1. David Hewson – ILCU, Monitoring Dept National Supervisors Forum 2011
W E L O O K A T T H I N G S D I F F E R E N T L Y
PEARLS Ratios
David Hewson – ILCU, Monitoring Dept
National Supervisors Forum 2011
Hello and thanks for having me here at the National Supervisors Forum.
My name is Dave Hewson and I work in the Monitoring Dept of the League
I look after the Prudential Return and PEARLS ratios so you will hopefully have seen some of my PEARLS reports over the years

2. What will be covered today
PEARLS background
Key PEARLS, worked examples
Your PEARLS report, what to look out for, trends, problems
How are you performing? Ranking your PEARLS
How can you improve your PEARLS?
Questions & answers
I’m here to look at PEARLS ratios with you.
As I understand it, there would be different levels of understanding of PEARLS, so I will keep this at a fairly basic level.
I hope to explain PEARLS, where they come from and what they are intended to do.
I’ll go through a couple of worked examples of how PEARLS ratios are calculated.
Not all of the ratios, as there are 27 in all, and that would take all night! But Some of examples of the most important ratios.
I will also cover a little bit on what to look out for in your PEARLS reports, the warning signs.
Also, I will cover how you can check performance of your PEARLS.
Lastly, I will go through what help is available to try and improve PEARLS ratios.

3. In operation world wide since 1990
Devised by WOCCU
In operation world wide since 1990
ILCU adopted PEARLS ratios & added ratios tailored to the Irish Credit Union Movement
ILCU updated PEARLS in 2008, 2009 and June 2011
In June 2011 we added E6c Net Capital Ratio (important solvency check) and A2b Fixed Assets ratio (recent issues on valuations of premises)
WOCCU created PEARLS in WOCCU has since refined and adjusted PEARLS over the years. Credit union national federations and associations uses PEARLS to supervise regulated credit unions.
One of the benefits of PEARLS is that it measures different credit union’s performance in a standard way, comparing “like with like” .
As a management tool, PEARLS helps signal problems to managers before these problems become detrimental to the credit union’s financials. For boards of directors, PEARLS provides a tool to monitor management's progress toward financial goals.
The ILCU adapted some of the goals and targets for the PEARLS ratios, and also incorporated some of the CAMEL ratios which were used previously by ILCU.
ILCU update ratios when necessary and added an updated Reserves Ratio last quarter. We also added a fixed asset ratio, to measure the proportion of fixed assets in the balance sheet, as revaluations of premises have become an issue recently, following the property crash.

4. EFFECTIVE financial structure
PROTECTION P
EFFECTIVE financial structure E
ASSET quality A
RATES of return R
LIQUIDITY L
SIGNS of growth S
Each letter of the word PEARLS represents a key are of Credit Union operations

5. P1 Provisions, P3 Solvency
E6c Net Capital/Assets E
A1 Arrears A
R5 Expense/Income R
L1 Liquidity L
S1 Growth in loans S
Each letter of the word PEARLS represents a key area of Credit Union operations as you can see here.
There are several ratios under each heading here, for example.
P - P1 Provision ratio
E – E6c Net Reserve / Assets
A – A1 Arrears
R – R5 Expenses/Income
L - L1 Liquidity
S – Growth in Loans (negative at the moment)

6. PEARLS report

7. Why use PEARLS?-Credit Unions
PEARLS ratios provide supervisors with a snap shot of the financial health of the credit union
Focus on the key ratios (Provisions, Arreras,Solvency etc)
Review the other PEARLS ratios for detail (Loan Interest, Growth in Savings)
PEARLS report shows current status, and results for previous year

8. Why use PEARLS? ILCU
Monitoring use PEARLS as part of risk based approach to Monitoring.
Assists with assigning resources (eg Field Officer visits)
Monitoring score credit unions on Arrears, Provisions, Solvency, Reserves, Liquidity, Regulatory Requirements and other factors

9. Prudential Return & PEARLS
Prudential Returns are loaded onto the database in ILCU, the PEARLS ratios are calculated
Movement average and ROI/NI averages are calculated using the pooled Prudential data.
PEARLS results depend on accuracy of the Prudential Return

10. Prudential Return updates
Prudential Return in the Republic was substantially revised in December The new version is now a more detailed 8 page document (guidance note runs to 56 pages)
Prudential Return for Northern Ireland will be replaced by the FSA return in 2012 (first reports due quarter end Dec 2012)
Revised NI PEARLS will be developed for FSA reporting

11. 2 - Key PEARLS, worked examples
Example (a) - P1 Provisions Ratio
Formula:
Bad Debt Provision Total per balance sheet
divided by
Res 49 provision minimum
Res 49 provisions is generated from the arrears table
Provision % increase as arrears become more long term

12. Example (a) - P1 Provisions Ratio
Arrears category
Min % Provision
Example provision
weeks
10%
€5,000
19-26 weeks
20%
€10,000
27-39 weeks
40%
€20,000
40-52 weeks
60%
€40,000
53+ weeks
100%
€25,000
Total provision
€100,000
This table outlines the provisions percentages in the Res 49 table.
As you can see, the short term arrears have a minimum of 10% provision attached.
The provision %’s increase through the table to 40%, 60% etc up to 100% for the loans that are 53+ weeks in arrears.
These provision %’s are minimum levels, and with the roll out of the revised Res 49 rolled out by ILCU credit unions can adjust up provisions where necessary, where they believe an additional provision is required.
So you may see a 50% provision on loans in the category etc.
This sort of adjustment up is obviously much more commonplace in the current difficult lending market.
The example here, shows a credit union that has a Res 49 provision estimate of €100,000 in total. These are just rounded figures for example purposes.

13. Example (a) - P1 Provisions Ratio
Total provision in balance sheet = €150,000 Res 49 provision minimum = €100,000 P1 Result = 150% This CU has a buffer of €50,000 Minimum is 100% Average is currently134%
This credit union has a provision of €150,000 in their balance sheet.
So when we divide the €100,000 Res 49 estimate by €150,000 we get the result 150% for the P1 ratio.
The minimum for this ratio is 100%, so while this result is well above this, it may not mean that this credit union is fully provided.
The Res 49 provision really is a good guide or starting to provision levels, but it is a programmed provisioning system, so as such cannot “know everything”
Provisions can only be verified by regular reviews of loan books.
This credit union has a buffer of €50,000 above the minimum, but if arrears climbed sharply this buffer will be eroded quickly.

14. Example (a) - P1 Provisions Ratio
Recent change to the ratio
With updated Res 49, credit unions can add provisions above the 10%, 20% minimums within Res 49 table
Your P1 ratio will take account of this and work off total provision / minimum provisions
If you adjust up provisions within Res 49, P1 ratio increases

15. Example (b) - P3 Solvency Ratio
Measures cover for member savings in the event of a wind up/liquidation Formula: (a)Assets + (b)Provision minus (c) Res 49 Provision + (d) Short Term Liabs divided by (e) Total Savings
This ratio is obviously hugely important, and very topical given the pressures on the SPS fund and credit unions experiencing solvency problems.
I also wanted to explain this ratio in particular, as the calculation is more complex, and a lot of credit unions have problems working it out.
Put simply the ratio measures how your balance sheet covers member savings, in the event of a liquidation or wind up.
Previously Solvency ratios were way above the required levels, but we all know that this is no longer the case.
This ratio is an ILCU variant of the original WOCCU ratio. You may wonder why the provisions and Res 49 provisions are included here.
It was worked out this way, so that any credit unions that were making higher loan provisions benefited from a stronger Solvency ratio.
In the PEARLS suite of ratios, we also include Regulatory ratios and Capital ratios as measures of solvency.
Credit unions that appear on the radar with low P3 ratios, will also appear on the low capital lists.

16. Example (b) P3 Solvency Ratio
Assets €1,000,000
Provision total €150,000 €1,150,000
minus
Res 49 provision €100,000
Short term liabilities €5,000 €105,000
divided by
Savings €900,000
P3 Result = %
Minimum is 109%
Again, the figures here are rounded up but reflect a typical credit union.
I’ve taken the provision amounts from our P1 examples, and used a credit union with assets of €1,000,000.
On average provisions are running at 12-14% of loan books, this example would be higher than that, but not uncommon.
You can see that when we do the calculations, taking €105,000 from the €1.15 million we arrive at €1,045,000.
This credit union has savings of €900,000 so, the €1,045,000 well covers this amount, and we arrive at the P3 ratio of 116%.
The goal for this ratio is 109%. The reason 100% is not used, is that in the event of the liquidation of a credit union, you must allow a buffer for costs and losses involved to ensure that members savings are covered.
The current WOCCU goal for their equivalent ratio is 111%.

17. Example (c) – E6c Capital Ratio
This a new ROI Capital Ratio and measures Realised Reserves over assets, and takes account of deficits.
Formula:
All realised reserves and surplus (less deficit)
divided by
Assets
Minimum range is 8.5% - 10%
(must be 10% by 2013)
As credit unions are coming under pressure and deficits are more common, we added this Capital ratio as other Reserves ratios did not take account of deficits, where this ratios spells out the credit unions net capital position.
We are all well aware of capital levels now, recapitalisation of the banks and the recent announcement of possible recapitalisation of credit unions next year.
Any credit union below the required level (8.5% for this year end) will require support.
The goal follows the Regulatory Reserve timeline and must be 8.5% this year end , and 10% by year end 2013.
Credit unions that appear on the radar with low P3 ratios, will appear on the E6c Capital list also. They are both good measures of solvency and falls in these ratios should ring alarm bells.

18. Example (c) – E6c Capital Ratio
Regulatory Reserve €90,000 Undistributed surplus €5,000 Current surplus €6,000 Realised Reserves €3,000 €104,000 divided by Assets €1,000,000 E6c Result = 10.4% (meeting requirement)
Thankfully, this credit union is in the happy position of having a surplus, and a capital ratio of 10.4% of assets.

19. Example (c) – E6c Capital Ratio
Regulatory Reserve €90,000 Undistributed surplus €5,000 Current deficit (€6,000) Realised Reserves €3,000 €92,000 divided by Assets €1,000,000 E6c Result = 9.2% (Borderline)
On this slide, you can see the impact of changing the €6,000 surplus into a €6,000 deficit.
The capital ratio drops to 9.2%.
If we increased the deficit to €15,000 then the ratio falls to 8.3%, below the required level. That credit union may need capital support.
In most cases, credit unions falling below required capital levels are as a result of losses through write offs and additional loan provisions.

20. Example (d) - A1 Arrears Ratio
Formula: Gross Loans 10 weeks+ in arrears divided by total Gross loans Gross loans 10 wks + in arrears = €200,000 divided by Total Gross Loans = €800,000 A1 Result = 25% Average is 17.8% Note the Goal for ratios is 5%!
The next example and most important of all ratios is the A1 Arrears ratio.
This is simply calculated by adding up all gross loan arrears from 10 weeks in arrears upwards, and dividing by total gross loans per the balance sheet.
So we add gross loans in the weeks category to week etc etc
In this case, the credit union has gross loans of 10 weeks in arrears or more of €200,000.
The total loans in their balance sheet is €800,000, so we arrive at an A1 arrears ratio of 25%.
A ratio of 25% would have been unheard of even a couple of years ago, but is not uncommon now.
And obviously these higher arrears are resulting in higher write offs and larger transfers to provisions which is putting such pressure on all credit unions throughout the movement, especially so in the Republic.
I have been asked why gross loans are used, and it is the case that on average 20-30% of loans have savings attached, which reduces the risk, but we cannot expect that 100% of these savings are available in all cases.
A move to net loans in the current situation we find ourselves in, would not be prudent.

21. Example(e) – R6 Wages/Income
Formula: Salaries and related expenses divided by total income Wages= €60,000 divided by Total Gross Loans = €500,000 Result = 12% Average is 19% Goal is 15%
Everyone is looking at costs at the moment, and on the other side of the equation, in credit unions income levels have been falling, due mainly to the fact that members are not borrowing as much as in the past.
In this example a ratio of 12% is healthy, well below the average of 19%.
If the ratio increased to 20% if a new credit controller had been hired, then in short term the ratio is above the norm, but you would hope over time the ratio will improve as the work of credit controller reduces delinquency costs

22. Example (e) - L1 Liquidity Ratio
Formula: Cash + Investments less than 3 months duration divided by total unattached shares Cash + short term inv= €100,000 divided by Unattached shares = €400,000 L1 Result = 25% Average is 39% Goal is minimum 20%, up to 30%
Liquidity must be closely watched, generally credit unions have more than adequate liquidity.
We updated this ratio to include current account balances, as more recently credit unions have held more funds in current accounts.
The minimum for this ratio is 20%, in Republic of Ireland depending on your loan book the Section 35 requirements may require higher Liquidity of up to 30%.
FSA requirements will come in next year for Northern Ireland credit unions, and again revised PEARLS will be brought in.
As you can see the movement average is 30%.

23. Questions on PEARLS examples?

24. 3 – PEARLS report, what to look out for
Q:What has changed this quarter? Jump in arrears?
Q: Arrears up over several quarters?
Q: Is the P1 ratio falling, or close to minimum 100% level?
Q: Expense/income ratio now above norm?
Arrears and provisioning ratios should be the first ratios reviewed.
There is serious pressure on members, and upward pressure on arrears but some credit unions are maintaining low arrears still.
As I mentioned earlier, most of the credit unions requiring capital support are as a result of losses relating to write offs and extra loan provisioning.
So a sharply rising arrears ratio couples with a low P1 ratio should be a big warning sign.

25. 3 – PEARLS report, what to look out for
Q: Are reserves ratios stable? Or falling?
Q: Capital ratio below 10%?
Q: Falling loan book?
Q: Income ratios falling?
The first two are obviously, but a Capital or net Reserves ratio below 10% could mean a serious solvency issue.
Loan books are shrinking, partly as a result of lending restrictions, and as I mentioned earlier, this puts pressure on income.
Income ratios should be high enough to cover expenditure and build reserves, this is easier said than done.

26. 4 – How are you performing?
Peer Rankings:
As part of your PEARLS pack we include peer rankings on key ratios
Ranked against similar sized Cus
e.g: CU ranked 13th of 40 CUs on arrears in their peer group (assets of €25-€50m)
Last quarter we ranked on A1 Arrears and P1 Provisions
We added peer rankings in recent years, as an added performance measurement tool.
It is useful to compare against movement averages, but as credit unions are so varied in size, we added peer rankings.
We also split Industrial Credit unions into their own peer groups, as arrears are traditionally much lower among Industrial credit unions, it was not worthwhile comparing Industrial and Community credit unions on arrears.
We also include Peer Group averages, and high and low scores in your PEARLS pack, for additional comparison purposes.

27. 4 – How are you performing?
Peer Rankings checks: Q: Are we ranked in top half of our peer group? Q: Has our ranking slipped from last quarter? Q: Did our arrears increase exceed increase in movement? Q: Are we beating the average? (average for Peer Group, and average for Movement)
The peer rankings should give you valuable performance data.
In particular on arrears, while the trend in the movement is climbing arrears, if your arrears ranking is slipping badly, your arrears are worsening significantly more than similar sized credit unions.
That is another big warning sign.

28. 5 – How can you improve your PEARLS?
P1 Provisions
Review Res 49 arrears report monthly
If P1 has fallen, an adjustment to provisions is likely, and needs to be planned for
Make adjustments to provisions quarterly
Don’t leave it until year end

29. 5 – How can you improve your PEARLS?
A1 Arrears- At Lending stage, ahead of the curve
Update loan assessment techniques
Stress testing – can borrower repay with higher mortgage rate?
ICB
What if member’s income falls? (inevitable)
Security on loans
These are all obvious points regarding the lending stage, but as most of problems facing credit unions relate to their loan books, these are worth repeating.
If the credit union is in the lucky position to lend to it’s members, then lending decisions must be well informed.
The last point on security is obvious, but these days, security is difficult to value and verify.

30. 5 – How can you improve your PEARLS?
A1 Arrears- at credit control stage
Take what you can get, but get something
Positive tone – engage with members
Preparation before contacting members
Information – obtaining, confirming, storing, follow up
In most cases the initial contact with members is key.
Credit unions have a good relationship with their members, and maintaining those contacts is important.
The last point on follow up is very important

31. 5 – How can you improve your PEARLS?
Income and Expenses ratios
Get detail on sharp changes in expense ratios
Apart from closely watching expenditure, can income be increased?
Should loan rates be increased?
Or credit control pulling in more recoveries?

32. Relevance of PEARLS
One of the major problems facing credit unions is lending restrictions, shrinking the loan books and putting pressure on income.
In the Republic approx 70% of credit unions have some form of restriction on their lending.
Monitoring did some analysis on this, and this graphs shows the average ratios for Cus with lending restricted and those with no lending restrictions.
There are anomolies in the way restrictions have been given out, but generally , those with stronger Arrears and Capital have not had their lending curtailed.
85% of credit unions restricted had above average A1 arrears.
These are the two key factors, none of the credit unions without restrictions had capital below 10%.
A small number had higher than average arrears, but good capital ratios.

33. Help is available ILCU training courses ACCUP
ILCUbis (business intelligence) to keep on top of your financials. Monthly PEARLS, graphs etc
Contact the ILCU Monitoring Department for Guidance

34. Thank you for your attention Questions? dhewson@creditunion.ie