Lost in the finger pointing of today's financial calamity is thefact that feeding the beast of consumption is at the foundation ofour system's failure. Keeping Americans engaged in consumption wasso important that we increased the supply of lenders beyond thepoint of saturation. America, the land of opportunity andentrepreneurs, allowed anyone to make credit available to everyone.Automakers, investment banks, manufacturers (over half of GE and GMrevenue comes from making loans) and many others became competitionfor traditional community lenders.
Good community lenders found themselves in nefarious competitionwith eight other lenders for one piece of A paper. As a result, themargin couldn't support the oversupply, leading many to experimentwith how to make money through subprime loans, overreliance onindirect lending and other ways.
For a time, the oversupply of lenders was good for consumers andlawmakers because a voter who is employed and consuming holds noone accountable. In the end, everyone lost.
America's community lenders now share the same draconian challengesand therefore should consider combining forces to become the nexttrade association.
We were throwing money at people.
The consumption binge led to record loan demand, yet CU earningsdeclined dramatically. Household debt more than tripled from 1990to 2007 to $13 trillion (U.S. Department of Commerce). Meanwhile CUnet interest margin eroded 21% and ROA declined 56% (1994-2008 NCUAstatistics).
Community bank NIM and ROA were also down 1998-2008, but less thanfor CUs. Banks more nimbly respond to consumer evolution becauseregulations related to risk weighting of assets, and capital, plusFOM restrictions and business lending caps lead to a 101 basispoint income advantage for banks before fees and a 46% bettergrowth performance over the last five years.
Interestingly, some CUs are marketing a loan promotion to supportthe purchase of American-made autos while GMAC (whose 0% financinghelped erode CU margins) has applied for and received a bankcharter. Yes, in a matter of days, GMAC got a bank charter thatenables access to capital, TARP, as well as cheap deposits.
Since 1998, we've cautioned CUs that the imbalance of supply anddemand, combined with the transition to community and SEG charters,mandates CUs change the way they individually market and operate.Among other things, we've discussed the need to boost financialcompetitiveness, analyze the impact CU regulation and the rolecapital plays on growth and earnings.
Recently, CU thought leaders called access to secondary capital theindustry's most important regulatory need. But the need forsecondary capital depends on the individual CU. Some CUs that needsecondary capital might have difficulty raising it. Investors won'tinvest in an institution that needs capital. The investors want theseed money to lead to growth and earnings, not to plug ahole.
A depositor would also expect a higher rate of return for the addedrisk as these investments would lack deposit insurance. In today'smarket of bank subordinated debt, the investor's yield exceeds10%.
Financial institutions with a high “state of readiness” will beable to access plenty of capital. High state of readiness lendersmaintain sound financials and possess a history of successfulcapital utilization. They will be attractive to both private andpublic investments. Note that TARP funds with some exceptionsaren't going to needy FIs but to strong FIs that can absorb woundedcompetitors, a better bet for the American taxpayer.
CUs no longer compete with one arm tied behind their backs. CUs arenow hog tied. This meltdown is exposing the regulatory imbalance.Despite the tax advantage, the regulatory tax is overwhelming manyCUs. Some CUs know this and are pushing the FOM envelope toleverage the tax advantage for as long as possible. Lawmakersrecently have said that secondary capital and MBL cap relief is notin the cards for CUs.
Meanwhile, the massive change promised by the Obama administrationand the Treasury Blueprint will likely include CUs. As I've beendiscussing with CUs, if the change means that CUs and banks comeunder the same regulator, it will mark the beginning of an excitingnew era for many CUs. Why? Because the math of the business modelis better with the tax, assuming the bank regulations come withit.
In short, “CURIA with tax” frees up CUs to compete more effectivelyand leverage the CU culture into more households.
The following are just a few of the considerations we believe willincrease leverage of your culture into more households.
Focus. Many CUs have begun to focus more attention on the needs ofthe member versus the needs of the movement.
Anticipation/Adaptation. Lately, I find myself advising CUs toavoid the burden of building the perfect plan. Better to implementthe well-considered plan and adjust it. We need to be prepared forlikely significant change; for example, has senior management andthe board discussed and modeled the impact of the Blueprint?
Vetting inventory. CUs are evaluating the value received fromvarious traditional expenses like branches and consultants, andmany other items that keep the marketing budget smaller than itshould be. The best culture in the business has not grown marketshare in 15 years, and marketing quantity and quality isappropriately under fire and so should the advisers be.
When in doubt, do without. The discipline here is simple. Highstate of readiness FIs are well positioned to expand, so if thereis any doubt about a traditional expense, do without because abetter choice may be right around the corner and you need morefunds for marketing, not less.
Get after sales. Are MSRs empowered, developed, motivated andmonitored to deliver more business? Do they understand howimportant their role is?
In short, logic supports the idea that the well-run, communitylender can still have a major say in the quality of our economicrevival, one household at a time, but not if it's business asusual.

Peter Duffy is associate director with Sandler O'Neill. He canbe reached at 212-466-7871 or [email protected]