State of the Credit Union Update

January 2009

As we begin 2009 I’m reminded of the popular saying, “out with the old and in with the new.” And although there were certainly a lot of positive achievements and beneficial lessons learned during the past year, it was a difficult year financially as we worked to help our members to meet their financial obligations, and to minimize or avoid loan losses to the credit union. We welcome the New Year with enthusiasm and anticipation of the opportunities that lay ahead, as we close the books on one of the most challenging years in our history.

Just as mid-year media headlines wrote of our $42 million loss for the first six months, you may soon read reports of Arizona Federal’s $115 million loss for all of 2008. This result reflects our financial reality as a greater number of our members did not or simply could not make their loan payments. Our net earnings before loan losses in 2008 were $54 million, a $12 million (29%) increase over 2007 results. However, this wasn’t sufficient enough to offset the five-fold increase in loan losses that we experienced. Actual net loan losses were $98 million for the year, with additional losses incurred as a result of making provisions for future loan losses. Read details.

Despite a challenging 2008, we remain standing and serving your needs in 2009, our 73rd year of service. You may continue to be confident in our financial strength as evidenced by our total capital and reserves, current and future earnings, and hopefully your individual commitment and the collective commitment of all members to the not-for-profit financial cooperative known as Arizona Federal. And under the leadership and direction of our Board of Directors, elected by our members, we will take the appropriate and necessary actions to ensure our on-going safety and soundness.

More specifically, as of year-end 2008 we have approximately $170 million in total capital and reserves for loan losses, or nearly 10% of total assets, which closed 2008 at over $1.7 billion. Our loan loss reserve has been funded to historic levels. We continue to have a strong earnings base which provides additional capital each and every day, as a direct result of members’ loyal use of our services. We modified our loan underwriting guidelines throughout 2008 to improve the credit quality of our loan portfolio. And, with the passage of the Emergency Economic Stabilization Act of 2008, your funds are now insured to at least $250,000 (an increase from the prior $100,000 minimum amount) through the National Credit Union Administration (NCUA).

And so it is with great anticipation that we welcome in 2009. We look forward to another year of serving the Arizona community. We look forward to moving through, if not past the current economic challenges and returning to better times.  And most of all, we look forward to continuing to deliver you financial services of value, through convenient points of access, and with the highest levels of superior service. We exist by you, and for you – and we’re committed to ensuring the long-term success of your credit union.

Thank you again for your membership, and for your trust in Arizona Federal. I wish you and yours all the best in 2009.

Sincerely,
Ronald L. Westad
President & CEO

Read more . . . links:
The Perfect Storm
2008 Financial Results -- Detailed
Save My Credit
Why is Arizona Federal Experiencing Loan Loss Levels That Others Are Not?
We Have Invested in You!
Have You Invested in Your Credit Union?
Actions in 2009 to enhance our Safety and Soundness
A Further Look Ahead – Exciting Changes in 2009

For most companies, and the financial industry particularly, 2008 may be best remembered (or perhaps best forgotten) as the year of the perfect economic storm. Business failures, collapses in home values, layoffs, wage loss, increased bankruptcy filings, decreased availability of credit, foreclosures, decline in consumer confidence and many other factors are evidence of the worst recession of our working careers. It was a perfect storm that few, if any, of us saw coming. And even as it began to emerge in 2007, we didn’t initially anticipate the strength and magnitude that its force continues to demonstrate.

The losses experienced in 2008 can be attributed to two primary sources: actual loan losses and provisions for future loan losses. Actual loan losses are simply the sum total of all debt that we were not able to collect. When one of our members is no longer able or willing to make their loan payments, we attempt to collect on the debt for a period of time before we must remove it from our books and consider it a loss (a process known as a “charge-off”). Every month we perform a comprehensive assessment of our loan portfolio to predict the number and dollar amount of future loan losses. When necessary, we transfer income or retained earnings to a loan loss reserve, in anticipation of future losses (a process known as making a “provision”). While the provision is immediately reflected on our income statement as a loss, that money may actually remain in our reserve account for many months. It is not money lost at that moment in time, but rather transferred and designated for a specific purpose.

Additional details of our 2008 financial results are provided below:

• Despite a $115 million loss reflected on our income statement, the reduction in capital in 2008 was $57 million from a previous level of $226 million;
• Although actual net loan losses were $98 million for the year, we took a charge (i.e., provision for loan losses) in 2008 of $170 million for current and future loan losses;
• Charging the $170 million provision for loan losses to our income statement resulted in a reduction in income and net worth, but increased our allowance for loan loss reserve;
• The current allowance for loan loss reserve is adequate to charge-off all loans 31 days or more delinquent;
• Net earnings before loan losses in 2008 were $54 million (a $12 million increase over 2007 results) and is estimated to be at a similar level in 2009;
• Assuming loan losses are at the same level as in 2008 (which we estimate to be a worst-case prediction of the future), we would use $40 million, net, of our $170 million of total capital and reserves leaving us with $130 million in total capital and reserves going into 2010.

 

Our initial reaction was to work with members in an attempt to save their credit records. After all, we exist for the benefit of members, and credit records are a key determinant in employment, housing, insurance, and certainly credit. Now we are working to avoid further loan losses to the credit union to protect those members that continue to honor their commitments. Net loan losses in 2008 were $98 million, compared to $18 million in 2007 – a fivefold increase that we didn’t see coming.

Why didn’t we see it, perhaps you ask?  Keep in mind that every loan made is a bet, so to speak, on the future. It is a prediction of a borrower’s current and future ability and commitment to fulfill their promise and repay their debt obligation. Simply stated, the bet or prediction is a function of the borrower’s current capacity (i.e., wages and earnings), character (i.e., credit history), and to a lesser degree the value of any pledged collateral at the time of the loan. Our bets and predictions were negatively impacted by all of the issues cited above which resulted in the following:

• Certain borrowers’ capacities were reduced due to wage or job loss
• Credit history became less predictive at best and irrelevant at worst as borrowers did not perform similarly as in the past
• In the case of loan default we could not recover monies at similar historical levels due to the decline in home and automobile collateral values.

But it was for unforeseen economic circumstances such as these that we had accumulated capital to a historically high level of $226 million or 12% of assets by the end of 2007.

Throughout the United States and, for that matter, the world, financial institutions are experiencing difficulties.  But not all are.  Why is Arizona Federal experiencing loan loss levels at a greater degree than some other financial institutions, even here in Arizona?  The answer is that other financial institutions operate differently – not better, not worse, just differently.

We have a long, proud history of serving the under-served, and of bringing into our financial cooperative those who might not be given an opportunity elsewhere.  We do this because we see the opportunities and bright futures that they see and we want to assist them in achieving their goals.  This philosophy has worked well, and has paid huge dividends to our membership.  We returned $14 million to members in the forms of loan interest refunds and bonus dividends in 2006 and 2007 and over $23 million in 9 of the last 14 years. Coupled with the expansion of other convenience and value factors, it is clear that we outperformed when conditions were different.  In the current environment, which many analysts continue to describe as a once-in-a-lifetime event, we are, regrettably, underperforming.

While we typically had a higher credit risk profile due to our member demography (Arizona Federal members are typically younger and less affluent when compared to our peers), we did not, and could not, forecast that actual losses would be five times higher than our historical loss rate. We planned for two-times and three-times higher loss rates, but not five times. We certainly made loans to members in an effort to assist many that other lenders would not, but not without consideration of capacity, character, and collateral. Many members we assisted, though, faced unforeseen challenges.

Again, we previously accumulated capital to provide enhanced safety and soundness for unforeseen challenges such as these.

Our primary objective is to serve you, our member. We are a not-for-profit financial cooperative. We have behaved as a credit union by investing in our members. Automobile loans, Credit card loans, and home equity loans comprise 90+% of loans we have made to members – these investments in our members were to help them to achieve a better stead in life. Our purpose, or mission if you will, is to provide access to low-cost financial services.  Just as they did not foresee their inability to repay their debts, we did not either. And while we regret the circumstance of these members, we are committed to ensuring the on-going viability of this cooperative for the benefit of those members that are able to make and keep their commitments.

Consistent with the cooperative credit union model, if you see the value and benefit to having financial options in the marketplace that are not profit-driven, then you will continue to invest in your credit union. We were there when you needed the credit union; will you be there when the credit union needs you? After all, you are not at risk – remember the $250,000 share insurance and that no depositor has ever lost money in a credit union.

Taking into consideration the new realities of our troubled economy, under the direction and leadership of our Board of Directors we are emphasizing our commitment to ensuring the on-going safety and soundness of your credit union. We are taking the following steps in 2009 to enhance our financial safety:

To do good by and for members, we must do well financially. Our emphasis in 2009 will be to improve the credit quality of our loan portfolio, enhance earnings, and reduce expenses. We will continue to serve your financial needs in 2009 from a posture of Trust, Value and Convenience. We will earn your trust by saying what we do and doing what we say, create value by saving you money on our core financial services, and provide convenience through our proprietary branch network, shared branch network, proprietary ATM network, surcharge-free national ATM networks, call center, and Internet (CU Online).

We’re proud of the overall value proposition that we’ve been able to put together for you. We’ve consistently been able to deliver services to you at below-market costs while maintaining above-market dividend rates. Our Members’ Auto Center provides what we believe to be the best auto buying experience possible. And if you’re not certain whether to buy, or what to buy, they can provide you with no-cost consultation, regardless of whether you end up purchasing a vehicle or not. As of January 6, 2009 we launched our Members’ Insurance Center. In a similar fashion, these consultants are available to provide you with free consultation and quotes on many types of insurance including auto, home, life, health, business, and more. We believe you’ll find value in obtaining insurance through the Members’ Insurance Center, but if not – we also believe you’ll receive value simply through the consultation process.

We also remain committed to making the financial services that you trust and value more convenient in 2009. Replacing lost debit cards more quickly is a challenge we’ll solve this year through the addition of “instant issuance” machines – which will debut at four branch locations this spring. For those of you who use CU Online and have always wanted to understand the difference between your balance and your “available balance,” we’ll help to answer that question by displaying your pending transactions within the coming weeks. We’ll also be making updates to our website to make it easier to use, and to increase the value of the content and tools found there throughout the year.