Why Credit Unions Are Running Circles Around Banks

By Markets Fool.com

Bank investors typically don't pay much attention to credit unions. That's a mistake.

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Since the financial crisis, credit unions have seen an explosion of business at the expense of banks across the country.

There are very clear cut reasons why. It's time for banks and bank investor to sit up, pay attention, and start catching up.

Credit union advantages banks won't easily overcome
To be fair to all the retail and commercial banks out there, credit unions do have some meaningful structural advantages that banks won't be able to replicate.

For one, credit unions don't pay taxes. Credit unions also operate under a less burdensome regulatory framework than comparable commercial banks.These are huge advantages.

Some in the banking industry have made public calls to begin taxing and increasing regulation for credit unions, particularly those with large and complex operations rivaling some of the biggest commercial banks in the country.

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Navy Federal Credit Union, for example, has $60 billion in total assets and more than 10,000 employees worldwide. If a bank, Navy Federal would qualify for significant regulatory oversight because with more than $50 billion in assets it would be considered systemically important. That burden alone can cost hundreds of millions of dollars to shoulder.

That said, large credit unions are outliers. In general, credit unions are much smaller than the typical bank, particularly at the upper end of the spectrum. For example, the average bank is 14 times larger than the average credit union in total assets, and the four largest U.S. mega banks are each larger than the sum of all U.S. credit unions combined.

Taxes and regulatory burden are poor excuses
Even with those structural advantages, they hardly account for credit union success head to head against banks.

The real secret sauce is customer satisfaction. Last year, the American Customer Satisfaction Survey found that credit unions dramatically outperformed their banking competitors. The survey's respondents lay out a blueprint for exactly what's wrong with banks -- and what's right for at credit unions.

First is size. The larger the institution, in general, the more poorly the firm fairs. Bank of Americaand Wells Fargoscored particularly low, alongside fellow megabanks JPMorgan Chaseand Citigroup.

The average for all banks was roughly 10% higher than Bank of America's score, for example, implying that smaller institutions likely had pretty good responses.

Credit unions, as a group, scored well above all bank comparisons, beating B of A by 23% and the all bank average by 12%. Credit unions scored much higher on speed, "courtesy and helpfulness of staff," and to boot also tend to offer better interest rates.

To me, this speaks to a fundamental cultural difference at banks versus credit unions. Credit unions serve members; banks serve customers.

The semantics may seem trivial, but it's critical. It shows itself in the customer satisfaction numbers and in the respective firm's financial statements.

Credit unions really do prioritize everything they do around the customer's experience and needs. Banks too often give lip service to customer experience, but take action on initiatives that cut short term costs at the expense of it.

Until the Dodd-Frank Act and Basel III regulatory overhaul, banks have generally operated with lower capital levels than credit unions. Banks have also tended to have higher levels of delinquent loans and charge offs than credit unions.

And yet, despite the increased risk taking at banks, profitability ratios at banks and credit unions have always been pretty close.

These financial realities reflect the customer first ethos. A credit union won't make a loan that a member can't repay -- that's bad for business, yes, because that loan will eventually become past due and ultimately create a loss. But I'd argue that it's even worse for the borrower. That poor loan decision can strip a family from its home, force a bankruptcy, or at best severely hurt the individual's credit score.

This approach to lending may sound boring and conservative, because it is, but the proof is in the pudding; the numbers clearly show that this model works financially as well as in terms of customer satisfaction.

The game plan
If banks want to repair their public image, attract new customers in a highly competitive landscape, and then keep those customers for life, it's as simple as putting the customer's needs first. Credit unions have proven that it works.

Banks should take a long-term approach. They should invest in projects to increase speed and reduce headaches for the customer, and they should be conservative in balance sheet decisions and credit underwriting.

If instead of thinking of its patrons as customers and rather considering them to be members, the change in culture will return to shareholders and customers many times over.

The article Why Credit Unions Are Running Circles Around Banks originally appeared on Fool.com.

Jay Jenkins has no position in any stocks mentioned. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of Bank of America, Citigroup Inc, JPMorgan Chase, and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.