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Say No to More Lending Power for Credit Unions

The Senate is preparing to consider legislation that would allow credit unions to engage in more commercial lending, a proposal that the industry has long championed. This proposal is a really bad idea, but because of the political constituency behind credit unions it may actually be passed into law. In the event, the National Credit Union Association and the U.S. taxpayer may be facing significant losses in the future.

Several years ago when I appeared before the Senate Banking Committee, Senator Charles Schumer (D-NY) asked me if it would be a good idea for credit unions to be giving expanded powers to make business loans. He related how a small heating oil business in New York was unable to get accounts receivable financing because commercial banks were no longer willing to finance this type of asset.

My response was immediate and unequivocal: No. While Schumer is correct that banks have largely withdrawn from small business lending (at least without a guarantee from the Small Business Administration), this does not mean that credit unions should now fill this very real need. Instead we need to regrow the nonbank financing sector, which was largely subsumed by commercial banks over the past twenty years. Names like Household Finance in the consumer space and numerous nonbank mortgage and commercial lenders must be recreated from scratch.

The first thing that needs to be said is that most commercial banks are not really equipped to make business loans, whether for general commercial  purposes or real estate. While there are some institutions which specialize in business lending and do an excellent job, generally speaking most regional and community banks have limited human, financial and operational resources necessary to make business loans in a safe and sound manner.

When we then move on to considering the capacity of credit unions to make business loans, the situation becomes even more problematic. Most credit unions outside of the top ten largest institutions do not have the internal systems and personnel to even begin to effectively underwrite and manage commercial loans, large or small. 

Keep in mind that when we talk about loans for small business, you are referring to very high risk assets where there is often a single point of failure – a sole proprietor. Indeed, this is why we have an SBA program for government guarantees for small business loans. 

Think about what the credit rating from Moody's or S&P would be for the typical small business – maybe a "B" or "CCC" equivalent.  Neither large nor small  banks, nor credit unions  are prepared to take first loss exposure on such credits. 

A "B" rating from Moody’s, for example, is equivalent to 1,100 basis points of default probability, implying that a lender would need to charge something north of 15-20% per annum to cover the risk on such a portfolio – at least without a government guarantee. This type of "subprime" lending is done by banks  such as Capital One (COF), Citigroup (C) and GE Capital, a unit of General Electric (GE). Does Senate Majority Leader Harry Reid (D-NV) really want to take responsibility for putting small, relatively undercapitalized credit unions into the subprime lending business? Most credit unions in the U.S. are like most small businesses, namely fairly low-tech, mom and pop operations that lack the capital, internal systems and controls and profitability to engage in such lending. 

Going back to my conversation with Senator Schumer, the nonbank lenders who once banked account receivable finance generally had capital levels over 20%. If you look at the leverage ratios of the subprime units of CapOne, Citi and GE, all are in the high teens to low 20 percent range. Credit unions simply do not have the capital to play in the subprime world – unless you are going to dump all of the risk on the SBA and the U.S. taxpayer.  I suspect that this is precisely the agenda of the NCUA and its supporters in the Congress.

Speaking of increased risk to the U.S. taxpayer, the Senate should not act on the credit union proposal unless and until the industry repays all of the money currently guaranteed by the U.S. Treasury to bail out several large wholesale credit unions in 2010. These corporate credit unions wandered into the subprime swamp and are now insolvent.

The Wall Street Journal noted in September 2010: "Under federal rules, wholesale credit unions were supposed to invest only in safe, liquid assets. But some chased higher returns by loading up on securities backed by subprime mortgages or other risky loans. Their portfolios were decimated by the mortgage meltdown."

The NCUA maintains that these borrowings to support corporate credit unions will not be paid by taxpayers, but the fact is that the credit unions as an industry do not have sufficient profits to even begin to repay these debts. Why should the Senate allow credit unions to take even more risk when the industry has already proven that it is incapable of managing complex securities much less risky small business loans?

Christopher Whalen is senior managing director of Tangent Capital Partners in New York. He is co-founder and vice chairman of Institutional Risk Analytics, the Los Angeles based provider of bank ratings, risk management tools and consulting services.

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Comments (13)
It's funny that Mr. Whalen is opposed to this due to the risk to the risk that taxpayers may be stuck with the bill if things go wrong, but he notes that the banks are now only lending when the SBA is on the hook. Given that, how are taxpayers less exposed by bank lending than credit union lending?

Also, I'll agree with Mr. Weinberg's qualification, but add that the same requirement should be applied to the big banks too. Do you think that could happen? The big bankers who own the government and rig the game will laugh until the cocktail hour at that proposal...
Posted by j.doe | Tuesday, April 17 2012 at 3:46PM ET
If the idea that as long as money is out of the US Treasury that financial services industry should not receive any enhancement of powers from Congress, then banks should never get anything. How much of the $150 billion from the S&L era bailout is still outstanding being repaid by banks AND credit unions thru the FHLBs? What about the billions that the FDIC has borrowed to keep BIF alive?

Come up with new reasons!
Posted by no political hacks preferred | Tuesday, April 17 2012 at 11:27AM ET
"Speaking of increased risk to the U.S. taxpayer, the Senate should not act on the credit union proposal unless and until the industry repays all of the money currently guaranteed by the U.S. Treasury to bail out several large wholesale credit unions in 2010..."

Retail credit unions are actually paying the cost of bailing out the corporate credit unions. The NCUA Guaranteed Notes (NGNs) are backed by the NCUA's stabilization fund that is paid by assessing credit unions annually over the life of the guarantee period. Retail credit unions also paid for the bailout by wiping out their capital investment in the corporate credit unions. While some taxpayers (i.e. individual members of credit unions) are indirectly paying for the cost of the credit union bailouts, not all taxpayers are at risk when it comes to credit unions.

I would actually be more interested in seeing what the estimated risk/cost to taxpayers are or would be since I think it still would be insignificant when compared to much bigger risks in the banking system. Even on the estimated high end of the range, total bailout costs may be around $10B. Btw, what's the cost to the taxpayers for Fannie and Freddie losses? I think that the GSEs have about $10B in losses per quarter. Again, credit union risk to the financial system and taxpayers is small change.
Posted by BondMgr | Monday, April 16 2012 at 3:48PM ET
PH Preferred

I would be happy to have all Credit Unions fall under Sub S tax law. They then pay taxes thru the division of profits to all shareholders. They then have to account for the amount of cash they have to dsiburse each year to pay their Shareholder's pro rata share of profit (Problem for Sub S shareholder is that the shareholders get taxed whether the bank pays them a cash dispersment or not. ) This reduction in capital ( portion of profits) causes them to have to price thier products to compensate - levels the playing field greatly to the taxation burden of the C-Corp.The problem for the vast majority of commercial banks is the availablity of Capital - Sub S has shareholder number restrictions and various other impediments that make that structure untenable for the vast majority of banks.
I would agree that Credit Unions and small Community Banks have many thing in common - however if they are providing the same basic services - Why should they not be treated the same from both a regulatory and tax basis?
Unless you are running a Top 20 Credit Union, I would think you would want to work with Community Bank's to halt the pushing of an issue that would benefit less than .5% of Credit Unions. Especially since their issue could easily be remedied by converting to a mutual. These Top 20 Credit Unions may be pushing an agenda that, in the end, jepordize the tax free status of the small Credit Unions that are operating very effectively under the original intent of the law.
Posted by Watchdog1 | Monday, April 16 2012 at 2:26PM ET
Watchdog 1: Banks have an opportunity for tax free status. That is called Subchapter S corporations that do not pay federal corporate income taxes. The biggest banks helped cause the subprime problem. What about World Savings with its poorly written mortgage loans that merged into Wachovia which needed a lifeline from Wells Fargo not to fail? Credit unions were caught up in DoddFrank just like the community banks who were and are operating in the best interests of its customers, communities and shareholders. Again, credit unions have been punished for the sins of some bankers. Go back to the FSLIC bailout which brought about Truth-In-Savings on all institutions. What about GLB which is responsible for privacy laws because of the sins of US Bank?

Credit unions and community banks have more in common than what separates them. We need to work together against the Top 10 banks.
Posted by no political hacks preferred | Monday, April 16 2012 at 1:31PM ET
Here we go again --- Only a handfull of all Credit Unions are even close to the current business loan restriction ( about 20 - less that .5% of all Credit Unions) If they want to get on the same playing field with Tax paying commercial banks - let them do it - but they need to convert their charters and become Mutuals - they then are subjected to the same regulatory ( CRA, Capital Standards, and Safety and Soundness) scrutiny. They would also be paying taxes! Once again if thier structure is so special -- Why not reduce the regulatory impediments (Cost) and provide banks with tax free status???? I bet they would be happy to readjust their pricing and risk models once the 36% Federal tax albatross is gone!
Also -- there were very few FDIC regulated Commercial Banks involved in the subprime fiasco -- those responsible for all the mayhem ( Sorry Allstate) were mostly Investment Banks or the very largest Commercial Banks -( a real different animal from the banks that are in main street America and provide the startup capital to those local entrepeneurs) - Like most issues, the Federal Government over reacts and we get the voluminous Dodd - Frank legislation. It hits the Community Banks the hardest, ( they have spanked the wrong Baby!) which will result in burdensome regulatory cost and have the unintended consequence of consolidation - As this process unfolds, you are going to see fewer independent banks in small town America. Ask any Mayor of a small town - how vibrant their town is after the ownership is non local - Attacking the small banks by picking winners and losers ( giving Credit Unions addtional advantages coupled with Dodd - Frank makes no sense )Hopefully, we will see some reason return and see Dodd - Frank rolled back and/or it's regulatory emphasis directed where needed. ( At systematic risk) All in all - Let's be sensible - We are spanking the Wrong Baby!
Posted by Watchdog1 | Monday, April 16 2012 at 12:25PM ET
Funny how the editor of American Banker shows bias. Credit Unions have more limitations on business loans than banks. Try getting a business loan from a credit union on a vehicle that includes taxes, licenses and other fees. Can't do it. Max is 100 LTV. Credit Unions have higher capital requirements because of the lying bankers lobby back in 1998. It takes seven percent capital (from retained earnings) to be well-capitalized. That does not apply to banks. Do bank executives have to give back money when their banks have loan losses? give back stock options? No.

Shows that this "publication" has an anti-credit union bias.
Posted by no political hacks preferred | Monday, April 16 2012 at 11:20AM ET
PS A large portion of the corporate CU problems mirror those of countless banks that were sold santized subprime pools by rating agencies and misrepresented by instiutuional sales department at large banks and Wall Street. When the rating agencies began adjusting their ratings the game was already up. Too large to fail institutions used their mdoels to sell to, may I say, gullible, which included many community banks. Pass the limit increase, kill Dood Frank, and then lets work together to dramatically reduce risk to tax payers by reducing regulation, increasing capital requirements and increasing disclosure.
Posted by parkerco | Monday, April 16 2012 at 9:40AM ET
Seems to me it was large banks that caused this country's worst financial crisis since the Depression. Banks received government bailouts - not credit unions. Most bankers believe in capitalism and free markets - EXCEPT when they have to compete with credit unions they become cowards. What are you so afraid of? Let freedom ring and may the people reap the benefits of competition!
Posted by tagart13 | Monday, April 16 2012 at 9:36AM ET
AB, Whalen, and Arvantis all embrace transferring risk to the tax payer and government regulation to keep competition away. It is a shame that Congress even needs to change law to allow CU to expand their lending practices. Finanical institutions around the world make bad loans often due to regulatory mandate or encouragement, e.g,, European banks buying sovereign European debt or affordable housing lending in the US or World Bank encouraged boondoggles. Generally banks (all fiancial institutions) get in trouble by rapid growth or high concentraion of activity. They also tend to do well when they know their customer. The small business authorization should move forward independent of the CU tax exemption. To try and unwind all the special perks on both sides (all sides when you consider insurance companies, small loan shops, peer to peer lending, State & Fed charters, corporate structures) is it beyond the scope of the current issue. Allowing CU to lend to small business fits with their strength of knowing their customers. Banks might shy away from judging underwirting ability considering their many follies and failure rates. Final note Fannie Mae & Freddie Mac are still using taxpayer support since they collapse from too much government regulation and special perks, like capital exceptions. Small business lending should pick up by increasing the lending limits to thoise of banks. All things considered the systemic risk and risk to taxpayers declines, but only on the margin.
Posted by parkerco | Monday, April 16 2012 at 9:20AM ET
Don't you guys get it? Credit Unions have made small business loans since the first CU charter was issued. Mr Whalen is attempting to limit competition for his high priced products. Cooperative businesses have always been a thorn in the side of for profit businesses.

Why not ask some "small businesses" that got here start with a C U business loan??
Posted by 81900427 | Monday, April 16 2012 at 9:18AM ET
Mr. Whalen does us excellent service, reminding us of the bad results from the last such adventure with S&Ls, under the first President Bush.

We do not learn from the past, we merely make new and more subtle mistakes.
Posted by Robert Arvanitis | Saturday, April 14 2012 at 10:28AM ET
Expanding the playing field for tax-exempt credit unions is just another way of creating moral hazard. If credit union execs want to make small business loans they should 1. be subject to very stringent limitations 2. be backed by capital levels on par with those of other small-business lenders 3. be tied to the pay of the credit unions' top executives so if losses mount the pay get clawed back. That's not a lot to ask when someone's seeking to make bets with other people's money. Neil Weinberg, Editor in Chief, American Banker.
Posted by Neil Weinberg | Friday, April 13 2012 at 3:53PM ET
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