Household & Member Statistical Reports: How Net Effective Rate is Calculated
The net effective rate calculation computes the return on a household's (or member's) activity with the credit union. It is based on each household (or member) being either a net borrower or a net saver and then matches the household's (or member's) savings/loan balance and calculates the spread.
NOTE:The example below is for the household version of the statistical report. The same formula is used for the member version, except that households are not summarized for a total savings and loan balance per household.
Terminology
Cost of Funds Weighted Effective Rate (dividends paid directly to the member based on his savings balances)
Spread Earning Rate minus the Cost of Funds
Comparison Rate Credit union-configured parameter used in Household Statistical Reports (click here for a sample of the screen used to configure these rates)
NOTE: Calculations use Average Balance (as of month-end) for savings accounts, and the Current Balance (as of month-end) on loan accounts.
Example Household #1 (Net Borrower)
Total Savings $3,092 with effective cost of funds (weighted effective rate) of 1.59%
Total Loans $17,795 with effective earning rate of 8.00%
Comparison Rate for Investing Excess Shares (CU parameter) = 9.15%
Comparison Rate for Excess Loan Cost of Funds (CU parameter) = 3.00%
Calculation Steps
1.Calculate whether HH is net borrower or net saver (Net Borrower = when loan balances exceed savings balances; Net Saver = when savings balances exceed loan balances)
2.If Net Borrower, calculate total HH balance equal to loan balance (HH#1 = $17,795)
a)Calculate interest spread on HH savings vs. HH loans based on savings balance (“Household Direct Funding of Loans”)
1)Balance used is equal to savings balance (HH#1 $3,092)
2)Calculate spread for HH savings balance (HH#1 = 8.00% - 1.59% = 6.41%)
b)Calculate interest spread on HH excess loan balances (“General CU Funding of Household Loans”)
1)Balance used is equal to the difference between loans and savings (HH#1 = $17,795 - $3,092 = $14,703)
2)Calculate spread for HH excess loan balance by comparing to “Comparison Rate for Excess Loan Cost of Funds” configured by CU (HH#1 = 8.00% - 3.00% = 5.00%)
WHAT DO WE KNOW AT THIS POINT? That the CU is making 6.41% on $3,092 when using the household's savings to fund the household's loans. The CU is making 5% on $14,703 when using general CU funds to fund the member's excess loan balance.
c)Calculate the net effective household rate for a) and b) above, using a weighted average formula
HH#1 a) $3,092 ¸ $17,795 = weighted balance (0.17)
Weighted balance ´ spread (6.41%) = effective rate part 1 (0.011)
HH#2 b) $14,703 ¸ $17,795 = weighted balance (0.82)
Weighted balance ´ spread (5.00%) = effective rate part 2 (0.041)
0.011 + 0.041 = 0.052; therefore 5.2% is the effective spread for Household #1
WHAT DO WE KNOW NOW? In general, the CU has an effective spread on household funds equal to 9.15% minus 3.00% cost of funds. This means, for household funds invested, the CU generally earns 6.15%. Based on the Household #1 example above, the household is less profitable than the average because this household yields only 5.2% as of month end.
Example Household #2 (Net Saver)
Total Savings $4,000 with effective cost of funds (weighted effective rate) of 2.25%
Total Loans $500 with effective earning rate of 10.25%
Comparison Rate for Investing Excess Shares (CU parameter) = 9.15%
Comparison Rate for Excess Loan Cost of Funds (CU parameter) = 3.00%
Calculation Steps
1.Calculate whether HH is net borrower or net saver (Net Borrower = when loan balances exceed savings balances; Net Saver = when savings balances exceed loan balances)
2.If Net Saver, calculate total HH balance equal to savings balance (HH#2 = $4,000)
a)Calculate interest spread on HH loans vs. HH savings based on loan balance (“Household Direct Funding of Loans”)
1)Balance used is equal to loan balance (HH#2 $500)
2)Calculate spread for HH loan balance (HH#2 = 10.25% - 2.25% = 8.00%)
b) Calculate interest spread on HH excess savings balances (“General CU Investing of Excess Household Savings”)
1)Balance used is equal to the difference between loans and savings (HH#2 = $4,000 - $500 = $3,500)
2)Calculate spread for HH excess savings balance by comparing to “Comparison Rate for Investing Excess Shares” configured by CU (HH#2 = 9.15% - 2.25% = 6.90%)
WHAT DO WE KNOW AT THIS POINT? That the CU is making 8.00% on $500 when using the household's savings to fund the household's loans. The CU is making 6.90% on $3,500 when investing the excess savings to fund general investments (loans for other members).
c) Calculate the net effective household rate for a) and b) above, using a weighted average formula:
HH#2 a) $500 ¸ $4,000 = weighted balance (0.13)
Weighted balance ´ spread (8.00%) = effective rate part 1 (0.01)
HH#2 b) $3,500 ¸ $4,000 = weighted balance (0.875)
Weighted balance ´ spread (6.90%) = effective rate part 2 (0.06)
0.01 + 0.06 = 0.07; therefore 7.0% is the effective spread for Household #2
WHAT DO WE KNOW NOW? In general, the CU has an effective spread on household funds equal to 9.15% minus 3.00% cost of funds. This means, for household funds invested, the CU generally earns 6.15%. Based on the Household #2 example above, the household is more profitable than the average because this household yields 7.00% as of month end.
The Point
Credit unions must subtract all their expenses from the net spread between dollars invested and the cost of attracting those dollars. Therefore, as downward pressure on loan rates is matched with upward pressure to pay good dividend rates, the actual spread narrows. Managing this spread can be the difference between a credit union being profitable or not being at all.
By measuring the spread based on each member relationship, the credit union can look for situations where certain activities by a member are more or less profitable when compared to other members. Once these activities are identified, the credit union can market to and encourage profitable activities.
If Household #1 only earns 5.2% and averages for the year $17,795 in loan balances and continues with the same savings balance and mix, the credit union will have gross earnings on the household of $925 for the year. It must pay all of its expenses to service this member using that $925.
If Household #2 was to continue like this for a full year, the credit union would gross $280 ($4,000 ´ 7%). The issue here is that the credit union is concerned both about the percentage spread on member funds invested as well as the balances.