I read an article about a credit union recently in which the CEO proudly noted a near-prime (ahem, subprime) lending program was responsible for generating an ROA of 2.93%. I read another article where a credit union CEO commented his ROA was 2.22%.
I was confused. Surely, no member-focused entity would produce profit-mongering returns like that. I re-read both articles, just to make sure the information was correct. Unfortunately, it was.
Producing an ROA like what was mentioned in the articles is not a badge of honor, it is a shameful scarlet letter.
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Credit unions serve a dual mandate. They must extract enough profit from their members (ROA) to stay adequately capitalized (cumulative profit not returned to members) and at the same time, they need to create tangible economic value for their members (lower loan yields, higher dividends rates and fewer fees) which comes at the expense of ROA and net worth. The objective of every member-focused credit union should be to optimize, not maximize, ROA so the dual mandate can be fulfilled.
Identifying the optimal ROA is not difficult. It's simply a function of appetite for asset growth and the target net worth ratio the credit union wants to maintain. For example, if the appetite for asset growth is 7.0% and the target net worth ratio is 10.0%, then the optimal ROA is 0.70%. End of story. Producing an ROA higher than 0.70% extracts too much profit from members (capital growing faster than assets). Producing an ROA less than 0.70% deteriorates the net worth ratio (assets growing faster than capital).
Let's circle back to the near-prime lending credit union. They charge their B, C and D members more to borrow money. It's called risk-based lending. It should be called perceived risk-based lending. The CEO confirmed this by noting that "during the downturn, nonprime borrowers were not the ones that cost the credit union the most money; it was the small number of prime and super prime borrowers."
I would assert this credit union has a moral and ethical obligation to return some of the 2.93% ROA generated off the backs of their near-prime members to them. A member that does not miss a payment and successfully pays all of the money back should get a rebate check. The credit union should recognize it was in error by over-charging for perceived credit risk when no credit risk was realized.
The optimal ROA is also a number both the board of directors and the management team can easily agree upon at planning time. It is literally where the bar of performance should be set because it satisfies the dual mandate.
Mike Higgins Jr.
Partner, Mike Higgins & Associates Inc., Kansas City
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