As experienced end users of financial statements are keenly aware, it is just
as easy to reach a misleading inference from a balance sheet ratio or trend as
it is to reach a meaningful one. To illustrate, consider the two-year (2003-2004)
comparative balance sheet and income statement for credit unions participating
in Callahan & Associates’ First
From a trend standpoint, two items from the balance sheet stand out. On the
asset side, real estate loans have grown 20%. On the liability side reverse
repurchase agreements (repos) and notes payable have risen 46% and 40% respectively.
Notwithstanding short-term repos, one possible conclusion from these raw trends
is that credit unions are extending their term liabilities (notes payable) to
mitigate interest rate risk associated with real estate loans – especially
against a backdrop of rising rates. If the effective durations match, this strategy
makes good ALM sense. This strategy makes even more sense given interest rates
on term borrowings.
What is misleading about the balance sheet numbers is the absolute (dollar)
change versus the relative (percentage) change. On an absolute basis, credit
unions still grew real estate loans $10 billion more than borrowings. Credit
unions would actually receive more risk immunization – depending on the
term – from the increase in share certificates. This liability increased
12% on a relative basis but over $4 billion in absolute terms! In many instances,
looking at just the percentage change from period to period does not explain
the real balance sheet impact on a financial institution.
The biggest change from a ratio standpoint between 2003 and 2004 was in the
Percent of Investments over One Year. This figure dropped from 53% at the end
of 2003 to 39%. The immediate reaction upon looking at this ratio is that credit
unions are shortening their investment portfolio durations – and that
is partially true.
However, it is necessary to compare another ratio, Mortgage-Backed Securities
as a Percent of Total Investments, to see how this ratio has changed for similar
periods. This is a critical comparison because the average life of these investments
can change drastically when compared to other investments. This ratio in fact
did move in the same direction as Percent of Investments over One Year, both
on a relative and absolute basis (22% lower in 2004).
The point of these examples is to illustrate how important it is to place financial
measures in their proper context when critically considering them as measures
of risk or performance. Credit unions balance sheets can be loaded with complexity
not captured by what non-industry users might consider straightforward trend
analysis or ratios.