Coronavirus dims outlook for new credit union charters
Launching a new credit union is a daunting task in an optimal operating environment, but doing it during a global pandemic can be a monumental challenge.
Organizers of de novo credit unions “are going to need a loyal and decent-sized member base and a lot of patience from the regulator,” said Peter Duffy, an analyst for Piper Sandler.
The industry already loses more than 150 credit unions each year due to mergers or, more rarely, liquidations, so the number of new charters isn't nearly enough to keep up with the rate of consolidation. And with most of the credit unions being merged out showing up at the lower end of the asset spectrum, any slowdown in new charters only exacerbates the divide between large and small institutions. According to recent NCUA data, credit unions over $1 billion in assets make up just 7% of the total industry but hold more than 70% of total assets.
New credit unions typically need one to three years from conception to the time they’re awarded a charter, after which the issue becomes whether they can survive in the current economic climate, said Geoff Bacino, an industry consultant and former member of the National Credit Union Administration board. Because credit unions don’t raise capital, he said, retained earnings then become the security net.
The coronavirus pandemic and the increase in remote examinations has stretched NCUA’s resources, limiting the attention and guidance the agency can provide for startups, Bacino added.
“Since the pandemic doesn't show signs of receding, it should be assumed that this is the new normal and the impact will be felt for a while,” he said.
The credit union industry has seen very little new blood enter the space in the form of de novos. Since 2014, the NCUA has granted only 16 new charters, including two last year.
One of those was Maine Harvest Federal Credit Union in Unity, Maine, which today holds $2.6 million in assets.
Scott Budde, the credit union’s president, CEO and co-founder, said the group’s original projections called for it to break even in its fifth year of operations. “I would describe these [projections] as aggressive but reasonable,” Budde said. “Given that interest rates were just starting to increase, no one was looking at the possibility of a massive rate drop and spread compression.”
So how has the pandemic impacted those projections? Budde is not sure. The credit union’s second-quarter call report shows losses of more than $59,000, with noninterest expenses having doubled since March.
“We need to regroup and reorganize,” said Budde. “Then I will have a better idea.”
COVID’s biggest impact for de novos could be how it has affected interest rates, Budde said. Maine Harvest had no historical assets that were put on the books at higher rates to cushion the blow. For example, simply investing its start-up capital went from earning $3,000 per month to $63, he said. Spreads compressed and that hurt even more.
A secondary COVID impact has been on the volume of lending. While many parts of the small-farm sector in Maine have actually benefited by an increased emphasis on locally produced, high-quality food, there is more hesitation among borrowers to actually borrow, he said.
“Equipment lending seems pretty good, but larger land loans are often on hold,” he said.
The NCUA in mid-August granted its first credit union charter of 2020 to Growing Oaks FCU in Goldsby, Okla., and operations are expected to begin in December.
Growing Oaks CEO Pamela Greening said this is her first charter experience, so she has nothing to compare it to. She said it took the group over two years to get the charter, and COVID has so far had no impact to its operational timeline.
“Financial institution professionals manage profitability and risk within volatile environments every day,” she said, adding that NCUA directed credit unions to start incorporating pandemic response into their business continuity plans well over a decade ago.
Michael Fryzel, former NCUA board chairman and an attorney in Chicago, said credit unions are already seeing a decline in revenue as the interest earned on investments drops to the “lowest of levels.”
“The Federal Reserve has already said no one should expect this to change anytime soon. Large, diversified credit unions will survive, but many small and mid-size [institutions] will have a difficult time doing so and will need to explore a merger in order to continue to serve their membership,” he said.
Fryzel said the NCUA must remain “extremely vigilant” as the industry enters the next year and closely monitor individual credit union performance.
Vincent Hui, managing director at Cornerstone Advisors, said new charters will be awarded going forward based on unmet need in their targeted market and their ability to provide enough capital for safety and soundness. He said there will likely continue to be underserved markets, but the trick will be whether there is enough capital to support those new credit unions in the economic downturn caused by the pandemic
Like most financial institutions, de novos may start out flush with a lot of new deposits, which decreases their net worth and exacerbates the challenges in an uncertain economy. “If their business model is effectively the carry trade in a flat yield-curve environment, they will have low NIM and earnings with lower net worth,” Hui said. “It’s not a good thing.”
Fryzel said despite the continued efforts of the NCUA to encourage and assist in the start up of new credit unions, that cannot be the regulator’s focus today. Instead, maintaining the strength of the industry and being ready to step in to make hard decisions and take all required action has to be job one, he said.
Generally, it takes years to turn a de novo into a viable financial institution, but with a solid business plan, hours of hard work and a little luck it can be done.
But all the old rules-of-thumb are out the window in the days of COVID-19.
“It’s hard,” Budde said.