The spread between the industry’s net interest margin and the operating expense ratio has narrowed from 36 basis points in the fourth quarter of 2013 to 10 basis points as of year-end 2017, according to our analysis of credit union call reports.
This is just one measurement that shows why non-interest income (NII) has become so important to credit unions. Cutting costs is one way to improve that ratio, of course, but adding products and services that generate revenue and value has proven to be more attractive and profitable in many playbooks.
Historically, the credit union business model has enabled cooperatives to cover operating expenses with interest income alone. But now, despite recent rate hikes, a persistent low rate environment combined with other competitive pressures has resulted in interest income no longer able to solely cover an institution’s operating expenses in totality. Thus, the need for non-interest income has emerged and is growing in importance.
NET INTEREST MARGIN VS. OPERATING EXPENSE RATIO
That doesn’t mean that business is bad. More and more consumers are turning to credit unions to serve as a primary financial institution and market share and membership have both shown steady growth for several years.
As member relationships deepen, revenue opportunities expand. The average member relationship grew $500 year-over-year in the fourth quarter, and total revenue, which has been on a positive trajectory since 2014, surpassed $66.0 billion in the fourth quarter of 2017 and has increased 9.4% annually.
Interest income, of course, still dominates the industry’s revenue composition, comprising 72.8% of total revenue at year-end 2017. The industry’s success in lending underpinned the 11.6% year-over-year interest income growth posted by credit unions.
On the other hand, NII accounts for a smaller proportion of total income, but is the revenue focal point for many credit unions. Fee income and other operating income are the key drivers of non-interest income.
Fee income historically comprised a larger proportion of total non-interest income until 2015, when the composition shifted in favor of other operating income. Other operating income accounted for more than half of non-interest income in the fourth quarter, whereas fee income accounted for 46.1%. Other sources such as gain (loss) on investments, non-trading derivatives, and disposition of fixed assets for example accounted for the remaining amount.
NII COMPONENTS/TOTAL NII
Fee income and other operating income consists of a diverse set of contributing sources, giving credit unions flexible income opportunities to improve their bottom lines. Fee income generally falls into one of three categories related to deposits, loans, or other member services.
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Sources of deposit-related fee income:
- Minimum balance/maintenance
- NSF/courtesy pay
- Stop payment
- ATM surcharge and interchange income
- Wire transfers
- Returned check
- Money order/travelers checks
Sources of loan-related fee income:
- Late charges
- Skip payment fees
- Loan application fees
Sources of member service-related fee income:
- Check cashing
- Safety deposit box fees
Sources of other operating income:
- Unconsolidated CUSO income
- Debit, credit, and prepaid card interchange income
- Loan servicing
- Mortgage sales
- Investment and insurance sales
A really useful metric for looking at the importance of NII is its ratio against average assets. We used Callahan’s Peer-to-Peer software to create a list of the top 25 credit unions by that ratio, limited to the 1,591 credit unions of $100 million or more in assets at year’s end.
That ratio ranged from 3.48% to 6.16%, and those 25 credit unions were from 17 states with total assets ranging from $103.5 million to $1.5 billion, showing a diversity as broad as the mix of NII streams that each of these credit unions employ.
This article appeared originally in the Credit Union Times in February 2018.