Credit unions are getting leaner - and need to keep going

Note: Saskatchewan credit unions received major one-time dividends in 2022 due to the sale of Concentra Bank. In some cases this improved profitability by 200% or more. Unless otherwise indicated the data below has not backed this out.

The good news is, Canada’s credit unions are getting more efficient. Even better, they are improving by growing revenue faster than expenses. This means their operating assets are becoming more productive. The challenge is that most still lag materially behind their big and small bank competitors. And, 1/3 of CUs are moving in the wrong direction. Working both individually and collectively to embrace efficiency will be critical for sustained credit union competitiveness.

From 2019-2022 credit unions over $500M in assets improved their efficiency from 74.4 to 70.8, and in doing so removed almost $300M in annual costs.

What's an efficiency ratio?

​In banking, an efficiency ratio is calculated by dividing operating expenses over operating income. Operating expenses are all non-interest costs (e.g., salaries, technology, rent). Operating income consists of net interest margin (interest revenue less interest expenses) plus non-interest revenue. An organization with $100M in revenue and $80M in expenses would have an efficiency ratio of 80, and an operating margin of 20%.

What's a good number?

The more efficient you are as an organization, the lower your efficiency ratio. Efficient operations allow a financial institution to grow capital, pay out dividends and invest in future growth. The higher your efficiency ratio the less able you are to continue as a going concern. Sustained efficiencies over 90 represent a major risk. Big banks typically range from 45-50 for Canadian Personal & Commercial operations and 50-55 overall, while niche FIs can go as low as the 30s or even 20s.

Efficiency ratios will naturally fluctuate over time. Significant uncapitalized technology spend, for example, can drive up the ratio in the short term in exchange for longer-term benefits. Merging in a less efficient peer can increase the ratio until economies of scale are realized. It's also possible to run too lean. Failure to invest for the future can have serious long-term consequences.

​Efficiency is particularly important for credit unions, who must rely on retained earnings as their primary source of regulatory capital. Credit unions who can grow top-line revenue faster than costs will see a continuous improvement to their efficiency ratios.

​How are credit unions performing?

For credit unions over $500M in assets, the weighted average efficiency in 2022 was 70.8. This is a material improvement over 2019’s 74.4. Note that this is generally due to scale benefits vs. structural cost reductions. In the three-year period revenue increased by 7.6% annually, while costs only increased by 5.9%. As a result, credit unions now spend an estimated $297M a year less than they would have if their efficiencies stayed unchanged!

For credit unions >$500M, 67% (44 of 66) saw their efficiency positions improve between 2019 and 2022. Conversely, 22 saw their efficiency ratios grow.

​Amongst large credit unions there are a few standouts:

Prospera
Went from 101.0 pre-merger with Westminster Savings down to 79.4, for an efficiency gain of 21.6 (Westminster Savings was at 80.5). In three years the combined organization was able to execute the single largest merger in credit union history and remove millions of dollars in overhead. The new Prospera has grown revenue by 12% vs the two legacy organizations, while costs are down by 1%. This demonstrates the power of economies of scale.

Conexus
Conexus is a good example of organic efficiency gains. From 2019-2022 expenses grew from $151M to $159M, while revenues increase from $202M to $278M. Conexus' efficiency ratio dropped from 74.9 to 57.2 without significant cuts. Rather, their operating assets became significantly more productive.

Meridian
​In the mid- to late-2010s Meridian launched an aggressive growth program. Meridian aquired Roynat Lease Finance, launched Motusbank and expanded their retail footprint in Toronto and the GTA. This resulted in higher operating costs and a 72.9 efficiency ratio. In the three years following Meridian has grown revenues by a third while only increasing costs by 15%. The resulting 61.4 efficiency for Canada's second-largest credit union is a gain of 11.4. Meridian now spends $120M less than Vancity to generate roughly the same revenue (note, however, that Vancity has consciously adopted a very different growth and service strategy).

Smaller credit unions also exhibited significant gains:

Radius, Weyburn, Prairie Centre and Diamond North
All four credit unions saw their efficiencies improve by over 20 due to growing revenue while holding down operating cost increases. Radius organically grew revenue by 67% while costs increased by just 7%. Diamond North merged in Debden credit union in 2019 and has gone on to more than double revenues while only increasing costs by 30%.

Westoba
Westoba realized the largest cost reduction in real dollar terms. Westoba was able to drop costs from $41M in 2019 to $33M in 2022, a reduction of almost $9M. This resulted in an efficiency gain from 88.4 to 70.0, putting the organization on a significantly stronger financial footing.

The efficiency imperative

What is the right number? That depends. A branchless digital bank or wholesaler should have a very low efficiency ratio. Conversely, a large community-focused organization that pays a living wage and rewards members with better rates will have a much higher ratio. Scale also plays an important role - it's much easier to run lean when you are very small or very large. Mid-sized financial institutions like Canada's largest credit unions will be caught in the middle. Should all credit unions be lower than the big banks? Probably not. But many are still sitting at unsustainable levels.

Efficient operations are a pre-requisite for sustained growth. Credit unions should explore efficiencies at both the individual and collective level. In particular, they should seek collective solutions to new business problems and opportunities so that the same costs aren't repeated 200 times.