Minnesota Credit Unions Want to Lend More to Business
They can claim less than 10 percent of Minnesota’s lending market, having made a little less than $10 billion in loans last year. At the same time, despite the bursting of the housing bubble and the disappearance of thousands of jobs, the state’s credit unions are growing.
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Credit unions say that for the most part, they have avoided the exotic mortgages and “NINJA” (no income, no job, no assets) and “liar” loans that brought down banks both big and small. This, local industry leaders assert, is because they lack the profit motive that drove the orgy of mortgage speculation, and have stuck instead to the relatively boring business of writing loans that consumers could actually afford, keeping most of them on their own books in the process.
What’s more, credit unions assert that their services are singularly well suited for these challenging economic times. Their executives believe that they can fill a credit hole that opened up in the recession. With small businesses in particular hungry for funding, credit unions have been pushing the federal government to expand their ability to lend, which is capped by federal law.
Banks are skeptical. They note that credit unions have an unfair competitive advantage because as not-for-profits, they are exempt from paying taxes on their earnings. What’s more, bankers say that credit unions have been affected by the same forces that caused the meltdown experienced by many parts of the commercial banking sector. Banking industry representatives point to overlending by some credit unions, particularly those active in home equity loans and commercial real estate projects, that caused these institutions to become squeezed when the economy contracted.
Credit unions would reply that they’re doing better than banks, and that small businesses are clamoring for funding. Born in the Great Depression, credit unions believe that when people need to stick to the basics, the homely but solid image of credit unions can pay big dividends.
“We’re not immune to what’s happening in the economy, but in a relative sense, we’re doing very well,” asserts Mark Cummins, president of the St. Paul–headquartered Minnesota Credit Union Network (MnCUN), “What we’re seeing is deposit growth and a continuation of lending activity. We haven’t cut back in lending so much,” he adds, it’s that “people aren’t borrowing as much for consumer purchases as they have before.”
According to MnCUN statistics, real estate loans—mainly mortgage and home equity lending—made up 57 percent of Minnesota credit unions’ total lending of $9.96 billion in 2008. The impact of the tanking housing market is reflected in a key operating ratio: the percentage of delinquent loans to capital reserves. That ratio was 9.15 percent in 2007; last year, it had jumped to 13.2 percent as the fallout from the housing collapse spread into the larger economy, affecting borrowers’ ability to pay back both real estate and consumer loans. As a whole, state credit unions’ net income plunged from $80.2 million in 2007 to $16.4 million last year.
But despite that downturn, Minnesota’s credit unions total lending rose 1.65 percent in 2008, and total shares and deposits surged 6.85 percent to $12.2 billion. Cummins says credit unions are still making loans despite their lower net income because their loans aren’t packaged and sold to secondary investors as was the case with the toxic derivative securities that lay at the heart of the mortgage crisis.
“When we make loans, we keep them in the portfolio,” he says. “We’re taking on the risk. The business model is to provide value to people who are members, as opposed to generating profits to smaller groups of investors. So we might take on a little more risk that may not be the right thing for commercial banks. It’s a primary differentiator. Credit unions cooperate with each other rather than compete.”
Still, how strong are those loan portfolios, particularly loans to homeowners? More than 26,000 households, or 1.26 percent of Minnesota’s total, lost their homes to foreclosure in 2008, compared to a 1.19 percent national rate in the first half of this year. Those most affected by the foreclosure crisis are right in the credit unions’ demographic wheelhouse. It was mainly young families headed by people between 35 and 44 years old who sought counseling from the Minnesota Home Ownership Center last year.
“Minnesota has had extremely high default and foreclosure rates when compared to other states, and it affects people in credit unions and everybody else,” says Mike Schenk, senior economist for the Madison, Wisconsin–based Credit Union National Association (CUNA). “But the really surprising thing to me is, given the heightened correction in housing in the Twin Cities, is that both banks and credit unions seem to be doing pretty well there. When we look at Minnesota credit unions generally, their asset quality is higher than we see throughout the nation, and it’s substantially higher than what we see at banks throughout the nation.”
For example, he says, Minnesota credit unions in March 2009 had a 60-day loan delinquency rate of 2.14 percent, while the state’s banks had a 90-day delinquency rate of 2.93 percent and U.S. banks as a whole were carrying a 3.77 percent 90-day rate. (Credit unions and banks are measured at different day rates.)
Another key measure of local credit unions’ health is loan charge-offs, Schenk says. There, Minnesota credit unions showed an annualized write-off rate on all loans of 0.94 percent, compared with rates of 1.11 percent for all U.S. credit unions and 1.94 percent for all U.S. banks. The difference was especially big in charge-offs of consumer loans, which still make up the bread and butter of the credit unions: While U.S. banks wrote off 4.88 percent of such loans, local credit unions showed a figure of 1.63 percent.
At the same time, Schenk asserts, credit unions remain at near-record levels for capital ratios, even after taking a substantial hit in late 2008 and early this year. This could have resulted in a dangerous situation for credit unions, since, as not-for-profits, they rely totally on retained earnings to supply their capital, and are barred from selling stock or taking debt. But Minnesota credit unions’ capital ratio reached a record high of 11.4 percent in 2006, and still stood at 10.2 percent in March 2009. Minnesota Department of Commerce and federal regulators consider credit unions to be “well capitalized” at 7 percent.
Targeting Business Loans
Minnesota credit unions say they’ve got the money to lend at a time when borrowers are running up against brick walls at commercial banks. But credit unions believe that they’re hampered by a perception problem—namely, that they’re not viable alternatives to banks because they’re only for people working at certain companies or in certain industries. Despite long ago winning the right to expand beyond their employee-group membership restrictions, their state membership rolls have remained static. In 2005, some 1.56 million Minnesotans belonged to 169 credit unions. The membership number last year was 1.52 million.
Some of the largest metro-area credit unions, however, are slowly seeing membership numbers go up. St. Paul–headquartered Hiway Federal Credit Union saw a gain of 2,191 members last year, while Plymouth-based TruStone Financial Federal Credit Union (which changed its name from Teacher Federal in June) added 2,472 members. That’s around a 4 percent boost for each.
Membership in Burnsville-headquartered U.S. Federal Credit Union, for most of its history, was limited to employees of the Minneapolis Post Office and U.S. government workers toiling for the Federal Reserve Bank, the Department of Agriculture, and the Federal Aviation Administration. U.S. Federal President William Raker says the institution still focuses on employee groups, but six years ago it obtained a community charter, and now anyone who lives in the seven-county metro area can join it.
Raker says there are some examples of Twin Cities–area credit unions aggressively moving to expand their visibility by opening up new branches. They include Roseville-headquartered Spire Federal (formerly Twin City Co-ops), the state’s fifth-largest credit union, which now has 10 branches, and TruStone Financial, which has opened a new branch in Maple Grove and has plans for two more by next year.
“We here at U.S. Federal have the potential of maybe two or three more physical locations in the future because the landscape is changing a little bit,” Raker says. “Membership is growing. One of the reasons for that is people are looking for a financial institution that they can trust and has the consumers’ interests at heart.”
Credit unions see business lending, long the domain of commercial banks, as a key future growth area. Indeed, the U.S. credit union industry has posted double-digit percentage growth in business lending every year since 2005. In the year ending March 2009, credit union business loans rose 18 percent to nearly $33 billion nationwide, CUNA says, with the average loan coming in at $215,000. In the month of March 2009, U.S. credit unions lent 16 percent more to businesses than in the same month the year before.
“We get a lot of members who say they’re being shut out for business loans,” says Hiway Federal President and CEO Jeff Schwalen. They “may be too small for many banks, at between $100,000 and $250,000, or maybe they don’t qualify. We’ll take a look, and for the most part, we’re able to do the loan, assuming they can meet our requirements.”
Credit unions have been seeking to convince Congress to allow them to devote more of their portfolios to small-business loans—now capped by law at 12.25 percent of assets. “Why are we hamstrung by an arbitrary number? We have the liquidity,” Schwalen asserts. “And if it weren’t for the cap, we’d be doing more business loans, which are desperately needed.”
Credit unions are responding to what they say is a crying need for lending services from entrepreneurs, shop owners, tradespeople, and small businesses of all stripes, whose access to capital has been all but cut off by the credit crunch.
Hiway Federal illustrates the historical changes that credit unions have gone through. Established in 1931 to serve Minnesota Department of Transportation workers, it now has 63,000 members and around $821 million in assets. MnDOT and Minnesota Department of Public Safety employees still comprise the core of its membership, as do employees for engineering-related companies. But Hiway also has a community charter to serve the residents of its immediate geographic area in St. Paul’s Frogtown neighborhood—a low-income area dominated by Hmong and other minority groups.
Schwalen says that Hiway Federal went through a big learning curve to get a handle on how to develop lending criteria for this new group. If it weren’t for Hiway Federal’s core group of members, he adds, “it would be tough.”
“They certainly don’t have the income that the others have,” Schwalen says. “We’ve had cases of people coming in and giving us the keys to their businesses because they couldn’t keep up. But after two or three years, we’ve gotten better at serving them and have had some real success in business lending in the neighborhood. The Hmong community is very entrepreneurial, and we have $80 million out in business loans right now. We would be in a position to help them more if we could.”
“We’re making more business loans in response to demand from our members,” says U.S. Federal’s Raker. “They asked, ‘Why can’t you also give me services for my small business?’ We’re in the business of working for our members, and there was a void in a segment of business lending that banks weren’t filling.
“If we’re allowed to do so, credit unions in the future will make more capital available to business customers,” Raker adds. “We have $10 billion in additional capital that we could lend if we were allowed to do so.”
But that money won’t be lent out this year: Efforts by the credit union industry to lift the cap on their business lending failed to pass in Congress; the view that banks were being put at a competitive disadvantage won out.
Bankers say that credit unions’ move to community charters, which base membership on geographical areas rather than on employment with certain companies or in certain industries, have drastically changed the ground rules. If credit unions want the authority to do more business loans, bankers say, then the tax exemptions they have been granted by Congress since the 1930s should also be reviewed.
“It goes all the way back to how credit unions were formed in the 1930s and how they’ve changed since then,” says Joe Witt, president and CEO of the Minnesota Bankers Association. “They originally started out as co-ops for people who had jobs on the railroad or in factories, but who weren’t making enough money to be considered ‘bankable.’ There was a true public policy purpose in allowing those credits unions tax-exempt status as not-for-profits—they were owned by depositors and were helping to serve low-income workers.
“But now, with some credit unions’ charters being interpreted as meaning they can service the entire Twin Cities area, or 2.87 million people, they’ve lost their original flavor,” Witt adds. “Today, most of them aren’t tied to employers. When they make business loans to corporations, they’re losing the original meaning of their charters, which was to perform a public service by lending to people of modest means.”
Witt also contends that credit unions’ performance in 2008 should raise concerns about expanding their loan business. About two dozen large corporate credit unions—which function like “banks” for local credit unions, giving the latter a place to earn interest on their funds—were hit hard by the meltdown in the mortgage market in 2008. The institutions collectively held about $64 billion in illiquid mortgage-backed securities at the beginning of this year. Their predicament resulted in federal regulators mandating this year that thousands of retail credit unions pony up cash to bail out their troubled brethren.
“The credit unions as well as banks have taken a big hit to their portfolios, and I would think that Congress would want to tread lightly in opening up new business lending by them at this point,” Witt says. “When you see the losses corporate [credit unions] have taken, you have to question the timing.”
Minnesota credit unions think the timing for their business is strong. So will that lending cap some day come off? Perhaps small businesses’ need for funding will remove it.