How Healthy Are Credit Unions?

How healthy is the credit union community? Watch Glatt Consulting founder and chief strategy consultant Tom Glatt Jr as he delivers an update on the latest Credit Union Industry HealthScore.

During this live online event originally airing March 5, 2013, Tom shared the latest calculation of the Credit Union Industry HealthScore, identified points of comparative health improvement, called attention to areas of concern, and shared his opinions on the future of the credit union movement.

Questions regarding credit union health can submitted via twitter to @glattconsulting or via our online Contact Us form.

The full transcript of the update is included below….

Hello and welcome to Glatt Consulting’s Credit Union Industry HealthScore update. I am Glatt Consulting founder and credit union strategy consultant Tom Glatt, Jr., and in this program I will share the 4th quarter calculation of the HealthScore and what it means for the credit union community.

Before we begin, I would first like to remind you that you can submit questions during this program either via twitter to @glattconsulting or via email to info@glattconsulting.com.

I’m going to kick our program off by first sharing with you exactly what the HealthScore is, where it came from, and what we use it for.

Back in 2007 we were asked by a credit union to help them find a merger partner. The challenge was that they were in an area particularly hard-hit early on in our most recent recession. They projected a substantial hit to their capital because of the downturn and needed to find a merger partner that was healthy enough no only to absorb their projected losses but also healthy enough to continue growth in service to credit union members. We created a scoring system to help us weed out the healthy from the unhealthy, and ultimately help our client find the strongest overall partner.

In creating the scoring system we defined five levels of healthy to unhealthy performance across eleven different key financial ratios. Our scale ranged from five, which reflected peak health, to zero reflecting poor health. We scored each key ratio for every credit union, then averaged those scores into a composite rating we called a health score. Those credit unions with the highest degree of overall health were then discussed by our client, with the scoring data used in part to help determine the best overall merger fit.

Upon completing the project we found we had a rather interesting model to use not only to help client credit unions make merger and other strategic decisions, but also to help uncover areas of industry performance requiring discussion and response. We fine-tuned our model and then began calculating and releasing what came to be known as the Credit Union Industry HealthScore. The score has since been referenced in a variety of industry publications and presentations.

So, as a short summary our health score is a model that:

  • Is based on a 0-5 scale, with 0 being very unhealthy and 5 being extremely healthy;
  • Identifies the health of credit unions in eleven different critical financial measurements, including net worth, return on assets, efficiency, expense management, credit quality (through delinquencies and chargeoffs), member relationships (through member deposits and loans), loan to share, and membership and asset growth.
  • Incorporates general performance measurement health into an overall composite benchmark,
  • Is used to define and spark discussion on overall industry health.

Now to our latest score calculation. The Credit Union Industry HealthScore for the 4th quarter of 2012 is 2.339 representing a decline of 2.14% over the 3rd quarter of 2012 – but an increase of 4.15% over the 4th quarter of 2011.

To help you better understand the score and what it means for the industry, we’ve pulled together a few charts and data tables I’d like to share with you.

HealthScore Trends
HealthScore Trends

This first chart plots two interesting, and perhaps disconcerting, bits of data covering a little more than a decade of credit union financial performance. On the left axis is our HealthScore scale ranging from 0 to 5. The red line is related to this scale, and it tracks credit union HealthScores over time. On the right axis is the number of credit unions. The gray bars are related to this scale, with the bars representing the total number of credit unions in existence over the same time period as tracked by the healthscore line.

I’d like to point out a couple of things in the chart. First, we see the continued decline in total credit unions (a trend that has been in existence since well before the timeframe covered by this chart). Where at one time we had more than 20,000 credit unions in the United States, by the start of the time period reflected in the chart we were down to 10,000 credit unions… and by the 4th quarter of 2012 we show slightly less than 7,000. We are averaging a quarter-to-quarter decline in numbers of about .89%, and a year-to-year decline of a little over 3%. This translates to a loss of around 70 credit unions every quarter. The disconcerting part is that this trend shows no sign of slowing, and in fact we had declines of over 1% in both the 3rd and 4th quarter. I know there is a bottom somewhere, but we don’t seem to be getting close just yet.

The second thing to point out is a trend of declining health. Despite some notable improvements, we still see a general trend to poorer, not stronger, health. This is better illustrated by a linear trend line, which is the black line now appearing in the chart. A linear trendline helps show whether something is increasing or decreasing at a steady rate over time. It certainly makes it easier to see the overall downward movement of health in our HealthScore data.

HealthScore Trends with Linear Trendline
HealthScore Trends with Linear Trendline

I think this long, but incremental decline in health is fact, but I also believe it is important to understand both the positive and negative drivers of industry health and the “contributions” individual credit unions make to industry health. Related questions include “Is this health trend reversible? Are the factors contributing to incremental declines in health facing all credit unions, or are they a concern for only a few?”

As we delve a deeper into the data we uncover important details that not only help answer these questions, but perhaps even help us define the likely makeup of the credit union community of tomorrow.

HealthScore Percent Change From Prior Period
HealthScore Percent Change From Prior Period

The chart now on your screen is a starting point in addressing our questions, and perhaps gives us some indication of whether we can reverse our declining trends. The chart illustrates the percent change in our healthscore from the same period the prior year. In other words, it compares the percent change in score from December of one year to December the year before, so on and so forth. By looking at the data this way we can better determine if we are moving in the right direction in terms of health on a year-over-year basis. So what do we see? After a very nasty period of declining health, beginning the 4th quarter of 2007 and really not ending until the 4th quarter of 2010, we see recurring improvements from one year to the next for each quarter of comparison. This is good news as it shows us clawing back a bit of what was lost over that 3-year period of poor performance.

As an aside, some question why we can point to quarter after quarter improvement in health on this chart yet still show a trend of declining health as illustrated in the prior chart I shared. The reason is two-fold. First, we have had much greater swings in scores over the last few years than is typical for our industry, and during that time our highs have been marginally high while our lows have been exceptionally low … more than countering our gains. Second, our low scores of prior years make it easy to show higher percent change improvements in health.

I don’t want you to think that I believe this chart illustrates negative information. As I said, it presents some good news. It showcases an emerging, positive outcome stemming from more than a little bit of grit, determination, and sound strategic decision-making during a very difficult and protracted recession. It also suggests that we can perhaps reverse the trend of decline and I believe the next set of data provides additional support for that assertion.

HealthScore Component Score Changes
HealthScore Component Score Changes

What you see on the screen now are the percent change composite HealthScores contained in the chart I just showed as well as the percent changes in scores for each of the HealthScore components. Red blocks indicate a negative percent change over the prior period. I’ve taken the table range back to 2005, and as you can see the red blocks become more numerous – and then less numerous – as as we move into and out of the recession. The fact that we now have but one red block (which I will point out is in the loan-to-share column) is very nice.

Point of clarification to avoid confusion… in truth we actually have two red blocks, but the other represents the percent change in total credit unions which is not a score component. We have already discussed this trend, but I will point out that we had higher-than-average changes in the 3rd and 4th quarters of 2012. I think this increase is the culmination of the merger decision-making process for credit unions not quite fully recovered from the recession rather than the start of a new escalation in the rate of decline in the total number of credit unions.

Now, back to our questions of reversing declining trends, and whether the trend of declining health is, in fact, the reality of a few or of all credit unions. This chart sheds some light.

HealthScore Score Range Distribution
HealthScore Score Range Distribution

In this chart, the left, vertical axis represents total credit unions. The bottom, horizontal axis represents HealthScore ranges. In general what we are showing are the total number of credit unions in each score range. For example, over 3,150 credit unions fall into the 2-2.9 score range, nearly 2,100 fall into the 1-1.99 range, etc.

There is a bit of added value to this particular chart in that we have also segmented the score range data by asset peer groups. These groups are defined as follows:

  • Peer Group 1: Assets less than $2,000,000
  • Peer Group 2: Assets from $2,000,000 to less than $10,000,000
  • Peer Group 3: Assets from $10,000,000 to less than $50,000,000
  • Peer Group 4: Assets from $50,000,000 to less than $100,000,000
  • Peer Group 5: Assets from $100,000,000 to less than $500,000,000
  • Peer Group 6: Assets $500,000,000 or more

While the chart reminds me of sticks of fruit stripe gum, it does help us understand not only the distribution of health scores overall, but also the general health of credit unions by asset size. While not a surprise, it is disappointing to see that the majority of less-healthy credit unions come mainly from peer groups comprised of smaller credit unions.

As something of an aside and with regard to the data totals for each score range, I do get a bit of common observational feedback that goes like this: “Why is the distribution of data a concern? It is simply a normal bell curve. Why would you expect anything different.” Yes, we do show a bell-curve distribution as would be expected, but remember that we are not grading on the curve here. Every credit union can be a 4, for example. Given that fact it is possible to see (and I would prefer to see) a bell curve constrained between 2.5 and 4, for example, rather than 0 and 4.

Back to the question of whether declining health trends are the province of all or a few. I think, at least as of the 4th quarter, smaller credit unions are having a much harder time meeting the standard of health defined in our HealthScore system and are actually driving down the health score of the credit union community.

I am not ready to say with certainly that the future of credit unions is fewer, larger institutions, but given current data and the underlying trends it would appear that without some change in course that is exactly the future that will materialize.

That said, let’s be clear that poor health is not solely the province of the small and good health of the large. This table clearly illustrates that there are large credit unions that are borderline unhealthy, and there are small credit unions that are quite healthy – but the norm is what it is.

Let’s take a look at another bit of data to explore further.

Component Score Comparisons to Average
Component Score Comparisons to Average

The table now on the screen showcases 4th quarter 2012 comparisons between industry HealthScores and component averages, and those of asset peer groups. For each peer group, red numbers indicate below average health. It is in this data that we really see the acute challenges facing smaller credit unions – and also the reason that so many refuse to alter their strategic course.

Starting with Peer group 1 we see that in every category this group scores below industry averages – with the exception of net worth. Peer group 2 is the same, though they also score below average in net worth – but not low enough to be considered impaired. This is the problem. For many small credit unions, a “well capitalized” status in terms of regulatory perspective is proof enough of good health that board members and managers feel justified in allowing underperformance in other areas that are, in the end, just as critical to maintaining long-term institutional health.

Another way I have heard this phrased is, because we have solid capital we must be doing something right. This particular sentiment reminds me of a family member who would routinely boast of glowing checkups at the doctors office even as he drank 12-oz glasses of hard liquor every day. The fact of the matter is that even if some measurements of health are on the level, other areas of poor health catch up with you sooner or later – and usually in a disastrous way.

In any case, taken in its totality this table shows that at the end of the day our largest credit unions, on average, are quite healthy in all (or nearly all) of the components making up our HealthScore. Because there are many more less-healthy smaller credit unions in number than larger credit unions, the general health of the industry is pulled down – but it is important to make this critical point… the majority of member assets have been placed at larger and/or more healthy credit unions.

I will end with one more slide…

HealthScore Strategy Focus
HealthScore Strategy Focus

The table now on your screen illustrates potential areas of strategic focus as determined by calculating the “distance” between optimum and current health. Green blocks indicate strengths to be leveraged. Red blocks indicate weaknesses to be corrected.

As you can see, all is not lost for small credit unions, and opportunities for improvement exist even for large credit unions. For small credit unions, income generation strategies have to be at the forefront of consideration – with strategy discussion covering loans, investments, and fees. In addition, smaller credit unions must seek out collaboration opportunities that allow for some degree of stability if not decline in operating expenses. Far too many smaller credit unions try to go it alone on all aspects of credit union operations. It is important for small credit unions to recognize that outsourcing or collaborating on back office functions does not mean ceding control of the member relationship. Own the relationship, collaborate on everything else.

For every credit union, bank transfer day and general bank dissatisfaction led to moment-in-time membership growth (in truth really only for small portion of the credit union community at that). Unfortunately moment-in-time circumstances are simply that… moments-in-time. They do not represent controlled, owned membership growth strategy. While a few credit unions do exceptionally well in consistently driving high levels of net membership growth, most credit unions do not. To drive long-term health credit unions of all sizes have to devise strategies capable of successfully driving membership growth. Growth does not have to be double-digit, but it should at least be positive. Nearly half of all credit unions do not have positive membership growth.

Finally, (though not a definitive finally), regardless of size credit unions need to be more efficient. Efficiency is a measurement of how much an organization spends to make each dollar of revenue. As the table shows, there is room for improvement.

Lest we end this program on a volley of concerns, I should point out the many strengths (and contributors to health) we see in the industry as a whole and illustrated by the green blocks.

  • Credit unions are well capitalized. Member money is safe and well cared for.
  • Credit quality, as measured by delinquency and charge-off, is generally good. Credit unions make good loans, and members pay their loans in overwhelming numbers on time as agreed.
  • Members trust credit union as evidenced by the generally high level of deposits held per member.

Now to the program’s end. The original decision leading to publishing this HealthScore was based on a desire to drive some discussion on where we are headed as an industry. Based on the data, I think we need to push some credit unions harder to do better for their members and for the credit union movement. I also think we owe a debt of gratitude to others for forming a firm foundation on which so much of the industry rests.

So, the credit union community stands perhaps at a crossroads. There is a deep recession in our recent past and we face lingering health problems today as a result. We have an amazing and timely cooperative message and, perhaps, an abundance of opportunity. The question is whether we have the will to change some of the sleepy practices of our past in order to both improve our health and equip ourselves to capitalize on the opportunity before us. Addressing this question will be a focus of ours throughout 2013 as we work with credit union clients in defining long-term strategy… but we hope that it will not just be a focus of ours but of all credit unions.

Once again I am Glatt Consulting founder and credit union strategy consultant Tom Glatt, Jr. Thank you for participating in our program.

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