HealthScore Chart of the Week: Delinquency, Charge Offs, and Health

This week’s HealthScore Chart of the Week focuses on credit union credit quality, specifically looking at the comparison of composite industry HealthScores to delinquency and charge off scores.

This week’s chart, covering the time period from Q2 2002 to Q1 2013, showcases just how far scores for delinquency and charge off fell during the recent financial crises – and how much they have improved since then. The real question is whether such improvements are sustainable, or should be sustained, given the general desire to drive growth in loans (not to mention escalating competition).

As a reminder, the HealthScore scale ranges from 0-5, with 0 being exceptionally unhealthy and 5 exceptionally healthy.

The chief means to improve portfolio credit quality outside of riding an improving economy is to beef up collections activity for short-term improvement (to include debt restructuring, etc.) and tighten lending standards for longer-term improvement. Being involved in credit union strategy discussions allows us to to say with certainty that many credit unions worked to develop improved collections efforts while in the midst of the crises. The chart below, the results of a survey of senior loan officers conducted by the Federal Reserve, provides supporting evidence for the strategy of tightening standards.

Net Percentage of Domestic Banks Tightening Standards on Consumer Loans, Credit Cards
Net Percentage of Domestic Banks Tightening Standards on Consumer Loans, Credit Cards

Note that in the chart above any mark above zero suggests a majority is tightening standards while marks below zero suggest a majority is loosening standards.

The key challenge with the tightening strategy is that it has an obvious impact on loan growth – and the strategy is difficult to maintain. Case in point… as the economy improved, albeit slowly, confidence and competitive pressure began to drive loosening standards as shown in the chart. Without loosening standards, institutions would have a hard time growing the loan portfolio to the same degree as competitors with looser standards. While this chart is solely comprised of input from bankers, credit unions undoubtedly followed similar trends.

To the question of sustained improvement in portfolio quality. Credit unions with exceptionally tight standards, not to mention the recession-inspired interest in quality collections, will be able to maintain credit quality improvements – but at the expense of solid loan growth and a suitable level of profitability.

Perhaps the best path forward, at least in general terms, is to leverage the skills in risk assessment and mitigation gained during the crises while at the same time loosening lending standards to market-competitive levels. In doing so, credit unions will be positioning themselves for loan growth but with the capacity to properly manage/mitigate risk. This may lead to a flattening of scores for delinquency and charge off (which themselves are driven by flat to increasing delinquency and charge off ratios), but improvements in lending relationships, member service, and income would be an effective offset.

Credit unions with industry-leading loan growth have done just that. The challenge for the remainder of the industry is to develop the confidence to follow the same path.

Comments and interpretations welcome. To share your thoughts, use the comments feature below.

Interested in learning more about where your credit union stands in relation to Glatt Consulting’s Credit Union Industry HealthScore? Schedule an appointment to discuss your scores. You may also want to learn more about our approach to credit union strategy consulting.

Data is as of 3/31/2013

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