Message from the President

January, 2010 

As we begin a new decade, I reflect on the challenges of the last two years. It is painfully apparent our local, state, and national economies are still operating at historical low points. And more specifically, the effects of this economy have had a devastating affect on our membership and the financial results of your credit union. Are conditions improving? I could respond in the affirmative by reporting a 4th quarter net income of $12.3 million. And I could highlight that our overall net loss of $29.5 million for 2009 was an improvement over our $115.8 million net loss in 2008. But I’ll call it as it is – net loan losses continue to exceed our ability to produce net income – improvement, while reportable, is still minimal and quite frankly unacceptable.   Therefore, rather than wait for economic conditions to improve, we have taken action in the areas that we can control. And in the cooperative spirit, we have identified the actions we’d like you, our membership, to take as well.

As we look forward to the remainder of 2010 and beyond, please allow me to first reflect on how we got to this point; how we behaved as a credit union.

Investment in Members
The Board of Directors and the employees of Arizona Federal Credit Union have consistently placed the interests of our members first. We have worked diligently to meet the credit needs of our members, to price loans competitively, to pay attractive rates of interest on deposits, to return excess earnings to members, to expand services and locations to provide more convenience, and to establish fees at levels below others or have no fees at all for certain services. And our diligence was rewarded with your trust and your business.

And then in 2007, conditions changed.

What Happened?
As graphically represented in the charts above, unrelenting loan delinquency and loan defaults have continued for the past two years despite amending our loan underwriting processes throughout 2008.  The majority of our loan losses are due to loans made two, three and four years ago and approximately 70% of loan defaults are due to unemployment or underemployment according to the impacted members.

My last reflection prior to looking forward relates to our financial safety and soundness. The most important financial number from a regulatory standpoint is “net worth.” We are required to have 7% or more of our assets in the form of net worth to be considered “well-capitalized.” We have 3.47% as of the end of 2009. The following chart highlights our net worth and loan loss reserves.

Historically we did not experience loan losses to the degree we are currently. But with losses on the rise, we are mandated by accounting rules and regulatory requirements to ensure reserves are specifically allocated for loan losses. Those reserves come from our net worth. And the only way a credit union can accumulate net worth is through net earnings as we can’t sell stock (or obtain TARP assistance) as for-profit banks are able. While our net worth is below standard, we still have 9% of our assets in total reserves (i.e., net worth plus allowance for loan losses), which is down from our high-point of 12.8% at the end of 2006.

How could all of this been avoided? What could have been done differently? We could have mitigated the financial risk by doing sooner what we are doing today.

Actions We’ve Taken
The actions we’ve taken over the last two years reflect our new reality.

The most obvious and difficult actions came through the consolidation of our branch locations. Throughout the years, and especially in recent years, the financial success of this credit union was returned to members in the form of additional branch locations and expanded services. And while success fuels expansion, challenges fuel contraction. We are saddened that many of our members no longer have the close proximity to an Arizona Federal branch that they once enjoyed, but we’re also thankful that in our most successful years we invested heavily in automated services like CU Online and TouchTone 24, and in partnerships with ATM and Shared Branching networks. These alternatives do not replace, but can certainly supplement the loss of branch proximity.

We also amended the terms of our VisaÒ credit card program this year, which was another painful but necessary action. By doing so we more appropriately aligned the pricing of the portfolio (i.e., the rates) with the associated risk. This did result in a higher credit card rate for some members, but our highest available credit card rate to this day is 17.99% APR (Annual Percentage Rate), which is considerably lower than the rate charged by most banks to a borrower of similar credit quality. We also do not subject our members to common practices like higher interest rates for cash advance balances, or increased “penalty” rates if payments are late.

Other actions included increases in certain avoidable fees, foregoing increases in employee compensation, reducing executive compensation and benefits, renegotiating contracts with service providers, lowering the number of our employees through attrition, and reducing dividend/interest rates paid on deposits.

So what’s ahead in 2010 and beyond? The actions we took in 2008 and 2009 will continue to produce financial benefits, which will strengthen our operating income and help us to further restore our net worth and our total reserves. More actions may be necessary if we do not continue to improve our financial performance, but such actions are considered contingencies at this point.

Our Value Proposition
With these actions, as a locally-owned, not-for-profit financial cooperative, we have preserved for our members a highly competitive overall value proposition, inclusive of the following:

• A free checking account (with no gimmicks, and no crazy minimum balances or transaction requirements!)
• A no annual fee credit card, with a rewards program
• Competitive loan interest rates and the convenience of our car buying service, Members’ Auto Center
• A full suite of insurance options through our Members’ Insurance Center
• A full suite of investment options through our Arizona Federal Financial Solutions program
• Automated self-service options like TouchTone 24 and CU Online with Free Bill Pay
• Free financial seminars and complimentary credit counseling
• Discounts to Arizona Federal members from large national service providers and retailers

That’s what we have done and what we are doing. And we will continue to be open and transparent in ways that matter.

Actions You Can Take
Arizona Federal Credit Union, like all credit unions, exists to deliver low-cost, high-value financial services to our member-owners. It is the responsibility of our Board of Directors, management, and staff to ensure that such services are available, and that they are delivered accurately, effectively, and with a superior level of personal service. However, it is the responsibility of all 200,000+ Arizona Federal members to utilize (or at a minimum, consider first and compare) these services. To that end, we ask the following of you:

1. First and foremost, we need loan commitments to be repaid. We ask to be paid first. We were there for you at your time of need; please be there for us.
2. Consider using CU Online and TouchTone 24 as alternatives to waiting on hold to reach our call center.
3. We ask that you enroll for direct deposit and use our surcharge-free ATM network in place of the branches we have closed.
4. As your annual insurance policies expire, give us an opportunity to review your policies and provide competitive quotes through Members’ Insurance Center.
5. If you are seeking higher returns on your deposits, please make an appointment to have Arizona Federal Financial Solutions review investment alternatives with you.
6. Make your Arizona Federal Credit Union check card or credit card your first choice when shopping or paying a bill.
7. And most importantly, if you are currently facing financial challenges and unable to meet your obligations, or are at risk in the future, we ask that you contact us and take advantage of our financial assistance resources.

Let’s work together cooperatively to make this another year of action, and ultimately a year of results. I wish you and yours all the best in 2010.

Sincerely,

Ronald L. Westad
President & CEO