August 6, 2014
Credit Union Management magazine’s Web-only “Loan Zone” column runs the first Wednesday of the month.
This column is an excerpt from Brett Christensen's article, "Measuring the Success of a Lending Operation" in the premium content section of the CU Lending Advice website.
A few months ago I was consulting with a credit union on the East Coast. As I prepared to start a meeting in which I would discuss with management how to fix every lending problem they had, the CEO asked me an outstanding and thought-provoking question: “Brett,” he said, “how do you judge a successful lending operation?”
So, here are some thoughts on key metrics you should be using to judge the success of your lending operation:
1. Loan-to-Share Ratio.
This is obviously the first ratio that I look at when I consider a credit union’s lending success. To be considered a good lender, I think your LTS ratio should be above the peer LTS ratio on your quarterly call report.
When I see a LTS ratio at a credit union above 80 percent, I know that I have walked into a credit union that is focused on serving its members with loans. But I will caution that I have been to plenty of credit unions with LTS ratios at or over 100 percent, and they aren’t making any money. The problem is that their entire portfolio is in mortgages and indirect auto loans, two loan types that are very difficult to turn into an above-average return on assets.
If your LTS ratio is significantly below peer (say more than 10 percent), there is something materially wrong with your lending operation. And please do not fall into the trap of blaming the local economy, your SEG or your field of membership for a low LTS ratio. When your LTS ratio is significantly below peer, you have internal issues you need to fix.
2. Loan Growth.
I think it goes without saying that you want to see net growth in loans each year, unless you are intentionally scaling back for a strategic reason. Cutting your concentration of in-house first mortgage loans or your concentration of indirect auto loans might be two reasons you would be OK with negative loan growth.
When I see loan growth that is way above normal (say in excess of 15 percent in a quarter or a year), I want to understand the reason for that exceptional growth. The expression, “If it seems too good to be true, it probably is” comes to mind.
- Is the huge growth in loans due to “buying” the auto loan business with a promotional loan rate you cannot really afford?
- Is it because you have decided to be the most aggressive buyer of indirect auto loans in your market (and this strategy usually does not end well).
- Is the growth because of a mortgage refinance boom that will only be temporary?
- Is it because you have jumped into member business lending with both guns blazing?
What impresses me most is organic growth of your direct consumer loans of 5 percent to 10 percent a year without using unprofitable promotions. This is loan growth that will translate to a strong increase in earnings.
3. Misery Index.
Any conversation about loan growth has to be counter-balanced by looking at your loan delinquency and loss ratios. Because bad loans can be in either the delinquency or charge-off bucket, I combine the two ratios and call it your “Misery Index.”
Your natural thinking might be to drive your Misery Index down as low as possible. I disagree. If your Misery Index is more than 50 or 60 basis points below peer, then I can make the case that you are too conservative in lending and you are leaving a lot of interest income on the table. Of course, you don’t want excessive delinquency and loss, as these are dollars taken right off your bottom line. I would say that if your average loan yield is at about peer and your Misery Index is more than 50 basis points above peer, then you probably have an underwriting or collecting problem (or combination of the two).
4. Average Loan Yield.
Looking at this number is a quick way for me to evaluate the composition of your loan portfolio. If your average loan yield is below 4.50 percent, it tells me you are most likely a big mortgage lender and you are almost exclusively an A and B-paper lender.
It is very difficult to turn an ROA over 1.0 percent if your loan yield is below 4.50 percent. If this is going to be your lending approach (mortgages and A-paper), then you had better drive your expense ratio down to well below peer.
If your credit union has an average loan yield above 6.50 percent, it tells me you have a large percentage of C, D and E-paper consumer loans on your books and you do not hold a large percentage of your loan portfolio in mortgages.
Ideally, I think you should target an average loan yield between 5.50 percent and 6.50 percent. You should have no problem turning a good bottom line with a loan yield in this range. The following loan portfolio composition by credit tier should give you an above-average loan yield:
Credit Tier Percentage of Total Loans
A+ and A-paper: 55%
D and E-paper: 10%
5. Product Mix.
Some credit unions are great mortgage lenders but they are lousy consumer lenders. Other credit unions I go to are awesome consumer lenders but they can’t make a mortgage loan to save their lives. Some credit unions have gone all-in with their indirect auto-lending program but making direct auto loans is a glaring weakness.
It just makes good strategic sense to have balance in your loan portfolio to spread out the concentration risk of the various loan types. For example:
- I think examiners are wise in suggesting that 35 percent or 40 percent of total loans in mortgages is sufficient.
- I agree that a cap of 12.5 percent of assets in commercial loans is sufficient for most credit unions.
- I don’t think indirect auto loans should ever get as high as 70 percent or 80 percent of your total auto loans. It is a very difficult business to run profitably and so a better idea is to have it just be a complement to your direct auto-lending effort (like 70 percent direct and 30 percent indirect).
Make it a great year at your credit union by measuring your lending operation for success and then working on your areas for improvement.
Brett Christensen is the owner of CU Lending Advice, LLC. Christensen will lead CUES School of Consumer Lending Sept. 15-16, 2014 and CUES Advanced School of Consumer Lending Sept. 17-18, 2014 in Denver.
Photo credit: dollarphotoclub.com/waldemarus