The Filene Institute recently issued a report written by Dr. Robert Hoel which advocates alternative capital for natural person credit unions. While the potential benefits of alternative capital seem clear, the risks involved merit extensive and careful evaluation.
Heart Surgery: The concept of alternative capital touches the very heart of what credit unions are. One of the strongest tenets of credit union philosophy is member ownership and control. Would raising alternative capital from others create a second category of "owners"?
As a general business concept, some of the indicators of "ownership" are:
-Risk of loss
-Potential for rewards
-Subordination to creditors
-A say in how the business is managed
Alternative capital has several of these characteristics. Certainly risk of loss and subordination to creditors are present. Potential for reward may be at least partially present, since alternative capital instruments presumably would involve a premium rate of return.
"A say in how the business is managed" is a bit more complex. It seems universally understood that alternative capital instruments would be "non-voting." However, that doesn't mean that holders of those instruments would not have a voice in or influence how the credit union is run. As a practical matter, they may speak with a very loud voice.
In short, trying to divorce ownership from capital investment seems like a tough sell, even here in Nevada where divorces are easy. And, having "owners" who are not members changes the very heart of what credit unions are.
Who's the Boss? As things stand now, credit union boards and management have a singular focus on their members--decisions are made based on those members' best interests. Alternative capital introduces another stakeholder into that process. As a practical matter, when making decisions, credit union boards and management will have no choice but begin to consider the interests of the alternative capital investors. This will become especially important if the credit union wants to retain that alternative capital or attract more. Admittedly, there will be issues where the interests of the membership and the investors are parallel. Undoubtedly, there will be other issues where those interests compete.
The Tax Man: The U. S. Code exempts from income taxes "credit unions without capital stock organized for mutual purposes and without profit." If one defines "stock" very narrowly, its unlikely alternative capital will qualify. A broader definition, however, with the concept of "stock" meaning outside ownership, could be very problematic. We all know that there can be significant disagreement with the IRS's interpretations of the law and that such interpretations can sometimes be very challenging. (A recent example being the IRS interpretation of the term unrelated business income.)
And, if alternative capital is deemed to create another category of "owners" who are not members, then the word "mutual" in the U.S. Code may also come into play with equally problematic results.
Quack, Quack: While restricting capital formation to retained earnings is certainly a limiting factor, it also constitutes a vitally important, unique characteristic for credit unions that should not be minimized. The bankers like to trot out the old spiel "If it walks like a duck, and quacks like a duck, it must be a duck" in arguing credit unions are just like banks. Allowing credit unions access to alternative capital will fuel the bankers' "quack like a duck" argument. Certainly we should not let the bankers' potential reaction influence our decisions. At the same time we should be mindful of giving them another arrow for their quiver. More importantly, we should think long and hard before giving up this important distinction.
The Atomic Age: So, alternative capital is a little like atomic energy. Handled correctly (and that's hard to do), it can yield benefits. Handled incorrectly, even one little misstep, and big problems can result.
Risk vs. Reward: Obviously, none of us can flawlessly predict future outcomes. The Filene report does a great job of pointing out the potential benefits of alternative capital. We also need to underscore the potential risks. One question for the credit union community to consider is whether the benefits justify the risks. As we consider this question, it's important to bear in mind that most credit unions are already very well capitalized. Another question is whether alternative capital can be structured in such a way as to mitigate the risks involved.
A Better Deal: A much more desirable approach to capital reform for credit unions is risk-based capital measurement. Measuring capital adequacy based on the relative risk of each credit union's balance sheet would be a giant leap forward, compared to the primitive approach now in use which assumes all credit union assets carry the same risk. And, risk-based capital measurement carries none of the concerns associated with alternative capital. Given the conservative nature of most credit unions, risk based capital measurement would present a more accurate picture of the financial strength of credit union community overall. If we're going to expend resources to reform credit union capital, those resources are much better spent continuing to strongly pursue a risk based capital system.
Nevada Federal Credit Union