One Lesson From 2008: A Re-Examination Of CU Capital Levels

ARLINGTON, Va.-The market and economic crashes of 2008 are forcing some new thinking of a 2007 study that had suggested credit unions may be overcapitalized.

That's the stance of credit union economists who weighed in on the Filene Research Institute's study, "Is the U.S. Credit Union Industry Overcapitalized?" Released in late 2007 and authored by William Jackson, professor of finance at the University of Alabama, the study fueled debate in 2008 about credit unions holding too much capital. Jackson concluded that at 11.6% net capital at the end of 2006 (the ratio is approximately the same now), credit unions are overcapitalized by as much as 40%, or some $12 billion.

CU economists agree that while for years the argument that credit unions have held too much capital has been justified, that position is not as strong today.

"The point is, with this particular economic downturn, we are happy to have the capital," said NAFCU Director of Research and Chief Economist Tun Wai, who acknowledged that he has questioned the merits of credit unions holding over 11% capital. "A lot of the credit for us sustaining this kind of downturn goes to the regulators, who have bashed credit unions about keeping capital."

What may weaken the Filene study's position, suggested Dave Colby, chief economist at CUNA Mutual Group, is that the subprime crisis had yet to hit during the time the study's research was conducted.

"One of the details within the study are the BASEL II ratings of mortgages, which showed mortgages as substantially less risky assets at the time," Colby said. "What a difference two years makes. So many of the fundamental givens about the economy and financial instrument valuation have been thrown out the window over the last year. The market moves on, and a lot of times we see that what were valid assets at one time are now toxic. And it's going to be a while before that changes back."

Despite the economic downturn, the study's author has not changed his stance. In an e-mail message to Credit Union Journal, Jackson said: "My opinion on CUs being overcapitalized is exactly the same today as it was before our financial system and overall economy exhibited these current problems. And, this is why capital is like insurance. And, CUs that hold too much capital have simply bought too much insurance. Just because the event that you have purchased insurance to protect yourself from actually occurs doesn't mean that you should purchase more than the optimal level of that insurance. I don't think this current recession will have nearly the negative effect on CUs as it will for banks. That may be why the current TARP program at Treasury, which is aimed at bailing out banks, does not even consider CUs. We all know that CUs did not get stuck with those subprime (toxic) mortgages."

Evans Harrell, director at the $600-million LGE Community CU in Marietta, Ga., didn't wait until the economy collapsed to offer his opinion about some of the Filene's study's findings. In a letter to Credit Union Journal in January, Harrell wrote: "As I read the article on Professor Jackson's recent Filene research paper on credit union capital in the Dec. 10 issue, I couldn't help but wonder what conclusions might be different if the selected base line of 1990 had been, say, 1980 when in the Carter years inflation peaked."

'Don't Believe It For A Millisecond'

"Can't happen again? I don't believe that for a millisecond," Harrell said recently when contacted by Credit Union Journal. "Do we have too much capital? No. I think today we better have the hatches battened down."

If the current economic conditions spur debate in favor of the merits of 11% capital and maintaining the high reserve levels, the recommendations in a recent Filene study about alternative capital-Alternative Capital for U.S. Credit Unions? A Review and Extension of Evidence Regarding Public Policy Reform-should be reviewed closely, pointed out Filene Executive Director and CEO Mark Meyer. "My sense is that the current economic environment presents a unique opportunity for debate amongst credit union leaders, regulators, and policymakers on the merits of alternative capital."

The supplemental capital study was authored by Robert Hoel, a professor emeritus of business at Colorado State University and Filene fellow in residence.


Originally Reported In CU Journal: Dec. 6, 2007

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