Two weeks ago, I wrote an article in which I discussed four different ways of selecting credit unions to benchmark against. The methods I suggested include peer groups that are based on asset size, geography, membership, and/or business model. While the first three are important factors to take into consideration, they are a little more straightforward and intuitive than creating a peer group that includes credit unions with business models similar to your own. So I thought it would be valuable if I went into a little more depth on how best to go about using your business model to create a peer group.
Defining a peer group based on your business model is highly valuable but equally complicated. There are several different ways that you could define a peer group based on your business model. For every characteristic of a credit union's business model, there is also a data point that should be considered when defining a peer group. Here are three starting points to give you an idea of how you could define your own business model.
1. Balance Sheet Composition: Balance sheet composition includes asset composition, outstanding loan composition, and investment composition. Most likely, each of these have a substantial impact on the way you run your credit union.
For example, if your outstanding loans are more heavily concentrated in auto loans than real estate loans, it would be appropriate for you to benchmark against credit unions with similar concentrations because auto loans typically have a higher yield than real estate loans. To illustrate this point, as of June 30th 2009, credit unions with a loan portfolio of more than 50% concentrated in auto loans reported an average loan yield of 6.8%. Compared to the 6.1% loan yield of credit unions with a concentration of over 50% in real estate, you can see that if you do not account for your credit union’s particular loan composition you will end up with less accurate benchmarking because dissimilar credit unions will skew your comparison.
2. Income Composition: Income composition is another example of a key indicator of a credit union's business model. Defining a peer group based on the percentage of revenue that comes from either interest income or service revenue (non-interest income), can help you target credit unions that have similar business model as yourself.
Earning ratios can vary depending on income composition. As of 2Q 2009, there were 99 credit unions over $100 million in assets that reported more than 35% of their income coming from service revenue. These credit unions recorded a core earnings ratio, which is calculated by annualizing total income less interest expense and operating expense and then dividing by average assets, of 2.0% through the first half of the year. There were 105 credit unions over $100 million in assets that generated less than 9% of their revenue from service income. Collectively, they recorded a core earnings ratio of 1.0%. Taking the income composition variances into account will lead to more accurate benchmarking, especially when you are focusing on earning ratios.
3. Product/Service Mix: One of the most detailed ways of creating a peer group based off of your business model is to define the group by the products and services that your credit union offers. While it does not include a comprehensive list of products and services, the 5300 Call Report does contain a substantial amount of data on the products and services credit unions offer.
As my colleague, Nick Connors, noted in his article "Indirect Lending Helps Drive Growth in the Auto Loan Portfolio," credit unions that offer indirect auto loans have grown their auto loan balances by 3.4% over the last year compared to a decline of 5.6% experienced by credit unions that do not offer indirect auto loans. Knowing this, anyone who wanted to benchmark their auto loan program to similar credit unions would want to take into account whether or not the comparison also offered indirect lending options or not. While indirect auto lending is a particularly illuminating example, this same principle would apply to most other products listed on the 5300 call report.