The Great Risk Of Not Knowing
It's no secret to any credit union that profitability is squeezed. But where the biggest risk lies for credit unions, according to one person, is in not knowing which member behaviors are contributing to profitability, and which are detracting from it.
Similarly, noted that same analyst, Bill Goedken, president and CEO of Profitstar, Inc., a developing trend at credit unions is that members at the profit extremes-both most profitable and most unprofitable-are becoming more extreme as credit union membership becomes more polarized.
The only solution, according to Goedken, is understanding essential profitability management and cost control. But the issue is complex, he told CUNA Mutual's Discovery Conference, and when credit unions don't get it right they start making decisions based upon either no data or bad data.
At the tactical level, Goedken said financial institutions typically examine profitability in a hierarchy, moving from the broadest to the narrowest: organizational, product, member and line of business.
"As you go from the bottom of the pyramid to the top, the amount of information and the time involved will grow," he said. "You can skip organizational, and go directly to product. But I've looked at dozens if not hundreds of these, and you absolutely must get product down and product down right before you move to member. And if you go to member profitability and you don't have product right, you may be looking at incorrect information. I think that's critical."
The good news in doing such analysis, he said, is that it allows for better information, meaning better decisions. It also fosters the creation of incentive plans and performance measurements, along with better service by targeting delivery channels, services, products and segments. In sum, it boosts profits.
One example of having good data shared by Goedken is a credit union that does significant lending to C-paper members that experiences higher-than-average losses. And yet the credit union is seeing a 9% margin on that loan product, the most profitable product it offers.
But there is also "bad news" in profitability accounting, said Goedken. "There are political hurdles," he said, referring to a recasting of the balance sheet that occurs. For instance, the largest and busiest branch may be shown to be less profitable than another branch.
There are also technical hurdles, and the resource constraints, as profitability accounting takes time and effort. Finally, he said, there is the "blame the messenger" response of many, which is why CFOs are often reluctant to tackle the project.
Goedken provided the following lists of Do's and Don'ts in profitability accounting.
The To-Do List
* Use the ALCO (Asset/Liability Committee) as the main group for the financial management process.
* Head of marketing should be on the ALCO.
* Have clear goals and objectives of what the financial management function does.
* MCIF, ALM and the profitability accounting should tie back to the general ledger.
* "Buy in" is critical, politics is aplenty.
* Keep it simple.
The Don't List
* Don't underestimate the time and effort on coordinating the strategies and tactics.
* Accuracy is important, precision is not.
* Don't leave this process to one person (if you do, you must keep it simple).
What are some of the issues with profitability accounting? According to Goedken, those issues include:
* The commitment level and the "buy in."
* Account structure needs to be "rearranged." Questions here include is the account structure complete? What funds transfer pricing is being used? And how does the credit union allocate non-interest income and expense?
* Outsource or in-house? Goedken said there are pro's and cons to both. If time is a big issue, the function should be outsourced, he reccommended. "But then you may be getting this information back on a less-timely basis," he added.
What types of information are needed to begin profitability accounting?
* G/L and subsidiary ledgers.
* Off-balance sheet items-statistics.
* Different systems may exist, but extraction must be similar.
* The vendor must be able to accept different formats.
* Methodologies. "No one wants to be allocated data processing expense," noted Goedken. "How do you do it?" Other difficult issues are measuring various costs of transactions, head counts, etc.
* Product profitability analysis, added Goedken, has shown that many credit unions' special CD promotions are profitability "dogs."
Among the chief reasons is that when a short-term, high rate account is offered, members just move funds from existing accounts into the certificate, raising the credit unionx's cost of funds for funds it has already captured.
Product profitability analysis has also shown big swings in profitability in a particular product according to balance tier. Overall analysis, for example, may show the product is a moneymaker for the credit union, but further analysis may show the number is skewed by higher balance accounts.
The general rules of profitability accounting, according to Goedken are:
* Know your members.
* 3%-5% of members generate 50% of profits. One CU found its second most profitable member was on the board, even though he had no loan products.
* 50% of members are unprofitable.
* 60% of cross-selling is not profitable. As an example, Goedken cited members who are cross-sold into unprofitable products or unprofitable balance levels. "Know what you're cross-selling before you sell it," he said.
* In-person transactions cost five to 30 times more than automated transactions. "That's not bad, but you just need to know it."
* 60% to 80% of front-line time is consumed by less than 20% of the profit potential.
Other important points, according to Goedken:
* Households are always better than individual members.
* Behavior is usually more important than demographics. "Who are the E members? There are two groups. The first is the loan losses, of course. But the one that may surprise you is the household in any income spectrum that has 14 of your products, so you've cross-sold them to death, and they consider you their PFI.
The problem is that of the 14, 11 of those products are underwater before you even sold it to them. That's why I'm so adamant about the need to do product profitability first."
Goedken said that one trend he and his company, ProfitStar, have seen, is that members at the extremes of profitability-the A's and the E's-are becoming more extreme. That is, credit unions are becoming polarized among extremely profitable and extremely unprofitable members.
PERCENTAGE OF ACCOUNTS THAT ARE PROFITABLE
Savings or checking only 22%
Low deposit-no loans 8%
High deposit-no loans 63%
Low deposit-low loans 22%
High deposit-low loans 61%
Low deposit-high loans 59%
High deposit-high loans 71%
All HH 38%