Dealing With Falling ROA
Lower returns on loans and investments continued to put pressure on credit unions' bottom lines last year and pushed profitability for the average credit union down to just 0.92% (92 basis points)-a 20-year-low.
Experts are citing two main reasons for the fall in ROA.
"The fizzling out of the mortgage refi boom, taking out lots of non-interest income (fees) for credit unions, as well as the gains on the sale of mortgages," said Bill Hampel, chief economist for CUNA. "And the flattening of the yield curve (short-term rates are closer to long-term rates). The flatter the yield curve, the harder it is for financial intermediaries to make money, because they borrow short and they lend longer."
The continued low interest-rate environment, even as the Federal Reserve tried to push up short-term rates, was perhaps the major culprit, making it tough for intermediaries such as credit unions.
Data compiled by NCUA based on fourth-quarter call reports for the nation's 9,014 credit unions shows the yield on average loans dropped in 2004 to a meager 6.19% -maybe the lowest ever-while the yield on average investments continued to fall to an all-time low of just 2.58%.
The result was a vise-like squeeze on the bottom line that has been building for several years.
But the low rates are not the only culprit. The multitude of options in the financial markets is also making it more difficult to capture mortgage and consumer loans.
"A pure depository intermediary function is not going to have the effects it used to. The competition is so intense on both the deposit and loan side," said David Dolby, chief economist for CUNA Mutual Group. "Credit unions are going to have to get used to living with less. Years ago, credit unions were counting on spread. That spread is just not going to be there."
In fact, NCUA data shows the net-interest-margin-to-average-assets also fell last year to just 3.32%, down from 3.41% in 2003 and 3.63% in 2002. That made it more difficult to earn a profit on many transactions.
At the same time, expenses continued to rise at many credit unions as they added branches and new technologies, like home banking services. NCUA figures shows non-interest expenses rose by 7% last year, after increasing 9% the year before.
"If your main money maker-interest on loans-goes down and your expenses go up, that's a tough situation to be in," said Jeff Taylor, a NAFCU economist.
So, credit unions have few options to loosen this squeeze that is expected to continue over the next few years.
Credit unions could strive to make more loans, but lending grew by 10% last year, anyway, noted the analysts. And loan demand is expected to slow this year as the mortgage refi boom continues to abate and short-term rates, those affecting car and home equity loans, continue to rise. In addition there is evidence to suggest that many credit unions may be near or at loan capacity (100% loaned out).
Bruce Beaudette, president of Sunmark FCU, in Schenectady, N.Y., sees the dilemma. Sunmark reported a higher-than-usual ROA of 1.4% last year, mostly because of the sale of its credit card portfolio. But 23% loan growth and a 100% loan-to-share limits the options to maintain profitability. "It's not as if we can make more loans," he said.
There also isn't much room left to lower cost of funds, the rates credit unions pay on savings products. That's because last year's average cost of funds fell again to a record low of only 1.37%, with average rates on core share accounts hovering under 1%. So there's little room to lower cost of funds more.
So what's a credit union to do?
"They have to lend more money and start looking at feeing abusive practices," suggested D. Michael Riley, former chief examiner at NCUA and now an industry consultant.
Sunmark's Beaudette said his credit union will be looking at raising fees, as one of the few options open to them. "Courtesy pay, wire transfer fees," he cited as some of the potential targets for fee increases. "We're way below our market on those."
A consensus is that ROA's will continue to fall to what are considered historic averages. Riley predicted the average ROA will decline to around 70 BPs or 80 BPs over the next few years. CUNA's Hampel predicted ROA will fall again this year to 85 BPs, and next year to around eight BPs.
For some industry experts the fall in profitability is not such a negative thing-after all, the core principal of credit unions is their not-for-profit status. Hampel is of that school of thought. With net capital ratios near all-time highs, Hampel feels there is little need to strive for high profitability. "Credit unions can still grow adequately at 92 basis points," said Hampel, noting that most credit unions can maintain their net capital ratio-a key concern of the regulators-with ROAs of around 60 basis points.
Hampel noted that high profits, like high capital, must be taken from someone-and for credit unions that means their members. So to build ROA, "what you have to do is take it out of the members through lower deposit rates, and higher loan rates and more fees," he asserted.
He urged credit unions boards and managers to ponder that conundrum.