How to Tiptoe (Rather Than Stumble) into Member Business Services

1. How to Tiptoe (Rather Than Stumble) into Member Business Services Jeff Stone EVP, Member Business Services North Island Credit Union jstone@myisland.com

2. What is a Board of Directors to Do? • Management wants to pursue Member Business Lending (MBL) and Deposit Services • How should the Board of Directors respond and what kind of due diligence and preparation should they be looking for??? • In short, what questions should you be asking?

3. Does Management Have a Business Plan? Have they determined what your credit union will do with the MBL Product? • Buy Loans Only (In-Participations) • Originate Commercial Real Estate Loans Only -- OR • Build a Full Member Business Services Infrastructure (including deposits)—and if so, have they identified a niche to serve?

4. Early on Board Education • Do you have Enough Information to: • Understand the Paradigm Shift from Consumer Lending? • Understand the Risks of these New Products? • Determine if your Credit Union has the Resources to pull off the plan over the next 2-4 years? • Decide: is the right move in today’s Economic Conditions? • Has Management Explained the Details and Sought out Your Input? • Have you Determined the Level and Process for Ongoing Board Oversight and Involvement? • Bottom Line: Do you “Buy In” to the Concept?

5. Policies • MBL Policy must be in place Before you do or buy your first loan • Must Conform to the Requirements of 12 CFR Section 723.6 • Should Quantify your Potential Exposure in Terms of Percentage of Net Worth • If your Credit Union will buy and/or sell Loan Participations, the NCUA also requires that you have a Separate Participation Policy • Policies vs Procedures • The NCUA has recently indicated that Procedures should also be approved by the Board

6. Continuous Monitoring via: • Policy vs. Regulatory Loan to One Borrower (LTOB) Limits • The Board may wish to set an Internal Policy Limit that is Lower than your Regulatory Limit (15% of Net Worth) • All Policy Exceptions should require Board Approval Prior to Loan Funding • Quarterly Reports on All Aspects of the Program • Especially on relationship to MBL CAP and • Procedural Exceptions

7. Which Road to Take? • What steps should your Credit Union take to get to the planned objective? • This Presentation will use North Island as an Example • Because we lingered at many of the possible stopping points as we wandered down our Road • Also, there are several CUSOs that have been created to assist you in this process

8. The North Island Approach: What We Will Cover • Why Do Member Business Services? • The How and What of North Island’s Program • Risk Mitigation and Board Oversight Tools

9. Why North Island Went Down this Road Why North Island Went Down this Road

10. Member Business Lending:The Starting Point • ALCO Asset Diversification Strategy • Enhanced Profitability—Alternative “Investment” Strategy—but these are all Loans and not Investments • A Means to Build Core Deposits

11. Asset Diversification • New Loan Types • Commercial Real Estate (CRE) Loans—to Start • SBA 504 Loans • Secured & Unsecured Lines of Credit • Equipment & Auto Term Loans • SBA 7a and State Government Guaranteed Loans

12. Portfolio Yield • 4-5 years ago CRE Loan yields were 200 bps over the portfolio average • Its still over average, even with the current tighter margins and intense competition, but now the bump is down to 60 bps • However, Loan Fees and Servicing Income add greatly to total income

13. Ability to Attract Low Cost Deposits • Conversion to a Community Charter Helps • Bank Consolidations = CU Opportunities • Displaced Bankers Are Source of Experienced Staff • CU Service Levels Get Results • Can Outsource other Fee Driven Services

14. How WeGot Started: The Gradual Approach

15. The Progression • Six Month Due Diligence Process • Built Portfolio & Infrastructure by Buying Loan Participations • Established Wholesale Lending Pipeline by Establishing Broker Network • Managed the CAP by Selling Participations • Created Relationships (and Core Deposits) with Direct Lending through Branches

16. The Due Diligence Process Spent 6 Months on a Consulting Contract to Determine Feasibility • Market Niche Created by Bank Mergers • Focus Groups to Ask Existing Business Like Members and Previous Clients what they Valued Most. • Step by Step Plan to Create Products & Services • Cost Analysis

17. Loan Participation Purchases Low Cost of Entry into a New Line of Business: • No Need to Hire Staff at the Outset • Due Diligence Can Be Performed by: • A Consultant OR Another Credit Union/CUSO with the Required Expertise • Your Credit Union Has to Make Final Decision on All Loans • Loans Typically will Fit on Your Existing Real Estate System

18. Loan Participation Sales • Provide Full Service to Members • Acts as a Tool to Deal with LTOB Limitations • Mitigates Impact of MBL CAP • 156% Without Participations • Increases Loan Yield • Prepayment Penalties and Servicing Fees

19. Accounting Benefits of Loan Participations Sales • The Fee Income Associated with the Sold Portion Goes to the Bottom Line • The Remainder Needs to be Amortized • Seller Collects a Servicing Fee • The Servicing Fee is Capitalized—It Too Goes to the Bottom Line • The Expense is then Amortized over the Expected Life of the Loan • Prepayment Exposure—Primary Reason for Penalties

20. What Came Next?

21. The Jump to Business Services Two Approaches—Depends on Your Market & Comfort Level —Prepare a Business Plan and Choose: • Add Services as Members Request Them • Limited Suite of Products • Like North Island—Move Quickly to Full Product Line • Requires Willingness to Make Expenditures for: • Experienced Staff • Powerful Host System—with Open Architecture, or • Bolt On Middleware

22. Our “Lucky” Breaks • Changed Charters to Community • Businesses themselves could now join • Host System Conversion • Old Legacy System was going out of service • New system handles both consumer and business transactions • Costly—but the income from several years of CRE Loan production helped pay the way • Bank Mergers made Staff Available

23. Infrastructure Overview

24. Branch Staff’s Role • Training a Must • We Have Our Own Six Week Omega Based MBS Training Program for Branch Managers and others • Incentives and Sales Culture • New Accounts Training • Internal Website Provides the Tools

25. Branches • Business Deposits • Basic, Classic and Analyzed Checking • Savings, Money Market & CDs • Loans • Overdraft Lines of Credit Approved at Branch Through Credit Scoring • Fed Tax Deposits

26. Branches with Business Services’ Support • Deposit Services • Business On-line Banking • ACH Origination • Sweep (on balance sheet) • Zero Balance Accounts • What did you say??? • Business Loans • Business Auto Loans • Unsecured LOC’s • Business Debit Cards

27. Through Business Services • Business Loans • Commercial Real Estate Loans • (Wholesale/ Direct and Participations) • Secured & Unsecured Lines • Government Guaranteed Loans

28. Through Vendors • Payroll • Merchant Credit Card • Business Credit Cards • Courier & Armored Car • Lockbox • Processing of payments from our Members’ customers • Equipment Leasing • Letters of Credit • Insurance & Investment Services • - Referred to Investment Dept (former CUSO)

29. Vendor Due Diligence • Several of the Vendors were known to us from our Previous Lives • Others We Checked Out via References and Test Cases • On others, we used Multiple Vendors • And in one case (Letters of Credit) we use a Statewide Bank • Regulators want the credit union to know who they are dealing with

30. Insurance & Investment Services Dept. Cross Sales • Employee Benefits • 401K and Pension • Cafeteria • Group Insurance • Medical • Term Life • Auto Insurance • Long-Term Care • Educational Workshops

31. Web Based Components • www.MyIsland.com - Public • www.MyIsland.com/brokers Public • www.MyIsland.com/partners –Public • Islandnet – Corporate Intranet

32. myisland.com (Consumer)

33. myisland.com (Business)

34. myisland/brokers

35. myisland/partners

36. Corporate Intranet

37. Intranet cont’d

38. Phase III Introductions • Phase III Introductions • Account Analysis Enhancements • Off Balance Sheet Sweep (future) • Positive Pay (on the way) • Third Party CD’s (done) • Remote Deposit Capture (this year)

39. Other Considerations

40. Staffing—The Relationship Managers • Former Bankers • Business Bankers from a Community Bank • Easier Fit in Credit Union Culture • Plus Usually Well Rounded • Often More Costly than Consumer Lenders • Becoming Harder to Find • Especially with Required Experience—7 to 10 years • Bank Mergers often make talent available • Training/Succession • Marketing Support

41. Underwriting • More Intensive than Consumer Loans • Financial Statement Analysis • How the Business is performing in relationship to its Peers and your Underwriting Requirements • Tax Analysis • Evaluating the Business Owner’s Tax Returns is quite Important—since most of us are Lending to Small Businesses with One or Two Owners • In other words, the financial capacity of the Business and its Owners are linked together

42. Credit Scoring • Cost of System vs. Credit Analyst • Determine Maximum Loan Size to Credit Score • Determine Loss Tolerance—especially in current economy • Look for Single Data Entry Capabilities • Can It Interface with Doc Prep and Host?

43. Loan Documentation • Look for Recognized System • Multiple options available • Again—Be aware of systems ability to interface with existing programs!!

44. Appropriate Controls

45. Quality Control Audit Need Independent Person Reviewing New Loan Files Ours comes in once a month Selects a Sampling of loans to review Does a Comprehensive Report on both technical issues and credit quality Report sent to EVP Risk Management Copy to Business Services Dept. Head for a Response

46. Annual Loan Reviews • Commercial Real Estate Loans • Annually we Inspect the Properties for Each Participated Loan • We Obtain Updated Rent Rolls and P&L Statements on the Property • We run a Negative Screen Credit Report on the Principals • We request Full Financials if Screen Reveals any Issues or Covenant Violations • Business Loans • Site Visits, Covenant Tracking and Financial Updates on Business Loans

47. Asset Quality Monitoring • Monthly, Our Credit Administrator prepares a Report to our EVP Risk Administration, who is in charge of the Loan Loss Allocation, regarding the Status (and Workout Progress) of all our Classified Member Business Loans • Stay on top of Problem Loans!!!!!

48. Quarterly Board Reporting

49. What We Report • Year To Date Production Results • Loans • Deposits • Fee Income • Commitments over $3MM with Procedural Exceptions • Attach Both the Exception and Mitigant Discussion from the Loan Memo • Delinquent Loan Status

50. What We Report—cont. • The Concentration Reports • The CRE Portfolio Breakdowns • The NAICS Code Breakdown • The Stress Test Results • Industry Trends • Our Evaluation of What is Happening in Our Market—Price Wars, CAP Rates, etc. • Articles on the Status of the Market for the Various Property Types