How do you measure loan portfolio performance?
A credit union invited me to be a guest speaker at their board of directors meeting. It was a typical Board Meeting, the directors started filing in, with about half of them breaking the seal of the board packet as they took their seats. One director immediately went to the delinquency ratio and started to gloat over how low their delinquency was. I thought this is not going to go over well, and if he shifted his focus to net income the credit union would be better served.
How do you measure success in your loan portfolio? Traditional methods include delinquency, charge offs, misery index, loan yields, loan growth ratios in comparison to peer group averages. I personally never have wanted to be average in anything! Why compare ourselves to average, especially when our industry is shrinking 20% every five years? As CEO, I used a custom peer group, eliminating the weakest 50% in ROA from the group.
Risk/Reward relationship typically is the higher the risk, the greater the potential rewards. In credit union land this may mean the greater the loan losses the higher the yields. That certainly is the case for unsecured loans vs. secured loans. But what if we can get the higher yields and not suffer the losses that come with it? That would be magical!
I use an efficiency ratio to measure success. For me the formula is:
Loan Yield percentage – Charge Off percentile = Efficiency Ratio
The greater the number the better. A positive number indicates you are out-performing peers. A negative number indicates you are under-performing peers.
I also calculate the dollar amount the credit union is over-performing, or under-performing peers. See the example below for my calculation.
One of my clients posted an efficiency ratio of 40% and I told them they would not be able to keep that number. Then they increased it! Here is what it was last time I worked with them.
Net Loan Yield Study compared to Peer.
Think about this for a moment. They are getting a loan yield that is associated with taking risk, but the losses don’t follow! They earn 1.88% more than their peer group which creates an additional $14,771,054 in income each year.
I have been working with this credit union frequently over the years. They do everything right. All ratios are calculated on every loan, including discretionary income, and inflated income, loan notes are unmatched in the industry and top management is very involved in lending. They also invest heavily in training their staff.
The above example is the good news story. A very efficient, well run credit union. I have also worked with credit unions on the other end of the spectrum. One credit union I worked with was earning $1,500,000 less than peer group. If they can match peer they pick up $1,500,000 in additional earnings each year.
I challenge you to calculate your credit union efficiency ratio and the dollar amount of earnings in relation to peers. If you find your credit union efficiency ratio and/or performance is less than peer, your problem will most likely be one of four categories, or possibly a combination of them:
- Loan pricing is too low.
- Loan underwriting is weak.
- Collection efforts are weak.
- Economic difficulties in your local economy.
Don’t be too quick to blame the local economy. That is the one thing you can’t control.
What is your efficiency ratio?
