ROA and the Road to Recovery

 While ‘normal’ ratios are still elusive, we’re moving in the right direction.

February 1, 2012

Credit union earnings took a big hit in third-quarter 2011, primarily due to a hefty corporate stabilization expense.

That’s the bad news. The good news: The days of declining credit union return-on-assets (ROA) likely are behind us…at least for now.

Full-year 2011 total credit union ROA should come in at about 0.65% to 0.7%. While that’s well below the 0.9% long-run average earnings rate, it would represent an approximate 20 basis point (bp) increase over earnings recorded in 2010.

Looking ahead, it’s likely earnings will again increase this year. Specifically, aggregate bottom-line results probably will jump by 15 bp to 20 bp in 2012, putting movementwide ROA in the neighborhood of 0.85%—just shy of the long-run norm.

Other projections include:

  • In NCUA’s most likely scenario, corporate stabilization expenses this year should be about half what they were in 2011. If so, that would add about 10 bp to credit union earnings.
  • A growing economy and improving labor markets should produce marginally higher incomes and higher confidence. That, in turn, could have consumers spending, and borrowing, a bit more.
  • Slightly faster loan growth would help to buoy income, even if market interest rates stay low. And that might add about 5 bp to total earnings.
  • Loss provisions are likely to decline in 2012. Loss provisions fund allowance accounts, and allowance accounts are built with an eye on net charge-offs—current levels and experiences of the recent past.

But given the stage of the economic recovery and the notion that it’s gaining steam, past performance (recent charge-off experience) is likely to be a poor indicator of future performance. Losses are likely to ease and more credit unions are apt to find allowance accounts overfunded. Hence, the expectation that lower provisions will boost earnings.

Credit union net charge-offs average about 0.5% over the long haul, but the recent crisis produced an incredible spike from 0.51% in 2007 to a cyclical high of 1.21% in 2009. Net charge-offs have since eased, but the current 0.95% annualized rate for the first nine months of 2011 is about double the norm.

Loss provisions totaled 0.43% in 2007 and then nearly doubled to 0.85% in 2008. They peaked at 1.11% in 2009, before declining to 0.78% in 2010 and 0.5% (annualized) by the end of third-quarter 2011. What’s normal? During the past 20 years, credit union loss provisions averaged 0.43% (0.35% if you remove the unprecedented spike of 2008 to 2011 from the calculation).

Big increases in loss provisions led to big increases in credit union loan loss allowance accounts, which held $3.88 billion at the start of the economic downturn but nearly tripled to $9.44 billion by 2010. They’ve since declined marginally—to $9.08 billion.

Though the dollar amount of allowances declined recently, the ratio of allowances to net charge-offs continued to increase, hitting a cyclical high of 1.74% by September 2011. The normal range is 1.4% to 1.5% during economic expansions. The aggregate difference between current readings and more normal levels translates to about $1 billion.

The bottom line: We obviously haven’t returned to “normal,” and the way forward likely will be bumpy. But if provisioning brings allowances into more normal ranges in 2012, net income could increase by as much as $1 billion—translating to an additional 10 bp in ROA this year.

MIKE SCHENK is CUNA’s vice president, economics and statistics. Contact him at 608-231-4228.