2 Presenter Bob Glynn, CPA Eric Lemke, CPA Audit Director, McGladrey Financial Institutions PracticeContact Information:Eric Lemke, CPAAudit Partner, McGladrey Financial Institutions Practice
3 Who is this presentation for? New committee membersWant to understand what their duties and responsibilities areSeasoned committee membersWant to refresh their understanding and share their experiences
4 What Have I Gotten Myself Into? Regulatory MattersCredit Union OrganizationsSupervisory Committee QualificationsSupervisory Committee ResponsibilitiesAdministration of the CommitteeRed FlagsInformation and ReportingFinancial Monitoring ChecklistResources available
5 Regulatory Matters Federal Credit Union Act Passed in 1934 Purpose of the act was to make credit available and promote thrift through a manual system of non-profit, cooperative credit unions.Act created the Federal Credit Union System.Requirements of a credit unionCommon Bond: Must have a common bond (many battles fought over the definition of a common bond)
6 Regulatory Matters Requirements of a credit union (con’t): Ownership: Credit union is a cooperative association (owned by its members)Capital Structure: Generate capital only through generating and retaining earnings
7 Regulatory Matters Requirements of a credit union (con’t): Administration: Administration of a credit union is vested entirely in the officials elected by the membershipTaxation: Federal credit unions are tax exempt as are most state credit unions
8 Regulatory MattersCurrent Section of NCUA’s rules and regulations states the Supervisory Committee is responsible to determine that:The financial condition of the credit union is accurately presentedThat management practices are sufficient to safeguard assetsThat accounting records are prepared promptly
9 Regulatory MattersThat internal controls are established and effectively maintainedThat plans, policies and control procedures established by the Board of Directors are properly administeredPolicies and control procedures to safeguard against error, carelessness, fraud and self-dealing have been established
10 Regulatory MattersThe annual audit and verification of member accounts are the activities generally used to carry out these responsibilitiesSupervisory Committee Guide for Federal Credit Unions – excellent educational background materials
11 Some Basic Supervisory Committee Regulatory Facts... The supervisory committee consists of between membersAppointment is by the Board of DirectorsFrom the Illinois Credit Union Act:“The board of directors shall appoint from among the members of the credit union, a supervisory committee of not less than 3 members at the organization meeting and within 30 days following each annual meeting of the members for such terms as the bylaws provide. Members of the supervisory committee may, but need not be, on the board of directors, but shall not be officers of the credit union, members of the credit committee, or the credit manager if no credit committee has been appointed.”
12 Opinion Audit on the Financial Statements An opinion audit may only be performed by a licensed CPAResults in a CPA expressing an opinion on the financial statements (statements of financial condition, income comprehensive income, members’ equity and statement of cash flows) and includes footnotes describing the statementsHighest level of audit engagement possible
13 Credit Union Organizations National Credit Union Administration (NCUA)Created by Congress in 1970Major responsibilities:Approve federal chartersSupervise and examine federal chartered and federally insured credit unions
14 Credit Union Organizations NCUA major responsibilities (cont.):Oversee the National Credit Union Share Insurance Fund (NCUSIF)Manage the Central Liquidity Facility
15 Credit Union Organizations Most states also have a regulatory body in charge of state chartered credit unions. Examples include:Illinois:Illinois Department of Financial and Professional Regulation (IDFPR)In addition to the federal and state regulator, state chartered-privately insured credit unions are also bound by the private insurer
16 Credit Union Organizations Credit Union National Association (CUNA)State leaguesCorporate credit unionsCredit Union Service Organizations (CUSO) and Numerous other organizations
17 Supervisory Committee Qualifications Must be a member of the Credit UnionMay also be a member of the Board of DirectorsNo employee of the credit union may be a member of the supervisory committee
18 Supervisory Committee Qualifications Experience in finance, accounting or auditing is helpful, but not required (as of now)Possessing such qualities as inquisitiveness, professional skepticism, good communication skills, willingness to invest time are the primary attributes
19 Supervisory Committee Responsibilities As a practical matter, the role of the supervisory committee consists of the following responsibilities to ensure “Safety and Soundness”:Ensure that the annual audit requirement is fulfilledEnsure that the verification of member accounts is performed when requiredMonitor internal controlsMonitor financial trends and reporting
20 Supervisory Committee Responsibilities The vast majority of credit unions hire an outside firm to conduct the auditUnder current regulation, the annual audit requirement can be satisfied by one of the two following engagements:An opinion audit (can only be done by a CPA) – Assets great than $5 millionAn Supervisory Committee Guide Audit engagement (non-opinion engagement) that can be done by a CPA or any other person – Assets from $3 million to $5 million
21 Supervisory Committee Responsibilities What is an opinion audit?Can only be done by a licensed CPAResults in CPA expressing an opinion on fairness of the credit union’s financial statementsPlaces responsibility on the auditor to follow GAASHighest level audit engagement possible, that demonstrates the credit union’s due diligence in conforming to the audit regulation
22 Supervisory Committee Responsibilities (CPA Audit) Relationship with the independent auditorSelection of the CPA firmUnderstanding the CPA firm’s quality control systemMaking it clear who the CPA firm is working forCommunication with the CPA firmAt the audit planning stage, at the fieldwork completion stage, when the audit reports have been finalized
23 Supervisory Committee Responsibilities (CPA Audit) Questions to ask the CPA firm (SAS 114)What are the significant accounting policies?Did the credit union select the accounting policies that were most appropriate given the options?What about management’s judgments and estimates that play a role in the financial statements? How would you characterize them?Did you have to post any significant audit adjustments?Were there any waived adjustments?Did you have any disagreements with management?
24 Supervisory Committee Responsibilities (CPA Audit) More questions to ask the CPA firmDid you encounter any difficulties in conducting the audit?Are there significant risks that management is not addressing?Meet privately with the independent auditor in conjunction with the final audit reportDecide on how final report is presented to Board of DirectorsConsider the CPA firm as a resource should you need advice on red flags that arise during the course of the yearReview annually all relationships between the CPA firm and the credit union
25 Supervisory Committee Responsibilities (CPA Audit) Evaluate the auditor and audit process before, during and after the financial reports and management letter have been issuedReview the verification of member accounts performed by the CPA firmAscertain that the audit fee is appropriate
26 Supervisory Committee Responsibilities (Other Audits) Relationships with other professionals who perform audit-like functionsReview results of significant regulatory auditsNCUA (or state regulatory agency)ACHBSABonding companyIT audits
27 Supervisory Committee Responsibilities (Internal Audit) Relationship with the internal auditorEstablish open line of communicationDetermine sufficiency of independenceConcur with the annual internal audit plan
28 Supervisory Committee Responsibilities (Internal Audit) Relationship with the internal auditorEvaluate the ongoing objectivity of the internal audit functionEmphasize that the committee wants prompt and thorough analysis of any significant risks that management is not addressingMeet at least quarterly and review the results of internal auditsMeet privately at least once a year with the head of internal audit
29 Credit Union’s System of Internal Controls Definition: A credit union’s organization and system of procedures that provides a reasonable assurance that errors or irregularities will be prevented or detected on a timely basisProvides reliance to:MembershipManagementAuditorsExaminers
30 NCUA Guidance Supervisory Committee Guide Regulatory Alerts Letters to Credit UnionsOther information from the website
31 Question: Who is responsible for the design and execution of the internal control system? A - The Board of DirectorsB - The internal auditorC - The CEOD - The Supervisory CommitteeE - Management
32 Credit Union’s System of Internal Controls The installation and maintenance of the system of internal controls is the responsibility of managementCommon examples of internal controls:Segregation of dutiesCross training/rotation of dutiesCompletion of general ledger account reconciliationsTone at the TopEntity Level controls
34 Supervisory Committee Responsibilities Remember management is responsible for establishing, maintaining & monitoringQuestions to ask management about internal control:What is your assessment of the internal control system and what criteria did you base your assessment on?Talk to us about the “Tone at the Top” and what you do to maintain an uncompromising ethical environmentHas a whistleblower channel been established?
35 Supervisory Committee Responsibilities Questions to ask management about internal control:Were any reported conflicts of interest or irregularities or other violations of the code of conduct identified during the year?Were any significant regulatory compliance issues identified?Are there any significant deficiencies in our accounting systems or personnel that should be addressed?What process is used to ensure the integrity of any new or revised operating or financial systems we have deployed in the current year?
36 Supervisory Committee Responsibilities Questions to ask management about internal control:Have the independent or internal auditors identified major control deficiencies?Is there a specific management-level person designated as responsible for knowing and understanding relevant legal and regulatory requirements?What are the key risks in this area and how are they identified and managed?
37 Supervisory Committee Responsibilities Keep abreast of changes in your credit union:New products and services being offered to membershipChanges in field of membershipImportant issues being discussed by BoardMergers, key personnel changes, new investments, etc.
38 Supervisory Committee Responsibilities Keep abreast of issues impacting other credit unions:Regulatory changesTechnical changesFrauds and scamsWhistle-Blower ProgramAnnual Conflict of Interest
39 What are your boundaries? Attendance at board meetings:While most regulators encourage the attendance of at least one supervisory committee representative at Board of Director meetings, attendance is only permitted at the discretion of the BoardThe Board of Directors must publish minutes, however, and those minutes must be made available to the Supervisory Committee (or its designee) for their review
40 What are your boundaries? You (or your designee) have access to ALL Credit Union records, without exceptionYou are responsible for maintaining strict confidentiality of these recordsYou shouldn’t remove any Credit Union records from the premisesIt is important to build an effective working relationship with the Board of DirectorsRespect your boundariesWork togetherCommunicate effectively
41 Administration of the Supervisory Committee Create a charterGet the right people on the busIndependent, objective & competent oversight is the goalFinancial literacyCollective skills is what is most importantUse outside advisors when necessaryContinuing education is essential
42 Administration of the Supervisory Committee Get the right information at the right timeSet meeting agendasAudit reportsDriven by the internal control assessmentLook at agendas for past 18 months and evaluate their relevanceConduct meetingsMake annual report to the membership
43 Red FlagsThe following are typical situations that give rise to red flags:Complex business arrangements that you can’t understandLast minute transactions that result in improvement in financial performanceFrequent differences between management and the auditorsFailure to enforce the credit union’s code of conduct
44 Red Flags Red flag situations continued: Failure by management to display and communicate an appropriate attitude regarding internal controlHigh turnover of senior managementRapid changes in the industrySharply rising interest ratesUnusually rapid growth or profitability compared to other credit unions
45 Information & Reporting Systems Reports receivedIndependent auditorInternal auditorThird partiesRegulatory examinationBonding companyOutside advisors/consultantsWhistleblower employees and members
46 Information & Reporting Systems Reports received (cont.)Management reports to Supervisory CommitteeInternal control assessmentInternal ethical & integrity issues as they ariseLegal and regulatory issues as they ariseRisk assessment, particularly emerging risksCredit union industry developments & competitive environment
51 The Financial Monitoring Checklist Condition/Observation:Questions/Concerns:Cash – Reduced or lower levels of cash by observing trends and balancesWhy have our cash balances gone down?Does the CU have an adequate level of cash to meet cash requirements?Cash – Increased levels of cashWhy do we have so much cash on hand?Should this money be invested to maximize yield?Investments – Levels or balances have changedWhy has this occurred?Is this a trend or an isolated event?Investments – Regarding the maturity of the investment portfolioWhat is our philosophy regarding the maturity mix of the portfolio?Do we have too much in short-term maturity and are we sacrificing yield by staying so short?Have we gone too far out on the yield curve?
52 The Financial Monitoring Checklist Condition/Observation:Questions/Concerns:Investments – Regarding yieldsWhy is our yield higher than average – are we taking excessive risk?Why is our yield lower than average – are we keeping too much for liquidity purposes?Investments - GeneralIs our portfolio adequately diversified?Real Estate LoansIs our level of real estate mortgage lending appropriate?Is our level of fixed rate mortgage lending too much or not enough?When was the last time we addressed limit parameters on all mortgage loan types?
53 The Financial Monitoring Checklist Condition/Observation:Questions/Concerns:Loans – Any portfolio that grows rapidlyWhy is it happening and have we done an extensive evaluation of the reasons?Are our rates and terms overly favorable?Have we lessened our underwriting standards?Have we had this loan area audited to make sure all internal controls are in place and working?When loans quickly increase, the allowance for loan losses should also increase – has it? (Often loan growth outruns the associated losses, since loss ratios are based on historical data)Any new staff? Have they been vetted?
54 The Financial Monitoring Checklist Condition/Observation:Questions/Concerns:Delinquencies & Charge-Offs – Increasing ratiosWhy are delinquencies and/or charge-offs increasing?If only delinquencies are increasing – why aren’t charge-offs also increasing?If there are loans over 6 months delinquent – ask why they haven’t been charged-off/Is this an indication of relaxed underwriting standards?Do we have necessary staffing in collections to handle the added collection burden?Is the allowance for loan losses properly valued given these higher levels of delinquency and charge-offs?Provision for Loan LossesThe provision for loan losses is primarily derived by the monthly/quarterly allowance for loan loss adequacy analysis and therefore the monthly expense should not be consistent – sometimes significantly. If the monthly provision amount is the same amount, it may indicate a “smoothing of expense” – ask about this.Collateral in ProcessFind out the details.Do we have any other loans at risk for this?
55 The Financial Monitoring Checklist Condition/Observation:Questions/Concerns:Borrowings/Interest on Borrowed MoneyDoes the credit union have a planned strategy for borrowings?If not, why did we have the borrow funds? Do we have cash flow problems?Shares/DividendsIf growth is occurring in excess of the normWhy?Are we paying above market rates for shares – if so why?If growth is below average:Why? Is this ok?Do we offer all share types we should?What is our strategy for share growth?
56 The Financial Monitoring Checklist Condition/Observation:Questions/Concerns:Net WorthWhy has it changed?Do we have enough capital or too much/little?Question the trend and make sure it conforms to your credit union’s strategic planIncome/ExpensesAsk about all trends and variances. Variances are normal and should be expected, especially in accounts affected by outside forces (i.e. loan income, investment income, dividends, loan losses, etc.)
57 The Financial Monitoring Checklist Condition/Observation:Questions/Concerns:Sale of Assets (Investments or Office Property) for Gains/LossesWhy was the sale made?Was the sale made to improve the bottom line or capital? If so, these motives need to be investigated to make sure the sale was ultimately in the best interests of the credit unionMake sure the impact of the sale to the bottom line is notated, so you can see the true results from operations exclusive of the saleOne Time/Unique TransactionsWhy did it occur? Dig deep into the reasons
58 References/Resources Federal Credit Union Act/ Bylaws, Rules and Regulations (www.ncua.gov)Supervisory Committee Guide (www.ncua.gov)Conferences with Regulator and External AuditorTrade association meetings (state and national associations)Trade literatureTraining classes (such as this)Various credit union publications & periodicals
59 Thanks for your participation! Wrap UpThanks for your participation!Contact InformationBob Glynn(312)