Can the Credit Union Industry Survive -- Its Regulator?

It is axiomatic that regulators never act before a crisis.  But the public still does not understand the degree to which regulators encourage acts of willful idiocy for political purposes.  Witness the recent track record for The National Credit Union Administration, the supposed regulator of the credit union industry, which has become an engine of systemic risk in this small but significant credit sector. 


The credit union industry is a bit over $1 trillion in assets, mostly in very small institutions around the country.  The NCUA has a federally insured insurance fund.  The skew towards very small institutions in the world of credit unions is even more severe than among banks, where 6 out of every seven depositories is a community bank.


The NCUA took an especially severe kicking in the subprime mess, with several corporate credit unions gutted by losses on subprime securities.  A tab measured in the tens of billions of dollars still awaiting a final resolution.  See my comment in American Banker, “Say No to More Lending Power for Credit Unions,” describing how the largest corporate credit unions dug an amazing financial hole by speculating on subprime debt – with the full knowledge of the NCUA and other federal regulators.


This fiscal black hole created by the NCUA is guaranteed by US taxpayers and now threatens the existence of little credit unions around the nation.   My esteemed friend and business partner Dennis Santiago, CEO of Institutional Risk Analytics, recently published ratings for credit unions as part of The IRA Bank Monitor.  For example, let’s look at the Doe Run credit union in Brandenberg, KY.  


The Doe Run depository is rated “Good” by IRA, but is also quite fragile in terms of its ability to absorb loan losses.  The $8.8 million asset depository had 20% of its assets and most of its liquid reserves invested in corporate credit unions at the end of 2011, of note.  In good quarters, this little credit union in KY does about 0.4% ROA.    


In 2011, assessments for the NCUA corporate credit union “stabilization” fund were consuming more than $6,000 out of the Doe Run credit union’s $20,000 or so in income for the year.  Retail credit unions like Doe Run are captive of the badly run corporate credit union vehicles, which are mismanaged under the watchful eye of the NCUA.   


The NCUA still cannot or will not tell its member institutions the true scale of the losses due to mismanagement at corporate credit unions.  Suffice to say that the corporate credit unions bought some particularly nasty toxic waste from the subprime zombie swamp.  This crisis affecting credit unions is one of the least recognized and reported aspects of the financial crisis.  Assessments needed to repay the Treasury could cripple the capital generation of credit unions for years.


Keep in mind that the NCUA has been audited repeatedly by the GAO and internal auditors over the past decade and found severely deficient in terms of internal systems and controls.  Nobody really, even today, knows the full extent of the losses in the NCUA.  But this is also why the back-door effort by the NCUA to allow business lending by credit unions is especially ill advised.  

The NCUA has allowed credit unions to make loans to small businesses under several loopholes known as member business loans or “MBL,” this in an effort to increase income in the industry.  Why?  Income is needed to fill the yawning deficit in the NCUA insurance fund due to the financial speculation by the now defunct corporate credit unions and several others on life support.  


Allowing expanded MBL lending is essentially a strategy to “double down” on the risk taken by credit unions, institutions which lack the people and the systems to effectively monitor small business credit.  Loan losses at credit unions will likely increase as a result, putting increased stress on these lightly capitalized banks.  Jeff Gerhart, chairman of the Independent Community Bankers of America, put it simply:


“The MBL cap was not set arbitrarily. Its purpose, as described by the Senate Banking Committee, is ‘to ensure that credit unions continue to fulfill their specified mission of meeting the credit and savings needs of consumers, especially persons of modest means, through an emphasis on consumer rather than business loans.’  With the NCUA’s sweeping expansion of MBL authority, which is sure to harm community banks and significantly increase risk to the National Credit Union Share Insurance Fund, why is MBL legislation needed at all?”


The push to give business lending authority to credit unions is a red flag.  Let’s recall that most regional and community banks are not equipped to deal with significant business lending exposures.  Banks have larger profits to support such activities than do credit unions, yet most banks stay away from business lending.  


All but the largest credit unions are simply too small to justify the people and resources needed to underwrite and service small business loans in a safe and sound manner.  Small business loans are often too small to be profitable.  Keep in mind too that most banks are already fleeing small business lending, so the idea of credit unions jumping into the gap and actually making money is truly madness.  


But if you are a regulator like the NCUA facing a financial black hole in your insurance fund and members of Congress anxious to promote growth, what do you do?  You double down on the bad bet and allow credit unions to expand small business risk exposures.  This is easy to sell up on Capitol Hill under the rubric of “job creation,” but the effect on the credit union industry and the economy will likely be negative when the full cost is totaled.  The real question, though, is whether the credit union industry can survive the continued operational chaos inside the NCUA.