CUs Embrace Alternative Capital

July 16, 2010

Credit unions worldwide are struggling to generate sufficient capital from retained earnings. An international panel addressed the issue of finding alternative capital without impinging on credit unions’ mutual structures during The 1 Credit Union Conference in Las Vegas this week.

In Australia, credit unions have access to alternative capital, but struggle with the question of how to ensure protection of their mutual status, said Dave Taylor, CEO of SGE CU Ltd., Australia.

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They can raise capital through a mutual capital raising auction but these may not be suitable for all credit unions, Taylor said.

The first aggregated mutual capital issuance began in 2006. Twenty-one credit unions collaborated to access cheaper capital at large volumes through special vehicles in two tiers.

They achieved a higher credit rating due to their collective strength, and built market credibility. Implementation challenges included more regulators, legal and tax structures of the special vehicles, ongoing licensing and management of the vehicles, and rating by Standard & Poor’s.

“These require strong trust and cooperation,” as well as high levels of management and board expertise, said Taylor. They can help maintain sustainable business, but are not a solution for underperformers, inadequate profitability and poor business models.

Jim Updike, CEO of Honda Federal Credit Union, Torrence, Calif., noted that he’s “chagrined that the U.S. is so far behind in addressing capital.”

U.S. credit unions must have 7% capital to be considered well-capitalized—200 basis points above banks’ 5%.

He noted three policy principles for alternative capital:

  • Preserve cooperative mutual credit union model;
  • Have robust investor safeguards; and
  • Have prudential safety and soundness.

“Alternative capital has proved its utility in other highly developed credit union movements,” said Ralph Swoboda, moderator and principal, The ProCon Group. Done properly, it could constitute a viable capital source.

Swoboda noted two sets of issues:
* Capital raised from members outside institutional investors (subordinated debt) requires a change in law, and there are costs related to dealing with and distributing capital; and
* Risk should relate to return.

“Setting up a facility to collectively raise capital from individual members pooled and paying patronage dividends as equity share requires discipline in business and a financial approach,” he said.