As depositor-owned cooperatives, credit unions have a long history of careful and responsible stewardship of member assets — amply demonstrated during the recent financial crisis.
Recently, however, some have raised concern over rising levels in credit union long-term assets — especially in light of increases in market interest rates on the horizon.
These concerns seem exaggerated. Credit unions, on the whole, appear prepared for changing market interest rates and continue to manage their balance sheets in a responsible manner.
History also offers important clues as to what the future holds.
At the start of the great recession there were 8,500 banks and 8,100 credit unions. During the downturn, nearly 500 U.S. banks failed (92% with more that $50 million in assets), pushing the FDIC into negative territory. In contrast, only 149 credit unions failed (17% with more than $50 million in assets) and the "equity ratio" of the National Credit Union Share Insurance Fund (NCUSIF; the federal insurer of credit union savings) remained above $1.22 per $100 in insured deposits during the entire crisis and subsequent deep recession.
Throughout modern history in fact, compared to banks, credit unions have held higher capital levels, suffered substantially lower loan losses, and have imposed far fewer losses on their deposit insurer — and NONE on taxpayers.
Today: credit unions pose no undue or broadly increasing level of risk to the NCUSIF.
While it is true that credit unions are increasing long-term assets, the increases have been modest and the level is manageable. Furthermore, the marginal growth in interest rate risk exposure we've seen has occurred at the same time that exposures to other risks — liquidity and credit risks — have been falling to cyclical lows. In other words, aggregate credit union risk profiles are low and manageable.
Long-term assets finished 2013 at an all-time high of 35.85% of total assets. However, this exposure is less than six percentage points above pre-recession levels for credit unions. To put this exposure in context: federally-insured savings & loans in the early 1980s reported long-term asset ratios that were equal to roughly 80% of total assets.
And the 35% aggregate long-term asset exposure is dwarfed by long-term funding sources (equity and long-term borrowing and deposits), which now represent 51% of credit union assets, significantly reducing IRR and liquidity risk.
Among the 340 federally insured credit unions that now report long-term assets greater than 50% of total assets, only 190 report exposures that are greater than long-term funding levels and only 105 report exposures that are more than 10% higher than long-term funding levels. These 105 credit unions represent a mere 1.6% of the total institutions and hold 5.2% of total CU assets.
Another clue to interest rate-risk exposure lies with unrealized losses. Although unrealized losses have increased recently, the current aggregate total ($1.34 billion) is equal to only 0.12% of total assets, 1.2% of total net worth and 17% of first quarter annualized earnings (which were $8 billion).
Also to be considered: Liquidity risk exposures have been falling and are low from a historical perspective. Credit union savings growth exceeded loan growth for five consecutive years starting in 2008. Since the beginning of the downturn in 2007, credit union aggregate savings balances grew by roughly 40%. In contrast, loans increased by only 20% over the period. As a consequence, the aggregate credit union loan-to-savings ratio dropped from 84% at year-end 2007 to 69% at the end of March 2014 — a 15 percentage point decline.
Among the 105 credit unions noted above, 40 report loan-to-share ratios below 60% and 60 report loan-to-share ratios below 70%. Those with loan-to-share ratios above 70% account for 1.4% of total credit union assets.
In the aggregate, credit unions reflect an abundance of liquidity, can easily meet financial obligations, and would experience little pressure to sell securities with unrealized losses even if market rates increased.
Further, credit union loan delinquencies and net chargeoffs are at seven-year lows. Both measures — loan delinquencies and loan losses — are about equal to long-run average levels even excluding the big jumps we saw during the great recession. For example, the first quarter 2014 annualized 0.50% net loan loss rate compares to a 20-year average of 0.60% and an average of 0.51% in the 17 years prior to the great recession.
Again, historical data is informative. Credit union loan losses were certainly elevated during the financial crisis, peaking at 1.21% — but this is less than half the peak levels reported by the nation's banking industry. Overall, credit union loan losses averaged 0.90% between 2008 and 2013, while banking institution losses averaged 1.62% over the same period.
And credit unions (including those that reported relatively high long-term asset ratios) have soundly managed their assets in rising-interest rate environments of the past.
For example (as is the case today) at the start of 2004 we can clearly identify a comparatively small number of credit unions with both high concentrations in long-term assets and credit unions with unrealized losses. In June 2004, the Federal Reserve Board began increasing short-term interest rates and by July 2006 the Federal Funds interest rate rose by 425 basis points, to a monthly average of 5.24%.
Yet, despite this substantial market interest rate shock, we are unable to identify — either through NCUA material loss reviews (MLRs) or by other means — any strain on the insurance fund caused by natural person credit union interest rate risk. In fact, the NCUSIF ratio increased over the period from $1.27 per $100 in insured shares at the start of 2004 to $1.31 per $100 at year-end 2006. We are specifically unable to identify any natural person credit union that failed as a result of interest rate risk.
Some credit unions experienced reduced net interest income as a result of the rise in interest rates. However, there is no evidence that this caused losses to the NCUSIF. In fact, the total of $20 million in insurance losses in the three years from 2004 to 2006, following the aforementioned dramatic increase in interest rates, is less than half the $50 million in losses in the two previous years.
Interestingly, among credit unions that reported long-term asset ratios exceeding 50% in 2004, all reported net worth ratios that remained above 7% through year-end 2007 and the average net worth ratios reported by these institutions increased over the period, finishing 2007 at 15.2% (as shown in the average net worth-to-assets ratio graph).
Of course a lot has changed since 2007. For example, despite the fact credit unions didn't contribute to the financial crisis, they are paying a high price in the form of unprecedented supervisory pressures and an avalanche of new rules and regulations, including a steady stream of new regulations and guidance papers from NCUA detailing (in excruciating detail) requirements for measuring, monitoring and controlling liquidity risk, credit risk, interest rate risk and concentration risk.
None of this is to suggest that credit unions shouldn't manage interest rate risk — they must. But all of this is intended to say, given the available data and putting that data into context, that credit unions have a strong track record of robust and reasonable interest-rate risk management.
Market interest rates will be increasing at some point in the near future. Nobody knows exactly when. But it will happen. And, no doubt, some credit unions may be squeezed by rising rates. But, by and large, most credit unions will be well prepared.
Mike Schenk is interim chief economist for CUNA.
