It’s Wednesday and we are marching forward with Financial Literacy Month! Last week, I took a look at liquidity. What it is, how it works, and what credit unions can do to manage it.
This week, we will be taking a look at another part of the credit union system that may be nebulous to the average staffer: the corporate credit union. You have probably heard about them, you know they do something for your credit union, but what exactly is their purpose and how they formed might be unclear.
A simple definition
Before we get into a history of corporate credit unions, let’s provide a basic definition of corporate credit unions from which we can continue to build our understanding of them.
To put it simply, corporate credit unions are credit unions for credit unions. In other words, where a “natural person” credit union has members like your neighbor down the street, a corporate has members like your credit union down the street. In the same way your neighbor deposits funds and borrows money, credit unions can use a corporate to manage their liquidity by depositing excess liquidity and borrowing from the corporate when becoming “loaned out.”
Corporate credit unions do way more than that though! We will touch on it later. Next, a brief(ish) history lesson.
Liquidity issues in the 1970s
To set the stage for the dawn of corporate credit unions, we must first understand the state of credit unions in the early 1970s. The biggest challenge credit unions were facing post World War II was accumulating enough deposits to fund new loans. Strapped for dollars to hand out, credit unions found themselves in a position where their loan-to-share ratio was approaching 100%. As I mentioned in other articles, “the higher the [loan-to-share] ratio, the less liquid the credit union is, and the more likely they’ll need to look to outside sources to fund new loans.”
This was in part solved with the advent of new deposit products (like certificates of deposit) and eventual deregulation regarding savings rates, but also with the development of “corporate credit unions” that could lend out money to natural person credit unions.
These corporates actually had their beginning as “central credit unions” which could serve the needs of credit union board members and staff who were restricted from using their own credit union for services as a fraud prevention measure. These central credit unions would over time also provide small credit unions with options for depositing excess cash and borrowing funds as alternatives were costly. By the late 70s, with rules changing regarding borrowing from one’s own institution, many central credit unions shifted their charter to serve as corporate credit unions.
In 1974, a meta or “wholesale” corporate would be formed: U.S. Central Credit Union. With its formation, the corporate credit union system became national as U.S. Central solely served other corporate credit unions, specifically affiliated with CUNA, CUNA Mutual, and its member leagues.
As the 70s would progress and inflation would ravage the nation, corporates would face great difficulties as investment values dropped. As an ad hoc system, the issues facing corporate credit unions then would rear their ugly head again later.
Trouble brews as the corporate system grows
U.S. Central helped tie the loosely organized corporate system together, but not entirely. Roughly half of the 40+ corporates at the time were linked to their leagues and U.S. Central. The corporates invested in U.S. Central, which in turn reinvested those funds conservatively, matching the rates and maturities of their underlying obligations.
Independent corporates, however, tended to invest a little more aggressively. Though this resulted in better yields for their member credit unions, it also opened up additional risks.
Among their more aggressive investments were collateralized mortgage obligations (CMOs), bundled mortgage loans sold as an investment and earnings as payments are made on the loans. “Agency CMOs” were considered fairly safe investments as they were backed by major agencies like Freddie Mac and Fannie Mae. Others, however, were created using loans that did not meet those agency standards and were less secure. Though these investments were considered generally secure, they did come with interest rate risk and in the 90s this would come to bite some.
As rates rose, the value of CMO holdings lost value. Capital Corporate Credit Union (CapCorp) was hit hard as its aggressive investment strategy backfired. CapCorp’s heavy concentration in CMOs resulted in a CAMEL 4 rating from the NCUA and the forced sale of two of its CMOs.
According to Paul Thompson, CUDE, “The forced sale resulted in a loss of $1.4 million. With the economy picking up steam, CapCorp’s members had already been withdrawing funds from the corporate to meet increased loan demand. Hearing of NCUA’s action, member credit unions, mostly the larger ones, began withdrawing deposits totaling half a billion dollars, a third of the corporate’s assets.”
Eventually, the NCUA would step back in, impose a 60-day freeze on withdrawals, and later, vote to conserve the corporate. Thankfully, no credit unions were endangered and the NCUSIF took no loss. But this only foreshadowed more severe issues during the Great Recession.
How the Great Recession shook up corporates
Over the decades that corporates had been around, they had changed to meet the needs of their member credit unions. No longer were they only a source of liquidity for natural person credit unions, they also provided much-needed products and services that before could only be attained at great expense from banking competitors.
And not only did corporates serve credit unions, but they also would come to provide services to leagues, trade associations, CUSOs, and more. As competition to serve credit unions regionally and nationally swelled, the corporate system shrank. When once it consisted of 46, it consolidated to 27 by 2008.
In a 2004 GAC report to the Committee on Banking, Housing, and Urban Affairs, it was said that since 2000 “a large influx of deposits coupled with low returns on traditional corporate investments has caused a downward trend in corporates’ overall profitability because deposits/assets have grown more quickly than income. . .To generate earnings, corporates increasingly have targeted more sophisticated and potentially riskier investments.”
These investments into CMOs and other mortgage-backed securities would prove fatal as the housing market collapsed in 2007. Initially, the losses from these investments were considered temporary, but would by late 2008 have to be charged against earnings or capital. As credit unions grew concerned, they withdrew funds.
“This was a classic ‘run on the bank’ in slow motion,” wrote Thompson. “By the end of 2008, credit union deposits in the corporate system had fallen from $92 billion in February to $59 billion, a plunge of 35 percent.”
The NCUA had to step in as credit union deposits in corporates far exceeded what was covered by the National Credit Union Share Insurance Fund (NCUSIF) or risk a cascading effect down. Attempts were made to stabilize the system using the CLF and other programs quickly launched to staunch the bleeding. Eventually, though, the NCUA would take more extreme measures, conserving first U.S. Central and WesCorp (the largest “retail” corporate), and later the corporate credit unions Members United, Southwest, and Constitution.
As with the conservatorship of CapCorp, the NCUA’s decision came with major scrutiny and accusations of overvaluing losses and acting prematurely. In 2010, the NCUA would establish new regulations for corporate credit unions to provide additional safeguards to the financial system.
Many corporates weathered the storm of the financial crisis and continue to provide valuable products and services to their member credit unions today. Though they remain a key source of liquidity for credit unions, easing the flow of cash in and out of natural person credit unions, they have grown to meet many more needs.
The financial landscape has evolved radically in the last 50 years, and credit unions are finding themselves in need of more sophisticated services and advise in the areas of balance sheet and risk management, services corporates can provide.
And there you have it, a history of corporate credit unions. Anything I missed? Let me know in the comments below.