normal again.

But non-interest income is likely here to stay as a solid component of credit union revenue. "If you're getting income, it's kind of hard to give it up," Wai said. He does think it will go down as a percent of credit union revenue, but credit unions need to balance the cost of offering products with who is going to pay for it.

Hampel agreed. "I see nothing different in principle for charging a fee and charging an interest rate," the economist said. He continued, "If you offer some services for free, you have to charge higher loan rates." Fees just help ensure all the members are carrying their fair share, he explained.

Wai also pointed out that fees should not only be viewed as income but as "negative incentives." The actions bringing on some of the usage-based fees, like not sufficient funds fees, cost the financial institution money. "You want to help the members but you don't want them taking advantage of you," he said.

As the economy continues to sag, Wai predicted, NSF fees are likely to become more common. On the other hand, "You don't want to fee them to death." Then the fee sensitivity issue can come into play.

But, as credit union members begin to save more with rising interest rates, credit unions should become less dependent on non-interest income. "The financial markets will offer more opportunity for net interest margins than the opportunity in the last few years," Hampel said. Two of the main reasons behind this are continued increasing competition in financial services and the yield curve will continue to become more positive.

Additionally, Hampel said, "Members will be doing more saving in the coming year and quite a bit more in the next couple years." Increasing savings mean

rising assets and then non-interest income will decrease in importance.

Real estate lending accounts for more than half of credit unions' outstanding loans right now, which carry a lot of fee opportunity, and Wai said the bank credit crunch will likely increase credit unions' mortgage lending. He also noted, "Look at the source. As the Fed lowers rates, you're going to have more and more people qualifying." The Fed is also timing its policy changes, he highlighted, to take effect around the peak time of the ARM resets from February through April next year, which could reduce credit unions' anticipated income, he said.

Wai also pointed out that while the Fed can impact interest rates on the short side, on the long side the Fed has less control. "China has more of an impact on the long side than anyone else," he said.

Credit unions can also retain servicing rights–and fees–after selling a loan on the secondary market. According to NAFCU Services Corp. President David Frankil, some of their most popular programs are their Prime Alliance and Fannie Mae deals where medium to large credit unions tend to maintain servicing rights. The same goes for their turndown lending solution, Express Credit where borrowers who might not meet the credit union's lending standards can still be serviced by their credit union but actually get the loan from this back-up, subprime lender. "You satisfy the member by providing a service, you keep the member relationship and get fee income," Frankil commented.

Hope Community Credit Union–with more than 50% of its revenues coming from non-interest income–is a rapidly expanding credit union, heavily invested in non-interest income in some traditional, and not so traditional ways. Chief Financial Officer Richard Campbell explained that Hope Community's primary sponsor, Enterprise Corporation of the Delta, is a charity working to help get people in the Hurricane Katrina ravaged Gulf Coast region back on their feet.

The credit union, which has just over 9,000 members, opened 3,000 accounts following Katrina to help provide access to funds for the storm victims. ECD is paying "fees" on these accounts to the credit unions. "These are very small accounts and they're costing Hope Community a lot to administer," Campbell explained. These fees account for approximately 35% of the credit union's total revenue.

Hope Community's "traditional" non-interest income accounts for about 15% of its revenue that has also been impacted by Katrina, which the credit union derives from user fees, like NSF. "We try to make our products really inexpensive unless you abuse them," Campbell explained.

He said that Hope Community does not have a problem charging fees because the credit union is providing a much needed service. However, he added, "We don't want to be predatory in any way. We don't want the member to be in a worse position with us than they were before." For example, the credit union participates in the Volunteer Income Tax Assistance program and offers 7% refund anticipation loans.

Hope Community's expansion plans–which have brought the credit union from $189,000 in assets in 2000 to $54 million according to their latest Call Report–hit a hurdle with Katrina. Plans were even changed to move a branch to the Mississippi Gulf Coast after Katrina to provide financial services when there was no one else there. Expansion has slowed on the ATM network as well, which the credit union plans to use to generate more fee income. Campbell said Hope Community also plans to look again at fees for current products and adding insurance products for increased non-interest income.

How We Got Here

"I'm always sort of a contrarian," Hampel stated. "I don't think it's as important as many credit unions have made it out to be in the last few years."

"I don't think that many credit unions thought they needed to get their net worth from 10.5 to 11.5%," Hampel said referring in approximations to the last five years but things have turned out that way. If credit unions had kept their capital ratio at 10.5%, then they could have let their return on assets decline further.

The reasons for the interest in non-interest income are not strictly financial. Credit union management also felt pressure from their boards and regulators as well as their peers, according to Hampel. The very largest credit unions have been able to maintain an ROA of 80 to 100 bps, but the really small credit unions are struggling for 50 bps. Hampel pointed out that an ROA of 40 bps puts them at about a CAMEL 3 or 4 on the matrix. NCUA's famous ROA letter was a key factor in credit unions even allowing ROA to drop to 76 bps, he said.

Wai said without non-interest income, some credit unions would have negative ROAs. However, he said, credit unions should focus more on "optimality of capital." He emphasized, "Everybody talks about regulatory minimums but nobody talks about optimality." Using capital to its fullest potential also aids in long-term member retention, he added.

Where We're Going

"I don't think it's necessary to get non-interest income up as high as it is," Hampel said indicating the high capital levels in credit unions. Still that does not mean credit unions will reverse their course on non-interest income. "I don't know," he admitted. "What they may do is keep fees where they are but be more competitive on the balance sheet."

And, the banks are making credit unions look good, Wai said. "Banks' non-interest income is going down, not because they're charging less fees–we know that. The banks are getting lower because they're making more money," he stated.

In order to help credit unions keep that non-interest income rolling in, Frankil is looking to new programs with new and old Preferred Partners. One company he is in discussions with right now has a solution to allow a credit union to reformat statements and combine them for members with multiple accounts, while at the same time increasing readability for members and providing greater flexibility to send

advertising with statements. The capability will not only help credit unions earn on the advertising but also save on postage.

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