Why Credit Unions Need Supplemental Capital

Michael Wettrich, president and chief executive of the $90 million Education First Credit Union in Ohio, makes the case for supplemental capital at credit unions.

 
 

Michael Wettrich is the president and chief executive officer at Education First Credit Union ($91.8M, Westerville, OH). Wettrich has been at Education First since August 2014. Prior to that, he was a credit union regulator for the state of Ohio and served on the board for the National Association of State Credit Union Supervisors, including as the board chair. As a regulator, he was a proponent of supplemental capital and has continued that stance as a credit union executive. For the record, Education First does not use supplemental capital.

Michael Wettrich, President/ CEO, Education First Credit Union

The last one we chartered in Ohio was Nueva Esperanza. It received grants, that,, placed into its retained earnings account, represented its capital. It was given a $100,000 grant on $1,000,000 in at-risk deposits — that’s a 10% capital base to start, and allows the institution to better establish their business model. That’s not going to happen if I have $1 billion in assets and my members love me but organic growth has diluted my capital to 6%. The credit union will have to adjust its business model and pull back on all the plans they put in place and likely took years to implement.

So there should be a mechanism for supplemental capital. We can’t raise capital like banks and private placement security offerings for capital just isn't the credit union way.

 

 

Take The Cooperative Model Further

If we wanted to build a structure for supplemental capital, we match the “haves” with the “have nots.”

Warren Buffett goes to Bank of America and says, “Sell me some preferred stock with a preferred rate and I’ll give you the money you need,” and BofA can count it toward its capital.

CU QUICK FACTS

Education First Credit Union
Data as of 03.31.15

HQ: Westerville, OH
ASSETS: $91.8M
MEMBERS: 15,294
BRANCHES: 3
12-MO SHARE GROWTH: 0.2%
12-MO LOAN GROWTH: 6.8%

Why can’t we do the same with credit unions with capital-ratios above 12-15%? They can take their excess capital and put in credit unions who are, say, under 8%. Those credit unions that need the capital will pay the premium on it. It won’t be insured, but it’ll get a priority payout in the case of liquidation.

This way, the credit unions that need capital can access it through their fellow credit unions. They would have to do a presentation to another group of credit unions that are potential investors — that’s how it works in the free market. And these credit unions that have excess capital will be able to earn a premium on it and thus support the cooperative movement without it being purely a case of charity.

Let’s say the average share rate at my credit union is at 2.0% and they desire $1 million in supplemental capital. They might pay 4% (400 basis points) for it, so I would give a 2.0% premium to thte investing credit union because it doesn’t have many loans and would appreciate that relatively low-risk investment, returning them 4.0%.

This way, credit union capital does not leave the credit union system; it’s still under NCUA’s purview.

This is essentially how the NCUA insurance fund works. If reserves decrease too low, NCUA as the National Credit Union Share Insurance Fund administrator can taps the capital of every credit union it insures to pay for losses.  

NCUA could adopt a framework that says if you have a certain amount of capital, you can access and invest in the capital network. On the other hand, if you need capital there should be stipulations, such as the term cannot exceed two years, the premium cannot exceed market plus 200 basis points, and you have to submit quarterly data to the credit unions who have invested in you. There are a lot of ways to do it.

One of the first things I learned back in the 1990s is "capital is king." That’s as true today as it was 25 years ago. Those who have capital — who can leverage it or employ it as they see fit — can earn as much as they want on it.

The capital market I have outlined, to me, is a way to get capital to those who need it without getting NCUA involved to the point where you need §208 assistance. Decisions made by those who have a stake often perform better, and allows for further innovation in our industry, with less regulatory intervention.

Next: Why NCUA Is Hesitant To Allow Supplemental Capital »


Why NCUA May Be Hesitant To Allow Supplemental Capital

The net worth-to-assets ratio (as part of the Key Ratios) is one of the first pages of any exam report. That’s what regulators and insurers look at. If capital is suffering, that’s an easy, low-hanging item for the examiners or NCUA to say, “Hey get this in shape.” The more control you have over those hard-and-fast (risk-based) net worth ratios, the easier it is to require credit unions to maintain certain levels of capital adequacy.

To mess with that and to give widespread access to supplemental capital would require NCUA to be a stronger insurer — and a better regulator — because it would have to look far beyond that capital ratio. It could mean a longer examination process, more examiners, and less investment authority for participants in the program.

This kind of capital discussion is great because it takes away a lot of black-and-white issues: Capital ratios go down, so NCUA says to increase capital. What if capital is going down because it’s diluted through growth and not because a credit union is losing money? If it’s going down because the credit union is losing money, then its generally that expenses are exceeding income. That’s a pretty easy explanation.

When you match the “haves” to the “have nots,” the problem takes care of itself. If a credit union isn’t doing what it should be doing or it does not have a viable plan, it’s not going to have folks (other credit unions) lining up to invest excess capital.

I agree that credit unions shouldn’t live on supplemental capital. An independent check and balance is that those with excess capital wouldn't (or shouldn't) put it into credit unions that are losing money if the business model isn't sustainable. Essentially, those that have diluted or grown out of their capital will still be profitable and should have no issues getting supplemental capital. Those that are losing money year after year are probably not the best candidates for supplemental capital unless they can make the sound case for why they lost money.

When you match the “haves” to the “have nots,” the problem takes care of itself. If a credit union isn’t doing what it should be doing, it’s not going to have folks lining up to invest excess capital.

The Future Of Supplemental Capital

This recent conversation about supplemental capital started because we’re all hot and heavy over the new risk-based capital proposal. Having worked on both sides, my opinion is that NCUA (and regulators in general) wants  — as any insurer would — as much capital as can be required at any institution because it creates a less burdensome examination process. NASCUS recognized this and wrote a white paper in 2005 on alternative capital, understanding that credit union growth, while good for members and the industry, has consequences that the current capital constraints could not resolve.

Instead, how about we examine correctly or put the risk-based capital model in place but make sure there is an outlet for capital to reach my institution. Why set credit unions up to fail or limit their business model because no true form of supplemental capital exists? If the NCUA implements risk-based capital without a way to raise supplemental capital, we’re going to have fewer players in the credit union space. Some will look at this capital model and their community impact and convert to a community bank charter. Fewer credit unions means more asset (and risk) concentration for those who remain, yet credit unions thrive because the more institutions that act as financial intermediaries, the better society is, in general.

For me, that’s a true credit union statement. More credit unions mean more access. While there is more risk because there are more credit unions and some do it better than others, at the same time we have more folks with access to financial products, which is important because there are still too many unbanked people in this county.

Each time NCUA changes the rules it has an unintended impact on the business models and operations at credit unions; making it harder for us to sustain something that could have been years in the making. I understand we’re trying everything we can to protect the members, but that’s why there is an insurance fund. If my credit union is not doing it right, then as my insurer, tell me specifically what’s wrong. Don’t adopt instate blanket rules designed to make it harder to make a profit to generate the only form of capital we have, it will cause a shift in our operations and perhaps set us back years. A successful credit union industry must be supported by successful programs to keep it viable. Supplemental capital, without Low Income designation or CDFI, is key to true capital reform.

— As told to Erik Payne

 

July 27, 2015


Comments

 
 
 
  • Thank you Mike. As a regulator you were thoughtful, fair and effective. As a credit union professional, I look forward to your continued support of the cooperative movement. My own involvement in chartering echoes your comment about the difficult road a new credit union faces without adequate capital. The difficult balance is still how to balance the need to retain the cooperative form against the inevitable pressures that non-ownership capital will bring.
    Bruce Jolly