A recent Wall Street Journal article (How Credit Unions Outgrew Their Down-Home Reputation by Ben Eisen) asserted that credit unions are “using their newfound financial heft to compete aggressively for business” and openly worried that “[e]conomists and analysts are uneasy about how these bulked-up credit unions will fare in a recession.” This handwringing strikes us as ill placed for a host of reasons.
First, despite their prolific growth over the past several years, credit unions remain a rather minor systemic player. To put it in perspective, the entire industry counts $1.56 trillion of assets, more than a trillion less than what is held in the accounts of the nation’s largest bank alone ($2.74T). Second, through regulation and careful underwriting, the balance sheets of the nation’s credit unions are remarkably simple (on both the asset and liabilities sides) as compared to the typical bank. Third, both the nature of the credit union business model and the composition of the typical CU loan portfolio can be risk mitigating. Rarely are credit unions given enough credit for intimately understanding their customers and the risks that they underwrite. And, the modest size of the average CU loan minimizes the risk of any single default. Fourth, we wonder whether efforts to keep credit unions and their members from more esoteric assets are motivated by the soft bigotry of low expectations. Finally, if credit unions as a class of institutions have an idiosyncratic risk, it derives from the concentration of their loan portfolios – in many ways, a risk that might be mitigated by writing some of the very types of loans that the article bemoans.
Any systemic riskiness of credit unions must be understood in perspective. First, if today's financial assets were broken into 100 pieces, the banking industry would control 92, with just 8 belonging to CUs. Yet, banks continue to focus attacks on credit unions, their regulation, their tax status and their business model. Unlike other depository institutions, credit unions are mutually owned and generally do not carry debt. At Olden Lane, we do assist a small number of credit unions that service low-income fields of membership to raise “Secondary Capital” – the credit union equivalent of subordinated debt. Even so, the industry’s total secondary capital outstanding is less than $300 million. And, if a CU does receive secondary capital, it must come from an institutional investor and it protects taxpayers, as it is subordinated to the industry’s National Credit Union Share Insurance Fund. The average credit union boasts $288 million in total assets, 22,000 member/owners and an average loan size of $15,000 – hardly the attributes of systemic risk.
Credit unions are also mission driven. As non-profit cooperatives, credit unions routinely reinvest back into their institution and its members. Absent the requirement of a return for shareholders, credit unions can be competitive in the markets they enter – offering better rates for depositors and borrowers and lower fees. Perhaps the fear of this competition in new markets motivates a mindset like that of the article’s author.
Credit Union balance sheets are quite simple. On the asset side, permissible investments are quite limited by smart regulation aimed at promoting a safe and sound industry. Loans are predominantly extended in traditional categories and the typical CU portfolio is well diversified. For example, as of the latest quarter, 41% of credit union loans were first mortgages, with 21% of loans in used autos, 14% in new autos, 8% in other real estate and 6% in credit cards. Less than 10% of all loans written by credit unions fall in the “other” category about which the article’s author raises such concern. And, while Mr. Eisen’s article implies that, in recent years, credit unions have jumped head-over-heels into auto lending and “now make nearly a third of U.S. auto loans,” he fails to describe how lending decisions evolve with time. For example, a recent Experian report shows that credit union auto finance originations are shrinking year-over-year, and banks have increased those originations at nearly double the rate of the CUs’ slowing.
On the liabilities side of the balance sheet, credit unions generally attract deposits from members in the form of regular shares, share certificates, share drafts, money market shares and IRA and Keogh accounts. CUs can also borrow money from corporate credit unions and the Federal Home Loan Bank system. Again, not the makings of a significant systemic risk story.
While other financial institutions look at numbers, credit unions look at the numbers and their members. And often, they know their members on a personal level. Customer service is in the credit union DNA. It is essential to the credit union mission.
If a credit union member has done well for him/herself – perhaps after years of saving and responsible financial behavior in concert with his/her credit union – why should he/she be denied the opportunity to take a loan from that same institution for a hobby craft – be it a boat, plane or RV? This article suggests that only a bank should be handling such a transaction. Missing from the analysis are the wishes of the credit union or its members. Absent too, is any concession that during the financial crisis, credit unions experienced nowhere near the surge of failures seen in the commercial banking sector. In 2008, for example, the rate of commercial bank failures was almost triple that of credit unions (0.60% to 0.23%), a rate that increased to almost five times the credit union rate by 2010 (1.86% to 0.40%).
Mr. Eisen’s article does contribute in cautioning that CUs should be deliberate as they migrate into these more esoteric loan classes. If underwritten correctly, however, these unconventional loans can be terrific diversifiers for the typical credit union portfolio. And, credit unions offering terms which other depository institutions cannot match can be beneficial to the market – making these loans more accessible to members. Again, this is wholly consistent with the credit union mission.
In large measure, today’s credit unions have been able to ramp up their lending because they avoided the mistakes of their banking brethren leading up to the financial crisis. With an industry net worth ratio of 11.39% (Q3/2019), today’s credit union industry is desirably well above its regulator’s well-capitalized level of 7.00%. And, the industry-wide delinquency rate is teetering at historical lows (0.67%), meaning that most credit unions are well positioned to grow lending responsibly. While the article asserts: “[CUs] have grown beyond what they were designed to do” it takes a needlessly narrow view of the credit union mission. Credit unions exist to offer an alternative to traditional banks. Credit unions employ a cooperative model where interests of customers or “members”, and not shareholders, is primary. Throughout its history, the credit union movement has been instrumental in expanding banking to under-served and under-banked communities and improving competition in the market generally by offering loans to those who may not qualify for one at a large bank or offering the same loan at a better rate. The fact that the member's wishes might have expanded beyond a house or a car should be of little matter.