An Understanding of a Credit Union Net Worth Restoration Plan

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Due to recent declines in the equity markets, some credit unions may experience an increased flow of funds coming into their organization at a time of weak loan demand and low investment returns. This “flight-to-safety” for some credit unions could result in the need to submit a “Net Worth Restoration Plan”.

The Net Worth Restoration Plan commonly referred to as NWRP serves as a blueprint for the board and management to restore and maintain for four consecutive quarters the credit union’s net worth ratio to 6% or greater and to establish a financial framework for the 1/10th percent (0.1%) quarterly earnings waivers transfers.

Understanding the implications of the credit union having an inadequate level of net worth is important.  Your primary goal should be safeguarding the member’s deposits through sound policies and practices, and by creating and sustaining a sufficient amount of net worth and reserves to absorb possible losses without endangering the stability of the credit union.

Your plan needs to meet the criteria set forth in NCUA Rules and Regulations 702.206-NWRP including: More

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Allowance for Loan Loss

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The ALL estimate is guided by NCUA Rules and Regulations and Generally Accepted Accounting Principles (GAAP). The following resources were considered in the creation of this article:

  1. FASB ASC Topic 450: Accounting for Contingencies [formerly FAS 5];
  2. FASB ASC Topic 310: Accounting for Receivables [formerly FAS 114];
  3. NCUA Interpretive Ruling and Policy Statement 02-3: ALLL Methodologies and Documentation for Federally Insured Credit Unions;
  4. NCUA Letter to Credit Unions 03-CU-01: Loan Charge-off Guidance; and
  5. NCUA Accounting Bulletin No. 06-01

Because of the newly implemented ASC, it maybe difficult, especially for those, like myself, who are familiar with the original FASB standards, to identify the most current accounting reference materials.

There are two primary topics under the ASC that address the ALL. Key concepts extracted from Topics 450 and 310 of the ASC are summarized below.

  1. Topic 450, Subtopic 20, “Loss Contingencies,” addresses accounting for loss contingencies. Much of this topic is derived from Statement of Financial Accounting Standards (SFAS) Statement 5, “Accounting for Contingencies.  Topic 450 specifically references Topic 310, noting that the ALL is a subset of loss contingencies.
  2. Topic 310, “Receivables,” addresses various issues related to accounting issues subsequent to the origination or acquisition of receivables, such as impairment. Former accounting standards SFAS 5, SFAS 15, and SFAS 114 provide much of the content for this section.

Subjective and Imprecise

The appropriate degree of allowance involves a high degree of “management judgment” within a “range of estimated losses.”  Moreover, determining the allowance for loan and lease loss, hereafter referred to ALL is “subjective and imprecise.”  ALL estimates are based on a comprehensive, well documented and consistently applied analysis of the credit union’s loan portfolio.

ALL takes into consideration available information as of the financial statement date including environmental factors. The ALL provides an estimate of probable but unconfirmed losses in the loan portfolio as of the financial statement date; it is not a reserve for future anticipated losses.    The use of environmental factors may likely cause estimated credit losses associated with the credit union’s existing loan portfolio to differ from the historical loss experience.  Your analysis should consider significant factors affecting the collectibility of the portfolio and attempts to support the credit losses estimated by the ALL process. A credit union should adopt methodologies and documentation practices that are appropriate for their size and complexity.  Credit unions with fewer and less complex loan products, the amount of supporting documentation for the ALL may be less exhaustive than for credit unions with more complex loan products or portfolios. Your methodology and documentation needed to support the ALL estimates should be prepared in accordance with generally accepted accounting principles (GAAP).  The Statement of Financial Accounting Standard (FAS) 5 will be most relevant to the majority of credit unions. Finally, understanding the theory, building strong policies and analytics, and increasing director governance are key to a successful ALL outcomes. More

Effects of the Economy on Credit Unions

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An operating environment resulting from slow growth in the economy, low interest rates, and nagging unemployment has from a macro-perspective produced an outcome of rapid savings growth, slow loan growth, and a steep yield curve.

We have seen:

  • Declining yield on assets due to lower interest rates plus the asset distribution shifting to lower-rate investments and maturing loans being replaced with low rate loans;
  • Declining cost of funds due to lower dividend rates plus the distribution of savings shifting to low-cost savings products;
  • Indeterminate net interest margin due to cost of funds falling faster than yield on assets if dividend rates are aggressively lowered.  However, if loan growth is very weak and savings growth very strong, yield on assets may fall faster than cost of funds;
  • Rising provisions for loan loss due to higher bankruptcies and charge-offs reflecting employment trends;
  • Lower operating expense to average asset ratio due to rapid savings growth increasing assets faster than the growth in operating expenses;
  • Higher fee income due to non-sufficient funds and late payments.
  • Return on assets will be flat to marginally lower; and
  • Capital-to-assets will be flat to marginally higher.

Things to consider in maintaining net income when interest rates are very low are listed below:

  • Avoid extending investment maturities significantly;
  • Limit additions to the fixed rate mortgage portfolio;
  • Don’t overreact by slashing operating expenses; and
  • Adjust rate paid on member savings downward.

Some factors to consider with respect to falling net worth ratios are as follows:

  • Members are seeking a safe place to store their financial assets (asset growth has been strong);
  • If rates paid on savings are not hyper-competitive, this savings growth can be healthy.

This blog entry you have just read was written by Edward Lis who is a former senior executive of three different credit unions. If you enjoyed this article I encourage you to learn more about Edward by visiting www.edwardlis.com or by calling 518-420-2108.

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Credit Union Mergers

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Back in the late 1970s there were approximately 20,000 federally insured credit unions in the US.  Fast forward to today and the number is down to less than 7,700 credit unions.

Our industry faces many challenges moving forward in the form of rising competition, new imposed regulations, as well as the long-term corporate stabilization and special NCUSIF premiums, a decrease in loan origination, increase deposit growth, low yielding investments prospects, and tighter margins. Collectively, these challenges have tempered growth opportunities for many credit unions.  Many are looking to the prospect of mergers as a means of building asset size, adding members, increasing net worth and/or expanding market share.  Mergers enable credit unions to increase their geographical footprint, enhance their technological capabilities, build their branch infrastructure or solve human resource challenges such as management succession issues.

Whether your the acquiring (acquirer) credit union or the one being acquired (acquiree) having a well-respected and knowledgeable credit union advocate and leader to assist in evaluating and acting upon one of the most important transactions that a credit union may consider-a merger with another credit union- is in the best interests of the credit union membership.  A merger has a life of its own; it contains a cycle from inception through “closing the deal” and the actual merging of the credit unions.

A merger can also be a tremendously emotional experience for volunteers, employees and members of a credit union.

Clearly, if considering a merger one may need to balance a number of competing interests as you begin the journey and undertake in determining whether to proceed with a merger opportunity.

I can assist the existing management and board in the determining the future of the credit union. If a decision to merge is made retaining outside assistance is highly recommended as this person can further provide guidance during the steps in the “life cycle” that the organization may encounter through the merger process and to raise pertinent legal, regulatory, accounting, and business issues that you may wish to consider in your credit union’s journey through the merger process.

This blog entry you have just read was written by Edward Lis who is a former senior executive of three different credit unions. If you enjoyed this article I encourage you to learn more about Edward by visiting www.edwardlis.com or by calling 518-420-2108.

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