The Avoidable Death of Small Credit Unions

Yet another small credit union calls it quits. $8M Cody Schools Federal Credit Union accepted a bid to merge with Valley Federal Credit Union, a credit union eighteen times its size.

Of course they had no choice, right? In terms of their Glatt Consulting, LLC HealthScore, which was 1.36 for the third quarter of 2010 and well below our industry average of 2.329, Cody Schools FCU was barely hanging on. In five of our scoring categories they had no score at all – a dismal situation. They had little capital and few prospects for future success as a stand-alone institution.

Did they have a choice? Was merging the only path to a bright future for their approximately 2,000 member-owners?

Given the present numbers, yes. Merger was the only option short of outright liquidation, no question about it. However, Cody Schools was not always in dire straights. Had they taken advantage of a particular option, a cooperative business model which I will describe shortly, they might still be operating as an independent credit union today.

In order to provide a frame of reference for my commentary on the cooperative model, we must first explore Cody Schools’ reasons for merging in the first place. In an article on the merger published this week on the Credit Union Times website, CU Times reporter Jim Rubenstein included the following comments from Valley FCU CEO C.H. Steele:

“They had undergone plenty of that crap that credit unions their size have had to go through on compliance etc. and so they accepted our merger bid,” Steele said.


“Cody Schools is a credit union that simply couldn’t afford to continue operating with too many hands in their pockets,” Steele said.

So, according to Mr. Steele, the root cause of Cody Schools’ decision to hand over the keys was a result of the impact of ever-escalating back office costs on operational profitability and institutional sustainability.

Understanding this rationale for making the decision to merge is very important, because to understand the rationale leads to identifying the option the credit union had for long-term survival outside of merger.

To better explain the option we turn to Harvard professor Michael Porter‘s 1985 book entitled Competitive Advantage. At the time of publication, American business was being outmaneuvered by the Japanese and other industrial powers. American industry seemed bloated, inefficient, and unfocused. In authoring the book, Porter perhaps was looking to shake American business up a bit, reminding them that the purpose of business is not to simply be in business, but to efficiently drive to greater levels of performance and return to stakeholders – otherwise known as value and margin.

A key concept introduced in the book was the value chain. The premise behind the value chain is that an organization must be “aligned,” meaning that various departments, functions, and activities act in concert to maximize whatever value the institution desires to deliver to customers, and in turn drive greater margin.

In describing his value chain model, Porter suggested two classifications of organizational activities, which he called primary activities and support activities. To summarize, primary activities are those activities that lead directly to the creation of value and, ultimately, margin. Support activities are those activities that don’t add value, but are necessary to support the activities that do create value.

Mr. Steele’s comment is telling. The cause of Cody Schools’ problems were the costs of support activities (meaning activities that did not add “value” to the organization) and NOT an underlying issue with its primary activities.

To frame the issue a bit differently let us focus on compliance, a function Mr. Steele specifically referenced. Compliance has nothing to do specifically with the delivery of the “value” associated with financial products and services. A credit union can be in compliance all day, every day, and it will not add one dollar in contribution to the value the institution endeavors to deliver to its members.

Cody Schools, then, ended up in the unenviable position of having to merge because the value of their primary activities was overwhelmed by the cost impact of support functions such as compliance.

At one point in its past Cody Schools had an option to diminish, to the greatest extent possible, the cost impact of its support activities. In terms of strategy execution, they should have outsourced every support function possible to the least expensive provider.

As a reader, you may be thinking to yourself that this is a glib, shortsighted, perhaps ill-informed “solution” to a very complex problem. If we were to stop there you’d be right, so what I need to clarify is what I mean by “the least expensive provider.” My clarification takes us to the concept of the not-for-profit cooperative business model.

A cooperative is defined as “involving mutual assistance in working toward a common goal.”  The credit union community is of course well-versed in the concept of cooperative organizations. It is how credit unions are organized (or supposed to be organized) – with members pooling resources for mutual financial benefit.

In terms of supporting one another, credit unions have also looked to the cooperative model, namely pooling resources for scale benefits for various products and services. Corporate credit unions, leagues, and CUSOs were all, at one time in the history of the credit union movement, examples of such cooperation.

With regard to Cody Schools, the “least expensive” option available to them was to band together in cooperation with other like-minded, like-sized credit unions to create a not-for-profit, cooperative organization tasked with managing/delivering support functions in ways that serve to reduce the operating (support) costs of its owners.

If groups of small credit unions took to banding together in this way, pooling resources to share the costs of back office support functions (including compliance, document preparation, accounting/bookkeeping, IT services & support, telephony, core system management, etc.), then each could obtain more service and quality support for primary activities for far fewer dollars. More importantly, each could also return its organizational focus to excelling at those primary activities that serve to drive value and increase margin.

Now, the common retort to the idea is that small credit unions already have access to such services. Any small credit union can call up a league or association to obtain compliance support, outsource bookkeeping to a local CPA, or run a core system via a service bureau relationship with an IT vendor. True. All true. However, the fee paid to any one of these service providers (leagues, CUSOs, 3rd party vendors) includes a profit premium over the cost of the services.

The difference between the cooperative model I am describing and a traditional service provider model is that such premiums would not be allowed by mutual agreement, which means that participating credit unions are not “subsidizing” the profits of the cooperative as they are when paying service fees to for-profit organizations (or to non-profit organizations offering fee-based services). Rather, they simply pay cost.

There is much I can write regarding the necessary steps to establishing an effective cooperative business that has a cost-saving impact on support activities – particularly for small credit unions – but explaining the “how” really is not the intent of this post. I’m more concerned with the “why.”

I believe that the ever-shrinking numbers of small credit unions is a problem. I believe that small credit unions deliver an irreplaceable value, both to the consumers that use them and to the industry itself, and that if small credit unions go away we will all be worse off.

The good news is that we are not predestined to witness the death of small credit unions. Losing small credit unions because their capital is eroded by support costs is preventable. The other bit of good news is that small credit unions do not need to rely on the “goodwill” of larger credit unions, leagues, or vendor discount coupons to greatly diminish support costs. They can, and should, do it themselves through “lateral cooperation.”

The expense reduction cooperative business model I described is the way to get there. As a matter of fact, there are groups of credit unions working through the model now, with each participating credit union firmly committed to the concept of expense reduction through cooperation (which I contrast to the unstated rationale for most CUSOs, which is to impact revenue and not expense).

With regard to Cody Schools, I am sure that Valley FCU will do an excellent job integrating Cody Schools’ members into the fold while elevating the service and support these members receive. In fact, I am glad that Valley was able to step in and preserve, to a certain extent, the Cody Schools institution. However, it remains for me an unfortunate reality that Cody Schools’ unique culture and approach to serving its members will be lost to history – especially because it didn’t have to be.


  1. Great post. Financial cooperatives supporting for profit businesses has never made sense to me, especially when there are alternative options. I hope small credit unions still have time to make the necessary changes so they can avoid the same fate as Cody Schools.

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