In the third quarter of 2018, the industry’s total loan portfolio eclipsed $1 trillion, according to data from Callahan. And 5300 filings indicate all but six credit unions reported some kind of lending activity. Sure, credit unions have incurred loan losses, but over the past five years, total delinquency at credit unions has decreased 34 basis points to 0.67%. Additionally, delinquency at credit unions is 40 basis points lower than at banks — a feat made even more impressive by the fact credit unions start reporting delinquency at least 30 days before banks — and credit unions are compensated for the risk they take on through the interest they charge.
“Every loan involves some risk,” Howard says. “Credit unions are not in a situation where they take risks and are not compensated for it. But how much risk they take should not reflect how much reward they want — it should reflect why they’re in the business in the first place.”
That business purpose is up to the credit union to decide, Howard says. But as it relates to risk, Howard says credit unions should create an environment wherein borrowers can repay their obligations, enabling the credit union to continue to lend to all members at a low cost.
Who the credit union serves — for example, an unbanked community; a certain trade, industry, or profession; a specific SEG; or more — should define the risk profiles it is willing to accommodate. The needs of a rural manufacturing plant’s employees are different from those who live in a high-tech community. So is the risk they present.
“Serving different members requires different skill sets and different risk management,” Howard says. “Different members might also present a different reward equation.”
Determining who to serve and how to serve them is an issue of strategic importance and another of Callahan’s opportunities for 2019.
Without understanding who the credit union serves — and why — the institution cannot properly assess strategic risks. Movie and video game rental store Blockbuster is a cautionary tale for what happens when an organization loses focus and misunderstands risk.
In the mid-2000s, Blockbuster operated more than 9,000 stores across the globe. In 2010, it declared bankruptcy and liquidated most of its brick-and-mortar locations. The fall of Blockbuster is commonly pinned to the company’s inability to innovate amid the rise of on-demand services such as Netflix, but Howard offers a more nuanced view.
When that first red Netflix envelope crossed Blockbuster’s path, the company’s leadership didn’t consider the fledgling, unprofitable, DVD-by-mail startup a threat. They were wrong, but not because consumers wanted better technology for movie rentals. They wanted better treatment.
Blockbuster wasn’t a video-rental company that built its empire on renting videos; it was a video-rental company that built its empire on charging late fees. In 2000, 16% of Blockbuster’s revenue, a full $800 million, came from late fees. Blockbuster grew its bottom line, which hit $4 billion by 2002, at the expense of its customers by charging late fees and marking up concessions. That’s an unsustainable business model.
Blockbuster operated on the idea that customers would pay an after-the-fact penalty for accessing movies on their own terms. That strategy benefited stockholders more than customers. Netflix operated on the idea that people would pay an upfront premium for that access, a customer-centric approach. The strategic divide between Blockbuster and Netflix mirrors the difference between banks and credit unions. But credit unions must understand why one model failed — and understand the importance of remaining member-centric — if they want to remain relevant and assess risk in a rapidly changing environment.
“If a credit union wants to understand the risks posed by competitors, it needs to understand why it’s in business,” Howard says. “It needs to understand who it is trying to serve and how it plans to serve them. Some credit unions know this. Some don’t.”
More Risk To Reach A Better Reward
CU QUICK FACTS
HQ: Portland, ME
Data as of 09.30.18
12-MO SHARE GROWTH: 9.8%
12-MO LOAN GROWTH: 6.2%
Five years ago, Infinity Federal Credit Union ($349.2M, Westbrook, ME) tackled its dilemma with strategic risk head-on. The credit union had lost nearly 6,000 members in 15 years and eschewed loan opportunities in favor of an investment portfolio that peaked at more than $100 million.
“It was a different credit union then,” says Infinity FCU board chair Sam Novick, who has been a board member since 2013. “From a style perspective, a growth perspective, something needed to change. We needed somebody willing to take a risk.”
In late 2014, Infinity hired a new CEO, and the organization’s priorities started to change.
“We had good capital ratios, but we needed new members,” says chief risk officer Sandy Cloutier.
Sandy Cloutier, Chief Risk Officer, Infinity FCU
The credit union couldn’t survive on the path it was on. But if it was to grow, Infinity had to take on new risks and reignite forgotten loan avenues, such as C-D-E paper borrowers and both consumer and business lending.
Cloutier and the executive team at Infinity provided the board with risk appetite statements that outlined the possible benefits and pitfalls of increased risk. Charge-offs and delinquencies would increase, of course, but product rates would also be higher and net interest income would grow. With those statements in hand, the board was more than accepting of taking on more risk.
“They said, ‘Yes, we want to grow memberships,’” Cloutier says. “’And we understand that to do that, we need to take risks and make loans that are not going to be A credit.’”
Infinity’s current leadership understands that the credit union is in business to make its members’ financial lives better. Its long-term goal is to serve more members than any other cooperative in the state, although it refuses to take on empty memberships to do so. Through a concerted effort to diversify its lending and deposit mix, the credit union posted the second-highest average member relationship of any credit union in Maine as of third quarter 2018. At more than $26,000, Infinity’s average member relationship was nearly $10,000 more than the average for Maine credit unions and credit unions with $250 million to $500 million in assets.
New memberships are helping Infinity work toward its service goal as well. Its third quarter member growth of 6.49% far outpaces state and asset-based peer averages of 4.05% and 3.20%, respectively.
Taking on more risk to realize the reward of stronger member growth has had its drawbacks, which the leaders at Infinity rightly foresaw. Charge-offs have climbed more than 10 basis points since Hayes took the reigns in late 2014. This has prompted the executive team to have more complex financial discussions with the credit union’s board to explain that the credit union remains below its risk threshold.
“We go through the financials with them to show them how it all breaks down,” Cloutier says. “It lets them see that we are still in line with our risk tolerance.”
With risk comes reward. For Infinity FCU, it’s working to maintain that balance.
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