The Ugly, the BadThe Ugly, the Badand the Good…and the Good…Impacting Credit Union Impacting Credit Union Scenarios Scenarios in a Decade of Changein a Decade of Change

Presented at Association of Credit Union Internal Auditors Presented at Association of Credit Union Internal Auditors by:by:

Dennis Dollar, Principal Partner - Dollar Associates, LLCDennis Dollar, Principal Partner - Dollar Associates, LLCAustin, TX – June 16, 2011Austin, TX – June 16, 2011

www.dollarassociates.comwww.dollarassociates.com

THE UGLYTHE UGLYPOSSIBILITIES…POSSIBILITIES…

CORPORATE CREDIT UNION CORPORATE CREDIT UNION FUTUREFUTURE

Complete corporate meltdown could have resulted in Doomsday Scenario for CUs…avoided

Could have depleted NCUSIF and required bailout request with potential untenable ramifications (taxation, regulation change)

Balanced legacy assets plan by NCUA brought clarity and quantified losses, now with strict but flexible supervisory action, reasoned regulation, recovering economy and appropriate timelines can avoid this scenario ever happening again

Natural person credit unions will control what happens with the corporate network

NATURAL PERSON CU NATURAL PERSON CU LOSSES AND IMPACT ON LOSSES AND IMPACT ON

NCUSIFNCUSIF Massive conservatorships, followed by P&A

mergers requiring significant NCUSIF outlays, could bankrupt fund or require untenable premium assessments to restore

Conservatorships without forced merger can balance these costs if credit unions are salvagable

Must salvage salvagable credit unions – remember that a 3% capitalized credit union is a stronger institution than a 3% capitalized bank

INABILITY TO GROW AND INABILITY TO GROW AND REMAIN COMPETITIVEREMAIN COMPETITIVE

Growing regulation restricts income Increasing supervisory action impacts

innovation and investment in members NCUSIF assessments for corporate

stabilization & natural person CU losses remove vital earnings needed to compete

Ability to achieve economies of scale through merger de-railed by unnecessarily tight view of FOM and “in danger of insolvency” interpretation

No industry or economy has ever regulated itself out of a downturn…growth is essential to righting the ship

Summary of Trends by Asset Group(Federally Insured Credit Unions Only)

Asset GroupUnder $10 million

Asset Group $10 million to$100 million

Asset Group $100 million to

$500 million

Asset Group Over $500

million

# of Credit Unions 3,274 3,249 954 329

Total Assets $12.37 billion $112.53 billion

$205.93 billion

$482.61 billion

Net Worth/Total Assets 16.60% 13.04% 11.32% 10.13%

Net Worth Growth 0.70% 2.79% 3.09% 3.99%

Return on Average Assets

0.13% 0.29% 0.27% 0.34%

Loans/Shares 67.42% 71.90% 80.48% 87.35%

Delinquency Ratio 2.50% 1.53% 1.39% 1.30%

Share Growth 4.68% 6.61% 8.12% 8.32%

Loan Growth -3.14% 3.09% 6.74% 8.79%

Asset Growth 3.88% 6.32% 7.97% 8.57%

Membership Growth -0.93% 0.27% 1.93% 4.65%

LOSS OF INDEPENDENT LOSS OF INDEPENDENT REGULATOR/INSURERREGULATOR/INSURER

NCUA under Treasury or Fed becomes driven by banking model approach

Treasury supervision would increase taxation likelihood significantly

Combined with CFPB regulation, the regulatory burden would be geared for banks but paralyzing for CUs (CRA, branching restrictions, FOM restrictions, product approval)

With all of its faults, a credit union specific regulator at the federal level and a healthy dual charter system with states is a franchise issue

TAX EXEMPTION IS LOST OR TAX EXEMPTION IS LOST OR ERODEDERODED

Still the Holy Grail issue for credit unions Budget crisis and federal debt keeps all revenue

sources on the table Obama study group has recommended its

consideration Greater Treasury influence in CU affairs through

corporate and insurance fund issues creates more pressure

Likely would begin with bifurcated taxation structure based upon size

Would bring about the end of credit unions as we know them

Would bring about massive conversion to MSB charter if this charter remains viable because the larger CUs would be most impacted – most able to convert

These Scenarios, These Scenarios, However Unlikely, However Unlikely, are Ugly….Raising are Ugly….Raising

the Question of the Question of Whether they are Whether they are Survivable with Survivable with Credit Unions as Credit Unions as we Know Them??we Know Them??

THE BADTHE BADPOSSIBILITIES…POSSIBILITIES…

THE FALLACY OF TRYING TO THE FALLACY OF TRYING TO REGULATE OUT OF A CRISISREGULATE OUT OF A CRISIS

Effective regulation is needed to help stay out of a crisis and primarily to be prepared for the inevitability of crisis

Excessive regulation has never, in American or world history, initiated a period of economic growth or industry recovery

The stimulation of innovation and growth is essential for recovery – excessive regulation and unnecessary supervisory action can kill those two essential factors for recovery

SUPERVISORY PRESSURESSUPERVISORY PRESSURES Currently, according to a leading publication, over

5200 credit unions (out of 7700 total) are operating under some form of formal supervisory action (DOR, LUA or Cease and Desist)

CAMEL ratings are dramatically lower, with CAMEL 3s, 4s and 5s dramatically up

Many downgrades are justifiable, as are many supervisory actions, in a difficult economic period

Practical impact is that regulators are running over 70% of credit unions, thus making them risk averse and largely unable to innovate or invest without supervisory approval

Supervisory action must, like regulations approved in this environment, be balanced – effective, not excessive

MISSED MARKETPLACE MISSED MARKETPLACE OPPORTUNITIESOPPORTUNITIES

With anti-big bank sentiment at an all-time high and “profit at any cost” Wall Street under high profile scrutiny, not-for-profit financial cooperatives are positioned for best growth opportunity in decades

Best opportunity in our credit union lifetime being hindered by corporate losses, insurance premiums, income hits through regulation and statutory changes and supervisory action proliferation

If credit unions cannot seize the marketplace brass ring when it is available, it is troublesome to imagine when such an opportunity will re-appear

When the fog lifts for credit unions, it lifts for all competitors…this opportunity is historic and loseable.

CFPB OUTLOOKCFPB OUTLOOK Far reaching regulatory has broad

umbrella of “consumer protection” without responsibility for factoring safety and soundness into the regulatory equation

Has examination authority on FIs over $10 billion in assets and can examine below $10 billion if it feels there is a consumer need

NCUA and states will enforce CFPB regulations

Potential areas of focus: overdraft fees, credit card fees, mortgage re-fi fees, ATM surcharges, affirmative action lending, disclosures, notifications, data collection

CRA…LIGHTS, CAMERA, CRA…LIGHTS, CAMERA, ACTIONACTION

NCUA data collection project is the obvious precursor, despite protestations to the contrary…why collect without scoring?

New NCUA FOM rules for community charters will require oversight of business plans for entire community over a three year period

CPFB will agitate and perhaps regulate for scoring system of all FIs on consumer service and protection ratios – all CRA like

Key congressional players are supportive of CRA for credit unions

Banks, while quiet now on issue because of their own vulnerabilities, will join a chorus if a chorus starts

Unnecessary with history, FOM uniqueness, size differential…but a regulatory burden that could come

Biggest concern would be impact of scoring model on branching, waivers, FOM expansions, etc.

LEGISLATIVE OUTLOOKLEGISLATIVE OUTLOOK Could not pass MBL cap increase with small business

focus strong in Congress and unpopular banks getting $30 billion

CURIA was watered down and still couldn’t pass Interchange loss was huge, defeated twice (once on

defense, once on offense) Can probably defeat major losses, taxation and

independent regulator loss Possibility of capital modernization, FOM

enhancements, MBL cap removal, CUSO investment limit increase…all questionable today, but needed

Political pendulums swing…strong industries make them swing (see retailers on interchange issue)

Going to have to be aggressive, willing to take risks and work to build a stronger credit union charter in a tough political environment

MARGIN CHALLENGES No margin, no mission. No mission, no margin. Debit interchange fee income impact – could be

as high as 70% Overdraft income still holding with opt-ins, CFPB

action still possible Spread getting thinner on interest rate products Assessments continue for corporate stabilization

through 2021, NCUSIF assessments possible in 2012-2013 – depending on economy

Supervisory pressures driving towards less risk in lending, thus reduction in loan-to-share ratios

These Scenarios, Regardless These Scenarios, Regardless of How Likely or Unlikely, of How Likely or Unlikely, Will Have an Impact on Will Have an Impact on

Credit Unions…Survivable Credit Unions…Survivable but Quite Costly to Bear??but Quite Costly to Bear??

THE GOODTHE GOODPOSSIBILITIES…POSSIBILITIES…

THE HISTORICAL THE HISTORICAL ASSURANCE OF THE ASSURANCE OF THE

SWINGING PENDULUM SWINGING PENDULUM Too much regulation creates unhealthy balance

sheets, thus forcing a shift back toward more reasoned regulation or the regulator’s job becomes impossible of their own making

Supervision that is beyond that which is required stymies innovation and keeps credit unions from having flexibility to serve members and invest in them

Regulatory and Supervisory pendulums swing…they always do (Callahan to D’Amours, D’Amours to Dollar)

The question is not if it will swing, but when and how will credit unions be positioned when it does

CORPORATE STABILIZATIONCORPORATE STABILIZATION

NCUA legacy assets plan is workable and the best possible outcome in a lose-lose situation

Treasury buy-in to legacy assets plan and extension of repayment until 2021 is very positive

New corporate regulations, through timetables and waivers, can – if implemented flexibly - allow longer periods to increase capital by corporates and for corporates to develop business models, merger scenarios, service parameters, etc.

CAPITAL MODERNIZATION CAPITAL MODERNIZATION CAN HAPPEN IN SOME FORMCAN HAPPEN IN SOME FORM

While legislative solutions seem unlikely in an environment when CUs could not get a simple MBL fix included in a small business tax funded $30 billion banker stimulus, a financial crisis is a great time to push for risk based or even secondary capital buffers to potential taxpayer losses

Regulatory options are not completely off the table…would require creative leadership but current legislative PCA standards could become leverage ratio and risk weighted formula could be incorporated into the supervisory actions taken within PCA. Secondary capital could even be brought into the formula, not undermining the legislative PCA standards but providing something other than “one size fits all” when assessing the level of NWRP required or other potential supervisory actions under PCA – PCA plus, if you will.

Capital modernization is the generational issue of credit unions today. It must be fixed. Leadership at the regulatory and industry level is essential on this linchpin issue.

ECONOMIES OF SCALE ECONOMIES OF SCALE DRIVES EFFICIENCY THRU DRIVES EFFICIENCY THRU

MERGERSMERGERS Mergers have averaged one per business day since

2000 – trend will continue and escalate with current pressures

Economies of scale, particularly with income pressures and impact of premium assessments, will drive more mergers – smaller and larger both

Although distressing to some, the sign of a maturing industry in a challenging time

Predict 5000 credit unions by 2015 NCUA and states will have to remove merger obstacles

or they will face insurance losses by waiting until credit union is on the death bed before allowing transfusion

This pendulum is already swinging and will continue

CUs CAN SEIZE MOMENT TO BECOME LEADING COMMUNITY

FINANCIAL INSTITUTIONS Differentiation opportunities in tough, anti-bank

and non-responsive bank marketplace Fewer community banks after current crisis Build new areas of community oriented product

growth – student lending, credit cards, business services, mortgages, checking account innovation

Shared branching / Nationwide branding 12-07 to 9-10: CU lending up 7.6%, while bank

lending down 6.5% - CUs are meeting a national need

2010 loan losses: consumer loans (1.15% vs 6.42%); mortgages (.64% vs 1.92%); MBL’s (.65% vs 1.83%) – and CUs are doing it smartly

GROWTH OPTIONS AVAILABLE

Checking account growth (average credit union has 42% member penetration rate)

Student Lending gap needs filling Re-tooling of ODP programs structured to

gain more opt-ins Bankruptcy management improvement Credit card growth potential Pre-funding employee benefits FOM expansions for diversification Risk sharing through loan participations CUSO development

Although not assured, Although not assured, there are possible there are possible

victories for the long victories for the long term viability of theterm viability of the

credit union charter… credit union charter…

What are credit unions What are credit unions willing to lay on the line willing to lay on the line to make these possible to make these possible

scenarios happen??scenarios happen??

And how ugly And how ugly could the could the

scenarios be if scenarios be if credit unionscredit unionsdo not make do not make

these these opportunities opportunities

happen??happen??

The Ugly, the BadThe Ugly, the Badand the Good…and the Good…Impacting Credit Impacting Credit Union Scenarios in Union Scenarios in

a Decade of a Decade of ChangeChange

www.dollarassociates.comEmail: ddollar@dollarassociates.comEmail: ddollar@dollarassociates.com