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 In 2010, the National Credit Union Administration (NCUA) adopted a final rule to clarify the fiduciary duties of directors of federally chartered credit unions becoming effective in  The rule requires directors to have or gain an understanding of basic finance and accounting principles within six months of election or appointment.  Some state regulators have adopted the NCUA ruling including IDFPR. 2

 Understand what it means to be “financially literate” as an officer of a credit union  Understand a balance sheet and income statement ◦ Identify important ratios to watch ◦ Explain how credit unions make money  Spread analysis  ROA and operating expenses  Non-interest income 3

 Understand capital ◦ How much do you need? ◦ Where does it come from?  Major risks every credit union faces ◦ Type of risks ◦ What can cause these risks? ◦ Ways to manage these risks  Ensuring adequate internal controls over risk ◦ Awareness of asset-liability management and allowance for loan loss 4

6 key provisions of general director duties 1. “The board of directors is responsible for the general direction and control of a federal credit union. The board may delegate operational functions to management, but not the responsibility for the credit union’s direction.”  Select a capable, competent and trustworthy chief executive officer (CEO) or manager.  Define the CEOs duties and responsibilities in writing and give the CEO the latitude needed to run day-to- day operations. 5

2. “A director must carry out his or her duties in good faith, in a manner reasonably believed to be in the best interest of the membership, and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.” 3. “A director must administer the affairs of the credit union fairly and impartially and without discrimination in favor of or against any particular member.”  Avoid conflicts of interest and self-serving practices. 6

4. A director must have at least a working familiarity with basic finance and accounting practices, including the ability to read and understand the credit union’s balance sheet and income statement and the ability to ask, as appropriate, substantive questions of management and auditors. 7

5. “A director must direct the operations of the credit union in conformity with the Credit Union Act, Rules and Regulations, other applicable laws and sound business practices.”  The board needs to ensure that there are adequate internal controls in place.  The board needs to adopt appropriate policies and procedures. 6. “A director may rely on information prepared or presented by employees or consultants the director reasonably believes to be reliable and competent and who merit confidence in the particular functions performed. “ 8

The expectation of this rule is that directors know enough about the financials to ask thought-provoking questions of both managers and auditors as needed. Do You Know: The basic accounting equation within your balance sheet (Assets = Liabilities + Equity/Reserves). ASSETS: It’s what the credit union owns, for example loans, cash, investments, and facilities. An asset account carries a debit balance. LIABILITY: It represents what the credit union owes, such as the members’ shares, dividends payable and accounts payable. A liability account carries a credit balance. EQUITY/RESERVES: Equity/reserves represent the members’ ownership interests. Consider it this way: Assets – Liabilities = Equity/Reserve. An equity account carries a credit balance. 9

Do You Know (cont’): The relationship between the income statement and balance sheet. They’re joined through the net income for the period and the subsequent increase, or decrease, in equity that results: Revenues – Expenses = Net Income (Loss). This net income or loss flows into the equity/reserves section of the balance sheet. That the balance sheet drives the income statement. Strong loan demand and underwriting increases revenues and minimizes loan losses (expense). Strong equity/reserves provide a “cost-free source” of funds to make loans and investments. Allowance for Loan and Lease Loss (ALLL) Account: It’s found in the asset section of the balance sheet and is considered a contra-asset that carries a credit balance. 10

Additionally Directors Should: Establish, regularly review, and revise as necessary policies, business plans, goals standards, and the operating budget. Board policies will address a wide range of activities including savings, lending, investing, personnel, security and record retention. Review operating results and performance of new and existing activities. 11

In fulfilling its responsibilities, board members must:  Operate independently from management.  Attend board meetings regularly.  Ensure the credit union serves the credit and savings needs of its field of membership. 12

 The key measure of the credit union’s success or failure is its financial statements. As such a director must understand these financial statements to participate in a meaningful manner in the direction and control of the institution.  The director’s financial skills should be “consistent with the size and complexity of the credit union operation.” 13

At a minimum, a director should be able to examine financial statements and answer the following questions:  What does this line item mean?  Why is it important to the credit union?  Is the value of the line item changing over time? If so, what does that change (either positive or negative) mean?  Is the change important to the credit union? 14

Assets=Liabilities + Equity 15

 Finding Your Financials  Balance Sheet  Income Statement  Spread Analysis  Key Ratios  The Effects  Allowance for Loan Loss Calculation 16

  Credit Union Analysis tab  Research a credit union  “Go to Research a Credit Union” Box  Enter your credit union name and hit “Find”  Choose your CU from list by hitting “View”  Click “Request FPR” under Financial Performance Report  Click “I want to view a 2-page FPR summary for one credit union online” then press OK  Choose from “Financial Summary” or “Ratio Analysis” by click the appropriate button. 17

 Assets ◦ Earning Assets  Cash  Investments  Corporate, Banks, CU  Loans  Auto, Signature, Home Equity, Credit Cards  Allowance for Loan Loss ◦ Non Earning Assets  Building, Equipment, Etc  NCUSIF Deposit  Prepaid Expenses  Accrued Assets  Other Assets  Liabilities & Equity ◦ Liabilities  Accrued Liabilities  Accounts Payable  Shares  CD, Checking, Savings ◦ Equity (Capital)  Regular Reserves  Undivided Earnings 18

Assets Cash $2,150,000 #1 Investments $8,840,000 #2 Loans$22,082,000 #3 ALLL ($457,000) #4 Building $1,800,000 #5 Fixed Assets $140,000 #6 NCUSIF $288,000 #7 Other Assets $245,000 #8 Total Assets$35,088,000 #9 Liabilities & Equity Other Liabilities $634,000 #10 Total Deposits $30,372,000 #11 Total Equity $4,082,000 #12 Total Liab & Equity $35,088,000 #13 19

 Revenue ◦ Loan Interest Income ◦ Investment Interest Income ◦ Fees  Expenses ◦ Occupancy ◦ Personnel ◦ Office Supplies  Provision for Loan Losses  Cost of Funds ◦ Dividends Paid  Net Income or Loss 20

Loan Income$1,533,000 #20 Investment Income$ 115,000 #21 Other Income$ 389,000 #22 Total Revenue$2,037,000 Operating Expenses$1,663,000 #23 Cost of Funds $252,000 #25 Provision for Loan Loss $187,000 #24 Total Expenses $2,102,000 Net Income (Loss) ($65,000) #26 21

Yield on Average Loans 6.97% #31 Yield on Average Investments1.17% #32 Average Yield on Earning Assets4.66% Fees & Other Operating Income1.10% #33 Total Revenue5.76% Operating Expenses4.66% #35 Provision for Loan Losses0.53% #36 Cost of Funds0.72% #34 Total Expenses5.91% Net Income/Loss (0.15%) #30 22

 Loan to Assets  Return on Assets (ROA)  Net Worth (Equity)  Operating Expenses  Cost of Funds 23

 Total Loans / Total Assets  Loan: $22,082,000 #3  Assets: $35,088,000 #9  $22,082,000/$35,088,000 = 62.9% #37  Industry Goal 80% to 85% Why is it so important? The higher the loan ratio then the more revenue the credit union makes since most credit unions make a higher return on their loans than their investments 24

 Net Income (Loss) / Total Assets  Net Income (Loss): ($65,000) #26  Assets: $35,088,000 #9  ($65,000)/$35,088,000 = (.19%) #30  Industry Goal.50% to.75% Why is it so important? This is how much money the credit union has earned. This amount will increase or decrease the net worth. 25

 Total Equity / Total Assets  Total Equity: $4,082,000 #12  Assets: $35,088,000 #9  $4,082,000/$35,088,000 = 11.63% #40  Industry Goal 8% to 14%  Minimum 6% Why is it so important? Capital is King. The bigger the capital ratio the better. Capital allows the credit union to grow. Not only in assets, but services and convenience. 26

 Total Operating Expenses / Total Assets  Total Operating Expenses: $1,663,000 #23  Assets: $35,088,000 #9  $1,663,000/$35,088,000 = 4.74% #35  Industry Goal 3.5% to 4.5% Why is it so important? This is the money that is going out. The more that goes out the more revenue the credit union has to bring in to keep a positive ROA (bottom line). 27

 Total Dividends Paid / Total Assets  Total Dividends Paid $252,000 #25  Assets $35,088,000 #9  $252,000/$35,088,000 =.72% #34  Industry Goal 0.5% to 1.5% Why is it so important? This is the money that is going directly to the members for depositing their money in the credit union. These numbers are driven mostly by market and the credit union’s philosophy. 28

 Loan to Assets  Return on Assets (ROA)  Net Worth (Equity)  Operating Expenses  Cost of Funds  Assets 29

As Assets Increase: Effect on Ratio Good or Bad Loan to Assets Decrease Bad Return on Assets (ROA) Decrease Bad Net Worth (Equity) Decrease Bad Operating Expenses Decrease Good Cost of Funds Decrease Good 30

 What does the board know about these risks?  Is the board aware of what risk controls or mitigation is in place?  Does the board know if the risk controls or mitigation is working as planned? 31

The board of directors of all credit unions must understand specific activities the credit union engages in and how these activities generate revenue and risks that could cause a loss.  Credit/investment  Liquidity  Interest rate  Compliance  Strategic  Transaction  Reputation 32

 Credit Risk: Risk that we won’t get our money back from a loan or investment.  Causes: Lending, Investments. 33

 Liquidity Risk: Risk that adequate cash will not be available to fund loans, meet withdrawal demands, or pay bills.  Causes: Investments not liquid or paying off as planned, new loans exceeding new deposits, loans not paying as planned, deposits leaving the credit union, lack of alternative funding sources (loans from others, lines of credit) 34

 Interest Rate Risk: Potential losses due to rising or falling interest rates. This happens when a credit union’s assets do not mature or re-price at the same rate as its liabilities.  Causes: Lending, deposits, changes in economic environment.  Change in interest rate affect:  Net Interest Margin  Net Income  Capital 35

 Compliance Risk: Risk of violations and non-compliance with applicable laws and regulations resulting in fines, penalties, payment or damages. 36

 Strategic Risk: Risk of adverse business decisions through management’s or board’s actions or inactions. 37

 Transaction Risk: Risk of fraud or operation problems in transaction processing that results in an inability to deliver products, remain competitive, and manage information. 38

 Reputation Risk: Risk of negative public opinion or perception leading to a loss of confidence and/or severance of relationships. 39

 Historical  Classification  Calculation 40

YearDec 31 Loan BalanceAverage Loan BalanceNet Loan LossesYearly Loan Loss Ratio 12/31/2010 $ 400, $ 350, $ 2, % 12/31/2009 $ 300, $ 325, $ (100.00)-0.03% 12/31/2008 $ 350, $ 325, $ 1, % 12/31/2007 $ 300, $ - Sum $ 1,000, $ 2, (A)(B) (B) is equal to chargeoffs minus recoveries for the year as reported on call reports Average Total Loan Loss Ratio (E)0.2900% = (B) / (A) 41

Estimated Loan #Loan BalanceCollateral Value Chargeoff Value Percent Classified Amount to Reserve 483A $300.00$0$ %$ A$500.00$200.00$ %$ A$750.00$100.00$ %$ Total$1,550.00$1,100.00= (C) 42

Loans outstanding at period ending $ 400, Less balances of loans devalued $ 1, Less share loan $ 3, total non classified loans $ 395,450.00(D) Required Historical Amount $ 1,146.81= (E)*(D) Required Classified Amount $ 1, (C) Required ALLL $ 2,

ALLOWANCE FOR LOAN AND LEASE LOSS FOR PERIOD ENDING December 31, 2010 YearDec 31 Loan BalanceAverage Loan BalanceNet Loan LossesYearly Loan Loss Ratio 12/31/2010 $ 400, $ 350, $ 2, % 12/31/2009 $ 300, $ 325, $ (100.00)-0.03% 12/31/2008 $ 350, $ 325, $ 1, % 12/31/2007 $ 300, $ - Sum $ 1,000, $ 2, (A)(B) (B) is equal to chargeoffs minus recoveries for the year as reported on call reports Average Total Loan Loss Ratio (E)0.2900% = (B) / (A) Estimated Loan #Loan BalanceCollateral ValueChargeoff ValuePercent ClassifiedAmount to Reserve 483A $ $ - $ % $ A $ $ $ % $ A $ $ $ % $ $ - Total $ 1, $ 1,100.00= (C) Loans outstanding at period ending $ 400, Less balances of loans devalued $ 1, Less share loan $ 3, total non classified loans $ 395,450.00(D) Required Historical Amount $ 1,146.81= (E)*(D) Required Classified Amount $ 1, (C) Required ALLL $ 2,

 Asset/Liability management (ALM) is the systematic analysis of a credit union’s financial performance in the critical areas of profitability, reserve adequacy, loan quality, liquidity and rate sensitivity. 45

 Capital Adequacy - Ensure adequate levels of net worth through significant and prolonged changes in interest rates.  Earnings Stability - Sufficient spread to cover net operating expenses, reserve transfers, loan net charge offs, investment losses, and other non- operating losses over all phases of the interest cycle  Liquidity Management - Maintain adequate liquidity to meet normal and seasonal patterns in loan/share flows 46

If you have any questions, we would be happy to answer them. Thank you so much for joining us! 47