SAN DIEGO–Credit unions were given a sobering reminder that not all loans are created equally when it comes to profitability, a problem exacerbated by the inability of many CUs to truly understand the real numbers.
One of the big problems for many CUs—significantly underestimating all of the costs involved in making a loan and then holding it in portfolio, according to one expert. Another challenge: mistakenly thinking a high volume of auto loans is more beneficial than a lower volume in other loan products.
Steve Wofford of Kohl Analytics Group, which specializes in the study of the profitability of loans and deposits, walked attendees at NACUSO’s annual meeting through an overview of loan profitability and shared findings that challenged the thinking of many.
Maximizing Efficiency
Wofford said profitability needs to be discussed within not-for-profit credit unions, but in a different context.
“You may not be in the profit business, but you are in the efficiency business, and your goal is to maximize the value for the entire relationship. That doesn’t mean it’s about making the most money,” he said.
In the case of a few credit unions that have fully embraced understanding actual loan and deposit profitability, Wofford said it’s no longer about making ROA, it becomes about managing ROA.
The First Mistake
The first mistake credit unions make: looking in the wrong place.
“When it comes to profitability, we like to look at financials. But that’s not where the good stuff is,” said Wofford. “We have to look beyond the obvious, and the financials are the obvious. There is an 800-pound gorilla everyone has sitting around, and it’s your people costs. People costs can reach 50% of all costs. If you don’t get this right…”
Wofford said most credit unions don’t understand how to properly or fully allocate personnel costs to each loan and deposit, or to each transaction, whether a loan or deposit is completed or not.
“This information is not easy to get, but it’s surprisingly straightforward,” he said.
Great Variations
Using data his company has compiled from the more than 70 credit unions with which it has worked, he said Kohl Analytics has found product profitability varies greatly among institutions. Business real estate loans tend to consistently perform well, while “returns on credit cards are all over the place, particularly if you are working on rewards cards. If you attribute all the people, time and add up all the costs, it’s tough to see profits there. One of the things we see is you cannot make a profit through interchange alone, because there is too much overhead and direct expense.”
Wofford ran his audience through a number of charts showing loan origination costs across a menu of options, amortized across the average duration of those products. In those numbers a credit union’s efficiency can be seen.
People Costs
“Most of the cost is people costs, and it’s not just the time a person sits there and does a loan,” said Wofford.
He explained that in determining actual costs what must also be factored in is, the case of an application being taken in a branch, when the process isn’t efficient, costs must be assigned to the non-utilization taking place as other members wait to be served.
To an extent, Wofford said in response to a question related to spending more time with members, it is possible to put a value on what quality service drives to the credit union.
He added that numerous expenses on the back-end of a mortgage often aren’t calculated. One organization the company worked with was spending 40 extra hours on mortgages that amounted to $500,000 in extra expenses.
Sales and Marketing
To no one’s surprise, Wofford noted lot of sales and marketing costs go into real estate lending, although the variability in costs among institutions is again “all over the place,” according to Wofford. Sales and marketing costs must be built into the model for determining profitability of all products, he reminded.
Origination Effectiveness
“Origination effectiveness is time,” said Wofford. It’s yet another area where there is great variability among products. Even though credit unions are relatively efficient on new auto loans, low rates have been “brutal” on profitability, he observed. “This is where your real opportunities are to find inefficiencies in your organization.”
Another “huge driver” of profitability in lending is the so-called “look-to-book ratio,” that is, how many applications did the credit union take, how many hit the books and how many were approved but never hit the books (the borrower switched to another channel or opted against the loan).
“If you have a 10% look-to-book ratio, that means you had to spend time on 10 loans to get one to hit the books. If it cost you $500 to book a loan, your real cost is $500 x 10. Somebody has to pay it.”
Have Automated Underwriting, But…
Wofford said it’s true many CUs have automated underwriting, but one survey found just 30% actually use the software. In some cases, credit unions use the automated underwriting, but then also manually review and approve, meaning they are playing twice.
Approved Applications Booked
Wofford said when business real estate loans hits the books, it may be expensive, but the CU only has to do it once. “That makes the real cost fall like a rock. On the other end of the spectrum is new vehicle direct loans, where many apps fall out, after the member goes through the app process, gets approved, and then walks into the dealer who says, ‘Oh, we can do it all for you.’ So now you’ve done all the work for you and the dealer,” observed Wofford.
Other Points Raised
Other points made by Wofford:
- Why do variable rate loans have a higher cost? Because more time is spent by staff explaining the product.
- Similarly, it’s the staff time involved that makes payday loans so expensive to offer.
- CRE pulls in better rates and the costs associated with doing them on a percentage of balance basis is miniscule compared to auto loans.
- “On average, the most profitable loan is the personal line of credit, but you can’t live on them because they are too small.”
- The number of auto loans closed doesn’t matter, it’s how many loans did the credit union keep. “The number closed isn’t the golden goose, it’s what you are making on the loans.”