It's no wonder that credit unions have found success offering awide variety of loans to their members--after all, lendingcontinues to be the foundation of our industry's product offerings.But in today's challenging environment, financial institutions areseeing a lackluster loan demand, as a result of a slower economyand modest consumer spending. As competition forces loan yieldsdown, some credit unions find themselves having to reassess theirtrue mission: to serve members or potential members at any cost, orachieve a predetermined bottom line. To make these decisions,credit unions' need to know what they are truly yielding onloans.

Taking An In-Depth Look

Considering today's economy, loans in general are not expected toperform as well this year, with credit quality likely todeteriorate and delinquencies on the rise. That, in turn, may welldrive down profitability. Some loans--in the consumer marketand
especially those made through indirect lending--are not likely tobe as rewarding
as in the past.

Today, many credit unions aggregate data to determine the valueof their loans. But loan aggregation does not enable your creditunion to see the true picture. Underperforming loan pools may goundetected, and bad loans may be masked by seasonality and growthof other loans. For example, fairly new loans or those that haveonly a few months to mature aren't very likely to default, comparedwith loans in the 18-month to 30-month range, which normally showmaximum losses in a specific loan pool. But when the data isgrouped 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 loanportfolio is through periodic loan analysis. This gives you adrill-down capability to measure profitability at the individualloan and loan-pool levels. Using loan analysis can help youidentify loan profitability within certain categories, as well ashelp to relate specific deal structures to loan performance. Armedwith this information, you can adjust the pricing for certain typesof loans that aren't doing well. Alternatively, if a loan type isin a highly competitive market, your credit union can decidewhether to stop offering it or to use it as a "loss leader."

Loan analyses can be done with loan pools that are grouped bycredit rating, loan type, geographic region, dealer, loan officer,or any other variable that is meaningful to your credit union. Tomeasure profitability, you will want to calculate the net yieldover the life of the loan. For example, an analysis may show thenet yield for a portfolio of loans to be healthy, while in-depthanalysis shows that certain credit tiers within the portfolio arepriced too low to cover the
cost of funds.

You can perform a loan analysis on your credit union's loanportfolio at any time, but they are most commonly done on aquarterly schedule. Whether conducting such an analysis in house oron an outsourced basis, the key steps are similar: collecting data,building a cash-flow model, and identifying sources for loss andpre-pay assumptions. In any event, remember that the loan levelanalysis should capture the effects of losses, prepayments, andexpenses, as well as payment performance. Thus, you need to collecthistorical information for both active and closed loans. Thisshould include losses, recoveries, fees paid and refunded, andpayment history. Depending on the type of loan analysis performed,you may need to collect payment history on a monthly basis, or usedates and balances in a single data file to recreate the paymenthistory.

For projecting future activity, make sure to have a basis forexpected losses and prepayments. This can be derived fromhistorical analysis of the loan program or from industry data. Ifyou really want to get fancy, you can use a statistical analysisthat can project various defaults and delinquencies dependent uponloan-to-values, credit scores, or maturity.

By utilizing the above information in a complete analysis, mostcredit unions will be able to regularly evaluate the profitabilityof past loans and the projected performance of current and futureloans. In other words, by integrating loan analysis into your loanportfolio analysis, you can get a clearer picture of your creditunion's profitability--and its future success.