Financial Metrics of Credit Unions vs. Banks

I often hear that credit unions (or mutual banks) don't have to maximize profits because they don't have shareholders.

This is technically correct. Shareholders demand a return in the form of capital appreciation on the stock and the dividends paid per share, also known as total shareholder return (TSR). Credit Unions, however, do have owners that they call members. Members may pay little attention to the increase or decrease in the value of what they own because they are comfortable under the umbrella of NCUA insurance (much like depositors with FDIC insurance). This comfort might not make them salivate in anticipation of their CUs next quarterly Call Report. Members rarely hold CU executives accountable for financial performance.

But financial performance has meaning. Credit Unions primary source of capital is retained earnings. And if they have sub-optimal profits because of a lack of expense or pricing discipline, there is less retained earnings and therefore less capital to support growth or serve as a buffer for hard times. 

In addition, if CUs are inefficient and squander resources deep in the bowels of their infrastructure, there is less for members/depositors, employees, or their communities, i.e., their stakeholders. In this sense, TSR has a different meaning: total stakeholder returns. For example, some credit unions pay special dividends to depositors if they have good earnings and sufficient capital.

This month Robins Financial Credit Union, a $4.6 billion in asset CU in Georgia, paid a $20 million member rebate, representing about $74 per member and 45 basis points of its ROA. The reason they did it: their YTD ROA was 1.31% and their net worth/assets was 16.12%. Combine that with a clean balance sheet (0.41% delinquent loans/total loans) and there were ample resources to return that solid performance to their members. It's their money, right?

But the CUs that don't deliver that performance or have that capital position and strong balance sheet, management teams and trustees are reticent to return that money to members. Or other stakeholders for that matter.

Below is a series of charts that compares and contrasts the financial performance of banks + thrifts and credit unions with between $1 billion and $10 billion in total assets. Banks were controlled for those with less than 20% of their loan portfolio in commercial real estate loans to mitigate the differences in bank vs credit union balance sheets. This yielded only 118 banks because of the commercial loan restriction, versus 319 credit unions. I used medians so a few outsized banks or CUs didn't skew an average. The median-sized bank was $2.1 billion in total assets and the median CU was $2.2 billion. 

Here are the results (courtesy of S&P Capital IQ):

 

Banks had a 41 basis points year-to-date advantage (1.00% vs .59%) in ROAA although banks pay federal taxes. Apply that to the median CU size of our sample ($2.2B in total assets) and that equates to $9 million. Perhaps that disadvantage is precisely because the measured CUs pay a special dividend to members, although banks' cost of interest-bearing liabilities was 1.21% more than CUs. Perhaps the salary and benefits per FTE is greater at CUs than banks, or their community support costs more. This we can't tell from the above charts. 

CUs will have to reflect on if that is true. 

Is it true that the 82 basis points disadvantage to banks in year-to-date non-interest expense to average assets, which equates to $18 million, is because CUs pay their people more, or provide that much more in community support?

Whether you have shareholders or not, running your business for the benefit of stakeholders should be your guiding star. You are doing stakeholders no favors by running it sub-optimally and wasting resources on inefficiencies deep in the bowels of your organization. Wouldn't it be great to have a full end-of-year bonus pool where you reward your most productive and loyal employees, have the pricing discipline to deliver a special dividend to your most loyal core depositors, or be able to meet some social needs in your community?

Profit performance matters, no matter which stakeholder(s) you favor.

Happy New Year to my readers!

~ Jeff

Note: My firm does two things to help create the culture for more optimal profit performance for financial institutions: 1) Profitability Measurement-we measure the profitability of lines of business and products on an outsourced basis so management teams can measure and maintain accountabilities for profit trends at much more granular levels than their Call Report; and 2) Process Improvement- we dispatch a team to analyze processes, resource and technology utilization and make recommendations for greater efficiencies. This is sometimes tough to do internally due to resource constraints and experiences outside of the organization. Follow the links to learn more or reach out to me. 

Bankers: Here's What We Do

I work for The Kafafian Group, a community financial institution consulting firm based in Bethlehem, Pennsylvania. Many of my readers might not know what my firm does, so I want to dedicate this post to the problems we help community bankers solve.

Here is what The Kafafian Group does:

Performance Measurement- We measure a financial institution's line of business and product profitability on an outsourced basis. We feed customer profitability systems. We do this on an outsourced basis, meaning we custom build the model based on how the institution is managed. If line of business profitability, we follow the institution's org chart. If product profitability, we follow their

product list. We do the costing, funds transfer pricing, report building, and education. We have yet to fail setting up a client on their own profitability system. And we've built our own solution because we found other solutions so challenging. We offer an online portal where clients can view their reports down to the general ledger level. And they can download anything they see within the portal for their own analysis and dashboards. If you want the head of commercial lending or retail banking to take ownership of the continuous improvement of their spreads so the bank can improve its net interest margin, you must first measure it. Our competition in this line of business are software solutions providers. But our real competitor is indifference. You no longer have to be indifferent to how well those responsible for deposit or loan generation are also responsible for continuous improvement in deposit or loan spreads.

Contact Ben Crowley if you want this level of accountability at your institution: Benjamin T. Crowley - The Kafafian Group, Inc.

Strategic Planning- Unlike Performance Measurement where there are very few competitors to us, there are many competitors in strategic planning. We bring a team approach to the engagement using our knowledge from our industry experience and other lines of business to benefit clients. We tailor our service to the needs of the client without dogmatic and rigid processes, although we do suggest processes that work. We believe strategic plans should be made with the best possible data, using the best that your management team has to offer in terms of strategic direction. We suggest one-on-one interviews to avoid group think and uncover critical issues that are difficult to determine in groups. We make suggestions based on our experience, both in banking and with the hundreds of financial institutions we have had the honor to serve. We draft your plan based on data, interviews and a group retreat. We guide your institution into creating an operating plan, or the "how" to strategy execution. We develop projections based on what success would look like in plan execution. The plan should identify the institution you strive to become and chart your path to getting there. Without direction, any road is the right road. With a well thought out plan, course modifications can be made with confidence. Resources can be allocated efficiently. And personnel can be hired and developed with successful plan execution in mind. Some financial institutions consider strategic planning a regulatory exercise or look to do it themselves to save money. Is there a more important question than "what do we want to be?" and "how do we intend to differentiate?" An outside facilitator can ensure planning gets done in a disciplined process that gives your financial institution the best opportunity to succeed at serving its stakeholders.

We also perform ancillary services such as an institution's Risk Appetite statement, clarifying the risks the board and management are willing to take in plan execution. We also do Capital Planning, identifying how much capital will be needed for plan execution and capital impacts of various adverse events and how the institution would enhance capital should those events come to pass. We perform 360 strategic alternative reviews, identifying who a financial institution can reasonably purchase and how much they can pay, who would be strategic partner candidates, and who can buy the institution and how much they can pay. We do this unpassionately because knowing this information helps management teams create aspirational plans. We also do regulatory business plans for de novo banks, mutual to stock converting banks, and banks switching charters.

Contact me if you would like to discuss strategic planning or any of our ancillary services: Jeffrey P. Marsico - The Kafafian Group, Inc.

Process Improvement- In every institution we have served with process improvement services we have found onerous processes, inefficient technology utilization, and silos prohibiting a near frictionless employee or customer experience. Most of these engagements result in cost savings as resources are allocated to unneeded processes, or technology can do the job. Most seasoned bankers have been through these types of engagements and have a bad taste about them because overbearing consultants come in and make declarations and pronouncements. Not so with us. We take a partnership approach where we keep supervisors informed every step of the way so there are no surprises. We think the engagement goes smoother and our recommendations more informed if we ask, for example, the head of wire transfer why the system isn't used to its fullest or why the institution is applying belts and suspenders processes to sending a wire. Supervisors may not agree with one of our process improvement recommendations, but they'll know about them before they end up in our report. It is a solemn responsibility that the institution be better situated with scalable processes when we leave from a process improvement engagement than when we started.

Contact Chris Jacobsen if you are considering improving processes for scalability, near frictionless customer and/or employee experiences, and/or cost savings: Christopher Jacobsen - The Kafafian Group, Inc.

Financial Advisory- Whole bank mergers and acquisitions, fee-based lines of business, branch transactions, fairness opinions, valuation services for private financial institutions, 360-degree strategic alternatives analysis, are all part and parcel to our Financial Advisory line of business. One client told us he felt he was getting JPMorgan service from a community financial institution consultancy, a duty we continuously sharpen in a changing environment and a badge we wear with honor. We consider this line of business complementary to our consultancy so we are responsive to client needs without the typical reticence to engage in talks about combining for fear of going down a slippery slope. Once a client determines to pursue a transaction based on the facts of it, we pursue it to achieve success based on the client's definition of success. We put our experience and transaction accomplishments against any in the business. 

Contact Rich Trauger if you are considering a strategic combination or any of our ancillary services: Richard B. Trauger, Jr. - The Kafafian Group, Inc.

Management Advisory- We do a menu of different things based on our individual and collective skill sets that are difficult to categorize but fall under the Management Advisory umbrella. Examples of engagements we are or have executed on: interim executive officer, management assessments, board evaluations, executive coaching, technology implementation, organizational structure, general ledger mapping, data needs and governance, regulatory assistance based on formal orders or memorandums, etc. Our talented staff with over a century of banking and bank consulting experience are drawn upon to successfully complete the engagement to the client's satisfaction. 

Contact Chris Jacobsen if you are considering an engagement that may fall under our expertise to see if we are a fit. Christopher Jacobsen - The Kafafian Group, Inc.

That's it! If you are a client, we sincerely thank you for your trust in us and leveraging our capabilities to improve your financial institution.

If you're thinking of becoming a client, please contact us. We are not pushy salespeople calling you weekly wondering "where are you at?" If we are a fit for your needs, let's roll!

Happy New Year!

~ Jeff

Things I Wish Bankers Did Better: Project Management

PPP urgency must be our norm.

On September 17, 2021 in the Scottsdale, Arizona desert, I delivered a speech to a ballroom full of bankers titled: 5 Things I Wish We Did Better. It was well received and was recently picked up by a banking school as an elective class.

Number 1 on that list: Project Management. I used the embedded commercial as indicative of the life span of a project at a community bank. In my presentation, I estimated the following: Time to identify high lifetime value customer segments to uncover their demands, 4 months; Actually uncovering their demands and solutions providers, 4 months; Select the solution, 4 months; Implement the solution, 6 months. That's a year and a half for those counting.

And my observation was validated at a recent bank strategic planning retreat where the strategy team said solutions contracts that they signed last year will be lucky to be implemented by the end of this year. Their experience is consistent with my observation.

This, in my opinion, is an existential threat to the relevance and survival of community banking. We have to be able to identify, implement, utilize and market technology solutions using PPP-level speed and urgency.

Can it be done? At Bank Director's Acquire or Be Acquired conference, Anthony Morris from nCino, in a Transformation Through Technology panel, gave a sample timeline of project implementation (time to implement) of four months, followed by a time to value (time from implementation until the solution adds value) of an additional two to three months.

I thought he was being wildly optimistic.

But Jill Castilla of Citizens Bank of Edmond told me that it took her community bank 10 days from idea to implementation for PPP.Bank, which was a critical tool in the early, wild-west days of the first wave of PPP loans. Ten days. Her bank at the time was just over $300 million in total assets and she had 56 FTEs. 

Mike Butler, CEO of Grasshopper Bank, thinks rapid tech integration shouldn't be anomalous. Mike has a history of getting solutions quickly from idea, to implementation, to time-to-value in his prior life as CEO of Radius Bank (acquired by LendingClub) and now at Grasshopper. They changed their core in four months! They contracted with a vendor for online account opening in November and are flipping the "on" switch this month. What's their secret sauce, according to Mike?

- Hire a rock star CTO, which he doesn't believe is the norm in community banking. He didn't define what he meant, but in my mind I think a rock star CTO does not allow hurdles, either erected by solutions providers or internal naysayers, to slow down the bank from its current state to its desired one. A rock star CTO is a plow driver, not a caution cone erector.

- Have a killer project management team inside the bank.

- Use the API concept to circumvent the fortress that cores build around their solution. This likely requires you to have the traditional core middleware that they will charge you for, but it avoids getting on the "we'll get back to you based on your size and how busy we are" attitude that community banks suffer as a result of core dependency.

- Don't try to boil the ocean. Use the MVP concept (minimum viable product) and GO! Solve one specific problem at a time rather than trying to solve multiple or all problems. Don't wait until perfection to launch. Launch and learn, make course corrections.

Linda Stahl, Chief Revenue Officer of Paladinfs, herself a recovering core provider veteran, thinks core dependency is getting worse, citing that it used to take 80 days on average to negotiate a core contract. And it's now taking 180 days on average. Once under contract, the time to convert is about nine months. The future, in her estimation, is that the core will serve as the record keeping solution, and we will use API based plug and play based on a bank's needs. But we're not there yet. We still require the core middleware as a bridge to the future, which an estimated half of all banks do, and cores charge tolls for access to your data. 

To navigate from now until a future, API-based plug and play state, Linda suggests building into your technology contracts specific service level agreements (SLAs) that have progressively sharper teeth. SLAs should essentially be a statement of work with milestones. If the technology solution doesn't meet the first or second milestone, there is a financial penalty such as credits or an outright cash payment. If it escalates to missing the third or fourth SLA, the bank can terminate the contract without penalty. Mike Butler suggests discipline in enforcing technology solution SLAs. Have some gumption. Although he used a more colorful word than gumption.

This week I noticed that my large financial institution had been charging me $15 per month for an account I used to pay my 23yo's college bills because I must have blown through their minimum balance as her college days neared the end. A tech-forward, trust-based financial institution that spends billions per year on technology should have sent notice to me or some relationship manager that this was happening. But no, I found out by accident a year after it started. If we think because our largest competitors that frequently brag about their tech spend are squared away, think again. 

A key strength a community bank has over those large institutions that dominate market share is we can act quickly. The context of the strength is in decision making or making strategic pivots. This strength should not exclude tech implementation. And it is in tech project management where we need to significantly improve.

~ Jeff

Please consider reading my book: Squared Away-How Can Bankers Succeed as Economic First Responders. 

Ten percent of author royalties go to K9sForWarriors.org, who work to bring down the suicide rate among our veterans. 

Kindle

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Hardcover

Thank you!

How Can Community Financial Institutions Improve? Project Management.

In this video blog, I discuss my thoughts on community financial institutions upping their project management game. In summary:

There are two types of projects: support function projects where you try to improve the gears within the bank, and customer experience projects (CX) where you meet the demands or emerging demands of your most valuable customer cohorts.

First, be selective in the projects you undertake. The ones that create the greatest value in terms of reducing resources needed to run the bank, or improve your most valuable customers' experiences.

Here are the high level steps:

1. If a CX project, determine your most valuable customer cohorts by lifetime value. Why undertake a project for customer segments that are unprofitable?

2.  Select a project team that includes executive sponsorship, mid-level leadership, do'ers (after selection), and vendors (after selection). Use a "many hands make light work" approach. Because it's true. And many hands make quick work.

3.  Evaluate and select the vendor based on their solution, support, and potential longevity. Don't be saddled by your rigid vendor management practices to eliminate promising vendors.

4.  Set deadlines. Not six months out. Think PPP fast. We did it then, we can build on that. Make sure you keep the vendor fully engaged in the process, like they promised in your contract.

5.  Maintain accountabilities. Even after flipping the "on" switch. 

The Jimmy McHugh's tour is a bonus!

Here is the actual link in case you can't click on the video:

https://youtu.be/prROd5F2ies

Two Ideas to Lower Operating Cost Per Account

Last week I wrote a TKG Perspective's article on Bank Profitability in 2019. I congratulated community financial institutions for delivering a positive trend in business checking account operating cost per account. The challenge is, aside from residential mortgages, all other product categories showed negative trends in operating cost per account.

In the below video blog, I offer two ideas to drive down long-term cost per account in other categories. 

Click HERE to view the TKG Perspectives article. 

Click HERE to view the cited blog post on re-thinking branch staffing.

~ Jeff

Bank Innovation: Three Ideas

I usually take more time researching blog posts than writing them. Today is an exception. Rather than searching reputable sources for how this bank or that bank innovates, I thought I would give it to you straight from the gut.

Because experience tells me that bankers are struggling with innovation. There is so much buzz about it, we are challenged to separate the wheat from the chaff. Fintech, regtech, martech (new one), AI, RPA, Chat Bot, actual bot. What's a banker to do?

At its core, innovation should solve problems. Problems we know we have. Problems we may not know we have. Customer problems. Process problems.

And who knows or can anticipate these problems better than 1) our customers, and 2) our people. 

Here is my opinion that may not sit well with some of my readers: Innovation through rapid change will rarely be led by those long in the tooth. Their experience clouds their view of the pace of change, especially if their experience is with slow, methodical, decades-in-the making change. Because we tend to believe past is prologue.

I'm full of idioms when I shoot straight from the gut.

I'm not telling you to build an innovation culture surrounded by young people. Make innovation a bank wide call to arms. But in creating a culture of innovation, don't have your long in tooth leaders shooting down innovation arrow after arrow offered by your short timers.

Here is how I think you could foster such a culture:


1.  Make Innovation Problem-Resolution Based. Nothing is more frustrating than expending organizational resources on a non-existent problem. Changing IHOP's name to IHOB comes to mind. HSBC putting actual robots in branches is closer to home. Community financial institutions' resources are already taxed by technology and regulation. Don't over-tax by encouraging innovation on problems that don't exist either internally or with our customers. So when you establish an innovation culture, the subject line of the memo proposing the innovation should be the problem the institution is trying to solve. Let your competitors waste resources on cool gizmos that only end up being resume' bullets for tech weenies.


2.  Coach Long-Timers. I've called them stoppers, sergeants, and old-schoolers. These are the people that implemented processes in the past that your innovators are now trying to solve. Like the cumbersome process that may exist in your bank to send wires. The story goes like this: a fraudulent wire got through, the bank CEO sternly directed ops personnel to ensure it doesn't happen again, and it now takes a DNA sample for someone to get a wire out. And the owner of that process is the department manager of the innovator trying to solve for a problem created by their boss. Here is where senior management will earn their leadership chops. Turn the stoppers into innovators. Or at least facilitators of innovation.


3.  Recognize and Reward. I called for a bank wide awards ceremony in a post two years ago (Five Ideas to Build an Accountability Culture at Your Bank). Innovation awards should be a part of the ceremony. Perhaps a central feature of it. Hand out a trophy. Give out meaningful cash and/or vacation time. Salute Long-Timers for fostering the culture that led to innovation. Demonstrate tangible results. Emphasize the problem solved.


These are my ideas on how to build an innovation culture that focuses innovation efforts on solving problems, real or emerging.

What other ideas do you have, or have heard of, that can move financial institutions forward fast enough to build a long-term future?

~ Jeff