Missing a Chance to Shine

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This should have been the perfect time for credit unions to outshine banks.

The nation's 7,600 member-owned financial institutions largely sidestepped the commercial real estate blowup that maimed a significant portion of their small-bank competition, keeping credit losses manageable. They devote a far higher percentage of their assets to lending than banks do, a key talking point at a time when the government's generous liquidity policies have failed to spur bank loans. And last quarter, credit unions surpassed 10% of retail deposits for the first time.

Yet all is not well in "credit union land," as insiders half-jokingly call the industry, and the challenges have prevented credit unions from taking advantage of bank stumbles.

For starters, credit unions are saddled with the rising costs of bailing out not only failed peers but also the shambled network of corporate credit unions that undergird the system. In large part because of investment decisions approved and monitored by the National Credit Union Administration, the two largest corporates are in receivership and numerous others would be insolvent without government guarantees.

The NCUA is planning to securitize and sell off $50 billion of the corporates' residential mortgage-backed securities holdings. To cover the resulting losses, the NCUA will levy extra "stabilization fees" on rank-and-file credit unions.

For an industry that has aimed for a 1% return on assets in good times, the expected fee of between 15 and 40 basis points will weigh heavily.

The prospect of paying such steep assessments for years to come is increasingly affecting credit union strategy, industry observers and participants say.

Because the assessments are levied according to members' insured deposits (known as shares), many credit unions are trying to rein in growth so as to avoid shouldering a heavier load and further eroding their net worth, a problem that NCUA Chairman Debbie Matz acknowledges.

"It's ironic that credit unions have to curb their deposit growth, because if it continues unabated it will have an inverse impact on their net worth," she said in an interview.

Industry observers say the pullback is becoming increasingly overt. A common credit union strategy is to "pay the lowest rates possible and try to get under the market and hope that the money doesn't continue to come in," said Charles Felker, a former NCUA chief investment officer who now works with dozens of credit unions as the managing director of regulatory affairs for First Empire Securities. "From a competitive standpoint, that calls into question your relevance."

Compounding the trouble is the need to restructure the corporate system, and in the minds of some, its regulatory oversight. Some credit unions have grown openly skeptical of the NCUA's ability to clean up the corporate mess, and worry that the associated costs coupled with credit unions' lending restrictions and statutory inability to replenish capital will marginalize their role in the financial system.

In one sign of tension, seven credit unions asked a judge to block the NCUA from taking over their litigation against the directors of Wescorp, one of the corporates now in receivership. According to Credit Union Journal, the credit unions argue that the NCUA has "dragged its feet and shown itself to be incapable of pursuing their claims because of its own culpability in the failure of the one-time $34 billion corporate credit union." Though such opinions aren't the position of the influential Credit Union National Association or the National Association of Federal Credit Unions, they've been frequently voiced in credit union trade publications.

In many ways, said Mike Moebs, head of Moebs Research, the corporates' trouble resembles that of Fannie Mae and Freddie Mac.

"They were a conduit for securitization, and they got caught," he said. Not only were they unhedged, they also loaded up on mortgage—backed securities — and often the riskier mezzanine tranches.

Although on a smaller scale, Moebs said, "when you start comparing the corporate problem to Fannie and Freddie, you're in the same league."

The precise size of the system's losses is still a subject of intense debate, though Credit Union Journal reported that a 2009 Pimco evaluation of the largest portfolio estimated the bonds' value at under 70 cents on the dollar.

And separate from the corporate stabilization costs is the prospect of special assessments to replenish the NCUA's regular insurance fund. By law, the NCUA must provide Congress with a plan to bolster the fund if it drops below 1.2% of the system's assets, and under no circumstances can it fall below 1%.

"In my view it's a foregone conclusion that the fund will drop below 1.2%," said Fred Becker, president and CEO of the National Association of Federal Credit Unions. Given the already onerous assessments for the corporate bailout, his trade association is lobbying for reducing, or at least temporarily ignoring, that minimum.

Given that backdrop, observers like Moebs say that credit union finances may be more vulnerable to coming restrictions on overdraft and interchange fees. Though lowered fee income would affect all financial institutions alike, credit unions' limited business lines would make such declines all the more painful.

"Now we're taking away sources of revenue that the credit unions vitally need," Moebs said.

According to Felker, the NCUA and the industry will likely have to seek additional help. Proposed legislation championed by Rep. Paul Kanjorski, D-Pa., would allow credit unions to increase their business lending to members beyond the current 12% cap, and would help some credit unions generate more income, but most credit unions aren't even lending that much. More useful would be permitting credit unions to access some form of supplemental funding, effectively allowing them to recapitalize as innumerable banks did last year.

The NCUA supports both ideas, but how to handle supplemental capital is a thorny question.

"We gave [credit unions] a range of what the assessments were likely to be for the coming year, and they know there will be assessments for the next seven years," Matz said. Though Matz acknowledged the burden of the corporate cleanup, she said: "It's just part of the business. We feel the system is strong enough to bear those losses."

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