By Ray Birch
LAKE FOREST, Ill.—Are credit unions throwing away their tax break? One economist says they are, noting the higher expense ratios at credit unions compared to banks negates the advantages the non-profit status offers CUs.
A new study on financial institution efficiency by Moebs $ervices reveals CU total expenses are 26% higher (2.68%) than either banks or thrifts (2.12%).
“This 26 BP difference basically negates the tax break credit unions receive,” said Michael Moebs, economist and CEO at Moebs $ervices. “For all banks, taxes represent 30 BPs of taxes to assets.”
Moebs asserts that scale—banks being bigger—is not the main reason for the higher expenses of credit unions. Instead, he contends many credit unions lack the motivation to reduce costs.
“The easy answer is because of the lack of taxation, a lot of CU leaders do not have a strong bottom-line view,” said Moebs. “Ultimately, it comes down to three words: compensation, subsidies and audits. CU directors are not paid. CU management is not paid as much as bank management in almost all functions. And the compensation issues flow down to even the teller line.”
Less Focus
Moebs contends that all of those factors have led leads more credit union leaders, management teams and staff to focus less on cost savings and efficiency than banks, which are motivated to drive every dollar profit possible back to shareholders. And, as CUToday.info recently reported, credit union merger-related policies may also be driving up expenses.
“And what about credit unions getting subsidized rent, utilities, land and buildings from their sponsors? This, too, leads to them to being less aggressive than their bank counterparts, who are much more bottom-line focused, answering to shareholders,” said Moebs. “The CU culture due to compensation, subsidies, and audits produces less motivation to get to an optimal efficiency level. Finally, most banks are examined by regulators and have audits conducted by CPAs. Most CUs are just examined by regulators.”
‘Diseconomy of Scale’
Michael Moebs
While size can help drive efficiencies, being too large can have the opposite effect, the Moebs $ervices study shows.
“Almost every bank or thrift above $25 billion in assets and almost every credit union above $10 billion in assets is beyond the economy of scale (EOS), or in diseconomy of scale,” stated Moebs.
What can cause diseconomy of scale in the very big banks, said Moebs, is they are incentivized to achieve diseconomy of scale with membership in the “too big to fail” (TBTF) club.
“The primary benefit of being a member of the TBTF Club is the government will step in and save the FI from going under, since each TBTF member could be a systematic risk causing national, economic panic or recession if it should fail,” said Moebs. “TBTF membership requires at least one-million consumer checking accounts or an equivalent number of top 1,000 U.S. businesses.”
Two Basic Measures
In order to understand the diseconomy of scale, Moebs said his company analyzed how to measure the economy of scale for FIs.
“There are two ways to measure EOS,” Moebs said. “The best way is to do a cash flow analysis adjusting for accruals and other variances caused by financial services. Much of the data needed is not publicly available on periodic call reports or even annual reports. The other method is a shadow EOS using call report data to shadow or mirror the EOS.”
FIs always start out below optimal EOS, said Moebs.
“This is normal. So, the FI leadership team needs to grow the depository. However, growth must be tempered with keeping expenses down—especially employee count. This is not easy to do. Management wants to grow quickly, yet realizes their resources are limited and must control limited resources by prioritizing people and systems to optimize growth efficiently,” Moebs explained.
“The most important task management has after achieving its economy of scale is keeping this state of performance,” he continued. “And most management fail at this.”
Additional Findings
The Moebs study further fund that those FIs that maintain EOS performance do so by becoming even more efficient. This is done in three ways, said Moebs:
- Growth will produce a lot of financial services which provide little or no bottom-line impact, or even contribute to overhead expense reduction. Cutting back on these services that got the FI to the economy of scale is very difficult, but must be done.
- Branches need scaling back in number, and in their overall expenses.
- “The key to expense control then becomes employee count. Less is more. This is achieved not by firing but by growing with the same number of employees and adding no more. Compensation becomes vital ,” Moebs said.
“There are 74 domestic banks, thrifts, and credit unions beyond their shadow optimal economy of scale category,” Moebs said. “Only nine are still at their economy of scale while the other 65 operate in a diseconomy of scale. These nine are the financial institutions for depositories to watch.”