How To Lower An Efficiency Ratio No Matter Your Size

CEOs of big and small credit unions share their secrets for generating income with less cost.

 
Yun Ma

By Yun Ma

 

The good news: Credit unions are more efficient than banks. According to a 2011 report by Celent, a financial services research and consulting firm, credit unions generally enjoy lower efficiency ratios than banks, in part because they don’t engage in commercial lending, and because they often share service centers, including ATMs and branches, with other credit unions.

The bad news: Not all credit unions are as efficient as they could be. According to Callahan’s Peer-to-Peer analysis of US credit unions, the industry’s efficiency ratio averages 71.3%. Efficiency ratios are calculated by dividing total operating expenses by the sum of net interest and non-interest income. A high efficiency ratio signifies that the financial institution is losing more of its income to overhead expenses, while a low efficiency ratio indicates that the institution keeps operating expenses in check.  

In general, large credit unions have lower efficiency ratios than small credit unions, which often face similar operating costs while generating less income. Credit unions with assets between $100 million and $500 million, for example, maintained an efficiency average of 82.8% in 2012, whereas those with assets of more than $500 million clocked in at 66.4%.

Still, efficiency is something that even the largest credit unions worry about. Everyone wants to do more with less, but the credit unions that excel at efficiency are those that have fine-tuned their approach over several years.

“Efficiency does not mean cheap,” says Frank Pollack, CEO of Pentagon Federal Credit Union ($15.5B, Alexandria, VA). “I can spend a dollar and get no return, versus spending $100 and get $1000 in returns. Do not confuse the two.”

“Our philosophy is simple,” says Pollack. “Members should never pay more for a loan than they need to nor accept less in return for their deposits than the most that they can get. Given that belief, we think that maintaining the lowest possible operating expense ratio is an absolute necessity to achieving that objective.”

EFFICIENCY RATIO (LESS PROVISION FOR LOAN LOSSES) 
DATA AS OF DECEMBER 31, 2012
© Callahan & Associates | www.creditunions.com

efficiency-ratio

Generated by Callahan & Associates' Peer-to-Peer Software.

PenFed boasts an efficiency ratio of 54%, well below the industry average. According to Pollack, the key to a low ratio is finding an optimal balance between technology and human resources. In other words, credit unions should determine which processes and tasks are performed best using either technology, such as online banking, or employees.

To get the lowest efficiency ratio possible, Pollack recommends using technology aggressively and in such a way that members will want to take advantage of it. At the same time, he urges credit unions to control their personnel costs, both the head count and pay scales.

Pollack doesn’t buy into the idea that it’s impossible for small credit unions to achieve efficiency. “Efficiency is not size restrictive,” he says. “It’s a mindset, a business strategy and a belief system, not a size issue.”

Even smaller credit unions have been known to attain low efficiency ratios. Summit Credit Union ($139M, Greensboro, NC) enjoys an efficiency ratio of 56.24%, an impressive decrease from 65.13% a year ago.  

CEO Sam Whitehurst directs his employees to concentrate their efforts on tasks that generate asset volume instead of becoming embroiled in processing duties and other minutiae.  “We look at work flow and make sure the staff is supported with tools that allow them to successfully promote our products and services,” says Whitehurst, whose goal is to keep the credit union’s efficiency ratio at or below 60%. “Controlling cost is important, but we feel growing revenue through greater member participation provides the better focus for us.”

Summit Credit Union consciously prioritizes revenue-generating products, such as lending, insurance, and investment services. “This is not rocket science, but it does take focus and discipline,” Whitehurst says.

Ryan Misasi, EVP at Patelco Credit Union ($3.8B, Pleasanton, CA), says efficiency is about creating a culture of awareness. “It’s not just the CFO’s job to drive efficiency. Our entire management team, from sales to marketing to operations to lending, all have the belief to manage as efficiently as possible. We’re all searching for new ways to lower expenses.”

Misasi cites one simple efficiency measure that Patelco undertook this year. “As a team, we identified that our members would rather get emails or text messages for their courtesy notices. We had been using snail mail for 10 years, and they were taking five to 10 days to get to those members. We eliminated those, and we’re going to save about $300,000 in mailing expenses.”

OPERATING EXPENSE RATIO
DATA AS OF DECEMBER 31, 2012
© Callahan & Associates | www.creditunions.com

operating-expense

Generated by Callahan & Associates' Peer-to-Peer Software.

Ultimately, it’s the member who enjoys the benefits of a lower efficiency ratio. When less is spent on operating expenses, more money is available for the credit union to return to the member or invest in new products that benefit the member.  Based on Callahan’s Peer-to-Peer analysis, both loan growth and asset growth tend to rise at a faster pace at credit unions with lower operating expenses.

A lower efficiency ratio shouldn’t be chased after for its own sake. At the end of the day, a low ratio is the result, not the cause, of a disciplined, forward-thinking management, or as Pollack puts it, “You have to be very comfortable saying no to a great many things.”

 

 

 

April 8, 2013


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