Credit Unions – Strengths and Weaknesses

Almost a year has passed with respect to the mortgage and banking related crisis in the United States and very few stories have been done on the safety and soundness of credit unions. Given the aggressive move into real estate loans by many credit unions, many are asking one simple question. How safe are my deposits? Having previously been a CFO of a major credit union and strong advocate of credit unions, here are a few thoughts that might be helpful.

1) Credit unions are not insured by the FDIC but rather the NCUA (National Credit Union Administration). This NCUA insurance pool has never really been tested and in my opinion should be greatly expanded via increased dues from member credit unions.

2) The NCUA is one of the strongest lobbies in Congress, similar to Fannie Mae in this respect. One successful lobbying effort has resulted in geographic chartering with respect to membership bases. This was once unthinkable since credit unions are tax exempt. In the old days you had to be a member of a defined group, for instance a certain employer.

3) Credit unions have been aggressively involved in real estate lending for about 15 years and often do not sell the loans to Fannie Mae but rather keep them on their own books. This decision has looked good thus far yet if rates were to rise sharply they could end up paying higher rates for deposits than they are earning on the loans. This is what happened to S&L’s.

4) Executive compensation is not fully disclosed in many credit unions and given their not for profit status, now would be a good time to make sure this disclosure is made in a practical standard filing and posted to the internet. Making this all the more necessary is the agressive use of CUSO’s (Credit Union Subsidiary Organizations) within which many activities that are not tax exempt are conducted, for example the sale of annuity based investment products. Most credit unions now have these.

5) Credit unions are required to maintain adequate capital ratios, just like banks, and failure to maintain them will result in regulators forcing them to merge with better capitalized credit unions. This is particularly important given the ease with which credit union members can withdraw deposits and the high loan to deposit ratio many now have due to real estate lending activities.

6) Loan loss reserves at many credit unions are now very low and do not reflect the underlying risk of many credit unions loan portfolios. What this is also doing is artifically inflating capital ratios.

7) Surplus deposits not loaned out to members are generally invested in Fannie Mae and Freddie Mac mortgage pool securities. Clearly, many of these investments require a writedown and such adjustments will directly impact a credit unions capital ratio. Even if the loans are fully repaid, there will still likely be large losses since the credit unions often paid a hefty premium and these premiums will be lost as refinancing occurs at an accelerated pace due to government programs designed to improve the overall real estate market. This is indeed perhaps the biggest untold story, the losses not yet recognized on premiums for mortgage pools purchased by banks and credit unions that were bought on the assumption of having a life of say 10 years that will instead be amortized over 2-3 years as unexpected refinancing is stimulated by the government.

Conclusion: Credit unions are great organizations yet they were designed to help provide access to credit, not as a place for significant deposits. As always, buyer beware of that money market account paying 2 percent above the current treasury rate. That difference is pure credit risk and clearly that is not a good risk if it involves a large share of one’s assets.