CHAPTER

2828 Credit Unions

© 2003 South-Western/Thomson Learning

Chapter ObjectivesChapter Objectives

Describe the main sources and uses of funds for credit unions

Present the terms and concepts related to credit unions

Describe how credit unions are regulated Describe how credit unions are exposed to

various forms of risk Evaluate the performance of credit unions

Background of Credit UnionsBackground of Credit Unions

Credit Unions (CUs) are nonprofit, mutual organizations Members have a common bond such as an affiliation

with Labor union Church University Residential area

There are about 10,000 credit unions in the U.S. with approximately 20 million members

Total assets of CUs are less than one tenth the amount in commercial banks

Background of Credit UnionsBackground of Credit Unions

Ownership of credit unions Credit unions do not issue stock Owned by depositors Deposits are called shares, and the interest paid is

called dividends Because they are nonprofit organizations their

income is not taxed They can be either federally or state chartered

Background of Credit UnionsBackground of Credit Unions

Objectives of credit unions Satisfy their members

Offer interest on share deposits Offer loans to members

What about earnings that the CU accumulates? Offer higher rates on deposits Offer lower rates on loans Advertising costs

Background of Credit UnionsBackground of Credit Unions

Size of Credit Unions A few CUs have assets of more than $1 billion

(e.g. the Navy Federal CU) Most, however, are very small

Advantages of credit unions Pay no federal income taxes Employer-supported facilities Exempt from anti-trust laws Powerful grass-roots lobby and trade associations

Credit Union DisadvantagesCredit Union Disadvantages

Limited diversification Economic risks impact funds providers and

borrowers High liquidity needs Concentrated default risk

Management Concerns Internal controls—separation of duties Volunteers vs. professionals

Small Entities Difficult to attain scale economies

Sources of Credit Union FundsSources of Credit Union Funds

CUs obtain most funds through share deposit by members Similar to passbook savings Insured up to $100,000

CUs also offer share certificates Compete with CDs from commercial banks

Checking accounts are called share drafts Compete with NOW accounts

Sources of Credit Union FundsSources of Credit Union Funds

If CUs need funds temporarily, they can borrow from other credit unions or from the Central Liquidity Facility (CLF) Acts as a lender for CUs much like the Fed’s

discount window for banks CLF is an emergency lending fund that is part of a

larger internal system called the Corporate Credit Union Network, which is a “credit union for credit unions”

The primary source of capital for CUs is retained earnings

Uses of Credit Union FundsUses of Credit Union Funds

CUs use the majority of funds for loans to members Automobiles Home improvements Personal expenses Some CUs offer mortgages

CUs also invest in securities

Regulation of Credit UnionsRegulation of Credit Unions

Federal CUs are supervised and regulated by the National Credit Union Administration (NCUA) NCUA is composed of three board members

appointed by the president Grants and revokes Federal charters Examines the financial condition of Federal credit

unions

Regulation of Credit UnionsRegulation of Credit Unions

Risk assessment NCUA examiners compare CU ratios with industry

norms to identify problems Employ the CAMEL system much like FDIC

examiners Capital, assets, management, earnings, and liquidity Assign each CU into a risk category ranging from Code 1

(low risk) to Code 5 (high risk) Less than 10 percent of CUs in Codes 4 or 5 Alerts examiners to CUs experiencing problems

Corporate Risk Information System (CRIS) analysis

Regulation of Credit UnionsRegulation of Credit Unions

Capital requirements for Federal credit unions CUs are subject to capital requirements of 8

percent of risk-weighted assets, 4 percent of primary capital (retained earnings and reserves) and 4 percent of secondary capital

CUs are regulated with respect to the types of services they can offer Now able to offer mortgages and can sell mortgages

they originate

State-chartered credit unions are regulated by states

Insurance for Credit UnionsInsurance for Credit Unions

Insured by the National Credit Union Share Insurance Fund (NCUSIF) (1970) Administered by NCUA 90 percent of CUs are insured by NCUSIF—all

Federal CU are insured Credit unions contribute annual insurance premiums

of 1/12 of one percent of share deposits to the insurance fund

Provides for up to $100,000 in insurance Low CU failure rates have meant that the reserves

have been more than adequate

Credit Union RisksCredit Union Risks

Liquidity Risk Credit RiskInterest Rate

Risk

Credit Union Exposure to RiskCredit Union Exposure to Risk

Liquidity risk Localized depositors Unanticipated surge of withdrawals Short-term solution: borrow from the CLF

Credit risk Concentrate on personal loans to members many of

whom may be employed by same employer Most loans are secured Common concern: volunteer employees may not

conduct a thorough credit analysis of loan applicants

Credit Union Exposure to RiskCredit Union Exposure to Risk

Interest rate risk More insulated from interest rate risk than banks Assets (consumer loans) maturities are typically

short term, matching the short-term liabilities Because of the similarity in maturity in both assets

and liabilities, the interest spread has been fairly stable for CUs

Exhibit 28.9 Interest Rate Spread of Exhibit 28.9 Interest Rate Spread of Federal Credit UnionFederal Credit Union

1975 1976197719781979 1980198119821983 198419851986 198719881989 1990

Year1991 199219931994 19951996 199719981999 2000

14.0

12.0

10.0

8.0

6.0

4.0

2.0

0

Average Yieldon Assets

Average Costof Funds

Average InterestRate Spread

Percentage

Performance of Credit UnionsPerformance of Credit Unions

CUs have been more profitable in the 1990s due to growth of CU assets and increased efficiency

CUs have been merging More diversified member base Achieve economies of scale Offer a variety of new products such as traveler's

checks, money orders, and insurance