Caught in the Middle: Determining a Dividend Payout Ratio

CUs' dividend payout ratio dropped from 43 percent in 1998 to a low of 23 percent at the end of 2004. Are credit unions caught between a rock and a hard place?


Credit unions reduced their dividend payout rate, the percentage of income paid out in dividends, on their share accounts as interest rates hit 40-year lows in the first half of the decade. The dividend payout rate has been cut almost in half since the late 1990s to a low of 23% at the end of 2004 (see below graph). The decline reflects the interest rate environment, which also led to investment and loan yields falling to 3% and 6%, respectively, as of June 2005.

Source: Callahan & Associates, Inc.

Share Growth Is at a 10-year Low

However, a worrisome trend is emerging. Shares grew only 4.2% to $585 billion through June 2005, which represents a 10-year low. As credit unions’ cost of funds has declined to 1.77%, well below the Fed Funds rate of 3.75%as of October 2005, credit unions are having a difficult time attracting new deposits. Credit unions were able to coast with low dividend rates as short-term rates were falling, but these institutions may be held accountable by their members given the recent disparity with Fed Funds.

The net interest margin has been affected by the declining yields as well. It has fallen to 3.26% through June 2005 from 3.80% in June 2000, making it increasingly difficult for credit unions to improve their dividend payout rate. As the spread narrows, credit unions may not have the means to pay a larger percentage of their income in dividends.

Credit Unions Are Playing Catch Up

The credit union industry is in a transitional mode right now. Credit unions are determining their pricing strategy in the face of a flat yield curve, a low return on asset (ROA) ratio and increasing competition from other financial institutions. Credit unions are caught between a rock and a hard place in determining how to remain competitive in the face of slow growth across the board.

Many credit unions have put their foot on the brakes and are delaying increasing their dividend payout ratio as they establish appropriate action steps. However, market pressure is heightening for credit unions to increase their dividend payout rate. Credit unions still offer a better value than other financial competitors, but the gap is shrinking. While credit unions typically deliver dividend rates that are 30-50 bps higher than banks, the margin on regular savings rates declined to 23 bps in October 2005 according to DataTrac Corporation, which follows 17,000 financial institutions.

Possible Next Steps

Credit unions have four approaches at their disposal moving forward. These include:

  1. Muddle through— Most credit unions have currently chosen this strategy and are highlighting other member benefits and values of belonging to their institution. These credit unions are waiting for the yield curve to return to historical levels so that their net interest margin can have more of a cushion.
  2. “Loss leader”— Other credit unions may decide that it is more important to continue to grow their various share balances and offer one-time specials to entice new deposits. For example, a credit union could offer for a limited time a more attractive rate on their 10-month share certificate. While this offer may become a loss leader for the credit union, it may focus new attention on the credit union’s rates and viability in the community.
  3. Reinvest in rates to establish momentum— In the competitive financial services industry, some credit unions may decide to reduce their ROA and increase their dividend payout ratio. However, credit unions must consider where their ROA currently is and whether the new dividend rate would be perceptually higher and of greater value to their members.
  4. Tighten the belt— Since it is difficult to control external factors, credit unions can focus on minimizing expenses. While a difficult endeavor, many successful credit unions have sat down and analyzed each line item to reduce unnecessary items in their annual budget.

Credit unions must determine a specific strategy regarding their dividend payout ratio to address the slow share growth at their institutions. Eventually, the dividend payout ratio must increase for credit unions to remain competitive in the financial services industry.




Oct. 24, 2005


  • often has excellent articles (at least in content). However, I find numerous mistakes in terms of grammar. For example, the decade of the 1990s is plural rather than possessive. Therefore it should be spelled "1990s" rather than "1990's" as your authors consistently do.
  • Very informative