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Are Millennials Finding You Attractive ?

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As time marches on, we find Millennials coming into their most financially productive years, and they need financial services. In 2010, Gen Y made up only 17% of vehicle sales. Five years later, that number has grown to 28% of sales, while Baby Boomers and Gen X have flatlined or fallen back (according to J.D. Power and Associates). Many credit unions are considering process improvement in order to refine their processes to better appeal to Millennials but, believe it or not, easy appeals to any generation!

Consider the lending process from a Millennial’s perspective:

  • How long will I have to wait for an answer? (Most things in my life so far have been instantaneous. I have never had to wait for the annual TV broadcast of “The Wizard of Oz” or for the radio station to play my favorite song, or sit through boring commercials)
  • How many hoops do I have to jump through? (I have to drive somewhere to sign something? On paper? I have to gather a bunch of documents?)
  • How many stipulations are on the deal? (Are all of these questions necessary? Why is this application so long? How does the other online place I found do it without all this? Why can’t this be easy like Amazon?)

Are you getting your fair share of Millennials’ business? Can you be found where they are looking? Are you offering the type of experience they value and expect? Have you considered that making things easy will appeal to other generations – not just Millennials?

Facebook recently published a white paper on Millennials and Money that uncovered some key findings. The Millennials on Facebook are turning out to be financially conservative, with a focus on paying off debt and saving. Unlike previous generations, Millennials talk openly about money matters and they talk about them online, crowdsourcing for their financial advice – the modern-day version of word of mouth. Who better to dispense financial advice than credit unions? The question is, are you part of that online conversation?

Even if you are, is the experience you’re providing relevant to this generation? It’s well known that Millennials “live” on mobile, and while they are often multichannel users, they typically start their journeys on mobile. How do you show up? People expect things to be easy and convenient. If you need inspirational ideas for how fast, easy, and convenient the financial experience can be, look no further than the internet for non-traditional competitors like Lending Club or Quicken’s Rocket Mortgage. How does your experience compare? It is commonly said that this generation isn’t loyal. Why should they be if others are offering a far superior experience?

Have you fully revamped your lending and account opening processes – often the first exposure your potential member has to your credit union – with the Millennial in mind? This takes a hard, honest look, which isn’t easy, but keep in mind that some of your toughest competitors have already done it. Don’t forget this benefits other generations. How many Baby Boomers miss going to Blockbuster to rent a movie?

Process improvement is typically conducted with a goal of eliminating waste, which is critical, but tying in the strategic goal of providing a rewarding experience across generations is key to remaining relevant as a financial institution into the future.

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Net Economic Value: 1 Tip on Effective Discount Rates

There are many tools that can be used to perform a model reasonableness check, or a model validation. Below we share a simple “sniff test” to help credit union CFOs and financial analysts assess one key assumption driving net economic value results, the effective discount rate applied to each loan category.

Tip: Compare the effective discount rate in the current interest rate environment to the applicable loan portfolio yield. Understand the reasons for material differences.

You might be thinking – “Why do I need to see the effective discount rate in the current environment if I can see the values?” Well, how do you know if the starting value is reasonable?

Seeing the assumed effective discount rate and comparing it to the loan portfolio yield would help you think in terms you deal with every day. For example, if you could see the weighted-average yield of your auto loan portfolio has been holding steady at about 5.50% yet the assumed effective discount rate in the current environment is 2.75%, you would probably want to understand why there is such a disparity. You begin asking questions.

Are we charging our members above market rates? If not, what might be the reason that our yields are so much higher than market? Do we accept a higher than typical credit risk? Perhaps insufficient credit spreads are being applied to the assumed discount rate.

Are there other unique lending practices that we perform that might account for higher than market yield in our portfolios? For instance, if your mortgage rates are materially higher than the effective discount rate, dig deeper. Maybe your mortgage loans are non-conforming and the discount rate has not been adjusted appropriately. Ask yourself why a purchaser of non-conforming loans would not want to be appropriately compensated for a potentially higher risk and less liquid asset.

Even if your ALM model touts that a unique spread is being applied for every single loan, you should still step back to determine the reasonableness of these assumptions and understand the overall portfolio effective discount rate for the current interest rate environment relative to your portfolio yield.

Performing this quick reasonableness test helps bring a common sense approach to values and ultimately NEV results.

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Interest Rate Risk Policy Limits: One Big Misconception

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We often see interest rate risk policy limits that rely too much on net interest income (NII) volatility and miss the absolute bottom-line exposure. Such reliance can cause boards and managements to unintentionally take on more risk than they intended. Why? Because these types of policy limits ignore strategy levers below the margin.

Establishing risk limits on only part of the financial structure is a common reason for why risks are not appropriately seen. Setting a risk limit focused on NII volatility does not consider the entire financial structure and can lead to unintended consequences.

For example, assume a credit union has a 12-month NII volatility risk limit of -30% in a +300 environment. The table below outlines their current situation and the margin and ROA they would be approving, as defined by policy, in a +300 bp rate shock.

-30% NII volatility risk limit policy vs. ROA

By definition, the credit union is still within policy from an NII perspective but because of the drop in NII, ROA has now decreased from a positive 0.50% to a negative 0.43%. This example helps demonstrate that stopping at the margin when defining risk limits can result in a false sense of security.

Not All 30% Declines are Created Equal

To punctuate the point, let’s apply the 30% volatility limit to credit unions over $1 billion in assets using NCUA data as of 3Q/2015.

On average, if this group of credit unions experienced a 30% decline in NII in a +300 bp shock, the resulting ROA would be 6 bps.

But each credit union’s business model and strategy are unique. So instead of looking at the average for this group, let’s look at the potential range of outcomes.

ROA for credit unions with assets >$1 billion
It is important to note that 46% of all credit unions with assets over $1 billion would have a negative ROA within 12 months if this volatility were to occur.

This enormous range of ROA, and with so many credit unions at risk of negative earnings, helps demonstrate that an interest rate risk limit along these lines could result in material risk with the unintended consequence of institutions being potentially blinded to the exposure of losses.

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Strategy and Risk Management – Is Leadership in Sync?

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Understanding and prioritizing strategy has never been more complex, especially as new disruption continues within the industry. Beyond delivering valued products and services profitably to members while remaining safe and sound, decision-makers face new threats to remaining relevant as non-traditional competitors create inroads into financial services. With limited resources, success can depend on choosing the right path.

Creating an optimal strategic focus requires decision-makers to share a common understanding of threats to the business, and a clear assessment as to which of those threats warrant attention and resources. This is where linking risk management practices to strategic planning can provide effective guidance.

Consider the following simple, yet powerful, exercise with your team:

    1. Begin with a high-level review of the financial results and risk reporting you prepare and review every month or quarter: monthly financials, key ratios, A/LM results, credit policies, etc.
    2. Identify critical risk areas (see the example below), starting with elements from financial and risk reporting, then allowing the group to add to the list as necessary.

      Note: We are using relevancy as a broad category to describe the myriad of new competitive pressures and changing member expectations. This should be customized for your credit union’s uniqueness.

    3. As a group, rank each risk on a scale of 0-10 (0=Low Risk, 10=High Risk).Rank your risk level from 0-10

THE VALUE
Here’s where this exercise can create significant value, as decision-makers begin to link results with their gut feeling and appetite for risk. What is your level of risk? Where does it exist? Where would you most want to see improvement? For some, these discussions may identify:

  • A lack of understanding of a specific risk (an opportunity for training)
  • Difficulty comparing and ranking different risks (an opportunity to share different perspectives)
  • Differing opinions (a need to achieve consensus)

Each of these outcomes can create opportunities for the credit union such as:

  • Taking strategic discussions to the next level
  • Advancing risk management
  • Refining focus and allocation of resources

In addition to aligning strategic planning with risk assessments and management, consider the benefit of knowing that the leadership team shares a deeper, common understanding of the risks facing the credit union and the reasons driving strategic priorities.

As the credit union industry changes and faces new competitive pressures, linking strategic planning and risk management could be key to ensuring ongoing success.

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Process Improvement Takes Strength

Excerpt from CUES Magazine – Published January 2016.

The challenge with process improvement is that it is not for the faint of heart; it requires rebels who are willing to step up and tear processes to shreds, and rebuild them from the ground up.

It is not human nature to constantly challenge the status quo. It takes a rebellious nature to question everything and accept nothing at face value. The death stroke of a good process improvement plan is the belief that everything is fine because “that’s how we’ve always done it, and it’s never been a problem.” A huge advantage non-traditional competitors have is that they are not bogged down with legacy thinking and processes.

Rebels are required to shake things up.

Process improvement is a habit credit unions can create to find better, faster, and easier ways of bringing value to members and employees. In some credit union circles, process improvement is slowly gaining traction as one of the most important tools in a credit union’s hip pocket.

Click here to read the full article on the CUES website.