The Challenge of Cooperative Governance Mike Higgins, Jr. Mike Higgins & Associates, Inc. Email: mhigginsjr@mhastakeholders.com Twitter: @mhigginsjr
Full Disclosure: I own stock in a bank. I own part of a credit union. 2
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No Singular Profit Mandate Maximize Return 4
Credit Union Dual Mandate Provide benefit to members Stay adequately capitalized Minimize ROA Maximize ROA 5
Context for Today s Discussion 1. Comfort Zone of Knowledge: What you know may not be what is best for members. 2. Member Focused Priorities: A member value approach to cooperative governance. 3. Board Governance Scorecard: Learn, trust and verify. 4. External Validation: How do we know if we are getting a good deal? 6
Comfort Zone of Knowledge
MONEYBALL It s unbelievable how much you don't know about the game you ve been playing all your life. -Mickey Mantle
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 10
CUBALL Your goal should not be to extract profit from members and hoard it away as capital. Your goal should be to create value for members and be good stewards of profit taken for regulatory compliance. 11
HELLO My Name Is Bank in CU Clothing 12
HELLO My Name Is Return on Assets Profit extracted from members in current year 13
HELLO My Name Is Net Worth Cumulative profit extracted from members 14
HELLO My Name Is Asset Size Members pay asset growth tax (more assets = more net worth) 15
Member Focused Priorities
Do Good Recognize Employees (Base, Benefits, Bonus) Create Member Value (Product Mix, Productivity, Provision, Pricing) Sustain the Entity (Optimal ROA to Maintain Net Worth) 17
Sustain Entity Net Worth Establish target net worth range. Product Mix Productivity Provision CU Board Chair: Uh, Mike, we don t think that s something we should play a role in. Pricing 18
Sustain Entity Net Worth Establish target net worth range. One of the most important Product Mix cooperative decisions is how much member capital to hold. Productivity Provision Set minimum for soundness. Set maximum to avoid Pricing hoarding. 19
Sustain Entity Net Worth Establish minimum and optimal return on assets. Product Mix Not Enough Just Too Much ROA Right ROA Productivity Provision Pricing Minimum Optimal 10% X 5% = 0.50% + 0.20% = 0.70% Target Net Worth Ratio X Asset Growth Appetite = Minimum ROA Minimum ROA + Safety Margin = Optimal ROA 20
Sustain Entity Net Worth Product Mix Deploy member net worth in fiduciary manner. $$$$ Weak Product Mix Mix Productivity Provision Pricing Assets $$$$ Member Investment Rate Sensitive Funds Relationship Shares Loans Non-Interest Income Income Low Strategic Value High 21
Sustain Entity Net Worth Product Mix Deploy member net worth in fiduciary manner. 10% Growth Weak Product Mix Mix Taking more from members and squandering it. Productivity Provision Pricing Assets 10% More Member Investment Rate Sensitive Funds Relationship Shares Loans Non-Interest Income Income Low Strategic Value High 22
Sustain Entity Net Worth Product Mix Deploy member net worth in fiduciary manner. 0% Growth Don t Grow (GASP!) Product -- Improve Mix Product Mix Productivity Provision Pricing Assets 0% More Member Investment Rate Sensitive Funds Relationship Shares Loans Non-Interest Income Income Low Strategic Value High 23
Sustain Entity Net Worth Deploy member net worth in fiduciary manner. Avoid Net Worth Tax: Product Mix 1. Generate Recurring, Value-Based Non-Interest Income 2. Grow Loans Productivity 3. Improve Funding Mix (Relationship Vs. Rate Sensitive) Provision Pay Net Worth Tax: Pricing 4. When Growing Assets Is Necessary (Lowest Priority) 24
Sustain Entity Net Worth Manage expense efficiently and effectively. Product Mix Net Operating Expense (Efficiently: Operating Expense minus Non-Interest Income) Productivity Provision Strategic Balance (Effectively: Loan Balance plus Regular & Draft Share Balance) Pricing The smaller the ratio, the more efficient and effective use of expense. 25
Sustain Entity Net Worth Manage expense efficiently and effectively. Product Mix Productivity Expense Assets Counts expense, but ignores revenue associated with income producing areas. Provision Pricing Efficiency Ratio Impacted by interest rates; driven by profit extracted from members. 26
Sustain Entity Net Worth Product Mix Avoid excessive credit losses. 1. Establish Net Charge-Off Tolerance 2. Determine Adequate Reserve for Losses Productivity Provision Pricing 27
Sustain Entity Net Worth Product Mix Provide tangible economic benefit for members. 1. Below Market Loan Yield 2. Above Market Dividend Rate Productivity 3. Superior Surplus Funds Yield Provision 4. Supplemental Dividend/Giveback Pricing Opportunity for value pricing function of product mix, productivity and provision. 28
Board Governance Scorecard
Member Focus Category Min. ROA Actual Status Sustain Entity Net Worth 9.0% Product Mix (% Assets) Loans Relationship Shares 82% 40% Non-Interest Income 1.54% Productivity Net NIE / Strategic Balance 2.08% Provision Net Charge-Offs (% Lns) Loan Loss Reserve 0.32% 1.50x NCO Loan Yield 4.69% Pricing Surplus Funds Yield 1.07% Cost of Funds 0.58% Profit (Optimal ROA) Return on Assets Asset Growth Supported 30
Algebra That Ties It Together Minimum ROA = Ln Asset Pct * Ln Yld + Surplus Funds Pct * Surplus Funds Yld + NII Pct Assets - (Net NIE / Strategic Bal * (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 Asset Growth Supported = ROA / Net Worth Pct 31
Member Focus Category Min. ROA Actual Status Sustain Entity Net Worth 9.0% Product Mix (% Assets) Loans Relationship Shares 82% 40% Changes made above line Non-Interest Income 1.54% Productivity Net NIE / Strategic Balance 2.08% Provision Net Charge-Offs (% Lns) Loan Loss Reserve 0.32% 1.50x NCO Pricing Loan Yield Surplus Funds Yield 4.69% 1.07% immediately reflected on bottom line. Cost of Funds 0.58% Profit (Optimal ROA) Return on Assets Asset Growth Supported 0.62% 6.9% 32
Board Governance Control Chart 33
Board Governance Control Chart Trend of recent performance 34
Board Governance Control Chart Stay Above Lower Limit 35
Board Governance Control Chart Stay Below Upper Limit 36
Board Governance Control Chart Strategic Plan 37
Board Governance Control Chart Forward Focus Going to be OK? 38
Board Governance Framework Learn: Scorecard maintains net worth. Trust: In control; move on. Verify: Out of control; mitigation plan. 39
External Validation
Define Peer on Similar Spend Vs. (not asset size) 41
Define Peer on Similar Spend Normal Distribution 42
Similar Investment in Operations Loan Balance: More = Better Relationship Share Balance: More = Better Non-Interest Income: More = Better Credit Losses: Fewer = Better Loan Yield: Lower = Better (Reduces ROA) Surplus Funds Yield: More = Better Dividend Rate: More = Better (Reduces ROA) 43
Similar Investment in Operations Loan Balance: +$113m Loan Yield: -0.42% $3,414k $1,750k Net Charge-Offs: -0.18% $741k Dividend Rate: +0.16% $677k Relationship Shares: +$41m $589k Surplus Funds Yield: -0.49% Non-Interest Income: -$530k Member Value Created ($355k) ($530k) $6,286k 44
Recapping 1. Focus on what is best for members, not comfort zone of knowledge. 2. Establish governance targets that drive long-term sustainability of cooperative. 3. Utilize scorecard to build trust and verify results. 4. Use expense peer to answer question: Are we getting a good deal for our investment in operations? 5. Use member value created to promote credit union!!! 45
The Challenge of Cooperative Governance Mike Higgins, Jr. Mike Higgins & Associates, Inc. Email: mhigginsjr@mhastakeholders.com Twitter: @mhigginsjr