For US credit unions, the pandemic has introduced new challenges and also accelerated existing trends – such as digital transformation, consolidation, and member centricity. Credit union executives must confront a long list of mandates, with very tight resources. Prioritizing action will be critical. Based on primary research, we have identified five trends that we believe will be particularly relevant for credit union executives as they plan for post-pandemic recovery.
COVID-19 has wreaked havoc on the global economy, causing radical changes in the needs and behaviors of consumers, businesses, and financial institutions. As the pandemic and resulting stay-at-home orders set in, U.S. credit unions scrambled to adjust to an uncertain and rapidly evolving environment – and have done a remarkable job of maintaining member services.
Six months after the first stay-at-home orders went into effect, much still remains unclear: How long will distancing measures remain in place? Will members want to visit branches again, or have they switched permanently to remote and digital banking channels? Will workers want to return to the office or branch? What percentage of the workforce can and will shift to permanent remote work? When will members who sought loan deferment or forbearance be able to meet those obligations? What will future government stimulus measures look like, and how effective will they be?
In addition to introducing various new challenges, the pandemic has also accelerated existing trends such as digital transformation, consolidation, and member centricity. As a result, credit union executives must confront a long list of mandates with tight resources. Prioritizing action will be critical.
Our team conducted research on the trends facing the U.S. credit union sector during the second quarter of 2020. We interviewed more than 15 credit union leaders from organizations across the country ranging from a few hundred million dollars to nearly $20 billion in assets.
We identified five trends that we believe are most relevant for credit unions right now and that require short-term attention from credit union leaders. Here is what we found, where we see the industry headed, and how executives can focus their attention to address them.
Some credit unions have been building out digital channels and enabling touchless payments via contactless cards and digital wallets for years. Others, however, were caught off guard and found themselves rushing to set up core digital services such as account opening in order to maintain continuity – both their own and their members’.
Adoption of contactless payment methods has been trending up for years, but the pandemic generated an immediate boost. One credit union executive we interviewed cited a significant increase in contactless transactions since the start of the pandemic. That is in line with external reports, including a survey by the National Retail Federation and Forrester Research released in August that found a 69% percent increase in contactless transactions across U.S. retailers since January. Mastercard also reported a 40% rise in contactless payments, including tap-to-pay and mobile pay, during the first quarter of 2020 alone.
In our interviews, credit union executives were in consensus that digital banking solutions and services will be increasingly important. On the other hand, executives diverged in their views about the degree to which members value digital and how they will continue to interact with traditional channels, such as branches and ATMs. Some credit union executives feel strongly that their member base wants face-to-face interaction and have continued to open new branches even during the pandemic.
To remain central to the lives and businesses of members and avoid being displaced by other institutions, credit unions first need to make sure they can deliver baseline activities via digital channels, such as opening an account, applying for a loan, making real-time P2P and A2A payments, and delivering member support effectively.
But going digital is not enough. In the long term, credit unions cannot compete on the basis of having digital capabilities – particularly when the competitive set includes the top banks . Therefore, digital solutions must be easy to use, effective in enabling human interaction, and designed to deliver excellent member experiences. Credit unions must invest effort in communicating these capabilities to members and supporting them with superior member services – videos, guides, and dedicated service experts – to realize a positive return on these digital investments. Those that are slow to embrace digital will find themselves in a difficult position, if not now then not too far into the future.
Credit unions that are already farther along in the digital process should focus on driving member education and adoption of existing digital capabilities. Additionally, moving solutions to the cloud and developing strong API technology can allow banks to be more agile in bringing new products and services to market faster in the future. Credit unions with strong digital engagement should also assess their operating model – both internally and member facing – as there may have opportunities to cut costs and create efficiencies to realize the full value of their digital investments.
Business disruption has had a significant impact on credit union balance sheets. High unemployment has reduced loan demand and consumer spending. Interchange revenue has dropped considerably due to the combination of lower overall transaction volume and a shift in spending from high rate categories, such as travel, to low rate categories and specific retailers such as Costco, Amazon, and Walmart. The Fed has slashed interest rates to near zero and has pledged to keep the benchmark rate low until the economy starts to recover from the pandemic – while this makes loans cheaper for borrowers, it is devastating many financial institutions’ net interest margins. In our interviews, credit union executives stated that the low interest rate environment has also encouraged auto manufacturers to offer low-interest loans themselves, cutting out or reducing the need for traditional credit union lenders. The increase in digital auto retailing is accelerating this trend.
On the other hand, many credit unions have seen an influx in deposits as consumers move to bolster their savings.
The Credit Union National Association forecasts further declines across credit union financial indicators. For example, it projects net margins will decrease from 3.15% in 2019 to 2.75% in 2020 and 2.5% in 2021.
With traditional revenue streams reduced and COVID-related patterns – including remote work, direct auto lending, and shifts in spending habits – expected to remain intact, CUs will need to restructure their balance sheets. The combination of lower revenue and a strong capital base will drive credit unions to pursue new lending channels such as direct auto lending, business lending, and point-of-sale (POS) installment loans to reverse revenue declines.
To build and diversify loan portfolios and take advantage of new ways to help members, credit unions may consider expanding into the Small Business Administration (SBA) lending market. Credit unions have traditionally stayed away from SBA lending because of their consumer focus and the risks associated with SBA loans. However, we have seen more credit unions investing time and resources to become approved SBA lenders so that they can offer loans under the Paycheck Protection Program (PPP). CUs that have done so can then begin to move further into small business and commercial lending.
Well-capitalized credit unions may find that they are able to capture market share while many banks look to minimize risk. Another option is for credit unions to introduce other types of lending products such as installment loans. The buy now, pay later (BNPL) market has grown significantly since the pandemic began, allowing major players such as Klarna and Afterpay to more than double their user bases. This product has been particularly attractive within younger demographics who want to avoid paying credit card interest and want the ability to pay for things outside of their current budget. PayPal just announced a new product for PayPal users called “Pay in 4” which allows members to pay a quarter of an item’s price upfront, then pay the remainder over a six-week period.
Credit unions should show they too are willing to be flexible to meet member needs. Offering “hot” products can help credit unions generate new revenue streams and gain relevance in the market, particularly among younger consumers.
While credit union mergers trended downward in the few years leading up to the pandemic, the current financial environment is likely to increase consolidation. Many CUs will look to build scale to support portfolio strength and investment needs. Others, particularly smaller credit unions (less than $100 million in assets), may be forced into an acquisition due to poor financial condition. Most of the CEOs we interviewed indicated that they are still in a wait-and-see mode and not immediately seeking or acting on merger and acquisition opportunities. One credit union executive told us the institution was more interested in a merger of equals to build considerable scale, as acquisitions of smaller credit unions were historically not worth the investment or effort.
Many of the executives we spoke to expect a swift pickup in M&A activity once the dust settles from COVID-driven member forgiveness policies and government programs – possibly as soon as 9 to 12 months down the line.
History suggests there will ultimately be a net increase in M&A due to pent-up demand, greater economic predictability, and lower acquisition target prices as players facing financial pressures must consider a sale. Many credit unions, particularly smaller institutions with narrow fields of membership, will come under financial pressure, leading them to seek a buyer as the impact of the crisis sets in. Regulators will become more involved in supporting failing credit unions and will encourage stable credit unions to acquire them. We may also see more credit union purchases of community banks as credit unions look to diversify their portfolios and get into SBA lending.
Additionally, we believe there will be increased interest in divesting card portfolios and seeking agent/issuer operating models. Some credit unions will opt to shed undifferentiated or underperforming card programs, while others will aim to raise capital and/or remove balance sheet risk.
Credit unions that may be in the position to acquire should be thinking about the type of institution they would like to take on and what they want to achieve, whether that is geographic expansion, growth in branches, complementary product lines, etc. As credit unions assess potential targets – either other credit unions or community banks – it will be critical to look at earnings capacity, in addition to how well the target’s loan portfolio reacted during the crisis. Technological infrastructure and capabilities should also be a key consideration. Credit unions should be wary of time-consuming and costly integration needs and should look to accelerate their digital business through M&A.
Credit union that are near the point of seeking a merger partner or buyer should proactively prepare not only in the ways already suggested but also by strategically considering the strengths they bring to a potential new entity, gaps they have that need to be filled, and using that assessment to identify other credit unions or community banks who might value what they bring to a potential merger, and possibly initiating discussions with potential partners or buyers.
Credit unions have taken rapid action to adapt branch services for the current environment, including temporarily shutting branches in many cases and reconfiguring branch layouts to accommodate continuing requirements for distancing. Many have opened drive-through windows, introduced video teller technologies, and changed visits to appointment only to ensure member safety.
Research suggests consumers want their financial institutions to have branches for “just in case” servicing and believe branches speak to a financial institution’s strength and longevity. The World Branch Report 2019 found that two-thirds of consumers greatly value branches – 29% of consumers say their branch must have branches and an additional 35% say they would prefer to use a bank with branches. Branches are especially important for small business lending, for institutions that choose to expand in that direction.
However, to what extent has the COVID-19 pandemic changes consumer preferences? Many credit union executives with whom we spoke believe that branches are still just as important and will continue to play a key role in their servicing and sales strategy. Other executives said they will look for opportunities to right-size their branch distribution, potentially by closing underperforming or redundant branches. There seems to be consensus that credit union branches are not going away, but the role they play might be changing.
The credit union sector may see a wide range of branch strategies going forward. Some will continue to expand their branch network, while others will shift branch approaches by inserting more ITMs, creating drive-throughs, and designating the branch for more “hands-on” services. While branches may not go away anytime soon, credit unions should reimagine their role and number in light of a strong effort to build digital products, tools and relationships with their members.
We believe branches will remain a key piece of the credit union strategy for the foreseeable future as they use their traditionally strong “human element” to compete with digitally enabled banks. However, the role of branches is likely to change over time. Members will go into a branch for an important transaction or an educational/advisory experience, but will be more likely than in the past to complete simple transactional needs, such as opening an account, digitally. Thus, branches will gradually become more consultative rather than transactional, and branch operations will become more efficient so representatives can focus on providing higher value services to members in the branch.
Overall, the number of branches will decline due to industry consolidation, a focus on cost containment, and growing emphasis on digital services. Branch operating approaches that emerged during the COVID-19 environment will remain in place for the longer-term. We also expect bifurcation between branch and digital focus based on credit union geography. Branches will remain more important in smaller markets and rural communities, while the shift to digital will be more pronounced in larger cities.
Credit unions should begin reevaluating their physical branch footprint – including the number of branches, locations, sizes, and layouts – in light of changing member preferences and the need to cut costs. This analysis can help to identify branch candidates for consolidation or downsizing and reveal opportunities to standardize and optimize the branch model.
Understanding member preferences and expectations relative to branches, for example through a “voice of the customer” program, can help in making decisions that will have a positive rather than negative impact on the business. We believe credit unions should help get members in the habit of using digital channels for simple transactions to free up branch resources. Positioning branches as a place to learn about products and get financial advice will help credit unions differentiate and deliver more value to members. To do so, credit unions must invest in employee training and ensure branch design, roles, technology are aligned with this strategy.
The use of analytics has changed the lending landscape. FinTechs and non-bank lenders have entered the scene, leveraging technology and data to develop non-standard underwriting criteria that allows them to provide more customized loans and increase overall approval rates. A majority of the credit union executives we interviewed see data analytics and business intelligence as a massive opportunity that they are not capitalizing on today. Many recognize that they lack the talent and technology solutions required to implement analytics effectively, which has stopped them from moving forward with such initiatives.
Data and analytics can be a differentiator for top-performing credit unions in the near term, but they will be a necessity across the industry in the longer term. For example, as credit unions further expand and diversify their loan portfolios to generate revenue, they will benefit greatly from analytics-based underwriting approaches. Additionally, as card-not-present (CNP) and mobile transactions increase in volume, fraud analytics capabilities are becoming even more essential to minimizing losses.
To compete effectively with top national banks and non-bank institutions, credit unions need to accelerate their use of transactional, lending, and deposit account data through the development of a data usage and visualization strategy. Many credit unions will need to begin with a thorough data cleanup to organize and standardize existing data and streamline data collection processes moving forward. The next step would be to generate insights that can enable informed decision-making.
Data can be used to improve functions across the bank – from product design and marketing, to underwriting and fraud prevention. For example, by using data to predict a member’s future behavior, an institution can target new offers more effectively. Creating and executing a data strategy will require significant new capabilities, as well as skills that are unfortunately in short supply. A good way to ramp up these capabilities quickly is to use outsourced services.
What’s next? Where do you begin? By assessing and analyzing your current market and conducting competitive analysis to know where you stand. Listen to the voice of your members as you begin considering steps for the future – the above analysis and research will help, but as we’ve come to realize in speaking with credit union leaders, the situation we find ourselves in is hardly one-size-fits-all. Focus on value creation, hold executive reviews to make sure the future you’re envisioning is the one you’ll actually produce that creates significant value.
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