Capital Options: Why Now is the Time to Act

As the housing and economic crisis continues, financial institutions are at the center of losses due to asset value declines. While both community banks and credit unions are experiencing some “spill over” losses on loans, each has different ways of responding to diminished capital levels.

 
 

Credit union capital is on the "front burner" once again. Many credit unions have seen ROA declines in recent quarters. Depending on asset growth, this decline may reduce the net worth ratio. One way some credit unions approach this situation is to shrink the balance sheet by "running off" shares. While this strategy might maintain the net worth ratio, it is neither sustainable nor responsive to member needs.

As the housing and economic crisis continues, financial institutions are at the center of losses due to asset value declines. While both community banks and credit unions are experiencing some "spill over" losses on loans, each has different ways of responding to diminished capital levels.

Many of the largest banks with shrinking capital look to raise additional capital through the sale of stock. Credit unions on the other hand, have no such option. If a credit union were to lose a substantial amount of capital, it must earn the capital back again, year after year. As detailed in the graph below, average capital growth rate is 8.3%. Given this figure, in the most extreme case of a credit union losing all of its capital, it would take around 12 years in order to earn it back. This number assumes no asset growth. Similarly, if a credit union lost only a quarter of their capital, they would still require approximately three years in order to return capital to its previous level.

In the current crisis, there is no doubt Congress will pass legislation that will impact credit unions, directly or indirectly. Therefore, now is an ideal opportunity to suggest changes in credit union's capital structure that will have long-lasting implications for the Movement's vitality.

 

 

 

July 28, 2008


Comments

 
 
 
  • As usual, Chip knows which issues are important. Credit union access to alternative capital stands near the top. Alternative capital should be an option and not mandatory, but it could assist CUs to match their competitors in deploying infrastructure, inject a bit more market discipline into a CU''s operation, and give CU consumer members a chance to actually invest in the CU. Rather than reduce capital requirements like some in the industry adcvocate, alternative capital increases it. If credit unions intend to spend "political capital", why not spend it on something that every credit union can choose to use like alternative capital instruments?
    Marvin Umholtz