Credit unions have grown to become a major factor in the U.S. economy. “Credit union assets have grown at nearly twice the pace of banks’ over the past decade.”1 Credit unions are owned by their members and are designed to offer lower borrowing costs and higher deposit rates. In addition, the median large credit union (greater than $50 million in assets) earned a return on equity (shares and reserves) of 6.6% and experienced 5% loan growth over the past year.
IDC Financial Publishing (IDCFP) focuses on the 2,326 credit unions with more than $50 million in assets to determine the risks to the financial system. These larger institutions are using their strength to compete aggressively for business. “Credit unions now make nearly a third of U.S. auto loans, compared to 23% in 2008.”2 The group of 3,066 credit unions with assets less than $50 million remain important to the industry, but are not a major risk factor in a potential economic downturn or the overall health of our financial system.
The Risk in Large Credit Unions
IDCFP calculated the CAMEL rank of 5,392 credit unions in the third quarter of 2019. The 2,326 large credit unions account for 97% of total credit union assets and remain the potential risk factor in a future major economic downturn.
To determine this risk, we separate the credit unions ranked under 125, which is the below-investment-grade industry standard. As of the end of the third quarter 2019, 89 large credit unions were ranked below 125 by IDCFP, down from 94 the previous quarter. The decline of poorly ranked credit unions has occurred over the last few years in a strong U.S. economy. At such time when the total number of credit unions ranked less than 125 reaches a low and begins to rise, IDCFP would issue a risk alert.
The same is true under the components of IDCFP’s CAMEL. For example, the “C” in CAMEL, which represents “Insufficient Capital,” reached a low of 75 institutions in the fourth quarter of 2018, and, subsequently, increased. Currently, this number is at 84, down from a peak of 88 institutions. We have found, a drop in institutions under “C” to 76 or below would recycle the risk alert for this CAMEL category. Similarly, the “A” in CAMEL, or Adequacy of Capital to meet loan delinquency, reached a low of 3 in the first quarter of 2018, then rose to a peak of 7, and is currently at 4. A decline to 3 or below would negate risk in this category of CAMEL. While the number of institutions below investment grade under “M” and “L” continue to decline, the “E” component bottomed in the second quarter of 2019 at 42, then rose to 51 in the third quarter.
Without an increase in the total number of large credit unions ranked below 125, and supported by all the components of CAMEL reaching lows and increasing in number, IDCFP scores a strong and solvent credit union industry (see Table I).
The Risk Seen in Credit Unions Prior to the 2008 Collapse
IDC successfully indicated a risk alert for the credit union industry as early as the fourth quarter of 2006, over a year prior to the financial and economic collapse of 2008 and 2009. Out of the 1,862 large credit unions in the third quarter of 2006, 108 were ranked below 125, or less than investment grade. The increase to 115 in the fourth quarter signaled the major risk alert for credit unions.
The “C” in CAMEL also bottomed at 117 in the third quarter of 2006, but then recycled when it hit a low of 101 in the third quarter of 2007. The “A” low of 0 was in the first quarter of 2005, the “M” low of 8 was in the fourth quarter of 2005, the “E” low of 31 was much earlier, in the first quarter of 2003, and the “L” component of CAMEL was 0 in the second quarter of 2006.
In summary, IDCFP’s risk alert for the financial downturn of large credit unions, as well as, the entire credit union industry, was evident in the fourth quarter of 2006, successfully forecasting the financial problem to occur in 2008 and 2009 (see Table II).
1,2 How Credit Unions Outgrew Their Down-Home Reputation, Wall Street Journal, 12.3.2019
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John E Rickmeier, CFA, President, firstname.lastname@example.org
Robin Rickmeier, Marketing Director