The Future of Corporate Credit Unions

Editor’s Note: The Illinois Credit Union League’s annual convention begins this Thursday. This week I will post a series of articles about topics that I expect to be major discussion points this weekend. Today, I look at the future of corporate credit unions.

Four days after NCUA regulators took control of U.S. Central and Western Corporate in March, prominent banking analyst Meredith Whitney told participants at the Wall Street Journal’s Future of Finance Initiative that the big-bank model isn’t going to last much longer. A more sustainable approach would be bigger regional banks, Whitney said. This too may be the future for corporate credit unions.

What Are Corporate Credit Unions?

As I explained a few weeks ago, corporate credit unions are to the credit union industry what the Federal Reserve System is to commercial banks.

Each [corporate credit union] is a private non-for-profit institution that is owned by natural person [consumer] credit unions. These corporate credit unions provide low-cost financing services and competitive investment and lending rates to their members, just like the Federal Reserve System. They are, in fact, credit unions for credit unions.

Prior to deregulation in the 1970s, there was one corporate credit union operating in each state. That number has been cut to 28 corporate credit unions today. Each of the approximately 8,000 consumer credit unions can choose to affiliate with any corporate credit union they choose.

What Happened?

As early as 2003, corporate credit unions started increasing their investment concentrations in mortgage-backed securities (MBS) because they provided better yields than traditional sectors while remaining highly rated. The NCUA told corporate credit unions to stop buying non-agency MBS in mid-2007 as the securities started to show signs of stress. But by 2008, MBS made up 79% of WesCorp’s portfolio and 34% of U.S. Central’s portfolio, according to Reuters.

Senior managers at WesCorp were prepared to report an impairment figure for certain securities as of December 31 that was based on the lower internal estimate, the National Credit Union Administration said.

An external analysis by [WesCorp] resulted in a credit loss estimate more than $500 million greater than WesCorp’s internal estimates, the credit union regulator said.

But warning lights had been blinking already. In January, for example, NCUA injected $1-billion into U.S. Central after the corporate credit union suffered dramatic declines in the value of MBS in its portfolio.

MBS are dragging down other corporate credit unions too, but there is another growing threat.

The Next Crisis: Commercial Loans?

The press and public have paid considerable attention to the crisis resulting from MBS. A growing trend among mid-sized commercial banks is the percentage of defaults within commercial lending portfolios.

Mid-sides bank loan portfolios are more than 50% commercial. This “rolling recession” among investment classes is a new threat that could further compound the corporate credit unions. Managers must keep their eye on this trend and work to shore up collateral on any questionable assets in their portfolios.

Why Consolidation Makes Sense

Last week, Navy Federal called for the abolition of the corporate credit union system altogether. As the largest credit union in the world, Navy Federal doesn’t use a corporate credit union. On the other hand, most credit unions don’t have $35-billion in assets among 3-million members. Corporate credit unions give consumer credit unions the resources to serve their members.

Scrapping a system used by thousands of credit unions does not make practical sense. It is akin to abolishing the Federal Reserve System because of a few problems among major banks.

Regionalization—through consolidation or merger—is a better path.

Merger and acquisition has been popular among consumer credit unions as a means of survival as well as a business strategy in the best interest of credit union members. In most cases, credit unions emerging from merger are stronger and able to offer better services to their members.

Commercial credit unions, in the best interest of the member credit unions they serve, should look to merger and acquisition in the same way.

What do you think? Would corporate mergers concentrate the system too much? Concentrate risk?

Here are other articles I have written on this topic:

• A Brief Explanation of the Credit Union System
• How Your Credit Union is Helping Fix the Credit Crisis
• ACU in Black for Second Year
• Previewing the Illinois Credit Union League Convention
• Beige Book’s Midwestern Summary
• Argonne Credit Union Annual Meeting
• Argonne Credit Union Board Passes Merger Resolution
• Credit Union Board of Advisors
• Network Upfront Ends; Prices Down
• Three Ideas To Position Yourself for the Recovery