System of Self Evaluation for Loan Programs

Standardized Evaluation Ratios and Formulas A variety of criteria are currently employed by various loan funds to evaluate their operations and the effectiveness of their programs. The use of standardized ratios and formulas eliminates the diverse criteria used by loan programs to evaluate their operations. Reasons why standardized financial ratios and formulas should be used: 1. It creates a universal financial language that everyone can understand and communicate with. 2. Objective, Comparative Rankings. Standardized accounting and financial ratios provides objective statistics. By avoiding subjective assessments, it is possible for loan programs to have objective reports that are substantiated by financial information from their balance sheets. 3. An objective system permits open discussion of problems with Board of Directors and Management. 4. Provides a system that individual loan programs can use. Analysis of programs could be conducted on a regular basis (quarterly, semi-annually or annually) of all key areas of loan program operations. These evaluations could be used to spot trends and detecting areas of concerns. PROTECTION OF ASSETS Protection of assets should be a basic tenet of any loan fund. Protection can be measured by comparing the adequacy of the allowances for loan losses against the amount of delinquent loans. Protection against loan losses is deemed to be sufficient if a loan fund has sufficient provisions to cover 100% of all loans delinquent for more than 12 months. Many loan programs may not be anxious to recognize loan losses or to charge them off against any earnings. This could lead, however, to asset values being inflated and provisions for loan losses that are inadequate.

Allowance for Loan Losses / Allowances required for loans delinquent less than 12 months. This formula measures the adequacy of the allowances for loan losses after deducting the allowances used to cover loans that are more than twelve months delinquent. Accounts: a. Total Allowance for Loan Losses b. Allowances used for covering Loans that are more than 12 months delinquent. c. Percentage of allowances for loans that are 1 12 months delinquent. d. Total Balance of all delinquent loans outstanding from 1 to 12 months. e. Percentage of allowances required for non-delinquent loans. f. Total Balance of all non-delinquent loans. (a-b) c* d + e * f

Formula:

Goal: 100% of allowances required for all loans delinquent less than 12 months and for non-delinquent loans. Total Charge-Off Of Delinquent Loans > 12 months This review provides a measure of the total charge off of all delinquent loans > 12 months. Account: a. Total Delinquent Loans greater than 12 months. Formula: If (a) = zero then Yes, else No. Goal: Charge-off 100% of all loans delinquent greater than 12 months. Quarterly Loan Charge-Offs / Total Loan Portfolio This formula measures the amount of loans charged off from the loan portfolio in the current year. Note that loans charged-off should be maintained in an auxiliary ledger and are not found on the balance sheet. Accounts: a. Accumulated Charge-Offs for the Current Year b. Accumulated Charge-Offs for the Previous Year c. Gross Loan Portfolio (excluding allowances) as of Current year-end d. Gross Loan Portfolio (excluding allowances) as of Last year-end (a b) (c + d) 2

Formula:

Goal:

Minimize

Accumulated Recovered Charge-Offs / Accumulated Charge-Offs This measures the accumulated amount of charge-offs that have been recovered through successful collection efforts. This is a historical figure that includes all previous years. Accounts: Formula: Goal: 100% EFFECTIVE FINANCIAL STRUCTURE The financial structure of a loan program is the most important factor in determining growth potential, earnings capacity, and overall financial strength. Loan programs should be encouraged to maximize productive assets as the means to achieve sufficient earnings. Non-earning assets should be discouraged because once purchased, they are often difficult to liquidate. The only effective way to maintain the ideal balance between productive and unproductive assets is by increasing the volume of productive assets. Net Loans / Total Assets The purpose of this formula is to measure the percentage of total assets invested in the loan portfolio. Accounts: a. Total Gross Loan Portfolio Outstanding b. Total allowance for loan losses c. Total Assets (a b) c a. Accumulated Recovery of Charge-offs b. Accumulated Charge-Offs a b

Formula:

Goal: Maintain a maximum between 70 80% Liquid Investments / Total Assets This ratio allows for a measurement of the percentage of total assets invested in shortterm investments.

Accounts: Formula:

a. Total Liquid Investments b. Total Assets a b

Goal: Maintain a maximum of no more than 20% Financial Investments / Total Assets This measures the percentage of total assets invested in Long-term investments Accounts: Formula: a. Total Financial Investments b. Total Assets a b

Goal: Maintain a maximum of no more than 10% Borrowed Funds / Total Assets This measures the percentage of total assets financed by external borrowings (i.e. debt obligations). Accounts: a. Total Short-term loan obligations b. Total Long-term loan obligations c. Total Assets ( a + b) c

Formula:

Goal: Maximum of 5% Institutional Capital / Total Assets This ratio measures the percentage of total assets by Institutional Capital. Accounts: Formula: a. Total Institutional Capital b. Total Assets a b

Goal: Minimum 10%

ASSETS QUALITY A non-productive or non-earning asset is one that does not generate income. An excess of non-earning assets affects loan program earnings in a negative way. The following indicators are used to identify the impact of non-earning assets: 1. Delinquency Ratio If delinquency is high, it usually affects all other key areas of loan fund operations. By using the following formula, loan funds are properly informed of the severity of the situation before a crisis develops. An ideal goal would be to maintain the delinquency rate below 5% of total loans outstanding. Accounts: Formula: Goal: a. Sum of all delinquent loan balances (a non-bookkeeping control) b. Total (Gross) Loan Portfolio Outstanding a b Less than or equal to 5%

Along with this ratio funds should also determine their Loan Loss Rate. Formula: Annual Loan Loss Average Balance of All Outstanding Loans

2. Percentage of Non-Earning Assets A second key ratio is the percentage of non-earning assets owned by the loan fund. The higher the ratio, the more difficult it is to generate sufficient earnings. A goal would be to limit non-earning assets to a maximum of 5% of the total loan fund assets. Examples of Non-Earning Assets

Cash on hand Non-interest bearing monetary checking accounts Accounts receivable Assets in liquidation Fixed assets (land, building, equipment, etc.) Prepaid expenses and other deferrals

Accounts: Formula: a b

a. Total Non-earning Assets b. Total Assets

Goal: Less than or equal to 5% RATES OF RETURN AND COSTS This financial ratio system segregates all of the components of net earnings to help management calculate investment yields and evaluate operating expenses. This methodology assists loan funds in determining which investments are most profitable. The system also allows loan funds to be ranked according to the best and worst yields. By comparing financial structure with yields, it is possible to determine how effectively the program is able to place its productive resources into investments that produce the highest yield. Yield information is computed on three main areas of investments:

Loan Portfolio All interest income; delinquent interest penalties and commissions from lending operations are divided by the total amount invested in the loan portfolio.

Total Loan Income / Average Net Loan Portfolio Measures the yield on the loan portfolio. Accounts: a. Total loan income (include commissions, fees, and delinquent interest penalties) during a year. b. Insurance premiums paid on loans. c. Net loan portfolio (net of allowances for loan losses) as of current year end. d. Net loan portfolio (Net of allowances for loan losses) as of last year end. a - b (c + d) 2

Formula:

Goal: A rate that covers financial, operating, and provisioning expenses and contributes to capital levels that maintain Institutional Capital at least 10%. Liquid Investments All income form bank/credit union savings accounts are divided by the amounts invested in those areas.

Liquid Invest Income / Average Liquid Investments Measures the yield on all short-term investments (i.e. bank deposits, etc.) Accounts: a. Total Liquid Investment Income during year. b. Total Liquid Investments as of current year-end. c. Total Liquid Investments as of Last year-end. a (b + c) 2 Highest rates possible without undue risk.

Formula:

Goal:

Financial Investments Loan funds may invest liquidity into financial investments (e.g. government securities) that pay higher yields than traditional savings accounts. This income is also divided by the outstanding capital invested in those instruments.

Financial Investment Income / Average Financial Investments To measure the yield on all long term investments (i.e. fixed deposits, securities, etc.) Accounts: a. Total financial investments income b. Total financial investments as of current year-end c. Total financial investments as of last year-end a (b + c ) 2 Highest rates possible without undue risk.

Formula:

Goal:

Operational costs are also important. They are broken down into three main areas:

Financial Intermediation Costs This area evaluates the financial costs paid on external loans.

Financial Cost: Borrowed Funds / Average Borrowed Funds Measures the yield (cost) of all borrowed funds. Accounts: a. b. c. Total Interest paid on Borrowed funds Total Borrowed funds as of Current year-end Total Borrowed funds as of Last year-end

Formula:

a (b + c) 2 Rates which maintain the same or a lesser yield (cost).

Goal:

Gross Margin / Average Total Assets Measures the gross income margin generated, expressed as a yield on all assets, before subtracting operating expenses, provisions for loan losses, and other extraordinary items. Accounts: a. b. c. d. e. f. g. Loan Interest Income Liquid Investment Income Financial Investment Income Other income Interest cost of Borrowed funds Total Assets as of current year-end Total Assets as of last year-end

Formula:

( (a + b + c + d) (e) (f + g) 2

Goal: To generate sufficient income to cover all operating expenses and allowances for loan losses and provide for adequate increases in institutional capital.

Administrative Costs An area requiring close analysis is administrative costs. Loan programs may have administrative costs that are higher on a per-unit basis. Costs may be higher because of smaller loan size. It may not be possible to spread fixed administrative costs over a larger loan amount. For example, the fixed costs to make a $1,000 loan may be identical to those of a $10,000 loan. High administrative costs are one of the main reasons why many lenders, including loan funds, are not profitable. An ideal target

utilized by many lenders is to maintain administrative costs at 5% of average total assets. Operating Expenses / Average Total Assets Measures the cost associated with the management of all loan fund assets. This cost is measured as a percentage of total assets and indicates the degree of operational efficiency or inefficiency. Accounts: a. b. c. a (b + c) 2 10% or less Total operating expenses (exclusive of provisions of loan losses) Total assets as of current year-end Total assets as of last year-end

Formula:

Goal:

Total Costs of Services / Total Loans Measures the total cost of services as applied to the number of total loans. Accounts a. b. a b Total Program Costs Total number of loans made

Formula:

Goal: As low as possible. At a minimum the ratio should be lower than the average amount of a loan. Provision for Loan Losses Traditional accounting standards usually include loan loss provisions as part of the overall administrative costs. In reality, the creation of adequate provisions represents a completely different type of expense. It is directly linked to experienced credit analysis and effective loan collection techniques. By isolating this expense from other administrative costs, it is possible to get a much clearer picture of weak credit administration practices in a loan fund.

Provisions for Loan Losses / Average Total Assets Measures the cost of losses from risk assets such as delinquent loans or uncollectible

accounts receivable. This cost is different from other operational expenses and should be separated to highlight the effectiveness of the loan fund collection policies and procedures. Accounts: a. b. c. a (b + c) 2 Enough to cover 100% of delinquent loans less than 12 months and 35% for loans delinquent 1 12 months. Total current year provision expense of all risk assets Total assets as of current year-end Total assets as of last year-end

Formula:

Goal:

Non-Recurring Income or Expenses / Average Total Assets Measures the net amount of non-recurring income and expenses. Accounts: a. b. c. Total Non-Recurring Income or Expenses (current year) Total Assets as of Current year-end Total Assets as of last year-end

Formula: Goal:

a (b + c) 2 Minimum possible

Net Income / Average Total Assets Measures the adequacy of earnings and also, the capacity to build institutional capacity. Accounts: a. b. c. Net income (after any dividends) Total assets as of current year-end Total assets as of last year-end

Formula:

a (b + c) 2 Goal: Enough to attain the goal as set forth in Operating Expenses / Average Total Assets.

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Liquidity Liquidity is traditionally viewed in terms of cash available to lend. Liquidity Accounts: Formula: a. b. a b Total liquid funds Total assets

Liquid Investments Plus Liquid Assets Less Short Term Payables Provides a measure of the adequacy of the liquid cash reserves to satisfy immediate obligations less than 30 days. Accounts: a. b. c. Total Earning Liquid Investments Total Non-Earning Liquid Assets Total Short-term Payables less than 30 days

Formula:

(a+b) C

Goal: Minimum amount needed to satisfy immediate obligations.

Idle Liquid Funds Liquidity reserves are important but they also imply a lost opportunity. It is important to keep idle liquidity reserves to a minimum.

Non-Earning Liquid Assets / Total Assets Measures the percentage of total assets that is invested in non-earning liquid assets. Accounts: Formula: Goal: a. b. a B Total liquid non-earning assets Total assets

Less than 1%

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Signs of Growth The only successful way to maintain asset values is through strong, accelerated growth of assets, along with ongoing profitability. Growth by itself is insufficient. Growth is measured in the following areas:

Total Assets By comparing growth in total assets to other key areas, it is possible to detect changes in the balance sheet structure that could have a negative or positive impact on earnings. The ideal goal for all loan funds is to achieve real, positive growth each year.

Growth in Total Assets To measure the year-to-date growth of Total Assets. Accounts: Formula: a. b. Total Current Assets Total Assets as of the Last Year-End

(a ) (b ) 1 x 100

Goal: Greater than the rate of inflation. Loans If growth in the loan portfolio keeps pace with growth in total assets, there is a good likelihood that profitability will be maintained. Conversely, if loan growth diminishes, less profitable areas are growing more quickly.

Growth in Loans Measures the year-to-date growth of the Loan Portfolio Accounts: Formula: a. b. Current Loan Portfolio Balance Loan Portfolio Balance as of Last Year-End

(a ) (b ) 1 x 100

Goal: Achieve growth that is greater than or equal to the total growth in assets.

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Growth in Liquid Investments Measures the year-to-date growth of liquid investments. Accounts: Formula: a. b. ( a) (b ) Total current liquid investments Total liquid investments as of last year-end - 1 x 100

Goal: Growth that is greater than or equal to that of total asset growth. Growth in Financial Investments Measures the year-to-date growth of financial investments. Accounts: Formula: a. b. Total current financial investments Total financial investments as of last year-end

( a) ( b) 1 x 100

Goal: Growth that is greater than or equal to that of total asset growth. Growth in Borrowed Funds Measures the year-to-date growth of borrowed funds. Accounts: Formula: a. b. (a) (b) Total current borrowed funds Total borrowed funds as of last year-end. - 1 x 100

Goal: To increase or maintain the percentage of total borrowed funds the growth should be greater than or equal to that of total asset growth. To decrease the percentage of total borrowed funds the equation must be less than that of total asset growth.

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Institutional Capital Institutional capital growth is the best indicator of profitability within loan funds. Static or declining growth trends in loan fund capital usually indicates a problem with earnings. If earnings are low, the loan fund will have great difficulty in adding to its institutional capital reserves. A goal would be to have sustained growth of institutional capital at a rate greater than the growth of total assets.

Growth in Institutional Capital Measures the year-to-date growth of institutional capital. Accounts: Formula: a. b. Current institutional capital Institutional capital as of last year-end

(a) ( b ) 1 x 100

Goal: To maintain or exceed the growth of total asset growth. Self Sufficiency Accounts: Formula: a. b. a b Internally generated income Total Expenses

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