An alternative source of capital would be any one source of capital other than retained earnings, the only source of capital open to the vast majority of federally insured credit unions in the U.S. In theory secondary capital could include access to capital markets as well as the ability to raise capital through capital investments by a credit union's members. In practice, almost all alternative capital discussions have centered on the ability to raise capital from credit union members.
Leaders and economists from a variety of different perspectives interviewed on the issue cited the very real philosophical and political challenges alternative capital approaches face, but they acknowledged that the issue was ripe for further discussion and possible progress.
Supporters of changing capital rules for credit unions point to three broad reasons credit unions should be able to raise capital from their own members. First, credit unions and other cooperatives have historically raised capital this way and have a record of careful stewardship of the capital with which they have been entrusted. Second, credit unions need access to capital to help them prepare to meet coming changes in their community's economy and their members' evolving financial service needs. Third, now is the time to have the discussion while the vast majority of CUs in the U.S. remain well-capitalized.
Jim Blaine, CEO of the $15.9 billion State Employees' Credit Union, is among the long-time advocates of the historical reasons credit unions should be able to raise capital from their members.
"This is not anything new," Blaine pointed out. "Credit unions have historically raised capital this way, from their members, and other cooperatives around the world raise capital this way. If credit unions are unique, they are unique in being the only cooperatives in the world forbidden by law from raising capital from their members." Blaine also pointed out that credit unions overall have an excellent record of managing their capital resources.
Chip Filson, president/CEO of Callahan & Associates, cited facts that back up Blaine's position. He pointed out that the NCUA only put a rule into place preventing federally insured credit unions from raising capital from their members in 1990 and that there have been examples of privately insured credit unions raising capital from other sources.
Filson cited the example of the Abbot Labs Employees Credit Union, a $484 million, privately insured CU in Illinois, which was started in part with a $6 million subordinated loan from the CU's sponsoring company. Not only did the CU pay back the loan, but it went on to build an 8% capital ratio and grow to serve 34,000 members.
A subordinated loan is an uninsured loan where the lender agreed that, should the credit union fail, it would be among the last creditors to be repaid and that there was a chance it might not be repaid at all.
"The credit union charter is now the hardest charter in the country to use to launch a financial institution," Filson remarked. "It's much easier to get a thrift or other bank started than a credit union in part because of the limitations on what capital federally insured credit unions can use." Filson is also a long-standing advocate of alternative sources of capital because of the effect the retained earnings restriction has on CUs' ability to help their members in hard times such as these.
Blaine, Filson and some alternative capital skeptics agreed that the best time for CUs to make a case for their access to alternative capital would be before the needs of their members push it even higher on their agendas.
It's a paradox, but the time to start looking for another way of raising capital is before your members are pressing you for help that you want to be able to offer but otherwise can't, Filson observed.
The skeptics of credit unions having alternative sources of capital stressed that they are not opposed to federally insured credit unions being able to get the capital they need, but they too raised three concerns. First, they worry about the ability of credit union members to differentiate between deposits in the credit union, which would be insured, and investments, which would not be insured. Second, they wonder if having members of a CU who are also investors might undermine the identity of the CU as a member-owned cooperative. Third, they doubt the feasibility of being able to advance the idea through the legislative process.
Of the three concerns, credit union members' ability to differentiate between insured deposits and uninsured investments in the credit union may be among the most important as that was the one to preoccupy Congress in the past.
"After [the Credit Union Membership Access Act], when we approached Congress about the capital situation, we got a lot of push back on it; more than the usual reflexive opposition from bank supporters who argue that whatever credit unions want to do must be bad because banks should be doing that," explained CUNA Chief Economist Bill Hampel.
Hampel outlined that the roots of the congressional opposition arose from the savings and loan crisis and particularly Charles Keating. Keating had raised money from investors in S&Ls and then lost it. The resulting loss and scandal scared Congress away from allowing the public, or even just CU members, from making uninsured investments in credit unions.
But Blaine pointed out that all members of cooperatives around the world make uninsured investments in their cooperatives with the understanding that if the cooperative fails, all the investors get a haircut; in other words, they lose their investments. He also observed that one approach might be to allow member investments in their credit unions but to limit per-investor amounts to keep members from investing too great a percentage of their assets.
The concern that allowing investments in credit unions might undermine CU identity as member-owned cooperatives was harder to pin down but nonetheless real. NAFCU's set of seven alternative capital principles, which the NAFCU Board adopted early in 2003, had as its first tenet that any viable alternative capital model "preserve the not-for-profit, mutual, member-owned and cooperative structure of credit unions and ensure that ownership interest (including interest) remains with the members."
Alternative credit union supporters argue that these concerns can be addressed by limiting credit union investors to being CU members and by capping how much they can invest, but NAFCU's Chief Economist Tun Wai observed that members who invest in a credit union might still have more influence over members who merely make deposits.
"Some are afraid that even if they don't have more votes, investors just might carry more weight than other members and that can be hard to control," Wai said. He acknowledged that these concerns could be mitigated but would need to be well thought out.
The last concern, whether an alternative capital proposal could make it through the legislative process, tended to include whether credit unions should instead focus on Congress adopting a risk-based capital standard.
Critics of the current capital system argued that merely making sure Prompt Corrective Action (see sidebar) is more risk-based only tinkers at the edges of the problem and does not really address CU capital needs.
But Hampel noted that credit unions, through their trade associations need to reflect the priorities of the majority of credit unions. CUNA's members have indicated that getting some relief in how PCA is calculated is more important to them than alternative capital, Hampel maintained, and that has to drive the industry's legislative agenda.
But both Hampel and Wai agreed that the conversation on alternative capital has been dormant for long enough and that the topic would likely begin to move up higher on the industry's priority list as more CUs recognize the benefits of having another way of raising capital.
NASCUS President/CEO Mary Martha Fortney reiterated her organization's long standing support of credit unions being able to use alternative capital. She added that NASCUS was considering sponsoring an alternative capital summit, where credit union leaders on all sides of the issue to could meet to decide how important the issue is and how to best proceed.
"This issue really falls across the whole spectrum of credit unions," Fortney said. "You have state-chartered credit unions on both sides and federally chartered credit unions on both sides. We just need to get the industry together to really start figuring out what the industry wants in terms of being able to raise capital," she said.