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

1. The Ugly, the Badand the Good…Impacting Credit Union Scenarios in a Decade of Change Presented at Association of Credit Union Internal Auditors by: Dennis Dollar, Principal Partner - Dollar Associates, LLC Austin, TX – June 16, 2011 www.dollarassociates.com

2. THE UGLYPOSSIBILITIES…

3. 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 CORPORATE CREDIT UNION FUTURE

4. 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 NATURAL PERSON CU LOSSES AND IMPACT ON NCUSIF

5. 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 INABILITY TO GROW AND REMAIN COMPETITIVE

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

7. 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 LOSS OF INDEPENDENT REGULATOR/INSURER

8. 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 TAX EXEMPTION IS LOST OR ERODED

9. These Scenarios, However Unlikely, are Ugly….Raising the Question of Whether they are Survivable with Credit Unions as we Know Them??

10. THE BADPOSSIBILITIES…

11. 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 THE FALLACY OF TRYING TO REGULATE OUT OF A CRISIS

12. 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 SUPERVISORY PRESSURES

13. 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. MISSED MARKETPLACE OPPORTUNITIES

14. CFPB 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

15. 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. CRA…LIGHTS, CAMERA, ACTION

16. 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 LEGISLATIVE OUTLOOK

17. 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

18. These Scenarios, Regardless of How Likely or Unlikely, Will Have an Impact on Credit Unions…Survivable but Quite Costly to Bear??

19. THE GOODPOSSIBILITIES…

20. 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 THE HISTORICAL ASSURANCE OF THE SWINGING PENDULUM

21. 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. CORPORATE STABILIZATION

22. 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. CAPITAL MODERNIZATION CAN HAPPEN IN SOME FORM

23. 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 ECONOMIES OF SCALE DRIVES EFFICIENCY THRU MERGERS

24. 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

25. 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

26. Although not assured, there are possible victories for the long term viability of the credit union charter…What are credit unions willing to lay on the line to make these possible scenarios happen??

27. And how ugly could the scenarios be if credit unionsdo not make these opportunities happen??

28. The Ugly, the Badand the Good…Impacting Credit Union Scenarios in a Decade of Change www.dollarassociates.com Email: ddollar@dollarassociates.com