Congress Passes, President Signs Two Bills: One Could Provide a Blue Ocean Opportunity-One Shouldn’t Be Needed

During the past ten days, President Obama has signed two Congressional bills that affect the credit union system.

The first was H.R. 2351, which provided borrowing authority for a corporate stabilization fund along with extended repayment terms: “not later than the date of the seventh anniversary of the first advance to the Stabilization Fund…” This legislation provides that NCUA may borrow an initial $6 billion, plus additional amounts not to exceed $30 billion. The borrowing draw authority ends December 31, 2010.

This legislation was widely followed and promoted by NCUA and the credit union trade associations. Hopefully, as explained below, this will be legislation that will have little or no impact on the credit union system.

The second bill was H.R. 627, the “Credit Cardholders’ Bill of Rights.” This legislation:

• requires lenders to apply payments to balances with the highest interest rates first prohibits “universal default” – increasing a consumer’s rate on existing balances based on late payments to another lender
• mandates 45 days’ notice before lenders can increase a card’s interest rate
• prohibits retroactive rate increases on existing balances unless a consumer is 60 days late with a payment
• tightens restrictions on lending to students
• adjusts redemption rules for gift cards
• bans fees for paying by phone or over the Internet, except for live services to make expedited payments.

New Opportunities for Credit Union Card Programs

This opportunity could be critically important to credit union success in the years to come. Credit cards are generally the highest yielding asset on a credit union’s balance sheet, even after allowing for higher loan losses than other assets. At March 31, 2009, credit unions reported $31.9 billion in credit card loans or 5.6% of total loans. Over the past five years, this amount and percentage has remained relatively steady.

As a result of H.R. 627, which prohibits certain fee and other anti-consumer practices, many large card issuers are reassessing their market strategy. This re-evaluation has been accelerated by the prospect of increasing losses for the rest of this year and into 2010 on unsecured card debt. The Nilson Report, for example, projects write-offs could hit $94 billion in 2009 – up from $64 billion last year.

On Wednesday, JPMorgan stated that losses from the $25.6 billion credit card loans added by the Washington Mutual merger could climb to 24% by year end if U.S. unemployment rises to 10%. Current charge-off rates on the rest of the Chase portfolio are currently running at 6.9%, although the rate varies by region of the country.

Because of the financial losses and more restricted pricing, the three largest card issuers in the United States have withdrawn credit card lines worth $320 million in the first quarter alone, according to a May 23 Economist article. One analyst forecasts that these credit reductions could run in the trillions by the end of 2010.

As banks exit these markets, credit unions will have a “blue ocean” of opportunity built on a tradition of trust and fair pricing that will be little changed by the bill. While not all consumers will be credit worthy, many customers with reliable payment histories will be looking for new card relationships. Credit unions can build their balances at a time when other loan products will have longer terms and much lower pricing. Once gained, a credit card relationship can extend 8-10 years on average.

This legislation creates a new environment for consumers; credit unions are universally recognized as trusted alternative. Congress has created the buzz—will credit unions pursue the opportunity?

Why H.R. 2351 Should Be a Non-Event

The premise for H.R. 2351 was that a “performance bond” or stabilization fund was necessary to “stretch out” the losses from the corporate stabilization plan. The NCUA’s projected loss estimate has been $6 billion since March 20. Extending the payments out over seven years at an even rate per year would cost about $860 million per year (plus interest) or about 14 basis points. This assumes a $250,000 insured share base, but does not factor in any growth of insured shares in later years.

This amount is not only manageable, but much of this has already been expensed. At March 31, 2009, more than 5,800 of the 7,745 NCUSIF credit unions reported an insurance expense. The total amount recorded in the first quarter alone is approximately $3.5 billion. In addition, comparing current net worth at March with reported net worth at December, it would appear that another $1-2 billion in losses were “backdated” to fiscal 2008.

So H.R. 2351 should be a non-event for most credit unions. Liquidity in credit unions at $263 billion is at an all time high. There is additional borrowing available from the CLF up to $41 billion.

The Looming Potential Problem

There is only one circumstance where this bill could make a difference and that would be if NCUA should borrow and spend more than the $6 billion initial amount. Every dollar drawn is repayable from future credit union earnings. Most credit unions have already expensed or planned this amount. Should NCUA spend more, than that addition will come right out of future earnings.

For example, if the full additional $30 billion were to be used, instead of 14 basis points, the annual payback premium could then average 84 basis points—for seven years. The stabilization fund could end up bankrupting the industry.

These two bills in very different ways capture both the promise and peril of regulatory-governmental responses to the economic crisis. One promises opportunity if carefully pursued. The second could create a renewed crisis should NCUA choose to liquidate and or sell the securities acquired through the conservatorships of WesCorp and US Central. Let’s hope H.R. 2351 is a true non-event.