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Strategic Budgeting/Forecasting Questions: Consider Key Forces

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This is the third entry in our 6 blog series about Strategic Budgeting/Forecasting Questions.

Question 3 – What key forces could impact our forecast?

Every good forecast should have a sound rationale and basis for the assumptions. If the current forecasting approach involves simply taking last year’s growth rates and assuming they continue, that will not be good enough going forward. A better approach is to identify key forces that could impact the budget/forecast and use this discussion as the rationale for the forecast assumptions.

It is important to understand that both internal and external forces have the ability to impact the forecast. Internal forces are largely driven by the strategic plan and initiatives set forth by the credit union, as well as the ability to execute (see the first and second blogs in this series for more).

Then there are external forces that have the ability to act as headwinds, which put pressure on the strategy, or tailwinds, which help move the strategy forward. The focus here will be on external forces. What is going on in the world around the credit union that could impact the forecast?

Start by getting decision-makers into a room and brainstorming different external forces that could impact the forecast. The list of forces can be quite extensive, so go through a process of prioritization. Group the ideas into two separate categories, headwinds and tailwinds as seen in the table below.

External Forces

The value is always in the discussion.  Take the top headwinds and tailwinds, study recent trends, and use this business intelligence to inform your forecast assumptions.  Take the potential auto sales headwind as an example.

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Source: macrotrends

Study historical data and discuss as a group. Auto sales have accelerated from 2010 to 2016. More recently, they have slowed. This trend should be incorporated into the forecast, especially on how it might impact the credit union’s strategic initiatives.

What about real estate? Are home values a key force that could impact your real estate lending and ultimately the forecast? Using the S&P CoreLogic Case-Shiller or another market source, decision-makers can understand what property values are doing in the area. If your area has experienced price increases well above national averages and prices are now above previous peaks, maybe that leads the group to assuming a slight decrease in new volume.

The combination of identifying key external forces, studying history, and having a discussion will better inform the forecast. Continue to use the what-if capabilities of your forecasting model to stress test the financial impact of changes in key market forces. Following this process will help decision-makers understand how external forces can impact the financial direction of strategic initiatives.

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Focusing on Branch Profitability, Solely, Misses the Mark: 4 Things to Consider

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As consumers’ preferences continue to evolve, it is becoming painfully clear that focusing solely on branch profitability will provide an incomplete or even misleading picture for decision-makers.

Think of it this way.   Traditional branch profitability analyses often reward branches for living off the past. 

Consider a branch that has a large loan portfolio, creating a lot of revenue, ultimately leading to today’s high ROA for that branch.  However after taking a closer look, it may turn out that this branch hasn’t produced many loans over the past year.  In fact, they are one of the lower ranked branches in terms of loan production.  However, the high ROA shown in a traditional branch profitability analysis is the result of living off loan production from years ago.

Evaluation in terms of current ROA alone may result in missed opportunities to realign resources today in order to have intentional focus on strategic objectives and evolving trends.

The following outlines 4 things to consider that is guaranteed to enhance business intelligence with respect to delivery channel effectiveness.

1.  Expand the evaluation to all delivery channels.  Credit unions are investing heavily in self-service options for members.  Effective adoption of these options is key to remaining relevant for many credit unions.  A focus during on-boarding has proven to help with adoption and engagement of new self-service options

2.  Align measures of success for each delivery channel with the credit union’s strategy.  This requires decision-makers to be intentional about the purpose of each branch, the contact center, and digital delivery channels

3.  Take a holistic approach to metrics.  Rank them to align with the credit union’s strategy.  For example:

  • Membership Growth
    • Not all growth is created equal.  This can be evaluated by segments if there is a strategic emphasis on the type of membership growth
    • Assigning indirect autos to the closest branch can significantly skew results.  Consider evaluating and managing the indirect channel as a stand-alone delivery channel
    • The same holds true for membership acquired digitally.  If a branch is credited, decision-makers will not have clarity with respect to the effectiveness of their digital delivery strategy or the physical branch
  • Value-Add vs. Routine Transactions
    • Work with your team to distinguish value-add from routine transactions, then rank delivery channels accordingly.  For example, many are revamping branches to remove routine transactions so that value-add and complex transactions can be effectively and efficiently handled.  In this case, the metric would evolve around reducing routine in-branch transactions and increasing value-add transactions
  • Member Engagement & Feedback
    • Comprehensive delivery channel evaluations should incorporate what the members are saying about their experiences with the different touch-points.  Credit unions are investing heavily in digital delivery.  It is not uncommon to hear that member satisfaction with digital delivery is lower than that provided in branches.  If this is true for your credit union, ask yourself how this can impact member engagement and how the gap in member satisfaction can be narrowed
    • If the credit union has strategic emphasis on particular demographic segments, consider establishing metrics that align with this focus
  • Loan Growth
    • Rank current balance, short-term, intermediate-term, and long-term performance independently.  This addresses a common flaw of profitability studies that can focus too heavily on older loans
    • Rank major segments of lending by balance and recent production.  This provides an early warning if production is falling off
  • Share Growth
    • Consider category evaluations.  Delivery channels that rank high for regular shares or checking may benefit the credit union differently than those with a heavy reliance on money markets or CDs

4.  Weighting Is Key

  • Each of the above can be important to monitor, but not all of them will contribute equally to the credit union’s performance or strategy.  Consider the credit union’s strategic objectives and then use these objectives to help weight the importance of each category.  This intentional view of production and member experience, connected to strategy, creates better business intelligence for decision-makers than a traditional branch profitability analysis

Having a broader understanding of delivery channels in terms of contribution to strategic objectives and the trends exhibited is the first step.  This can then be combined with profitability estimates if desired.

As the financial services industry becomes more complex, it is important for decision-makers to have the right type of business intelligence so they can take action and make necessary course corrections, timely.

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Where Are Loans Falling Off?

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Credit unions need to analyze and understand their loan pipeline.  Many institutions currently look at their approval ratio or a “look-to-book” that tells them the percentage of applications being funded.  Both of these measures have value but don’t necessarily provide the full picture.

Ideally, credit unions should be looking at the number of applications, percent of applications approved, percent of applications funded and percent of approved applications funded.  Additionally, credit unions should be looking at how those numbers have changed over time to identify trends.  Reviewing this information by delivery channel can also be helpful.

Below are just a few questions decision-makers should consider as they analyze the more comprehensive view of their pipeline:

  • How have the number of applications and the percentage of approvals and funding changed over time?  Why?  For example, the credit union may be approving and funding the same ratio of applications as during the boom times of 2005 and 2006, but the number of applications has decreased.  As such, they need to look into how to increase applications
  • How have credit standards changed?  What impact is this having on approvals and denials?
  • Besides credit score, why are members not being approved?
  • What are the top three reasons approved applications are not funded?  These reasons can identify opportunities to increase loans and revenue without having to adjust credit standards to do it

With these answers, credit unions can determine how best to make changes that will increase loans funded and increase revenue.

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SILO RISK MANAGEMENT NEEDS TO STOP

Many credit unions are beefing up their risk management process.  However, a critical component of the risk management process that is missing for many is evaluating and managing risk in aggregate.

According to conventional wisdom, risk is quantified and managed in silos—including interest rate risk (IRR), credit risk, concentration risk, etc.  External forces no longer support this conventional wisdom as the world has changed.  Our belief is that decision-makers and regulators need to have a more comprehensive view of risk by attempting to quantify and manage risks related to the entire financial structure.

To read the full article, click here.

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Excerpt: Silo Risk Management Needs To Stop

Many credit unions are beefing up their risk management process.  However, a critical component of the risk management process that is missing for many is evaluating and managing risk in aggregate.

According to conventional wisdom, risk is quantified and managed in silos—including interest rate risk (IRR), credit risk, concentration risk, etc.  External forces no longer support this conventional wisdom as the world has changed.  Our belief is that decision-makers and regulators need to have a more comprehensive view of risk by attempting to quantify and manage risks related to the entire financial structure.

To read the full article, please see our c.notes page, available here.