The NCUA requires 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. For personalized information on your credit union, check out Callahan & Associates’ two-year financial comparison, available on Search & Analyze on CreditUnions.com.
1) 12-Month Loan Growth
Loan growth is the year-over-year change in outstanding loans. These are loans the credit union holds on its books, not the loans it makes over the course of the year. Credit unions wrote almost $34 billion more in first mortgage loans than they did one year ago, reporting year-over-year growth of 10.2% as of March 31, 2017. By comparison, the 5,856 U.S. banks in Callahan & Associates’ Peer-to-Peer database issued more than $330 billion in additional loans and reported first mortgage loan growth of 5.7%.
Advanced Metric: If outstanding shares grow faster than loans, the loan-to-share ratio, a measure of credit union liquidity, decreases. In this circumstance, the credit union has additional shares available to lend if it desires.
2) Provision For Loan Losses
This line item is the point for transferring funds to the Allowance for Loan Loss account. As credit unions foresee or experience worsening asset quality, they may increase the provision amount to provide for additional coverage in their Allowance for Loan Loss reserve. As the recession passed and asset quality improved, credit unions nationwide decreased their annual provision amounts by nearly 25%. These cuts helped improve net income.
Advanced Metric: Once the funds have reached the Allowance account, credit unions can measure their coverage ratio by dividing the Allowance balance by total reportable delinquent loans. This metric essentially states how much the credit union has to cover loans it might not recover.
3) Loan Portfolio Profile
A credit union’s loan portfolio is broken into three primary classifications — real estate loans, auto loans, and all other loans. Each of these categories has characteristics that make a positive contribution to the credit union as well as creates challenges for the credit union to manage. Balancing profitability, member relationships, asset liability management policies, and operational risk across key lending areas is one of the primary jobs of credit union management.
Advanced Metric: Yield on Loans varies depending on the credit union’s loan concentration. Loan portfolios with high percentages of real estate loans have a tendency toward lower yields just as portfolios with higher percentages of high rate consumer loans (credit cards or signature loans) have a tendency toward higher yields.
4) 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.
5) 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.
6) 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.
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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.
8) 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.
9) 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.
10) Operating Expense To Income
The operating expense ratio is a measurement of operating expenses relative to the credit union’s asset base. Although it is important to be aware of the operating expense ratio, it is equally important to understand how expenses compare to the credit union’s income. The relationship between operating expenses and income is driven by several factors, including member demographics and the credit union’s philosophy toward products, service levels, and technology.
The credit union’s expense-to-income ratio depends upon its ability to generate income from its products and services. A credit union’s operating expense-to-income ratio can also measure its productivity, as successfully managed technology investments contribute to a credit union’s productivity, which, in turn, lowers expenses. Finally, on the income side of the equation, product-pricing strategies also have a significant impact on the ratio.
11) Efficiency Ratio
The operating expense-to-income ratio measures expenses to total income. The efficiency ratio, on the other hand, compares expenses to operational income (interest income, fee income, and other operating income) minus interest expense. A high or increasing efficiency ratio means the credit union is losing a larger share of its core income to overhead expenses. A low efficiency ratio means operating expenses represent a smaller percentage of income (i.e., the credit union is comfortably covering operating expenses through its key business lines). So, the lower the efficiency ratio, the better.
The efficiency ratio can fluctuate. Because income is generally more sensitive than expenses to interest rate changes, the ratio is influenced, in part, by the interest rate environment. In theory, credit unions with higher ratios of fee income to total income should see less fluctuation in the efficiency ratio than credit unions with little fee income.
12) Members Per Employees
The members-to-employees ratio measures the number of members per each full-time equivalent employee. Given that human resource costs are typically credit unions’ highest dollar operating expense, this ratio is critical. Theoretically, a higher ratio means a credit union is more productive; however, there are many factors that influence it.
When examining the ratio, credit unions should also consider product penetration rates, members per branch location, the geographic distribution of the membership, and field of membership requirements. The strategic factors that impact the ratio include organizational service level goals, growth, and product and technology development.
13) Fee Income Per Member
This metric, the level of fee income per member, is driven by the credit union’s fee strategy, which is a function of the credit union’s field of membership and overall financial structure. A credit union’s fee strategy is generally designed to fill in the shortfall between the results of the other aspects of net income and the credit union’s ROA goal.
Other issues include the field of membership’s tolerance for fees, competitive pressures in the credit union’s trade area, and the Board’s attitude toward fees. Beyond this, fee income per member can also indicate member usage. Generally, credit union members pay some type of fee for their use of products and services (as they would at any financial institution).
Prefer not to think of member usage in terms of fees? Check out another metric, Share Draft Penetration.
14) Member Growth
The Board’s philosophy toward service levels, delivery channels, product pricing, and breadth of services drives the strategies the credit union uses to acquire new members. Consumers join a credit union for a variety of reasons, but the predominant reason is the credit union fulfills or meets a need.
Therefore, the variety of products and services the credit union offers has a direct correlation to the number of members joining it. Also, the level of service the members receive affects member retention and word of mouth marketing.
15) Average Member Relationship
The average relationship per member reflects how much the retail member is using the credit union’s share and loan products. The credit union’s pricing strategy, underwriting policies, product mix, service levels, and sales culture contribute to this performance measure. In addition, the makeup of the field of membership and the economic environment can have an impact. Factors that can contribute to higher share and loan balances include competitive rates, affluent membership, and loan and deposit product variety. The credit union’s ability to market and sell loan and deposit products can also have a measurable impact on the average relationship per member.
16) Return of the Member
There’s a lot gray area in credit union financials. Although a low cost of funds is generally perceived to be better than a high cost of funds, in conjunction with a high ROA, high fee income, and low member growth, it would indicate larger concerns about whether members are receiving good value from their institution. Likewise, institutional efficiency is advantageous, particularly if it improves processes so members can more easily apply for loans or use technology to manage their accounts.
But efficiency should not come at the cost of superior service or be used merely to improve the bottom line. Callahan & Associates’ Return of the Member Index uses 18 metrics (many of them used in this 15 Key Ratios series) to weigh and rank credit unions relative to their peers. Learn more about how Callahan calculates ROM, then find your credit union’s score in the online section of Credit Union Strategy & Performance, CUAnalyzer, or Peer-to-Peer.