Periodically, outside observers reach the conclusion that the credit union industry is overcapitalized. Dr. William Jackson’s Filene Research Institute paper (Credit Union Journal, Dec. 10, 2007) is the latest example. I believe the conclusion is based on an incorrect comparison of the role of capital for credit unions versus for banks.
Regulators set minimum capital standards to protect the insurance fund. Capital (net worth) at credit unions provides additional benefits that indirectly accrue to the member owner. In the tables at right, using 2006 NCUA 5300 data, I compare performance on a number of key metrics by the net worth/ asset ratio after controlling for asset size.
Within each asset size range we find the following when comparing credit unions with a less than 11% net worth ratio to those with over 15% net worth:
* Yield on Assets tends to decline with increasing net worth.
* Provision for Loan Loss also declines.
* Cost of Funds is lower. This is a result of the extra “free” funds available to loan or invest.
* Operating Expenses as a percentage of assets declines sharply with an increasing net worth ratio.
* Reliance on Other Income tends to decrease as net worth increases although there is substantial variability between adjacent Net Worth categories among the over $500-million credit unions.
* Return on Assets usually increases with improvement in the capitalization ratio. We do have a “check and egg” situation because higher ROA in the past has contributed to the current higher Net Worth.
* Assets per Member tend to increase with higher net worth ratios. This means that not only a higher percentage net worth but also a higher absolute dollar amount is available to work for each member.
Many banks, at this point in the mortgage meltdown cycle, might wish they had been “overcapitalized.” If they had been “overcapitalized,” Citicorp and others would not have been forced to sell partial ownership to new investors to replenish capital and thus dilute the ownership share of the earlier shareholders.
Much has been written about the ability of smaller CUs to survive. From these results, it appears that a well-capitalized, smaller CU can be as efficiently run as a larger, but less-well-capitalized credit union. This is especially true if the smaller credit union has been able to build higher assets per member.
“Excessive” capital appears to add strength to credit unions. Let’s keep that in mind as we set strategic goals for capitalization.
I would like to thank D Hilton Associates for providing resources that were helpful in this analysis.
Fred Ringenburg is a Seattle-based research analyst who also serves on the board of a $235-million credit union. Previously, he held positions as VP-Transaction Systems at CUNA Service Group and as Director of the Harland Credit Union Division. He can be reached at fmringenburg
