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The CU2.0 Podcast
This podcast explores contemporary, critical thinking and issues impacting the nation's credit unions. What do they need to be doing to not just survive but prosper?
The CU2.0 Podcast
CU 2.0 Podcast Fast Take Peter Duffy on the First Tech DCU Merger and What It Signifies
Buckle up, the ride just got a lot bumpier.
The news exploded in credit union land on September 30: First Tech, the 12th largest credit union in the country with assets over $16 billion, is merging with Digital Credit Union, the 18th largest with assets over $12 billion. The resulting crosscountry credit union will have assets of $28.7 billion, making it the nation’s seventh biggest credit union serving nearly 2 million members in 50 states.
Of course that’s pending NCUA approval but there’s no indication that would be withheld.
Is this a one off marriage - or is it the start of a new trend where ever bigger mergers help giant credit unions better compete with the money center banks and the huge fintechs where scale matters, great technology is table stakes, and the gloves are off in the fight.
On the show to shed light on what just happened and what the next moves will be is Peter Duffy, a past podcast guest and an adviser to many large credit unions.
Let’s cut to the chase. Duffy in the show says there’s nothing surprising about the First Tech and DCU merger and he predicts we will see more couplings of giant credit unions, probably soon.
What’s fueling this? Duffy offers his perspectives.
Listen up.
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SPEAKER_01:Hi, and welcome to the CU2.0 podcast with big new ideas about credit unions and conversations about innovative technology with credit union and fintech leaders. This podcast is brought to you by Quillo, the real-time loan syndication network for credit unions, and by your host, longtime credit union and financial technology journalist, Robert McGarvey. And now, the CU2.0 podcast with Robert McGarvey.
SPEAKER_00:Buckle up, the ride just got a lot bumpier. The news exploded in credit union land on September 30th. First Tech, the 12th largest credit union in the country with assets over$16 billion, is merging with Digital Credit Union, the 18th largest with assets over$12 billion. The resulting cross-country credit union will have assets of$28.7 billion. making it the nation's seventh biggest credit union, serving nearly 2 million members in 50 states. Of course, that's all pending NCUA approval, but there's no indication that would be withheld. Is this a one-off marriage, or is it the start of a new trend where ever-bigger mergers help giant credit unions better compete with the money-centered banks and the huge fintechs, where scale matters, great technology is table stakes, and the gloves are often the fight? On the show to shed light on what just happened and what the next moves will be is Peter Duffy, a frequent past podcast guest and advisor to many large credit unions. Let's cut to the chase. Duffy in the show says there's nothing surprising about the First Tech and DCU merger, and he predicts we will see more couplings of giant credit unions probably soon. What's fueling this? Duffy offers his perspectives. Listen up. Tell me, this first tech digital merger, did this come out of nowhere, number one? And I think the answer to that is no. And number two, will this set off a stampede of similar mergers? I mean, why doesn't Pentagon merge with Randolph Brooks and maybe one or two other military credit unions? I mean, Navy is so much bigger. I mean, why doesn't teachers merge with another teacher's credit union?
SPEAKER_02:It probably is a harbinger of things to come. The operating environment for community banks and credit unions with assets below economy of scale, as we've discussed previously, has gotten increasingly more difficult. And the higher rate environment accelerated some of the less than positive trends in the business. So you look at net interest margin, for example. You can actually, and I have gone all the way back to the early 90s, and you look at the net interest margin of banks and credit unions, and it's really been almost uninterrupted tighter. And when your margin's tighter, that puts more emphasis on fee income in order to have a positive net income. And that's kind of how it went for credit unions for a while. But then through various new initiatives coming out of the government, particularly the CFPB, you see an erosion of non-interest income, particularly fee income. And as you know, in the state of California, They began requiring banks and credit unions to report specifically what they were generating on income from NSF and bounce check fees and that kind of thing. Share draft protection, as it's referred to in credit unions. After a year of reporting on it, the state released some information that related to how each individual bank and credit union was generating income off of their customers and members off bounce checks and NSF. And they even listed them in descending order by the amount generated. So that's an environment that doesn't augur well for being able to maintain net income.
SPEAKER_00:Also, Peter, I would say, and I've been saying this and Obviously, CFPB has a bigger platform to say it. It was morally inconsistent for credit unions, defenders of the poor and the lower working class, to make their living, to pay their bills on fees levied against those very same people. And at the other side of their mouths, to complain about predatory lenders. Well, these are predatory practices, man. It's called what you want.
SPEAKER_02:Yeah. And people like you have been thundering away at this for a while. I know myself as an advisor. I remember providing a PowerPoint slide going back to 2004, where I showed the non-interest income as a percentage of gross income for credit unions was much higher than it was for banks. Now, that can be a little deceptive. So let me explain it because I don't want people in the industry getting the wrong idea here. I had to explain it when I showed it, but I was making a point about balance sheet efficiencies and improving performance in the investment portfolio and finding alternative sources for loans. And so I showed that graphic for those purposes. But eventually what occurred is the net interest margin eroded so much for the... smaller banks and credit unions below, say,$10 billion in assets, that it heightened the awareness of the industry as to the struggles of being able to generate an income. And what I was about to say was something that's become now very evident, and that's that institutions, though not for profit, need profit. And they need it in order to pay for... technology and digital and operating platforms that make it easier for the consumer to do business with them. But at the same time, and here's where it's gone, the younger people require of their depository that they provide state-of-the-art technology, and that costs money. Increasingly, it's become more evident that the institutions that don't provide it are going to struggle to maintain who they have, let alone get new young people. And so when you look at a proposed merger along the lines of a digital credit union in Marlboro, Mass., and First Tech on the West Coast, it makes– I was not surprised at all.
SPEAKER_00:And their DNA is identical. They both grow out of the tech business.
SPEAKER_02:Right.
SPEAKER_00:And approach life with a tech mindset.
SPEAKER_02:Yes, they do. And their customer base is a patchwork quilt of various select employee groups, be it technology or not. For example, First Tech has SEGs that are not even related to technology.
SPEAKER_00:I think one of their SEGs, I think it's Nike.
SPEAKER_02:Yeah,
SPEAKER_00:Nike is one of their sets. I don't know quite how Nike fits in there with Microsoft and Google, but so be it.
SPEAKER_02:Well, but it doesn't matter.
SPEAKER_00:No, it doesn't matter at all.
SPEAKER_02:No, because the bottom line is you need every customer you can get. The purpose of a company is to get another customer, period, end of story. Because if you're good at that and you're better than most at it, you're not going to suffer– in your pursuit of the new customer, losing current members. Because if you're doing a good job for your current members, they're going to net promote you. And if you're doing a good job for your current members, you're going to have stories to tell to your proposed new customers. And if you're good at adding net net incremental new customers, you'll be one of the winners in the end. Whether you get that in a combination of organic growth or merger or both. And what I think has become more clear to many institutions is that they're going to need to be good at both because the market's not going to let them get away with not being good at both.
SPEAKER_00:And to go back to something you just said, they have to be very good at technology too.
SPEAKER_02:Yes.
SPEAKER_00:I'll give you a tiny example. My credit union, using some tools from Cunexus, sent me a thing saying, hey, you don't have a credit card with us and you're pre-qualified for this credit card. It's free. No fee. You want it? And I said, oh, geez, I don't have one. So what the hell? And so I put some money on it. Then I go to set up AutoPay. which I have on every other credit card. I can't figure out how to do it. I'm a pretty smart guy about technology. I can't figure out how to do it. So I call them up. I say, hey, how do I set up BottlePay? Answer, you can't. I haven't used that credit card since. This is a massive technical fail since I have that on credit cards from Chase, from Bank of Montreal. I mean, you go down this list. It's- And
SPEAKER_02:there are credit unions that provide it too.
SPEAKER_00:Oh, quite a few.
SPEAKER_02:But- The business is just, I think what you started out asking was, do we think there will be more?
SPEAKER_00:At this size, at this size. I mean, my eyeballs had been on the sub, let's say,$5 billion credit unions, thinking, well, they all have to get a marriage quick, really quick. Now we have these two big guys, and what they're saying is, The way I read this is as we assess the market, we can compete at our current size with JPMorgan Chase on the one hand and Chime on the other hand. And those are our arch enemies. We don't care about some lousy little$10 billion credit union, not our arch enemy. But who's going to destroy them? It's going to be Chase, which doesn't even know they exist. And that's the irony of it.
SPEAKER_02:So you're saying the size of DCU and First Tech surprised you?
SPEAKER_00:This is, I believe, unprecedented in the world of credit unions. We've got two pretty healthy credit unions. Neither, as far as I know, was about to declare to have NCUA seize it.
SPEAKER_02:Yeah. Well, they are healthy. They're well run. They both have had some wind in their sails due to good management and focus. And you're right. They apparently looked at each other and internally to themselves and said, this is all good, but it really isn't enough. And I'm not surprised because I had, over the last two years, multiple conversations with credit unions at the table to discuss merger where both sides of the transaction contemplated was greater than a billion. And I had three or four where both sides of the transaction were greater than 10 billion. And that's a fact. There were similar themes to those conversations, including but not limited to margin erosion and the need to keep investing in technology and branches and all things related to consumer satisfaction. And that all costs a lot of money. And the inability to charge more for anything to be able to generate some income in order to pay for those things that the consumer is demanding, increased regulation and cost of regulation, both in terms of time, people, and capital, the increase in prodigious competition. When you and I can sit here and observe over a 13-year period from 2005 to 2018, and we're six years past that, where FinTech made their first consumer loan, and 13 years later had more consumer loans and mortgage loans than the banks and credit unions combined. Think about that. But here's the hummer, in my opinion. And I was calling it, I was previously calling it the battle for core deposits. where coming out of the housing crisis, Sheila Baer, the former chairman of the FDIC said, look, we have common themes from these previous bubbles that popped and we had to bail you guys out. And one of the common themes is you over levered. You borrowed a lot of money and made loans. We're going to reduce your willingness to over-lever by charging you insurance on borrowings, not just deposits. And I remember people in the industry, not in credit unions, saying, wow, the banks are going to hate this. It's going to hurt their ROA. And I was telling credit union boards for 10 years, they're not going to take a hit on ROA. They're going to go after core deposits and borrow less. Because if you're going to pay insurance on borrowings now and deposits, and core deposits are cheaper, you're going to go after core deposits. And it took a while for them to kind of adjust the model, but they did. And the last time I had any analytics done, the 50 biggest banks and the credit unions above$10 billion- were within about 60 basis points of each other on cost of deposit, but the biggest banks were paying more than the largest credit unions. But when you got below that group of credit unions above 10 billion and the 50 biggest banks, the cost of deposit was 100 basis points or more different in every market in America that we had looked at. So what does that mean? First of all, let's understand the importance of this. That's not because rates went up. It's because the DNA of banks was rewired to care about core deposits. It's not going away as the Fed starts to move rates down. So what's been occurring all over America is Again, I haven't looked at call report data from June 30, but through the first quarter and going back a year or two, it's not a new phenomenon. The community banks and credit unions were trying to move their offering rates on deposits up, and they were, but they were simultaneously seeing an erosion in margin because they're not able to charge a lot more on loans and not earning more on investments. But at the same time, they weren't able to meet the competition. So money was disintermediating out of the institutions, the community banks and credit unions, who were basically in the same bathtub facing the same issues. So where we are in America as of then, and I believe, because I've been trying to look at call report data out of curiosity over the last couple of weeks, it's very clear that margin erosion is here to stay and is particularly nefarious for the institutions with assets less than$10 billion, which means the credit unions and community banks with assets at$10 billion and greater are saying, what do we do now? And DCU and First Tech said, let's get together. I think you're going to see more of that.
SPEAKER_00:Well, I think it's become a survival issue. Historically, credit unions didn't worry too much about survival. But now, as the big banks are getting bigger and bigger and bigger, and the neobanks and the non-banks are getting bigger and bigger and bigger, I mean, a lot of credit unions will say, look, we have a million members. What percentage of wallet of those million members do you have? If 25 years ago, you had big chunks of member wallets, now you have this tiny little sliver. And how much money are you making on that tiny little sliver? You're giving away free checking. Can you afford to keep giving away free checking? I don't think credit unions actually can afford to keep doing that. Chase doesn't do it. You get free checking if you have, I think it's three grand in a checking account at Chase. And then you get free checking. Otherwise, you pay 10 or 12 bucks a month.
SPEAKER_02:Yeah. Yeah. You know, we all enjoyed, you and me by extension, because we were advisors or vendors to the credit union space. And, you know, I think that they're housed and managed by really good folks who do set out every day to do the right thing and try to live to the mission. The difference now, though, is the big credit unions and the big banks have gotten bigger. But in the case of the big banks... they now actually really want consumer business. And that's the difference, along with, as you noted, FinTech and the neobanks, banks without walls and without the overhead, and importantly, without the legacy systems that are curmudgeons and difficult to maneuver around. And They're not handicapped by that so that they can go to market fast, flexibly, with fine-tuned messages to the consumer and bring them home. And they've done it to a fare-thee-well degree. Again, fintech has more consumer and mortgage lending than the banks and credit unions combined
SPEAKER_00:in this country. Oh, and another big piece of fintech businesses is personal loans, which historically credit unions wanted nothing to do with. They only wanted loans with security. I mean, if you have$50,000 in a savings account with me, of course I'll lend you$5,000 on a signature. Right. But if you have...$500 and you want to borrow$5,000, get out of here, man.
SPEAKER_02:But the thing is, there's still time left. And there's a lot of people that call me and say, what do you make about what's going on, people in the credit union space? And I'm having a lot of discussions about, well, have you thought about this? And I'm just really being a friend. And the thing that I've been telling them, though, is... There's still time. You got it. You got to get in the saddle and giddy up, but you got to get going. You got to start what I think credit unions really need to understand is they can say their board understands what's going on. But I used to do, you know, and did a bunch of board meetings a lot and a lot of C-suite meetings and what it's going to take. to get going both organically on growth, which there are things that can be done, and inorganically through merger and acquisition where you get together with like-minded institutions and you combine on strengths and leverage them, enjoy cost saves, everything from you can negotiate better contracts, you can price your goods better, a lot of things that add up to being able to to get accelerated growth and then add on with more organic growth and mergers. That's what it's gonna take, but there's spade work that's gonna have to be done with the boards and the C-suites to be shovel ready to do it correctly. There are institutions that talk to each other and they don't combine And there's a combination of reasons for that that are very valid, such as you're running a credit union while you're trying to negotiate a merger or you're negotiating on good faith, but the other side is negotiating on good faith, but they're also nervous about being all cards on the table on things. So those transactions, they're not buying a bond. They're not like originating an auto loan. It's the most human complex transaction that a credit union or a bank will do. And it requires a lot, including soft hands during negotiation. And these institutions need to realize that although nobody started out wanting to do these things, they're going to have to start happening. And First Tech and DCU, they're not the only one. There are others that have been talking about They're still talking. There are institutions that
SPEAKER_00:talk and stop. Those ones that are still talking, will this prompt them to say, it's time to pull the trigger? So if I were CEO of a big credit union, and I'd been talking for a year with another big credit union, everything's harmonious, but we've not done it. I would call up saying, it's time to pull the trigger or stop this.
SPEAKER_02:It's a wake up call for sure at a minimum, because here's what happens. If you look at the most, one of the biggest examples is the large banks, the money center banks are statutorily not allowed to acquire other banks. A lot of people don't know that. But when the government has a problem with WAMU, what do they do? They call Jamie Dimon at Chase.
SPEAKER_00:Right, right.
SPEAKER_02:And then
SPEAKER_00:Chase- Or the Silicon Valley Bank, which is a pretty big thing. And Jamie says, I don't know if I want it. the feds say we'll make a good deal you're going to love it and he does love it
SPEAKER_02:well here's the deal suddenly there's a blue chase sign up and down the west coast from seattle to san diego and that sends a shutter throughout all the other banks and credit unions on the west coast well If you're in Plano, Texas, or Los Angeles, California, or New Orleans, or Miami, or anywhere else, and you're one of the top 10 institutions in that market, and one of your competitors who's number three does a deal and is now number one, the competitive landscape just changed in your market. And that ought to be what a lot of these institutions should be thinking about and asking themselves, what can be done to make us more competitive, but still be fair to our people on staff? And that's what has to get solved for, is to do right by the people, do right by the membership first. And these things can be done. And my bet is that that Greg and Trudy at First Tech and DCU, they probably solved for all that before they even brought it formally to their board. And by the way, it's going to keep happening because you saw it in the Pacific Northwest with Advantis and Rivermark and state employees and Capcom in Albany, New York. These things are going to keep happening.
SPEAKER_00:Yeah, I think
SPEAKER_02:they are. Here's the deal. There's 9,400 banks and credit unions in America, and the smallest ones in any market can be a thorn in the side when they run a marketing promotion for a deeply discounted auto loan. The problem in America or the opportunity, and frankly, it's an opportunity for everybody, including vendors and advisors and trade associations. The opportunity in America is that there's 9,400 banks and credit unions and 335 million people. We are oversupplied order of magnitude greater than the next closest country to us, and that's Canada. There are 69,000 unique people per credit union in America, if you do the math on population.
SPEAKER_00:I've done that. We're grossly. Right. In the car business, people have talked about being over-dealer for some
SPEAKER_02:years. Right.
SPEAKER_00:And in Canada- We have a very similar problem. That's
SPEAKER_02:what I'm saying is there's 69,000 unique people per credit union in America, and there's 150,000 per credit union in Canada. But then after Canada, the next closest country is 800,000 people per credit union, and then it's in the millions. We have more lenders- than Americans need. And Americans know it, and they ruthlessly shop for the best auto loan rate and deposit rate. And when FinTech came along, it exacerbated it. And that was after the iPhone made it easy to shop for the best deal. So it's way past pretending that this stuff hasn't happened. It has. And where we are is we have to get prepared to do the right thing by our members and by the staff and by the foundation or the community. And there are ways that that's going to happen. There are ways to make it happen. And it's going to accelerate from here. The trick is to get prepared and do it the right way. Ah, the Boy Scout motto, be prepared. Right, exactly.
SPEAKER_00:Before we go, think hard about how you can help support this podcast so we can do more interviews with more thoughtful leaders in the credit union world. What we're trying to figure out here in these podcasts is what's next for credit unions. What can they do to really, really, really make a difference in the financial scene? Can all be mega banks, can it? It's my hope it won't all be medical banks. It'll always be a place for credit unions. That's what we're discussing here. So figure out how you can help. Get in touch with me. This is rjmcgarvey at gmail.com. Robert McGarvey again. That's rjmcgarvey at gmail.com. Get in touch. We'll figure out a way that you can help. We need your support. We want your support. We thank you for your support. The CU2.0 Podcast.