If you were asked to name the primary reasons for declining ROAs and capitalization in credit unions, you would probably mention the write-off of Corporate Membership Capital and NCUA stabilization expenses. Of course both of these expenses contribute to the problem, and both are not items management teams can control; however, many credit unions are facing an additional “growing” problem.
For the first time in a long time, money is flowing into credit unions, mainly because credit unions are pricing deposit rates extremely competitively, putting a strain on earnings. As credit union deposit rates are priced too high, and as credit unions experience subsequent rapid growth, capital levels are pushed lower and lower.
During the first nine months of 2009 credit unions had an average annualized growth rate of 7.6%, an average ROA of .27% and an average capitalization of 10.06. If the entire industry (886 billion) were one gigantic credit union, at this growth rate and current earnings, capitalization would shrink to 8.05% by December of 2014. Growth requires earnings in order to sustain capital. To sustain capital with this growth rate, the ROA would need to be .97% year after year!
We recently worked with a credit union whose CFO illustrated this point beautifully. He walked into a recent staff meeting steering a wheelbarrow full of play money, and then wheeled around the room looking for a good place to park the $34 million “dollars.” A bank would pay him .05% Corporate would pay him .1% and so on. He said, “When more money comes into the credit union than what goes out via loans to members, I have to find a place for the money. When you match a competitors’ CD rate for 2%, I have to find a place to invest the funds. We are currently losing money on any funds brought into credit union accounts that pay more than .1%, unless it is money used to fund loans.”
The barrow full of money presents both a temptation and a problem for cu’s…how does one maximize returns in a down rate economy, without taking on greater risk?
When a credit union takes in more deposits than it is able to lend out to its members the management team may start looking for riskier ways to increase yield, such as retaining more mortgage loans on their balance sheets for fixed terms, jumping back into the indirect market or buying loan participations to boost return.
A better way to protect a credit union’s capital position is to price deposit accounts in a way that maintains growth rates in proportion with the credit union’s ability to produce ROA. This avoids the pressure of increasing loans during a time of high unemployment
What is a good asset growth rate? Of course each credit union would be different, but using the consolidated industry totals of the average ROA of .27%, if deposits were priced to slow growth rate to 3%, even without any of the pricing changes increasing ROA, capital would remain at 10.01%. With pricing changes ROA should increase, so the asset growth rate could be proportionately higher.
Margin management or more specifically, dividend management may be a good goal to monitor and manage as you seek to rebuild the capital being spent on the recapitalization of the industry. By developing a plan for constant monitoring and management of your Credit Union's goals, you should be able to build the Credit Union's net worth and profitability.
Ultimately, credit unions that are able to protect or grow their capital position during this economic cycle will be the credit unions positioned to capitalize on opportunities this environment will ultimately generate.