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)
(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 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
Balance Sheet
Income Statement
ASSE T S
LIABILIT IE S & CAPIT AL
EARNI NG ASSETS
MI SCELLANEOUS LI ABI LI TI ES
REVENUE
Loan Interest Income
Loans
Less Allowance for Loan and
Lease Losses
Investment Interest Income
Fees and Other Non-Interest
SHARES
Income
EXPENSES
Investments
Occupancy
Personnel
Provision for Loan Losses
Held -to-Maturity
Available-for-Sale
Trading
NON-EARNI NG ASSETS
Building, Equipment, etc.
NCUSIF Deposit
COST OF FUNDS
Dividends Paid
CAPI TAL
4
Regular Reserves
Other Assets
Undivided Earnings
NET I NCOME or LOSS
Balance Sheet
Income Statement
ASSE T S
LIABILIT IE S & CAPIT AL
EARNI NG ASSETS
MI SCELLANEOUS LI ABI LI TI ES
REVENUE
Loan Interest Income
Loans
Less Allowance for Loan and
What
You
Have
Lease Losses
What
You
Owe
SHARES
What
Comes
In
Investment Interest Income
Fees and Other Non-Interest
Income
EXPENSES
Investments
Held -to-Maturity
Available-for-Sale
Trading
NON-EARNI NG ASSETS
Building, Equipment, etc.
NCUSIF Deposit
What
Your
Members
Own
What
Goes
Out
Occupancy
Personnel
Provision for Loan Losses
COST OF FUNDS
Dividends Paid
CAPI TAL
Regular Reserves
Other Assets
Undivided Earnings
5
NET I NCOME or LOSS
Balance Sheet
ASSE T S
Income Sta te me nt
LIABILIT IE S & CAPIT AL
R EVENU E
EAR NI NG ASSETS
Cash
LOANS
Unsecured
Vehicle
Real estate
Total loans
$ 160,000
Miscellaneous Liabs
$ 151,000
1,350,000
3,500,000
300,000
5,150,000
(101,875)
Share savings
Share drafts
Money market
IRAs
Other
1,680,000
3,500,000
3,624,000
41,000
4,000
Total Shares
8,849,000
Avail for sale
TOTAL
563,400
Investments
Total Int Inc
Non Interest Inc
200,400
763,800
78,200
TOTAL
842,000
3,500,000
441,875
3,941,875
Property and equip
NCUSIF
Other assets
$
CAPI TAL
150,000
200,000
Regular reserve
Undivided earn
Reserve for
Investment losses
500,000
Total Capital
Other N. E. assets
10,000,000
EXPENSES
Occupancy
Personnel
Provission for
Loan Losses
TOTAL
NON-EAR NI NG ASSETS
TOTAL ASSETS
$
5,048,125
INVESTMENTS
Held to maturity
INTEREST INCOME
Loans
SH AR ES
Less allowance
Net Loans
MI SCELLANEOU S LI ABS
44,000
376,000
COST OF FU ND S
80,000
920,000
1,000,000
TOTAL LIABS & CAP $
332,000
10,000,000
364,000
Dividends Paid
6
NET I NCOME
NET INCOME
$
102,000
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
8
Balance Sheet
ASSE T S
Income Sta te me nt
LIABILIT IE S & CAPIT AL
R EVENU E
EAR NI NG ASSETS
Cash
LOANS
Unsecured
Vehicle
Real estate
Total loans
Less allowance
Net Loans
$
160,000
MI SCELLANEOU S LI ABS
Miscellaneous Liabs
$
151,000
Loans
SH AR ES
1,350,000
3,500,000
300,000
5,150,000
(101,875)
Share savings
Share drafts
Money market
IRAs
Other
1,680,000
3,500,000
3,624,000
41,000
4,000
Total Shares
8,849,000
Avail for sale
TOTAL
NCUSIF
3,500,000
441,875
3,941,875
TOTAL ASSETS
CAPI TAL
150,000
200,000
Regular reserve
Undivided earn
Reserve for
Investment losses
500,000
Total Capital
Other N. E. assets
Other assets
563,400
Investments
Total Int Inc
Non Interest Inc
200,400
763,800
78,200
TOTAL
842,000
$ 10,000,000
EXPENSES
Occupancy
Personnel
Provission for
Loan Losses
TOTAL
NON-EAR NI NG ASSETS
Property and equip
$
5,048,125
INVESTMENTS
Held to maturity
INTEREST INCOME
332,000
44,000
376,000
COST OF FU ND S
80,000
920,000
1,000,000
TOTAL LIABS & CAP $ 10,000,000
364,000
Dividends Paid
NET I NCOME
NET INCOME
$
9
102,000
Which CU is Doing Better?
Why we use Comparable ratios
At a $10,000,000 CU
Interest income
Cost of funds
Net Interest Margin
Operating costs
Provision for loan losses
Net loss before other income
NII – Non-interest income
(Fee income, Other)
Net Profit or Loss
10 Bil CU
$ 496,000,000
(175,000,000)
321,000,000
(329,000,000)
(111,000,000)
(120,000,000)
10 Mil CU
763,000
(364,000)
399,000
(332,000)
(44,000)
23,000
136,000,000
78,000
$ 16,000,000 102,000
10
Total Capital
$ 50,000,000
$1,000,000
Which CU is Doing Better?
Why we use Comparable ratios
As a % of Average Assets
Yield: Interest income
Less:
Cost of funds
Net Interest Margin (NIM-Spread)
Less:
Operating costs
Less:
Provision for loan losses
Net loss before other income
Plus:
NII-Non-interest income
(Fee income, Other)
Equals: Return on Assets (ROA)
10 Bil CU 10 Mil CU
4.96
(1.75)
3.21
(3.29)
(1.11)
(1.20)
7.63
(3.64)
3.99
(3.32)
(0.44)
0.23
1.36
0.16
0.78
1.02
11
Capital to Assets Ratio
5.00%
10.00%
Spread Analysis
National Averages
As a % of Average Assets
Yield: Interest income
Less: Cost of funds
Net Interest Margin
Less: Operating costs
Less: Provision for loan losses
Net loss before other income
Plus: Non-interest income
Minus: Corporate Stabilization
Equals: Net Profit or Loss (ROA)
9/30/11 Our CU
4.10
(0.94)
3.16
(3.03)
(0.50)
(0.38)
1.30
(0.26)
0.66
7.63
(3.64)
3.99
(3.32)
(0.44)
0.23
0.78
1.02
12
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
EARNING ASSETS
Yield on Average Assets
M
Loans
Total Interest Income from Loans and
Investments / Average Assets
National Average = 4.10%
Our Example:
Investments
763,000/10,000,000 x 100 = 7.63%
Loan Inte re st Income
NON-EARNING ASSETS
Building, Equipment, etc.
NCUSIF Deposit
Inve stme nt Inte re st Income
Other Assets
14
Spread Analysis
National Averages
As a % of Average Assets
Yield: Interest income
Less: Cost of funds
Net Interest Margin
Less: Operating costs
Less: Provision for loan losses
Net loss before other income
Plus: Non-interest income
Minus: Corporate Stabilization
Equals: Net Profit or Loss (ROA)
9/30/11 Our CU
4.10
(0.94)
3.16
(3.03)
(0.50)
(0.38)
1.30
(0.26)
0.66
7.63
(3.64)
3.99
(3.32)
(0.44)
0.23
0.78
1.02
15
EARNING ASSETS
Cost of Funds
M
Loans
Total Dividends and Interest paid /
Average Assets
Cost of borrowing money from
members to loan out at a higher
price to other members
Investments
National Average = 0.94%
Our Example:
NON-EARNING ASSETS
364,000/10,000,000 X 100 = 3.64%
Divide nds Paid
Building, Equipment, etc.
NCUSIF Deposit
Other Assets
16
Spread Analysis
National Averages
As a % of Average Assets
Yield: Interest income
Less: Cost of funds
Net Interest Margin
Less: Operating costs
Less: Provision for loan losses
Net loss before other income
Plus: Non-interest income
Minus: Corporate Stabilization
Equals: Net Profit or Loss (ROA)
9/30/11 Our CU
4.10
(0.94)
3.16
(3.03)
(0.50)
(0.38)
1.30
(0.26)
0.66
7.63
(3.64)
3.99
(3.32)
(0.44)
0.23
0.78
1.02
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
Spread or Net Interest Margin
Yield on Assets
Spread
8.00%
7.00%
3.99
6.00%
3.79
5.00%
3.77
3.71
3.55
3.59
4.00%
3.00%
3.16
3.41
Cost of Funds
3.32
3.12
3.20
3.24
3.21
3.25
3.16
2.00%
1.00%
0.00%
1997
1998
1999
2000
2001
2002
2003
2004
Yi el d
2005
2006
2007
2008
2009
2010
2011
COF
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
19
Spread and still have enough left over for a Profit. What has happened?
Spread Analysis
National Averages
As a % of Average Assets
Yield: Interest income
Less: Cost of funds
Net Interest Margin
Less: Operating costs
Less: Provision for loan losses
Net loss before other income
Plus: Non-interest income
Minus: Corporate Stabilization
Equals: Net Profit or Loss (ROA)
9/30/11 Our CU
4.10
(0.94)
3.16
(3.03)
(0.50)
(0.38)
1.30
(0.26)
0.66
7.63
(3.64)
3.99
(3.32)
(0.44)
0.23
0.78
1.02
20
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 All
that
a credit
Credit
Unions union needs to do more than take
Deposits and make Loans to earn a profit. If not, credit union profitability can be
3.90%
hard to find.
3.80%
Net Interest Margin
3.70%
3.60%
3.50%
3.40%
3.30%
3.20%
Operating
Expenses
3.10%
3.00%
1998
1999
2000
2001
2002
2003
2004
Net Interest Margin
2005
2006
2007
Operating Expenses
2008
2009
2010
2011
21
EARNING ASSETS
Operating Expenses to
Average Assets
M
Loans
Total operating expenses / Average
Assets
National Average = 3.03%
Our Example:
Investments
332,000/10,000,000 X 100 =
3.32%
NON-EARNING ASSETS
EXPENSES
Occupancy
Personnel
Operations
Building, Equipment, etc.
NCUSIF Deposit
Other Assets
22
Spread Analysis
National Averages
As a % of Average Assets
Yield: Interest income
Less: Cost of funds
Net Interest Margin
Less: Operating costs
Less: Provision for loan losses
Net loss before other income
Plus: Non-interest income
Minus: Corporate Stabilization
Equals: Net Profit or Loss (ROA)
9/30/11 Our CU
4.10
(0.94)
3.16
(3.03)
(0.50)
(0.38)
1.30
(0.26)
0.66
7.63
(3.64)
3.99
(3.32)
(0.44)
0.23
0.78
1.02
23
EARNING ASSETS
M
Loans
Provision for
Loan Losses to
Average Assets
Total Provision for Loan Losses
Expense / Average Assets
Investments
National Average = 0.50%
Our Example:
NON-EARNING ASSETS
44,000/10,000,000 X 100 = 0.44%
Building, Equipment, etc.
NCUSIF Deposit
24
Provision for Loan Losse s
Other Assets
Not for Profit,
Not for Charity,
But for Service
25
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
Sources of Non-Interest Income
Not 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
Spread Analysis
National Averages
As a % of Average Assets
Yield: Interest income
Less: Cost of funds
Net Interest Margin
Less: Operating costs
Less: Provision for loan losses
Net loss before other income
Plus: Non-interest income
Minus: Corporate Stabilization
Equals: Net Profit or Loss (ROA)
9/30/11 Our CU
4.10
(0.94)
3.16
(3.03)
(0.50)
(0.38)
1.30
(0.26)
0.66
7.63
(3.64)
3.99
(3.32)
(0.44)
0.23
0.78
1.02
28
2.00
1.50
Credit Union
profit in ROA
1.00
0.50
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
09
20
11
0.00
-0.50
-1.00
-1.50
One more look at it. This graph shows
credit union profitability over time. And
Credit Union profit
what that profit would be if all Non-Interest without Fee
Income were removed. This should give Income
you a very clear picture of the importance
of Non-Interest Income.
29
EARNING ASSETS
M
Loans
Non-Interest Income
(Fee and Service
Revenues) to Average
Assets
Measure’s the contribution of noninterest income to profitability
Investments
National Average = 1.30%
NON-EARNING ASSETS
Our Example:
78,000/10,000,000 X 100 = 0.78%
Non-Interest Income
Building, Equipment, etc.
NCUSIF Deposit
30
Other Assets
Spread Analysis
National Averages
As a % of Average Assets
Yield: Interest income
Less: Cost of funds
Net Interest Margin
Less: Operating costs
Less: Provision for loan losses
Net loss before other income
Plus: Non-interest income
Minus: Corporate Stabilization
Equals: Net Profit or Loss (ROA)
9/30/11 Our CU
4.10
(0.94)
3.16
(3.03)
(0.50)
(0.38)
1.30
(0.26)
0.66
7.63
(3.64)
3.99
(3.32)
(0.44)
0.23
0.78
1.02
31
EARNING ASSETS
M
Loans
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
Investments
National Average = 0.66%
Our CU:
NON-EARNING ASSETS
102,000/10,000,000 X 100 = 1.02%
Building, Equipment, etc.
NCUSIF Deposit
32
NET INCOME or LOSS
Other Assets
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
Balance Sheet
Income Statement
ASSETS
LIABILITIES & CAPITAL
EARNING ASSETS
MISCELLANEOUS LIABILITIES
REVENUE
Loan Interest Income
Loans
Investment Interest Income
Fees
SHARES
EXPENSES
Investments
Occupancy
Personnel
Provision for Loan Losses
NON-EARNING ASSETS
Building, Equipment, etc.
NCUSIF Deposit
COST OF FUNDS
Dividends Paid
CAPITAL
Regular Reserves
Other Assets
Undivided Earnings
35
NET INCOME or LOSS
Balance Sheet
ASSE T S
Income Sta te me nt
LIABILIT IE S & CAPIT AL
R EVENU E
EAR NI NG ASSETS
Cash
$ 160,000
LOANS
Unsecured
Vehicle
Real estate
Total loans
1,350,000
3,500,000
300,000
5,150,000
Miscellaneous Liabs
$ 151,000
(101,875)
Share savings
Share drafts
Money market
IRAs
Other
1,680,000
3,500,000
3,624,000
41,000
4,000
Total Shares
8,849,000
Avail for sale
TOTAL
563,400
Investments
Total Int Inc
Non Interest Inc
200,400
763,800
78,200
TOTAL
842,000
3,500,000
441,875
3,941,875
Property and equip
NCUSIF
Other assets
$
CAPI TAL
150,000
200,000
Regular reserve
Undivided earn
Reserve for
Investment losses
500,000
Total Capital
Other N. E. assets
10,000,000
EXPENSES
Occupancy
Personnel
Provission for
Loan Losses
TOTAL
NON-EAR NI NG ASSETS
TOTAL ASSETS
$
5,048,125
INVESTMENTS
Held to maturity
INTEREST INCOME
Loans
SH AR ES
Less allowance
Net Loans
MI SCELLANEOU S LI ABS
44,000
376,000
COST OF FU ND S
80,000
920,000
1,000,000
TOTAL LIABS & CAP $
332,000
10,000,000
364,000
Dividends Paid
NET I NCOME
NET INCOME
$
36
102,000
Capital (Net Worth) To
Assets Ratio
Total Capital/Total Assets
EARNING ASSETS
MISCEL
Loans
Measures stability of the
credit union
Total
Assets
National Average = 10.15%
Investments
Our CU:
1,000,000/10,000,000 = 10.00%
NON-EARNING ASSETS
CAPITAL
Regular Reserves
Undivided Earnings
Building, Equipment, etc.
NCUSIF Deposit
NETAssets
INCOME or LOSS
Other
Capital (Net Worth) To
Assets Ratio
EARNING ASSETS
MISCEL
Loans
Total Capital/Total Assets
If Assets grow, and
Capital doesn’t grow proportionately,
the Ratio will decline
Investments
Woops! Now
$1,000,000/12,000,000 = 8.33%
NON-EARNING ASSETS
CAPITAL
Building, Equipment, etc.
NCUSIF Deposit
Regular Reserves
Undivided Earnings
Other
NETAssets
INCOME or LOSS
Total
Assets
History of Capital to Assets Ratio
National Average
14.00
12.00
11.14
11.42
10.83
10.71
10.72
10.96
11.30
11.61
11.41
10.93
9.91
10.03
10.15
2010
2011
10.00
8.00
6.00
4.00
2.00
0.00
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
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
How much Capital
is enough?
Enough to get you through the 3 Worst
Imaginable Years
Capital can disappear fast
Arizona Federal CU
Prompt Corrective Action
PCA
• 7% or higher
• 6%-6.99%
• 4%-5.99%
• 2%-3.99%
• Less than 2%
Well capitalized
Adequately capitalized
Undercapitalized
Significantly
undercapitalized
Critically undercapitalized
Balance Sheet
ASSE T S
Income Sta te me nt
LIABILIT IE S & CAPIT AL
R EVENU E
EAR NI NG ASSETS
Cash
LOANS
Unsecured
Vehicle
Real estate
Total loans
$ 160,000
Miscellaneous Liabs
$ 151,000
1,350,000
3,500,000
300,000
5,150,000
(101,875)
Share savings
Share drafts
Money market
IRAs
Other
1,680,000
3,500,000
3,624,000
41,000
4,000
Total Shares
8,849,000
Avail for sale
TOTAL
563,400
Investments
Total Int Inc
Non Interest Inc
200,400
763,800
78,200
TOTAL
842,000
3,500,000
441,875
3,941,875
Property and equip
NCUSIF
Other assets
$
CAPI TAL
150,000
200,000
Regular reserve
Undivided earn
Reserve for
Investment losses
500,000
Total Capital
Other N. E. assets
10,000,000
EXPENSES
Occupancy
Personnel
Provission for
Loan Losses
TOTAL
NON-EAR NI NG ASSETS
TOTAL ASSETS
$
5,048,125
INVESTMENTS
Held to maturity
INTEREST INCOME
Loans
SH AR ES
Less allowance
Net Loans
MI SCELLANEOU S LI ABS
44,000
376,000
COST OF FU ND S
80,000
920,000
1,000,000
TOTAL LIABS & CAP $
332,000
10,000,000
364,000
Dividends Paid
44
NET I NCOME
NET INCOME
$
102,000
Loan to Share Ratio
Total Loans / Total Shares and Deposits
% of our Deposits currently loaned
out to members?
National Average
= 69.2%
EARNING ASSETS
SHARES
MISCELLANEOUS
LIABILITIES
Loans
Our CU:
= 58.2%
$5,150,000/8,849,000
SHARES
45
History of Loan to Share Ratio
National Average
90
82.4
79.5
80
76.1
83.6
83.1
79.4
73.8
76.1
74.5
70.8
71.2
2002
2003
71.8
69.2
70
60
50
40
30
20
10
0
1999
2000
2001
2004
2005
2006
2007
2008
2009
2010
2010
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
Delinquency and
Charge-offs
It is important to consider Delinquency and
Charge-offs together!
Normal
9/30/11
Delinquency
Charge-offs
0.75%
0.40%
1.59%
0.91%
Combined
1.15%
2.60%
48
49
Using an Dash Board
http://www.forteamresources.com/event_code.html?prod=7
Event Code: Harp
51
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