The Treasury yield curve is flat and that means tighter margins for credit unions.
It's a scenario consultant Jared Cahill called this "perfect storm that is brewing-low margins, increased employee costs and increased competition-as well as other serious issues weighing down industry returns."
Cahill is a financial consultant and national director of alliances for John M. Floyd & Associates, Inc. of Baytown, Texas. He shared strategic tips with the recent Florida league meeting about how to respond to the sea change in CU economics.
"If short-term rates eventually exceed long-term rates, an inverted yield curve is produced, which can be detrimental to the overall health of the economy," Cahill said. "A recession will typically follow, by about nine months. Additionally, rising interest rates reduce loan demand." And loan demand is critical to a CU's bottom line.
"Margins are getting tighter; asset and liability pricing elasticity is declining and competition is getting stiffer," stated Cahill. "As short-term interest rates rise, credit union bottom lines will be squeezed ever more tightly, requiring some of them to reshape their asset/liability portfolios, to boost non-interest revenue and to invest in developing a sales and service culture that better markets and cross-sells products and services to their members and potential members," he said.
Fee Income Must Grow
One of the specific challenges in the past six or seven years has been the ability of spread income to generate a positive bottom line," Cahill stated. "In other words, credit unions have experienced an increasing reliance on fee income to break even. From 1990 to 1997, return on assets (ROA) less non-interest income ranged from about 0.2% to 0.6%. However, since 1998, ROA less non-interest income has been very close to zero, and in both 2003 and 2004 was actually negative by -0.2%. Based on the economic outlook and rate trends for the past two economic expansions, credit unions may be looking at an average reduction in their 2005 ROA of 46 basis points or 0.46 percent," he concluded. "Strong core deposit competition from banks and other non-bank financial institutions will lead to additional pressure on funding costs during this rising rate environment."
It's time for credit union people to stop squabbling among themselves, Cahill seemed to suggest. They should be "less concerned about peers and more anxious about competitors. And consolidations and mergers are only driving up the ante."
That may mean taking a much closer look at an idea that is largely unpopular with credit unions: fee income. Cahill pointed to data suggesting CEOs are lukewarm, at best, about raising fee income. But ensuring the health of a credit union isn't a popularity contest.
"To survive and thrive, credit unions must increase non-interest income, lower operating costs, grow and be competitive."
Cahill cited overdraft programs, credit disability insurance and credit life insurance as sources of non-interest income that should be pursued.
He also suggested lowering fee waivers and charge-offs. "A project to increase non-interest income will bring the quickest value. Studies show it is faster than account acquisition, sales and service or expense reduction projects. Credit unions, which have grown capacity at about 15% a year while growing only 8%, can lower operating costs by attracting more members and services to soak up over-capacity, " said Cahill.
