43 US credit unions considered undercapitalized or below in Q1'22

Forty-three U.S. credit unions were considered below "adequately capitalized" as of March 31, down from 62 in the first quarter of 2021 and 57 in the fourth quarter of 2021 but in line with 43 in the first quarter of 2020.

The primary regulator for the industry, the National Credit Union Administration, considers a credit union "well capitalized" if its net worth ratio, a measure of reported net worth divided by reported assets at quarter-end, sits above 7%. Approaching that threshold is a red flag for the National Credit Union Administration, or NCUA.

"Approaching that 7% threshold, then the alarm bells start going off and the regulator is going to have some concerns and their auditors are going to have concerns," Glenn Christensen, founder, president and CEO of CEO Advisory Group, an M&A consulting company focused on the credit union industry, said in an interview. "So you're not going to often see very many credit unions below that. They're going to seek alternatives or find a different strategy to get out of that situation."

A credit union not classified as a "new" credit union, is considered "undercapitalized" by the NCUA if its net worth ratio falls between 5.99% and 4% and its risk-based capital ratio is below 8%, if applicable. A credit union is considered "significantly undercapitalized" if the measure falls between 3.99% and 2%. "Critically undercapitalized" means the metric is below 2%.

Undercapitalized credit unions

As of the first quarter, 37 credit unions were considered "undercapitalized," another five were "significantly undercapitalized" and one — MSBA Employees FCU — was considered "critically undercapitalized."

But falling below "adequately capitalized" is uncommon for the industry. The 43 credit unions considered less than adequately capitalized in the first quarter make up less than 1% of the 4,977 credit unions operating in the U.S., according to S&P Global Market Intelligence data.

The median net worth ratio for credit unions considered "well capitalized" or "adequately capitalized" at March 31 was 10.53%. Christensen said many credit unions have a personal "comfort level" of around 10%, well above the 7% minimum to be considered "well capitalized" by the NCUA.

NCUA's role

When a credit union's net worth ratio falls below the well capitalized minimum of 7%, the NCUA intervenes in an effort to require improvements to the ratio. An "adequately capitalized" credit union, which has a net worth ratio between 6% and 6.99%, will become subject to a mandatory earnings retention plan.

"Undercapitalized" and "significantly undercapitalized" credit unions also become subject to an earnings retention plan, as well as a net worth restoration plan. For "critically undercapitalized" credit unions, the NCUA's mandatory actions include conservatorship and liquidation.

Discretionary actions for credit unions considered "undercapitalized" and below include restrictions on approvals for new ventures like branching, acquisitions and new lines of business, prohibiting asset growth or changes to the credit union's senior leadership and board.

The NCUA can also force a merger for credit unions below a 4% net worth ratio. As of March 31, six credit unions reported net worth ratios below 4% and two of those six have since merged with another credit union.

When a credit union's net worth ratio begins deteriorating, the NCUA may "strongly hint" that the institutions should seek out a merger partner, "but if the credit union doesn't clean up its act and there's a threat to the insurance fund, then the NCUA is going to step in and find a partner for them," Christensen said.

It can often be tough for a credit union with a low net worth ratio to find a merger partner, according to Christensen.

"A number of credit unions, they end up holding on too long and the choices then get really limited, especially for the smaller credit unions," he said.