One Michigan credit union’s push for parity with federal charters

Dennis Hanson has lived through a moment that no CEO of a credit union wants to experience: He realized his institution could be in violation of a state regulation.

In 2016, Michigan revised the law that oversees its roughly 140 state-chartered credit unions. Prior to revising the Michigan Credit Union Act, Hanson explained, CUs could make unlimited investments in government-sponsored enterprises such as Fannie Mae and Freddie Mac. While the law’s revision significantly expanded credit unions’ powers, it limited GSE investment to just 25 percent of a CU’s net worth.

With this new interpretation of the law, Hanson’s institution, Dow Chemical Employees’ Credit Union in Midland, Mich., was significantly over that cap. But how Hanson addressed the issue – his institution petitioned state regulators for a change – demonstrates the limits financial institutions face in managing a securities portfolio, the importance of a strong relationship with regulators, and the necessity of parity for state and federally chartered institutions.

Credit unions deploy excess liquidity through their securities portfolio, something that became even more prominent during the financial crisis and its aftermath as lending opportunities dried up. If managed well, the securities portfolio can help an institution earn additional interest income in a relatively safe manner.

“You want diversification amongst your assets that are held,” explained Rebecca Gersonde, chief compliance officer at Heber Fuger Wendin Investment Advisors. “You don’t want all of your risk in one bucket.”

Federally insured credit unions earned $6.8 billion in investment income in the second quarter, up about 21 percent from a year earlier, according to data from the National Credit Union Administration. That totaled about 13 percent of these institutions’ overall interest income.

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“By nature credit unions are very conservative,” said Edward Meier, lead portfolio manager at Madison Investment’s credit union investment management team. “They are [not-for-profit]. They like to make sure they are very stable in what they do.”

But credit unions are also limited in what they can invest in. In general, investing in GSEs, such as buying mortgage-backed securities issued by Fannie and Freddie, have higher yields than purchasing bonds from the Treasury Department. Many investors – banks and CUs alike – see them as fairly safe bets, even though GSEs are not explicitly guaranteed by the U.S. government. This lack of a guarantee was the reason that state-chartered Michigan credit unions were limited in their investments after the law was revised.

A blow to Michigan CUs

Because of that, losing the ability to invest an unlimited amount of excess liquidity in GSEs was a blow to Michigan credit unions.

The $1.6 billion-asset Dow generally takes a conservative approach to its securities investments, said Hanson, and the credit union had about $300 million invested generally in securities issued by Fannie and Freddie.

“This is probably cliché, but we do want to be safe and we want to make sure we have adequate liquidity, and yield is secondary,” Hanson said. “It supplements earnings. But we are a conservative shop and we don’t get too far out on the risk curve.”

Under the revised law, Dow would only be allowed to invest $40 million in GSEs based on its net worth, Hanson said. Selling off securities to become compliant with the regulation would have likely resulted in a loss of about $6 million, he added.

To overcome this, Hanson began working with the Michigan Department of Insurance and Financial Services, including John Kolhoff, the director of the office of credit unions, to find a solution. (Kolhoff is set to leave Michigan in early December to head the Credit Union Commission of Texas.)

Hanson was already familiar with his regulators after serving on an advisory council for at least 15 years. He had also always tried to view regulators as a resource rather than a foe.

Hanson argued to the state regulators that the new interpretation of the law limiting investments in GSEs was not only incorrect but would also be bad public policy. In July, Dow Chemical filed a request with the department to allow state-chartered credit unions to invest without limitation in Fannie, Freddie, the Federal Home Loan Banks and the Farm Credit System.

Lifting the cap would also allow Michigan-chartered credit unions to remain competitive with other institutions. Federally chartered credit unions and banks can already invest in these entities with no caps.

Patrick McPharlin, director of the Department of Insurance and Financial Services and the former CEO of Michigan State University FCU, seemed to agree with Dow Chemical’s arguments and found that this limitation created a competitive disadvantage. His department issued an order last month, allowing state-chartered credit unions to invest, in a safe and sound manner, in these entities without a cap.

“The director found that those powers are appropriate and necessary to compete with other providers of financial services in the state and agreed the competitive authority regarding these investments (without the limit) can be handled in a safe and sound manner by credit unions,” a DIFS spokeswoman said in a statement.

Hanson believes having an established relationship with his regulators helped smooth the process to securing the change, and he encouraged other CUs to make those connections.

“Our state regulators are great to do business with; they want to allow credit unions to have the power do things they should be doing for their members,” he said.

Relationships matter

That sentiment was echoed by Lucy Ito, president and CEO of the National Association of State Credit Union Supervisors.

“It never hurts to have a good relationship with your regulator,” she said. “If there is a good relationship there, it is certainly good for the regulator to know the credit union is well managed in their assessment of a request.”

Dow’s experience, added Ito, demonstrates the importance of ensuring parity between state and federally chartered institutions. Forty-four states have a provision that allows state-chartered credit unions to have parity with federally chartered ones.

If a credit union believes that a regulation needs to be tweaked to ensure the rules are fair for different charters, Ito encouraged executives to work with their local trade groups to address the issue.

“This is showing the dual charter system at work,” Ito said. “It is important to make sure the federal charter and state charter provide a competitive check on one another. If a state gives an authority that the [National Credit Union Administration] does not and is able to test it, then the NCUA can look and say, ‘That makes sense.’ And vice versa.”

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Investment strategies GSEs Interest rate risk Net interest margin State-chartered credit unions Federal credit unions Fannie Mae Freddie Mac
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