As the housing crisis spread like wildfire across hard-hit Sunbelt states, the loan portfolio at Arizona Federal Credit Union ($1.2B, Phoenix, AZ) was in free-fall — $101 million in net charge-offs in 2008 — and the hemorrhaging had just begun.
Over the next three years, as members struggled to repay mortgages amidst soaring unemployment and tumbling home values, the credit union wrote off more than $300 million in bad loans from its books.
The steep losses slashed Arizona Federal's total capital from a high of $220 million in October 2007 to just $98 million in April 2011, plunging the institution into undercapitalized territory during much of that time. By early 2011, its ratio of net worth-to-total assets had fallen to a mere 2.9%, far below the 7% regulators needed to consider the institution well capitalized.
A near-death experience like this one would traumatize any credit union, but what makes Arizona Federal's story compelling is not just how the cooperative navigated its way back to solid capitalization, where it has been for more than two years. Rather, it's what came next that garnered this credit union the biggest backlash it has ever seen.
In November 2012, Arizona Federal announced it would begin charging a $3 monthly membership fee in January 2013.
The credit union knew the decision to charge membership dues, as it calls the fee, would be controversial, and it was. Arizona Federal may be the first credit union to impose membership dues, which critics quickly condemned as contrary to cooperative values. Many of those same critics predicted the institution would pay dearly for this unforgivable breach of trust, driving members away while earnings plummeted.
We didn’t do this for other credit unions or for the trade papers’ approval. We did this for our members.
"The judgment was this was not a good, credit union-like thing to do, that a true cooperative wouldn't do this and that we were behaving like a bank," says Steve Kelley, Arizona Federal's senior director of marketing. "But we didn't do this for other credit unions or for the trade papers' approval. We did this for our members."
Charging membership dues might seem like a funny way to give back more money to the members, but that's exactly what happened. The credit union, which has a tradition of paying bonus dividends at year-end, rewarded members last December with a $5 million payout, its largest since 2006, when Arizona Federal distributed a record $10 million in bonus dividends.
The 2013 payout exceeded what the credit union collected in dues for the year by approximately $1 million, essentially returning the fees and then some to members.
"The size of the payout is entirely a function of our financial results, and if we had made a mistake by charging membership dues, those results would have suffered," Kelley says.
CU QUICK FACTS
ARIZONA FEDERAL CREDIT UNION
HQ: Phoenix, AZ
12-MO SHARE GROWTH: -5.02%
12-MO LOAN GROWTH: -0.96%
The Case For Membership Dues
In an industry that differentiates itself from banks by minimizing fees, imposing a membership fee could have been disastrous, but Arizona Federal's experience demonstrates just the opposite — that credit unions can successfully navigate the treacherous waters of charging for membership. The credit union succeeded because it not only made a strong case to its membership for the fee but also adeptly handled the inevitable fallout from disgruntled members.
The argument for this fee strategy stems directly from Arizona Federal's traumatic history. The credit union had failed its members badly and wanted to carve a new pathway forward, one that offered solid financial footing while better rewarding a smaller but actively participating membership. Inactive members who had little interest in making Arizona Federal their primary financial institution were free to leave.
"Our goal was not to take money from someone who didn't find value in being a member," Kelley says. "We wanted the membership to use more of our products and services, and we were going to be whatever size institution we ended up being based on finding members who were more actively engaged."
Nevertheless, charging dues was a risky move, so months before announcing the fee publicly, senior managers sought opinions about it from everyone in the organization. At meetings, they discussed worst-case scenarios and hammered out solutions. They also established basic ground rules. The credit union would not waive the fee for anyone. Every member, including employees and board members, would pay the same $3 charge to access all the benefits of membership, like paying dues at a club. The only difference was that Arizona Federal never intended to keep the money.
Instead, it hoped to repay members with year-end dividends that were at least as much as the credit union collected annually in dues. Extra money would also come from the additional merchant interchange fees that Arizona Federal expected to generate by requiring members to become more active credit union users.
The cooperative had always had a thriving credit card business, and traditionally, all members had shared in any year-end bounty. But under the new system, only members who had used their Arizona Federal debit or credit card for 10 transactions a month over the preceding year would be eligible for dividends. Any member who failed to meet that standard would get nothing. "Everyone has monthly expenses and buys something, so we have a hard time understanding why they wouldn't use our cards," Kelley says.
Payouts would also be scaled according to how much each member used the institution that year so that, for instance, a member with a car loan would receive more money than someone who only met the 10-transaction standard.
Although the strategy seemed harsh, Arizona Federal wanted all members doing their part to keep the cooperative healthy.
All Hands On Deck
On the last day of November 2012, a letter from Arizona Federal's CEO Ronald Westad announcing the new changes went out to all 160,000 members. The letter concluded with the credit union's decision to resume paying year-end dividends in 2012 after a five-year suspension, but there was a catch. In keeping with the new requirement that only active debit or credit card users got the dividend, Arizona Federal stipulated that only members who met the 10-transaction standard in December 2012 would receive dividends.
The credit union wasted no time calling those members who were most likely to object the loudest to paying membership dues. Anyone without an active checking account made the list, as did individuals with only a modest savings account of $1,000 or less.
"These were the people who were not going to see any benefit from paying dues," Kelley says. "So we went out of our way to show them how to get value from their membership and also to make it easier to close their account if they thought they wouldn't derive any value."
Members with a certificate of deposit and an accompanying minimal savings account of $25 presented an especially tricky problem. An earlier promotion that paid a better rate to certificate holders who also opened a $25 savings account had attracted new members whose only relationship with the credit union was that deal. Arizona Federal was unwilling to expire the certificate early to release the funds but couldn't in good faith charge $36 in monthly dues, which would take the accompanying savings account balance negative.
Initially, the credit union froze the savings accounts. However, it eventually released the money and waived the dues when the certificates expired, marking the only time the credit union has ever broken its rule of never waiving the fee.
Meanwhile, the fallout had begun, and it was all hands on deck. Phones began ringing off the hook from members who were unhappy about paying dues. Anticipating the response, Arizona Federal had recruited employees from other departments to help take the calls.
One angry member, who lived out of state and had only a $25 savings account, sent hate emails to the credit union before setting up a website that claimed to represent 100 disgruntled members by copying posts directly from Arizona Federal's Facebook page, Kelley says. On Facebook, where many members vented their frustration, the comments were especially harsh.
"We had to coach employees not to get defensive because with social media, the gloves are off and people say things they would never have said otherwise," Kelley says.
The dues were a nonstory in Arizona's local newspapers, but the national trade press was having a field day quoting experts who vilified the credit union's decision. No one seemed to understand or care about Arizona Federal's strategy to more than reimburse those dues for the credit union's active users.
This was a shame, because the credit union did distribute $3 million to 77,000 eligible members at the end of 2012 for an average payout of $38 per member — more than enough to cover their dues for the following year.
The hubbub continued into February with a second wave of angry responses coming from members who hadn't read the credit union's letter in November and had just realized their account was being charged the fee. Then, almost as suddenly as the crisis began, it went away.
One Year Later
In one respect, the critics were right. As a result of the membership fee, approximately 30,000 Arizona Federal members ran for the exits. At the same time, the credit union's remaining 130,000 members have become more dedicated users of its products and services. The percentage of members with loans, for instance, rose modestly from 35% to 39% in 2013, with average loan balances growing 8% over the same period.
Arizona Federal's assets and capital also held steady despite the leaner membership and losses that continued to trickle in from loans that predated the economic collapse. In many respects, the credit union is still in the process of rebuilding the business it had before the recession hit, and there are signs that it might finally be turning the corner.
The cooperative does expect to have erased all its loan losses by early 2014 and hopes to begin growing its business later in the year by courting new members who will make Arizona Federal their primary financial institution.
Some of that new growth could come from referrals of members who stayed loyal to the credit union and were rewarded handsomely in 2013. Despite having a membership that was nearly 19% smaller than in 2012, Arizona Federal paid dividends to 11,000 more people in 2013 and increased the average payout amount by 67%.
Demographics are also working in the credit union's favor, with younger members in their prime borrowing years taking the $3 monthly membership dues in stride.
Younger members, Kelley says, didn't view those dues as a terrible expense "because they go to Starbucks every day to buy a $5 cup of coffee." Plus, those members recognize there are costs and benefits associated with being part of a group.
"These are the folks who grew up with study groups in school and like to be a part of something," Kelley says. "If we can help them understand why they should pay to be a part of our group, the benefits will speak for themselves."