For decades, funds transferpricing has been one of the most important management tools for thefinancial industry, as it is the key factor in determiningthe profitability of a credit unions' members, products,organizational units and channels. With clearer insight into howthese factors contribute to a credit union's net interest margin,executives can make more informed decisions regarding itsprofitability drivers and therefore effectively determine productpricing.

The challenge is not necessarily the calculating of FTP ratesbut in how many of today's credit unions fall short in terms of howthey analyze and leverage that information to make more-informeddecisions. Many institutions focus solely on calculating preciseFTP rates, which under-utilizes the analytical value that a deeperFTP reporting tool would provide.

Implementing a sophisticated, well-structured FTP mechanism willprovide credit unions with margin clarity throughout every level ofthe organization. To create a clearer picture of member, businessunit, product or officer profitability, a credit union must startwith a theoretically sound approach to calculating FTP. This wouldinclude an FTP system with comprehensive calculation methodologiesthat are inclusive of appropriate assumptions reflecting thecharacteristics of the institution's products, such as FTP rates, aFTP yield curve and even spread adjustments. These are necessary asFTP, if calculated correctly, will be processed for each individualaccount (record level) and be based on that product'scharacteristics.

Once this FTP process is inplace, credit unions should ensure their FTP reporting frameworkgoes beyond typical accounting reports and adds an analyticalframework for the institution.

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For example this should include:

1. Analysis of Risk-Based Pricing Traditional FTPreporting includes balances, rates, FTP rates and FTP spread forthe portfolio. By simply incorporating other fields such as eachmembers FICO score, credit unions can determine whether its loanofficers, departments, or channels are practicing risk-basedpricing – (for example – lower credit score loans should show ahigher FTP spread, higher quality loans should show lower spreads).If reports indicate that there is no measurable distinction betweenhigher and lower credit quality loans, it reveals the creditunions' lack of correlation between its pricing and risk.
2. Analysis that Considers the Time DimensionUtilizing a robust database, a credit union can gain insight intothe historical and current pricing decisions that have been made bythe institution. Although it may seem important that a credit unionfocuses just on its portfolio's current activity, it can gain agreat deal of insight by also analyzing historical trends.Reviewing a loan officer's current loans is indeed important, butby going back to prior periods' pricing decisions the credit unioncan gain insight into whether a currently underperforming officer(or department or line of business) has a history of badperformance. Furthermore, the credit union can also gain insightinto prospective (future) performance by analyzing a portfolio'srunoff over a selected time horizon which will help them understand“runoff spread” over that horizon. This will help the institutionanalyze what “new spreads” are needed to either maintain or growprofitability.

By ensuring some of these elements are incorporated into the FTPprocess, credit unions will extract considerably more value fromtheir transfer pricing system, which as noted above, is the maincomponent in the institution's profitability framework. To maximizevalue, credit unions must ensure that these processes and analyticscome together holistically through one unified platform.

Ken Levey is vicepresident, Financial Institutions, at Axiom EPM in Portland, Ore.