HEFCU Board of Directors

Financial Literacy - trainingJanuary 28, 2011

Summary

• Background

• Balance Sheet

• Income Statement

• Ratios and interpretations

Background

• Losses caused by liquidations and mergers within the banking, credit union and corporate credit union industry can often be traced back to ineffective oversight by Boards of Directors

• NCUA has issued a new regulation on Financial Literacy Requirement for Federal Credit Union Boards of Directors.

Background - compliance

• New Rule will take effect on January 27, 2011• Compliance date by July 27, 2011• Each existing Board of Director must be able

to read and understand the Credit Unions Balance Sheet and Income Statement

• New Board of Directors will have 6 months from date of election to comply.

Background – Key provisions• Carry out duties in good faith• In a manner reasonably believed to be in the best

interests of the membership.• Including reasonable inquiry • As ordinarily a prudent person in a like position

would use under similar circumstances• Prohibits FCU from indemnifying Directors or

Employees for liability associated gross negligence, willful misconduct or reckless decisions which adversely affect the rights of the membership.

Balance Sheet

• Assets– Represents items acquired by the Credit Union

since its inception• Cash• Loans• Investments• Pre-paid deposits• Fixed assets• Contra – accounts ( valuation allowances)

Balance Sheet

• Liabilities– Represents cumulative amounts owed by the

Credit Union since its inception• Member Deposits• Accounts Payable ( vendors)• Dividends Payable -earned by members but not

reflected in member balances as of Balance Sheet date• Deferred Revenue – used primarily to reflect cash

received but not yet earned- ex. multi year commission

Balance Sheet• Equity– Represents the residual difference between Assets

minus Liabilities – Represents a cushion for unexpected material losses– Free source of funds for investment – Belongs to members in event of liquidation ( after sale

of assets and payment of liabilities)– Regular Reserves is a static amount from prior NCUA

regulations– Changes in market values of Available for Sale

Investments is reflected as a change in Equity.

Income Statement

• Revenue– For the period reported represents income earned

from operations:– Interest on Loans– Interest on Investments– Fee Income– Commission Income– Interchange Income

Expenses

• Expenses for operating the Credit Union for the period reported using accrual method of accounting.

• Cost of Funds – dividends earned by members during the period reported

• Operating expenses itemized by category for significant areas

• Provision for loan losses reflect recognition of potential losses on loans to members

• Non – operating expenses reflect abnormal situations that are not necessarily part of operations or from a prior period

Net Income

• Net Income ( profit/loss) represents the residual difference between Income and Expenses.

• The profit/ loss difference is how capital/equity is formed for the Credit Union

• Profits accumulated since the Credit Union was formed is represented in Undivided Earnings under the Equity section of the Balance Sheet.

Income Statement Schedules

• Statements of Members Equity – represents changes in Equity as a result of net profit/ losses during the period.

• Departmental Statement – represents a product line profit/loss report by significant area of operation.

• Schedule of Investments – represents detailed listing of all investments made by the Credit Union including market value information.

Income Statement Schedules – continued

• Schedule of Aging - represents delinquency information on Loans outstanding.

• Schedule of Loan Composition – represents a comparative approach of loans outstanding by product line.

Ratios

• Ratios represent the relationship between various financial items which often provide useful information to management, Board and regulators. These ratios are often best used as a benchmark against peers.

• Ratios can be both financial and non-financial measures used to paint an overall assessment of the condition of the Credit Union.

Ratio – Net Worth

• Net Worth Ratio = Capital / Assets– Important solvency indicator; generally the higher

level of assets should indicate a higher level of Equity

– As assets increase the use of those assets would typically be used to generate positive earnings and thus Equity

– Net Worth Ratio is a critical regulatory measure which can trigger Prompt Corrective Action notice from the NCUA if below 6%.

Statutory Net Worth ClassificationsCredit Union Net Worth Ratio Classification

7% or above Well Capitalized

6% to 6.99% Adequately Capitalized

4% to 5.99% Undercapitalized*

2% to 3.99% Significantly Undercapitalized*

Less than 2% Critically Undercapitalized*

* Requires Prompt Corrective Action and Net Worth Restoration Plan

Ratios – Asset Quality

• Asset Quality Ratio– Delinquent Loan ratio – represents the level of

delinquency as compared to the level of loans outstanding and measures underwriting and collection performance.

– Net Charge off ratio – represents those loans expensed against the Allowance for Loan Loss account as uncollectible. This ratio is best used in conjunction with the delinquency ratio to determine overall loan performance (i.e. low delinquency ratio could be the result of higher than normal charge off ratio).

Ratio - Earnings

• Return on average assets – represents net profit for the period compared to average amount of assets for the period. Measures the performance of using assets to generate net income.

• Operating Expense – represents expenses incurred in the use of assets to earn net income.

• Net Operating Expense – reduces expenses by fees earned in providing services and provides a true use of expenses incurred in using assets to generate revenue.

Ratio - Liquidity

• Liquidity measures the total amount of loans as compared to level of member deposits

• Used as a measure to determine if the Credit Union can meet member demands for cash withdrawals and operating expenses.

• High percentages would indicate need for potential borrowings in the future or sale of assets.

Ratio - Performance

• The majority of what the Credit Union categorizes as performance ratios involves product pricing, investment practices, and marketing.

• Cost of funds – measures how much we have paid to members in exchange for their deposits.

• Net Interest Margin – measures the spread between interest earned from loans and investments (less cost of funds). This measure is important as an indicator need to cover operating expenses

Ratio - Performance

• Membership growth – measures ability to attract and retain members

• Average share balance – measures ability to attract and retain deposits

• Loan growth – measures ability to produce loan products that members will use

• Borrowers/Members – measures the ability to penetrate membership and mitigate concentration risk to individual borrowers.

Ratio - Performance

• Average Loan Balance – measures concentration risk of dollars associated with individual borrowers

• Yield on Investments – measures ability to produce returns on cash not being used for lending or operations.

• Yield on Loans – measures the return on overall loan portfolio and is the single most important contributor to net income.

• Yield on Earning Assets – measures overall effectiveness of deploying assets to produce positive net income.

Best Practices• Training and education of directors should be

commensurate with the size and complexity of the Credit Union ( there is no mandated training required).

• Ensure staff training and education so that Boards can reasonably be assured that compliance and execution of decisions are carried out.

• Continually asks questions of staff and auditors, challenge thinking, understand risks and monitor results in all business areas.

• Boards can rely on credit union staff and outside professionals if the director reasonably believes the individual is reliable and competent in the advice rendered.

Basic Concepts• Debits : entry to general ledger to increase Assets and Expenses• Credits : entry to general ledger to increase Liabilities and Revenue• Allowances: value the underlying asset net of projected loan losses ,depreciation

or changes in market values• Accounting method: Accrual

– Income recognized when earned not received– Expenses recognized when incurred not paid

• GAAP: generally accepted accounting principles used in preparing financial statements

• Budget: an estimate for upcoming year for both revenue and expense using various assumptions

• Peer: typically based upon those credit unions in the 50-100mm asset range nationally.

• Audit: independently performed by licensed CPA to render an opinion on the financial statements and conformity with GAAP.

• NCUSIF Deposit and Premium: cost of deposit insurance on member accounts up to $250,000 each; adjusted annually based upon insured deposits and financial performance of the Insurance Fund.