CU Conversions Are Looking Inevitable
The reality is sinking in.
Growth-minded credit unions will need to rein in their strategic plans or consider charter conversion in order to access equity capital and grow.
Credit unions complacent with slow or flat growth will find it increasingly difficult to remain profitable and will be shrinking shares and assets (or already are) to adjust to the new world of consumer lending.
Recent discussions with over two dozen large credit unions revealed that an average increase in net income of more than 30% is needed to offset the potential impact of the combined income loss from interchange legislation and special assessments while meeting possible new minimum capital requirements.
In our meetings, we chose 10% growth as a discussion starter for the strategic plan. Each credit union then either guided to a lower growth level or discussed solutions to the higher capital and earnings requirements.
Even the best will struggle to achieve growth goals without access to capital
We have modeled every credit union (with help from R.P. Financial), but let's look at just the larger ones:
There are 375 credit unions with assets greater than $500 million in the U.S., having aggregate assets of $573 billion representing 62% of all credit union assets, per SNL data. The average credit union in this group will need to generate increased earnings at an even higher hurdle rate than 30% for the next 5 years in order to be considered minimally capitalized and while growing assets 10% per year.
The results vary widely by institution, but given the margin erosion experienced in the last 15 years, many will barely be able to deal with the new obstacles to earnings while scaling back growth plans.
Significant incremental income will be needed to offset the impact of 8 basis points of special assessments for the Corporate Credit Union bailout, potentially higher capital requirements (we assume the credit union minimum capital ratio will increase by the same amount banks have), and lower income as a result of interchange legislation.
Also, credit unions expect to be assessed more than their trade association's projection of 8 basis points in each of the next five years and insisted on modeling at least double that.
Generating a 30-plus percent increase in earnings over the next five years is a daunting task for most. Something has to give. Accomplishing growth goals while meeting a higher minimum capital requirement is unlikely if the incremental income has to come from higher fees, higher loan rates and lower share rates. For many, investment in branches and technology improvements has already been scaled back.
Charter conversion accomplishes immediate regulatory parity.
Credit unions must face the reality that the lack of regulatory parity with banks has begun to challenge their value proposition, and, in turn, their strategic plan for growth.
Credit unions also know that healthy community banks have seen their base range of assessments lowered this year to 2.5 to 9 basis points and can access equity capital.
Credit union boards need to understand this dynamic and should see that federal taxation is a beneficial trade-off for regulatory parity and access to equity capital.
We have built models demonstrating for credit unions how access to equity capital and regulatory parity enable growth and higher after tax income. In fact, many community banks consistently generate a higher after-tax return on assets than do tax-exempt credit unions and for many years.
Credit unions with growth aspirations are becoming serious in their charter due diligence because they know they will need more capital and don't believe regulatory improvement is in the cards.
What's more, nearly half of credit unions nationally are unprofitable, and have begun to shrink assets in an attempt to survive. And as I mentioned in my prior piece, "Credit Union Choice: Protect Members or Other CUs," each credit union that shrinks passes assessment burden on to the credit unions that are growing, triggering a "growth tax" that adds to the higher hurdle rate for income.
The mathematics of credit union regulation simply do not appear to work for growing credit unions.
Peter Duffy is a managing director at Sandler O'Neill & Partners LP.