Use It Or Lose It
I was watching the women's Wimbledon tennis finals last month and, not really being more than just a recreational player myself, I was struck by what a simple game it actually is. You serve the ball, stay back and volley until an opening is created, and then pounce, usually with a strong corner shot which, even if your opponent returns it, puts them far out of position. You follow that up by charging the net to slam home your opponent's feeble return.
It is rare that you find a player in control of the game anywhere near the middle of the court. To a novice this may seem to be the best place to be, all parts of the court are somewhat in reach. However, this is really "no man's land", too far from the net for an aggressive return and too close to the net to return a well-placed lob shot (that's the soft shot that goes over a players head, just inside the baseline).
So what does this have to do with credit unions, you might ask?
Nearly seven out of eight credit unions have a capital-to-asset ratio greater than 9%. Read that again, 9%. Think about that. That's one out of every 11-member dollars locked up safely in the cash drawer at night. Is this more about the best use of your member's money or helping you sleep at night? To paraphrase everybody's favorite quirky capitalist Ross Perot, capital makes you well, let's just say sluggish and content (I heard that he was actually more direct than that, but you get the point). It may feel like that comfortable middle of the court strategy, but it's really a false illusion.
At a time when our industry struggles to find new and creative ways serve our members, and members are struggling to maintain their lifestyle (in the face of higher mortgage and energy costs), here's a couple of old-fashioned ideas that I hope catch on: either pay it back through a capital redemption program, or get more out of it through leverage. As the saying goes, "Use it or lose it."
I know, I know, "but Ron, what if it rains? What if my sponsor goes under? Or what if taxation occurs? Or what if ... (you fill in the blank)?"
Well, we manage it. That's in fact, why we're here isn't it, to serve our members? What better way to serve members than by ensuring that, 1) we get the most, the most, out of every dollar that they entrust to us. And when we're fresh out of ideas, 2) give it back with a big smile and a warm "thank you."
First, getting the absolute most out of our capital. As an industry, we have a well-deserved reputation for providing our members with the highest quality of service, especially in the traditional areas of retail deposits and consumer lending. These products and services have a direct impact on our members' well being. However, our track record, when it comes to other products and services, is a bit spotty. For example, according to recent 5300 data, nearly two-thirds of us have less than 20% of our assets in real estate loans. This market, where most of our members will make the biggest financial commitment of their life, can offer us a safe and stable source of interest income, not to mention the countless opportunities for cross-selling to our members. But let's say that your membership doesn't really lend itself to a successful real estate lending program. There are countless loan participation programs being offered by the credit union network where you have the opportunity to not just increase interest income, but to help another credit union in a higher lending area. Other alternatives include business lending, where credit union activity is really still just a blip on the radar screen. There are many providers that can help you in selecting and monitoring the best group of loans for your portfolio. And from a risk perspective, three-quarters of us have over half of our balance sheet in risk-reducing core deposits, so we have ample room to take on risk from an interest rate standpoint.
Now some of you are reading this and saying, if only I could get more deposits in the door without paying the high rates of the early '80s. Well, this is where the "L" word comes into play (Leverage). Your competitors think nothing of taking down an advance or some other form of long-term borrowing to (profitably) fund their lending operations. It's part of their culture. Having previously been employed on the funding desk of a multi-billion dollar institution, I can tell you that we were completely indifferent as to how we raised funds, either through our customer base or on Wall Street (as are most banks today). We also had all of the resources needed to fully load the costs associated with each alternative, and this was 15 years ago. Imagine the resources you have available to you now to manage an efficient funding program.
This leverage also helps to serve your members, although in a slightly less direct fashion because when all is said and done, it's the members that benefit from the growth in capital that this leverage creates. And, yes, it will erode your ROA while the balance sheet is ballooned, but poll your members and ask them if they would rather you have a high ROA for the next, say, three years, or more capital?
Now, if we've reasonably exhausted all of the areas where we can put our members' capital to work, and we still have a double digit capital ratio, its time to develop a plan for returning capital to its rightful owner. There are many schools of thought on this today, and no one method stands out, but suffice it to say, if this is an option, find a trusted provider to help you develop a program that allows you to generate the most member goodwill. I think most of us would prefer to NOT return capital, but work to get more out of it, and I agree. Retaining and using our members' capital better helps us advance our mission, but we really should start putting it to work. By the way, if I am a government bureaucrat and I see a very healthy 9% capital and tax-exempt status, I might be inclined to think very hard about CU taxation (I don't like it either, but like they say on the Sopranos, "I'm just sayin' Tony.").
So, to use a tennis analogy, either charge the net with a sound strategy to leverage efficiently, or stay back and volley with a well thought-out long-term capital redemption strategy, because there aren't many tennis players out there whose success comes from playing in the middle of the court.