The Health of Small Credit Unions

Every quarter Glatt Consulting publishes what we call the Credit Union Industry HealthScore. The score is essentially an averaging of the HealthScores we calculate for all federally-insured credit unions. Recently we shared the 2nd quarter industry HealthScores along with basic data on individual credit union scores, such as the highest score, lowest score, score ranges for the top 10% and bottom 10%, etc. In this post, we will share new findings on the diversity of credit union health by asset peer group. What we found is not surprising but is nonetheless disheartening.We decided to use the National Credit Union Administration’s peer group designations to evaluate credit union health by asset peer. NCUA defines these peer groups as follows:

  • Peer group 1: $2 million or less
  • Peer group 2: $2 million to less than $10 million
  • Peer group 3: $10 million to less than $50 million
  • Peer group 4: $50 million to less than $100 million
  • Peer group 5: $100 million to less than $500 million
  • Peer group 6: $500 million or more

In the table below we highlight the breakdown of HealthScores by each peer group. The HealthScore column represents the average score for the peer group, while the Max and Min columns reflect the highest and lowest scores within the peer group. A score of 5 represents the most healthy, 0 the least healthy.

Peer Group HealthScore Max HealthScore Min HealthScore
1 1.526 4.00 0.182
2 1.933 4.545 0.091
3 2.279 4.364 0.364
4 2.555 4.273 0.818
5 2.719 4.455 1.000
6 3.113 4.727 1.364

The peer group breakdown, which shows scores for the time period ending 12/31/2011, illustrates one clear fact. Smaller credit union peer groups possess substantially lower HealthScores than larger credit union peer groups.

The philosophy behind our HealthScore is this: the lower the aggregate health, rating the less likely a credit union can sustain its existence over time. Given our perspective on what a HealthScore means, the data above suggests the sustainability of small credit unions as a whole is in doubt.

Certainly there are small credit unions doing very well, as evidenced by the 4.00 and 4.545 high scores in Peer Groups 1 and 2 respectively, but given the low aggregate score for each group, such stellar performance should be seen as an exception.

So, what factors are contributing to the lower scores – particularly in the smaller asset peer groups? To answer this questions it helps to know what factors drive the HealthScore in the first place. When calculating a credit union’s HealthScore, we look at eleven measurements considered key ratios indicating the quality of credit union performance. These measurements are:

  • Net Worth
  • Earnings
  • Asset Growth
  • Membership Growth
  • Loan Delinquency
  • Loan Charge-Offs
  • Operating Expense
  • Operating Efficiency
  • Loan to Share
  • Member Loan Balances
  • Member Deposit Balances

Our perspective is that the more effectively a credit union balances all of these factors, the healthier it is. To be considered most healthy, each of these areas must be managed as soundly as possible. A leadership team cannot allow one or more components to slip for expended periods, lest the institution end up unhealthy and unable to compete.

As a means of explaining this point, consider the basic correlation between earnings and net worth. A credit union with high net worth but persistent negative earnings will find its net worth deteriorating over time (barring any changes in assets). This situation does not lead to sustainable health. In fact, the longer the credit union allows its earnings to be depressed, the more impaired and unhealthy it becomes over time.

So, to the question of what is driving such low health scores for smaller peer groups. With the exception of Net Worth, Expenses, and even Efficiency scores, which tend to be on par with all other peer groups save for Peer Group 6, smaller credit union peer groups suffer lower scores in every other category. Of particular concern, both Peer Groups 1 and 2 have substantially lower scores in Member Loan Balances and Member Deposit Balances, meaning that they do not average near the level of financial relationships we consider requisite to institutional health.

When you combine the fact that smaller credit unions are not driving balanced loan and deposit relationships with the fact that the industry has a persistent membership growth problem, you uncover the real possibility that the 2,000+/- credit unions making up Peer Groups 1 and 2 will not exist in 5-10 years. Why? Because they have neither the lending relationships required to drive greater net income today nor the solid pipeline of new members to drive lending demand and income tomorrow. Unless something is done to help smaller credit unions drive greater growth in loans and new members, and/or unless these credit unions begin adopting more flexible lending policies designed to allow growth, the future for small credit unions is rather bleak.

In this basic analysis something else becomes quite clear. The “expense” of competing, or being compliant, is not the primary driver of this unhealthy diagnosis for the smaller credit unions making up Peer Groups 1 and 2. For all the talk of escalating costs faced by smaller credit unions, both Peer Group 1 and 2 seem to be managing expenses as well as other peer groups. The real key to the unhealthy scores, as stated, is the anemic relationships small credit unions have with their members combined with the lack of new member growth. Discussions to solve the “expense problems” of small credit unions, while interesting, fail to address the real reason small credit unions face health challenges today.

It should be noted that the health of small credit unions can change – perhaps not overnight but certainly over time. We obviously do not define the path to improved health in this post (we drafted this simply to explore the health disparity that exists between small and large credit unions), but small credit unions can surely and dramatically improve their health and sustainability with well-chosen growth strategies. The first step is to make a choice to improve.

Based on one conversation I had with a small credit union CEO a few moths ago, however, I think making that choice may be harder than necessary due to entrenched resistance to change. This CEO said that they were happy with their small size and could see no reason to do anything differently – even as they struggled with an extremely low HealthScore. They were small and getting smaller, a sure path to failure, but believed themselves to be complying with the will of the membership. What gave them such confidence in maintaining the status quo? Net worth, for they believed their high net worth was indicative of sound corporate strategy – but as we have defined, being healthy in one out of eleven metrics is really not healthy at all.

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