7 Ratios Every Employee Should Know About Credit Union Lending

Lending is the engine that powers credit unions, and these seven ratios will help every employee understand why.

 
 

Credit unions built on milestones set in 2015 and achieved all-time highs in loans. The industry's loan balances neared $810 billion as of first quarter 2016. And the 10.8% year-over-year loan growth credit unions posted in the first three months of the year bested the 10.5% they posted at this tine last year.

“This continued momentum occurred despite relatively weak economic growth and spending nationally in the first quarter," says Callahan partner Jay Johnson. "But low unemployment and gas prices coupled with strong consumer sentiment and retail sales seems to set the stage for an even stronger 2016."

To build on that momemtun, every credit union employee must understand the role lending plays in the success of the credit union. Educating them on a few key ratios is a necessary first step.

1. Loans To Assets

The loans-to-assets ratio indicates how successfully a credit union uses its balance sheet to drive lending among members.

Loans are the highest-earning asset for credit unions, which means a higher loans-to-assets ratio is more favorable. However, management must balance loan demand with funds available for withdrawal. 

Credit unions that employ assets more effectively than their peers should benefit from additional net interest income through their lending activities.

2. Loan To Share

The loan-to-share ratio assesses liquidity constraints by dividing total loans by total deposits. 

Ultimately, a high ratio signals lending is outpacing deposits. If the ratio is too high, a credit union might have inadequate liquidity to cover fund requirements beyond the loan portfolio. 

Credit unions with modest loan-to-share ratios and low delinquency rates might want to revise their underwriting policies to take on additional credit risk.

3. Loan Growth

The loan growth rate indicates whether lending and leasing activity is increasing or decreasing by measuring the change in total loans and leases over time.

Ultimately, member demand and the credit union’s confidence in their ability to manage debt determine how many loans an institution makes. However, other factors such as the economy, membership demographics, risk appetite, and market share also influence loan growth.

Credit unions should revisit their marketing, products, culture, and delivery channel usage to increase loan growth.

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4. Yield On Loans

Credit unions use the yield on loans ratio to indicate how much income outstanding loans generate within a period.

Loan composition and pricing strategies together drive loan yield. For example, portfolios with large concentrations of real estate loans generally have lower yields. Conversely, portfolios with higher concentrations of high-rate consumer loans tend to have higher yields.

For most credit unions, loan income is the biggest source of gross income and focusing on yield on loans is a critical element of their net interest margin.

5. Loan Delinquency

The delinquency ratio is a measure of current credit risk associated with the loan portfolio. Loan delinquency signals potential losses, and unusual swings might significantly impact future earnings.

A higher delinquency ratio often accompanies loans with higher-risk borrowers. One way to compensate for the risk is to offer risk-based pricing — i.e., higher rates for riskier borrowers — which leads to higher loan yields.

Although no credit union wants a high delinquency rate, a delinquency rate that is too low can indicate an institution’s underwriting policies are too conservative.

A solid strategy is to evaluate this ratio in tandem with the loan-to-share ratio, loan loss ratio, and return on assets.

6. Allowance For Loan Losses To Delinquent Loans

The allowance for loan losses-to-delinquent loans ratio measures whether reserves are adequate to cover potential losses within the loan portfolio.

Because credit unions fund the allowance from current earnings, an increase in delinquent loans suggests a credit union will have to increase the allowance account as those loans turn into losses.

Credit unions with ratios higher than their peers should evaluate the appropriate level of reserves needed to cover their credit risk.

7. Net Charge-Offs To Loans

The net charge-offs-to-loans ratio is a measure of past credit risk within the loan portfolio, expressed as the difference between gross charge-offs and subsequent debt collection. 

Risk-based pricing, membership demographics, and loan products are all components of underwriting policies that have a direct impact on the quality of loans originated. Collection efforts also impact charge-off levels.

Generally, the lower the ratio, the sounder the credit union. This ratio has a direct impact on return on assets and should be monitored to mitigate growing defaults.

 

 

 

June 13, 2016


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