Dramatic changes have taken place in the financial services industry in the United States over the last quarter century. This has been the era of deregulation in financial services and it has dramatically affected every institution operating within the industry. The objective of this study is to examine forces influencing the changing structure of the credit union industry as it competes with larger financial services entities.
In the last three decades, the unique characteristics and distinctions of commercial banks, savings and loans and credit unions have blurred. Each group has expanded and diversified its product and service offerings to both lenders and borrowers. As new opportunities for providing financial services have developed, there has been increased competition from other market segments. Full service brokerage houses, money market mutual funds and mutual fund families have created new savings and investment instruments, advertising and marketing them nationwide. With the repeal of the Glass-Steagall Act in 1999, the "one-stop" financial services institution became a reality.
In terms of total assets, as well as average assets per institution, credit unions are the smallest "players" in the financial services industry. Therefore it would be easy to conclude that in this increasingly competitive marketplace, their position would be the most likely to deteriorate, vis- -vis larger more diversified firms. Yet the operating performance of the industry has been extraordinary. Operating data analyzed in this study show clearly how the industry has grown and evolved to meet the financial services needs and desires of its growing membership base while experiencing significant consolidation.
Competitive Perspective in Financial Services
The structure of the credit union industry has evolved over the last quarter century influenced by both internal and external forces. Inside the industry, data will show enhanced efficiencies due to asset size providing members with expanded services at competitive prices. External forces have also been contributing to the structure and shape of the industry. The competitive landscape of financial services has created challenges and opportunities that must be addressed by credit union managers, boards of directors and government regulators.
In addition to reducing and then eliminating branching restrictions, important technological innovations have contributed to concentration throughout the financial services industry. The computer revolution for data gathering, analysis and storage and the growth of ATM utilization by the public have had an impact on industry structure. The efficiency gains are greatest in large high- tech financial institutions with customers of banks and members of credit unions deriving the benefits of lower product costs and enhanced speed of transaction execution.
In response to regulatory changes in the financial services industry of the 1990s, the Credit Union Membership Access Act of 1998 was critical to this market segment. Limited membership of federally chartered credit unions had created portfolio concentration risks over the years. By expanding and diversifying fields-of-membership, these risks can be mitigated, thus providing enhanced products and services to members.
Credit Union Industry Overview
Credit union industry membership grew by almost 18 million in the 1990s from 61.1 million in 1991 to 78.9 million in 2000 and 80.7 million in 2001. This represented an average annual growth rate of 2.8 percent, almost three times the growth rate of the U.S. population (1.01 percent per year).
In one of our analyses, credit union members were broken down by the asset size of the credit unions to which they belonged. There has been a steady exodus of members in all asset categories below $50 million. All the growth in membership has taken place in the four asset categories from $50 million up to the $500 million plus group. Upon further examination, there was a 23.7 million member increase in just those credit unions with assets of $200 million and higher. This consolidation trend, especially in the larger asset size credit unions, is the significant story of the last decade.
In terms of member assets held by various asset size credit unions, once again, it is clear that there has been a significant shift in funds toward the larger institutions. Smaller credit unions with assets below $10 million have seen declines in asset holdings, while those above $10 million have attracted funds. Also the larger the asset category the greater the asset growth, while the smaller the asset category the larger the decline in asset holdings.
Factors Underlying CU Consolidation
It may be observed that within the credit union industry there is a positive relationship between the level of savings rates and the size of the credit union. For every year of the period under analysis, larger credit unions paid out higher average savings rates to their members. Larger credit union (assets over $50 million) payouts were 30% to 40% higher each year than those paid out by the smallest asset categories (under $5 million) The $500-million-plus asset group has paid interest rates above the "all credit union" category every year of this study. The under $100-million credit unions have paid lower rates each year while the $100 million-to- $500 million asset groups generally paid approximately the overall industry average rates. For individuals who are members of more than one credit union, it is not difficult to expect them to keep most of their funds in the larger asset institutions.
Credit unions have also been very successful at supplying members with funds when they have been required. It can be observed quite clearly that the largest credit unions (assets over $200 million) charged their members rates lower than those of the industry average. In fact the $500-million-plus asset group has charged rates at least 20% lower on average than those charged by the smallest credit unions (under $5 million) every year. This has been another reason for the much more rapid expansion in membership and asset growth of large over small credit unions.
It is not just the volume of loans nor the interest charged on those loans that generates income for the credit union. All loans involve the risk of delinquency and/or default by the member resulting in expenses that must be covered as part of the operations of the institution. Variations between large and small credit unions are quite significant for our data period. The smallest credit unions consistently exhibit delinquency ratios that are four to five times as high as those for the largest credit unions Even when credit union size reaches $10 million, delinquency rates are approximately double those of the $500-million-plus asset group.
Not all delinquent loans result in net charge-offs to operating income. Credit union managers across all asset sizes are proud of their record in this area. While larger credit unions sustain smaller write-offs, the differentials in size categories are not nearly as great as they were for delinquencies. The largest credit unions ($500-million-plus assets) generally have net charge-offs/average loan ratios that are approximately one-half of the smallest credit unions (under $2 million assets).
For asset groups above $200 million, charge-off rates are equal or less than the overall average. In contrast, all credit unions with assets under $20 million have charge-offs higher than industry averages. These differentials translate into significant average cost savings for larger institutions.
When operating expenses are examined by asset size, it is observed that per dollar of asset the largest credit unions have the lowest expense ratios. The operating expense/asset ratios for large credit unions ($500-million- plus assets) are approximately 60% to 65% of those for the smallest credit unions(assets under $5 million).
The $500-million-plus asset category has achieved operating expense ratios below the industry average in every year of the study. All groups with assets under $100 million have higher operating ratios, while the $100-to-$500 million categories have mixed levels in relation to the industry average. By holding down expenses, larger credit unions take advantage of economies of scale and scope, passing along these savings to their members.
Another set of data also contribute to the findings. In examining net capital/asset ratios of credit unions by asset size, there are significant inverse relationships between the size of this ratio and the asset size of the credit union. The trends over time have been towards the increasing size of the net capital/asset ratio for all asset size credit unions. This shows that credit unions have been able to generate more income each year than expense with the result being an increasing trend in the net capital/asset ratio. For each year, it may be observed that the smallest credit unions have the highest capital ratios.
In the annual CUNA yearbook survey of credit union services, it may be observed that selected services offered by credit unions expand significantly as the asset size of the credit union increases. Credit unions with assets under $10 million generally do not offer many services needed by their members. For organizations between $10 million and $50 million, the offerings grow significantly and above $50 million, members can be quite confident of being offered the broadest spectrum of financial services.
Do these findings imply that the "small" credit union (assets under $10 million) will soon disappear? There will always be small credit unions to provide services to new membership groups. Of course, the other way is through select employee groups (SEGs) that become part of larger credit unions. Both methods result in expanding credit union membership.
Smaller credit unions (assets under $20 million) have enhanced their competitive positions over the last decade. Strategies such as "shared branching" and sharing ATM networks have contributed to expanded member services. Yet these initiatives may have slowed the rate of decline in those series, but they have not stopped the declines. While smaller credit unions will continue to be formed, they will quickly realize that their membership will be expecting expanded loan and savings products as well as other financial services. If they are able to grow their assets and expand their offerings, members will be served. However, if they lag behind member demands, consolidation with a larger credit union will be the best strategy for their membership.
About the authors: Dr. James S. Gould is Professor of Marketing; Dr. Surendra K. Kaushik is Professor of Finance and Associate Director of the Center for Applied Research, Lubin School of Business, and Dr. Raymond H. Lopez is Professor of Finance and chairman of Academic FCU. All are with Pace University, White Plains, N.Y. They can be reached at 914-422-4165 or at rlopez pace.edu.