It's no wonder that credit unions have found success offering a wide variety of loans to their members–after all, lending continues to be the foundation of our industry's product offerings. But in today's challenging environment, financial institutions are seeing a lackluster loan demand, as a result of a slower economy and modest consumer spending. As competition forces loan yields down, some credit unions find themselves having to reassess their true mission: to serve members or potential members at any cost, or achieve a predetermined bottom line. To make these decisions, credit unions' need to know what they are truly yielding on loans.
Taking an in-depth look
Considering today's economy, loans in general are not expected to perform as well this year, with credit quality likely to deteriorate and delinquencies on the rise. That, in turn, may well drive down profitability. Some loans–in the consumer market and especially those made through indirect lending–are not likely to be as rewarding as in the past.
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Today, many credit unions aggregate data to determine the value of their loans. But loan aggregation does not enable your credit union to see the true picture. Underperforming loan pools may go undetected, and bad loans may be masked by seasonality and growth of other loans. For example, fairly new loans or those that have only a few months to mature aren't very likely to default, compared with loans in the 18-month to 30-month range, which normally show maximum losses in a specific loan pool. But when the data is grouped together with newer loans that have replaced loan run-off, your results will be thrown off. And if loan growth is included, results will be even more distorted.
Using Loan Analysis A better method to consider when reviewing your credit union's loan portfolio is through periodic loan analysis. This gives you a drill-down capability to measure profitability at the individual loan and loan-pool levels. Using loan analysis can help you identify loan profitability within certain categories, as well as help to relate specific deal structures to loan performance. Armed with this information, you can adjust the pricing for certain types of loans that aren't doing well. Alternatively, if a loan type is in a highly competitive market, your credit union can decide whether to stop offering it or to use it as a "loss leader." Loan analyses can be done with loan pools that are grouped by credit rating, loan type, geographic region, dealer, loan officer, or any other variable that is meaningful to your credit union. To measure profitability, you will want to calculate the net yield over the life of the loan. For example, an analysis may show the net yield for a portfolio of loans to be healthy, while in-depth analysis shows that certain credit tiers within the portfolio are priced too low to cover the cost of funds.
You can perform a loan analysis on your credit union's loan portfolio at any time, but they are most commonly done on a quarterly schedule. Whether conducting such an analysis in house or on an outsourced basis, the key steps are similar: collecting data, building a cash-flow model, and identifying sources for loss and pre-pay assumptions. In any event, remember that the loan level analysis should capture the effects of losses, prepayments, and expenses, as well as payment performance. Thus, you need to collect historical information for both active and closed loans. This should include losses, recoveries, fees paid and refunded, and payment history. Depending on the type of loan analysis performed, you may need to collect payment history on a monthly basis, or use dates and balances in a single data file to recreate the payment history.
For projecting future activity, make sure to have a basis for expected losses and prepayments. This can be derived from historical analysis of the loan program or from industry data. If you really want to get fancy, you can use a statistical analysis, which can project various defaults and delinquencies dependent upon loan-to-values, credit scores, or maturity.
By utilizing the above information in a complete analysis, most credit unions will be able to regularly evaluate the profitability of past loans and the projected performance of current and future loans. In other words, by integrating loan analysis into your loan portfolio analysis, you can get a clearer picture of your credit union's profitability –and its future success.
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