In many cases, loans-to-members declined by about 50% during the five-year period. Almost all of that decline was in auto loans. New auto loans declined more than used auto loans. In almost every case, the auto loan portfolio decreased more than any other loan type ,and its composition shifted to used auto loans. In almost every case, real estate loans became the largest component of loans. First-mortgage fixed-rate loans became a larger percentage of total loans. The shift to used auto loans, in my opinion increases credit risk because used cars have historically had a higher charge-off rate than new auto loans. The shift to fixed-rate first mortgages means more liquidity risk and more interest rate risk.

The declining loan portfolio coupled with a big decline in loan rates has significantly reduced loan income and investment income. The larger credit unions have offset that decline with more noninterest income. The main sources of noninterest income are courtesy pay and NSF fees, debit and credit card interchange and commissions for selling real estate loans to the secondary market. Smaller credit unions have low checking penetration so they don't get much courtesy pay/NSF fees or interchange revenue. The smaller credit unions don't originate or sell many real estate loans so they haven't benefited from the refinance boom in real estate. In almost every case, the smaller credit unions have been unable to offset the decline in loan and investment income with noninterest income. The loss of income and the corporate resolution costs have eroded capital.

The decline in capital has been offset by a similar or greater decline in assets so the capital ratios still look good. But a 9% capital ratio doesn't mean much if it is maintained by shrinking assets and shrinking capital.

Scale is very important. You touched on scale, but I don't think you realize how important it is. Net interest margin was the main source of income before the meltdown. The net interest margins have been shrinking. That makes scale very important. You have to have a large asset base to make up for narrower margins for two reasons. You make less margin on every dollar of assets so you need more assets to sustain income. And you are more dependent on noninterest income that is entirely volume driven. The more debit card transactions, the more interchange you earn. The more checking accounts you have the more NSF and courtesy pay you earn.

Scale is a huge advantage. You mentioned that about 80% of credit unions have less than $100 million in assets. You won't see that same percentage of banks with less than $100 million in assets. The reason is that scale argues against that. Too much of the credit union's income is eaten up by overhead and expenses. That means less member benefits, less service, less convenience and less return to members. The difference is that banks are owned by investors who demand financial performance. Members only demand service and when they don't get it, they leave. That explains the rapid decline in members that you referred to in the column. There isn't anyone, other than the board and management to enforce financial performance measures, until disaster strikes and the regulators enter the picture.

Henry Wirz
President/CEO
SAFE Credit Union
North Highlands, Calif.