Return on Assets : How Well Does Your Institution Fare?

One of the standard methods of measuring financial institution performance is using the return on asset ratio.  This is an easy calculation made by dividing net income into total assets.  Net income starts with net interest income, or all interest income less interest expenses.  Non-interest income is added and non-interest expenses are taken out to reach a net income figure.  On the banking side, this number is calculated before income tax expenses. 

Net income is then divided into average total assets to reach a return on assets or ROA.  Basically, this tells the net return you make on your assets.  Credit Unions nationally average a ROA of 0.77%, according to the NCUA.  Banks had an average ROA of 1.44%, according to the FDIC website.  In our area of the country, some of the highest performing credit unions have ROAs that reach 1.60%. 

So why should you be concerned with the ROA of your institution?  After all, aren’t credit unions supposed to be not-for-profit?  True, but not-for-profit does not mean “no profit”.  Successful net earnings performance allows the institution to grow its capital base and also return more net profits back to the members.   A successful capital base and net earnings also allow the credit union to better serve its community and membership as well. 

So what should be a good target for ROA?  I would start with shooting for at least a 1% return on assets.  If you are already above 1%, aim to improve your ROA.  You should be cognizant of the factors that go into the calculation and understand how each item is impacted with the existing and new business that is added to the books. 

If your ROA is low, what is the cause?  There could be many factors to consider and to properly diagnose is similar to a financial institution check-up.  Start first with looking at the net interest margin of the institution.  How does the spread on what is earned on loans and what is paid on deposits compare to the industry and market area?  Could a problem be that there are too many low earning assets on the books?  Perhaps your firm has too much in non-earning assets like buildings and real estate in proportion to its loan portfolio.  Maybe you are known as being the cheapest place in the market to get a loan.  Maybe you are giving away the store to the point that the earning assets are not profitable. 

As a side note, I actually saw this on two different credit union’s websites in the past month.  They were advertising a deposit interest rate special that was higher than the rate they were touting for a new loan product.  Fund enough business on both sides of that equation will lead to insolvency.

Another balance sheet issue is how will your institution perform if there is a change in the rate environment?  If rates go up in 2015, how will it impact your net interest margin and profitability?  So when considering the balance sheet the level, rate, and duration of your earning assets and funding liabilities all come into play.

Other factors to consider are the non-interest income earned and non-interest expenses paid as the final components to reach the net income number.  Are you not only the cheapest place to get a loan in terms of interest rate but are you also paying all third party costs for the loan and not charging any fees to originate the transaction?  Do you not receive fees when they are expected in the market for your services?  Do you have higher than normal non-interest expenses? 

So as you see, finding the source of the problem for poor performance often leads back to low cash, low net interest margin, and low net profits.  There can be a multitude of causes for each of these items that must be researched and understood to accurately assess and also improve your shop.  Once you understand the performance of your CU, you can also determine the profitability, or lack thereof, of a new transaction.  That information can be used to see if there will be an incremental increase or decrease in ROA once the transaction is booked.  If you have questions, ask us.  We are here to help.