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PEARLS//AboutPEARLS
April25,2016
WhatisPEARLS?
Protection
EffectiveFinancialStructure
AssetQuality
RatesofReturnandCosts
Liquidity
SignsofGrowth
PEARLSisafinancialperformancemonitoringsystemdesignedtooffermanagementguidanceforcreditunions
andothersavingsinstitutions.PEARLSisalsoasupervisorytoolforregulators.PEARLScanbeusedtocompareand
rankinstitutionsandcanprovidecomparisonsamongpeerinstitutionsinonecountryoracrosscountries.
PEARLSisasetoffinancialratiosorindicatorsthathelpstandardizeterminologybetweeninstitutions.Intotal,there
are44quantitativefinancialindicatorsthatfacilitateanintegralanalysisofthefinancialconditionofanyfinancial
institution.Thepurposeforincludingamyriadofindicatorsistoillustratehowchangeinoneratiohasramificationsfor
numerousotherindicators.
Eachindicatorhasaprudentialnormorassociatedgoal.Thetargetgoal,orstandardofexcellenceforeachindicatoris
putforthbyWorldCouncilofCreditUnionsbasedonitsfieldexperiencewithstrengtheningandmodernizingcredit
unionsandpromotingsavingsbasedgrowth.Depositorscanhaveconfidencethatsavingsinstitutionsthatmeetthe
standardsofexcellencearesafeandsound.
PEARLS,primarilyamanagementtoolforinstitutions,canalsobeusedasasupervisorytoolbyregulators.Asa
managementtool,PEARLSsignalsproblemstomanagersbeforetheproblemsbecomedetrimental.Forboardsof
directors,PEARLSprovidesatooltomonitormanagement'sprogresstowardfinancialgoals.Forregulators,PEARLS
offersindicatorsandstandardstosupervisetheperformanceofsavingsinstitutions.
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WhousesPEARLS?
Inpartnershipwithcreditunions,WorldCouncilcreatedPEARLSinthelate1980s.WorldCouncilhasrefinedand
adjustedPEARLSoverthepastdecades.WorldCouncilusesPEARLSwithallcreditunionsparticipatinginitstechnical
assistanceprogramsaroundtheworld.Inadditiontoindividualcreditunionsandcreditunionnationalfederationsand
associations(includingmanyWorldCouncilmembers),theBolivianSuperintendencyofBanksusesPEARLSto
superviseregulatedcreditunionsinBolivia.
WhatdoesPEARLSmonitor?
rotection
Theprimarygoalofevaluatingtheprotectionindicators,astheheadingimplies,istoensurethatthefinancialinstitution
providesdepositorsasafeplacetosavetheirmoney.Provisionsforloanlossesarethefirstlineofdefenseagainst
unexpectedlossestotheinstitution.Allowancesforloanlossesareessential,sincedelinquencysignalsthatloansare
atriskthus,theinstitutionmustsetasideearningstocoverthosepossiblelossessothatmemberclientsavingsremain
protected.
Whenfinancialintermediariesdonotrecognizeloanlosses:
Assetvaluesareinflated
Reportednetincomeisoverstated
Provisionsforloanslossesarelacking
Memberclientsavingsarenotsecure
Dividendsareoverstatedanderroneouslypaidout
ThemostcriticalratiounderprotectionisP1.ThegoalofP1istohave100%provisionsforloanlossesfromloansthat
aregreaterthan12monthsdelinquent.Accuratemeasurementofdelinquency(totaloutstandingbalanceofportfolioat
riskat30days),indicatorA1,isintegrallylinkedtothecreationofadequateallowancesforloanlosses.
Theprotectionsectionconsidersloanwriteoffsonaquarterlybasisforloansdelinquentmorethan12months.The
practiceofwritingoffloansisimportantbecauseafteraloanisdelinquentforoneyear,itisunlikelytheinstitutionwill
receiverepaymentofthatloan.Theinstitutionusestheprovisionsithassetasideof100%ofthevalueofthatloantowrite
offthedelinquentloan.Asaresultofthewriteoff,thebalancesheetwillaccuratelystatethevalueoftheinstitution's
assets.
Towriteoffaloandoesnotmeantheinstitutionstopsseekingtocollectpaymentontheloan.Forthisreason,protection
indicatorsalsoconsideramountsrecoveredfromwrittenoffloans.
Thelastindicatorundertheprotectionheadingissolvency.Thisindicatormeasurestherelativeworthofonedollarin
memberclientsavingsafteradjustingforknownandprobablelosses.
Theformulaforcalculatingthisratiois:
[(TotalAssets+TotalAllowances)(100%ofLoansDelinquent>12Months+35%ofLoansDelinquentfrom1
12Months+TotalLiabilities+ProblemAssets)Deposits]/TotalSharesandTotalDeposits
PProtection
Goals(Excellence)
1.LoanLossesAllowances/Delinq.>12Mo.
100%
2.NetLoanLossAllowances/WorldCouncilAllowanceRequiredforDelinq.
112Mo.
35%
3.CompleteLoanChargeoffofDelinq.>12Mo.
Yes
4.AnnualLoanChargeoffs/AverageLoanPortfolio
Minimized
5.Accum.ChargeoffsRecovered/Accum.Chargeoffs
>75%
6.Solvency(NetValueofAssets/TotalShares&Deposits)
111%
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ffectiveFinancialStructure
Thefinancialstructureisthemostimportantvariablethataffectsgrowth,profitabilityandefficiency.Creditunions
thatmaintainmost(7080%)oftheirtotalassetsintheloanportfoliohavethegreatestopportunitytomaximizereturnson
theseproductiveassetswhileprovidingtheirmemberclientswiththecreditservicestheyseek.Similarly,institutionsthat
fundtheirassetsprimarily(7080%)withmemberclientdepositsareindependentfromthefluctuatingpriceofexternal
funds.
Financialstructureisalwayschangingandrequirescarefulmanagement,especiallyincasesofrapidgrowth.
TheeffectivefinancialstructureareaofPEARLSfocusesonaninstitution'ssourcesoffunds(savings,shares,external
creditandinstitutionalcapital)anditsusesoffunds(loans,liquidinvestments,financialinvestmentsandnonearning
assets).ThePEARLSsystemprovidesinformationovertimetherefore,managers,directorsandregulatorscanobserve
thestructuralevolutionofboththesourcesoffundsandtheusesoffunds.
Aninstitutionhasaneffectivefinancialstructurewhenassets,financedbysavingsdeposits,generatesufficient
incometopaymarketratesonsavings,coveroperatingcostsandmaintaincapitaladequacy.
Institutionalcapital,alllegalreservesandsurpluscreatedeitherfromtheaccumulationofnetincomeorfromcapital
donations,isthesecondlineofdefensetoabsorbunexpectedlosses.Institutionalcapitalcanbeinvestedtoexpand
productsandservices.Italsocanbeusedtopayforthehighcostsoftechnologyandbuildingconstruction.
NetInstitutionalCapital,ratioE9,isReserves,RetainedEarningandProvisionsnetof100%ofdelinquentloansgreater
than12monthsandnetof35%ofdelinquentloansbetween30364daysoverduedividedbyTotalAssets.
EEffectiveFinancialStructure
1.NetLoans/TotalAssets
Goals(Excellence)
7080%
2.LiquidInvestments/TotalAssets
16%
3.FinancialInvestments/TotalAssets
2%
4.NonfinancialInvestments/TotalAssets
5.SavingsDeposits/TotalAssets
6.ExternalCredit/TotalAssets
0%
7080%
05%
7.MemberShareCapital/TotalAssets
20%
8.InstitutionalCapital/TotalAssets
10%
9.NetInstitutionalCapital/TotalAssets
10%
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ssetQuality
AssetQualityisthemainvariablethataffectsinstitutionalprofitability.Anexcessofdefaultedordelayedrepayment
ofloansandhighpercentagesofothernonearningassetshavenegativeeffectsoncreditunionearningsbecausethese
assetsarenotearningincome.AsmentionedintheProtectiondiscussion,itisessentialthatdelinquencybemeasured
correctlyandminimized.Delinquency,commonlyreferredtoasportfolioatrisk,isthetotaloutstandingbalanceofloans
delinquentgreaterthan30days.Thisratioisameasurementofinstitutionalweaknessbecauseifdelinquencyishigh,
thenotherkeyareasofcreditunionoperationscouldbeweake.g.loanlossprovisions,institutionalcapitalandnet
income.
Inadditiontocontrollingdelinquency,institutionsalsomustmonitortheratioofnonearningassetstototalassetsand
ensurethatthesenonearningassetsarenotfinancedbysavingsdeposits,externalcreditormembershares(inthecase
ofacreditunionorotheruserownedfinancialcooperative).Sourcesoffundsthathaveafinancialcostsuchassavings
depositsneedtobeinvestedinproductiveassetsthatwillearnareturngreaterthanthecostoffunds.Theonlywayto
havenonearningassets,suchasfixedassets,withoutnegativelyaffectingearningsistofinancethoseassetswithno
costcapitalsuchasinstitutionalcapitalorreserves.
AAssetQuality
Goals(Excellence)
1.TotalLoanDelinquency/GrossLoanPortfolio
5%
2.NonearningAssets/TotalAssets
5%
3.NetZeroCostFunds/NonearningAssets
200%
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atesofReturnandCosts
TheRatesofReturnandCostsindicatorsmonitorthereturnearnedoneachtypeofasset(useoffunds)andthecostof
eachtypeofliability(sourceoffunds).Ontheassetsside,onecandeterminewhattypesofassetsearnthehighest
returns.Ontheliabilityside,onecandeterminewhataretheleastandmostexpensivesourcesoffunds.
Yieldsandcostsdirectlyaffectthegrowthratesofaninstitution.Theintentisforaninstitutionto:payrealratesof
returnonsavingsandshares,chargeratesonloansthatrecoverallcostsandpaycompetitivesalariesforemployees.
ThegoalofR1,NetLoanIncomedividedbytheAverageNetLoanPortfolio,isforloanpricestobesetat
entrepreneurialrates.Theentrepreneurialrateneedstocoverthecostoffunds,thecostofoperationsand
administration,thecostofprovisionsandthecostofcontributionstoincreasecapital.
Theincomeratiosidentifyincomefromnetloans,liquidassets,financialinvestmentsandnonfinancialinvestments.
Financialcostratioslookatthecostsofsavingsdeposits,externalcreditanddividendsonshares.Operatingcostratios
(R9,R10)separateoutoperatingcostsandprovisionsforriskassets.
RRatesofReturnandCosts
Goals(Excellence)
1.NetLoanIncome/AverageNetLoanPortfolio
EntrepreneurialRate
2.LiquidInv.Income/Avg.LiquidInvestments
MarketRates
3.Fin.InvestmentIncome/Avg.Fin.Investments
MarketRates
4.Nonfin.Inv.Income/Avg.Nonfin.Investments
R1
5.Fin.Costs:SavingsDeposits/Avg.SavingsDeposits
MarketRates>Inflation
6.Fin.Costs:ExternalCredit/Avg.ExternalCredit
7.Fin.Costs:MemberShares/Avg.MemberShares
8.GrossMargin/AverageAssets
9.OperatingExpenses/AverageAssets
MarketRates
MarketRates,>R5
E9=10%
5%
10.ProvisionsforRiskAssets/AverageAssets
P1=100%,P2=35%
11.OtherIncomeorExpense/AverageAssets
Minimized
12.NetIncome/AverageAssets(ROA)
E9=10%
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iquidity
Managingliquidityisanessentialcomponentofadministeringasavingsinstitution.
ThegoalofL1,15%ofshortterminvestmentsminusliquidassetsminusshorttermpayablesovertotalsavingsdeposits,
servestomaintainshortterminvestmentliquiditytorespondtomemberclientwithdrawalanddisbursementdemands.
ThegoalofindicatorL3,tomaintaintheratioofcostlynonearningliquidassetstolessthan1%oftotalassets,isto
minimizenonearningcashtomostdailyopeationalneeds.
LLiquidity
Goals(Excellence)
1.LiquidAssetsSTPayables/TotalDeposits
1520%
2.LiquidityReserves/TotalSavingsDeposits
10%
3.NonearningLiquidAssets/TotalAssets
<1%
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ignsofGrowth
SignsofGrowthreflectmemberclientsatisfaction,appropriatenessofproductofferingsandfinancialstrength.
Growthdirectlyaffectsaninstitution'sfinancialstructureandrequiresclosemonitoringtomaintainbalanceforexample,
growthinsavings(S5)drivesgrowthintotalassets(S11),butifloans(S1)arenotgrowingasquicklyassavings,thenthe
institutionwillhavehighliquidity(L1)andlowearnings(R12).Similarly,assavingsaregrowing,itisimportanttowatch
thatinstitutionalcapital(S8)isincreasingatasimilarpacesothattherewillbeabuffertoprotectthosesavingsagainst
unexpectedlosses.ThegrowthindicatorsofPEARLScanhelpmanagersmaintainabalancedandeffectivefinancial
structure.
GrowthinTotalAssetsisacriticalindicatorsince16oftheotherPEARLSperformanceindicatorsarelinkedtoit.
Aninstitutionneedstomaintainaccuratemacroeconomicinformation,particularlytheannualizedinflationrate,inorderto
attainpositiverealgrowth.
SSignsofGrowth(AnnualizedRates)
1.NetLoans
Goals(Excellence)
E1=7080%
2.LiquidInvestments
E216%
3.FinancialInvestments
E32%
4.NonfinancialInvestments
E4=0%
5.SavingsDeposits
E5=7080%
6.ExternalCredit
E6=05%
7.MemberShares
E720%
8.InstitutionalCapital
E810%
9.NetInstitutionalCapital
E910%
10.Membership
15%
11.TotalAssets
>Inflation+10%
HowdoPEARLS&CAMELdiffer?
TherearethreeprimarydifferencesbetweenthePEARLSandtheCAMEL(CapitalAdequacy,AssetQuality,
Management,Earnings,Liquidity)monitoringsystems:
PEARLSusesstrictlyquantitativeindicatorswhileCAMELusesquantitativeandqualitative(e.g.,Management).
PEARLSprovidesanobjectiveevaluationoffinancialperformancebyreviewingtheresultsofthestrictly
quantitativeindicators.
PEARLSevaluatesthefinancialstructureofthebalancesheet.Financialstructurehasadirecteffectonthe
efficiencyandprofitabilityofafinancialinstitutionsincethemoreaninstitutionmaximizesproductiveassets,the
morepossibilitiesithastogenerateearnings.
PEARLSmeasuresgrowthrates.Monitoringgrowthindifferentareasnotonlyallowsinstitutionstoassessthe
degreeofsatisfactionamongmemberclients,butalsoassistsmanagerstomaintainaneffectivefinancial
structuregiventhatgrowthdirectlyaffectsfinancialstructure.
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2016WorldCouncilofCreditUnions,Inc