In December, the NCUA passed a rule requiring Board members of federally insured credit unions to have a “working familiarity with basic finance and accounting practices.” The extent of financial literacy that volunteers must meet varies depending upon each credit union’s complexity, but there are basic concepts, definitions, and formulas every volunteer should know. To that end, CreditUnions.com is breaking down 15 ratios by providing definitions and describing how the ratios affect the balance sheet.
Cost of Funds
A credit union’s cost of funds is calculated as the dividends paid to members or interest paid on borrowed money, divided by the average outstanding shares and borrowings. This metric, the deposit/payout equivalent of Yield on Loans, is influenced externally by the overall rate environment and internally by the makeup of the deposit portfolio and member demographics. For example, older members might have more CDs or a more affluent membership might have higher balances on tier-priced products. Both situations will drive up the cost of funds. Credit unions with high checking account penetration will generally have lower cost of funds.
Advanced Metric: A credit union’s dividends-to-income ratio, also known as the payout ratio, is influenced by the organization’s loan and deposit pricing strategies and ALM strategies. Credit unions with strong lending performance will increase the income component of the ratio, thereby driving down the ratio.
Net Interest Margin
A credit union’s net interest margin, interest income from loans and investments minus interest paid to members or on borrowed funds divided by average assets, is the result of the organization’s execution of its lending, investing, and liquidity strategies. The credit union’s ability to manage spread is a critical component in managing this metric. For example, a credit union’s ability to appropriately price loan products (through risk-priced loans) or deposit products (through a pricing strategy that clearly differentiates between rate sensitive and non-rate sensitive products) significantly enhances the organization's flexibility in managing the margin.
Operating Expense Ratio
Operating expenses to average assets reflects both the operating efficiency and the operating strategy of a credit union. In comparing expenses to assets, this ratio underscores the idea that a larger balance sheet results in a larger operation that requires greater resources. Some credit unions pursue strategies focused on a physical member service network that requires investment in branches and ATMs; other credit unions focus on serving members through alternative channels such as call centers and the Internet. Cooperative efforts to manage expenses can have a significant impact on a credit union's market competiveness and the value it creates for members.
Note: Recent changes to the 5300 call report by the National Credit Union Administration now include NCUSIF premiums and TCCUSF assessments in total operating expenses. Excluding these line items allows for a more accurate historical comparison.
More key ratios every Board member should know ...
Part 1: 12-month loan growth, provision for loan loss, loan portfolio profile.
Part 3: Delinquency, return on assets, net worth to assets.
Part 4: Operating expense to income, efficiency, members per employee.
Part 5: Fee income per member, member growth, average relationship per member.
Click here for a complete listing of the 15 ratios every Board member should know.