In week one of this financial literacy for credit unions series I dove into some commonly seen acronyms in the credit union space. Last week, we learned the basics of financial statements so you can more confidently dive into your institutions numbers and not get lost.
This week we will be taking a look at some key ratios and stats C-Suite executives track to maintain a grasp of the credit union’s financial performance and why they are important. Even if it doesn’t fall strictly in your area of expertise, the key to any good analyst is curiosity and a desire to understand the focus of your stat gathering better.
Growth: the SLAM dunk
Starting off with a simple concept, growth of Shares, Loans, Assets, and Members, gives a very general idea of how the credit union is performing. To calculate, simply take current period value divided by previous period value, then subtract by 1. E.g. (8741 members in 2022 / 8329 members in 2021) – 1 = 0.049 or 4.9%.
As a major contributor to revenue, loan growth is an important benchmark that’s impacted not only by your marketing efforts, but the economy at large, interest rates, demographics, and how risky the credit union is willing to be when making loans. With inflation on the rise, credit unions can expect the Fed to raise interest rates in the near future, with the intention of “pumping the brakes” on the economy. This means lending will slow and credit unions may have a tougher time booking new loans.
Cost of Funds
A credit union’s cost of funds is one measure of determining how much it pays in interest for every dollar of shares or borrowings it receives. Or said more simply, what it costs to acquire more funds.
To calculate that cost take the dividends paid to members and interest paid on borrowed money, divided by the average outstanding shares and borrowings. An older membership with large certificates or high-yield tiered savings products will increase the cost of funds. Alternatively, high penetration of checking products is generally indicative of a lower cost of funds. Without keeping a tight rein on cost of funds, credit unions can run into interest rate risk issues.
Capital and Net Worth Ratios
The capital ratio measures what percentage of a credit union’s assets are backed by capital. As mentioned in last week’s segment, credit unions with a strong net worth have a little more liberty to assume risk than those with weak net worth. As the primary measure of a credit union’s financial strength, it’s important that credit unions manage their net worth (to assets) ratio. A net worth ratio of 7% or higher is considered “well capitalized” and 6% is considered “adequately capitalized.” But if you’re thinking more is better, credit unions can go overboard and be considered “over-capitalized” which can also harmful to members’ interests.
Worth noting however that although the capital and net worth ratios are often used interchangeably, there is a difference in how they are calculated. Specifically, the capital ratio includes allowance for loan and lease losses whereas the net worth ratio does not.
Operating Expense Ratio
The operating expense ratio is another simple calculation that gives us a lot of insight into the operations of the credit union. To calculate, take operating expenses divided by the average total assets of the credit union. It’s a basic measure of the operating efficiency and strategy of the credit union. The more efficient the credit union is at managing its resources, the lower its operating expense ratio. As a credit union grows, so too will its operating expenses in most cases as it scales up to manage more demands.
Your credit union’s delinquency ratio will show you what percentage of your total outstanding loans are delinquent. It provides a look at your current loan portfolio risk as well as a forecast for future loan losses and earnings. The riskier your loan portfolio, i.e. more loans of poor credit rating, the likelier the delinquency ratio will climb. However, this can also be affected by economic circumstances. As we saw during COVID and the Great Recession, defaults became more common, necessitating financial intervention in some cases, and generous loan forgiveness or deferment. But as is the case with other ratios, too much of a good thing isn’t necessarily beneficial. Too low a delinquency ratio could indicate the credit union is being too risk averse, meaning missed revenue opportunities and a harder time for your members seeking loans.
Loan to share ratio
A measurement of credit union liquidity, the loan to share ratio divides total value of outstanding loans by the total of share deposits. In 2018, the average loan-to-share ratio in the US reached over 85% as rates were low and borrowing was high. In the wake of COVID, this average ratio had dropped down to 76.3%. This marked the lowest it had been since the years following the Great Recession when loan-to-share plummeted to the mid-60s. This was brought on by slowed loan growth and increased savings from consumers who were boosted by government stimulus packages. The higher the ratio, the less liquid the credit union is, and the more likely they’ll need to look to outside sources to fund new loans.
Net interest margin
How well is your credit union managing its loans and shares? Net interest margin gives one indication. To calculate subtract dividends paid from interest income, then divide by average total assets. According to the NCUA, “The net interest margin for federally insured credit unions was $48.7 billion in the first quarter of 2021, or 2.57 percent of average assets. That compares with $47.2 billion, or 2.95 percent of average assets, in the first quarter of 2020.” Although credit unions have seen this margin shrink the last couple years, at least they’ve fared better than banks.
These are just a handful of the ratios that are important to track a credit union’s success, efficiency, and risk. What other ratios are you tracking?