PEARLS MONITORING SYSTEM

WORLD COUNCIL OF CREDIT UNIONS TOOLKIT SERIES Number 4 PEARLS MONITORING SYSTEM by: Dvid C. Richrdson World Council of Credit Unions October 2002 2001 The World Council of Credit Unions The World Council of Credit Unions Toolkit Series presents the tools nd methodologies developed in the field of credit union development crried out through World Council of Credit Unions ctivities. For further informtion on this series plese contct: World Council Informtion Center P.O. Box 2982 Mdison, Wisconsin 53701-2982 USA

PEARLS Monitoring System EXECUTIVE SUMMARY Mny different finncil rtios nd rules of thumb hve been promoted for finncil institutions worldwide, but few hve been consolidted into n evlution progrm tht is cpble of mesuring both the individul components nd the system s whole. Since 1990, the World Council of Credit Unions, Inc. hs been using set of finncil rtios known s PEARLS. Ech letter of the word PEARLS mesures key res of CU opertions: Protection, Effective finncil structure, Asset qulity, Rtes of return nd cost, Liquidity nd Signs of growth. The use of the PEARLS evlution system ccomplishes the following objectives: A. OBJECTIVES 1. Executive Mngement Tool Monitoring the performnce of the credit union is the most importnt use of the PEARLS system. It is designed s mngement tool tht goes beyond the simple identifiction of problems. It helps mngers find meningful solutions to serious institutionl deficiencies. For exmple, the PEARLS system is cpble of identifying credit union with wek cpitl bse, nd cn lso identify the probble cuses (e.g., insufficient gross income, excessive operting expenses, or high delinquency losses). Use of the system permits mngers to quickly nd ccurtely pinpoint troubled res, nd to mke the necessry djustments before problems become serious. In essence, PEARLS is n "erly wrning system" tht genertes invluble mngement informtion. 2. Stndrdized Evlution Rtios nd Formuls The use of stndrdized finncil rtios nd formuls elimintes the diverse criteri used by credit unions to evlute their opertions. It lso cretes universl finncil lnguge tht everyone cn spek nd understnd. One result cn be enhnced communiction tht fcilittes greter understnding of the min concepts long with commitment to chieve greter uniformity in the qulity nd strength of ech individul credit union, by improving deficient opertionl res. PEARLS MONITORING SYSTEM PAGE 1

3. Objective, Comprtive Rnkings The combined use of the stndrdized ccounting system nd the PEARLS performnce indictors produces completely new type of informtion: comprtive credit union rnkings. Historiclly, it ws impossible to compre one credit union with nother due to the diverse criteri nd reporting formts tht existed. The stndrdiztion of finncil informtion elimintes the diversity nd provides n effective tool for compring credit union performnce on ntionl bsis. One prticulrly importnt spect of the PEARLS comprtive rnkings is its objectivity. No qulittive or subjective indictors re included in the rnkings. This differs from the U.S. CAMEL system tht gives mngement numericl rting bsed upon the exminer's overll subjective judgment. By voiding subjective ssessments, it is possible to present objective reports to the credit unions tht re substntited by finncil informtion tken from their blnce sheets. The objective rnking system permits open discussion of problems with Bords of Directors nd mngement. It is prticulrly useful in situtions where credit union is t the bottom of the rnking scle. No time is lost debting different points of view, nd ledership cn become more focused in seeking solutions to the problems ffecting their institutions. 4. Fcilitte Supervisory Control In ddition to its usefulness s mngement tool, the PEARLS system provides the frmework for supervisory unit t the Ntionl Federtion. Ntionl Associtions cn use the finncil rtios generted by PEARLS to conduct qurterly or monthly nlyses of ll key res of credit union opertions. These evlutions re invluble for spotting trends nd detecting res of concern mong the ffilites. With the stndrdiztion of the key finncil rtios, ll interested prties re looking t the sme thing--wht is importnt to the exminer is lso importnt to the credit union mnger. The introduction of the PEARLS evlution system cn chnge the role of Ntionl Assocition exminers to tht of verifying the finncil informtion used in clculting the rtios. If errors re found, they re reltively esy to correct nd often provide mngement with further insight to their opertions. The Federtion exminers should ply key role in preserving the credibility of the finncil informtion nd rtios reported by the credit unions. B. PEARLS VS. CAMEL The PEARLS system cn be dpted to the specific needs of mture or emerging Credit Union Movements. An erly ttempt ws mde to dpt the U.S. CAMEL rnking system to credit unions by the World Council of Credit Unions, Inc., but too mny modifictions were needed. PEARLS MONITORING SYSTEM PAGE 2

In prticulr, the CAMEL system possessed two mjor deficiencies tht limited its effectiveness: 1. The CAMEL system does not evlute the finncil structure of the blnce sheet. This ws criticl re of concern in mny countries since moderniztion implies mjor restructuring of credit union ssets, libilities nd cpitl. Blnce sheet structure hs direct impct on efficiency nd profitbility. These res re criticlly importnt for effective nd sustinble credit union opertions in competitive environment. 2. CAMEL does not consider growth rtes. In mny countries, growth of totl ssets is key strtegy used to ddress the problems tht ccompny monetry devlutions nd runwy infltion. In reltively hostile mcro-economic environment, the credit unions hve to sustin ggressive growth if they re to preserve the vlue of their ssets. The filure of the CAMEL system to evlute finncil structure nd growth is indictive of its current ppliction in the United Sttes. CAMEL ws creted s supervisory tool, not mngement tool. The min concern of the CAMEL rtios is to protect the solvency of the institution nd the sfety of member deposits. It is not designed s tool for the nlysis of ll key res of credit union opertions. C. COMPONENTS OF PEARLS The PEARLS system is uniquely different. It ws first designed s mngement tool, nd lter becme n effective supervisory mechnism. Ech letter of the nme "PEARLS" looks t different, but criticl spect of the credit union: 1. P = Protection Adequte protection of ssets is bsic tenet of the new credit union model. Protection is mesured by 1) compring the dequcy of the llownces for lon losses ginst the mount of delinquent lons nd 2) compring the llownces for investment losses with the totl mount of non-regulted investments. Protection ginst lon losses is deemed dequte if credit union hs sufficient provisions to cover 100% of ll lons delinquent for more thn 12 months, nd 35% of ll lons delinquent for 1-12 months. Indequte lon loss protection produces two undesirble results: inflted sset vlues nd fictitious ernings. Most credit unions re not nxious to recognize lon losses, nd much less, to chrge them off ginst ernings. Tht unwillingness leds to widespred buse of the principles of sfety nd soundness. Reported net income is overstted, sset vlues re inflted, provisions for lon losses re indequte, nd member svings re not dequtely protected. Mny credit unions re not concerned bout the indequcy of their llownces for lon losses since they view their cpitl reserves s the primry source of protection ginst lon losses. This erroneous ide is grdully chnging s mngement becomes PEARLS MONITORING SYSTEM PAGE 3

convinced tht it is much esier nd less pinful to use the llownces for lon losses s the primry source of protection, rther thn hving to get pprovl from the membership to diminish cpitl reserves becuse of losses. The World Council of Credit Unions, Inc. promotes the principle tht the llownce for lon losses is the first line of defense ginst non-performing lons. The PEARLS system evlutes the dequcy of protection fforded to the credit union by compring the llownce for lon losses to lon delinquency. 2. E = Effective Finncil Structure The finncil structure of the credit union is the single most importnt fctor in determining growth potentil, ernings cpcity, nd overll finncil strength. The PEARLS system mesures ssets, libilities nd cpitl, nd recommends n "idel" structure for credit unions. The following idel trgets re promoted: Assets * 95% productive ssets composed of lons (70-80%), nd liquid investments (10-20%) * 5% unproductive ssets composed of primrily fixed ssets (lnd, buildings, equipment etc.) Credit unions re encourged to mximize productive ssets s the mens to chieve sufficient ernings. Since the lon portfolio is the most profitble sset of the credit union, the World Council of Credit Unions, Inc. recommends mintining 70-80% of totl ssets in the lon portfolio. Excess liquidity is discourged becuse the mrgins on liquid investments (e.g., svings ccounts) re significntly lower thn those erned on the lon portfolio. Non-Erning ssets re lso discourged becuse once purchsed, they re often difficult to liquidte. The only effective wy to mintin the idel blnce between productive nd unproductive ssets is by incresing the volume of productive ssets. Libilities * 70-80% member deposit svings A helthy percentge of deposit svings indictes tht the credit union hs developed effective mrketing progrms nd is well on its wy to chieving finncil independence It lso indictes tht members re no longer "sving" in order to borrow money, but re insted sving becuse of the competitive rtes offered. PEARLS MONITORING SYSTEM PAGE 4

Cpitl * 10-20% member shre cpitl * 10% institutionl cpitl (undivided reserves) Under the new cpitliztion system, member shres re de-emphsized nd replced with institutionl cpitl. This cpitl hs three purposes:. Finnce Non-Erning Assets Since the institutionl cpitl hs no explicit interest cost, its primry function is to finnce ll non-income generting ssets of the credit union (i.e., lnd, buildings nd equipment). If sufficient cpitl is unvilble, the credit union is forced to use more expensive deposit svings or member shres to finnce the difference. Even though this mkes little sense, the prctice is still widespred. b. Improve Ernings Institutionl cpitl lso hs powerful effect on the credit union's cpcity to generte net income nd hence, dditionl cpitl. With no explicit interest cost, cpitl tht is lent out t mrket interest rtes provided 100% return to the credit union. The use of this institutionl cpitl to finnce productive ssets (e.g., lons) is very profitble for the credit union. Institutionl cpitl cn be generted much fster thn by relying only on the slim mrgins from deposit svings. For credit unions with wek cpitl bse, the process is much slower, since the cpcity to generte sufficient cpitl is linked to the cpcity to retin cpitl. c. Absorb Losses As lst resort, institutionl cpitl is used to bsorb losses from lon delinquency nd/or opertionl deficits. In mny countries, the lw requires tht ny reduction in institutionl cpitl from losses must be pproved by the Generl Assembly. This cn be pinful nd oftentimes, ftl experience for credit union mngement. Consequently, it mkes much more sense to crete dequte lon loss provisions in order to eliminte non-performing ssets. The PEARLS mesurement of institutionl cpitl is key rtio tht is linked to number of other opertionl res. If deficient, it cn quickly signl where potentil weknesses might exist in other res of the opertion. PEARLS MONITORING SYSTEM PAGE 5

3. A = Assets Qulity A non-productive or non-erning sset is one tht does not generte income. An excess of non-erning ssets ffects credit union ernings in negtive wy. The following PEARLS indictors re used to identify the impct of non-erning ssets:. Delinquency Rtio Of ll the PEARLS rtios, the delinquency rtio is the most importnt mesurement of institutionl wekness. If delinquency is high, it usully ffects ll other key res of credit union opertions. By using the PEARLS formul to ccurtely mesure delinquency, credit unions re properly informed of the severity of the sitution before crisis develops. The idel gol is to mintin the delinquency rte below 5% of totl lons outstnding. b. Percentge of Non-Erning Assets A second key rtio is the percentge of non-erning ssets owned by the credit union. The higher the rtio, the more difficult it is to generte sufficient ernings. The gol lso limits non-erning ssets to mximum of 5% of the totl credit union ssets. Where credit unions re in dire need of improving their poor physicl imge, the non-erning sset rtio cn increse in the short run. An improved imge is more importnt to the success of ggressive mrketing progrms thn it is to keep rtio within its limits. As new members join nd deposit their svings with the credit union, the non-erning sset rtio begins to decrese s result of incresed public confidence. c. Finncing of Non-Erning Assets While reducing the percentge of non-erning ssets is importnt, the finncing of those ssets is just s importnt. Trditionlly, credit unions use member shre cpitl to finnce the purchses of fixed ssets. Under the WOCCU model, the objective is to finnce 100% of ll non-erning ssets with the credit union's institutionl cpitl, or with other libilities tht hve no explicit finncil cost. By using no-cost cpitl to finnce those ssets, credit union ernings re not unduly ffected. This is one of the strong rguments supporting the cpitliztion of ll net ernings--to upgrde old buildings nd worn-out equipment. 4. R = Rtes of Return nd Costs The PEARLS system segregtes ll of the essentil components of net ernings to help mngement clculte investment yields nd evlute operting expenses. PEARLS MONITORING SYSTEM PAGE 6

In this wy, PEARLS demonstrtes its vlue s mngement tool. Unlike other systems tht clculted yields on the bsis of verge ssets, PEARLS clcultes yields on the bsis of ctul investments outstnding. This methodology ssists mngement in determining which investments re the most profitble. It lso permits the credit unions to be rnked ccording to the best nd worst yields. By compring finncil structure with yields, it is possible to determine how effectively the credit union is ble to plce its productive resources into investments tht produce the highest yield. These powerful nlysis techniques help mngement sty brest of the finncil performnce of the credit union. Yield informtion is computed on four min res of investment:. Lon Portfolio All interest income, delinquent interest penlties nd commissions from lending opertions re divided by the totl mount invested in the lon portfolio. b. Liquid Investments All income from bnk svings ccounts nd liquidity reserves deposited in either the Ntionl Assocition or regultory body is divided by the mounts invested in those res. c. Finncil Investments Mny credit unions invest liquidity into finncil investments (e.g. government securities) tht py higher yields thn bnk svings ccounts. This investment income is lso divided by the outstnding cpitl invested in those instruments. d. Other Non-finncil Investments Any investment tht does not fit into the previous ctegories is clssified s "other" non-finncil investments. For mny credit unions, this includes investments in supermrkets, phrmcies, schools, nd residentil development projects. All income from these different sources is likewise divided by the originl cpitl investments. Opertionl costs re lso importnt. They re broken down into three min res: e. Finncil Intermedition Costs This re evlutes the finncil costs pid on deposit svings, member shres, nd externl lons. Unlike commercil bnks tht try to minimize finncil costs, PEARLS MONITORING SYSTEM PAGE 7

credit unions should try to py s high rte s possible without jeoprdizing the stbility of the institution. In mny instnces, poor growth rte for deposit svings is linked to noncompetitive interest rtes. Likewise, dividends on member shre cpitl re closely monitored to ensure tht credit unions re not tking dvntge of their members by pying substndrd dividend yields on their shre cpitl. f. Administrtive Costs Another criticl re requiring close nlysis is dministrtive costs. Mny credit unions re highly competitive with commercil bnks on interest rtes for deposits nd lons, but their dministrtive costs re much higher on per unit bsis. Costs re higher becuse of the smller lon size. Fixed dministrtive expenses could not be spred over lrger lon mount. For exmple, the fixed costs to mke US$1,000 lon re lmost identicl to those of US$10,000 lon. High dministrtive costs re one of the min resons why mny credit unions re not profitble. The "idel" trget recommended by the PEARLS system is to mintin dministrtive costs t 5% of verge totl ssets. g. Provisions for Lon Losses The finl cost re evluted by PEARLS seprtes the costs of creting provisions for lon losses from other dministrtive costs. This cn be fcilitted by the use of cler ccounting nomenclture. Trditionl ccounting stndrds usully include lon loss provisions s prt of the overll dministrtive costs. In relity, the cretion of dequte provisions represents completely different type of expense. It is directly linked to experienced credit nlysis nd effective lon collection techniques. By isolting this expense from the other dministrtive costs, it is possible to get much clerer picture of wek credit dministrtion prctices in the credit union. By segregting income nd expenses into the previously mentioned res, the PEARLS rtios cn ccurtely pinpoint the resons why credit union is not producing sufficient net income. 5. L = Liquidity Effective liquidity mngement becomes much more importnt skill s the credit union shifts its finncil structure from member shres to more voltile deposit svings. In mny movements following the trditionl model, member shres re very illiquid nd most externl lons hve long pybck period, therefore there is little incentive to mintin liquidity reserves. Liquidity is trditionlly viewed in terms of csh vilble to lend-- vrible exclusively controlled by the credit union. With the introduction of PEARLS MONITORING SYSTEM PAGE 8

withdrwble svings deposits, the concept of liquidity is rdiclly chnged. Liquidity now refers to the csh needed for withdrwls-- vrible the credit union cn no longer control. The mintennce of dequte liquidity reserves is essentil to sound, finncil mngement in the WOCCU credit union model. The PEARLS system nlyzes liquidity from two perspectives:. Totl Liquidity Reserves This indictor mesures the percentge of svings deposits invested s liquid ssets in either Ntionl Assocition or commercil bnk. The "idel" trget is to mintin minimum of 15% fter pying ll short-term obligtions (30 dys nd under). b. Idle Liquid Funds 6. S = Signs of Growth Liquidity reserves re importnt but they lso imply lost opportunity cost. Funds in checking ccounts nd simple svings ccounts ern negligible returns, in comprison with other investment lterntives. Consequently, it is importnt to keep idle liquidity reserves to minimum. The "idel" trget of this PEARLS rtio is to reduce the percentge of idle liquidity to s close to zero s ws possible. The only successful wy to mintin sset vlues is through strong, ccelerted growth of ssets, ccompnied by sustined profitbility. Growth by itself is insufficient. The dvntge of the PEARLS system is tht it links growth to profitbility, s well s to the other key res by evluting the strength of the system s whole. Growth is mesured in five key res:. Totl Assets b. Lons Growth in totl ssets is one of the most importnt rtios. Mny of the formuls used in the PEARLS rtios include totl ssets s the key denomintor. Strong, consistent growth in totl ssets improves mny of the PEARLS rtios. By compring the growth in totl ssets to other key res, it is possible to detect chnges in the blnce sheet structure tht could hve positive or negtive impct on ernings. The idel gol for ll credit unions is to chieve rel positive growth (i.e., net growth fter subtrcting for infltion) ech yer. PEARLS MONITORING SYSTEM PAGE 9

The lon portfolio is the most importnt nd profitble credit union sset. If growth in totl lons keeps pce with growth in totl ssets, there is good likelihood tht profitbility will be mintined. Conversely, if lon growth rtes drop, this suggests tht other, less profitble res re growing more quickly. c. Svings Deposits With the new emphsis on svings mobiliztion, svings deposits re the new cornerstones of growth. The growth of totl ssets is dependent on the growth of svings. The rtionle for mintining ggressive mrketing progrms is tht it stimultes growth in new svings deposits tht in turn, ffect the growth of other key res. d. Shres Although member shre svings re de-emphsized under the WOCCU model, some credit unions my mintin dependence on shres for growth. If growth rtes in this re re excessive, it usully signls n inbility of the credit unions to dpt to the new system of promoting deposits over shres. e. Institutionl Cpitl Institutionl cpitl growth is the best indictor of profitbility within credit unions. Sttic or declining growth trends in institutionl cpitl usully indictes problem with ernings. If ernings re low, the credit union will hve gret difficulty in dding to institutionl cpitl reserves. One of the indisputble signs of success of robust credit union in trnsition is sustined growth of institutionl cpitl, usully greter thn the growth of totl ssets. PEARLS MONITORING SYSTEM PAGE 10

THE "PEARLS" MONITORING SYSTEM GOALS 2001 World Council of Credit Unions QUICK KEY TO "PEARLS" AREA PEARL DESCRIPTION GOAL P1 Allownce for Lon Losses / Allownces Required for Lons Delinquent >12 months 100% P2 Net Allownce for Lon Losses / Allownces Required for Lons Delinquent less thn 12 months 35% P = PROTECTION P3 Totl Chrge-Off of Delinquent Lons >12 months 100% P4 Annul Lon Chrge-offs Miniml P5 Accumulted Lon Recoveries/Accumulted Lon Chrge-offs 100% P6 Solvency >= 100% E1 Net Lons/Totl Assets 70-80% E2 Liquid Investments / Totl Assets Mx 20% E3 Finncil Investments / Totl Assets Mx 10% E = EFFECTIVE FINANCIAL STRUCTURE E4 Non-Finncil Investments / Totl Assets 0% E5 Svings Deposits / Totl Assets 70-80% E6 Externl Credit / Totl Assets Mx 5% E7 Member Shre Cpitl / Totl Assets 10-20% E8 Institutionl Cpitl / Totl Assets Min 10% E9 Net Institutionl Cpitl/ Totl Assets Sme s E8 A1 Totl Lon Delinquency / Gross Lon Portfolio <=5% A = ASSET QUALITY A2 Non-Erning Assets / Totl Assets <=5% A3 Net Institutionl & Trnsitory Cpitl + Non Interest-Bering Libilities / Non-erning Assets >200% PEARLS MONITORING SYSTEM PAGE 11

AREA PEARL DESCRIPTION NORM R1 Net Lon Income / Averge Net Lon Portfolio Entrepreneuril Rte R2 Totl Liquid Investment Income / Averge Liquid Investments Mrket Rtes R3 Totl Finncil Investment Income / Averge Finncil Investments Mrket Rtes R4 Totl Non-Finncil Investment Income / Averge Non-Finncil Investments Greter thn R1 R5 Totl Interest Cost on Svings Deposits / Averge Svings Deposits Mrket Rtes >Infltion R6 Totl Interest Cost on Externl Credit / Averge Externl Credit Mrket Rtes R = RATES OF RETURN & COSTS R7 R8 Totl Interest (Dividend) Cost on Shres / Averge Member Shres Totl Gross Income Mrgin / Averge Totl Assets Mrket Rtes >= R5 Vrible - Linked to R9, R11, R12 R9 Totl Operting Expenses / Avg. Totl Assets 5% R10 R11 Totl Lon Loss Provision Expense / Averge Totl Assets Non-Recurring Income or Expense / Averge Totl Assets Dependent on Delinquent Lons Miniml R12 Net Income / Averge Totl Assets Linked to E9 PEARLS MONITORING SYSTEM PAGE 12

L1 S.T Investments + Liquid Assets - S.T. Pybles / Svings Deposits Min 15% L = LIQUIDITY L2 Liquidity Reserves / Svings Deposits 10% L3 Non-Erning Liquid Assets / Totl Assets <1% S1 Growth in Lons to Members Dependent on E1 S2 Growth in Liquid Investments Dependent on E2 S3 Growth in Finncil Investments Dependent on E3 S4 Growth in Non-Finncil Investments Dependent on E4 S5 Growth in Svings Deposits Dependent on E5 S = SIGNS OF GROWTH S6 Growth in Externl Credit Dependent on E6 S7 Growth in Shre Cpitl Dependent on E7 S8 Growth in Institutionl Cpitl Dependent on E8 S9 Growth in Net Institutionl Cpitl Dependent on E9 S10 Growth in Membership >12% S11 Growth in Totl Assets >Infltion PEARLS MONITORING SYSTEM PAGE 13

THE PEARLS MONITORING SYSTEM MANUAL I. P=PROTECTION The indictors in this section mesure the dequcy of the provisions for lon losses. P1. ALLOWANCE FOR LOAN LOSSES / ALLOWANCES REQUIRED FOR LOANS DELINQUENT >12 MONTHS To mesure the dequcy of the llownces for lon losses when compred to the llownces required for covering ll lons delinquent over 12 months. Accounts:. Allownce for Lon Losses (Blnce Sheet) b. Percentge of llownces required for covering lons tht re more thn 12 months delinquent. WOCCU suggests use 100%, but different percentge my be used in countries where locl lws or regultions re different. c. Lon Blnces of ll lons delinquent more thn 12 months b * c Gol: 100% P2. NET ALLOWANCE FOR LOAN LOSSES / ALLOWANCES REQUIRED FOR LOANS DELINQUENT LESS THAN 12 MONTHS To mesure the dequcy of the llownces for lon losses fter deducting the llownces used to cover lons tht re more thn twelve months delinquent. Accounts:. Totl Allownce for Lon Losses b. Allownces used for covering Lons tht re more thn 12 months delinquent c. Percentge of llownces required for covering lons tht re 1-12 months delinquent. WOCCU suggests using 35%, but different percentge my be used in countries where locl lw or regultions re different. d. Totl Blnce of ll Delinquent Lons outstnding from 1-12 months e. Percentge of llownces required for non-delinquent lons. While WOCCU does not require ny specific llownce for this ctegory, some countries my require specific percentge tht is mndted by locl lw or regultions. f. Totl Blnce of ll Non-Delinquent Lons. ( -b ) c * d + e * f Gol: 100% of llownces required for ll lons delinquent less thn 12 months nd for non-delinquent lons. PEARLS MONITORING SYSTEM PAGE 14

P3. TOTAL CHARGE-OFF OF DELINQUENT LOANS > 12 MONTHS To mesure the totl chrge-off of ll delinquent lons > 12 months. Account:. Totl Delinquent Lons >12 months Gol: If () = 0 (Zero) then Yes, else No. Chrge-off 100% of ll Lons Delinquent > 12 months P4. QUARTERLY LOAN CHARGE-OFFS / TOTAL LOAN PORTFOLIO To mesure the mount of lons chrged-off from the lon portfolio in the current yer. Note tht the lons chrged-off should be mintined in n uxiliry ledger nd re not found on the blnce sheet. Accounts:. Accumulted Chrge-offs for Current yer b. Accumulted Chrge-offs for previous yer c. Gross lon portfolio (excluding llownces) s of Current yer-end d. Gross lon portfolio (excluding llownces) s of Lst yer-end Gol: ( - b) (c+d) 2 Minimize P5. ACCUMULATED RECOVERED CHARGE-OFFS / ACCUMULATED CHARGE-OFFS To mesure the ccumulted mount of chrge-offs tht hve been recovered through successful collection efforts. This is historicl figure tht includes ll previous yers. Accounts:. Accumulted Recovery of Chrge-offs b. Accumulted Chrge-offs b Gol: 100% PEARLS MONITORING SYSTEM PAGE 15

P6. SOLVENCY Mesure the degree of protection tht the credit union hs for member svings nd shres in the event of liquidtion of the credit union s ssets nd libilities. Accounts:. Totl Assets b. Allownces for Risk Assets c. Blnce of Lons Delinquent greter thn 12 months. d. Blnce of Lons Delinquent from 1 to 12 months. e. Totl Libilities f. Problem Assets (Losses tht will be liquidted) g. Totl Svings h. Totl Shres [(+b)-(c+.35(d)+e+ f (g +h) - g)] Gol: > 110% PEARLS MONITORING SYSTEM PAGE 16

II. E= EFFECTIVE FINANCIAL STRUCTURE The indictors in this section mesure the composition of the most importnt ccounts on the Blnce Sheet. An effective finncil structure is necessry to chieve sfety, soundness, nd profitbility, while t the sme time, positioning the credit union for ggressive rel growth. EARNING ASSETS E1. NET LOANS / TOTAL ASSETS To mesure the percentge of totl ssets invested in the lon portfolio. Accounts:. Totl Gross Lon Portfolio Outstnding b. Totl Allownce for lon losses c. Totl Assets ( - b) c Gol: Between 70-80% E2. LIQUID INVESTMENTS / TOTAL ASSETS To mesure the percentge of totl ssets invested in Short-term Investments. Accounts:. Totl Liquid Investments b. Totl Assets b Gol: Mximum 20% E3. FINANCIAL INVESTMENTS / TOTAL ASSETS To mesure the percentge of totl ssets invested in Long-term investments Accounts:. Totl Finncil Investments b. Totl Assets b Gol: Mximum 10% PEARLS MONITORING SYSTEM PAGE 17

E4. NON-FINANCIAL INVESTMENTS / TOTAL ASSETS To mesure the percentge of totl ssets invested in non-finncil investments (i.e., supermrkets, phrmcies, residentil housing developments etc.). Accounts:. Totl Non-Finncil Investments b. Totl Assets b Gol: 0% LIABILITIES E5. SAVINGS DEPOSITS / TOTAL ASSETS To mesure the percentge of totl ssets finnced by svings deposits. Accounts:. Totl Svings Deposits b. Totl Assets b Gol: Between 70-80% E6. BORROWED FUNDS / TOTAL ASSETS To mesure the percentge of totl ssets finnced by externl borrowing (i.e., debt obligtions with other finncil institutions outside of the credit union) Accounts:. Totl Short-term lon obligtions b. Totl Long-term lon obligtions c. Totl Assets (+b) c Gol: Mximum 5% PEARLS MONITORING SYSTEM PAGE 18

CAPITAL E7. MEMBER SHARES / TOTAL ASSETS To mesure the percentge of totl ssets finnced by Member shres. Accounts:. Totl Member Shres b. Totl Assets b Gol: Mximum 20% E8. INSTITUTIONAL CAPITAL 1 / TOTAL ASSETS To mesure the percentge of totl ssets finnced by Institutionl Cpitl. Accounts:. Totl Institutionl Cpitl b. Totl Assets b Gol: Minimum 10% E9. NET INSTITUTIONAL CAPITAL To mesure the rel level of institutionl cpitl, fter djusting the llownces for risk ssets to meet the stndrds of P1&P2, nd covering ny other potentil losses. Accounts:. Institutionl Cpitl b. Allownces for Risk Assets c. Blnce of Lons Delinquent greter thn 12 months. d. Blnce of Lons Delinquent from 1 to 12 months. e. Problem Assets (Losses tht will be liquidted) f. Totl Assets 2. Institutionl Cpitl is defined s ll legl nd non-distributble reserves, cpitl dontions nd the portion of the current yer s surplus tht will be retined s legl or non-distributble reserves. These reserves re not expended nd no member my present n individul clim. PEARLS MONITORING SYSTEM PAGE 19

Gol: [(+b)-(c+.35(d)+e)] f Sme s E8 III. A=ASSET QUALITY The indictors in this section mesure the percentge of non-erning ssets tht negtively impct profitbility nd solvency. They re: lon delinquency, non-erning ssets, nd the finncing of nonerning ssets. A1. TOTAL LOAN DELINQUENCY / TOTAL LOAN PORTFOLIO To mesure the totl percentge of delinquency in the lon portfolio, using the criterion of outstnding delinquent lon blnces insted of ccumulted delinquent lon pyments. Accounts:. Sum of ll delinquent lon blnces ( non-bookkeeping control) b. Totl (Gross) Lon Portfolio Outstnding b Gol: Less Thn or Equl to 5% A2. NON-EARNING ASSETS / TOTAL ASSETS To mesure the percentge of the totl ssets not producing income. Exmples of Non-erning Assets: 1. Csh on hnd 2. Non-interest bering monetry checking ccounts 3. Accounts receivble 4. Assets in liquidtion 5. Fixed ssets (Lnd, Building, equipment etc.) 6. Prepid expenses nd other deferrls Accounts:. Totl Non-erning Assets b. Totl Assets b Gol: Less Thn or Equl to 5% PEARLS MONITORING SYSTEM PAGE 20

A3. (NET INSTITUTIONAL CAPITAL +TRANSITORY CAPITAL 2 + NON INTEREST- BEARING LIABILITIES) 3 / NON-EARNING ASSETS To mesure the percentge of non-erning ssets tht re finnced with institutionl cpitl, trnsitory cpitl nd libilities without interest. Accounts:. Totl Net Institutionl Cpitl (See numertor for P7 rtio) b. Totl Trnsitory Cpitl c. Totl Non Interest-Bering Libilities d. Totl Non-erning ssets (+b+c) d Gol: Greter thn or equl to 200% IV. R=RATES OF RETURN & COST These indictors mesure the verge income yield for ech of the most productive ssets of the Blnce Sheet. In ddition, they mesure the verge yield (cost) for ech of the most importnt libility nd cpitl ccounts. The yields re ctul investment returns nd not the typicl "spred nlysis" yields tht re figured on the bsis of verge ssets. The corresponding yields indicte whether the credit union is erning nd pying mrket rtes on its ssets, libilities nd cpitl. R1. TOTAL LOAN INCOME / AVERAGE NET LOAN PORTFOLIO To mesure the yield on the lon portfolio. Accounts:. Totl Lon income (including commissions, fees, nd delinquent interest penlties) during yer. b. Insurnce Premiums pid on Lons c. Net lon portfolio (Net of Allownces for Lon Losses) s of Current yer-end d. Net lon portfolio (Net of Allownces for Lon Losses) s of Lst yer-end Gol: b (c + d) 2 Entrepreneuril rte which covers finncil, operting, nd provisioning expenses nd contributes to cpitl levels which mintin INSTITUTIONAL CAPITAL t 2 3 Trnsitory Cpitl includes Monetry, Eductionl & Socil Reserves, Revlued Assets, nd Undistributed Income Referred to s Zero Cost Funds PEARLS MONITORING SYSTEM PAGE 21

lest 10%. R2. LIQUID INVESTMENT INCOME / AVERAGE LIQUID INVESTMENTS To mesure the yield on ll short-term investments (i.e., Bnk deposits, etc.). Accounts:. Totl Liquid Investment Income during yer. b. Totl Liquid Investments s of Current yer-end. c. Totl Liquid Investments s of Lst yer-end. (b+c) 2 Gol: Highest rtes possible w/o undue risk R3. FINANCIAL INVESTMENT INCOME / AVERAGE FINANCIAL INVESTMENTS To mesure the yield on ll long term investments (i.e., Fixed Deposits, Shres, Securities, etc.) Accounts:. Totl Finncil Investment Income b. Totl Finncil Investments s of Current yer-end. c. Totl Finncil Investments s of Lst yer-end. Gol: (b+c) 2 Highest rtes possible w/o undue risk R4. NON-FINANCIAL INVESTMENT INCOME / AVERAGE NON-FINANCIAL INVESTMENTS To mesure the yield on ll non-finncil investments which do not belong to ctegories R1-R3. Typiclly, this is income from supermrkets, phrmcies, rentl properties nd residentil housing developments. Accounts:. Totl Non-Finncil Investment Income b. Totl Non-Finncil Investments s of Current yer-end. c. Totl Non-Finncil Investments s of Lst yer-end. (b+c) 2 PEARLS MONITORING SYSTEM PAGE 22

Gol: Rte greter thn R1 R5. FINANCIAL COST: SAVINGS DEPOSITS / AVERAGE SAVINGS DEPOSITS To mesure the yield (cost) of Svings Deposits. Accounts:. Totl Interest Pid on Svings Deposits b. Totl insurnce premium pid on Svings Deposits c. Totl Txes pid by Credit Union on Svings Deposit Interest d. Totl Svings Deposits s of Current yer-end. e. Totl Svings Deposits s of Lst yer-end. Gol: ( +b 2 + (d + e) c) Rtes which protect the nominl vlue of the svings deposits (>Infltion) R6. FINANCIAL COST: BORROWED FUNDS / AVERAGE BORROWED FUNDS To mesure the yield (cost) of ll Borrowed Funds Accounts:. Totl Interest Pid on Borrowed Funds b. Totl Borrowed Funds s of Current yer-end c. Totl Borrowed Funds s of Lst yer-end (b+c) 2 Gol: Sme or lesser yield (cost) thn R5 R7. FINANCIAL COST: MEMBER SHARES / AVERAGE MEMBER SHARES To mesure the yield (cost) of Member Shres. Accounts:. Totl Dividends pid on Member Shres b. Totl insurnce premium pid on Member Shres c. Totl Txes pid by credit union on Dividends on Shres d. Totl Member Shres s of Current yer-end e. Totl Member Shres s of Lst yer-end ( +b 2 + (d + e) c) PEARLS MONITORING SYSTEM PAGE 23

Gol: Sme or greter yield thn R5 R8. GROSS MARGIN / AVERAGE TOTAL ASSETS To mesure the gross income mrgin generted, expressed s yield on ll ssets, before subtrcting operting expenses, provisions for lon losses, nd other extrordinry items. Accounts:. Lon Interest Income b. Liquid Investment Income c. Finncil Investment Income d. Non-Finncil Investment Income e. Other Income f. Interest Cost of Svings Deposits g. Dividend or Interest Cost of Member Shres h. Interest Cost of Borrowed Funds I. Totl Assets s of Current Yer-end j. Totl Assets s of Lst Yer-end Gol: ((+b...+e)-(f + g +h)) (i+ j) 2 To generte sufficient income to cover ll operting expenses nd llownces for lon losses nd provide for dequte increses in institutionl cpitl. R9. OPERATING EXPENSES / AVERAGE TOTAL ASSETS To mesure the cost ssocited with the mngement of ll Credit Union ssets. This cost is mesured s percentge of totl ssets nd indictes the degree of opertionl efficiency or inefficiency. Accounts:. Totl Operting Expenses (exclusive of Provisions for lon losses) b. Totl Assets s of Current yer-end c. Totl Assets s of Lst yer-end (b+c) 2 Gol: <10% PEARLS MONITORING SYSTEM PAGE 24

R10. PROVISIONS FOR LOAN LOSSES / AVERAGE TOTAL ASSETS To mesure the cost of losses from risk ssets such s delinquent lons or uncollectible ccounts receivble. This cost is different thn other opertionl expenses nd should be seprted to highlight the effectiveness of Credit Union collection policies nd procedures. Accounts:. Totl Current Yer Provision Expense of ll Risk Assets b. Totl Assets s of Current yer-end c. Totl Assets s of Lst yer-end (b+c) 2 Gol: Enough to cover 100% of delinquent lons >12 months nd 35% for lons delinquent 1-12 months. R11. NON-RECURRING INCOME OR EXPENSES / AVERAGE TOTAL ASSETS To mesure the net mount of non-recurring income nd expenses. These items typiclly should not be significnt mount if the Credit Union is specilizing in Finncil Intermedition. Accounts:. Totl Non-Recurring Income or Expenses (Current Yer) b. Totl Assets s of Current yer-end c. Totl Assets s of Lst yer-end (b+c) 2 Gol: Minimum possible R12. NET INCOME / AVERAGE TOTAL ASSETS To mesure the dequcy of ernings nd lso, the cpcity to build Institutionl Cpitl. Accounts:. Net Income (After dividends) b. Totl ssets s of Current yer-end c. Totl ssets s of Lst yer-end (b+c) 2 Gol: Enough to ttin the gol of E9 PEARLS MONITORING SYSTEM PAGE 25

IV. L=LIQUIDITY The liquidity indictors show whether the Credit Union is effectively mnging its csh so tht it cn meet deposit withdrwl requests nd liquidity reserve requirements. In ddition, idle csh is lso mesured to insure tht this non-erning sset does not unduly ffect profitbility. L1. LIQUID INVESTMENTS (+) LIQUID ASSETS (-) SHORT-TERM PAYABLES / SAVINGS DEPOSITS To mesure the dequcy of the liquid csh reserves to stisfy deposit withdrwl requests, fter pying ll immedite obligtions <30 dys. Accounts:. Totl Erning Liquid Investments b. Totl Non-erning Liquid Assets c. Totl Short-term Pybles <30 dys d. Totl Svings Deposits (+b - c) d Gol: Minimum 15% L2. LIQUIDITY RESERVES / SAVINGS DEPOSITS To mesure complince with obligtory Centrl Bnk, CFF, or Other Liquidity Reserve Deposit requirements. Accounts:. Totl Liquidity Reserves (Erning Asset) b. Totl Liquidity Reserves (Non-erning Asset) c. Totl Svings Deposits (+b) c Gol: 10% L3. NON-EARNING LIQUID ASSETS / TOTAL ASSETS To mesure the percentge of totl ssets tht is invested in non-erning liquid ccounts. Accounts:. Totl Liquid Non-Erning Assets b. Totl Assets PEARLS MONITORING SYSTEM PAGE 26

b Gol: <1% VI. S=SIGNS OF GROWTH The indictors of this section mesure the percentge of growth in ech of the most importnt ccounts on the finncil sttement, s well s growth in membership. In infltionry economies, rel growth (fter subtrcting infltion), is key to the long run vibility of the Credit Union S1. GROWTH IN LOANS To mesure the yer-to-dte growth of the Lon Portfolio. Accounts:. Current Lon Portfolio blnce b. Lon Portfolio blnce s of Lst yer-end -1 x 100 b Gol: To Increse the Percentge of Totl Lons Outstnding (E1) S1 must be greter thn S11 To Mintin the Percentge of Totl Lons Outstnding (E1), S1 must be equl to S11. To Decrese the Percentge of Totl Lons Outstnding (E1), S1 must be less thn S11. S2. GROWTH IN LIQUID INVESTMENTS To mesure the yer-to-dte growth of liquid investments. Accounts:. Totl Current Liquid Investments b. Totl Liquid Investments s of Lst yer-end -1 x 100 b Gol: To Increse the Percentge of Liquid Investments (E2), S2 must be greter thn S11. To Mintin the Percentge of Liquid Investments (E2), S2 must be equl to S11. To Decrese the Percentge of Liquid Investments (E2), S2 must be less thn S11. S3. GROWTH IN FINANCIAL INVESTMENTS PEARLS MONITORING SYSTEM PAGE 27

To mesure the yer-to-dte growth of Finncil Investments. Accounts:. Totl Current Finncil Investments b. Totl Finncil Investments s of Lst yer-end -1 x 100 b Gol: To Increse the Percentge of Finncil Investments (E3), S3 must be greter thn S11. To Mintin the Percentge of Finncil Investments (E3), S3 must be equl to S11. To Decrese the Percentge of Finncil Investments (E3), S3 must be less thn S11. S4. GROWTH IN NON-FINANCIAL INVESTMENTS To mesure the yer-to-dte growth of the Lon Portfolio. Accounts:. Totl Current Non-finncil Investments b. Totl Non-finncil Investments s of Lst yer-end -1 x 100 b Gol: To Increse the Percentge of Non-Finncil Investments (E4), S4 must be greter thn S11. To Mintin the Percentge of Non-Finncil Investments (E4), S4 must be equl to S11. To Decrese the Percentge of Non-Finncil Investments (E4), S4 must be less thn S11. S5. GROWTH IN SAVINGS DEPOSITS To mesure the yer-to-dte growth of Svings Deposits. Accounts:. Totl Current Svings Deposits b. Totl Svings Deposits s of the Lst yer-end -1 x 100 b Gol: To Increse the Percentge of Totl Svings Deposits (E5), S5 must be greter thn S11. To Mintin the Percentge of Totl Svings Deposits (E5), S5 must be equl to S11. To Decrese the Percentge of Totl Svings Deposits (E5), S5 must be less thn S11. S6. GROWTH IN BORROWED FUNDS PEARLS MONITORING SYSTEM PAGE 28

To mesure the yer-to-dte growth of Borrowed Funds. Accounts:. Totl Current Borrowed Funds b. Totl Borrowed Funds s of Lst yer-end -1 x 100 b Gol: To Increse the Percentge of Totl Borrowed Funds (E6), S6 must be greter thn S11. To Mintin the Percentge of Totl Borrowed Funds (E6), S6 must be equl to S11. To Decrese the Percentge of Totl Borrowed Funds (E6), S6 must be less thn S11. S7. GROWTH IN MEMBER SHARES To mesure the yer-to-dte growth of Member shres. Accounts:. Totl Current Member Shres b. Totl Member Shres s of Lst yer-end -1 x 100 b Gol: To Increse the Percentge of Totl Member Shres (E7), S7 must be greter thn S11. To Mintin the Percentge of Totl Member Shres (E7), S7 must be equl to S11. To Decrese the Percentge of Totl Member Shres (E7), S7 must be less thn S11. S8. GROWTH IN INSTITUTIONAL CAPITAL To mesure the yer-to-dte growth of Institutionl Cpitl. Accounts:. Current Institutionl Cpitl b. Institutionl Cpitl s of the Lst yer-end -1 x 100 b Gol: To Increse the Percentge of Totl Institutionl Cpitl (E8), S8 must be greter thn S11. To Mintin the Percentge of Totl Institutionl Cpitl (E8), S8 must be equl to S11. To Decrese the Percentge of Totl Institutionl Cpitl (E8), S8 must be less thn S11. S9. GROWTH IN NET INSTITUTIONAL CAPITAL To mesure the yer-to-dte growth of Net Institutionl Cpitl. PEARLS MONITORING SYSTEM PAGE 29

Accounts:. Current Net Institutionl Cpitl (the definition of NIC s in E9) b. Net Institutionl Cpitl s of the Lst yer-end -1 x 100 b Gol: To Increse the Percentge of Net Institutionl Cpitl (E9), S9 must be greter thn S11. To Mintin the Percentge of Net Institutionl Cpitl (E9), S9 must be equl to S11. To Decrese the Percentge of Net Institutionl Cpitl (E9), S9 must be less thn S11. S10. GROWTH IN MEMBERSHIP To mesure the yer-to-dte growth in Membership of the Credit Union. Accounts:. Current Number of Members (non-bookkeeping control) b. Number of Members s of Lst yer-end (non-bookkeeping control) -1 x 100 b Gol: > 12% S11. GROWTH IN TOTAL ASSETS To mesure the yer-to-dte growth of Totl Assets. Accounts:. Totl current ssets b. Totl ssets s of the Lst yer-end -1 x 100 b Gol: Greter thn the infltion rte PEARLS MONITORING SYSTEM PAGE 30