On Jan. 27, 2011, NCUA rule 12 CFR § 701.4, “General authorities and duties of Federal credit union directors,” took effect. The rule contains six provisions on how credit union board members should undertake their duties. But the one that’s getting the most attention is No. 3, which states the following:
“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.”
It’s hard to argue with a rule that seems to be a statement of the obvious, says CUES member Tom Swierzy, president/CEO of Sb1 Federal Credit Union, Philadelphia. “I have manuals that we’ve purchased, going back to the ’80s, which have to do with credit union accounting,” he says. “And believe it or not, the material in those books is exactly what NCUA is asking board members to do.”
John Oliver, president of Laurel Management Systems, Inc., a Palm Springs, Calif.-based consultancy that trains managers and directors in the financial industry, agrees heartily.
“What NCUA is saying, quite rightly, in my opinion, is that if you are going to be responsible for the monitoring and oversight of a financial institution, you’ve got to have a certain degree of financial literacy to do the job diligently,” he says. “When you look at the business model of a credit union, it is effectively taking other people’s money and putting it at risk. Therefore, if you’re going to have any kind of effective governance, you’ve got to be able to review numbers. Unlike some industries, virtually everything that’s presented to a board in the financial services sector is in the form of numbers and ratios.”
Initially, NCUA gave federal credit unions three months to comply with the new rule, but many commenters objected, saying that three months was an unreasonably short period in which to become adequately proficient at understanding accounting and finance. As a result, NCUA passed guidance saying that existing directors have until July 27, 2011, to have the required financial knowledge. New directors have six months to achieve competency, starting from the day they join the board.
This change in timeframe was a weight off many executives’ and directors’ minds. But the rule still caused consternation because it was deliberately vague in its requirements. Even NCUA’s February 2011 letter 11-FCU-02, which clarified the expectations considerably, noted that directors should obtain financial knowledge “commensurate with the size and complexity of the credit union.” In other words, if anyone was expecting them to release a single, cut-and-dried syllabus, they’re out of luck.
Again, though, it makes sense, says Ron Parker, CPA, of Tucson-based Parker Consulting.
“If you take just one piece of the balance sheet, like investments, maybe CDs are the only investments that small credit unions are going to have,” he explains. “Or maybe some money in a corporate. On the other hand, a bigger credit union is going to have mortgage-backed securities, treasuries, a lot more complicated, complex instruments. So as a director, you kind of have to say, ‘Well, if this kind of information is more complicated, then I need to be more involved in these areas.’”
Janice Hollar, CCE, senior vice president of RP Financial LC, a CUES Supplier member based in Arlington, Va., concurs. “If you are a director at a very large and complex credit union, you’re going to have more resources on the management team [for guidance], but it also means there is more to evaluate,” she says. “It potentially is more complex, and there is a bigger onus on you to be more fully informed, to understand what they’re telling you.”
Credit unions in trouble may want to hold their directors to a higher standard of financial literacy, too, she says, so that they can fully comprehend the institution’s predicament and make decisions that will bring the CU back into the black. But, she laughs, “Even if you’re not in a difficult situation, you still need to have enough information and understanding to avoid getting into one.”
Will This be on the Test?
Perhaps because of the “size and complexity” issue, regulators haven’t said exactly what level of expertise directors must have, or how many hours of coursework they must undertake. Parker says credit unions are interpreting the rule in a wide variety of ways.
“I’ve seen some leagues or organizations who’ve wanted to do the training in just a couple of hours,” he says. “There are others who are taking more like a day, or longer. The scope of the training is a little bit all over the place. Who can say what it means to be ‘financially literate’? My view on that might be different than yours. When I teach financial accounting I and II at the college level, it takes a year.”
But NCUA has offered a little bit of guidance on subject matter in its February letter, in a section titled “What a Director Should Know.” It says, in part:
Accordingly, to be an effective director, an individual must have a certain base level of financial skills, consistent with the size and complexity of the credit union operation they serve. At a minimum, directors must have the ability to read and understand the credit union’s balance sheet and income statement. If directors do not have the requisite skills when elected or appointed, they must obtain these skills in a timely manner…
The letter suggests that, at minimum, upon examining the credit union’s balance sheet and income statement, a director should be able to 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?
The letter also says directors must understand the specific activities in which their credit union engages—how those activities generate revenue, what types of risks are associated with the activities, and what control structures are in place at the credit union to limit and manage those risks.
The nature of this material suggests a hands-on approach to training, and that’s exactly what Parker is doing in the six-hour financial seminar he and some partners are offering.
“We’re asking [directors] to bring their call reports and their financial statements,” he says. “We’re going to go through those one by one—if you’ve got a number here, this is what it means, and so on.” In addition to discussing the meaning of these real-life numbers, he plans to talk about some key ratios, seven major risk areas for credit unions, and even a bit of asset-liability management.
NCUA’s February letter condones classes like these, when it says the knowledge may be gained from third-party vendors, trade associations, credit union leagues, colleges and universities, or even NCUA itself. But it also notes that if CUs prefer not to hire trainers, their directors can obtain the necessary skills via internal training, self education, on-the-job experience, or a combination of any of these sources.
Oliver, who recently taught a financial literacy course for directors at a CUES conference, says many credit unions are gravitating toward formal training by outside entities simply because they want to be absolutely sure they’ll be seen as complying with the new rule.
“Generally speaking, most credit unions are using an external source of some sort, whether that be an online source or a seminar or whatever, simply because they want the certificate that comes at the end of it to be able to put in the file and pull out to demonstrate compliance to regulators,” he says. Of course, a board of directors that receives training at a board meeting can make note of the training in its minutes and attach the presentation slides.
For CUES Director member Rich Biege, board chairman at $1.6 billion, 180,000-member Langley Federal Credit Union, Newport News, Va., this sort of training is nothing new. In fact, the institution won’t need to change its rules at all in order to comply. Since 2005, the CU has required all its directors to complete the 13 modules of the online CUES Director Education Center, covering everything from finance to governance issues—“everything a leader should know something about,” Biege says.
A requirement like Langley FCU’s isn’t unusual, says Hollar.
“At credit unions that I have worked at in the past, many have had requirements of so many hours of education per year,” she says. “And it’s common for directors to come back from conferences and share the information with others. That’s why I think maybe credit unions are building [this rule] up a little bit too much. I understand why credit unions are looking for some kind of proof that they did something. But I don’t believe the rule says they have to have a certificate or that they have to have any proof.”
In fact, there isn’t even any language indicating that training is necessary. If directors are already financially literate, they’re good to go. And they’re not going to be rounded up and quizzed by examiners, either, according to NCUA’s February clarification:
It is not NCUA’s intent to increase examiner scrutiny of the financial skills of particular directors. Rather, examiners will evaluate whether the credit union has a policy in place to make available the appropriate training to enhance the financial knowledge of the directors.
What those policies will entail remains to be seen. Some credit unions have already jumped in with both feet. Others, like Sb1 FCU, are still waiting to see what best practices might emerge as the deadline gets closer. Swierzy says his eventual reaction might be as simple as discussing the new rule at a board meeting and asking all of his already financially literate directors to sign off on it.
Above and Beyond the Call
When Christine Brown Petro, president/CEO of Tyco Federal Credit Union, Redwood City, Calif., heard about rule 701.4, there was no doubt in her mind that her board already had more than basic financial literacy. Even the newest director had served for three years, and most had closer to 10 years of experience. Several had MBAs, and one was a controller for a sponsor company. They knew their way around a profit and loss statement, but how would they prove it?
At the same time, the usually well-capitalized credit union was having a rough year. Its capital had fallen to 6.8 percent due to corporate credit union stabilization costs. Petro hoped to get capital back above 7 percent by making tough pricing decisions and running off some shares, but she knew the board would push back.
Suddenly she realized she could kill two birds with one stone.
“We decided to spend our strategic planning conference looking at our capital position—how we make money, what costs us money,” says the CUES member. “We wanted to go through and make some of those tough decisions about how we price our products and services, especially dividend rates and loan products. So we had a CPA come in, and we spent a day and a half poring over all of our financial ratios, not at a basic level like NCUA requires as part of this new literacy, but really much more in depth than that. We also had an economist come in and speak about how economic trends affect credit union balance sheets, income statements and member behavior.”
The in-depth study helped the directors to understand why some money-losing products and services could no longer be free, and why radical changes were necessary. When the directors understood how paper statements affected the bottom line, they were far more willing to charge members for them. And they reluctantly agreed that the CU’s long-time no-fee checking program could not continue.
“We’re at like 78 percent checking penetration,” Petro says. “But if these members don’t have a loan with us, we can’t afford to keep giving them free checking accounts. They’re probably one of our biggest expenses, especially when you count the insured shares premium on top of it. So one of the things we went through that day was ‘OK, here’s what a checking account costs us, here’s what a member with a loan earns us, and here’s what we need to charge them on the checking account to at least break even.’”
Petro says without the financial education program, it might have been difficult to make the changes the credit union needed in a timely manner. But it’s hard to deny the facts, she says, when you have an accountant standing in front of you saying, “You can’t be losing money on this stuff.”
New board members won’t have the benefit of that one intense weekend. Petro plans to send future volunteers to CUES director training seminars in order to comply. From there, she says, they’ll catch up with where the other directors are by participating in committees and board meetings. It’s a similar tactic to one used by Langley FCU, which rotates new directors into the ALM committee so they are immediately immersed in the numbers and get up to speed more quickly.
Parker says if credit union CEOs are in doubt, they might want to simply sit down individually with each board member and go through the balance sheet line by line.
“I don’t think there’s any better way to understand the material than to go through every number on the balance sheet with somebody who understands it,” says Parker, who wrote “Valuation: Squeezing Meaning From the Numbers” for CUES’ Center for Credit Union Board Excellence. Directors can ask, “‘What is this? How do we derive it, and how is it valued? Is it cost? Is it market? Is it the lower of cost or market? And so on,’” he suggests.
Can Non-Accountants Still Serve?
The increased interest in number-crunching has led some commenters on the new rule to worry that the rule will discourage non-accountants from serving as directors. Some even expressed concern that it was tantamount to imposing an eligibility requirement. However, technically speaking, any members who meet the eligibility requirements of the Federal Credit Union Act can serve, be they truck drivers, electricians or elementary school art teachers. They must simply attain basic financial literacy within six months of being elected. And that’s something that can be established in a day or two, without even breaking a sweat.
“I think boards need to be well-rounded and have a range of backgrounds and skill sets, bringing various areas of expertise,” says Hollar. “This requirement shouldn’t discourage all those different people from serving. I don’t think [NCUA] is asking them to become financial experts. I think they’re asking them to learn enough and to know enough to be able to ask good questions.”
“I think a lot of people are being scared by this thing, the idea that they’ve got to understand all this stuff,” says Oliver. “But I would like to offer this reassurance that NCUA is not saying that every director needs to be a CPA. It’s just financial literacy, which is probably a very acceptable thing to be asking of them.”
Jamie Swedberg is a free-lance writer based in Athens, Ga.