New Metric Expands on Return on Assets
Historically, return on average assets has been a benchmark credit unions have used to measure performance. Simply stated, ROAA is calculated by dividing net income by average total assets, the result of which is used to gauge profitability. It is a narrow measurement using what traditional accounting standards refer to as “assets.”
The term asset is defined by the Financial Accounting Standards Board as “probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.” This definition indicates the appropriate question to ask in trying to decide whether a particular item is an asset: Is there a probable future economic benefit?
If we accept this narrow definition of what constitutes an asset, we’re overlooking two important asset classes: members and charged-off accounts. Why, one might ask, should members and charged-off accounts be classified as assets? A simple test of the FASB definition will provide the answer. Do members provide their credit union with probable future economic benefits? Clearly, the answer is yes. Now, let’s apply the same test to charged-off accounts. Do charge-offs provide the credit union with probable future economic benefits? The answer may surprise you.
Consumer credit problems are, in the majority of situations, temporary. Divorce, medical emergencies and long-term unemployment may be catastrophic events with lingering negative effects. However, those negative effects mitigate in time and may even become completely resolved. To the old adage “bad things happen to good people,” add the caveat that, over time, good people often recover from those setbacks. This resilience has been proven time and time again.
Financial institution regulations require that nonperforming assets be written off. In most cases, these loans must be charged off before borrowers have had the opportunity to recover and re-establish their credit standing. Because there is a probability that borrowers will recover from divorce, medical emergency, job loss or other financial crises, a probable future economic benefit exists from charged-off loans.
Typically, two or three years post charge-off, financial institutions and collection agencies end their efforts to recover these assets. The assets themselves—both the members and their loan repayment—are abandoned and eventually time-barred from recovery by federal statute. The incredible irony here is this is the time frame when many members associated with charged-off loans are regaining their capacity to repay their obligations so they can return as members in good standing with their credit union.
Thus, there are two reasons why credit unions should not give up on these abandoned assets. The first is the potential for “found money,” or recoveries on charged-off consumer loans, lines of credit, stranded home equity line of credit balances, first mortgages, credit card balances, overdrafts and personal guarantees of member business loans that have been “worked” and abandoned by collection departments, law firms and collection agencies. Credit unions and their third-party collectors have limited resources. While they do the best they can, older charged-off balances are systematically ignored in favor of the “low-hanging fruit” of newly charged-off credit. Without the proper resources and technology, older charged-off accounts are too costly to collect.
The second reason for persistence is the opportunity to re-establish profitable relationships with these members. Financial setbacks can happen to anyone, even prime borrowers with high credit scores. Crises such as prolonged unemployment and health problems can and have disrupted the lives of millions of American families. If we view members as assets, we need to acknowledge that new members come with a significant acquisition cost. Qualified former members, on the other hand, have zero acquisition cost. Those “prior prime” members who have suffered through a financial crisis, gotten back on their feet and want to repay their obligation to the credit union and earn back the privileges of membership should be given that chance. They are willing to pay their way back to the credit union, which will have an impact on profitability.
The return on average abandoned assets, which we refer to as ROA3, is a profitability metric that measures more than just balance sheet and membership growth. ROA3 measures the credit union’s commitment to the promise “once a member always a member” and differentiates credit unions from other financial institutions. The benefits of a positive return on average abandoned assets accrue to both credit unions and their loyal members. Credit unions can enhance ROA3 by identifying and revesting qualified borrowers who have recovered from financial setbacks and are now willing and able to repay their obligations and become members in good standing.
Mike Hales is EVP/strategic relationships with CU Revest, San Diego, Calif.