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 and income statement.
The credit union’s delinquency ratio is a measure of the current credit risk associated with the credit union’s loan portfolio. Delinquency is a forecaster of future loan losses; therefore, unusual increases or decreases generally have an impact on future earnings. The level of delinquency a credit union can sustain is a function of several factors such as the income generated by the loan portfolio, management of credit risk, and ability to manage loan losses. Risk-based pricing is often accompanied by higher delinquency and should be weighed with higher loan yields. Conversely, low delinquency rates can indicate a credit union’s underwriting policies are too restrictive. Credit unions should evaluate this ratio in conjunction with their loan-to-share ratio, loan loss ratio, and ROA.
In today’s environment a high delinquency ratio might indicate a credit union is restructuring members’ troubled debt and, per their auditor’s suggestions, are classifying those loans as delinquent until they return to market value.
Return on Assets
ROA provides insight into how efficiently management is running the credit union and how able management is at generating profits from the credit union’s available assets. A comparison of net income and average total assets, ROA reveals how much income management is able to generate from each dollar's worth of a credit union's assets. In general, a high ROA relative to peers reflects management's success at utilizing its assets to generate income. Credit unions, however, should view ROA in light of each institution's distinct strategy. For example, if a credit union passes along potential profits to members (i.e., no fees, high deposit rates, low lending rates), then its strategy might result in a low ROA relative to its industry peers.
Net Worth to Assets
The credit union’s net worth is all of the credit union’s earnings since inception. The net worth-to-asset ratio is the primary measure of each credit union’s financial strength. According to current Prompt Corrective Action (PCA) regulations, a 7% or higher net worth ratio is a "well capitalized" credit union. At 6% the credit union is "adequately capitalized."
Capital serves several purposes. It is an insurance-like reserve to protect the credit union against unforeseen or unusual losses. Credit unions also use it to invest in future member service expansion efforts. An adequate level of capital is a judgment that balances risk and growth factors. Too high a ratio can be as detrimental to members’ interest as too low a level. Bonus! Click here for an interactive dashboard measuring asset growth and ROA to determine future net worth levels. Click and drag on 0.00% beneath the respective play buttons to show negative values.
More key ratios every Board member should know ...
Part 1: 12-month loan growth, provision for loan loss, loan portfolio profile.
Part 2: Cost of funds, net interest margin, operating expense ratio.
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.