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Strategic Budgeting/Forecasting Questions: Connect Strategic Initiatives with Financial Direction

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Strategic initiatives impact results – members may be better served and membership may grow, assets may grow, and earnings and net worth may increase. Some strategies may cause temporary or long-term reductions in membership, assets, earnings, or net worth. Budgets and forecasts should incorporate the anticipated impacts of strategic initiatives and establish common expectations for results. Connecting the dots to better understand the financial implications of strategic initiatives can lead to greater success.

In this and subsequent blogs, we will review 6 questions strategic boards can discuss during the budgeting and forecasting process to better connect the dots. These 6 questions are merely a starting point and will undoubtedly lead to more questions during the process, creating more thorough communication and a greater understanding of strategic plans.

Question 1 – What is the expected financial direction of each strategic initiative?

Begin with a simple, high-level assessment of strategic initiatives. Identify each strategic initiative with a short description. Then, consider what you believe will be the earnings impact next year and in the following years. For this exercise don’t focus on the numbers, just consider the direction of the impact. Draw a quick table or use a spreadsheet as follows:

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Consider that not all strategic initiatives will generate increases to earnings. The important point is to understand why. Some initiatives may hurt earnings in the short term to achieve longer-term improvements, while others might only reduce earnings. For example, a strategy might be to increase member giveback through reduced overdraft fees or installing additional ATMs for improved member access.

In this example, initiative #1 is to become the lending machine – perhaps to make the process more efficient and create capacity – or to generate more loans for the credit union. This initiative may include a project to implement new technology or acquire talent. In Year 1, the project is expected to incur costs that would reduce earnings, or the ROA. We indicate that in the chart with a downward arrow. By Year 2, however, we expect to see some additional loans or experience cost savings that would improve ROA. We show that with an upward arrow.

Continue to complete the chart.

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In Year 3 and beyond, the impact to ROA of the lending machine strategic initiative is expected to continuously increase.  We can use multiple arrows to show the additional impact expected.

For strategic initiative #2, to decrease account opening time, there’s no hard dollar costs in Year 1 as the credit union conducts an internal review and designs process improvements.  In Year 2 and beyond, the efficiencies are expected to lower costs and drive some additional new accounts, thereby increasing ROA.

Beyond looking at each strategic initiative, notice that now the aggregate expected impact of all initiatives can begin to be understood.  If all or a significant number of initiatives have negative ROA impacts, that can be an indication of needing to consider other, offsetting strategies to generate additional revenue.  Or, it may make sense to accept lower earnings for some period.  That would be important to recognize and to make sure that everyone, including the board and management, is on the same page with the expectation so there are no surprises.

After completing this exercise, board members and management can be better prepared to review the budget with a high-level expectation for how it may look.  If projections don’t align with expectations, more “why” questions can be asked and differences understood.  As financial results occur and new budgets are created, this can be a great tool to keep as a reference.  Strategic initiatives can be reassessed for what was originally expected versus what actually happened, and to determine what changed and why.

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Process and Profitability – Living Deliberate Process Improvement

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Strategic-minded and forward-thinking financial leaders respect the fact that they are in a street fight for relevance. Decision-makers are scrambling to remain relevant to their target markets which continue to expect fresher, faster experiences. Living deliberate process improvement is a greatly underutilized weapon that can be quickly activated to your advantage, resulting in a more satisfied target market and improved profitability. Executive Vice President and Principal, Rob Johnson, discusses this in more detail in the April 25, 2017 FMS Update newsletter. In addition, c. myers will be speaking on this topic at the FMS Forum in Las Vegas on June 27, 2017.

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Strategic Thinking: Not Just Another Payment Competitor

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A little more than 10 years ago, Apple® announcedapple-logo the creation of the first iPhone®. The ability to move seamlessly between phone calls, music, and browsing the web, all from a handheld portable device using our fingertips was a revolutionary concept at the time, and has forever changed the way consumers interact both at a personal and professional level.

Today, as more and more consumers move their entire lives onto (and into) their smartphones, Apple® is pondering taking its imprint a couple steps forward, potentially offering all iPhone users the ability to send digital payments to other iPhone users and, further, the possibility of issuing an Apple prepaid debit card.

Apple has long been rumored to be yet another competitor for the traditional financial marketplace, analyzing ways to build its own money transfer service.  Recent news indicates that Apple has, once again, begun looking into ways that would allow iPhone owners to send money digitally to other iPhone owners, offering a service akin to Square Cash and Venmo, but with the financial backbone of Apple behind it.  It’s no wonder, too, with a vast marketplace of loyal users already at its fingertips.  As consumers move towards a more digital experience, including paying for things – like a portion of the dinner bill – through payment transfer apps that bypass normal interchange channels, apps and devices that make this process both easier and more convenient will no doubt have an advantage.  With this in mind, it’s no stretch to imagine Apple, with its already strong consumer base, diving deeper into money transfer systems in an attempt to both grow market share and provide its consumers with yet another reason to choose Apple.

Venmo, for instance, a subsidiary of PayPal, reported quarterly payment volume processed of nearly $7 billion in Q1 2017, double what was processed in Q1 2016 ($3.2 billion).

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And yet, even if it’s not Apple, it’s likely only a matter of time before the next competitive threat enters the arena of payment transfers, and continues to whittle away at some of the sources of income that credit unions rely upon to fund their business model.

Though there are numerous challenges that Apple faces in getting such a service off the ground and in the hands of iPhone users (estimated at over 100 million users in the US alone), the scope of Apple’s potential marketplace shouldn’t be lost on your credit union as you regularly analyze and plan to respond to threats from non-traditional avenues and FinTechs.

In analyzing threats of this nature, it’s useful to employ some multidimensional thinking exercises in order to better analyze the situation.  Consider the following questions and ideas:

  1. In an ever competitive race to be top of wallet, how would Apple’s new potential money transfer system impact your credit union’s bottom line?
  2. One potential target audience for this service would be the underbanked (or unbanked) segment of our society, or even college-aged young adults adept at using technology and unafraid of eschewing traditional banking methods. Take time to consider the profitability of this segment and the revenue streams they bring into the credit union, as well as the costs inherent to building a system that is, for all intents and purposes, a pure cost center that rarely helps the bottom line.  As technological change marches forward, the choices of how and what you embrace will become even more important than ever.
  3. If Apple (or Amazon, or X corporation) issues a prepaid debit card that becomes top of wallet for that consumer, how will your credit union respond? Or, will your credit union respond by not engaging that segment of the population? Consider that there were 9 million unbanked households in 2015, roughly, or 7% of US households, while another 25 million households, or about 20% of US households, were considered underbanked.  (Source: 2015 FDIC National Survey of Unbanked and Underbanked Households)
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Trends in Auto Sales and Prices: Questions to Consider

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Automakers have been informing investors for months now of a potentially difficult road ahead. Recent articles indicate trends that may present risks or opportunity to your credit union, depending on your situation.

Auto sales have declined the first three months of the year with the current, seasonally-adjusted pace annualizing out to 16.6 million compared to 16.7 million this time last year. Goldman Sachs Group, Inc. is now estimating demand for only about 15 million vehicles in 2017. Compare that to the record of 17.6 million set in 2016. (Source: Bloomberg)

For used cars, the National Automobile17-04-car-row Dealers Association’s (NADA) price index dropped in February by the most since November 2008. Both General Motors and Ford have warned about lower used car prices as many cars come off leases and into the used car pool. (Source: Bloomberg)

Additionally, auto loan delinquencies have increased across all credit tiers causing some lenders to tighten terms or pull back.

As you plan for the remainder of the year and beyond, the list below offers some great discussion topics for ALCO meetings and/or reforecast scenarios to consider:
If auto lending declines, what other avenues are available to us to grow loans? What investment opportunities are available?

  • How might slower-than-expected auto growth impact earnings?
  • If the average used car price falls, how many additional loans will need to be booked in order to meet budget goals? Given our current funding rate, how many more applications would we have to process in order to book those additional loans? How could we process more loan applications without adding expenses related to additional staff or overtime pay?
  • What if we have to dramatically reduce offering rates or increase fees paid to dealers to get the volume?
  • What if credit losses are higher than expected?
  • Are there opportunities that could be created if competition pulls back? Should we take advantage of any such opportunity?
  • How might loan demand be impacted if interest rates rise?
  • What if interest rates rise, putting pressure on us to raise deposit rates, but fierce competition for auto loans leaves us unable to raise loan rates?

The list above is not all inclusive but is a great start. As with most things, there are both opportunities and risks to consider. The sooner you start to consider them, the better off your credit union will be.

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HELOC Considerations in a Rising Rate Environment

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With the recent increase in short-term interest rates, specifically Prime rate, many credit unions are taking a closer look at the impact of higher rates on their HELOC portfolios. Anything is possible when it comes to future market interest rates but a continued increase in Prime means members will have higher interest rates and higher payment amounts. This begs the question, how much of a payment increase can members handle?

To help answer this question, a simple exercise can be performed in Excel. Come up with an approximation of the average HELOC balance. Depending on geography and the type of membership, this answer can vary widely. In some metro markets, credit unions have found their average HELOC balance to be close to $100,000. Even if the average HELOC balance is lower than this, consider the fact the member may have student loans or credit cards that are also potentially affected by an increase in Prime. For purposes of our example, assume an average HELOC balance of $75,000.

To keep the example simple, consider just the HELOC interest payment, not even building in principal paydown. This is important to acknowledge because many HELOCs from the real estate boom (2005-2007) are at the end of their 10-year draw period. This could add considerable pressure to the monthly payment, as some will start paying down principal at a time when interest rates might be going up.

Prime is currently at 4.00%, which results in a monthly interest payment of $250 based on a balance of $75,000.

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If Prime continues to increase, have a discussion and try to answer the question, could the member afford another 200 basis point (bp) increase in Prime?

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The members’ monthly interest payment has increased from $250 to $375, representing a $1,500 increase on an annual basis. Perhaps a conclusion is reached that, sure, our members could handle that increase.

Consider a more dramatic change in Prime. If the lifetime cap on the HELOC portfolio is 18%, determine if you feel the member could handle an increase to that level.

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The members’ monthly interest payment has increased from $250 to $1,125, representing a $10,500 increase on an annual basis. At this point many decision-makers might arrive at the conclusion that members can’t absorb an increase in Prime of this magnitude. If there is agreement that the member can handle a 200 bp increase in Prime but can’t handle a 1400 bp increase in Prime, somewhere in the middle is an implied cap on the benefit of having this variable rate product.

Once there is a consensus on how much payment increase the member can handle, the interest rate risk modeling becomes easier. Every HELOC portfolio has the potential to be unique but take a look at the characteristics and consider incorporating a more restrictive periodic cap in you’re A/LM modeling or increasing prepayments to account for this risk.

The value is in the discussion, especially if the credit union is counting on HELOCs offsetting interest rate risk in higher rate environments.