Getting to Know Our Mutual/Cooperative Relatives

There are many insights we can garner from well established cooperative/mutual financial systems across the globe. Although many of our credit unions system leaders often look to Canada and Australia, there are also mature cooperative systems in Germany, Netherlands and the United Kingdom.

We recently had the opportunity to meet in Manchester, England with leaders of Building Societies across the United Kingdom to discuss topics relating governance, finance and value proposition. Although there are a number of differences compared to U.S. credit unions, there are also a number of similarities. Here are a few examples:

	U.K. Building Societies	US Credit Unions
# Institutions	47	7,300
Assets	$500 Billion	$980 Billion
Branches	1,700	21,400

Source:  Building Societies  Association & NCUA 5300 data

Similarities:

• One member, one vote
• Strong member focus with better rates and fees relative to banks
• Weathered the economic recession well relative to their non-mutual/cooperative peers
• Have been facing earnings pressure from tight interest margins
• Going through a period of increased regulation
• Industry is consolidating
• Lobbying for alternative capital
• Looking to capitalize on consumer distrust of banks

Key Differences:

• Building Societies are required by law to have at least 75% of lending on residential property
• They generally rely more heavily on wholesale funding
• Building Societies pay tax
• They can serve non-members

A key insight we took away from meeting with Building Societies relates to bank conversion.  Starting in the early 90’s there was a wave of demutualization driven by new regulation and the perceived desire for short-term windfall payments.  However, many now look back at the conversions as a failure. While the converted Northern Rock was a high profile disaster of the global financial crisis; not a single converted society has remained an independent entity.

Society Demutualization

Name	Year	Result	Year
Abbey National	1989	Taken Over	2004
C&G	1995	Taken Over	1995
N&P	1996	Taken Over	1996
Alliance & Leicester	1997	Taken Over	2008
Halifax	1997	Taken Over, Part Nationalized	2008
Northern Rock	1997	Nationalized	2008
Bristol & West	1997	Taken Over	1997
Woolwich	1997	Taken Over	1997
Birmingham Mid.	1998	Taken Over	1999
Bradford & Bingley	2000	Taken Over, Part Nationalized	2008

Source: Building Societies Association

Cooperative/mutual financial institutions are integral to a mature and healthy financial services market.  The credit union system in the U.S. is relatively young compared to the rest of the developed world and there are many lessons we can learn from their experiences.  Here are just a few links to get you started exploring:

Building Societies (U.K) – www.bsa.org.uk

CU Central (Canada) – www.cucentral.ca

Desjardins (Canada) – www.desjardins.com

DZ Bank (Germany) – www.dzbank.com

Rabobank (Netherlands) – www.rabobank.com

Abacus (Australia) – www.abacus.org.au 

European Association of Cooperative Banks – www.eurocoopbanks.coop

Too Many Branches? (Part One)

Our recent post on Channel Shifts noted the rise of mobile banking and the decline of bank branch utilization. Despite the decline in overall branch utilization, some credit unions are still planning to add to their branch networks (see chart below).

Source:  NCUA 5300 Call Report data and CUNA Mutual analysis

The above finding is supported by The Financial Brand’s State of Bank & Credit Union Marketing Study, which found that 42% of the banks and credit unions surveyed were planning to add more branches in 2012 vs. 6% that planned to close branches. 

Either approach, expanding vs. pruning branch networks, might be appropriate depending upon a particular credit union’s specific circumstances. However, based on the following analysis, an argument could be made that certain credit union segments need to pursue greater efficiency in their distribution channels. 

Source:  NCUA 5300 Call Report data and CUNA Mutual analysis

As the above graph shows, the smallest credit unions (<$50M) have a 7% share of system assets, but a 31% share of branches. Credit unions between $50M-$250M also have a disproportionately higher share of the systems’ branches. These two categories are also less efficient, i.e., have higher operating expenses / average assets, than larger credit unions in aggregate.  In contrast, the very largest credit unions ($1B+), which are the most efficient as group, comprise nearly 50% of the system’s assets, but only 20% of the branches.  

In short, larger credit unions, on average, have a substantially higher assets-per-branch ratio than smaller credit unions.  This helps to explain why it may make sense for larger credit unions to continue their branch expansion strategies as noted above.  It also suggests that smaller credit unions may need to trim their branch networks.  

As we learned in this post, credit union scale and size of branch network appear to be related to operational efficiency.  An upcoming post on Sustainable Growth Blog will examine whether a relationship exists between average branch size and operational efficiency.  

Your Ultimate Competitive Advantage

Credit unions compete with banks across many fronts including: breadth of product offering, pricing, channel access, convenience, and more. In each of these areas, it is increasingly difficult for any financial institution to develop a truly sustainable competitive advantage.

Financial institutions of all sizes recognize that financial products have largely been commoditized. Most financial products are essentially written contracts that can be easily replicated. At the same time, competing primarily in terms of price can be a risky strategy except for those few players who have the greatest operating efficiency, and therefore the lowest cost structure.

As a result, financial institutions ranging from banks to insurance companies and brokerage firms are emphasizing customer experience as their basis of differentiation. This can be a powerful and natural value proposition for credit unions, but it too has its limitations – when every player focuses on customer experience it no longer is a differentiator but rather becomes a prerequisite to competing in the FI sector.

The good news for credit unions, in the midst of this murky competitive dynamic, is that the cooperative ownership structure fundamentally differentiates credit unions from banks in a way that banks cannot replicate. This is very different from competing in terms of price, product or experience where a bank can meet or beat a credit union at its own game.

The cooperative ownership structure is defined within the seven cooperative principles (please view this link to the University of Wisconsin’s Center for Cooperatives – which contains a full explanation of each cooperative principle). Of particular importance to our immediate topic is the second principle: “democratic member control”. The key implication of this principle is “one member, one vote”.

This structure is fundamentally different from the ownership of a stock bank. [Note: Most banks are stock entities - 94% of all banks which hold 99% of bank assets are stock entities; only 6% of banks holding 1% of bank assets are mutual savings banks or cooperative banks.] In the case of a credit union, the member is the customer and is also the owner. There is no gap or separation of interest between the customer and the owner.

In the case of a bank, the retail customer is often not the owner. As the table below indicates, on average 70% of the shares of the five largest bank holding companies in the U.S. are held by institutional investors, an even higher percentage than the largest Fortune 500 non-bank companies. While these institutions may represent the aggregated assets of many individual investors, they nonetheless constitute a highly concentrated ownership bloc whose interests may or may not be aligned with those of a retail customer.

Even in the case of smaller stock banks, stock ownership is often closely held by management or private families. Again, this is a distant remove from “one member, one vote”.

Especially in the wake of the massive disaffection shown towards large banks last year, one would expect “one member, one vote” to be a powerful marketing tool for credit unions. But how many current and prospective members are even aware of the cooperative principles? Our dialog with CEOs across the country suggests that the answer is “Not many.”

We certainly cannot blame current and prospective members if we have failed to communicate and educate them about the real value the cooperative principles hold for them. Now is the time to embrace and utilize the cooperative model to create a truly sustainable competitive advantage.

Proposed Legislation May Impact Student Loan Risk

Recent stories by the Wall Street Journal, Businessweek, and other media outlets have put the spotlight on the growing debt load of today’s young adults.

Student loans outstanding (federal and private) now surpass the outstanding credit card balance ($867B vs. $704B), according to the New York Fed. By contrast, young adults’ ability to pay off their student loan debt has decreased in recent years. The Bureau of Labor Statistics shows the current unemployment rate for 20-24 year olds is 13.2% compared to 8.2% for the total labor force. In addition, According to the Conference Board, median wages for new graduates with a university degree declined in both 2009 and 2010 and remains below 2008 levels.

Within the credit union system, private student loans outstanding grew at the remarkable rate of 44% between Q1 and Q4 of last year.

The rapid growth and lack of seasoning of the credit union private student loan portfolio make it difficult to draw any firm conclusions about overall loan performance.

In the future, student loan performance may have a greater impact on credit union earnings. Recently introduced legislation by Sen. Dick Durbin (D., Ill.), The Fairness for Struggling Students Act, could change the economics of private student loans by allowing them to be discharged in bankruptcy.

As the private student lending marketplace continues to evolve, credit unions with these loans on their balance sheets will need to carefully monitor:

• Further regulatory changes 
• Performance of their loan portfolio 
• Other headwinds facing Gen Y that could affect demand for private student loans 

The mounting debt represents only one of several headwinds currently facing Gen Y. Future posts on Sustainable Growth Blog will explore both the headwinds facing this generation and the implications and opportunities for credit unions.