The Importance of Context in Balance Sheet Trends

Mike Philbin discusses how important it is to place financial measures in their proper context when critically considering them as measures of risk or performance.


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 Look Program.

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.




Feb. 14, 2005


  • Great Financial Analysis, Mr. Philbin should write more articles, his insight is an asset to your organization.
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    Jeanette taylor