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For Perspective, You Need To Remove Rose-Colored Glasses

Are credit unions simply looking at the world through rose-colored glasses? In the first part of this two-part series (CU Journal, May 7), we agreed that two industry trends of great concern are lagging membership growth and deteriorating earnings. CU membership growth since 1996 has been a lackluster 2.5%, and only 1.5% since 2002. Factoring out temporary members from indirect lending, net growth has likely been flat, if not negative.

Meanwhile credit union earnings continue to erode both in absolute terms and versus competition. The average CU with more than $100 million in assets loses 28 basis points before fees, leading to increased reliance on fee income. As of December 2005, CUs derived 14% of gross income from fees, up from 7.6% in 1998. Compare this to the bank trend which shows, in the same time frame, fee income as a percent of gross income was unchanged (8.0% to 8.1%).

In this the second-half of this series, we examine other related issues.

Embracing or Merely Managing Change?

With the advent of a community charter, the "evolution" process is in full stride and many CUs are seeing that the culture of "putting the member first" can and must co-exist with the drive to achieve competitive profit. Branch expansion, service enhancements, competitive value and many other needs are funded though profit. This is the members' way of saying CUs need to be very much "for" profit. Many CUs know this and are concerned about the lack of progress on CURIA, which they see as the mandatory next step in the evolution of a CU.

From a marketing perspective, the culture of "putting the member first" would seem to be the basis of an effective marketing campaign, one that should lead to more members. It hasn't. Perhaps two factors are at play here:

* First, credit unions have been stuck at the 50-yard line. CUs have always had the culture. It is proper marketing that is missing. From a marketing perspective, most CUs have not developed a brand that works. What is more, the campaigns seem lacking in reach, frequency, media and focus. Largely, CU marketing is promotional (auto loan deals, hot rates, etc.). In short, CUs have not gotten the word out to unsold households why a broader switch from the local bank should be made. (Some CUs spend thousands advertising to a market that includes households that can't "bank" with the CU because they're not in the FOM, which also impairs efficiency). Likely, the size of the marketing budget (too small) is part of the problem. With the earnings shortfall to competition, banks are increasing their advertising while CUs are struggling to justify the current size of the marketing budget.

The second reason CUs have not added members is because the competition does not give an inordinate amount of their incremental profit to executives and shareholders, as you have been told. Banks pay both taxes and shareholders while marketing aggressively and providing enough competitive value to generate a leadership share on loans and deposits.

Rosy Vision Vs. Clarity

Let's consider the following advice and comments in the context of competing for households in the open community. (If you are a CU with a single-sponsor FOM, some of these still make sense.)

1. "It's OK to make less than a 1.0 return on assets (ROA) because your capital can handle it."

It is not OK to make less than your competitors, especially when they maintain adequate capital levels and invest in the customer while paying both shareholders and federal taxes. At my breakout session during a November CU CEO conference, we asked attendees to vote "yes" or "no" to these questions:

* "Has your local market experienced a noticeable increase in bank branches (or announced expansion)?" 82% of the 79 attendees voted "yes."

* "Has your local market experienced a noticeable increase in bank advertising and marketing?" 90% said "yes."

Call data support this. The 50 largest bank holding companies added 10% more branches in the last five years, for example. The competition is using some of its income advantage to bolster efforts to attract CU members.

2. "The CU charter is the best charter in the world!"

It certainly is for some, especially if the CU is able to remain a single FOM institution. Once the charter changes to allow marketing to the local community, however, it becomes less enabling. It is important, here, to distinguish between charter and culture. A growing number of CUs recognize that culture is what you make it and is not derived from the charter or how you're regulated. Regulation does impact the ability to leverage the culture, and this becomes very important as a CU evolves into a community charter.

During the CU CEO conference, we asked attendees whether or not they agreed with this statement:

"CUs want to return more to the members, but the lack of both earnings and regulatory flexibility limit the mission and the marketing budget." 60% agreed.

3. "Data Trac says we offer better rates on loans and deposits than banks!"

How much of the business is actually priced at the posted rate? Most CU people know that the actual rate a member gets is "negotiated" based on their services per household, the size of their deposit balance and by simply asking for it. All of these contribute to the actual pricing of a product, and the posted rate is meaningless in many cases. The banks are very competitive at "actual" pricing, or they wouldn't have a leadership share of deposits and most loan products.

CUs should seriously reconsider taking comfort in "winning" the posted rate battle, given the lack of credibility versus how loans and deposits are actually priced.

4. "XXth member of Congress backs CURIA!!"

CURIA has been in the making for more than three years and hasn't had a hearing. At the CU CEO conference we posed this for response about CURIA, and then asked how many agreed: "Secondary capital and the full passage of CURIA will receive Congressional approval in the next two years." Only 8% agreed.

Meanwhile, heaven forbid that a credit union needs a higher business loan cap (among other things), and decides it cannot wait any longer, and votes to convert its charter. Suddenly, regulatory relief is not about relief, it's about newfound greed. As the old saying goes, "You can't have your cake and eat it, too." Many CU people are wondering when a more frank and open dialogue will occur regarding the lack of progress on CURIA.

5. Some folks seemed confused about market-related fee information, noting, "Analysts say CUs charge more fees than banks!"

Clearly, what the data show is that CUs have had to become more reliant than banks on fee income to maintain a positive bottom line. Lacking regulatory parity, and if the trends continue, many CUs may face the prospect of charging more fees than banks to reach a positive bottom line. The trends point to this unfortunate possibility.

Looking Back, Looking Forward

Risk-based lending, share draft protection, member business loans, indirect lending and credit card partnering all came under attack, when they were first introduced. Today, these are all commonplace. For example, according to Brookwood Capital, about half of all CUs still manage their own credit card portfolios, while only about 4% of banks still manage their own. Clearly, knowing all the options and thoroughly evaluating them for suitability is something CUs have embraced before.

Many senior managers are looking for balanced analysis and solutions while analyzing all the data and perspectives. Such dialogue is good for all of us and leads to vision with more clarity.

Pete Duffy is with Sandler, O'Neill, New York, and can be reached at Pduffy<at>sandleroneill.com.

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