Guest Opinion: Margin Pump Up With Limited Options
While some believe the overall financial condition of the credit union industry has improved since a near collapse several years ago, the number of credit unions considered for conservatorship is still high. The NCUA reports that more than 15% of federally insured credit union assets are troubled. In an economic climate that is yielding diminished margins for credit unions, it is not too far-fetched to believe that the balance sheets of many of these institutions could slowly bleed out if they do not embrace change.
A slowdown in loans, a major source of revenue for credit unions, coupled with historically low interest rates are putting unprecedented pressure on credit unions to sustain their profit margins and to effectively maintain membership benefits. This has put institutions in the tenuous position of deciding whether to take on greater investment risks in search of higher returns to compensate for lost fee revenues. Further squeezing credit union balance sheets are the growing costs related to the regulatory oversight of the industry that emerged during the economic downturn.
Another issue potentially threatening the profitability of credit unions is the legacy costs related to the $9 billion still owed the federal government through the NCUA’s stabilization fund that was implemented to bolster the credit union industry following the financial market collapses in 2008 and the ensuing failure of five of the largest corporate credit unions. The NCUA indicates on its website that the legacy asset gross losses will continue to grow throughout the next decade.
The myriad of tactics that credit unions can utilize to improve earnings are often mitigated to a certain degree by short-term effectiveness and competitive disadvantages. However, aside from a dramatic increase in a credit union’s core loan business, its investment portfolio stands to have the greatest sustained impact in growing the credit union’s profit margin. While it may not be a primary source of yield as compared to loans, nor should it be, it can play a complementary role of organically growing earnings.
Here is a quick overview of the tactics that may be utilized to improve credit union earnings.
Increase the volume of loans. It’s essentially a no-brainer that a credit union will work to fully exploit the loan market and act on the highest number of qualified loans possible. However, this is largely reliant on macro market forces.
Raise loan rates. Unfortunately, in a competitive environment there isn’t much opportunity to significantly raise loan rates without losing business to competitors.
Lower cost-of-funds. Same story here. Deposit rates are also being influenced by the competition, and in this environment there isn’t much room to significantly lower deposit rates.
Increase your fee income. Again, fee income is also a very competitive area, and it is unlikely a credit union will be able to significantly increase fees without losing some customers as well.
Cut expenses. If at all possible, keep a close tab on the budget and cut costs whenever possible. However, in many cases there is only so much that can be squeezed out of the budget.
Sell assets at a profit. This is typically a good short-term fix but isn’t a very profitable long-term solution. In most cases, the sale of an asset is simply a trade of future earnings for an immediate profit. It will have little impact to the bottom line, especially at current reinvestment rates.
Maximize capital utilization. This involves growing assets as much as possible while still maintaining the minimum regulatory capital ratio and keeping adequate reserves aside for loan losses and other contingencies. If the interest rate risk associated with this strategy can be managed, it can dramatically improve the bottom line.
Expand investment portfolio. Credit unions could take on more credit or duration risk, but that is not something most are typically comfortable with. So, ultimately the name of the game is to define the purpose of your portfolio and diversify. Diversifying lessens risk and gives the overall portfolio less volatility. It also may provide more predictability and flexibility so that a credit union is postured to react to changes in their core business.
Working in concert with a robust loan portfolio, a diversified investment strategy can be essential to the success of credit unions as they navigate an economic landscape that has squeezed their ability to manage their margins and pass along benefits to their membership.