Analyst: Credit Union Results Climb, but Has Warning for Leaders

“If you don’t have economy of scale and rely only upon net interest margin for your survival, you are doomed,” Higgins wrote. “Why? Inefficient credit unions will get picked apart on pricing by those (including banks) who can win on price because they are productive. Full stop.”

For credit unions, “costs are fixed and increase each year,” Higgins wrote.

“It’s why your employees must produce more net revenue every year. There is no vacation from this reality, at least until the promise of technology and artificial intelligence expense savings finally (if ever) stand and deliver,” he wrote. “There is a lot of ‘chasing the next shiny object’ going on right now.”

Higgins uses an “Economy-of-Scale Ratio” that combines non-interest expense, non-interest income, loan balance and non-time funding balance into a ratio that shows whether output is growing faster than input. A declining ratio is good because it signals that economy of scale is being realized.

“Because the ratio takes interest rates out of the productivity equation it overcomes the shortcoming of the Efficiency Ratio,” he said – another measure often used by credit unions.

During the era of low rates from 2012 through 2021, credit unions experienced steady gains in operating economy.

“However, in 2022 that all changed,” Higgins wrote. “Since that time, credit unions have been in a period of diseconomy of scale – with input growing faster than output.”

For one thing, non-interest income has waned. Higgins measured non-interest income as a percent of non-interest expense (overhead). When rates were low it was 42% to 46%; now it “has cratered to below 35%.”

One culprit for lower output is the decline in mortgage lending, which produces income from loan sales and loan servicing. Hurting credit unions on input is inflation, especially for wages and compensation, which typically accounts for about half of overhead.

Higgins measures earnings as “Operating ROA,” which substitutes actual loan write-offs for loan loss provisions, “providing a clean read on the ‘real-time’ ROA of credit unions.” Those returns as a percent of average assets have been improving throughout the year.

Net charge-offs rose to a peak of 0.86% in 2024’s fourth quarter, but have been declining since. They are now slightly higher than historical norms, but well below levels during the Great Recession.

Credit unions have more interest rate risk because most of their lending is fixed rate. “New loans put on the books after rates rocketed up are pulling up loan yields across the industry,” he wrote.

Meanwhile, the Fed’s recent rate cuts have lowered the cost of funds. On top of that, Higgins wrote that loan demand is down, “which means banks and credit unions don’t have to bribe the marketplace as much to attract deposits.”

The current golden age of net interest income will fade when long-term rates fall, which he wrote will trigger higher loan demand, “driving up demand for deposits and shrinking margin.”

One plus of higher loan demand is that it will generate more income from fees and gains on loan sales.

Higgins wrote that a credit union’s survival depends on revenue growth, not size.

“There are only two ways to do this – get more from existing relationships or get more relationships,” he wrote.

Higgins wrote credit unions can help build a strategy to increase their revenue by answering five questions:

1. “What table stakes products/services/features must we have to remain relevant to our EXISTING customers? Not like to have, MUST have – like to have is a waste of resources.
2. “What products/services/features do we need to expand relationships with our EXISTING customers?
3. “Where are NEW customers going to come from and how will we attract them? (FYI: Satisfying 1 and 2 above should make us relevant to new customers.)
4. “Can we deliver upon 1, 2 and 3 above in a regulatory compliant manner (profitably, within capital constraints, concentration limits, etc.)?
5. “What people, process and technology obstacles must we overcome to successfully execute upon 1-4 above?”