Controls. Board of Directors Fiduciary Duties. PART Three: Ratios, Risk and Internal

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1 Board of Directors Fiduciary Duties PART Three: Ratios, Risk and Internal Controls Mark Brown, SVP, Chief Financial Officer First Carolina Corporate Credit Union

2 Mark Brown Introduction First Carolina Corporate Credit Union, SVP/CFO - 16 years Sara Lee Credit Union, Accounting Manager/Controller - 9 years United Federal Credit Union, Accounting Manager - 3 years Licensed NC CPA

3 Agenda Key Ratios Risk Management Internal Controls

4 Ratio Analysis Ratio analysis is the comparison of ratios for making decisions The most immediate function of ratio analysis it to determine the soundness of a credit union s operations One ratio by itself cannot give an accurate picture of financial performance

5 Important Ratios Capital Adequacy Capital Ratio Asset Quality Delinquency Ratio Net Charge-Off Ratio Earnings Return on Average Assets (ROA) Operating Expense Ratio Liquidity Ratio Loan to Share Ratio

6 Important Ratios Capital Adequacy Capital Ratio Asset Quality Delinquency Ratio Net Charge-Off Ratio Earnings Return on Average Assets (ROA) Operating Expense Ratio Liquidity Ratio Loan to Share Ratio The capital ratio indicates how much capital is available to cover claims on assets in the event of both expected and unexpected losses. For purposes of examining the safety net member shares and savings are not included.

7 Capital Ratio Statutory Reserves + Other Capital Reserves + Undivided Earnings Total Assets

8 Prompt Corrective Action 7 % or > 6% or > <6% <5% <3% Well Capitalized Adequately Capitalized Undercapitalized Significantly Undercapitalized Critically Undercapitalized

9 Important Ratios Capital Adequacy Capital Ratio Asset Quality Delinquency Ratio Net Charge-Off Ratio Earnings Return on Average Assets (ROA) Operating Expense Ratio Liquidity Ratio Loan to Share Ratio Shows the proportion of total loans outstanding that are behind their repayment schedules and may become losses in the near future. Most regulators focus on loans delinquent two months or more.

10 Delinquency Ratio Total Delinquent Loans Total Loans Outstanding

11 Important Ratios Capital Adequacy Capital Ratio Asset Quality Delinquency Ratio Net Charge-Off Ratio Earnings Return on Average Assets (ROA) Operating Expense Ratio Liquidity Ratio Loan to Share Ratio May be calculated for any time period, including the entire history of the credit union. Most credit unions are interested in loans charged off during that year.

12 Net Charge-Off Ratio Loan Charge-Offs During Year, Net of Recoveries Average Loans Outstanding

13 Important Ratios Capital Adequacy Capital Ratio Asset Quality Delinquency Ratio Net Charge-Off Ratio Earnings Return on Average Assets (ROA) Operating Expense Ratio Liquidity Ratio Loan to Share Ratio Measures a credit union s current ability to earn an acceptable rate or return. Net income is is a measure of profitability.

14 Return on Average Assets Net Income Average Total Assets

15 Important Ratios Capital Adequacy Capital Ratio Asset Quality Delinquency Ratio Net Charge-Off Ratio Earnings Return on Average Assets (ROA) Operating Expense Ratio Liquidity Ratio Loan Ratios Is computed relative to the credit union s average total assets. It gives some indication of the organization s efficiency.

16 Operating Expense Ratio Operating Expenses Average Total Assets

17 Important Ratios Capital Adequacy Capital Ratio Asset Quality Delinquency Ratio Net Charge-Off Ratio Earnings Return on Average Assets (ROA) Operating Expense Ratio Liquidity Ratio Loan to Share Ratio Measures the degree to which members savings are funding loans. A high ratio can signal possible liquidity problems if the credit union faces heavy savings withdrawals or high loan demand. A low ratio might result from high loan interest rates, low loan demand, or restrictive lending policies.

18 Loan to Share Ratio Loans Outstanding Total Member Shares

19 Ratio Summary Many credit unions place a ratio review in the monthly board packet > Shows changes in value of the ratio over time. > Be sure to understand if the change (either positive or negative) is good for the credit union!

20 Risk Management Risk management is the process of protecting the credit union from loss

21 Types of Risk Strategic Risk Credit Risk Interest Rate Risk Liquidity Risk Transaction Risk Compliance Risk Reputation Risk

22 Types of Risk Strategic Risk Credit Risk Interest Rate Risk Liquidity Risk The risk that poor business decisions or improper implementation of strategic goals will reduce earnings and net worth. If the credit union does a good job in addressing strategic risks, the rest of the risk areas should flow well. Monitoring and changing strategies are part of the process. Transaction Risk Compliance Risk Reputation Risk

23 Types of Risk Strategic Risk Credit Risk Interest Rate Risk The risk of non-repayment where the credit union invests or loans funds. Boards must understand the current and new loan products a credit union offers and the risks associated with the product. For example, Business loans have a completely different risk level than used auto loans. Liquidity Risk Transaction Risk Compliance Risk Reputation Risk

24 Types of Risk Strategic Risk Credit Risk Interest Rate Risk Liquidity Risk Transaction Risk The risk that changes in market rates will not be adequately managed to maintain an appropriate net interest margin. The credit union must demonstrate that it understands its interest rate risks and how to address those risks. The ALCO should actively evaluate loans and investments and make recommendations to the board when appropriate. Compliance Risk Reputation Risk

25 Types of Risk Strategic Risk Credit Risk Interest Rate Risk Liquidity Risk Transaction Risk The risk that the credit union will not be able to liquidate assets quickly and with minimal loss in value to meet its obligations. Matching is the structuring of the maturities and amounts of assets loans and investments to match the maturities and amounts of liabilities savings. Compliance Risk Reputation Risk

26 Types of Risk Strategic Risk Credit Risk Interest Rate Risk Liquidity Risk Transaction Risk Compliance Risk The risk that fraud or errors will cause a loss. This risk is a function of internal controls, information systems, employee integrity, and operating processes. Poor record keeping is one of the main reasons fraud is occurring. The board needs to ask questions of management to make sure there is proper recordkeeping. Reputation Risk

27 Types of Risk Strategic Risk Credit Risk Interest Rate Risk Liquidity Risk Transaction Risk Compliance Risk Reputation Risk The risk that failure to comply with laws and regulations, prudent ethical standards, and contractual obligations will harm the credit union. BSA is the number one compliance issue today. Make sure your credit union is in compliance and your staff is getting the proper training!

28 Types of Risk Strategic Risk Credit Risk Interest Rate Risk Liquidity Risk Transaction Risk Compliance Risk Reputation Risk The risk that the credit union s public image will be tarnished due to improper actions on the part of officials, management or staff. A good reputation is the most important asset a credit union has to protect.

29 Internal Controls Internal controls are part of a system that ensures the accuracy of records, guards assets and makes for efficient operation.

30 Internal Controls Maintaining an adequate financial reporting system Limiting access to cash Segregating duties Adopting effective personnel policies

31 Internal Controls Maintaining an adequate financial reporting system The process of updating and summarizing financial records provides directors with reliable information about daily operations. The reporting system also helps deter crimes such as embezzlement.

32 Internal Controls Limiting access to cash A vital internal control. The board authorizes cash amounts in temporary and permanent change funds, such as petty cash. Access to storage devices, including vaults and files, requires two keys or two sets of combinations under the control of two people.

33 Segregation of Duties Internal Controls When two or more people are involved in a transaction, one can act as a check on the other. Example: One employee process a loan application while another disburses the funds.

34 Internal Controls Adopting effective personnel policies Reference and background checks are essential before hiring a new employee. Rotation of staff is another element of internal control. Required annual vacations are a wise policy for all employees, since embezzlers depend on being able to maintain constant vigilance over evidence of their crimes.

35 Resources CUNA Volunteer Network CUNA Board Financial Literacy Certificate Kit CU Analyzer NCUA

36 Reminder Board of Directors Fiduciary Duties, Part One: The Balance Sheet Board of Directors Fiduciary Duties, Part Two: The Income Statement

37 Contact Information Mark Brown SVP, Chief Financial Officer First Carolina Corporate Credit Union Phone: , ext. 3264