The past year was tricky to navigate. There was a new fee regulation to implement. There were NCUSIF stabilization expenses to absorb. There was a return of captive financers to the auto market. Despite these challenges, credit unions have stabilized their margins. In fact, the operating expense ratio increased just two basis points in third quarter 2010 (not taking into account the stabilization expenses).
Challenges, like old acquaintances, are not forgotten in 2011, and the credit union model, with its focus on depository relationships and individual members, is particularly vulnerable to the proposed 70% cut in debit card interchange.
Increasingly, financial institutions already operating on tight budgets are taking a closer look at product profitability. Likewise, credit unions that want to create value for their member-owners are gaining a better understanding of what products are profitable and what products are loss leaders that build toward the greater goal of creating lifetime member value. In other words, it’s acceptable to be a credit union and want to be profitable; it’s why it wants to be profitable that makes a credit union a different kind of financial institution.
“Every financial institution is going to have to do a good job of developing product profitability analysis for each and every product,” says Tim Kolk, credit card expert and president of TRK Advisors. “Simply looking at the pricing of your in-market peers and benchmarking off of that is not going to be good enough. Too many will price unprofitably, and mimicking them is simply being second to jump off the cliff.”
“Over the course of time, every financial institution will have an ALM tool either because it is required by regulation or for other reasons,” agrees Brad Dahlman, RPM product manager for ProfitStars, a company that offers risk management and cost control software. “They’ll want to understand what is working and what is not.”
In today’s low loan-to-share ratio environment, every product needs to pull its own weight. Unfortunately, popular products — such as debit card-linked depository products — are the very products where measuring profitability is most challenging for credit unions.
Evaluating profitability, however, doesn’t have to be a daunting process.
“Traditionally, organizations look at the top down,” Dahlman says. “They start with ALM, then they delve into organization or branch profitability, then they get into product profitability, and then into member profitability. They are seeing more competitors taking away members and want to understand what they can offer so can they can differentiate their services.”
Institutions are now looking at profitability on all levels, asking questions such as: Is this organization profitable? Is this branch profitable? Is this product profitable? Is this member profitable?
“This could challenge the very culture and purpose of many credit unions,” Kolk says. “Banks historically have been better at implementing profitability analysis at these levels and as such have initial advantages.”
Banks might be better at analyzing profits and pushing weak relationships out the door, but instituting profitability analysis does not mean a credit union is looking to purge the members who need its services the most. On the contrary, analysis is yet another tool to help credit unions price products, identify good and poor credit, and allocate costs and capital, all in the vein of creating a stronger institution that can better serve its member-owners.
Financial institutions that have their data elements and calculations in place can then use that information in a variety of ways, says Dahlman, including building better product awareness and understanding, better managing relationships, and informing staff with proper reporting and analytics.
“There are still some organizations that have their heads down and are unsure about how to move forward,” Dahlman says. “We can’t manage business the way we have in the past and expect different results. FIs need more effective tools to manage business more effectively. This is back to basics: understand your product; understand your member.”