6/6/2016. Copyright Mike Higgins & Associates, Inc. Copyright Mike Higgins & Associates, Inc.

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2 No Singular Profit Mandate Maximize Return 3 Credit Union Dual Mandate Provide benefit to Stay adequately capitalized Minimize ROA Maximize ROA 4 2

3 Four Steps to Solve the Riddle 1. Guiding Philosophy: We will be a Member focused entity. 2. Quantify It: How do we measure success? 3. Prepare for It: Roadmap to long-term sustainability. 4. Prove It: External validation. Minimize ROA Maximize ROA 5 MONEYBALL It s unbelievable how much you don't know about the game you ve been playing all your life. -Mickey Mantle 6 3

4 MONEYBALL Your goal should not be to buy players. Your goal should be to buy wins. In order to win, you need to score runs. In order to score runs, you need to get on base. On Base Percentage: Walk = Hit 8 4

5 CUBALL 9 HELLO My Name Is Bank in CU Clothing 10 5

6 HELLO My Name Is Return on Assets Profit extracted from in current year 11 HELLO My Name Is Net Worth Cumulative profit extracted from 12 6

7 HELLO My Name Is Asset Size pay asset growth tax (more assets = more net worth) 13 HELLO My Name Is Executive Compensation Incentivized to Take From (Maximize ROA, Net Worth and Asset Size) 14 7

8 CUBALL Your goal should not be to extract profit from and hoard it away as capital. You goal should be to create value for and be good stewards of profit taken for regulatory compliance. = Take Only What is Necessary 15 Guiding Philosophy 16 8

9 Hierarchy of Member Do Focused Priorities Good (Performance Dividend) Create Member Value (Efficient Use of Member Resources) How much can we create? (Maintain Net Worth) 17 Maintain net worth. Efficient use of Member resources. Retain and attract talent. Concern for community. Take only enough to maintain net worth. 18 9

10 Maintain net worth. are the owners. They contribute to and democratically control the capital of the cooperative. 1. Set minimum for safety and soundness. 2. Set maximum to avoid hoarding. 19 Make efficient use of Member net worth. Balance Sheet Product Mix 1.20% Cost 1.20% Yield 10% Asset Growth Tax Relationship Shares Rate Sensitive Funds Capital Loans Surplus Funds Non Earning 20 10

11 Make efficient use of Member net worth. Improve Product Mix First; Grow Assets Second Demonstrates Knowledge, Skill and Ability Demonstrates Knowledge, Skill and Ability No Asset Growth Tax Relationship Shares Rate Sensitive Funds Capital Loans Surplus Funds Non Earning 21 Make efficient use of Member net worth. Improve Product Mix First; Grow Assets Second Not an Asset; No Tax Relationship Shares Rate Sensitive Funds Capital Non-Interest Income Loans Surplus Funds Non Earning 22 11

12 Make efficient use of Member net worth. Priorities to Avoid Asset Growth Tax: 1. Recurring, Value-Based Non-Interest Income 2. Improve Asset Mix (Loans) 3. Improve Funding Mix (Relationship Shares) Pay Asset Growth Tax: 4. When Liquidity Needed (Lowest Priority) 23 Make efficient use of Member net worth. Implications of Strong Product Mix: 1. Improves ROA without taking from. 2. Demonstrates institutional competency. 3. Improves overall safety and soundness

13 Balance Sheet Balance Sheet Income Statement Balance Sheet Balance Sheet Income Statement 6/6/2016 Operate in a productive manner. Traditional Productivity Components Loans Investments Non-Earning Relationship (Low Int Rate Risk) Rate Sensitive (High Int Rate Risk) Capital Net Interest Income Non-Interest Income Non-Interest Expense 25 Operate in a productive manner. Strategically Most Valuable Loans Investments Non-Earning Relationship (Low Int Rate Risk) Rate Sensitive (High Int Rate Risk) Capital Net Interest Income Non-Interest Income Non-Interest Expense 26 13

14 Balance Sheet Balance Sheet Income Statement Balance Sheet Balance Sheet Income Statement 6/6/2016 Operate in a productive manner. Expense to Asset Ratio Loans Investments Non-Earning Ignores Strategic Balance Relationship (Low Int Rate Risk) Rate Sensitive (High Int Rate Risk) Assumes All Assets Equally Important Capital Counts Expense; Ignores Income Net Interest Income Non-Interest Income Non-Interest Expense 27 Operate in a productive manner. Efficiency Ratio: Expense / (Net Interest + Non-Int Income) Ignores Entire Loans Investments Non-Earning Balance Sheet Interest Rates Productivity Relationship (Low Int Rate Risk) Rate Sensitive (High Int Rate Risk) Capital Net Interest Income Non-Interest Income Non-Interest Expense 28 14

15 Operate in a productive manner. A Better Way: Higgins Ratio (SM) Non-Interest Expense Minus Non-Interest Income = Net Cost Loans Plus Relationship (Low Int Rate Risk) Strategic Balance Lowest Net Cost per Strategic Balance Dollar is Most Productive 29 Operate in a productive manner. Grow Expense 5 Percent A Better Way: Higgins Ratio (SM) Non-Interest Expense Non-Interest Income = Net Cost Loans Relationship (Low Int Rate Risk) Strategic Balance Manage Right Growth to Restore Ratio 30 15

16 Manage credit losses within tolerance. 1. Establish Net Charge-Off (NCO) Tolerance 2. Set Loan Loss Reserve Multiple (Wall Height) 3. Loan Loss Reserve is NCO X Multiple 2.00 X NCO Net Charge-Offs LLR Multiple Loan Loss Reserve Member Net Worth 31 Provide Member favorable pricing. 1. Below market loan yield. 2. Above market dividend rate. 3. Superior surplus funds yield. 4. Lower prices on fees and charges

17 Retain and attract talent. 1. Performance dividend based upon value created for (not taken from). 2. Competitive compensation and benefits. 3. Career and personal development plans. 33 Concern for community. 1. Member give-back. 2. Community outreach. 3. Foundational funding. Intrinsic Reward 4. Do something good! 34 17

18 Take only what is necessary. Not Enough ROA Just Right Too Much ROA Minimum Optimal 10% X 5% = 0.50% % Safety Mgn = 0.70% Minimum ROA = Target Net Worth Ratio X Appetite for Asset Growth = Minimum ROA + Safety Margin 35 Hierarchy of Member Do Focused Priorities Good (Performance Dividend) How much can we create? Create Member Value (Efficient Use of Member Resources) (Maintain Net Worth) 36 18

19 Measure It 37 Algebra that Builds Hierarchy of Member Values Formula to Provide Member Benefit = (Ln Asset Pct x Ln Yld + Surplus Funds Pct x Surplus Funds Yld + NII Pct Assets - (Higgins Ratio (SM) * (Ln Asset Pct + Rel Share Pct) + NII Pct) - NCO Pct * Ln Asset Pct - Ln Growth x Ln Asset Pct x NCO Pct x LLR Mult) x (1-( Pct + Pct) Formula to Stay Adequately Capitalized Asset Growth Supported = / Target Net Worth Pct 38 19

20 Hierarchy of Member Values Sustain Create Member Value 39 Hierarchy of Member Values Total Assets Sustain Net Worth Definitions Total Assets in dollars Net Worth as a percentage of assets. Create Member Value 40 20

21 Hierarchy of Member Values Total Assets Sustain Net Worth Loans Relationship Shares Non-Interest Income Higgins Ratio (SM) Create Member Value Net Charge-Offs Loan Loss Reserve Loan Yield Surplus Funds Yield Cost of Funds Performance Dividend Community Giving Net Income (ROA) Growth Supported Definitions Loans, Relationship Shares and Non-Interest Income as a percentage of assets. Higgins Ratio (SM) as defined earlier. Net Charge-Offs as a percentage of loans Loan Loss Reserve as a multiple of net charge-offs. Loan Yield, Surplus Fund Yield and Cost of Funds as a percentage of balance. 41 Hierarchy of Member Values Total Assets Sustain Net Worth Loans Relationship Shares Non-Interest Income Higgins Ratio (SM) Create Member Value Net Charge-Offs Loan Loss Reserve Loan Yield Surplus Funds Yield Cost of Funds Performance Dividend Community Giving Net Income (ROA) Growth Supported Definitions Performance Dividend and Community Giving as a percentage of operating net income

22 Hierarchy of Member Values Total Assets Sustain Net Worth Loans Relationship Shares Non-Interest Income Higgins Ratio (SM) Create Member Value Net Charge-Offs Loan Loss Reserve Loan Yield Surplus Funds Yield Cost of Funds Performance Dividend Community Giving Net Income (ROA) Growth Supported Definitions Net Income as a percentage of average assets. Growth Supported as defined earlier. 43 Hierarchy of Member Values Sustain Create Member Value Now Total Assets $ Net Worth % Loans % Relationship Shares % Non-Interest Income % Higgins Ratio (SM) % Net Charge-Offs % Loan Loss Reserve Loan Yield % Surplus Funds Yield % Cost of Funds % Performance Dividend % Community Giving % Net Income (ROA) % Growth Supported % X Status Quo Analysis (Now) Review current performance. Eliminate outliers and non-recurring items. Populate current performance values. Combination of values is what the credit union will make and how much asset growth it will support if nothing changes (algebra ties it all together). Analysis helps with vetting budget

23 Hierarchy of Member Values Sustain Create Member Value Now Total Assets $ Net Worth % Loans % Relationship Shares % Non-Interest Income % Higgins Ratio (SM) % Net Charge-Offs % Loan Loss Reserve Loan Yield % Surplus Funds Yield % Cost of Funds % Performance Dividend % Community Giving % Net Income (ROA) % Growth Supported % X Growth Supported Not enough to support strategic priorities? Then something has to change; performance must improve or strategy revised. Performance Options: - Reduce/eliminate performance dividend. - Reduce/eliminate community giving. - Improve productivity. - Improve asset quality. - Take more from via pricing. 45 Hierarchy of Member Values Now Mitigation Sustain Create Member Value Total Assets $ $ Net Worth % % Loans % % Relationship Shares % % Non-Interest Income % % Higgins Ratio (SM) % % Net Charge-Offs % % Loan Loss Reserve X X Loan Yield % % Surplus Funds Yield % % Cost of Funds % % Performance Dividend % % Community Giving % % Net Income (ROA) % % Growth Supported % % Mitigation Values Mitigation values are minimum levels of acceptable performance. Review current performance, recent trends and peer to establish targets. If performance falls outside of mitigation boundary, plan of corrective action is required. Combination of mitigation values is the worst thing that can happen to credit union (algebra ties them together)

24 Hierarchy of Member Values Now Mitigation Yr. +1 Yr. +2 Yr. +3 Yr. +4 Yr. +5 Total Assets $ $ $ Sustain Long Range Plan Net Worth % % % Establish long term targets. Loans % % % Relationship Shares % % % Non-Interest Income % % Review current performance % Higgins Ratio (SM) % % and peer for perspective. % Create Member Value Net Charge-Offs % % % Hitting targets will: Loan Loss Reserve X X X Loan Yield % % - Increase Member value % - Fund community giving Surplus Funds Yield % % % - Fund performance dividend Cost of Funds % % - Demonstrate competency % Performance Dividend % % - Improve safety and soundness % - Allow CU to make destiny Community Giving % % % Net Income (ROA) % % % Growth Supported % % % 47 Hierarchy of Member Values Now Mitigation Yr. +1 Yr. +2 Yr. +3 Yr. +4 Yr. +5 Sustain Total Assets $ $ $ Net Worth % % % Loans % % Taking Too Much % Relationship Shares % % % Non-Interest Income % % % Higgins Ratio (SM) % % % Create Member Value Net Charge-Offs % % % Loan Loss Reserve X X X Loan Yield % % % Surplus Funds Yield % % % Cost of Funds % % % Performance Dividend % % % Community Giving % % Member Net Worth % Net Income (ROA) % % % Growth Supported % % % 48 24

25 Hierarchy of Member Values Now Mitigation Yr. +1 Yr. +2 Yr. +3 Yr. +4 Yr. +5 Sustain Total Assets $ $ $ Net Worth % % % Loans % % Look for Merger Partner % Relationship Shares % % % Non-Interest Income % % % Higgins Ratio (SM) % % % Create Member Value Net Charge-Offs % % % Loan Loss Reserve X X X Loan Yield % % % Surplus Funds Yield % % % Cost of Funds % % % Performance Dividend % % % Community Giving % % Member Net Worth % Net Income (ROA) % % % Growth Supported % % % 49 Hierarchy of Member Values Now Mitigation Yr. +1 Yr. +2 Yr. +3 Yr. +4 Yr. +5 Sustain Total Assets $ $ $ Net Worth % % % Loans % % Just Right % Relationship Shares % % % Non-Interest Income % % % Higgins Ratio (SM) % % % Create Member Value Net Charge-Offs % % % Loan Loss Reserve X X X Loan Yield % % % Surplus Funds Yield % % % Cost of Funds % % % Performance Dividend % % % Community Giving % % Member Net Worth % Net Income (ROA) % % % Growth Supported % % % 50 25

26 Prove It 51 Expense Peer Vs. What are we getting for similar investment in operations? 52 26

27 Loans for $16m Spend TCU $298m $155m 0.84% ROA Benefit Peer $298m $0m $100m $200m $300m $400m $500m 53 Relationship Shares for $16m Spend TCU $193m $47m 0.12% ROA Benefit Peer $193m $0m $50m $100m $150m $200m $250m 54 27

28 Non-Interest Income for $16m Spend TCU $4.7m $0.7m 0.13% ROA Opportunity Peer $5.4m $0.0m $1.0m $2.0m $3.0m $4.0m $5.0m $6.0m 55 Net Charge-Offs TCU $0.6m $0.5m 0.09% ROA Benefit Peer $1.1m $0.0m $0.2m $0.4m $0.6m $0.8m $1.0m $1.2m 56 28

29 Loan Loss Reserve TCU $1.4m $0.7m 0.13% ROA Benefit Peer $2.1m $0.0m $0.5m $1.0m $1.5m $2.0m $2.5m 57 Loan Yield TCU 3.96% 0.54% 0.45% ROA Benefit Peer 4.50% 0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 58 29

30 Dividend Rate TCU 0.59% 0.10% 0.08% ROA Benefit Peer 0.59% 0.00% 0.20% 0.40% 0.60% 0.80% 59 Surplus Funds Yield TCU 1.29% 0.26% 0.03% ROA Opportunity Peer 1.55% 0.00% 0.50% 1.00% 1.50% 2.00% 60 30

31 Member Value Summary Loans 0.84% Loan Yield 0.45% Loan Loss Reserve Relationship Shares Net Charge-Offs Dividend Rate 0.13% 0.12% 0.09% 0.08% Surplus Funds Yield Non-Interest Income -0.03% -0.13% Overall 1.55% -1.75% -1.25% -0.75% -0.25% 0.25% 0.75% 1.25% 1.75% 61 Recapping 62 31

32 Credit Union Dual Mandate Provide benefit to Stay adequately capitalized Minimize ROA Maximize ROA 63 Solve the Riddle!!! 1. Establish guiding philosophy. 2. Measure success using de-facto member value drivers. 3. Develop a long-range plan that focuses on member value. 4. Validate value created against expense peer. 5. Do the Most Good!!! 6. Brag about it (virtuous cycle)

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