capital-to-assets ratio will rise to 10.9%. During the next two years, economists expect capital growth to outpace asset growth (spurred on by projected savings growth of 5%), pushing the capital-to-asset ratio toward its record level of 11.5%.

Now, suppose asset growth speeds up. And suppose members, especially newer ones escaping from for-profit banks, entrust more of their savings to their credit unions.

CUNA economists have already made some calculations. Suppose, for example, a credit union with 7.5% net worth at the end of 2012 sets a goal of reaching 9% net worth (assuming 80 basis points return on assets annually). If assets grow at the 5% rate, it will take three years for this credit union to reach 9% capital. But let’s say assets grow 7.5%. At that pace, assuming all other things are equal, it will take the credit union seven years to reach its target.

Assume an even faster asset growth rate of 10% (not out of the realm of possibility). With that growth, the credit union will never reach its 9% target.

And while the credit union is attempting to boost its net worth, solely through retained earnings, credit union members might face a long drawn-out period of reduced services (lower dividends, higher loan rates, fewer branches, or the delay of mobile banking services).

The practice of reducing services is not why credit unions exist.

Access to supplemental capital— particularly as proposed in H.R. 719 to sufficiently capitalized, well-managed credit unions—would allow credit unions to grow responsibly, ensure their safety and soundness, and offer a full range of financial services to members. That’s why NCUA Chairman Debbie Matz recently wrote a letter to Congress in support of this important legislation.

Securing access to supplemental capital is part of CUNA’s overall objective of enhancing the credit union charter, which is one of three legislative priorities for CUNA (the others being protecting and preserving the credit union tax exemption, and reducing the regulatory burden on credit unions).

Can this be the Congress to accomplish that? If it can, we remove a key barrier to growth for credit unions—and open a door to a better future.

BILL CHENEY is CUNA’s president/CEO.