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CDFA Spotlight:
Efficiency Evaluations of Loan Funds
By Stan Provus |
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This article covers the basic steps in conducting loan and guaranty program evaluations.
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This article is intended to provide accurate and authoritative information in regard to the subject matter covered. The author and CDFA are not herein engaged in rendering legal, accounting or other professional services, nor does it intend that the material included herein be relied upon to the exclusion of outside counsel.
Methodology for Efficiency Evaluation
Efficiency evaluation focuses on the actual operation of a loan fund and asks how well resources have been used to achieve program outputs or impacts such as the number of loans made, servicing of the outstanding loan portfolio etc. This analysis:
- Reviews major costs, revenues, and surpluses (or losses) to assess the overall financial well being of the loan fund (program) and identify cost or revenue categories that may require attention. For example, growing loan losses or disproportionate increases in specific costs may indicate operating problems, particularly when compared to peer group loan funds or programs.
- Identifies, quantitatively or qualitatively, the costs associated with specific activities of the fund (such as marketing, application review, loan closings ( if direct loan program), technical assistance provided, etc.) and specific outcomes such a total loans or guarantees made.
- Compares these costs, where possible, with the levels of the loan fund's activities, and outputs to provide measures of how efficiently the loan fund is carrying out its programs. Comparisons over time or between similar loan funds of costs per loan or guarantee can provide information useful in determining a loan fund's efficiency.
An efficiency evaluation relies heavily on internal financial and operations data from the fund, interviews with staff and board members, surveys or interviews with borrowers who qualified for loan or guarantees to comment on the program's operations and efficiencies (those who did and did not qualify for loans or guarantees, lenders, etc.). In addition, comparisons to other similar loan programs can be particularly useful because they give you a sense of averages or benchmarks.
Step 1: Review Loan Fund Costs, Revenues, and Surplus (or Losses)
This analysis looks at current and past levels of all major cost and revenue items for the fund. Costs include all operating costs, including the value of in-kind costs such as donated space, telephone, etc. that are not paid from program funds, costs of contracted services, and costs associated with loan losses. Revenues include interest payments on direct loans (if applicable), interest earnings from CDs or other investment instruments securing loan guarantees (if applicable), interest earnings on funds used to capitalize a program and any other source of revenues or operating income. Surplus (or loss) is the difference between revenues and costs. For example, a program that had $100,000 of revenues and $110,000 of costs, including a $20,000 loss on a loan, would have a $10,000 loss for the year. Comparisons of data over time and with other similar loan programs are facilitated by "common sizing" the data—showing individual cost and revenues as percentages of total costs and revenues.
A number of questions about program efficiency can be addressed with this financial data (and data from comparable programs), such as:
- How have loan fund program surpluses or losses changed over time and in comparison with similar program funds? What are the main reasons for these changes?
- Which major cost areas have been increasing or decreasing in importance relative to past levels or other programs. What are the explanations for these changes? Do these changes suggest areas where resources can be used more efficiently?
- What changes have occurred in revenue sources for the program over time and compared to similar programs? What areas of program strengths and weaknesses can be identified?
- To what extent is the loan fund self-sufficient; i.e. revenues exceed costs? How dependent is the program on non-operating revenues?
This analysis of financial data may be extended to the loan fund's assets, liabilities, revenues, and fund balances (or net worth), and may include both comparisons of balance sheet items (assets, liabilities, and fund equity) over time and comparisons with the balance sheets of other funds. An analysis of the loan fund's portfolio in terms of the risks of individual loans and the overall risk of the portfolio may also be carried out.
Cost Estimates of Specific Activities and Outputs
The next step in efficiency analysis is to go beyond the general financial statements and data and try to estimate the costs incurred by the fund in carrying out specific activities, particularly booking loans.
This step requires a close examination of exactly what the loan fund staff does in the conduct of the Fund's business of making loans or guarantees. Operations need to be broken down (even if only one or two staff do everything) into major activities such as marketing, developing and processing applications, reviewing loan applications or guarantees, closing loans, monitoring loans, doing workouts of problem loans, and providing specific services to loan applicants and borrowers. The costs ( often based on an allocations of staff time) of these activities need to be estimated both from financial data and from interviews with the individuals who carry them out.
Loan fund staff and possibly board members may be able to identify areas where activities and processes are inefficient; so may loan applicants (both those receiving loans and those turned down), and lenders (if a guaranty program). While information from these sources does not produce actual dollar costs, it can point to areas of serious inefficiency.
Comparisons of Activity and Outcome Costs
In areas where dollar costs or measurable surrogates for costs can be developed, some effort to relate costs to activities, and outputs, particularly loans or guarantees closed, may be useful. While specific efficiency measures—such as dollar costs per loan made or guaranty closed—may be difficult if not impossible to develop, total loan fund operating costs can be used to estimate operating costs per loan or guaranty. Such estimates can be compared over time and between loan funds to gain a measure of loan fund efficiency.
Important Performance Ratios
1. Measuring Operational Self-Sufficiency
Income from credit operations and investments
Financing costs + operating costs + loan loss provisions
2. Measuring Financial Self-Sufficiency
Income from credit operations and investments
Financing costs + operating costs + loan loss provision + cost of inflation + cost of subsidy.
The financial self-sufficiency ratio shows what the credit program viability would look like if it were to rely entirely on its own equity and commercial sources of funding at market rates and were not to receive donations of any kind to cover operating expenses.
3. Measuring Efficiency
Efficiency Ratio
The efficiency ratio displays how well loan programs are utilizing their resources. The efficiency ratio can be thought of as total overhead expense (i.e. non-interest expense) divided by total operating income less interest expense. The efficiency ratio is calculated by:
Total Overhead Expense / (Total Operating Income - Interest Expense)
This article is intended to provide accurate and authoritative information in regard to the subject matter covered. The author and CDFA are not herein engaged in rendering legal, accounting or other professional services, nor does it intend that the material included herein be relied upon to the exclusion of outside counsel. CDFA is not responsible for the accuracy of the information provided in this fact sheet. The information provided has been collected from a variety of sources. Those seeking to conduct complex financial deals using the tools mentioned in this document are encouraged to seek the advice of a skilled legal/consulting professional.