Credit unions’ reliance on fee income, specifically overdraft charges, could open the industry up to additional risk.
Industry data has shown credit unions collect more in fee income as a percentage of assets than banks. This helps credit unions offset higher expenses, but this model may be untenable if consumer expectations change or new laws are implemented to rein in overdraft charges.
"Branding-wise, credit unions have done a marvelous job of saying we have free checking and we are friendlier,” said Mike Moebs, CEO of Moebs Services, an economic research firm. “But when you add up the fee income and service charges on deposits, you see that they collect far more than the banks do.”
Credit unions’ 2018 fee income-to-assets ratio totaled 0.61%, according to data from Moebs. That’s more than double the 0.28% for all financial institutions and the 0.24% for banks. Moebs calculated fee income using charges for items such as overdrafts, stopped payments and transferring funds from one account to another.
Ben Loveless, managing director at the consulting firm Sentinel Project Management, said the reliance on fee income at credit unions stems from the industry’s focus on retail banking. Consumer products, such as credit cards and mortgages, tend to have more opportunities to collect fees, he said.
In contrast, many banks focus on commercial customers. A bank will usually assign a business manager to these accounts who will then analyze the customer’s overall account activity, including the lending and deposit relationship. The bank might end up waiving certain fees to encourage these customers to park more of their money there or to deepen their relationship with the institution.
That process doesn’t usually happen with retail consumers.
“It is really two different business models,” Loveless said.
About 80% of fee income at credit unions comes from overdrafts, according to Moebs’ data, compared with about 70% for banks. And that reliance on fee income – and especially overdraft charges – is a business model that can be easily disrupted, Moebs said.
For one, he explained, millennials have different consumer preferences than past generations and seem to be more resistant to paying fees.
Secondly, a number of Democratic politicians, including Sens. Elizabeth Warren and Bernie Sanders and Rep. Alexandria Ocasio-Cortez, have shown a willingness to fight against perceived abuses by the financial services industry. Overdraft charges could easily fall into that category. Some Democratic lawmakers have
If Democrats take the White House and both chambers of Congress in 2020, then it’s likely they would pass legislation to curb overdraft charges, Moebs said.
“Credit unions are at a greater risk,” he said. “What if Sen. Warren or Rep. Ocasio-Cortez were able to pass a law in Congress that says you can’t charge more than $15 for an overdraft? That would be disastrous for credit unions. The banks and thrifts could live with that but credit unions would lose half of their fee income and many of them would not have enough in the bottom line to offset that.”
However, Loveless thought this scenario was unlikely and wouldn't significantly hurt credit unions. Financial institutions would find other ways to generate fee income from overdrafts, such as charging a high interest rate on the amount a consumer overdraws, he added.
A number of credit unions have also been sued
Over the last decade, KEMBA Financial Credit Union in Gahanna, Ohio, has proactively worked to reduce its reliance on overdraft charges and instead focus on other areas that can generate fee income, such as financial planning, said President and CEO Mark Decello.
For instance, in 2012, the $1.4 billion-asset credit union started assessing overdraft fees using actual balance instead of available balance. That change was driven by feedback from members and employees who were confused by the previous process. Even though that change cut into fee income, it was worth it from a member-service perspective, Decello added.
KEMBA earned roughly $2.4 million in fee income in the first quarter, according to its call report from the National Credit Union Administration. That’s a little over half of its earnings for the quarter.
“We have done a number of initiatives to lower fees or eliminate them,” Decello said. “We are always trying to diversify our revenue stream to eliminate that dependency.”
Experts noted that credit unions are using fee income to offset higher expenses. Non-interest expense to assets at credit unions last year totaled 3.07%, according to data from Moebs. That’s compared with 2.57% for all financial institutions and 2.51% for banks, according to the data.
“Whether banks do a good job with it or not, they try to maintain staff levels as low as they can get away with,” said Bob Doby, a partner at DJ Consulting. “I don’t see credit unions doing that quite as much.”
Credit unions have higher expenses bases for a number of reasons. They tend to be smaller than banks so they lack the same economies of scale. Consumer banking, especially in areas such as mortgages, tends to be more expensive than providing commercial services.
There's also the issue of some credit unions failing to take into account all of the expenses tied to member relationships, such as the origination costs on short-term used car loans. This leads to the institution not charging sufficient interest rates on loans, Doby said.
“The sad fact is [fee income] kind of camouflages them from making other bad decisions on loan pricing,” Doby said. “Credit unions are more income focused and not profitability focused.”
It’s difficult to control expenses in the current regulatory environment and because of increasing demands for technology, Decello said. For instance, KEMBA is too big to outsource its compliance functions so it has had to increase its headcount over the years to ensure it meets requirements.
Still, it’s important to keep an eye on costs, he said.
“You need to know where the money is being spent,” Decello said. “Expense control is critical, but with our environment you have to make some healthy investments so you are running a safe and sound institution.”
