Movement Can't Afford To Wait For Failure Before Consolidating

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A former CPA colleague of mine called me this year and asked if we would be interested in buying a bank. A number of credit unions have bought banks or bank branches in the last couple of years. The American Banker just reported that the economic and regulatory tide has shifted and a large number of community banks are considering putting the bank up for sale. We did a lot of due diligence and then decided not to do the deal. But I expect to see more deals done in the next year.

The article In the American Banker is of great relevance to credit unions. There are many credit unions that could buy a bank. We think that the economics of buying a bank is, in many cases, similar to that of merging a distressed credit union. Most of the credit union mergers are with distressed credit unions. You pay for the merger of a distressed credit union by assuming the costs associated with fixing the problems that lead to the distress and by taking on a balance sheet that is probably undercapitalized. When you buy a bank you pay cash for the assets and assume the liabilities.

The American Banker article talks about the increased opportunity to buy community banks.
But for me the bigger issue is the statement in the article that three quarters of all community banks think that you have to have at least $1 billion in assets to remain independent. That supports my observation that banks and credit unions are heavily dependent on scale and market share in order to be successful. I realize that a credit union can be less than $1 billion in assets if the credit union has significant market share and scale in the market that it serves. So a smaller credit union and bank that serves a niche market can be smaller than $1 billion. Geographic niches and product/service niches are everywhere. Unfortunately many credit unions are not serving geographic or market niches.

The Advantage Of Scale
The Callahan statistics for March 2013 indicate that there is a great deal of advantage to scale. There are 4,605 credit unions with assets of $50 million or less. Credit unions are on average much smaller than banks and far less consolidated. I believe our lack of consolidation is an artifact of the old days when credit unions were a part of the employer organization and were sponsored and supported by the employer and had a protected field of membership. The community banks long ago consolidated most of the banks in that asset range. These under-$50-million-in-asset credit unions are in real distress. They have negative member growth, checking penetration well under 40%, low loan originations per FTE, they spend more than 85 cents per dollar of revenue and over half of them have negative net income.

There are 208 credit unions with assets over $1 billion. On average they have member growth of 4.40%, checking penetration of just fewer than 58%, loan originations per FTE of just under $2 million (more than three times the average of credit unions under $50 million), they spend only 67 cents to earn a dollar of revenue and they have an ROA of 1.07%.

I believe financial statistics offer a window into how well you serve your members. A credit union that is relevant to its members and is meeting their needs will have positive growth and good statistics.

Credit unions are non-profits that were created to serve members. So how is it that we have a credit union system where two-thirds (4,605 out of 7,000) of credit unions show clear signs that they are not meeting their members' needs? I pay close attention to credit union statistics and the trend for the last three years has been the same. It shows a large segment of the credit union system is no longer relevant to the members.

Given that we say that credit unions are member-owned, how is it possible that owners would allow their business to fail in meeting the needs of the members when the members and the owners are the same people? The answer for me is clear. Members do not act like owners, they act like customers. Negative member growth means the members are doing what any unsatisfied customer does - they move their business elsewhere.

Differing Interests
The problem is that boards of directors and management have a different interest than members. Members want a good experience with the credit union and good value for their membership. They are not getting that. The board and management want to retain their jobs and keep the credit union independent. Ironically, in the end everyone loses.

Unlike the community banks we do not have an economic incentive to consolidate. When we talked with the bank about a purchase, management was excited because a purchase increased the value of the bank, provided them with cash for their stock, and increased future business prospects.

Credit union mergers only achieve two of those objectives. Credit union management has no ownership interest and therefore does not profit from a merger unless the merger partner agrees to reward management.

We need to change the incentives for credit union boards and management. If we don't do that we are going to lose a lot more members and we are going to waste a lot of credit union capital. The underperformance of two-thirds of all credit unions is creating a negative perception for the public about all credit unions. We all share the same brand name - credit union. The underperformance means we drive out thousands of members every year, we lose market share and we burn our most valuable asset - our capital.

Go ahead and buy a bank. You may as well do that. In the meantime we can say goodbye to market share, members and capital as our own consolidation is based on waiting for failure before we consolidate. Our Shapiro Groups and NCUA small credit union policies are not the answer to the problem. Being small isn't the problem. The problem is lack of relevance, and that is highly correlated with scale. You can be small if you have scale and market share in your market.

Henry Wirz is CEO of SAFE CU, North Highlands, Calif.

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