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By Tim Harrington, CPA President, T.E.A.M. Resources 7049 E. Tanque Verde Rd. PMB 136

Financial Literacy Requirements for Directors. By Tim Harrington, CPA President, T.E.A.M. Resources 7049 E. Tanque Verde Rd. PMB 136 Tucson, Arizona 85715 (800) 788-9542 tharrington@forTeamResources.com. Financially Literacy Regulation. NCUA Rules and Regulations 701.4(b)(3)

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By Tim Harrington, CPA President, T.E.A.M. Resources 7049 E. Tanque Verde Rd. PMB 136

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  1. Financial Literacy Requirements for Directors By Tim Harrington, CPA President, T.E.A.M. Resources 7049 E. Tanque Verde Rd. PMB 136 Tucson, Arizona 85715 (800) 788-9542 tharrington@forTeamResources.com

  2. Financially Literacy Regulation NCUA Rules and Regulations 701.4(b)(3) (3) At the time of election or appointment, or within a reasonable time thereafter, not to exceed six months, have at least a working familiarity with basic finance and accounting practices, including the ability to read and understand the Federal credit union’s balance sheet and income statement and to ask, as appropriate, substantive questions of management and the internal and external auditors

  3. Financially Literacy Policy Should identify: • Risks within our credit union • Level of financial literacy Directors need • Individual analysis and plan for each Director in order to achieve financial literacy • Can consider past education or experience • CPA, Financial background, etc. • Should include supplemental education where deficiencies are identified

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  5. What Comes In What You Owe What You Have What Your Members Own What Goes Out 5

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  7. What are the most important items to watch? Depends • But there are some Basics • ROA • Capital to Assets Ratio • Loan to Share Ratio • Delinquency and Charge-off Ratios • But if you have Areas of High Risk, you’ll need more • Concentration • Real estate • Indirect lending • Commercial (member business) lending

  8. What is ROA? ROA stands for Return on Assets (or Return on Average Assets) • It is a standard measure of profitability in financial institutions • It can tell you how profitable your credit union is • It allows you to compare your profitability to other credit unions of any size (as it is based on Asset size) • It tells you how effectively the credit union is using its Assets and Liabilities 8

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  10. Which CU is Doing Better?Why we use Comparable ratios At a $10,000,000 CU10 Bil CU 10 Mil CU Interest income $ 496,000,000 763,000 Cost of funds (175,000,000) (364,000) Net Interest Margin 321,000,000 399,000 Operating costs (329,000,000) (332,000) Provision for loan losses (111,000,000) (44,000) Net loss before other income (120,000,000) 23,000 NII – Non-interest income (Fee income, Other) 136,000,000 78,000 Net Profit or Loss $ 16,000,000 102,000 Total Capital $ 50,000,000 $1,000,000 10

  11. Which CU is Doing Better?Why we use Comparable ratios As a % of Average Assets 10 Bil CU 10 Mil CU Yield: Interest income 4.96 7.63 Less: Cost of funds (1.75) (3.64) Net Interest Margin (NIM-Spread) 3.21 3.99 Less: Operating costs (3.29) (3.32) Less: Provision for loan losses (1.11) (0.44) Net loss before other income (1.20) 0.23 Plus: NII-Non-interest income (Fee income, Other) 1.36 0.78 Equals: Return on Assets (ROA) 0.16 1.02 Capital to Assets Ratio 5.00% 10.00% 11

  12. Spread AnalysisNational Averages As a % of Average Assets 9/30/11 Our CU Yield: Interest income 4.10 7.63 Less: Cost of funds (0.94) (3.64) Net Interest Margin 3.16 3.99 Less: Operating costs (3.03) (3.32) Less: Provision for loan losses (0.50) (0.44) Net loss before other income (0.38) 0.23 Plus: Non-interest income 1.30 0.78 Minus: Corporate Stabilization (0.26) Equals: Net Profit or Loss (ROA) 0.66 1.02 12

  13. The ‘Banking’ Business Credit unions make money 2 ways: • Interest Income • Non-Interest Income Credit unions spend money 3 ways: • Cost of Deposits (Cost of Funds) • Operating Expenses (cost of people, buildings, etc) • Provision for Loan Losses (cost of bad loans) 13

  14. Yield on Average Assets Total Interest Income from Loans and Investments / Average Assets National Average = 4.10% Our Example: 763,000/10,000,000 x 100 = 7.63% 14

  15. Spread AnalysisNational Averages As a % of Average Assets 9/30/11 Our CU Yield: Interest income 4.10 7.63 Less: Cost of funds (0.94) (3.64) Net Interest Margin 3.16 3.99 Less: Operating costs (3.03) (3.32) Less: Provision for loan losses (0.50) (0.44) Net loss before other income (0.38) 0.23 Plus: Non-interest income 1.30 0.78 Minus: Corporate Stabilization (0.26) Equals: Net Profit or Loss (ROA) 0.66 1.02 15

  16. Cost of Funds Total Dividends and Interest paid / Average Assets Cost of borrowing money from members to loan out at a higher price to other members National Average = 0.94% Our Example: 364,000/10,000,000 X 100 = 3.64% 16

  17. Spread AnalysisNational Averages As a % of Average Assets 9/30/11 Our CU Yield: Interest income 4.10 7.63 Less: Cost of funds (0.94) (3.64) Net Interest Margin 3.16 3.99 Less: Operating costs (3.03) (3.32) Less: Provision for loan losses (0.50) (0.44) Net loss before other income (0.38) 0.23 Plus: Non-interest income 1.30 0.78 Minus: Corporate Stabilization (0.26) Equals: Net Profit or Loss (ROA) 0.66 1.02 17

  18. What is Net Interest Margin? Net Interest Margin: • NIM • Spread • You don’t control your Interest Income, the Market does • You don’t control you Interest Expense, the Market does You try to control the spread between the two: NIM or Spread 18

  19. Spread or Net Interest Margin Yield on Assets Spread 3.99 3.77 3.79 3.71 3.55 3.12 3.59 3.16 3.20 3.41 3.24 3.21 3.32 Cost of Funds 3.25 3.16 Long term decline in Spread The Spread or Net Interest Margin is the difference between Yield on Assets and Cost of Funds. A credit union historically could pay its operating costs from the Spread and still have enough left over for a Profit. What has happened? 19

  20. Spread AnalysisNational Averages As a % of Average Assets 9/30/11 Our CU Yield: Interest income 4.10 7.63 Less: Cost of funds (0.94) (3.64) Net Interest Margin 3.16 3.99 Less: Operating costs (3.03) (3.32) Less: Provision for loan losses (0.50) (0.44) Net loss before other income (0.38) 0.23 Plus: Non-interest income 1.30 0.78 Minus: Corporate Stabilization (0.26) Equals: Net Profit or Loss (ROA) 0.66 1.02 20

  21. Net Interest Margin & Operating Expense Ratio You can see in this graph that several years ago, there was enough Spread to more than cover Operating Expenses. Recently, Operating Expenses have exceeded the NIM. This means that a credit union needs to do more than take Deposits and make Loans to earn a profit. If not, credit union profitability can be hard to find. Net Interest Margin Operating Expenses 21

  22. Operating Expenses to Average Assets Total operating expenses / Average Assets National Average = 3.03% Our Example: 332,000/10,000,000 X 100 = 3.32% 22

  23. Spread AnalysisNational Averages As a % of Average Assets 9/30/11 Our CU Yield: Interest income 4.10 7.63 Less: Cost of funds (0.94) (3.64) Net Interest Margin 3.16 3.99 Less: Operating costs (3.03) (3.32) Less: Provision for loan losses (0.50) (0.44) Net loss before other income (0.38) 0.23 Plus: Non-interest income 1.30 0.78 Minus: Corporate Stabilization (0.26) Equals: Net Profit or Loss (ROA) 0.66 1.02 23

  24. Provision for Loan Losses to Average Assets Total Provision for Loan Losses Expense / Average Assets National Average = 0.50% Our Example: 44,000/10,000,000 X 100 = 0.44% 24

  25. Not for Profit, Not for Charity, But for Service 25

  26. Is Non-Interest Income (NII) Important? Vital: • Where a majority of CU profit is derived • Has been growing in importance for decades • Is more flexible than other forms of income • Causes less financial risk to the credit union when expanded 26

  27. Sources of Non-Interest IncomeNot Just Fees!!! • Fee Income – NSF and late loan fee • Service Revenues – Overdraft Protection • Commission Income – sales of something • Interchange Income – Debit and Credit cards • Other Non-Interest Sources – CUSO selling some product or service 27

  28. Spread AnalysisNational Averages As a % of Average Assets 9/30/11 Our CU Yield: Interest income 4.10 7.63 Less: Cost of funds (0.94) (3.64) Net Interest Margin 3.16 3.99 Less: Operating costs (3.03) (3.32) Less: Provision for loan losses (0.50) (0.44) Net loss before other income (0.38) 0.23 Plus: Non-interest income 1.30 0.78 Minus: Corporate Stabilization (0.26) Equals: Net Profit or Loss (ROA) 0.66 1.02 28

  29. Credit Union profit in ROA One more look at it. This graph shows credit union profitability over time. And what that profit would be if all Non-Interest Income were removed. This should give you a very clear picture of the importance of Non-Interest Income. Credit Union profit without Fee Income 29

  30. Non-Interest Income (Fee and Service Revenues) to Average Assets Measure’s the contribution of non-interest income to profitability National Average = 1.30% Our Example: 78,000/10,000,000 X 100 = 0.78% 30

  31. Spread AnalysisNational Averages As a % of Average Assets 9/30/11 Our CU Yield: Interest income 4.10 7.63 Less: Cost of funds (0.94) (3.64) Net Interest Margin 3.16 3.99 Less: Operating costs (3.03) (3.32) Less: Provision for loan losses (0.50) (0.44) Net loss before other income (0.38) 0.23 Plus: Non-interest income 1.30 0.78 Minus: Corporate Stabilization (0.26) Equals: Net Profit or Loss (ROA) 0.66 1.02 31

  32. Return on Average Assets (ROAA or ROA) Net income / Average assets* *Average assets = Total assets last period + Total assets this period / 2 Measures a credit union’s profitability National Average = 0.66% Our CU: 102,000/10,000,000 X 100 = 1.02% 32

  33. Why is Capital Important?

  34. What is Capital? Capital is not cash • It is the accumulated earnings and losses since you started the credit union. • Tells you what portion of your assets belong to your members (collectively) and what part is dedicated to your depositors and other creditors • Your ‘rainy day’ fund • Your ‘hibernation’ fat

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  37. Capital (Net Worth) To Assets Ratio Total Capital/Total Assets Measures stability of the credit union Total Assets National Average = 10.15% Our CU: 1,000,000/10,000,000 = 10.00%

  38. Capital (Net Worth) To Assets Ratio Total Capital/Total Assets If Assets grow, and Capital doesn’t grow proportionately, the Ratio will decline Total Assets Woops! Now $1,000,000/12,000,000 = 8.33%

  39. How much Capital is enough? No consensus Prompt Corrective Action Rules National or Peer Averages Depends on how much risk your assets and liabilities represent Depends on level of growth Depends on profitability of CU Depends on future plans

  40. How much Capital is enough? Enough to get you through the 3 Worst Imaginable Years

  41. Capital can disappear fast Arizona Federal CU

  42. Prompt Corrective ActionPCA • 7% or higher Well capitalized • 6%-6.99% Adequately capitalized • 4%-5.99% Undercapitalized • 2%-3.99% Significantly undercapitalized • Less than 2% Critically undercapitalized

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  44. Loan to Share Ratio Total Loans / Total Shares and Deposits % of our Deposits currently loaned out to members? National Average = 69.2% Our CU: = 58.2% $5,150,000/8,849,000 45

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  46. Delinquency and Charge-offs • Delinquency ratio Delinquent loans over 60 days old / Total loans • Charge-off ratio Charge-offs (less recoveries) / Average loans • Recovery ratio Recoveries / Charge-offs 47

  47. Delinquency and Charge-offs It is important to consider Delinquency and Charge-offs together! Normal 9/30/11 Delinquency 0.75% 1.59% Charge-offs 0.40% 0.91% Combined 1.15% 2.60% 48

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  49. Using an Dash Board http://www.forteamresources.com/event_code.html?prod=7 Event Code: Harp

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