February 10, 2011

Credit Union Management magazine’s Web-only “CFO Focus” column runs the second Thursday of each month.

CEOs and CFOs play key roles in helping boards understand a credit union’s financial picture. Last week in San Diego, John Oliver presented “Fundamentals of Financial Understanding for Credit Union Directors.” This summary of that presentation might help you think about your own directors’ current financial knowledge and future learning needs.

President of Laurel Management Systems, Palm Springs, Calif., Oliver noted that a new National Credit Union Administration rule underscores the duty of credit union directors to understand the financials of their institutions. NCUA has said that current directors must comply by July 27; all new directors will have six months to comply with the financial education requirement. What is not known is how examiners will expect credit unions to document their directors’ financial knowledge.

In his presentation, Oliver started by offering a simple look at the construction and use of credit union financial statements for non-financially experienced directors. He started by addressing a credit union’s balance sheet and its income statement.

In talking with the director attendees, he said a balance sheet is like a photograph—it  captures the credit union’s financial situation at a particular point in time. It considers amounts owed by the credit union, amounts owed to the credit union and equity amounts that reflect the members’ ownership position. He pointed out that, for someone new to finance, the balance sheet of a credit union can be confusing as it requires us to turn upside-down our personal viewpoint of what is an asset and what is a liability.

The balance sheet, he said, answers such questions as:

1. Where are we getting our funding from? (These are the credit union’s liabilities- the amounts the credit union owes to others.)
2. How are we using that money?  (These are the CU’s assets - the amounts owed to the credit union and things it owns.)
3. What is our net worth? (These are reserve amounts owed to members and simply reflect the difference in value between the assets and the liabilities.)

In contrast, Oliver explained the income statement as describing the credit union’s profitability over a period of time. It shows how revenues received over that period minus expenses paid equals profit for the period.

The income statement, he said, can help to answer such questions as:

1. How much did we earn from our assets during the period? (This is the credit union’s revenue.)
2. How much did we pay for our liabilities? And, how much did we pay to operate the organization? (Both of these are the credit union’s expenses.)
3. How much profit resulted over the period of time in question? (Simply deduct expenses from revenue This is the credit union’s net income, which is transferred into the member reserves section of the balance sheet at the end of the period.)

Oliver also explained a variety of key performance indicators to director attendees, noting that they needed to be equipped to understand whether a particular number was good news or bad news for the credit union ad which direction they would ideally like to see the indicator moving. He reassured directors that they would never need to calculate these ratios, but they did need to understand them in concept.

He described the calculation and interpretation of various performance measurements, including:

• Efficiency ratio
• Operational expenses/average assets ratio
• Profit growth compared to asset growth ratio
• Return on assets
• Net interest margin/average assets ratio
• Non-interest income/average assets ratio
• Non-interest income/total net revenue ratio
• Leverage ratio in the area capital adequacy
• Non-performing loans compared to total net loans ratio
• Allowance for loan and lease losses compared to total net loans
• Non-performing as percentage of the allowance for loan and lease losses
• Net loan losses compared to primary capital
• Liquid assets compared to total assets and
• Loan-to-deposit ratio.

Rounding out the course in CU finance for directors, Oliver discussed interest-rate risk and its potential impacts on both profitability and capital, some foundational macroeconomic concepts, and the preparation and use of a sources and uses of funds statement.

Finally Oliver offered some reassurance to participants by expressing the opinion that NCUA is not trying to insist that all directors need to be CPAs but that, as directors of financial institutions, they do need to attain a level of financial literacy that allows them to diligently undertake the monitoring and oversight role that is at the heart of good governance.

CUES will offer a similar program on June 26, as a pre-conference workshop in conjunction with CUES Annual Convention.

Lisa Hochgraf is a CUES editor.