Rising Rates, Steady Cost of Funds Help Paint Pretty Income Picture

Thanks to rising interest rates on loans and investments, as well as efficient internal management, the credit union industry is making enough to pay for its operating expenses for the first time in seven years.

On a practical basis, this means the average credit union could, theoretically, eliminate noninterest income and still be able to keep the lights on. More to the point, credit unions can use that bolstered bottom line to invest in their staff and offerings, each with an eye toward boosting member service and value.

Year-over-year income growth hit 12.6% as of Sept. 30, 2018. That equates to $54.8 billion in total revenue. (It should be noted here that the NCUA injected $736 million into the system in dividends paid out this year as a result of the merger of the Temporary Corporate Credit Union Stabilization Fund into the National Credit Union Share Insurance Fund.)

Operating expenses increased at a slower rate of 7.5% and are on track to total $33.2 billion for the year. Net income growth was 29.3% since the third quarter of 2017, driving up the aggregate bottom line of the industry to $10.2 billion.

Rising interest rates lead to loan and investment income outpacing deposit and borrowing expenses, pushing the net interest margin up 15 basis points to meet operating expenses at 3.12%. This is the first time since March 31, 2011 that the net interest margin has been at or greater than the operating expense ratio.

The accompanying charts from Callahan & Associates help illustrate this dynamic. The “Income Portfolio” and “Total Revenue and Annual Growth” charts show that net loan income is still nearly two-thirds of the income portfolio, at $34.9 billion through the first three quarters of this year. Investment income adds another $5.2 billion, or 9.5%, resulting in total interest income accounting for 73.1% of total credit union income, leaving the rest from fee income and other operating income.

Although interest income comprises most of the income portfolio, noninterest income is still a significant revenue driver. Fees charged for services like overdrafts, ATMs and credit cards were up 5.2% year-over-year, a $322.1 million jump since the third quarter of 2017. Other operating income, meanwhile, accounts for 54.4% of NII and includes secondary market sales, interchange income, loan participations and certain CUSO income. Other operating income, where the NCUSIF dividends are recognized with a one-time gain in 2018, is up 16.6% since September 2017, while total NII jumped 11.1%.

The chart labeled “Yield Analysis” illustrates how the industry is generating more income per loan and investment as rates credit unions charge for loans and receive for investments are rising faster than what credit unions are paying for deposits.

For instance, after falling steadily since 2008, yield on loans rose 12 basis points in the past year to 4.66% as of Sept. 30. Yield on investments, meanwhile, after steadily increasing each quarter since March 2015, has sharply risen (40 basis points) from 2017 to 2018 as the Fed began more aggressively raising rates. The 11 basis point increase in cost of funds indicates that credit unions are returning a portion of this profit to members in the form of dividends.

The graph titled “Operating Expense Breakdown” shows how credit unions are investing in themselves. Credit unions committed 51.2% of all operating expenses to employee compensation and benefits as of the third quarter of 2018. The total balance of spending on salaries and benefits industry-wide jumped 7.3% year-over-year, to total $17.1 billion through the first three quarters of 2018.

Credit unions added 3.6% more full-time equivalent employees to the industry over the year to keep pace with 4.1% membership growth. Over the same time, revenue increased 12.6%,   indicating a positive return on investment in the people who help people, the core ethos of the credit union movement.

The increase in ROI is also reflected in the 17 basis point spike in return on assets over the year, to 0.96% as of Sept. 30, 2018. Callahan estimates an increase of five basis points to credit union ROA can be attributed to the NCUSIF refunds. The remaining 12 basis point increase is largely due to the higher yields on loans and investments in the last 12 months.

ROA is an important gauge of a credit union’s profitability. It reveals how much income is generated for each dollar of assets deployed. Being able to leverage the improved spread between interest paid and interest received with efficient operations, and investment in people and products, seems to be a winning strategy that portends well for the movement’s future.

Samantha Cristobal is an Industry Analyst for Callahan & Associates. She can be reached at 202-223-3920 or scristobal@callahan.com.