Will Mistakes Of The Few Outweigh The Good Of The Many?
Unfortunately, it has become a truism in the credit union industry that the many will pay for the mistakes of the few. The National Credit Union Share Insurance Fund (NCUSIF) stands to lose hundreds of millions from the speculative real estate construction and risky business lending directly resulting from the poor judgment of a mere handful of credit union leaders. Credit unions running responsible operations are now paying the price for the mistakes and recklessness of their less-than-prudent brethren.
This unpleasant story about risky lending and underwater participations by Norlarco Credit Union, New Horizons Community Credit Union, Huron River Area FCU, and Cal State 9 Credit Union, among others, grows more distasteful with each day's revelations.
Rather than pretend it's an isolated event as some within the credit union industry have already tried to do, the industry needs to "self-fix" this systemic problem. If the industry does not act, the bankers associations, regulators, Congress, and even credit union members will line up to force "reforms" down everyone's throat.
The dollar losses are small by big bank standards, but the potential losses may be the largest ever suffered by the NCUSIF. There is already speculation that there will be no dividend for insured credit unions in 2008 and that by 2009 there will be a special assessment needed to bring the insurance fund back up to statutory requirements.
The real estate downturn is expected to deepen and a recession is predicted. Today's reported and recognized credit union losses may just be the tip of the iceberg.
As painful as shoring up the NCUSIF losses may be for credit unions, unfortunately there will be other costs as well.
Bankers Associations Use CU Mess-Up As Lobbying Message
The bankers associations have already advised key state and federal officials about how these risky credit unions made tax-subsidized speculative business loans to non-core members thousands of miles away from their local communities. Bankers assert that credit unions have tangibly demonstrated their mishandling of the statutory powers that they already have and should not be given new authorities.
And bankers insist that the credit union regulatory system isn't up to the job of protecting consumers because they have been too busy cheerleading for the industry rather than properly policing them.
Some are even saying that credit unions may be facing their own savings and loan debacle. It's a harsh accusation, but on the surface there appear to be many historical similarities.
The recent real estate-related losses at these high-profile credit unions give enhanced credibility to the bankers' lobbying claims. The legislative hurdles that the credit union industry must now leap over to achieve its much-coveted "regulatory relief" have just gotten exponentially higher.
The resulting legislative gridlock will cost all credit unions through lost marketplace opportunities and delayed modernization of the charter.
Media Bad News Creates CU Reputation Risks
The saga about credit union losses has also reached the mainstream media in several local communities, causing significant image issues and reputation risk for the exposed credit unions. In some instances, huge deposit outflows have occurred and regulators have been forced to step in and sell off the assets of these credit unions at fire sale prices.
The investigative media coverage can readily become alarming to members, leading quickly to loss of confidence and trust.
Since credit unions all share the same last name, this bad news hurts everyone's reputation. If the problem grows and the media coverage of it spreads, the market value of the "credit union" name will spiral downward. Similarly, the value of the entire charter could plummet or, in the worst-case scenario, become an insurmountable liability.
Once lost, a good reputation is difficult and costly to rebuild.
CU Member Lawsuits Inevitable
In response to this real estate lending mess-up, there are already several lawsuits filed by consumers, investors, and even by other credit unions.
It is only a matter of time before more displeased members bring lawsuits against the affected credit unions, their regulators, the NCUSIF, the bonding company, the CUs' auditing firms, the credit union service organizations (CUSOs) that brokered participations, and anyone else within arm's reach with deep pockets.
These suing members will complain about how these parties conspired to cause them loss of income, loss of ownership equity, and created extreme financial hardship.
These litigants are sure to ask how making risky loans in distant states to non-traditional members was good for existing members. They will allege that credit union leaders misrepresented their best interests, deceived the membership, and destroyed the institution.
The line at the courthouse is certain to grow, as will CU attorneys' billable hours.
NCUA And State Regulators Will Over-React
In a predictable over-reaction to the huge losses, the National Credit Union Administration (NCUA) and state regulators will inevitably make business lending and participations a top examination priority-the examination issue de jour. Even for the best-run credit unions, regulators will tighten existing member business lending regulations, perhaps to the point of strangulation. There will be less forbearance for non-performing loans and higher expectations for loan-to-value ratios, credit quality monitoring, and in-house expertise. Business lending CUSOs and participation brokers will also be closely scrutinized, if not paralyzed.
Regulators bear some responsibility for this mess-up. They apparently missed some red flags and stepped in later than they should have to staunch the bleeding. However, the fundamental responsibility lies with the credit union CEOs and boards who were so eager to roll the dice with their members' insured deposits. Their hunger to chase yields brought them nothing but unacceptable risks and insolvency-causing losses. It's possible that there were even more questionable motivations (greed, fraud, kickbacks, extreme bonuses, etc.) driving this display of "moral hazard," but without increased regulator transparency, the full fact situation may never come to light.
Increased regulatory oversight and compliance never come cheap.
The Final Price Tag
There are no shortcuts to success. Even if competition becomes too tough, expenses become too high, margins become too low, or revenues become too small, credit union leaders must realize that nothing good will come from investing in assets that are outside the institution's normal business model and expertise. What credit unions really need are additional legitimate options to grow and earn income. When real alternatives exist, credit unions are much less likely to succumb to flimflams that promise exorbitant returns, but deliver nothing but failed institutions and ruined careers.
The projected losses to the NCUSIF, new hurdles blocking a modernized credit union charter, a sullied credit union reputation, member reprisals and lawsuits, and regulatory push back are already-realized costs that every credit union will bear from this unfortunate gamble. The final price tag will not be known until years from now after this mess is all cleaned up.
Hopefully, that price will not be so high that the credit union industry suddenly finds itself irreparably bankrupted.
Marvin Umholtz is CEO of Umholtz Strategic Planning & Consulting Services. He can be reached at 360-951-9111 or marvin.umholtz