Are We Facing The Great Escape?
All the talk about merger and "bank-raiding" acquisition of CUs is another sign of an industry in search of answers and not getting them, leading some to wonder if we're going to see a credit union version of "The Great Escape."
In this, the first of a two-part series, we'll examine the earnings shortfall when compared to banks that is affecting many credit unions and the very tough questions being examined by those who truly understand all the related issues.
Many CU people tell me the rallying cry of "hate the banks" is wearing thin. Years of fearing taxation and wrath toward banks has neither created a brand that resonates with consumers, who are shopping an increasingly diverse market for financial services, nor resonated with the lawmakers voting on CURIA.
What's more, no solutions have surfaced that show promise in reducing the earnings shortfall to competition. This earnings shortfall is a consequence of regulation that emphasizes short duration and capital retention for CUs, in contrast to banks, which enjoy more commercially appropriate asset duration, greater concentration of business loans, proper utilization of capital and freedom to market to all who drive by their branch.
The ROE difference between banks and CUs is now close to 500 basis points (after tax), virtually all of which is the result of the prevailing regulatory imbalance. The industry (CU folks, directors, trades, press) is split between those who understand the impact and those who don't understand or don't care.
While you are told that a lower ROA is acceptable, banks are putting a meaningful chunk of the incremental earnings into branching, marketing and the elimination or reduction of fees.
Inability To Leverage Culture
The lack of competitive earnings impedes CU growth. CUs, needing to educate AND market their story to the consumer are scrambling to justify the CURRENT level of spending. Unfortunately, MUCH MORE NEEDS TO BE SPENT.
As a result, CUs have been unable to leverage their culture and member care into more households. Membership growth since 1996 has been 2.5%, and 1.50% since 2002 and this is before adjusting down for indirect auto "members".
The lackluster growth is accompanied by an erosion of earnings that results in CUs ($100 million-$26 billion (Navy Federal)(in assets) LOSING 26 BASIS POINTS before fees. Banks (the same size) make 82 basis points before fees.
That's a 108 BP difference in an 80 BP ROA world.
Many CUs believe they can compete effectively but find regulation and traditional advice lacking. Lacking, that is, in the market reality that expects competitive earnings be made and spent on the customer.
The Nationwide deal got you thinking?
Multiple CEOs have shared with me that THE hot topic of recent conference breakout sessions has been concern that banks will make a run at acquiring credit unions.
Some see banks offering a premium to members as a carrot to acquire the CU, the thinking being that the Nationwide Insurance acquisition of the former Nationwide FCU is the beginning of the end, a harbinger of bankers to come.
I'm not so sure.
Sandler O'Neill has done more merger/acquisition transactions in the banking sector than any firm in the last two years and has been one of the top two advisors in every year since 1998.
We have been asked frequently, "Can a bank buy a credit union?"
There is no federal law or regulation that prohibits a bank from acquiring a federal credit union. The ability of a bank to acquire state-chartered credit unions depends on the individual state's law.
Is a bank acquisition of a CU good for both parties and their customers/members and is the transaction practical?
In confidential discussions, I have seen solid reasons for consummating such deals. Particularly, with the imbalance of supply and demand in the lending industry (too much supply), there are no shortage of potential good deals.
Thoughts regarding practicality:
There are plenty of good deals WITHIN the CU industry, but they don't get done. In my view, the reasons for the persistent failure of CU-to-CU mergers help to understand why bank acquisition of CUs may not be quite as frequent as one may think.
Why Nationwide Was Unique
CU-to-CU mergers, other than the small and/or unhealthy takeovers, are rare. The reasons are many, including a lack of true accountability. If boards and CEOs don't want to do CU-to-CU mergers, why would they be willing to do a bank merger?
The Nationwide transaction was unique because CU staff was employed by Nationwide Insurance Company, most of the back-office functions were provided by the parent, and the branches were sponsored.
These facts of course gave the company more than your typical "sponsor" influence; the facts also suggest that it is unwise to compare the Nationwide deal to that of an independent bank making an offer to acquire a standalone CU.
Nationwide saw first-hand through its MSB how much easier growth and earnings can be (with taxation) under the MSB charter (due to the regulatory difference) and decided to consolidate the CU within the savings bank.
In the second part of this series we'll examine what could ever motivate a credit union to consider a merger with a bank.
Pete Duffy is with Sandler, O'Neill, New York. He can be reached at Pduffy