The CU Business Model: Prospects for Growth

A financial performance management tool developed in 1919 works remarkably well for CUs today.

February 1, 2011
Prospects for growth


  • The sustainable growth model (SGM) consists of three financial ratios: profit margin, asset turnover, and leverage.
  • While CUs' sustainable growth rate has improved this year, the long-term trend requires improvement.
  • Board focus: SGM provides a comprehensive view of a CU's financial strength and weaknesses.

In 1919, F. Donaldson Brown developed the Sustainable Growth Model (SGM), a financial performance management tool that transformed two industry giants, DuPont and General Motors Corp. More than 90 years later, the model still is widely studied and used.

Brown developed SGM (also known as the DuPont formula) when serving as DuPont’s treasurer, and he brought the concept to General Motors as chief financial officer. Many believe the powerful financial analysis tool Brown pioneered helped these companies ascend to and maintain leadership positions in their respective industries for years.

SGM has demonstrated rare longevity among financial analysis tools. It has served as the basis for a 30-year Harvard Business School case study of Brown Lumber.

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

The key lesson from the Brown Lumber study was that the company, which appeared to be successful at first analysis, was trying to grow faster than its capital and income would support. In fact, it was on an unsustainable trajectory and would soon require infusions of capital to survive.

The Brown Lumber case was my introduction to SGM as a first-year MBA student. A few years later, when I was a strategy consultant with Boston Consulting Group, I learned to apply the model to industries as diverse as transportation, energy, health care, and electronics.

And, as we will see, the formula also works remarkably well for credit unions.

This model has remained popular for so long because it’s easy to use and understand. It pulls data from both the balance sheet and income statement, and provides a comprehensive view of a firm’s financial strengths and weaknesses.

Next: How SGM works

How SGM works

The SGM formula consists of three financial ratios—profit margin, asset turnover, and leverage—multiplied by each other (“CU movement sustainable growth”).

As you examine the formula, you’ll notice several interesting facts. First, if you multiply only the first two ratios by each other (profit margin and asset turnover) you can cancel "revenue” in the denominator of profit mar-gin and in the numerator of asset turnover and you’re left with profit divided by assets. That equals return on assets (ROA), a financial metric that’s widely used and understood throughout the credit union movement.

CU Movement Sustainable GrowthNext, if you multiply ROA by leverage, you can cancel "assets" in the denominator of ROA and the numerator of leverage. This leaves you with profits divided by capital, which equals return on equity (ROE).

Brown’s key finding in 1919, which still applies today, was that ROE is equal to the rate at which a firm can grow its assets on a sustainable basis. If a firm wants to grow faster than its current ROE, it must improve at least one of the three ratios—profit margin, asset turnover, or leverage—without depressing the other two.

While ROE hasn’t been widely used in the credit union movement (because credit unions don’t have traditional stockholders), the formula works perfectly as a measure of capacity to grow assets.

In fact, because credit unions don’t pay income tax or stock-based dividends, and they don’t have access to secondary capital, the formula can be applied in a simpler, cleaner fashion than in many other industries.

Next: CU applications

CU applications

Let’s examine how to apply the formula to credit unions and what the benefits might be. The figure, “CU sustainable growth analysis,” (click to enlarge) shows the full detail of SGM applied to the credit union movement using financial data from the third quarter of 2010.

Moving from the top of the chart down, we see first that ROE is equal to ROA multiplied by leverage (for credit unions, leverage is approximately the inverse of the net worth ratio).


1. 2010-2011 Credit Union Environmental Scan Report
2. Operational research resources

* CUNA Mutual Group, Madison, Wis.: 800-356-2644

Therefore, a credit union with 8% net worth is leveraged 12.5 times, while a credit union with 10% net worth is leveraged 10 times. As net worth decreases, leverage increases, and vice versa.

Continuing down the chart, note that ROA is equal to profit margin multiplied by asset turnover. Asset turnover can be thought of simply as how much revenue a firm can derive from its asset base.

Some industries (i.e., grocery) have low profit margins but very high asset turnover levels. If a grocery store doesn’t turn over its inventory of fresh merchandise regularly, it will soon be out of business.

The credit union movement, on average, has low asset turnover (typically 3% to 7%), but relatively higher profit margins.

Moving further down the chart, we see that profit margin is equal to net income divided by net revenue. Net income, in turn, is equal to net revenue minus total expenses.

Most credit unions have three primary sources of net revenue: Net interest income (i.e., spread income), fees and other operating income (i.e., noninterest income), and nonoperating income.

In a typical year, most credit unions generate little nonoperating income. In 2009, however, nonoperating income was a relatively large factor for many credit unions due to accounting treatment of the first corporate credit union assessment.

Similarly, most credit unions have two primary sources of total expenses: loan loss provisions and operating expenses.

You can apply this model to the credit union movement as a whole, to individual credit unions, or to categories of credit unions.

Next: Key insights

Key insights

A key insight emerging from SGM is that credit unions have six primary financial factors or “levers” they can manage to improve ROE and sustainable asset growth. The levers are leverage, asset turnover, spread income, fee income, loan losses, and operating expenses.

As the figure, “CU sustainable growth analysis,” shows, the ROE for the credit union movement as of Sept. 30, 2010, was 4.48%, indicating that the movement as a whole can sustain asset growth at this rate.

While the movement’s ROE, or sustainable growth rate, has improved over the past two quarters, the long-term trend still needs improvement.

CU Movement Sustainable GrowthThe credit union movement’s sustainable growth rate (ROE) has declined steadily for 25 years (“CU movement’s sustainable growth rate”). The early part of this decline (1985 to 2000) can be attributed primarily to rising net worth levels, which translated into declining leverage. That isn’t a bad thing.

The more recent decline (2000 to present), however, can be attributed almost entirely to declining ROA. That’s not healthy, and it’s a situation that requires our collective attention.

The table, “CU Summary,” provides SGM results for credit unions in different asset categories. As it indicates, ROE increases as credit union asset size grows, from less than 1% for credit unions with less than $250 million in assets to more than 12% for those with more than $10 billion in assets.

What accounts for the considerable difference in ROE between small and large credit unions? As the “CU Summary” table shows, the difference isn’t due to asset turnover. That ratio is similar for all credit unions. Some of the difference can be attributed to varying degrees of leverage: larger credit unions tend to be more leveraged (i.e., operate at lower net worth levels) than smaller credit unions.

The biggest difference by far, however, is profit margin. The largest credit unions have an average profit margin 10 times larger than that of the smallest credit unions (23.1% versus 2.3%). And it’s the operating expense ratio that accounts for this significant difference in profitability.

Operating expenses for credit unions with less than $250 million in assets average 87.3% of net revenue, compared to 56.3% for the largest credit unions. This difference is so great that it can’t be overcome by superior performance in spread or fee income.

The need to achieve greater operating efficiencies across the credit union movement is one of the key findings emerging from the SGM formula.

In the next and final segment of this three-part series, we’ll discuss how credit unions can improve financial performance not only in terms of operating efficiency but other key factors that drive sustainable growth.

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

Note: The conclusion of this three-part series will address how credit unions can use principles of sustainable growth to improve financial performance.