In Q1 2022 we saw the first year-over-year score decline since Q4 2020. We anticipated another decline for this quarter, Q2 2022, but even so it is still alarming to see back-to-back quarterly declines, especially considering that this is only the third year-over-year decline since well before 2016.
Some “negative” score drivers were expected, such as declines in scores for Cash & Short Term Assets to Total Assets (CS), and Asset Growth (AG). Stimulus funds continue to drain from consumer accounts, driven in part by higher costs of living, a situation that influences both balance sheet cash and asset growth. For the record, CS scores declined year-over-year by 20.92% and AG by 46.23%.
Ratio Reminder: Cash and Short-Term Investments to Assets (CS) is an indicator of the level of cash and liquid assets available to meet share withdrawals or additional loan demand.
Also in Q2 we saw the first decline in the Delinquent Loans to Total Loans (DL) score since Q1 2020. Remember that all of our HealthScores are on a 1-10 scale, meaning that score declines, including in the case of loan delinquencies and charge offs, are not necessarily a positive result. In any case, this quarter’s DQ score is interesting because of the positive improvements to the Loan Growth (LG) score. This means that the pace of change in delinquencies is outpacing the pace of change in loan growth.
As an aside, LG continued a string of improving scores – a trend that first began in Q1 2021. Overall the loan growth score improved 66% this quarter.
Getting back to DL scores, what’s possible in the quarters to come? With history as a guide we would anticipate complementary decreases in the Net Charge-Offs to Average Loans (CO) score, meaning charge offs are increasing. While the CO score in Q2 rose yet again, a trend of year-over-year improvements that began in Q2 2018, the rate of improvement slowed notably. In Q1 2022 the CO score improved by 3.77%. In Q2 the score improved by only 1.55%. See the chart below.
It is important to look at both year-over-year score changes and the actual raw score. In the HealthScore model, a score of 5 is roughly average based on 20 years of industry performance – so scores below 5 represent components that are below historical average and industry best practices.
For Q2, where do we see sub-5 scores? In these four areas;
- Return on Average Assets (RA)
- Efficiency (EF)
- Asset Growth (AG)
- Membership Growth (MG)
Of these, AG is to be expected given the continued shedding of stimulus fund deposits. In some ways, this trend is not surprising nor is it alarming.
RA scores, however, are more of a concern, and below-average scores could persist if inflation pressures persist, in particular inflationary pressure on wages. The EF score is one to watch here for guidance on RA. The Operating Expenses to Average Assets (OE) score, a measure of expenses, has been “strong” due to its relationship to asset growth. Asset growth improvements that are “stronger” than operating expense increases will manifest in an “improved” OE ratio and a higher score.
Over the last few quarters AG scores have been above average (even as the rate of asset growth itself declined). As noted, however, AG is now below 5, meaning that the positive influence of asset growth on the operating expense ratio is weakening – hence the interest in watching the EF score. EF is a measure of how much a credit union spends in relation to income. EF has not been consistently above 5 since prior to Q1 2020, meaning that in any given quarter credit unions are spending more to make below-average income. If this situation persists, competitive ability will begin to degrade.
It’s helpful to keep the factors influencing revenue and expense in mind as you develop and/or assess strategy. Inflation and wage pressure, interest rate increases, the need to invest more dollars in marketing, quality of staff relative to costs, etc. are all worth paying very close attention to over the coming months.
If you’re looking to tighten up your understanding of inflation with additional insight and intel, visit Dr. Tom Simpson’s blog, in particular his most recent article titled “Will Slower Inflation Lead to a Slowdown in Fed Tightening?“
Every credit union is different. Institutional focus and strategic interests combine to create unique entities with unique HealthScore profiles – meaning one HS profile does not fit all. One credit union’s business model may suggest a need to maintain high CS scores while another’s may be better supported with a “below average” CS score. The important takeaway is that a credit union’s individual HealthScore should be driven by safety, soundness, and strategic interests. Top performing credit union know their interests, and they manage well to those interests. What are your interests, and how should they influence your performance priorities and trade-offs? If you don’t know you have some work to do.
Speaking of top performers. This quarter’s Top Ten are listed below. What we love about the Top Ten is that it is diverse – just like the industry itself. There are large credit unions, small credit unions, and the group is generally geographically distributed. Well done!
That said, we’d would be remiss if we didn’t specifically point out that Sycamore FCU out of Alabama has retained the top spot this quarter with a score of 9.265. The team there is obviously at the top of their game.
|JOLIET MUNICIPAL EMPLOYEES||IL||http://www.jolietmunicipal.com||$10,134,472||821||8.765|
Photo by Ruthson Zimmerman on Unsplash
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