by tim harrington, cpa president, t.e.a.m. resources 7049 e. tanque verde rd. pmb 136

By Tim Harrington, CPAPresident, T.E.A.M. Resources

7049 E. Tanque Verde Rd. PMB 136Tucson, Arizona 85715

(800) [email protected]

Financial Literacy Requirements for

Directors

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

Financially Literacy Regulation

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

Financially Literacy Policy

Balance Sheet Income Statement ASSETS LIABILITIES & CAPITAL

REVENUEEARNING ASSETS MISCELLANEOUS LIABILITIES

Loan Interest IncomeLoans

Less Allowance for Loan and

Lease Losses

Investment Interest Income

Fees and Other Non-Interest SHARES Income

EXPENSES

Investments Held -to-Maturity Occupancy Available-for-Sale Personnel Trading Provision for Loan Losses

NON-EARNING ASSETS COST OF FUNDS

Building, Equipment, etc. Dividends PaidNCUSIF Deposit CAPITAL

Regular Reserves

Other Assets Undivided Earnings NET INCOME or LOSS

4




Less Allowance for Loan and

Lease Losses


Fees and Other Non-Interest SHARES Income

EXPENSES

Investments Held -to-Maturity Occupancy Available-for-Sale Personnel Trading Provision for Loan Losses



Regular Reserves

Other Assets Undivided Earnings NET INCOME or LOSS5

What You

Have

What You Owe

What Your

Members Own

What Comes

In

What Goes

Out

Balance Sheet Income StatementASSETS LIABILITIES & CAPITAL

REVENUE

EARNING ASSETS MISCELLANEOUS LIABS

Cash 160,000$ Miscellaneous Liabs 151,000$ INTEREST INCOME

LOANS SHARES Loans 563,400$ Unsecured 1,350,000 Vehicle 3,500,000 Share savings 1,680,000 Investments 200,400 Real estate 300,000 Share drafts 3,500,000 Total Int Inc 763,800 Total loans 5,150,000 Money market 3,624,000 Non Interest Inc 78,200

IRAs 41,000 Less allowance (101,875) Other 4,000 TOTAL 842,000 Net Loans 5,048,125

Total Shares 8,849,000 EXPENSES

OccupancyINVESTMENTS Personnel 332,000 Held to maturity 3,500,000 Provission for Avail for sale 441,875 Loan Losses 44,000 TOTAL 3,941,875 TOTAL 376,000

NON-EARNING ASSETS CAPITAL COST OF FUNDS

Property and equip 150,000 Regular reserve 80,000 NCUSIF 200,000 Undivided earn 920,000 Dividends Paid 364,000 Other N. E. assets Reserve for

Investment losses

Other assets 500,000 Total Capital 1,000,000 NET INCOME

TOTAL ASSETS 10,000,000$ TOTAL LIABS & CAP 10,000,000$ NET INCOME 102,000$

6

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

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

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REVENUE









Investment losses



9

Which CU is Doing Better?Why we use Comparable ratios

At a $10,000,000 CU 10 Bil CU 10 Mil CUInterest income $ 496,000,000 763,000Cost of funds (175,000,000) (364,000)

Net Interest Margin 321,000,000 399,000Operating costs (329,000,000) (332,000)Provision for loan losses (111,000,000) (44,000) Net loss before other income (120,000,000) 23,000NII – 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

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As a % of Average Assets 10 Bil CU 10 Mil CUYield: Interest income 4.96 7.63Less: Cost of funds (1.75) (3.64) Net Interest Margin (NIM-Spread) 3.21 3.99Less: Operating costs (3.29) (3.32)Less: Provision for loan losses (1.11) (0.44)

Net loss before other income (1.20) 0.23Plus: 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%

Which CU is Doing Better?Why we use Comparable ratios

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Spread AnalysisNational Averages

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As a % of Average Assets 9/30/11 Our CUYield: Interest income 4.10 7.63Less: Cost of funds (0.94) (3.64) Net Interest Margin 3.16 3.99Less: Operating costs (3.03) (3.32)Less: Provision for loan losses (0.50) (0.44)

Net loss before other income (0.38) 0.23Plus: Non-interest income 1.30 0.78

Minus: Corporate Stabilization (0.26) Equals: Net Profit or Loss (ROA) 0.66 1.02

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)

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Loan Interest Income


EARNING ASSETS MISCELLANEOUS LIABILITIES

Loans

SHARES

Investments

NON-EARNING ASSETS

Building, Equipment, etc.NCUSIF Deposit

Other Assets

Yield on Average AssetsTotal Interest Income from Loans and Investments / Average Assets

National Average = 4.10%

Our Example:

763,000/10,000,000 x 100 = 7.63%

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15

Dividends Paid


Loans

SHARES

Investments

NON-EARNING ASSETS


Other Assets

Cost of FundsTotal Dividends and Interest paid / Average Assets

Cost of borrowing money from members to loan out at a higher price to other members


Our Example:

364,000/10,000,000 X 100 = 3.64%

16





17

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

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Yield COF

Spread or Net Interest Margin

3.993.79

3.713.77

3.553.59

3.413.32

3.163.24

3.123.20

3.21

Long term decline in SpreadThe 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?

SpreadYield on Assets

Cost of Funds

19

3.253.16





20

All Credit Unions

3.00%

3.10%

3.20%

3.30%

3.40%

3.50%

3.60%

3.70%

3.80%

3.90%

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Net Interest Margin Operating Expenses

Net Interest Margin & Operating Expense Ratio

Net Interest Margin

Operating Expenses

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.

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EXPENSES

OccupancyPersonnelOperations


Loans

SHARES

Investments

NON-EARNING ASSETS


Other Assets

Operating Expenses to Average AssetsTotal operating expenses / Average Assets National Average = 3.03%

Our Example:

332,000/10,000,000 X 100 = 3.32%

22





23

Provision for Loan Losses

Provision for Loan Losses to Average Assets


Our Example:

44,000/10,000,000 X 100 = 0.44%

Total Provision for Loan Losses Expense / Average Assets


Loans

SHARES

Investments

NON-EARNING ASSETS


Other Assets24

Not for Profit,Not for Charity,But for Service

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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

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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

2727





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-1.50

-1.00

-0.50

0.00

0.50

1.00

1.50

2.00

Credit Union profit in ROA

Credit Union profit without Fee Income

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.

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Non-Interest Income

Non-Interest Income (Fee and Service Revenues) to Average Assets


Our Example:

78,000/10,000,000 X 100 = 0.78%

Measure’s the contribution of non-interest income to profitability


Loans

SHARES

Investments

NON-EARNING ASSETS


Other Assets30





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NET INCOME or LOSS


Loans

SHARES

Investments

NON-EARNING ASSETS


Other Assets

Return on Average Assets (ROAA or ROA)Net income / Average assets**Average assets = Total assets last period + Total assets this period / 2


Our CU:

102,000/10,000,000 X 100 = 1.02%

Measures a credit union’s profitability

32

Why is

Capital

Important?

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





FeesSHARES

EXPENSES

InvestmentsOccupancyPersonnelProvision for Loan Losses



Regular Reserves

Other Assets Undivided Earnings NET INCOME or LOSS35


REVENUE









Investment losses



36

CAPITAL

Regular Reserves

Undivided Earnings NET INCOME or LOSS


Loans

SHARES

Investments

NON-EARNING ASSETS


Other Assets

Capital (Net Worth) To Assets Ratio

Total Capital/Total Assets


Our CU:

1,000,000/10,000,000 = 10.00%

Measures stability of the credit union

TotalAssets

CAPITAL

Regular Reserves

Undivided Earnings NET INCOME or LOSS

Capital (Net Worth) To Assets Ratio

Total Capital/Total Assets

Woops! Now

$1,000,000/12,000,000 = 8.33%

If Assets grow, and Capital doesn’t grow proportionately, the Ratio will decline Total

Assets


Loans

SHARES

Investments

NON-EARNING ASSETS


Other Assets

History of Capital to Assets Ratio National Average

11.1411.42

10.71 10.7210.96

11.3011.61 11.41

10.03 10.1510.83

9.91

10.93

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

How much Capital is enough?

No consensus

Prompt Corrective Action RulesNational or Peer AveragesDepends on how much risk your assets

and liabilities representDepends on level of growthDepends on profitability of CUDepends on future plans

How much Capital is enough?

Enough to get you through the 3 Worst Imaginable Years

Arizona Federal CU

Capital can disappear fastCapital to Assets Ratio in a Recession

11.07 11.17

11.97

3.47

10.96

4.76

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

2004 2005 2006 2007 2008 2009

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


REVENUE









Investment losses



44


Loans

SHARES

SHARES

EXPENSES

COST OF FUNDS

Loan to Share RatioTotal Loans / Total Shares and Deposits


Our CU:

= 58.2%$5,150,000/8,849,000

% of our Deposits currently loaned out to members?

45

46

History of Loan to Share Ratio National Average

76.179.5

70.8 71.274.5

79.482.4 83.6 83.1

71.869.2

76.173.8

0

10

20

30

40

50

60

70

80

90

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2010

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

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

Return on Average Assets (ROA)

0.00%0.20%0.40%0.60%0.80%

1.00%1.20%1.40%1.60%

Actual Results Planning Goal Preferred Range Preferred Range

Using an Dash Board

http://www.forteamresources.com/event_code.html?prod=7

Event Code: Harp

Return on Average Assets (ROA)

0.00%0.20%0.40%0.60%0.80%

1.00%1.20%1.40%1.60%


Loan to Share Ratio

68.00%

70.00%

72.00%

74.00%

76.00%

78.00%

80.00%

82.00%


Operating Expense to Average Assets

3.50%3.60%3.70%3.80%3.90%4.00%4.10%4.20%4.30%


Asset Growth

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%


Capital to Assets Ratio

17.00%

17.50%

18.00%

18.50%

19.00%

19.50%

20.00%

20.50%


Average Loan Balance

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000


GoalGoal Safe

Safe

RangeRange

51

By Tim Harrington, CPAPresident, T.E.A.M. Resources

7049 E. Tanque Verde Rd. PMB 136Tucson, Arizona 85715

(800) [email protected]

Financial Literacy Requirements for

Directors

by tim harrington, cpa president, t.e.a.m. resources 7049 e. tanque verde rd. pmb 136

Documents

total loans5

loan lossesnon

total capital1

loan andlease lossesinvestment

total shares8

loan losses44

total liabs cap

literacy requirements