A CREDIT UNION WATCH A CREDIT UNION WATCH LIST for 2013 and LIST for 2013 and

BEYOND BEYOND

2013 Utah Credit Union Association Annual 2013 Utah Credit Union Association Annual Meeting and ConventionMeeting and Convention

March 9, 2013March 9, 2013

Ron Parker, CPARon Parker, CPAparkerconsult@cox.net

520-275-5043

Watch List AreasWatch List Areas

WHAT CAN CAUSE WHAT CAN CAUSE OUR CREDIT UNION OUR CREDIT UNION

SIGNIFICANT LOSSES SIGNIFICANT LOSSES AND/OR THREATEN AND/OR THREATEN

OUR FUTURE OUR FUTURE EXISTENCE!EXISTENCE!

Watch List AreasWatch List Areas• Governance—right thingsGovernance—right things

• Personnel—right peoplePersonnel—right people

• Membership—right demographicsMembership—right demographics

• Products—right for our membershipProducts—right for our membership

• Services—right for our membershipServices—right for our membership

• Delivery systems—right for our membershipDelivery systems—right for our membership

Watch List AreasWatch List Areas

• Planning—effective planning processesPlanning—effective planning processes

• Monitoring and measuring operational Monitoring and measuring operational results—what and howresults—what and how

• Risk assessment—what and howRisk assessment—what and how

• Profitability and maintenance of capitalProfitability and maintenance of capital

• Regulatory and compliance focusRegulatory and compliance focus

Observations• More business like—profit orientedMore business like—profit oriented

• More delegation to managementMore delegation to management

• Greater focus on strategic vs. operational Greater focus on strategic vs. operational issuesissues

• More is expected and required—More is expected and required—compliance for instancecompliance for instance

Observations• Clarification of responsibilities– NCUA Clarification of responsibilities– NCUA

rule 701.4, rule 701.4, General authorities and General authorities and duties of Federal credit union duties of Federal credit union directors, took effect on January 27, directors, took effect on January 27, 2011. 2011.

The purpose of this rule is to clarify The purpose of this rule is to clarify and document the important duties of and document the important duties of boards of directors of federal credit boards of directors of federal credit unions.unions.

Observations• Increased focus on ethical conduct

• Increased emphasis on improved corporate governance

• Challenges in succession

• Increased understanding of general credit union finances and risks

ARE WE ARE WE DOING THE DOING THE

RIGHT RIGHT THINGS? THINGS? or the same or the same

thingsthings??

2011 Letters to Federal Credit Unions

11-FCU-0211-FCU-02 Duties of Federal Duties of Federal Credit Union Boards of Directors;Credit Union Boards of Directors; 02/2011

Key ProvisionsKey Provisions

1.1.Responsible for the credit union’s Responsible for the credit union’s general direction and controlgeneral direction and control

2. Carry out duties in good faith, in 2. Carry out duties in good faith, in the best interests of the the best interests of the membershipmembership

3. Administer affairs fairly, 3. Administer affairs fairly, impartially, and without impartially, and without discriminationdiscrimination

4.4.Maintain a Maintain a working familiarity working familiarity with basic finance and with basic finance and accounting practicesaccounting practices

5. Direct operations in conformity 5. Direct operations in conformity with Federal Credit Union Act, with Federal Credit Union Act, NCUA Rules and Regs, other NCUA Rules and Regs, other laws, and laws, and sound business sound business practices.practices.

6. Rely on information prepared 6. Rely on information prepared or presented by employees or or presented by employees or consultants to be reliable and consultants to be reliable and competentcompetent

Always Does the Right Things (even when Always Does the Right Things (even when unpopular) and believes in the unpopular) and believes in the Importance of Importance of

Tone at the Top Tone at the Top and Effective Corporate and Effective Corporate GovernanceGovernance

Ethical--Understands and Supports the Credit Ethical--Understands and Supports the Credit Union’s Core Values (what we believe) and Union’s Core Values (what we believe) and

Code of ConductCode of Conduct

Understands what constitutes effective Understands what constitutes effective corporate governancecorporate governance• Governance framework should provide Governance framework should provide strategic strategic

guidance and effective oversight of managementguidance and effective oversight of management• Clarify the roles and responsibilities Clarify the roles and responsibilities of board of board

members and senior management in order to members and senior management in order to facilitate board and management accountability to facilitate board and management accountability to the both the credit union and its stakeholders.the both the credit union and its stakeholders.

• Ensure a workable balance of authority Ensure a workable balance of authority

BOARD GOVERNANCE• Understanding the board and management Understanding the board and management

rolesroles

• Assessment of Assessment of needs (succession) and and recruit accordingrecruit according

• Annual Annual board evaluationboard evaluation, assessment and , assessment and rewardsrewards

• Conflict and other appropriate Conflict and other appropriate ethics and ethics and conduct policiesconduct policies

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From Good to Great—

You can’t achieve great things without great people!

When in doubt, don’t hire or appoint—keep looking.

When you know you need to make a When you know you need to make a people change, act.people change, act.

Determine the Determine the Appropriate Role for Appropriate Role for your Board and make your Board and make

certain that certain that Management and Management and Board roles are Board roles are clearly defined.clearly defined.

1. Establish expectations1. Establish expectations: What is the board and management responsible for; what do we what do we expect from management, staff and expect from management, staff and ourselves.ourselves.

2. Clearly stated responsibilities and 2. Clearly stated responsibilities and authorityauthority: To the CEO, staff, committees etc. Doing so will allow the board to hold these Doing so will allow the board to hold these groups accountable for meeting board-groups accountable for meeting board-stated expectations.stated expectations.

Policy Governance ModelPolicy Governance ModelBy John CarverBy John Carver

Corporate Governance

The definition of corporate governance most widely used is "the system by which

companies are directed and controlled”

More specifically it is the framework by which the various stakeholder interests are balanced, or "the relationships among the management, Board of Directors and other stakeholders".

Corporate Governance

Golden Rule of corporate governance is that the business morality or ethic must permeate an

organization from top to bottom and embrace all stakeholders.

Evaluate the Performance ofEvaluate the Performance ofManagement, Board of Directors Management, Board of Directors

and major Committees and major Committees

(How many Committees do we (How many Committees do we need to function effectively?)need to function effectively?)

New Directors on the Board

Source: Filene Research Institute

Our board should have term limits

Our board should have a mandatory retirement

age

Avoid Avoid any and all actual orany and all actual or appearanceappearance of of conflict of conflict of

interestinterest; unethical or ; unethical or inappropriate conduct!inappropriate conduct!

No Official nor No Official nor Family Member Family Member

Should Ever Profit in Should Ever Profit in any manner from any manner from their position as a their position as a

Credit Union Credit Union Volunteer!Volunteer!

In which areas do WE as a Board need to focus our

attention?

Where do I as an individual Board member need to

focus my attention?

Right Management Right Management PersonnelPersonnel

--Officials--Officials and Key and Key ManagementManagement

--Now and in the Future----Now and in the Future--SuccessionSuccession

CEO Succession Planning

If you had to name someone as CEO immediately (not on an interim or

emergency basis), could you?

Source: Stanford University, Heidrick & Struggles (2010)

If you have an emergency candidate to replace the CEO, is this person also a

succession candidate?

Seven Steps To A Board Succession Plan

Assess your credit union’s needs.

List required attributes.

Assess current board members.

Provide opportunities for development.

1

2

Develop a process to anticipate voluntary board member departures.

Build a list of potential members and start to orient them to the credit unions.

Develop a formal board member succession policy.

3

4

5

6

7

Who are our Leaders and Who are our Leaders and Managers?Managers?

Where will future Where will future leaders come fromleaders come from?

DO WE HAVE THE RIGHT MANAGEMENT TEAM IN

PLACE TO PROVIDE FUTURE LEADERSHIP—

BALANCE OF MANAGERS AND LEADERS

Leadership VsLeadership Vs. Management. Management

• Leaders climb trees and determine the direction we should go to get out of the jungle.

• Managers

cut down the trees in the most efficient and effective manner.

Have the Right Have the Right Personnel…Hold Personnel…Hold Accountable…Accountable…

RewardReward

AppropriatelyAppropriately

Appropriate Appropriate Membership Membership

Growth/Demographics, Growth/Demographics, Products, Services and Products, Services and

Delivery SystemsDelivery Systems

ARE WE OFFERRING THE PRODUCTS AND SERVICES THAT OUR MEMBERS WANT?

ARE WE DELIVERING THESE PRODUCTS AND SERVICES IN THE MANNER THAT OUR MEMBERS WANT?

WILL OUR PRESENT MEMBERSHIP DEMOGRAPHIC PROVIDE US WITH THE DIVERSIFICATION WE NEED TO COMPETE IN THE FUTURE

Mobile vs. Online Banking Adoption(by millions of households)

85

60

40

15

0.1

75

70

65

60

40

2025

2020

2015

2010

2005

Online banking Mobile banking

Source: BAI Online Banking Report, 2010

Likelihood of CUs’ Tech Investments

28%

18

24

31

24

36

34

41

45

47

57%

12%

23

18

20

28

18

22

19

22

22

19%

High priority in next two years Probably will in next two years

Source: Aite Group, 2011

Basic mobile banking (check balances/transfer funds)

Online account opening

Mobile payments

E-statements

Remote deposit capture(RDC) for all members

Online banking application

Mobile person-to-person payments

Personal financial management tools

RDC for business members

Member-analytics tools

Small-business online banking application

Membership Growth and Membership Growth and DemographicsDemographics

• Decreasing rate of membership growthDecreasing rate of membership growth

• Decreasing number of members in prime Decreasing number of members in prime borrowing yearsborrowing years

• Not able to attract 18-24 age groupNot able to attract 18-24 age group

• Not able to attract minoritiesNot able to attract minorities

• Loyalty decreasingLoyalty decreasing

• 40% of eligible members not familiar with 40% of eligible members not familiar with Credit UnionsCredit Unions

Growth of Ethnic Groups in U.S.

2010 2050

Source: U.S. Census Bureau (16% Hispanic in 2010=50.5 million)

Are You Eligible to Join a CU?*

Age Yes No Maybe

Overall 36% 19% 45%

18 to 24 11 10 79

25 to 34 55 13 32

35 to 44 28 27 44

45 to 54 41 22 37

55 to 64 45 22 33

65 or older 33% 20% 47%

*Asked of nonmembers

Source: CUNA’s 2011-2012 Survey of Potential Members

CU Members’ Age Distribution

Source: CUNA’s 2011-2012 National Member Survey

RISK RISK ASSESSMENT, ASSESSMENT, MEASURING MEASURING

AND AND MONITORINGMONITORING

DO WE UNDERSTAND THE DO WE UNDERSTAND THE

LEVELS OF RISKLEVELS OF RISK BEING BEING

ASSUMED BY THE CREDIT ASSUMED BY THE CREDIT

UNION AND HOW THEY UNION AND HOW THEY ARE ARE

MONITORED AND MONITORED AND

MEASURED MEASURED BY BY

MANAGEMENT!MANAGEMENT!

WHERE ARE THE SIGNIFICANT RISKS OF LOSS IN OUR CREDIT UNION

HOW DOES MANAGEMENT/BOARD

MONITOR AND MEASURE RISKS?

DOES MANAGEMENT HAVE APPROPRIATE METHODS TO MEASURE AND MONITOR RISK AREAS---DO WE UNDERSTAND THEM?

Types of RiskTypes of Risk1.1. Credit RiskCredit Risk

2.2. Interest Rate RiskInterest Rate Risk

3.3. Liquidity RiskLiquidity Risk

4.4. Transaction RiskTransaction Risk

5.5. Compliance RiskCompliance Risk

6.6. Strategic RiskStrategic Risk

7.7. Reputation RiskReputation Risk

8.8. Concentration RiskConcentration Risk

9.9. Growth RiskGrowth Risk

Credit RiskCredit Risk

The Risk that we The Risk that we won’t get our won’t get our

money back from money back from a loan, a loan,

investment or investment or other asset!other asset!

Interest Rate Risk

1.1.If interest rates change, If interest rates change, what will happen to our what will happen to our earnings?earnings?

2.2.How much capital is at How much capital is at risk? risk? Earnings--CapitalEarnings--Capital

Liquidity Risk

Risk that adequate Risk that adequate cash will not be cash will not be available to fund available to fund

loans, meet loans, meet withdrawal withdrawal

demands, or pay demands, or pay bills.bills.

Transaction RiskTransaction Risk

Risk of Risk of fraudfraud or or operation problems in operation problems in transaction processing transaction processing

that results in an that results in an inability to deliver inability to deliver products, remain products, remain competitive, and competitive, and

manage informationmanage information

Compliance Risk Compliance Risk

Risk of violations Risk of violations and non-compliance and non-compliance with applicable laws with applicable laws

and regulations and regulations resulting in fines, resulting in fines,

penalties, payment, penalties, payment, or damagesor damages

45%

Source: About Resources Inc.

Weak economy/ loan

demand

70%

Interest-rate environmentRegulatory

burden

53%

24%

19%

18%

12%

NCUA assessment

Membership growth

Credit quality/ problem loans

Growing fee income

CEOs Concerned About Regulatory Burden

Source: Abound Resources Inc.

Address regulatory compliance requirements

Improve lending policies & processes for improved risk management

Improve investment management policies & processes

Improve overall examination scores

Lower cost of funds by other means

Address fraud & information security concerns

Replace NSF income with other fee income sources

Clean up the balance sheet/improve credit quality

Top CEO Compliance Concerns

Strategic Risk

Risk of Risk of adverse adverse business decisions business decisions

through through management’s or management’s or board’s actions or board’s actions or

inactions inactions

Reputation RiskReputation Risk

Risk of Risk of negative public negative public opiniopinion or on or perception perception

leading to a loss of leading to a loss of confidence and/or confidence and/or

severance of severance of relationships relationships

Risk ManagementRisk Management

•How does Management How does Management measure and monitor risk in measure and monitor risk in each of these risk categories?each of these risk categories?

•How is this measurement, How is this measurement, monitoring and trend analysis monitoring and trend analysis communicated to you?communicated to you?

RISK MANAGEMENTRISK MANAGEMENTIN WHICH RISK AREAS DOES IN WHICH RISK AREAS DOES

YOUR YOUR

RISK MANAGEMENTRISK MANAGEMENT PERSONNEL PERSONNEL

SPEND THEIR TIME?SPEND THEIR TIME?

ARE WE SPENDING THE PROPERARE WE SPENDING THE PROPER

AMOUNT OF RESOURCES AMOUNT OF RESOURCES MONITORING MONITORING

THE KEY RISK AREAS?THE KEY RISK AREAS?

RISK MANAGEMENTRISK MANAGEMENTTHE FOLLOWING RISKS ARE THE FOLLOWING RISKS ARE

GENERALLY MEASURED AND GENERALLY MEASURED AND

MONITORED BY A SPECIFIC MONITORED BY A SPECIFIC

INDIVIDUAL or GROUPINDIVIDUAL or GROUP

• COMPLIANCECOMPLIANCE• TRANSACTIONTRANSACTION• INTEREST RATEINTEREST RATE• LIQUIDITY LIQUIDITY

RISK MANAGEMENTRISK MANAGEMENTTHE FOLLOWING RISKS ARE THE FOLLOWING RISKS ARE

GENERALLY MEASURED AND GENERALLY MEASURED AND

MONITORED BY VARIOUS GROUPS:MONITORED BY VARIOUS GROUPS:

• CREDIT RISKCREDIT RISK

• STRATEGIC RISK

• REPUTATION RISK

Monitor Peer and Monitor Peer and Budgeted/Projected data and Budgeted/Projected data and

Trends…Understand Trends…Understand why why

are we different!are we different!

DO WE HAVE DO WE HAVE APPROPRIATE APPROPRIATE

PLANNING PLANNING PROCESSES?PROCESSES?

ARE WE PERFORMING APPROPRIATE PLANNING PROCESSES—STRATEGIC, BUSINESS, TECHNOLOGY AND CAPITAL

HAVE WE ESTABLISHED WELL DEFINED MEASUREABLE GOALS AND PROVIDED MANAGEMENT WITH THE NECESSARY RESOURCES TO COMPLETE OUR GOALS?

DO WE HOLD RESPONSIBLE PERSONNEL ACCOUNTABLE?

DO WE REWARD PERSONNEL APPROPRIATELY?

Merger Strategy PlansMerger Strategy Plans

• Up stream and down stream criteria and Up stream and down stream criteria and guidelinesguidelines

• Change in ownership provisionsChange in ownership provisions in in management contractsmanagement contracts

• Fundamentals---Best interest of Fundamentals---Best interest of membership and staff short and long term!membership and staff short and long term!

WHY WILL OUR WHY WILL OUR

CREDIT UNION BE INCREDIT UNION BE IN

EXISTENCE IN 2020?EXISTENCE IN 2020?

CU System OverviewSystem Concentration

• The trend towards the The trend towards the “mega-Credit Union“mega-Credit Union will will continue:continue:

– By 2012 the U.S. CU system is projected to have By 2012 the U.S. CU system is projected to have 199 CUs with assets greater than $1 billion199 CUs with assets greater than $1 billion

– The billion dollar CUs will control:The billion dollar CUs will control:

• 51% of total CU system assets51% of total CU system assets

• 42% of total CU members42% of total CU members

– An additional 800 CUs will have between $200 An additional 800 CUs will have between $200 million and $1 billion in assetsmillion and $1 billion in assets

• 33% of total CU system assets33% of total CU system assets

• 35% of total CU members35% of total CU members

What are some warning signs or red flags that may indicate that a credit union may not be in existence in the future?

General QuestionsGeneral Questions

Do we have a formalized contingency plan for steps Do we have a formalized contingency plan for steps we will take if operating conditions deteriorate we will take if operating conditions deteriorate further? further?

What are those steps and are bench marks identified What are those steps and are bench marks identified when they will be implemented?when they will be implemented?

Succession Planning• How often is a projection/assessment of future management needsfuture management needs made?

• How is the assessment made?

• The assessment should be an appraisal of the quality and quantity of senior and middle management and should be relative to the size and complexity of the Credit Union.

Succession Planning• Has the Credit Union developed a formal Has the Credit Union developed a formal

written succession plan? written succession plan?

• When was it last updated and approved by When was it last updated and approved by the board of directors?the board of directors?

• Does the succession plan address the Does the succession plan address the steps steps to be followed in finding new management to be followed in finding new management personnel in the event of termination, personnel in the event of termination, retirement or resignation?retirement or resignation?

Succession Planning

• Does the plan address both retirement and Does the plan address both retirement and extended absences of key Credit Union extended absences of key Credit Union personnel?personnel?

• Is there a Board of Directors succession Is there a Board of Directors succession plan?plan?

Strategic PlanningStrategic Planning

• Does the Credit Union have a written Does the Credit Union have a written plan and how was the plan developed?plan and how was the plan developed?

• What time period does the plan address?What time period does the plan address?

• How is the strategic plan utilized by How is the strategic plan utilized by management?management?

Strategic Planning • Does it identify Credit Union strengths and weaknesses? Does it identify Credit Union strengths and weaknesses?

• Does it outline and define the Credit Union objectives, action plans, goals, etc.?Does it outline and define the Credit Union objectives, action plans, goals, etc.?

• The plan should contain a long-range plan of what we hope to achieve “down the road” and an operational plan that The plan should contain a long-range plan of what we hope to achieve “down the road” and an operational plan that has goals for business units or departments to focus on and action steps needed for the achievement of those goals.has goals for business units or departments to focus on and action steps needed for the achievement of those goals.

Budgeting• Does Credit Union management prepare an annual annual

operating budget?operating budget? Does the board of directors provide input and final

approval of all budgets? Are changes and revisionschanges and revisions to the budget

approved by the board? Has the Credit Union developed a formal written written

Technology Plan and related budget?Technology Plan and related budget? What time frame does it cover?

BudgetingBudgeting • Are Are explanations of monthly variancesexplanations of monthly variances

and their causeand their cause presented in writing to presented in writing to the board of directors by the board of directors by management?management?

The final and most important steps are The final and most important steps are measuring results against the budget, measuring results against the budget, seeking explanations for variances, and seeking explanations for variances, and evaluating the performanceevaluating the performance of the persons of the persons responsible for carrying out delegated duties responsible for carrying out delegated duties and responsibilities. and responsibilities.

Pricing of Loans, Dividends and Pricing of Loans, Dividends and Fees for Member ServicesFees for Member Services

• Does the Credit Union have a well-defined ALM Does the Credit Union have a well-defined ALM system that consistently assesses interest rate, system that consistently assesses interest rate, credit and liquidity risks? What software or credit and liquidity risks? What software or outsourced vendors are used?outsourced vendors are used?

• Appropriate members of the ALCO committee? Appropriate members of the ALCO committee?

• What reports are issued by the ALCO committee What reports are issued by the ALCO committee and who reviews them?and who reviews them?

DO WE HAVE A COMMON VISION FOR THE FUTURE? IS

OUR VISION REALISTIC AND IN THE BEST INTEREST OF OUR

MEMBERSHIP?

PROFITABILITY AND PROFITABILITY AND MAINTENANCE OF MAINTENANCE OF

CAPITALCAPITAL

WHAT ARE PROFITABILITY AND CAPITAL TRENDS AND PROJECTIONS?

WHAT ARE THE SIGNIFICANT AREAS OF

CONCERN EXPRESSED IN AUDIT AND EXAMINATION REPORTS AND ARE THEY APPROPRIATELY ADDRESSED BY MANAGEMENT?

Credit Union Financial Credit Union Financial RemindersReminders

Revenue/Income - What we Revenue/Income - What we EarnEarn

What are our sources of Income?What are our sources of Income?

•Loans-Loan IncomeLoans-Loan Income• Investments – Investment IncomeInvestments – Investment Income•Fees, Charges and Other IncomeFees, Charges and Other Income

Costs/ExpensesCosts/Expenses• Cost of funds--DividendsCost of funds--Dividends

• Provision for loan lossesProvision for loan losses

• Operating expensesOperating expenses

Net IncomeNet IncomeTotal Income Total Income lessless

Total Expenses = Total Expenses =

Net Income or Net Income or loss!loss!

Net Worth and EarningsNet Worth and Earnings

•Presently, a Credit Presently, a Credit Union’s ONLY source of Union’s ONLY source of Capital is_________________?Capital is_________________?

•Supplemental/Alternative Supplemental/Alternative Sources of Capital??Sources of Capital??

Net Worth and EarningsNet Worth and EarningsWhat are the 5 ways to increase What are the 5 ways to increase

earnings/net income?earnings/net income?

Net IncomeNet IncomeWhich of these five ways of increasingWhich of these five ways of increasingNet Income would you say is the Net Income would you say is the easiest? easiest?

The most difficult?The most difficult?

Which source of income has been a Which source of income has been a primary focus in the past few years?primary focus in the past few years?

Which of the five ways are most Which of the five ways are most controllable?controllable?

Net Worth and EarningsNet Worth and Earnings

• The primary Capital ratio is the ratio of The primary Capital ratio is the ratio of capital (member’s equity) to assets.capital (member’s equity) to assets.

• What are What are thethe two ways to two ways to increase your increase your Capital ratio?Capital ratio?

Credit Union ROA and Credit Union ROA and Capital RatioCapital Ratio

ROA necessary to maintain a given capital ratio under a given asset growth rate:

Capital Ratio (Percent)6 8 9 10 11 12

Asset 5 0.29 0.39 0.44 0.49 0.54 0.59Growth 7.5 0.43 0.58 0.65 0.72 0.80 0.87

Rate 10 0.57 0.76 0.86 0.95 1.05 1.14(percent) 12.5 0.71 0.94 1.06 1.18 1.29 1.41

15 0.84 1.12 1.26 1.40 1.53 1.6717.5 0.97 1.29 1.45 1.61 1.77 1.93

20 1.09 1.45 1.64 1.82 2.00 2.18

WHAT KEY AREAS WHAT KEY AREAS DO YOU FOCUS ON??DO YOU FOCUS ON??