Secondary Capital: Fueling Credit Union Growth to Achieve Their True Potential

by Pablo DeFilippi, National Federation of CDCU

2012 marked a turning point for credit unions. CUNA’s mid-year report  shows that asset growth was 6.9%, compared to the 4.2% of the prior year.  Fueled by continued widespread resentment with banks , CU membership growth rate was 2.3% compared to 0.6% in 2011. This was the fastest membership growth in over 10 years. At 95.3 million, CU  membership it’s at an all times high!

That’s great, but could have been more? Given the media exposure Bank Transfer Day and the Occupy Movement received and the falling consumers satisfaction with banks, that growth should have been much stronger. But it turns out that many credit unions were in no position to absorb that liquidity, in part because traditional loan demand is still weak and those additional funds couldn’t be put to work fast enough. Also with investment income at an all time historic low, there wasn’t much appetite from CUs to attract more members and capture more deposits.

That’s only one side of the spectrum. If we look at the unbanked or underbanked population, which is estimated to be 25% of the entire US population, then the opportunity for CU is even more obvious.  Although estimates vary, most experts agree that around 28 million people  or 10% of the US general population are unbanked –those without a traditional savings or checking account-; and 45 million people or 15% of the population are underbanked -those with some limited relationship with a financial institution-.

We’re at a cross road:  in one side there’s a hugely untapped market starving for better, more affordable options, and in the other an industry that needs to grow and that by the most part, has the tools required to meet the needs of that market. What’s keeping us back to capitalize in these opportunities that are so aligned with our mission?

You guessed it! Capital constrains, albeit it could be argued it’s more perceived than real. At 10.11% the industry as a whole is well capitalized. CUNA’s 2012 mid-year report shows that net capital for the entire system was over $104 billion. That leaves around $30 billion of capital over the legislatively mandated level of Well Capitalized, that could be used to grow the entire industry by another $400 billion. In 2007 Filene published their report Is the Credit Union Industry Overcapitalized? , which examines this issue. Of course, the Great Recession and the meltdown of the Corporate CU system made it painfully clear that as long as credit unions can only grow their capital through retained earnings, there will be a strong incentive to save any additional capital rather than using it for growth.

Filene has done extensive research supporting the case for supplemental capital for credit unions. Bob Hoel points out in his report “A Review and Extension of Evidence Regarding Public Policy Reform” that’s in the public best interest to permit credit unions greater access to alternative capital sources.

There’s though, a growing number of credit unions that have access to supplemental capital: Low Income Designated credit unions, which as a result of NCUA’s fast track process, have increased from 1,169 in June 2012 to 1,912. Although final year end numbers aren’t yet available, it’s clear than more than 70% of the 1,003 credit unions that were informed by NCUA about their eligibility have accepted the designation.

If all these 1,003 eligible credit unions accepted the designation, then roughly 30% of the entire credit union system would become low income designated. LID credit unions (existing and eligible) currently serve 17 million members and have combined assets of over $140 billion. Since the NCUA fast track initiative only affects federally chartered credit unions, there are potentially hundreds of additional state chartered credit unions that might also be eligible. NCUA has announced plans to work with state regulators to roll out the fast track approach to them as well. This could bring the percentage of LID CUs closer to 40%!

Asset wise, low income designated credit unions are increasingly more diverse and even though institutions below $10 million still make up more than 44% of all LICUs, there’s been a significant shift as larger credit unions are obtaining their designation. There are now:

• 16 credit unions (up from only 4 before) with over $1 billion in assets;
• 19 CUs between $500 million and $1 billion (up from 7)
• Over 200 CUs between $100 million and $500 million (up from 101).

The implications of these changes are significant as more high capacity institutions recognize the opportunity as well as the imperative that low and moderate income (LMI) consumers represent for the future and relevance of the credit union system.

To educate credit unions about effectively using their Low Income Designation, my organization, the National Federation of Community Development Credit Unions (the Federation) and CUNA joined forces to offer a webinar series, the fist installment of which was delivered throughout the last quarter of 2012.

• Benefits of Low Income Designation: which provided an overview of the tools, resources and expertise available through the Federation, NCUA, the CDFI Fund and others to help credit unions more effectively grow their market share in the growing LMI market segment
• CDFI Certification – Benefits and Opportunities: that provided an overview of the benefits the CDFI certification, both in terms of access to the most important funding source available to credit unions (which have received more than $130 million in grant awards); requirements and the process to apply for the certification.
• Fuel for Growth -Secondary Capital: which provided an overview of the regulatory framework to obtain secondary capital, sources and best practices.

All these webinars are archived and currently available for download. I’m also pleased to share that throughout 2013the Federation and CUNA will be offering monthly webinars on best practices and sustainable strategies that capitalize on the LID, CDFI Certification and CDCU affiliation as the building blocks to develop sustainable strategies to serve LMI consumers while strengthening institutional capacity to increase access to CU services in LMI communities. Stay tuned!

As the number of LICUs rises and also their size, the Federation and its credit union system partners will be busy expanding the infrastructure to make supplemental capital available to meet the demand expected to materialize as credit unions learn how to use it.  Each dollar of secondary capital can leverage up to $14 dollars of new deposits, which in turn provide additional liquidity to meet loan demand.

Through its Community Development Investment Program, the Federation is the largest individual investor of secondary capital loans in the credit union system. Over the past 15 years we have learned valuable lessons as to what works and what doesn’t when it comes to deployment of supplemental capital. Since most of our experience is with small credit unions, we’ll be also analyzing the performance of credit unions that participated in the US Treasury Department’s Community Development Capital initiative, which resulted in $70 million invested as low cost secondary capital in 48 credit unions across the country, some of which had more than $100 million in assets.

With our community finance partners, we’ve also been exploring the feasibility of establishing a mechanism through the CDFI Fund to issue bonds to securitize secondary capital to and loans generated by CDFI certified credit unions and other types of CDFIs. There are promising signs that program will be running in 2013.

Under our new leadership, we’re also gauging interest from institutional investors, although as CUNA’s Chief Economist Bill Hampel stated last year “it would take some time before investors become familiar with credit unions as a desirable place for their money.

Both through our Secondary Capital Loan portfolio and CDCI participants, we have documented dozens of experiences in which supplemental capital has helped propel credit unions to their next level of growth. We’ve also seen failures, but believe we’ve learned valuable lessons that have improved our underwriting  and assisted us with the decision making process.

Working together with NCUA and others in the credit union system, it is possible to scale up the sources and impact of supplemental capital to help credit unions increase their capacity, engage in more lending and expand access in underserved communities.

We have now the chance to move the needle beyond the 6% market share we’ve had for the last two decades. With enough fuel to run our credit unions, there is no telling where we can go. Let’s fill up our tank and step on the gas pedal: there’s a whole country waiting for us.