Credit Union Financing 101 | CUNA news
Credit union directors come from all walks of life. Some are familiar with business and financial issues, others are not. Even if you have a business or financial background, there’s a good chance you don’t have a background in banks or credit unions.
I’m a chartered accountant, and when I began auditing credit unions’ clients 30 years ago, I realized that the methods, problems, and metrics that credit unions use are inconsistent with those of other companies.
I had to learn the nuances of credit union financing – and so did you.
Directors are required by law to understand key financial information. It is even anchored in law with NCUA regulation 701.4.
Here are some key financial concepts every member of the board of directors and supervisory committee needs to know:
► Capital or net worth. Know why capital matters, where it comes from, and how much is enough for your credit union.
Capital comes from profit. As soon as credit unions make a profit, it becomes “historic” and turns into capital. This is the stabilizing factor that keeps credit unions afloat in bad economic times. Capital is king.
► Return on investment (ROA) is a measure of profit. Capital comes from profit, and ROA is the way we report profit. What most directors don’t know is that ROA is the end result of an equation called spread analysis that contains the “five pieces of profitability”:
- Cost of funds.
- Provision for loan losses.
- Operating cost.
- Non-interest income.
These five pieces of the puzzle are the only things you need to manipulate in order to achieve the ROA you want.
You also need profit. Profit is not a bad word or a bad thing to make from your members. Profit is vital.
► Loan loss allowance (ALL). This is an amount that will increase your reported loan portfolio balance to what you are likely to be collecting.
That large negative number on your balance sheet is a mystery to most directors. It is planned to change and is likely to become a larger negative amount by January 1, 2023. Then the new method of current expected credit losses (CECL) comes into play.
► Active / passive management (ALM). This is the rocket science of credit union regulator. It’s one of the more complex areas to understand, but it’s important to know where your credit union can go financially as interest rates change.
Essentially, what you’re looking for is how much capital is at risk when interest rates change. Credit unions provide fixed rate loans in a variable rate world. The impact of changes in interest rates needs to be forecasted so that you can predict what will happen to your credit union over time.
Financial metrics and statements may seem like a foreign language. But once you understand the key elements, you can trust your knowledge of how your credit union is performing.
TIM HARRINGTON is the founder and CEO of TEAM Resources (forteamresources.com). Contact him at [email protected]
This article originally appeared in Credit Union Directors Newsletterthat provides strategic insights for policy makers. Subscribe to the print or PDF version now.