ONTARIO, Calif.-The business model for many small credit unions appears to be changing-by necessity-with at least one CEO saying it's now fee income supporting the loan process.
A number of sources have told Credit Union Journal that many credit unions, but especially those that are smaller, have little choice in a margin-strapped environment that shows no sign of reverting to the old model of operating purely on spread but to focus on a different income model.
Moreover, say analysts, many of those smaller CUs will need to get better focused on underserved markets in order to survive. It's a symbiotic win, say analysts, as those underserved markets need CUs as much as CUs need them.
How Low-Income Members Help
Many small credit unions need to generate more non-interest income and a greater average loan yield to survive, which low-income individuals can provide. And, low-income consumers need a trusted financial services provider that offers less-expensive products than what they receive from fringe financial services providers. According to a 2011 FDIC study, 8.2% of U.S. households are unbanked and 20.1% are underbanked.
The shift in business model, sources say, is occurring because smaller institutions are finding it more difficult than larger credit unions to generate non-interest income revenue (Credit Union Journal, Feb. 4) at a time when margins are shrinking.
Dwight Johnston, chief economist at the California and Nevada Credit Union Leagues, believes many small credit unions will have to "re-invent themselves. I don't know to what level or what definition of reinvention it will be, but they have to get away from relying on traditional interest rate spread," said Johnston, noting as many other experts have that small CUs' lack of mortgage offerings will hurt them from spread and non-interest income standpoints. "I am concerned for small credit unions going forward."
That may lead many small CUs to try to control expenses even further-something Johnston does not see as an answer. "Cut costs too much and you risk turning away loyal members by not providing enough of the hands-on service they are accustomed to."
With small credit union boards typically averse to charging members more fees, it's going to be a "tough balancing act for the small credit union," insisted Johnston. "In addition to boards not wanting to charge fees to the current membership, the small credit union tends to have members who are very close to the credit union and watch fees closely. It's not like at a larger credit union, where members see their CU more as a bank, and as long as fees are below what banks are charging then it's OK."
Philosophy Change Will Be Slow
Dave Colby, CUNA Mutual Group chief economist, does not disagree, saying that small credit unions adding fees to make up for shrinking revenue won't be the solution. "To add more fees, to the amount needed, takes a change in leadership philosophy, and for a small credit union that does not happen quickly. Sometimes these kinds of changes only happen after the examiner writes you up for erosion of capital."
Scott Butterfield, principal at CU consulting firm Your CU Partner in Sumner, Wash., however, is seeing a number of small credit unions taking matters into hand and shifting their business model to one that serves the underserved. "I work with a large number of these credit unions and what is happening is one of the best-kept secrets."
Groups of small credit unions are carving what Butterfield calls a community development products and services niche. These CUs are offering payday loans, check-cashing services, remittances, title loans, courtesy pay, microenterprise small business loans, and adding returned check fees and safety deposit box charges for a group of new members that welcomes the services and pays the costs.
Tapping Into Different Types of Loans
"There are hundreds of small credit unions changing their business model," said Butterfield. "They are tapping into where the loan need is now-not the boat and RV loan, but in the loan to cover a transmission repair or the cost to get that check engine light fixed so the member has reliable transportation to work. A lot of credit unions are focusing on the Hispanic community. They are adapting."
The National Federation of Community Development CUs reports that the number of CUs with the low-income credit union (LICU) designation almost doubled this past year, reaching almost 2,000, but reminds there are several reasons. The growth came after NCUA last year informed more than 1,000 federal credit unions from small to large asset sizes of their eligibility to become an LICU. NCUA said the low-income expansion was part of a broader White House initiative to expand assistance in drought-stricken areas.
The LICU designation affords a number of special privileges, including being eligible for the Community Development Revolving Loan Fund grants and loans, the ability to obtain supplemental capital, the ability accept non-member deposits from any source, and being exempt from the 12.25% of assets cap on member business loans.
Bankers have termed the NCUA's actions an end-run on the MBL cap. Whatever the reasons for CUs converting, Federation CEO Cathie Mahon said her group has received "dozens and dozens" of requests for more information on how to go after an LICU designation. "There is a lot of interest now," said Mahon.
Fee Income At 7.17%
The community development business model typically produces much higher fee and other income and loan yield, said Butterfield, citing the example of Detroit's Communicating Arts CU, run by CEO Hank Hubbard.
"Hank serves people no other mainstream financial institution wants to serve. CACU is not charging predatory fees, but they do charge fees. As of September, their fee and other income was 7.17%, and their peer group 0.99%. Hank's credit union's membership growth was 3.6%, loan growth 4.91%, average loan yield 9.5%, and delinquencies 2.5%. I know many credit unions that would take 2.5% delinquencies for that yield."
At the end of the year, the $34-million CACU reported 2.44% ROA, 16.86% net worth, and 5.01% membership growth. Hubbard emphasized that in no way is CACU's approach predatory and is a solution that gets the underserved away from fringe providers and on track toward financial stability.
"Our target members are low-income/low-wealth people living in Detroit who have been deserted by banks and left to predatory providers like check cashers, payday lenders and corner car lots," he told Credit Union Journal. "They tend to have very low balances (80% have less than $500 on deposit) and low credit scores. Many years ago we defined these people as our target, and set about creating our products and services with them in mind."
Hubbard emphasized these members are high-touch and high-transaction oriented.
"They are not averse to fees in general, as long as they understand them and can control them. For instance our members love our courtesy pay program ($29 per overdraft)," said Hubbard. "I can't say that strongly enough. We also have a payday lender alternative (18% APR) that has an annual fee ($70). It costs about 25% of what similar transactions at a payday lender would cost, and members love it."
Pulling Their Weight
It wasn't until CACU initiated courtesy pay that its target members were able to pull their own weight in the cooperative.
"We stopped actively courting what our industry defines as 'good members' and started to put every product and service through what I think of as a low-balance filter. If the product doesn't serve that segment, we don't put any resources toward it. Regular CDs for example-we have not promoted our regular CD rates in ages, even though they are often top of the market."
Despite a high overall loan yield, operating expenses (7.78% net operating expense to average assets) make the loan program a break-even, said Hubbard, a situation Butterfield points out is commonplace with credit unions that have to perform a great deal of one-to-one member counseling and conduct lengthy loan interviews.
"Now it is the fee income supporting the loan process," said Hubbard, pointing out fee and other income exceeds loan income. "That's a little backwards from traditional CU thought. Frankly, if we did not have this level of non-interest income, we could not afford to serve our chosen field of membership."
Ratios Are Misleading
Pointing again to CACU's high operating expenses and employee-to-member ratios, Hubbard said, "What casual observers will say is that we aren't efficient, and that these low-balance/high-transaction members are dragging us down. Actually the opposite is true. We decided this was who needed us and figured out how to make this business model work."
In, Sunnyside, Wash., the $60-million Lower Valley CU two years ago increased its lending focus toward the local low- to moderate-income community. Since then it has had double-digit loan and member growth with little or no charge-offs.
8.35% Loan Yield
"Their model is allowing them to grow and they have an average loan yield in the mid-90 percentile among their peers-almost 200 basis points higher than their peer group," explained Butterfield. "Consequently, this credit union's ROA (1.07%) is more than double its peer group. The credit union is interesting too, because it has been able to secure almost all of its loans, not an easy task."
CEO Suzy Fonseca said Lower Valley has become an "expert" at lending to lower credit scores, typically B and C credit and 500-600 Beacon scores. "When an individual does not qualify under our regular terms, say the collateral value is not there, we bring them into the office and talk to them. We try to work something out, see if we can get other types of collateral to secure the loan and get them what they need."
LVCU prices for the risk and the extra time it takes to work with these members. The average loan yield is 8.35%, and delinquencies are 0.48% with charge-offs at 0.12%. Fonseca said low-income members can be very good borrowers as long as it takes the right approach-doing extra counseling up front, securing the loans with additional collateral, and pricing for the risk.
Fonseca emphasized, though, what really keeps members paying on time is if they understand the credit union is giving them special attention and listening to them.
"We have a lot of members who are Spanish migrant workers, a culture that is extremely passionate and reserved," said Fonseca. "But if they see you take time for them, they become very dedicated to you. Often we see if they encounter financial trouble they pay our loan first."
Fonseca also added that to take a community development focus, the credit union needs staff who are part of the community. For Lower Valley that means people who live nearby a branch and speak Spanish.
"More than half of our team speaks Spanish. You can't have someone who works at your office but lives in Timbuktu. The members won't relate to them and your staff won't understand your members' issues."
Turning A Profit
The $48-million TMH FCU in Tallahassee, Fla., received its Community Development Financial Institution (CDFI) designation last August and the credit union projects this year it is on pace to make a $200,000 profit. The main fee driver, said CEO Tim Cook, is the courtesy pay program that charges $31.50 for each item paid. This year, too, Cook expects interest in its Payday Loan Advantage will be up.
"The first time members take this loan they get up to $500 no questions asked as long as they are on the job for a year. The rate is 18%. They pay that loan and the next time maybe we can give them $1,000."
TMH is applying for a CDFI grant to hire another loan officer and pay for more staff to be trained as certified financial counselors. "Our goal is to improve members' financial positions and eventually shift them from D and C borrowers to A and B."
With NCUA's move to allow more CUs to obtain the low-income CU designation last year, Butterfield said he is getting a lot of inquiries from CUs asking, 'I have this designation now, what can I do with it?'"
CACU's Hubbard says the answers for small credit unions lie with each co-operative. "Smaller credit unions should figure out what makes them different, and design their own model based on who they want to serve. They need to figure out what that is, then price products and services to make them profitable as a whole."
'Don't Want To Die'
Butterfield cautioned that the battle many small credit unions are fighting to stay profitable and in existence may not be winnable if they try to compete with mainstream FIs.
"They can't compete with everyone. For example, these new auto loan rates now are ridiculously low."
Still, there is hope that many small credit unions will change their model, offered Butterfield. "I was in a credit union last month, one with a board that has always been resistant to change. But they were asking, 'What can we do? We don't want to die.' So a number are changing their business model, and I think more will come, serving members of low to moderate means with products that meet those people's needs. Those credit unions will be OK for the most part. But for those trying to hang onto their old business model, I think the situation will eventually become dire."
MORE@CUJOURNAL.COM
Subscribers can read related stories by going to www.cujournal.com and typing the following headlines into the search function:
New Pressure On Non-Interest Income Requires New Strategies
The Great CU Divide: Overall Industry is Growing, But Many Are Not
