What it Will Take for a Small CU to Survive

08/27/2023 02:54 pm

By Homer Fager

In a 2021 article, Bill Streeter, former editor-in-chief at The Financial Brand, asked, “Can a $50 million, $200 million or even a $500 million credit union expect to survive?”

This group represents 87% of all credit unions, and 66% of those are $100 million in assets and below. How can these small credit unions survive the competitive forces of dominant megabanks, rapid uptake of digital banking, fintech inroads, low rates and operating expenses? 

Per the National Credit Union Administration’s 2020 Annual Report, the benchmark for bank profitability–return on average assets ratio (ROA)–for all credit unions ranged from a high of 0.78 for billion-dollar institutions to a low of 0.06% for less than $10 million in assets. The FDIC report, Community Banks Remain Resilient Amid Industry Consolidations, acknowledged those institutions with less than $500 million in assets find it tough to comply with regulation, higher capital requirements, aggressive competition for deposits and loans, etc.

Managerial Governance Change Required

To manage this reality, a change of managerial governance by small credit unions must take place. No amount of market research or collaboration will change their ROA or provide scale to compete in the 4th Industrial Revolution environment. 

What is causing the low ROA of small credit unions? Its “FMB” (front, middle, back office) expenses. Small institutions do not have the scale to manage the cause of low ROA, which is fixed costs. When an examiner reviews a credit union’s financial condition, they consider budget, budget variance, risk profile, operational structure, and fixed expenses. In accounting, fixed expenses or costs are those operating expenses that do not change with increasing or decreasing services or products delivered to customers. They are normally time-related, such as interest, rents, utilities, labor, IT (staff, hardware & software) paid per month, and are also called overhead costs. 

What has to change are which FMB activities are maintained as manager’s primary responsibility–fixed or variable expense? 

Managers of small credit unions must change their business model from that of a fixed-expense operation to a variable-expense operation. “MB” expenses are not primarily the responsibility of managers; it is member-centric service that takes place in the front office. Other than regulatory audits, managers need not handle middle office, day-to-day compliance, accounting or HR activities. Activities relating to “MB” and IT services are not primary, they need to be outsourced.

Improving Advantage

Outsourcing of selected services is a means to gain scale that leads to reducing costs and increasing the institution’s ROA. The cost-benefit from outsourcing comes due to reduction of operating labor and overhead expenses while focusing on core competencies, such as member-centric service. By focusing on core competencies the entity improves its competitive advantage and efficiency by redirecting internal resources to its primary need, front office consumer-centric service. 

A most important advantage of outsourcing and, possibly most noteworthy, is the option to afford expertise and best in class software previously unaffordable. When incorporating outsourcing a significant benefit is the scale outsourcing brings, which equals lower cost per member leading to improved capability. The reduction-profitability realized is the cost-benefit of economies of scale produced by outsourcing of back-office accounting and middle office regulatory reporting functions. 

This economies of scale (EOS) technology helps small credit unions grow into consumer-centric enterprises. EOS technology is a digital-first core solution that will integrate with unlimited number of options from internal business to external third-party platforms. EOS technology is a corrective action to the previously noted operating expense/ROA disadvantage that small credit unions must manage. 

Call to Action

Managers of small credit union: Join the 4th Industrial Revolution and build a disruptive cyber-physical customer-centric enterprise. In short, survival is possible, but it calls for a change of managerial governance by small credit unions managers. The single element small credit unions lack is scale, which outsourcing non-growth activities can correct. 

How large of a scale is required? Mega-institutions with asset above $3.8 billion have economies of scale from 286,000 to 320,000 members and ROAs above 1.2, versus 0.40% for $500 million institutions per Weiss Ratings. 

Credit union managers need to incorporate 4th Industrial Revolution’s disruptive trends of “cyber-physical systems” integrating modern digitization, physical, and biological processes with the needs of the enterprise and their consumers. 

Homer Fager is the former president of core data processor FedComp Inc., a small business owner and advisor, and a multi-million-dollar project manager, providing him an extensive resume of experience in governance, risk, and consulting work.