Analyst: Squeezed Margins Demand Two Responses

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Despite moderate growth in recent years, credit unions hold just 6.4% of financial institution assets. Revenue growth remains flat, while operating expenses continue to rise.

So how can credit unions succeed under those conditions in 2004? The answer, according to Chip Filson, is innovation and cooperation.

Filson, the president of Callahan & Associates, Washington, D.C, told WesCorp's Credit Union Outlook 2004 conference that credit unions have remained profitable only because of continuing increases in service income. But two categories in that sector are at risk, he said: interchange income and real estate loan fees. And that leads to the question: can growth be maintained?

"What will be successful in 2004 depends on the definition of 'success,' " Filson said. "The jury is out, because the traditional definition of success might not be enough. To really fulfill their promise, credit unions must win the battle of the marketplace."

Before offering his solutions, Filson first addressed several areas where CUs face their biggest challenges. According to statistics compiled by Callahan, net-interest margin is falling more steeply than operating expense ratio. Filson said he believes it will not be long before the operating expense ratio will be higher. As a result, service income is vital and an efficient transaction business is critical.

Another problem area is operating expenses. The average CU spends more than 50 cents of each dollar of revenue on operating expenses. Filson said it is not unusual for some credit unions to spend 70 to 75 cents of every dollar on expenses.

"Expense growth continues to rise, while revenue is flat," said Filson. "How long can credit unions continue to have operating expense growth far outstrip revenue growth?"

Filson said historically low interest rates are the most significant factor in credit union planning and have made lending critical. While the total number of loans originated has risen for several consecutive years, those loans are not "sticking" on the balance sheet, he said. Refinancing of outstanding loans means CUs have realized just a tiny increase in balance sheet loan growth.

"Credit unions have got to find ways to do more loans," he urged.

In recent years, the movement's share of auto financing has fluctuated between 13% and 15%-a figure Filson termed "significant." Instead, he said the problem for credit unions is in not having an "aggregated presence" in the minds of auto dealers and manufacturers.

Treading In Mortgage Waters

Mortgage loans are another area where CUs are treading water, Filson continued. First mortgage originations have grown in the past two and a half years, mostly due to the refinancing boom.

The alarming side to this trend, he said, is credit unions' market share is unchanged despite the growth.

In addition, credit unions are losing market share in credit cards. Through Dec. 31, 2002, CUs have lost about one-half of 1% of the market since 1997.

"Many credit unions are leaving the credit card business because they say they can't compete. This bodes poorly for the mortgage market, because a handful of credit unions have a large share of mortgage origination."

Credit unions must create "superior member value," according to Filson., and doing that takes hard work, as there are no "silver bullets."

"Managers must gird their loins and do what is necessary, but sometimes they are hesitant to do. Cooperation is critical to the future of credit unions."

CUs are notorious for merely "adding on," rather than trying to break through, Filson said, adding it's because of the cooperative nature of the movement. On the other hand, Filson suggested, many innovative solutions to the movement's problems will come through cooperation. "The wonderful part of the credit union system is they will tell others how they are succeeding. This cooperation is the key," he said.

One way to truly have a breakthrough gain, Filson said, is the establishment of multi-owned CUSOs. These cooperative CUSOs can be used for a variety of purposes, including data processing, e-statements, trust services, branching, ATMs, member business loans, mortgage processing and indirect lending. Such CUSOs, he said, bring scale to a problem as long as they are treated like a partner, not a vendor.

With numerous credit unions looking to expand into member business lending, Filson said CUs in several areas of the country are teaming up to form MBL CUSOs.

Another innovation Filson advocates is looking for ways to lower the cost per transaction on ATMs, checks and telephone calls. "Test your system and look for areas where there is excess capacity and where there is a capacity constraint. Look to shift resources, rather than adding resources."

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