The Net Worth Ratio is a measure of the capital strength of a credit union. The formula is calculated below:
Net Worth (Retained Earnings) / Total Assets
Where the numerator in the formula is retained earnings (this consists of regular reserves and undivided earnings of the credit union) and the denominator is the credit unions total assets.
The strength of the net worth ratio determines its classification among the five net worth categories statutorily mandated for credit unions. Thus, credit unions which take in new deposits and at the same time fail to simultaneously increase their retained earnings, see a drop in their statutory classification from “well capitalized union” to “adequately capitalized” or “undercapitalized”. A drop in the net worth ratio triggers a drop in the classification, which in turn leads to heavy statutory and regulatory restrictions under the “Prompt Corrective Action” (PCA) rules of the NCUA.
The Net Worth Ratio is similar to bank capitalization ratios (Tier 1 Capital Ratio, TCE/RWA) in that it measures capital adequacy for credit unions but it relates most closely to the Tier 1 Leverage Ratio as it does not adjust asset value through risk-weighting.