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Reformulating CUs’ Margin Model

Reliance on margin income is unique to credit unions among deposit-taking financial institutions in North America. For decades, when interest rates hovered in the double digits, treasury managers could simply ride the mortgage market, earning more in interest paid on home loans than they had to lay out in interest to keep deposits. Today, those same managers struggle as 90 percent of income is tied to the value of margin, which has been dropping year-over-year, decade-over-decade.

In 2018 I spoke at the World Council of Credit Unions ( conference in Singapore on the need for Canada?s CUs to diversify their portfolios or continue to be crushed by margin compression and competition. The simple fact is, relying so heavily on one revenue stream is wrought with dangers. When a devaluation of that one stream occurs, any good business person would seek other sources of income.

The problem is exacerbated by the fact that CUs? greatest competitors?banks?have been significantly more effective in shifting to non-margin in- come sources and by the rise of fintech competitors.

Credit unions often think they can rely on their unique relationships with members to solve the problem. They really can?t. Even a rise in interest rates wouldn?t be enough to ensure CUs? viability in the long term.

Before I describe how I led the reformulation of my former CU’s business model to address this problem, let?s talk a bit more about the environ- ment that drove the shift.


On most Canadian CUs’ income statements, margin comprises 80 to 90 percent of revenue. The remain- ing non-margin income is made up of fees and commissions?income derived in part as a result of the traditional margin model, setting the ratio of margin to non-margin income to 80/20 at best.

By comparison, the Canadian Banking Association (, Toronto, reports that banks? ratio of margin to non-margin income is close to 45/55. CBA defines NMI as fees (5 percent) plus ?a variety of value-added services, including trading of securities, assisting companies to issue new equity financing, commis- sions on securities and wealth management.?

While CUs did not diversify their income streams, Canadian banks did. They now own wealth man- agement, insurance, real estate and even American banks, among many other entities and ventures too numerous to list.

The point of this ?mix? discussion is that the bank model we compete against in Canada is not the same as the CU model. It features a greater diversity of revenue streams and, therefore, does not hold the same risks for margin compression.


Fintechs have been a hot topic in the credit union industry of late. The general consensus is that these companies? new approach to potential consumers and the affinity they build with younger generations will create new and more focused competition for CUs. It can be argued that their rise will not only create new competitive factors, but also is likely to escalate margin compres- sion via a stronger efficiency cost for those services. The fact that fintechs are making relevant, more cost-effective offers to new consumers through more focused and lower-cost online delivery will undoubtedly drive offering prices down on the loan/mort- gage side while offering competitive rates with low fees on the deposit side.


Credit unions in Canada have relied on two things to keep mar- gins strong. The first is stronger relationship with ?members??a relationship that goes beyond just price. The second is the idea that the member relationships credit unions have groomed for many years are so loyal and long-term that they will continue at higher margin overall.

Both of these positions face challenges. First, CUs can no longer state categorically that they are better at service than our competi- tors. Banks have come a long way.

For example, in recent IPSOS Best Banking awards (, Toronto), while credit unions were the top performers in overall customer service excellence and branch service excellence, Tanger- ine (, the online bank owned by Scotiabank) was first (or tied) in friend or family recommendations, rates and service charges, products and services excellence, and online and mobile banking excellence. In addition, banks tied or led credit unions in value for financial planning and advice, ATM banking excellence and telephone banking.

To the second point, historical loyalty is a positive factor for CUs in Canada today, but unlikely to be as firmly held in the future. According to the World Council of Credit Unions, the av- erage age of credit union membership in Canada is 53, while the average age in Canada is 40. The average age of a bank customer would likely be closer to 40, as banks serve the vast majority of the population (including most credit union members). This is significant, considering that credit unions? aging members have to be replaced at some point.


But what about this new, increasing interest rate environment we?re in? Won?t margins bounce back? Can credit unions look to simply weather the storm? I don?t think so.

According to the Regulatory Performance Report for the third quarter 2018 from the Canadian Credit Union Association (ccua. com), Toronto, credit unions in Canada reported a financial margin for 2018 of 2.16 percent while selected banks (Bank of Montreal, Scotiabank, CIBC, Royal Bank and TD) operated at 1.61 percent.

According to CCUA, credit union margins have dropped from 2.58 percent to 2.16 percent since 2010; at the same time, bank mar- gins have dropped from 1.72 percent to 1.61 percent. As long ago as 2008, some banks were operating at a margin of 1.51 percent.

If your main competitors?banks?operate on a lower margin (when in fact their cost of funds is historically lower than yours), it means they must be offering better pricing?the math would indi- cate significantly better. So why do CUs think they can continue to operate effectively without moving our prices to a more competi- tive level? Ultimately, CUs will need to move rates to compete for new business. And to do well, CUs will have to be able to operate at margins very similar to their main competitors, the banks.

The bottom line as I?ve studied it is: There is no foreseeable change in margin trends for Canada other than driving downward toward the levels currently held by the banks. And, in absolute thinking, our margins should actually be lower than those of the banks, as we will never be able to match them on a cost-of-funds basis.


While many credit unions have recognized the trends of rapidly compressing margins, many have not really changed their finan- cial models. Instead they have refocused on ways to protect margin.

This is a dangerous game. To play it, CUs either place member investments into the best margin plays for the organization or take greater lending risks for greater return?or both. It does not help members for the CU to stay quiet when their money is in a low- paying account or their mortgage renewal rate is above market. Yet some CUs let sleeping giants lie. What happens when those same giants wake up?

In contrast to others, we changed our model.

FirstOntario CU?s margin currently is at 1.6 percent, as we?ve made ourselves very competitive to drive growth. However, four years ago we decided to reformulate our financial model of reli- ance on margin.

Studying the bank model of almost 50/50 margin/non-margin income, we determined we had to try to get to a similar ratio. After all, members of a credit union, a cooperative financial institution, don?t invest their money with a qualifier that all you can invest in are mortgages and loans. They want safe use of their money to drive returns for them and ensure sustainability of the services they expect.

It was evident early on that we simply could not invest in the same things that our bank competitors could. However, we felt there might be some model that would relate to our environ- ment and set us on the path of stronger diversification. As we scoured the research, one model stood out?that of Canadian pension plans.


As reported in the World Bank Report, ?The Evolution of the Cana- dian Pension Model? (, ?As recently as the mid 1980s, many of the public pension plans in Canada were largely invested in government bonds and other domestic and tra- ditional investments.? The reality they faced was that the returns on those investments were not able to match the returns and expec- tations for the pension funds going forward.

From the report: ?Many of Canada?s top pension organizations were quite unsophisticated as little as 20-30 years ago. The same organizations that today are regarded as global leaders had little to no independent gover- nance, lacked investment diversification, operated under strict investment limits.? (Sound familiar?) ?Today, Canadian funds are distinctive in their abil- ity to invest directly in alternative asset classes such as infrastructure, real estate and private equity.?

The top 10 public pension plans in Canada now manage assets in excess of $1.2 trillion and have avoided the funding crises and government bud- get issues that other jurisdictions have encoun- tered in their public pension plans.

CUs can and should learn from this structural model, not necessarily the exact investment model. Both CUs and public pension plans provide trusted stewardship of others? assets and must be ever-con- scious and diligent about understanding and miti- gating risks. We both also have return expectations for the funds we hold that need constant evaluation and re-evaluation.

At FirstOntario CU, this discussion got us thinking about what else might we consider for investments and what risks might come with that expansion of idea? Could we look at investing in vehicles offering stronger returns? What risks would they pose?

We determined we should consider this more fully, but would proceed slowly, one project at a time, to ensure that the learning curve was neither too com- plicated nor that the possibility of positive outcomes would blind us to the risks we were taking.


We started with real estate joint venture owner- ship in 2010, specifically in the shopping plaza environment, one that we had a great deal of expertise in as adjudicators for a few key mem- bers that were extremely successful. To ensure we were not taking on unfamiliar decisions,

we approached a couple of key members in this business to see if they had any appetite for a joint venture that they would lead and we would invest in. Our thinking was that we were very comfortable with both their expertise and long historical success, and we could provide good cash in as a relatively silent partner.

They loved the idea. It reduced their capital invest- ment, allowing them to diversify into other projects. At the same time, they controlled the project and its return and solidified their relationship with us.
That first project was painstaking in its t-crossing and i-dotting, and each CU stakeholder group was engaged in intimate detail?management, board and regulator. The plan was to buy a tired shopping plaza, improve the tenants and get them into new leases, upgrading the income for the facility and possibly making it attractive to future buyers. Our investment was approximately $13 million.

Within a few years of our investment, the plaza was sold. Our share of the net profit was $10 mil- lion. While our partner warned that we shouldn?t expect such home runs every time, the early win and extra time taken on the risk evaluation stood as both testament of possibilities and template for future projects.


In 2015, we split our CU into three divisions?cor- porate investment, member experience and member experience support?to support two focus areas: escalating member experience and building a new financial model. The mandate of the corporate in- vestment division is to diversify our non-margin in- come sources and produce capital, with the objective of bringing our margin/non-margin income ratio to 50 percent on a recurring and sustainable basis.

Since then, we entered into several other commer- cial real estate projects one at a time. More impor- tantly, we expanded our focus on other investment areas, using the same principles of due diligence and leveraging the appropriate expertise on a partnered risk basis, ensuring skin in the game. Our income ratio improved from 19 percent in 2014 to 24 percent in 2015; 30 percent in 2016; and 29 percent in 2017. (At press time, 2018 figures were not final.)

I am convinced that establishing the dedicated di- vision was worthwhile. Many CUs are attempting to go after new income sources, often off to the side or by bringing in focused expertise to plan and oper- ate the investment almost as a separate business. We avoided these, as the ?side of the desk? management could be distracted or, conversely, the independent management would be making decisions in isola- tion and without a broader view.

At a CU, every investment brings risk and needs
a meticulous evaluation of the return for that risk, at the heart of its decision. Our due diligence on these projects was meticulous and took into consideration a full review by our analytical team, the executive team and the board, plus the regulator?s review before every investment. We also engaged various third-party reviews for every line of investment.

Of any CU leaders looking into our windows
and thinking that our new model creates risks
that they?d just as soon avoid, I would ask directly, ?What is the alternative?? In this environment, the alternative is the status quo and that, in my opin- ion, will do no more than postpone the inevitable. The reality is that reliance on a margin model is not sustainable and amounts to just kicking the can down the road.