Is the CU Business Model Built to Last?

It has served CUs well for more than 75 years. Is it up to the task for the next 75?

January 1, 2011




  • Personal savings and debt levels are adjusting in reaction to the Great Recession.
  • CU ROA, though improving somewhat recently, has been on a downward trend for the last two decades.
  • Board focus: Be alert to the bottom-line effects of rising interest rates, a growing regulatory burden, and diminishing fee income.

(Note: This is Part I in a three-part series.)

It’s dangerous to be complacent and to simply assume credit unions will thrive for decades to come. Very real threats exist to the credit union business model in its current form.

We examine those threats in this first part of our three-part series. We’ll also look at potential actions industry leaders are considering to keep the credit union business model viable.

Sustainable growth

What does it mean for a system to be “built to last” or “sustainable”? One definition: “The ability to continue a defined behavior indefinitely.” Another definition seems especially relevant to credit union sustainability: “A sustainable system or process must be based on resources that will not be exhausted over a reasonable period.”

If you take the latter definition and substitute the word “capital” for “resources,” the definition becomes especially relevant to credit unions: “A sustainable system or process must be based on [capital] that will not be exhausted over a reasonable period.”

In this three-part series, we’ll attempt to answer these questions:

  • How sustainable are major economic and credit union trends today?
  • How can we measure the ability of a credit union to grow on a sustainable basis and to remain viable well into the future?
  • What are some practical tools and actions credit unions can use to enhance their ability to grow?

Key macroeconomic trends

Most experts agree the financial shocks to the global economic system during the past three years have been the most severe since the Great Depression. But what happens next?

John Lass
video John Lass examines the sustainability of the current CU business model. Watch now.

Leaders from every business sector are trying to determine whether the severity of the shock will result in permanently altered behaviors by consumers, businesses, and governments, or if life will eventually return to “normal.” Some talk about “a new normal,” but no one seems to know exactly what that means.

Economists, industry observers, and consumers have focused too much on the word “normal” and not enough on “new,” suggest Bill Gross and Mohammed El-Arian, co-founders of the global investment management firm PIMCO. They imply we might be in for some major and lasting changes, meaning that the new order might be very different from the recent past.

Several economic trends in place for the past generation might not be sustainable.

Next: Consumer savings and debt

Consumer savings and debt

From the 1950s through the 1970s, U.S. consumers saved at a healthy rate equal to 8% to 10% of disposable personal income (DPI). But starting in 1980, the savings rate started a steady decline (“U.S. savings rates,” p. 46).

Some argue the reason was the popularity of new retirement planning instruments, such as individual retirement accounts and 401(k) plans. But as the past three years have demonstrated, many of those vehicles weren’t particularly “safe” investments. It’s indisputable that true savings accounts, with minimal risk of loss of principal, fell out of favor during the past 30 years.

Not only were U.S. consumers not saving from 1980-2007, they were borrowing as if there was no tomorrow. Personal consumption increased accordingly. During the same period, the level of household debt as a percentage of disposable personal income (DPI) more than doubled from approximately 60% in 1980 to its peak of 130% in 2007. Recently, that figure has declined to 119%, but most of the decline can be attributed to loan defaults rather than a change in consumer behavior.

These household-debt trends beg several questions:

  • Is it possible the amount of consumer debt relative to DPI could have continued to increase indefinitely?
  • Was that a sustainable trend?
  • What will be the “new normal” level of debt?
  • How will it affect credit union lending?
  • What if the new equilibrium level of consumer debt to DPI is 80% rather than 130%?
  • How will that change consumer behavior?
  • How will it affect your credit union’s loan-to-share ratio?

As the savings rate declined and consumer debt increased from 1980 to 2007, interest rates also declined. The 10-year U.S. Treasury rate declined from about 11% in 1980 to about 4% in 2007 and beyond.

An entire generation of business leaders has never had to manage during a prolonged cycle of rising interest rates. We might now all have that “opportunity.”

Government debt

The U.S. Congressional Budget Office’s latest forecast of debt as a percentage of gross domestic product (GDP) includes an extended baseline scenario, based on current law, and an alternative fiscal scenario.

 The alternative fiscal scenario incorporates several changes to current law—changes widely expected to occur or modifications of provisions that might be difficult to sustain for a long period. The alternative scenario assumes that most provisions of the 2001 and 2003 tax cuts will be extended, the reach of the alternative minimum tax will be kept close to its historical extent, and overall, the tax law will keep revenues around 19% of GDP—near their historical average.

The alternative forecast literally goes off the chart in the outer years, rising above 200% of GDP by 2035. The primary causes of this rapid increase in debt burden are the costs of the current entitlement programs combined with continuation of the tax breaks. Even under the extended baseline scenario, federal debt rises to 79% of GDP by 2035.

Just how serious would it be for federal debt to exceed 200% of GDP? The debt rose above 50% of GDP only once in U.S. history (1942-1956). Neither of the current forecasts is attractive, but the alternative fiscal scenario would mean we’re heading toward a new all-time high.

Most economists agree sovereign debt above 100% of GDP indicates a high risk of default. Greece’s sovereign debt recently increased to about 115% of GDP, and it caused international turmoil.

The consensus: The current U.S. government debt trend clearly is not sustainable. President Obama has convened a special bipartisan commission to focus specifically on solutions to this impending debt crisis. Corrective actions almost certainly will further reinforce the concept that the “new normal” will be very different from the recent past.

Of these key economic trends—consumer savings, consumer debt, 10-year Treasury interest rates, and U.S. government debt—not a single one was sustainable. This suggests that, collectively, we were living on borrowed time and exhausting the resources necessary for those behaviors to endure.

We can apply the same questions to the credit union system.

Next: CU gross spread

CU gross spread

Comparing average credit union gross spread to average return on assets (ROA) reveals telling trends.

Credit union gross spread, which is similar to net interest margin, declined steadily over a 15-year period from 1992 through 2007 by approximately 100 basis points (bp) relative to assets. Recently, however, the spread has widened, which isn’t unusual during a credit crisis because some lenders exit the market while the remaining lenders tighten credit standards.

Credit union ROA declined more or less in tandem with gross spread until 2007; gross spread is clearly a primary driver of ROA. Recently, however, the linkage was broken as ROA plummeted in 2008 and 2009 while the spread widened. The deterioration of credit union ROA was driven mainly by loan losses and assessments. The good news: ROA has improved somewhat through the first three quarters of 2010, but the long-term trend still remains in overall decline.

Noninterest fee income

Another key trend for the sustainability discussion is the credit union system’s increasing reliance on noninterest (fee) income. A direct comparison of ROA to ROA without fee income isn’t perfect, because National Credit Union Administration (NCUA) reports don’t separate out expenses associated with fee income. But the comparison clearly demonstrates the system’s dependence on fee income.

In the early 1990s, the credit union system could have generated a healthy average ROA of 50 bp to 70 bp, without any fee income.

Not so today. The credit union system, in recent years, has generated approximately $13 billion in fee income per year. The leading contributors: overdraft and interchange fees and, more recently, mortgage refinancing fees. The first two sources of fee income may become subject to regulatory caps, and mortgage refinancing fees are likely to decline considerably, if and when interest rates begin to rise.

Looking to the future:

  • What will happen to these three sources of fee income going forward?
  • Will the long-term trend of spread compression continue, or will the spread continue to widen?
  • Will ROA continue to improve, as it did during the first three quarters of 2010, or will the long-term trend of decline continue?
  • Will credit unions find new ways to generate meaningful fee income, even as some of the current sources diminish?

Answers to these questions will have major impacts on the future viability of individual credit unions and the system as a whole. Certainly some trends are influenced by outside factors. National and local market conditions, for example, influence gross spread. NCUA’s assessments will continue to affect ROA for the next decade, and regulatory actions will affect fee income.

The answers also will depend on decisions and actions credit union leaders take today and in the near future. In the next two segments of this series, we’ll examine a powerful tool to analyze sustainability and discuss practical steps to achieve growth.  

JOHN LASS is senior vice president of strategy and business development for the CUNA Mutual Group, Madison, Wis.

Note: Part two in this three-part series will focus on tools and practices credit union leaders can use to make critical decisions.



•  CUNA:
1. 2010-2011 Credit Union Environmental Scan Report
2. Operational research resources:, select “reports.”
•  CUNA Mutual Group, Madison, Wis.: 800-356-2644.