The United Members of Corporate One
Corporate One
2011 Annual Report
In 2011, 771 members in 37 states with $168B in assets, united, making Corporate One one of the strongest corporates in the nation.
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Corporate One 2011 Annual Report
A Letter to our Members from the President and the Chairman
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Midwest Region: A Year in Review
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Northeast Region: Solution Growth in 2011
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West Region: Cooperative Roots Yield Purposeful Work
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South Region: A Look Forward
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Corporate One Board of Directors
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Corporate One Senior Management
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Management’s Discussion and Analysis of Financial Condition and Results of Operations 16 Report from Supervisory Committee
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Report of Independent Auditors
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Financial Statements
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Notes to Financial Statements
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A Letter to our Members In 2011, Corporate One continued our strategic evolution to become financially stronger, more efficient and a more geographically diverse corporate credit union. Focusing on operational efficiency allowed us to provide enhanced member service at lower costs. Meeting and exceeding the new capital regulations set forth by the National Credit Union Administration (NCUA) was also paramount. These facets, along with our projected merger with Southeast Corporate, made 2011 a year for the history books. Yet, it was the uniting of our members around their corporate credit union that was our biggest success of the year. Without our members unwavering support, Corporate One would not be the firstclass corporate it is today.
Lee Butke, President/CEO
As Corporate One was one of only a few corporate credit unions that did not impair their members’ capital, we had hoped for a successful recommitment campaign in 2011 to convert our members’ existing membership capital instruments to Perpetual Contributed Capital (PCC), the new form of capital required by the NCUA. We were not disappointed, and actually are greatly appreciative of the high-level of support our members demonstrated, even with all the challenges they have faced over the last few years. Our members united around their corporate by converting nearly 85 percent of their existing capital to PCC as well as by purchasing Non-perpetual Capital Accounts (NCA), and did so in such an overwhelming way as our NCA offering was over-subscribed. Thanks to this support, Corporate One now exceeds the well-capitalized ratios currently required by the NCUA, and already meets the well-capitalized permanent leverage ratio, which goes in to effect in October 2013. The overwhelming response to our capital recommitment offering was a great affirmation of the value that Corporate One provides its membership, and has made us one of the most financially sound corporate credit unions in the nation. While working toward the transition to new forms of capital and new capital guidelines, Corporate One also remained focused on efficiency. By adding 65 new members from across the nation in 2011, we also increased our aggregated volumes on correspondent payment services across the board, helping to keep down associated costs. Throughout the year, we continued to see success in the growth of our debit and credit card programs, and we began offering members multiple options for sending us their forward clearing items. Additionally, we began offering DTC-eligible CDs through the SimpliCD program and we partnered with Federated® to offer members mutual funds. Our growth in membership, along with the addition or enhancement of services, helped our bottom line, as Corporate One saw core earnings of $5.5 million in 2011.
Gerald D. Guy, Chairman, KEMBA Financial Credit Union
Perhaps the biggest news of 2011 was the announcement that Southeast Corporate may merge into Corporate One. Never before has such a single event had the potential to significantly transform the organization. With the addition of Southeast Corporate’s service offerings, their infrastructure and most importantly the complement of their membership with ours, Corporate One is poised to become the premier corporate credit union in the nation. As this merger progresses, both our existing and new members can expect even greater offerings and service from their corporate credit union. Finally, while the support of members has led to the continued strength of Corporate One, there are many people behind the scenes who work tirelessly to serve our credit unions. It is with great pride that we recognize our Board of Directors, Supervisory Committee, management and staff for all of their hard work. Their experience and dedication, along with the support of our loyal members, has enabled us to provide continuous and unparalleled service and financial solutions, even during the trying times of the past few years. For Corporate One, our future is now brighter than ever.
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Lee Butke, President/CEO
Gerald D. Guy, Chairman
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The overwhelming response to our capital recommitment offering was a great affirmation of the value that Corporate One provides its membership. And, we thank our members for their continued support and patronage of Corporate One.
South Bend, Indiana Decatur, Illinois
Midwest Spotlight The Midwest region is the traditional footprint for Corporate One’s field of membership. In this region, the majority of our loyal members are located, including credit unions of all sizes and with various fields of membership. In the Midwest, Corporate One has 540 members, and serves 347 additional credit unions through our Alliance One program. 4
LaGrange, Ohio
Hagerstown, Indiana
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A Year in Review Corporate One has been providing innovative, reliable and successful financial solutions to credit unions for more than 60 years. But no year has defined us more than 2011. 2011 was a year of re-confirmed trust and commitment. Throughout the financial crisis, Corporate One operated competently and transparently on our members’ behalf, proving to be good stewards of our members’ investments with us by effectively managing our corporate throughout the economic downturn without any impairment of their capital dollars. In response to updated regulations and new capital requirements governing our industry, Corporate One members overwhelmingly came together in support of their corporate, affirming the value of the services we provide. This show of support solidified Corporate One’s ability to serve our membership and our movement well into the future. With our members’ support, including the support of 65 new members in 2011, Corporate One holds more total regulatory capital account balances than any other corporate in the country, with more than $285.4 million as of December 31, 2011.
Midwest Member Spotlight South Bend Firefighters FCU
Sun Center Federal Credit Union
South Bend, Indiana Assets: $33.1M
LaGrange, Ohio Assets: $35.4M
2011 was defining for Corporate One because it was the year our members united to create one of the strongest corporate credit unions in the nation.
Land of Lincoln Credit Union Decatur, Illinois Assets: $153.6M
Perfect Circle Credit Union Hagerstown, Indiana Assets: $48.5M
Latham, New York
Windsor Locks, Connecticut
New Castle, Pennsylvania
Northeast Spotlight The recent economic downturn of the past few years caused many credit unions to look for an alternative to their traditional corporate credit union provider. With the ability to serve credit unions in any U.S. location, Corporate One benefited from credit unions looking for a stronger corporate, and we now serve 77 credit unions in this region through direct membership or through Alliance One. 6
Carteret, New Jersey
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Solution Growth in 2011 Thanks to the support of our members, Corporate One continues to be an aggregator of successful financial solutions for credit unions nationwide. And, it is the success and profitability of the solutions we offer, which have never been sold as loss leaders, that fuels Corporate One’s strong business model. Consistent net interest income and profitable solutions combined with a high coverage ratio drove core earnings to more than $5.5 million in 2011. As a result, Corporate One continued to build reserves and undivided earnings (RUDE) to more than $36.7 million as of December 31, 2011. Continued growth in reserves is a key business strategy for Corporate One, and significant for our members, as it is RUDE that is the cushion that protects our members’ capital investment. The story behind these numbers points once again to our members coming together to choose Corporate One as their #1 partner. Proudly, we worked with member credit unions from across the country and brought on nearly 300 new contract offerings, such as ACH services, remote deposit capture, ATM/Debit and SimpliCD. Overall, share draft volumes remained steady in 2011 due to the addition of new credit union members. ACH volumes, especially origination, increased significantly in 2011 as a result of new business and an overall national upward trend in ACH as the preferred non-cash payment type. Remote deposit capture, such as our Automated Capture & Exchange (ACE) offering, also saw a substantial increase due to new business growth as well as the expansion in key strategic partnerships that enabled us to receive check image files from additional front-end systems. Further, as part of our mission to provide high quality solutions to credit unions, Corporate One introduced and improved key brokerage and correspondent solutions in 2011, such as expanding our investment offerings to include the Federated Mutual Fund and upgrading our domestic and international wire platforms to a single, streamlined system that includes several enhancements and more robust reporting. Continued year-over-year solution growth is one of the key strategies to Corporate One’s success, and one of the many reasons why we are an industry leader.
Northeast Member Spotlight Windsor Locks Federal Credit Union
Community Resource Federal Credit Union
Windsor Locks, Connecticut Assets: $49.7M
Latham, New York Assets: $65.3M
MidState Federal Credit Union Carteret, New Jersey Assets: $17.7M
GNC Community Federal Credit Union New Castle, Pennsylvania Assets: $70.6M
Eugene, Oregon
Carson City, Nevada
Denver, Colorado
Hollywood, California
West Spotlight With the conservatorship of some large corporate credit unions in the Western region of the U.S., Corporate One gained many new members from this area. Many credit unions that were looking for a financially strong, full service corporate credit union partner joined Corporate One. Thanks to our reputation as a conservatively run corporate credit union, we now serve 95 credit unions in this section of the country. 8
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Cooperative Roots Yield Purposeful Work As a corporate credit union, we pride ourselves for being more than just another vendor to our members; but rather a trusted partner who shares the same cooperative ideals, and who understands and honors the role of member/owner. Corporate One exists for the mutual benefit of our membership, and for those credit union foundations and organizations that work for the enduring success of our movement. We are a long-time partner of the World Council of Credit Unions and support the strengthening of the global cooperative movement. We are also an ardent supporter of the National Credit Union Foundation (NCUF). In 2011, we proudly took a bold step forward in assisting the NCUF in furthering its cause by partnering with them to create expanded investment options for their Community Investment Fund (CIF). The CIF is a unique investment vehicle that credit unions can leverage to support their state credit union foundation while also contributing to the primary funding mechanism for the NCUF’s national programs and grants. The Corporate One CIF option was created to allow all credit unions to easily participate, with no Corporate One capital or membership requirements. The program provides for free safekeeping and participating credit unions have the ability to choose which investment product is best for them. Since launching the program mid-year, we are pleased to be generating support for the NCUF and more than 10 state foundations through our CIF option. Corporate One is passionate about this program as we have held a significant investment in the CIF for years and are familiar with its successes and its meaningful impact on those in our movement. As a corporate credit union, “cooperative” is at the heart of who we are, and is the spirit in which we work with others to leverage opportunities for those within our industry.
West Member Spotlight Deluxe Laboratories Federal Credit Union
EWEB Employees Federal Credit Union
Hollywood, California Assets: $10.8M
Eugene, Oregon Assets: $20.9M
Greater Nevada Credit Union
Credit Union of Colorado
Carson City, Nevada Assets: $444.8M
Denver, Colorado Assets: $967.4M
Huntington, West Virginia Lexington, Kentucky
South Spotlight The southern region of the country has not been an area where Corporate One has traditionally served many credit unions. However, that’s about to change dramatically. With the pending merger of Southeast Corporate Federal Credit Union with Corporate One, Corporate One will potentially be serving an additional 400 credit union members. Currently, Corporate One serves 162 credit unions through membership and Alliance One in this region.
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Lake Jackson, Texas
Tampa, Florida
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A Look Forward The overwhelming capital support Corporate One members provided during our capital re-commitment campaign put us in a very favorable position to meet the new capital requirements governing our industry. In fact, Corporate One’s capital ratios now exceed all of the well-capitalized levels set forth by the NCUA, including meeting all Net Economic Value (NEV) ratios in both base- and stressed-case scenarios. We exceed the RUDE ratio required by 2016 as of today and exceed the permanent leverage ratio as well as the Tier 1 risk-based capital and Total risk-based capital ratios.* Because of our strong capital position and our ability to meet these ratios, Corporate One’s balance sheet is strong. And, a strong balance sheet means we can continue to grow our corporate and enhance the solutions we provide our members, like we’ll be doing in 2012 with our new ACH offering. December 31, 2011 RUDE ratio Interim leverage ratio
South Member Spotlight Texas Dow Employees Credit Union
Well Capitalized
1.18%
0.45%
Lake Jackson, Texas Assets: $1.7B
KUE Federal Credit Union Lexington, Kentucky Assets: $35.5M
Adequately Capitalized 0.45%
8.27%
5.00%*/7.00%**
4.00%
Tier 1 risk-based capital ratio
14.19%
6.00%
4.00%
Total risk-based capital ratio
20.90%
10.00%
8.00%
* Base Plus Expanded Authority Requirement. Under Base Plus, a 20% maximum decline in the Net Economic Value in the stress test required per Reg. 704 is permissible. ** Part I Expanded Authority. Under Part I, a 28% maximum decline in the Net Economic Value in the stress test required per Reg. 704 is permissible.
Also, due to the immense support of our members, Corporate One is in the unique position to expand through a merger with Southeast Corporate, if so approved by their members. For our current members, the merger will make us a more efficient and effective provider of payment, investment and liquidity solutions as well as a corporate that is better able to meet their future needs. As far as Southeast Corporate’s more than 400 members, a successful merger will preserve their capital and continue services, and while doing so, help our industry to avoid any further losses. The merged organization will effectively and efficiently serve credit unions thanks to a strong capital position, both in terms of ratios and actual dollars. It will be a “well,” not marginally, capitalized institution, meeting the required interim and permanent leverage ratios and exceeding all risk-based capital ratios under the new rule, just as Corporate One does today. Further, the combined balance sheet will be of sufficient size to provide much needed liquidity to the credit union system. With the potential addition of nearly 400 new members from Southeast Corporate, we expect efficiencies along with the growth potential inherent in combining the two corporates. The merger with Southeast Corporate presents a great opportunity for Corporate One to grow and become a financially stronger and more efficient operation with added solutions to offer our members and all credit unions, nationwide.
*See Regulatory Capital Position section beginning on page 18 for further details.
Suncoast Schools Federal Credit Union Tampa, Florida Assets: $4.9B
Universal Federal Credit Union Huntington, West Virginia Assets: $60.8M
Throughout the financial crisis, Corporate One operated competently and transparently on our members’ behalf, proving to be good stewards of their investments with us by effectively managing our corporate without any impairment of their capital dollars.
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Executive Leadership Corporate One Senior Management
Corporate One Board of Directors
Phillip R. Buell Secretary, Superior FCU
Jeffrey R. Meyer Three Rivers FCU
John J. Shirilla Treasurer, Best Reward CU
Robert D. Burrow Bayer Heritage FCU
Charles F. Plassenthal Dayton Firefighters FCU
Janice L. Thomas Vice Chair, PSE CU
Sonja J. Delaney Midwest Community FCU
R. Lee Powell, Jr. DESCO FCU
Melissa Ashley SVP and Chief Financial Officer
Tammy Cantrell SVP, Asset/Liability Management
Cheri Couture VP, Human Resources and Administration
Robert Coyan SVP, Marketing and Operations
Joe Ghammashi SVP and Chief Risk Officer
Kurt Lykins VP and Chief Technology Officer
With our members’ support, Corporate One holds more total regulatory capital account balances than any other corporate in the country, with more than $285.4 million as of December 31, 2011.
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Corporate One Financial Review Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Report from Supervisory Committee
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Report of Independent Auditors
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Financial Statements
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Notes to Financial Statements
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Management’s Discussion and Analysis of Financial Condition and Results of Operations
EXECUTIVE SUMMARY We began 2011 with regulatory changes that tested the ability of corporates across the nation to garner member support and raise capital to meet the new corporate capital requirements of the National Credit Union Administration (NCUA). We are proud to report that our members united in support of Corporate One and we have the greatest amount of regulatory capital of any corporate in the nation as of December 31, 2011. We ended the year with total regulatory capital account balances of $285.4 million. This is a $97.7 million, or a 52 percent increase from the prior year. There is strength in this number. First, this capital protects member shares and certificates. This is important because the Temporary Corporate Credit Union Share Guarantee Program (TCCUSGP) of the NCUA will expire at the end of 2012. This program was designed to provide stability to the credit union system during the financial crisis by guaranteeing all shares held at corporate credit unions. The NCUA no longer believes that this program is necessary and has not extended it past December 31, 2012. Our members’ shares and certificates are protected by our $285.4 million of capital. Secondly, this capital resulted in Corporate One exceeding all of the new capital requirements of the NCUA at the “well capitalized” level. Strong capital ratios are important for our members when they perform their due diligence of Corporate One. Additionally, we continue to grow and expand our membership; and new members cite our strong capital ratios as one of their requirements when looking for a corporate. Third, we believe that one of the fundamental reasons that corporates exist is to provide liquidity to their members when they need it. This important function can only be achieved if the corporate’s balance sheet can support it. With the balance sheet being limited by the amount of capital a corporate maintains, one can see why capital is so important for a corporate to be a liquidity provider. Our members understood this and supported us with the necessary capital so that we can provide them with liquidity when they need it. The NCUA’s new regulation, Part 704, focuses on the building of reserves and undivided earnings (RUDE) through earnings. In 2011, we reported net income of $1.8 million. Our core earnings, which exclude other-than-temporary impairment losses on securities, were $5.5 million for 2011. We started 2011 with a new regulation that changed our capital ratio requirements, as well as imposed new asset/ liability restrictions. As we navigated the transition to the new regulatory requirements, we were defensive in the management of our balance sheet in 2011. For example, we managed down our total balance sheet size somewhat to help ensure that we would meet our capital ratios. We also re-invested all cash flows from security maturities and paydowns into cash. Further, we raised Non-perpetual Capital Accounts (NCA) at an interest rate of 4 percent to ensure that we would meet our capital ratios and Net Economic Value (NEV) ratio requirements. All of these actions were important for us to ensure that we would meet the NCUA’s new regulatory requirements. However, lower levels of assets resulted in lower net interest income as compared to 2010. Additionally, as a greater percentage of our assets were in cash, we had pressure on our net interest margin. Also, while we are proud to be able to reward the members who participated in helping us raise $82.7 million of NCA, we knew that paying 4 percent on this new capital would contribute to lower net interest income in the short term. We firmly believe that there will be a time when we can be more offensive in our management style but 2011 was not the year. 2011 was a year to focus on the new regulation and ensure compliance. As compared to 2010, net service fee income was down due primarily to decreases in net income from brokerage services and our ATM/Debit product. We have been in the brokerage business since 1996 and have built a staff of registered representatives – two principals and five with Series 7 licenses. While demand for securities has increased significantly, demand for other types of investments – namely SimpliCD, has decreased from prior years. The margins on the products are different and the change in mix resulted in lower net service fee income from brokerage. We have seen shifting demand before and we stand ready to assist our credit unions with the best product for their needs. Over a year ago we revamped our ATM/Debit product to enhance the features and functionality and reduced the fees to our members. These changes position this product for growth in the future; however, they resulted in lower net service fee income for 2011.
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Our operating expenses were $17.0 million in 2011, an $880,000 increase from 2010. We are very focused on running our operations in an effective and efficient manner. In fact, in 2009 and 2010, we drove expenses to historically low levels. In 2011, we incurred increased expenses related to our capital raising efforts. Additionally, cost-of-living increases to employees resulted in an increase to salaries and benefits expense. In 2011, we incurred other-than-temporary impairment (OTTI) losses on securities of $3.8 million. Although this is down from $7.5 million in 2010, last year we had net gains on the sales of securities of $5.7 million which helped to offset the OTTI losses in 2010. This contributed to lower overall net income in 2011 as compared to 2010. Overall, we have seen improving trends in our private-label mortgage portfolio, with steadily decreasing OTTI each year. Table One provides selected financial information for the last five years. Table One: Selected Financial Information (Dollar amounts are in thousands) As of and for the year ended December 31, 2011 2010 2009 2008 2007 Net interest income $ 12,046 $ 18,714 $ 17,671 $ 28,029 $ 21,490 Net service fee income 10,498 11,394 12,817 12,596 10,524 Total operating expenses 17,047 16,167 15,143 19,125 16,819 CORE EARNINGS BEFORE NET GAIN (LOSS) 5,497 13,941 15,345 21,500 15,195 ON INVESTMENTS AND OTHER ITEMS Other-than-temporary impairment losses on securities (3,844) (7,534) (42,555) (43,383) Net gain (loss) on other investments 118 5,696 (15,137) (50,673) 549 NET INCOME (LOSS) $ 1,771 $ 12,103 $ (42,347) $ (72,556) $ 15,744 Average assets $ 3,109,653 $ 3,391,202 $ 3,852,818 $ 3,965,896 $ 3,809,373 Return on assets 0.06% 0.36% -1.10% -1.83% 0.41%
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Regulatory Capital Position On October 20, 2010, the NCUA published the final revisions to the NCUA Rules and Regulations, Part 704, in the Federal Register. The regulation contains a multi-step, multi-year phase-in of the new capital requirements. The new requirements generally took effect on October 20, 2011; however, certain definitions change over time as various requirements are phased in. The revisions establish a new capital framework including risk-based capital requirements. The old capital instruments, Paid-in Capital (PIC) and Membership Capital Shares (MCS), will be phased out and two new capital instruments were established. The new capital instruments are Perpetual Contributed Capital (PCC) and NCA. During 2011, we worked with our existing members to recommit their existing PIC and MCS by converting them to the new qualifying capital instrument, PCC. We also raised PCC from new members. Additionally, we offered our members the ability to invest in NCA. In addition to counting toward certain capital ratios, this new capital increased our NEV to a level that allows us to achieve the minimum regulatory NEV ratio of 2.0 percent. Our capital raising efforts in 2011 resulted in total regulatory capital account balances of $285.4 million at December 31, 2011, which is an increase of approximately $97.7 million, or 52 percent since December 31, 2010. Table Two provides the components of regulatory capital for the last five years. Table Two: Regulatory Capital (Dollar amounts are in thousands) For the year ended December 31, 2011 2010 2009 2008 2007 RUDE $ 36,781 $ 35,431 $ 23,648 $ 30,818 $ 104,171 PIC 20 25,332 25,682 25,682 25,682 PCC NCA
141,917
82,700
MCS TOTAL REGULATORY CAPITAL ACCOUNT BALANCES
24,023
126,924
119,990
116,278
98,388
285,441
187,687
169,320
172,778
228,241
Less amortized PIC, MCS and NCA
(24,119)
(4,781)
(1,625)
(366)
(9)
182,906 $
167,695 $
TOTAL REGULATORY CAPITAL
$
261,322
$
172,412 $
228,232
Table Three summarizes Corporate One’s capital ratios as of December 31, 2011, under the new regulation that became effective in October 2011. Corporate One exceeds all of the capital ratios at levels in excess of the well capitalized requirements. Additionally, the
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Net Interest Income Due to the new NCUA regulation and the new asset/liability restrictions and capital ratio requirements, we were defensive in the management of our balance sheet in 2011. For example, we managed down our average interest earning assets by $258.3 million to help ensure that we would meet our capital ratios. However, lower levels of assets resulted in lower net interest income as compared to 2010. We also reinvested all cash flows from security maturities and paydowns into cash. Figure One shows our steady increase in cash and cash equivalents and investments in financial institutions as compared to the decline in the par value of our securities portfolio over the last five years. With a greater percentage of our assets in cash versus higher yielding securities, the mix of assets resulted in pressure on our net interest margin. Further, we raised NCA at an interest rate of 4 percent to ensure that we would meet our capital ratios and NEV ratio requirements. We fully anticipated that paying 4 percent on this new capital would result in lower net interest income in the short term and it was necessary for us to issue this to meet the NCUA’s requirements. The new regulation also requires that a corporate’s total investment portfolio has a weighted average life of less than two years. This overall restriction on our investment portfolio has naturally translated into shorter term liabilities and shares. This factor, along with the current interest rate environment has resulted in a decrease in term shares from our members. We continue to be very competitive with our overnight share offerings, and balances held steady as a result.
Table Three: Capital Ratios
Regulatory Capital Minimums
December 31, 2011 Well Capitalized Adequately Capitalized RUDE ratio 1.18% 0.45% 0.45% Interim leverage ratio 8.27% 5.00%*/7.00%** 4.00% Tier 1 risk-based capital ratio 14.19% 6.00% 4.00% Total risk-based capital ratio 20.90% 10.00% 8.00% * Base Plus Expanded Authority Requirement. Under Base Plus, a 20% maximum decline in the Net Economic Value in the stress test required per Reg. 704 is permissible. ** Part I Expanded Authority. Under Part I, a 28% maximum decline in the Net Economic Value in the stress test required per Reg. 704 is permissible.
Figure One: Trended data for Cash and cash equivalents, Investments in financial institutions and Par value of securities $3,000 $2,500 $2,000 Millions
new regulation ensures that corporates focus on building RUDE by requiring an increasingly greater percentage of RUDE to total assets. With a RUDE ratio of 1.18 percent at December 31, 2011, Corporate One already exceeds the .45 percent required in October 2013 and the 1.00 percent required by regulation in October 2016. The NCUA also phased in the capital requirements by establishing an interim and a permanent leverage ratio. During our capital raising efforts, we focused on ensuring that we will meet the permanent leverage ratio which goes into effect in October 2013. The permanent leverage ratio only allows reserves and undivided earnings plus PCC to be counted in the numerator as compared to the interim leverage ratio, which allows all capital to be included. Although, not required at December 31, 2011, our permanent leverage ratio was 5.61 percent which exceeds the requirement of 5 percent to be well capitalized under the regulation.
$1,500 Investments in financial institutions
$1,000
Cash and cash equivalents
$500 $0 2011
2010
2009
2008
2007
Par value of securities
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overall net interest income was $12.0 million in 2011. Although this was a decrease from 2010, this was a year to focus on the new regulation and ensure compliance. We are satisfied with our efforts to successfully navigate the transition to the new NCUA regulation. Table Four provides more information on the composition of interest-earning assets, interest- and dividend-bearing liabilities and members’ share accounts and their weighted average rates. The resulting net interest margin of Corporate One for 2011 and 2010 is presented for comparison purposes. Table Four: Components of Net Interest Income (Dollar amounts are in thousands) 2011 2010 Average Interest or Average Average Interest or Balance Dividends Rate Balance Dividends
Average Rate
Interest-Earning Assets: Time deposits $ 186 $ 9 4.84% $ 259 $ 12 4.63% Asset-backed securities 947,900 10,241 1.08% 1,229,116 18,179 1.48% 79,595 661 0.83% 31,689 681 2.15% Government-sponsored enterprises Mortgage-related securities 369,757 8,833 2.39% 507,733 13,008 2.56% Cash and cash equivalents 1,491,131 3,664 0.25% 1,071,744 3,489 0.33% U.S. Central term deposits 129,729 1,214 0.94% 394,551 5,259 1.33% Other investments 224,060 2,170 0.97% 264,305 2,387 0.90% 4,180 115 2.75% 5,455 143 2.62% Loans to members Total Interest-Earning Assets $ 3,246,538 $ 26,907 0.83% $ 3,504,852 $ 43,158 1.23% Interest- and Dividend-Bearing Liabilities and Members’ Share Accounts: Overnight shares $ 2,380,179 $ 4,855 0.20% $ 2,341,347 $ 4,951 0.21% Term shares 504,333 6,388 1.27% 946,185 16,926 1.79% Membership capital shares 58,270 125 0.21% 122,318 376 0.31% Non-perpetual capital accounts 55,575 2,223 4.00% 31,164 1,270 4.08% 50,891 2,191 4.31% Other borrowings Total Interest- and Dividend- Bearing Liabilities and Members’ Share Accounts $ 3,029,521 $ 14,861 0.49% $ 3,460,741 $ 24,444 0.71% NET INTEREST INCOME $ 12,046 $ 18,714 NET INTEREST MARGIN 0.37% 0.53%
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Table Five provides a volume and rate analysis that further illustrates changes between 2011 and 2010 in the components of net interest income attributable to dollar volume (changes in volume multiplied by prior year’s rate), interest and dividend rates (changes in rates multiplied by the prior year’s volume) and the combined impact of dollar volume and interest and dividend rates (changes in volume multiplied by changes in rate). Table Five: Volume and Rate Variance Analysis (Dollar amounts are in thousands) 2011 versus 2010 Volume and Volume Rate Rate Total Interest-Earning Assets: Time deposits $ (3) $ 1 $ (2) Asset-backed securities (4,159) (4,900) $ 1,121 (7,938) 1,030 (418) (632) (20) Government-sponsored enterprises Mortgage-related securities (3,535) (879) 239 (4,175) Cash and cash equivalents 1,364 (855) (334) 175 U.S. Central term deposits (3,531) (1,567) 1,052 (4,046) Other investments (364) 173 (26) (217) (33) 7 (2) (28) Loans to members Total Interest-Earning Assets (9,231) (8,438) 1,418 (16,251) Interest- and Dividend-Bearing Liabilities and Members’ Share Accounts: Overnight shares 82 (175) (3) (96) Term shares (7,907) (4,937) 2,306 (10,538) Membership capital shares (197) (113) 59 (251) Non-perpetual capital accounts 2,223 2,223 (849) (117) 45 (921) Other borrowings Total Interest- and Dividend- Bearing Liabilities and Members’ Share Accounts (8,871) (5,342) 4,630 (9,583) DECREASE IN NET INTEREST INCOME $ (360) $ (3,096) $ (3,212) $ (6,668)
Management’s Discussion and Analysis of Financial Condition and Results of Operations
In order to attract and maintain share balances, our deposit products have to be competitive, and we differentiate ourselves by assigning our member credit unions to a specific Corporate One investment representative. Our investment representatives are licensed and able to understand the investment needs of our members. They are proactive in calling both members and prospective members to discuss their needs and communicate those needs to our product development team. Our product development team then works to arm our investment representatives with a variety of products to serve our member credit unions. In addition to our on-balance-sheet products, Corporate One is a co-broker of Primary Financial Company LLC (Primary Financial), enabling us to offer SimpliCD. SimpliCD allows credit unions to easily invest substantial amounts of funds in federally insured certificates of deposit. SimpliCD searches for the best rates and offers single transaction settlement. Credit unions may also issue share certificates through Primary Financial, providing them a source of liquidity. In addition to SimpliCD, our members have access to securities through a branch of Multi-Bank Securities, Inc. (MBS)* housed within Corporate One’s office. Through MBS, our members have access to the inventories of multiple broker/dealers’ institutional trading desks and receive very competitive pricing on the securities they buy and sell. Beyond the competitive pricing, we differentiate ourselves when it comes to selling securities by listening to credit unions and trying to find securities that fit their needs. Because we are also a credit union, we are keenly aware of the importance of complying with the investment stipulations set forth in the NCUA regulations. Therefore, we don’t just sell securities; we strive to find securities that comply with the NCUA regulations while meeting the needs of our members. Since SimpliCD and securities are both off-balance-sheet products, they contribute to service fee income instead of net interest income. However, it is important to mention them in the context of net interest income because these are examples of the investment alternatives we provide our members. We believe it is critical to offer a variety of investment products, enabling our member credit unions to diversify their portfolio and earnings potential. Service Fees In addition to providing a wide range of competitive investment products and brokerage services to meet our members’ needs, Corporate One also offers a complete line of correspondent services. Table Six below summarizes net service fee income for 2011 and 2010. Table Six: Net Service Fee Income (Dollar amounts are in thousands) 2011 2010 Percentage Change Brokerage $ 2,733 $ 3,235 -15.5% 2,943 3,045 -3.4% ACE ATM/Debit 1,462 2,280 -35.9% Share drafts 1,295 1,167 11.0% 782 721 8.5% ACH Settlement 604 566 6.7% 470 228 106.1% Vault services Other 209 152 37.5% NET SERVICE FEE INCOME $ 10,498 $ 11,394 -7.9%
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* All securities are offered through Multi-Bank Securities, Inc. (MBS). The home office of MBS is located at 1000 Town Center, Suite 2300, Southfield, MI 48075, (800) 967-9045. MBS is registered with the Securities and Exchange Commission (SEC) as a broker-dealer under the Securities Exchange Act of 1934. Member of FINRA and SIPC. Securities offered by MBS are not insured by the FDIC or NCUSIF and may lose their value.
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High liquidity levels at our member credit unions combined with a flight to safety during the recent financial crisis made the SimpliCD insured certificates a wildly popular investment. Additionally, financial institutions in need of deposits paid high rates to attract funds through these brokered certificates of deposits. These factors all contributed to record sales of SimpliCD certificates during the financial crisis. However, as financial institutions have recovered from the crisis and are not willing to pay as much for brokered certificates of deposits, demand for the SimpliCD product has slowed. This has resulted in lower net service fee income from brokerage in 2011 as compared to 2010. We have seen a significant increase in sales of securities to our member credit unions, as they are diversifying their investment portfolios. While we have experienced an increase in service fee income from the increased sales of securities, the net spread earned on security sales is not as great as the SimpliCD product. Overall, net service fee income related to our brokerage services continues to be a significant contributor to our net service fee income. Additionally, we believe it is important to offer credit unions a wide variety of choices when it comes to their investment needs. Volumes continue to increase year over year for Automated Capture & Exchange (ACE), our proprietary forward check collection product. However, more of the items processed fell into lower priced tiers resulting in lower net service fee income. We continue to utilize our least-cost-routing technology to drive down our clearing costs which helped to decrease our costs and offset some of the decrease in revenue. This least-cost-routing technology has been critical in that it allows us to provide our credit unions a valuable service at a very competitive price. In fact, since the time we began offering this service, we have decreased the pricing to our Partner member credit unions. Our ATM/Debit service continues to be an important service for our member credit unions and is a significant contributor to our net service fee income. In 2009, we announced an exciting new partnership with the premier credit union service provider for ATM/Debit and credit card solutions, PSCU Financial Services (PSCU). With PSCU, we can now offer our members a stronger ATM/Debit program, as well as a comprehensive suite of card solutions, including credit cards. As more and more consumers utilize electronic payments, we believe that this is a strategically important product. With the stronger program, our direct costs to provide this program have increased. However, we have not passed those costs on to our members and in fact, we have decreased our pricing for many of the services provided under this program. This has resulted in a lower overall margin for this product and contributed to the decrease in net service fees in 2011 compared to 2010. We believe we have positioned this product for growth in future years. Another significant service we offer our members is share draft services. Net revenue from our share draft services increased year over year, primarily due to decreased processing costs. As consumers move toward alternative payment methods, the number of checks being written continues to decrease each year. Accordingly, our actual gross revenue from this product decreased slightly from 2010 to 2011. However, due to increased electronic processing, we are realizing decreased costs. With declining volumes, we understand that it is important to focus on the most efficient way to provide this necessary service to our members. Additionally, the conversion to 100 percent electronic processing of share drafts allows Corporate One to provide services to any credit union in the country, significantly expanding our opportunity to generate additional business with this foundational service. With the trend in payments processing moving toward electronic payments, the volume of ACH activity we process continues to increase. Accordingly, year-over-year net revenue from our ACH services increased. Settlement services include domestic and international wires, national settlement and Federal Reserve pass-through charges. With the increase in new members and the transferring of their accounts to Corporate One, we have seen an increase in net service income related to settlement services year over year.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Providing cash and coin services is one of the most essential payment services a credit union can provide its members. In 2010, Corporate One partnered with a national provider to ensure our members have the most dependable, secure vault services program available. This program, while not only cost-effective for our members, has allowed for greater efficiencies in our own back-office operations. As such, net service income related to our vault services increased 106 percent over 2010. Operating Expenses Total operating expenses were $17.0 million in 2011, an increase of $856,000 or five percent relative to 2010. This increase in operating expenses over 2010 is related to cost-of-living increases in salary and benefits and increased travel and marketing expenses related to our 2011 capital raise efforts. Enterprise Wide Risk Management Corporate One is committed to managing the risks associated with our business activities and has maintained a formal risk management department for many years. We feel so strongly about managing risk that over six years ago we embarked on an initiative to deploy enterprise wide risk management (EWRM) throughout our entire organization. We believe that EWRM is critical not only to managing our risks, but to maximizing our value to our members. To that end, Corporate One has adopted the Committee of Sponsoring Organizations of the Treadway Commission (COSO) framework for EWRM as the structure for the governance of risk. Corporate One utilizes a core process risk assessment methodology to identify, categorize and mitigate its risk. We have an established EWRM Committee comprised of members of our Board of Directors, our Supervisory Committee and our senior management. The EWRM Committee is responsible for reviewing completed risk assessments and coordinating, in conjunction with the Supervisory Committee, the testing of controls over critical processes. They are also responsible for reporting the residual risks of Corporate One’s activities to the Board of Directors. The risks an organization takes should be balanced by the rewards. The Board of Directors ultimately uses the information from Corporate One’s EWRM Committee to determine if those residual risks are balanced by rewards or if the risks are too great and should be mitigated. Interestingly, during the revisions to the NCUA Regulation Part 704, the NCUA made it a requirement for all corporate credit unions to establish an EWRM committee responsible for reviewing the enterprise-wide risk management practices of the corporate credit union. Even though the NCUA does not require this until 2013, we have already incorporated EWRM into our culture, processes and expense structure here at Corporate One.
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We constantly monitor our members’ demands on our liquidity and evaluate the adequacy of our liquidity sources. To meet day-to-day member liquidity requirements, we keep a portion of our assets very liquid. In fact, as of December 31, 2011, we had approximately $1.7 billion in cash and cash equivalents and approximately $845.2 million in remaining borrowing capacity (total existing lines less borrowings outstanding). This is significant given our total balance sheet of $3.2 billion and settlement and regular shares of $2.6 billion.
Figure Two: Trended data on liquidity sources (Dollar amounts are in millions) $4,500 $4,000 $3,500 Millions
Liquidity Risk Management Liquidity risk is one of the most important risks that we manage. With every deposit we accept, we understand that we need to appropriately manage our liquidity to ensure our members have access to those funds when needed. Accordingly, we have certain daily liquidity management strategies that we employ, as well as more long term, overarching liquidity strategies.
$2,500
Cash and cash equivalents
$2,000 $1,500
Total assets
$1,000
Figure Two shows our available liquidity as compared to our total assets over the last five years.
$500 $0
2011
2010
2009
2008
2007
Figure Three: Trended data for Cash and cash equivalents compared to share balances (Dollar amounts are in millions) $3,000 $2,500 Millions
Additionally, we generally match our members’ term certificates against assets with similar cash flows and maturities. As a result, when a term certificate matures, there is also an asset maturing at about the same time, producing the necessary liquidity to meet our members’ needs. We are able to do this because members have historically held term certificates to maturity. A summary of our cash and cash equivalents in relation to our overnight and term share balances is shown on an annual basis in Figure Three.
Total borrowing capacity
$3,000
Cash and cash equivalents
$2,000 $1,500
Term shares
$1,000
Overnight shares
$500 $0
2011
2010
2009
2008
2007
Management’s Discussion and Analysis of Financial Condition and Results of Operations
We also mitigate our liquidity risk by monitoring our top depositors. We have limits on the maximum any one credit union may deposit with us. By striving to diversify our shares and member base, we shield ourselves from the risk of sudden withdrawals by large depositors. In fact, as of December 31, 2011, our single largest depositor represented only 7 percent of our total member shares. In addition, we strive to buy securities with readily determined market values that may be sold or borrowed against to generate liquidity. Should we need to generate liquidity, we have diversified sources of funds and we test these sources often to ensure availability. As noted earlier, Corporate One’s remaining borrowing capacity at December 31, 2011, was approximately $845.2 million. We maintain a line of credit with the Federal Home Loan Bank of Cincinnati (FHLB) of approximately $133.2 million. This line of credit is secured by certain investments held in safekeeping at the FHLB. Corporate One’s remaining borrowing capacity at the FHLB was approximately $113.2 million at December 31, 2011. In addition, we maintain a reverse repurchase agreement with another party totaling $500.0 million. This agreement is secured using certain of our asset-backed securities as collateral and we have recently tested this source to ensure that it represents a viable liquidity source. Also, we maintain $55.0 million of federal funds lines with various financial institutions. The federal funds lines do not require collateral for overnight borrowing. To further strengthen our liquidity position, we elected to voluntarily hold Reg D reserves in order to gain access to the Federal Reserve Discount Window. Previously, as a bankers’ bank, we were unable to access the Federal Reserve Discount Window. By changing our status with the Federal Reserve Bank, we have the potential to access the ultimate backstop for liquidity. In August 2011, we were granted Primary credit with the Federal Reserve Bank. Primary credit is available to generally sound deposit institutions on a very short term basis, typically overnight, at a rate above the Federal Open Market Committee’s (FOMC) target rate for federal funds. All extensions of credit must be secured to the satisfaction of the lending Reserve Bank by collateral that is acceptable for that purpose. Corporate One’s borrowing capacity at the Federal Discount Window was approximately $177.0 million at December 31, 2011. Although Corporate One’s on-balance-sheet loan portfolio is small, we have total outstanding advised lines, committed lines and letter of credit commitments to members of approximately $1.4 billion at December 31, 2011. All outstanding line of credit commitments are collateralized by specific or general pledges of assets by members. Commitments to extend credit to members remain effective as long as there is no violation of any condition established in the agreement. Advances on these commitments generally require repayment within one year of the advance. Since a portion of the commitments is expected to terminate without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Credit Risk Management Another material risk that we manage is credit risk. One way we mitigate credit risk is by actively managing our balance sheet to ensure that it is well diversified. We purchase investments based on high credit ratings, as assigned by Nationally Recognized Statistical Rating Organizations (NRSROs), or issued by agencies of the U.S. government or by other regulated depository institutions. Corporate One’s portfolio diversification as of December 31, 2011 is shown in Table Seven by rating. Securities with ratings differing between NRSROs are classified using the lowest credit rating.
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Table Seven: Investment Portfolio Diversification (Dollar amounts are in thousands) As of December 31, 2011 U.S. Net Central Cash and Total Unrealized Term Cash Book Gain Agency AAA AA A Below A Deposits Other Equivalents Value (Loss) Total U.S. Central* $ 12,283 $ 37,250 $ 49,533 $ 49,533 Deposits with other financial institutions Loans to members
1,685,264 1,685,264 1,685,264 $ 7,825
Federal Home Loan Bank-Cincinnati 15,702 Certificates of deposit Mortgage-related securities
$ 62,915 $
Government-sponsored enterprises
16,434
3,989 $ 11,167
$ 16,984 $ 248,597
78,179
7,825
7,825
15,702
15,702
16,434
16,434
343,652 $ (80,674) 262,978
78,179
317
78,496
Asset-backed securities: Student loan Credit card Auto
122,923 141,497 60,567 246,070 571,057 (88,800) 482,257 253,775 58,178 311,953 2,605 314,558 58,651 46,996 11,655 12 58,663
Corporate debt
TOTAL BOOK VALUE
89,920
15,000
189,658
141,094 427,683 249,057 225,649 509,667
Net unrealized gain (loss) TOTAL
84,738
392
(8,833)
(8,680)
$ 141,486 $ 418,850 $ 240,377
(3,135) 186,523
12,283 39,961 1,722,514 3,327,908 $ (169,675) $ 3,158,233
(17,288) (135,266) (169,675)
$ 208,361 $ 374,401 $ 12,283 $ 39,961 $ 1,722,514 $ 3,158,233
*Amounts held at U.S. Central are 100 percent guaranteed by the NCUA through December 31, 2012.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
As shown in Table Seven, our portfolio remains well diversified. Eighty-three percent of the book value of our portfolio is in cash and cash equivalents, agencies, securities rated “A” or higher and U.S. Central term deposits. Corporate One does not have any investments in structured investment vehicles (SIVs), collateralized debt obligations (CDOs) or commercial mortgage-backed securities. Corporate One’s mortgage-related securities have a book value of approximately $343.7 million at December 31, 2011, which represents only 10 percent of the book value of our total investable portfolio. Of Corporate One’s mortgage-related securities, 19 percent of these securities are issued by agencies of the U.S. government or are rated AAA by at least one rating agency. The book value of our sub-prime mortgages comprises only 2.3 percent of the book value of our total investable portfolio. During 2011, we received principal repayments on our mortgage-related securities of $92.9 million, of which $56.4 million related to non-agency mortgages. Table Eight details the book value of Corporate One’s investment in residential mortgage-backed and home equity asset-backed securities as of December 31, 2011. Table Eight: Mortgage-Related Securities (Dollar amounts are in thousands) As of December 31, 2011 Agency AAA AA A Below A Total Prime collateral $ 585 $ 585 Near-prime collateral* $ 961 $ 5,473 107,528 113,962 $ 3,989 8,405 9,754 53,466 75,614 Sub-prime collateral** Agency $ 62,915 62,915 Insured 1,801 1,757 87,018 90,576 TOTAL BOOK VALUE 62,915 3,989 11,167 16,984 248,597 343,652 Net unrealized gain (loss) TOTAL
74 $
62,989
*Based on the definition used in offering circulars **Based on 600 or lower FICO scores
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(788) $
3,201
$
(1,439) 9,728
(3,457) $ 13,527
$
(75,064) 173,533
(80,674) $
262,978
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A portion of Corporate One’s securities have insurance coverage to further support the senior classes in the event of deteriorating collateral performance. The insurance coverage provided by the monoline insurers increases the existing credit enhancement provided to the senior class owned by Corporate One. The monoline insurance companies that insure Corporate One bonds are: Syncora Guarantee Inc. (SGI), Financial Guaranty Insurance Company (FGIC), Assured Guaranteed Municipal (AGM), MBIA, Inc. (MBIA) and Ambac Assurance Corporation (AAC). SGI and FGIC stopped paying claims in April 2009 and November 2009, respectively. As a result, Corporate One has recorded OTTI charges on all securities that were dependent upon SGI and FGIC for the payment of future principal and interest claims. Beginning in July 2010, SGI resumed the payment of claims; however, accounting rules do not allow for immediate reversals of prior OTTI taken. Corporate One has placed reliance on AGM and MBIA. These insurers are currently paying principal and interest claims timely and management believes they will continue to pay future claims. However, deterioration of these monoline insurers could result in additional OTTI charges. Corporate One has 15 bonds that are insured by AAC, a subsidiary company of Ambac Financial Group, Inc. One of the bonds is a student loan asset-backed security and the remaining 14 bonds are mortgage-backed securities. The underlying borrowers are making principal and interest payments, so we only require support from AAC to cover shortfalls. We receive an analysis from a third party consultant on a monthly basis to help us quantify our expected losses on the mortgage-backed securities. Due to the economic downturn that began in 2007, claims made against AAC for principal shortfalls on insured bonds escalated to a point where its ability to pay on such claims was in question. On March 24, 2010, the Ambac Financial Group, Inc.’s Board of Directors voted to create a segregated account and consented to rehabilitation of that account by the Wisconsin Office of the Commissioner of Insurance (OCI), AAC’s primary regulator. Under Wisconsin law, the segregated account is treated as a separate insurer from AAC. All of Corporate One’s AAC-insured bonds have been allocated to the segregated account by OCI. OCI has implemented a temporary moratorium on claims payments to segregated account policyholders to provide a measured transition into rehabilitation and to conserve claims-paying resources while the plan of rehabilitation is finalized. Through this plan, the segregated account policies should receive a combination of cash and interest-bearing surplus notes in consideration for claims made. On October 8, 2010, OCI, as the rehabilitator of the segregated account, filed the final plan of rehabilitation of the segregated account. While the overall aspects of this final plan were largely consistent with the one filed in March 2010, the final plan included detailed financial projections that provide a range of potential outcomes for policyholders. The plan calls for 25 percent of claims to be paid in cash and 75 percent in surplus notes. The detailed financial projections show recoveries on the surplus notes ranging from 100 percent in the best scenario to 45 percent in the most stressful scenario. Therefore, according to OCI’s estimates, even in the most stressful scenario the ultimate recovery on policy claims would be 58.75 percent (the result of 100 percent recovery on the 25 percent paid in cash and 45 percent recovery on the 75 percent paid in surplus notes). OCI has made available a copy of the plan and other valuable information regarding the segregated account at http://www.Ambacpolicyholders.com. On January 24, 2011, the OCI’s motion for confirmation of the final rehabilitation plan was granted and the plan was confirmed by State of Wisconsin’s Circuit Court for Dane County (the Court). While the rehabilitation plan for the segregated account was approved, no payments or surplus notes have been issued to the segregated account policyholders. During 2011, the rehabilitator for the segregated account disclosed that amendments to or modifications of the rehabilitation plan are possible, however, no specific timeline or deadline were given.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
We continue to believe ultimate recovery on policy claims to be between 100 percent and 58.75 percent as originally presented in the final rehabilitation plan. However, recent financial statements of AAC and the segregated account lead us to believe that our recovery may be lower than our originally projected 75 percent. Therefore, we adjusted our reliance from 75 percent to 67 percent beginning in December 2011. Through December 31, 2011, we have recorded $1.9 million in OTTI charges on AAC-insured bonds. We are currently placing reliance on AAC to cover $3.8 million of expected principal shortfalls on our AAC-insured bonds. Should the rehabilitator make amendments to the plan of rehabilitation that have an adverse effect on the segregated account or if there is further deterioration of AAC or the underlying insured securities, it could result in additional OTTI charges. Table Nine details our mortgage and non-mortgage securities by monoline insurer at December 31, 2011. Table Nine: Securities by Monoline Insurer (Dollar amounts are in thousands) As of December 31, 2011 Amortized Net Unrealized Monoline Insurer Par Value Cost Fair Value Losses FGIC $ 46,111 $ 36,693 $ 29,151 $ (7,542) MBIA 36,042 36,042 28,762 (7,280) AAC 28,557 27,415 18,869 (8,546) SGI 6,877 6,118 3,803 (2,315) AGM 1,801 1,801 1,761 (40) Total $ 119,388 $ 108,069 $ 82,346 $ (25,723)
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Insurer Rating S&P Moody’s NR B NR NR AA-
WR B3 WR Ca A1
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Market/Spread Risk Because we invest in securities, we are also exposed to market risk due to liquidity and credit spreads. When the credit crisis that began in 2007 became a liquidity crisis, it resulted in a severe dislocation in the global credit markets, which caused all credit-related securities to experience deterioration in spreads and, hence, in fair values. Massive government programs were instituted over the last several years, to try to help bring liquidity back into the markets. Accordingly, we have seen fair values improve and the net unrealized losses on our securities have decreased since the trough in 2008. The reduction in the net unrealized losses in our mortgage-related portfolio is also due to the recognition of losses through OTTI charges.
Figure Four: OTTI charges by year $45.0 $40.0 $35.0 Millions
For securities where we believe not all principal and interest will be received, OTTI charges were recorded. The charges, which represent the estimated credit losses, are determined by calculating the difference between the discounted cash flows of the securities and their current amortized cost. Since 2008, we have recorded total OTTI, or expected credit losses, of $61.8 million. As seen in Figure Four, the majority of these OTTI charges were recorded in 2009.
$25.0 $20.0 $15.0 $10.0 $5.0 $0.0
Figure Five illustrates the improving trend of the net unrealized losses on our securities.
2011
2010
2009
2008
Figure Five: Net Unrealized Losses trend
$0 -$100 -$200 Millions
Approximately 48 percent of Corporate One’s mark-to-market adjustment in our available-for-sale portfolio at December 31, 2011 is related to residential mortgage-backed and home equity assetbacked securities. However, the remaining amount of our unrealized losses is related to asset classes outside of the mortgage sector, primarily student loan asset-backed securities. Every student loan position we hold is graded an A or better by at least one NRSRO. We hold Federal Family Education Loan Program (FFELP)-backed student loan securities as well as private-issue student loans securities. We believe the unrealized losses in this sector are related to illiquidity and are not due to a lack of creditworthiness. We believe the unrealized losses on our mortgagerelated securities are the result of historically high defaults, delinquencies and loss severities on mortgages underlying the mortgage-related securities, as well as the deterioration of liquidity due to an imbalance between the supply and demand for these securities. For both our student loan asset-backed and our mortgage-related securities, we expect the fair value to recover as the securities approach their maturity date or as the credit markets stabilize.
$30.0
-$300 -$400 -$500 -$600
2011
2010
2009
2008
2007
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Interest Rate Risk Management When members deposit funds with us, we can invest those funds in a variety of securities that closely match the duration and re-pricing characteristics of the underlying deposit, resulting in minimal mismatch. For our overnight liabilities that re-price daily, we generally invest such deposits in investments that re-price every one to three months or sooner. We generally match fixed-rate liabilities that mature in excess of one month with fixed-rate securities that have the same or approximately the same maturity. As a result of the way we manage our balance sheet, when interest rates move, the value of our floating-rate assets and liabilities does not fluctuate significantly. Movements in interest rates do affect our fixed-rate securities; however, there is typically a corresponding change in the value of the deposits matched against those fixed-rate securities. Our primary interest-rate risk-measurement tool is a NEV test. NEV is defined as the fair value of assets less the fair value of liabilities (excluding unamortized MCS and NCA). The purpose of the NEV test is to determine whether Corporate One has sufficient capital to absorb potential changes to the market value of our assets and liabilities given sudden changes in interest rates. As the credit crisis that began in 2007 became a liquidity crisis, the fair values of many of our securities have experienced declines, which put significant downward pressure on our NEV and NEV ratio. Although liquidity began to return to the market in 2010 and 2011, uncertainty in certain sectors – in particular mortgage-backed securities and student loan asset-backed securities has continued to weigh on the fair values of such securities. Because the NEV incorporates the unrealized losses on our available-for-sale securities that are due to uncertainty regarding liquidity and credit, it is losing some of its value as a tool to measure interest rate risk. Currently, the NEV and NEV ratio are more reflective of market/spread risk. Throughout this time, the fundamentals of how we manage interest rate risk have not changed.
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During 2011, due to the changes in the NCUA Regulation Part 704, we raised a significant amount of regulatory capital. Total regulatory capital as of December 31, 2011 was $261.3 million, which was an increase of $78.4 million or 43 percent compared to December 31, 2010. In addition to counting toward certain capital ratios, the new capital raised increased our NEV to a level that allowed us to surpass the minimum regulatory NEV ratio of 2.0 percent. Accordingly, beginning in April 2011 and continuing through December 31, 2011, we exceed the required NEV ratio in both the base case scenario as well as the 300 basis points (bps) stress scenario. NEV scenarios are performed monthly, testing for sudden and sustained increases or decreases in interest rates of 100, 200 and 300 bps. A summary of Corporate One’s NEV calculation as of December 31, 2011 and 2010 is shown in Table Ten. Table Ten: Net Economic Value Calculation (Dollar amounts are in thousands) Actual Dollar Net Economic Value NEV Ratio Change from Base As of December 31, 2011 * 300 bps rise in rates $ 70,359 2.21% $ (19,358) Base scenario $ 89,717 2.82% As of December 31, 2010 * 300 bps rise in rates $ (3,787) -0.13% $ (12,071) Base scenario $ 8,284 0.29% * 300, 200 and 100 bps decline did not apply in the interest rate environment present on December 31, 2011 and 2010. Operational Risk Management Corporate One provides a variety of products and services to our members and is reliant upon the ability of our employees and systems to process a large number of transactions. Accordingly, Corporate One is exposed to a variety of operational risks, including errors and omissions, business interruptions, improper procedures, and vendors that do not perform in accordance with outsourcing arrangements. These risks are less direct than credit and interest rate risk, but managing them is critical, particularly in a rapidly changing environment with increasing transaction volumes. In the event of a breakdown or improper operation of systems or improper procedures, we could suffer financial loss and other damage, including harm to our reputation. To mitigate and control operational risk, Corporate One developed comprehensive policies and procedures designed to provide a sound and well-controlled operational environment. All critical vendor relationships are reviewed on an annual basis and a financial analysis of our major business partners is completed. Corporate One also engages an accounting firm to perform periodic internal audit procedures on the internal controls of Corporate One. This firm reports on such procedures to Corporate One’s Supervisory and EWRM Committees and Board of Directors. Additionally, business continuity plans exist and are tested for critical systems, and redundancies are built into the systems as deemed appropriate.
Corporate One Supervisory Committee
Report from the Supervisory Committee Corporate One’s 2011 financial statements, prepared by management, were audited in accordance with auditing standards generally accepted in the United States of America by Crowe Horwath LLP, independent auditors. Crowe Horwath’s report on Corporate One’s financial statements is included within this annual report.
Bill Allender BMI FCU
Arthur D. Boehm The Ohio Educational CU
In addition to the annual audit, Schneider Downs & Co., a Public Accounting Firm, has been contracted by the Supervisory Committee to perform internal audits of select processes, controls and systems of Corporate One, and report quarterly on such procedures to the Supervisory Committee. Based on the annual audit and internal audit procedures, the Supervisory Committee is confident that Corporate One is subjected to a thorough and professional examination process.
Fritz Comes Directions CU
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R. Lee Powell, Jr. (Board Liaison) DESCO FCU
35
Report of Independent Auditors
Supervisory Committee and Board of Directors Corporate One Federal Credit Union Columbus, Ohio We have audited the accompanying balance sheets of Corporate One Federal Credit Union (“Corporate One”) as of December 31, 2011 and 2010, and the related statements of income, changes in members’ equity and cash flows for the years then ended. These financial statements are the responsibility of Corporate One’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our report dated March 14, 2011, we expressed an opinion that the December 31, 2010, financial statements did not fairly present the financial position and cash flows in conformity with accounting principles generally accepted in the United States of America because of a departure from such principles. Corporate One had reported share accounts as equity in the balance sheet and statement of changes in members’ equity that should be reported as liabilities. As described in Note 2(r), Corporate One has changed its method of accounting for these items and restated its December 31, 2010 financial statements to conform with accounting principles generally accepted in the United States of America. Accordingly, our present opinion on the December 31, 2010, financial statements, as presented herein, is different from that expressed in our previous report. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Corporate One Federal Credit Union as of December 31, 2011 and 2010, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
Columbus, Ohio March 22, 2012
Crowe Horwath LLP
Balance Sheets
December 31, 2011 Assets Cash and cash equivalents $ Investments in financial institutions Available-for-sale securities, at fair value Held-to-maturity securities (fair value 2011 – $1,723,539, 2010 - $2,370,191) Loans to members Accrued interest receivable Other assets
2010 (Restated)
1,722,514,098 $ 44,419,300 1,381,105,445
895,130,835 394,262,519 1,566,582,966
2,369,572 7,824,722 2,110,647 18,775,348
1,265,564 4,284,418 2,452,336 17,102,498
TOTAL ASSETS $ 3,179,119,132 $ 2,881,081,136 Liabilities and Members’ Equity (Deficit) Liabilities: Settlement and regular shares $ 2,566,605,020 $ 2,203,542,892 Share certificates 472,911,927 602,175,946 Membership capital shares 24,022,540 126,923,896 Non-perpetual capital accounts 82,700,000 Borrowed funds 20,000,000 50,000,000 Dividends and interest payable 1,442,957 1,856,118 Accounts payable and other liabilities 2,393,240 2,169,830 TOTAL LIABILITIES 3,170,075,684 Members’ equity (deficit): Paid-in capital 20,000 Perpetual contributed capital 141,917,275 Reserves and undivided earnings 36,780,976 Accumulated other comprehensive loss (169,674,803) TOTAL MEMBERS’ EQUITY (DEFICIT) TOTAL LIABILITIES AND MEMBERS’ EQUITY (DEFICIT) $
36
See accompanying notes to financial statements.
9,043,448
2,986,668,682
25,331,996 35,431,056 (166,350,598) (105,587,546)
3,179,119,132 $ 2,881,081,136
37
Statements of Income
Year ended December 31, 2011
2010
Interest income: Investments and securities $ 26,791,871 $ 115,450 Loans to members
43,015,326 142,965
TOTAL INTEREST INCOME 26,907,321 Dividend and interest expense: Share accounts 13,591,453 1,270,093 Other borrowings
43,158,291
TOTAL DIVIDEND AND INTEREST EXPENSE 14,861,546 NET INTEREST INCOME 12,045,775 SERVICE FEE INCOME, NET 10,497,529 Net loss on investments: Total other-than-temporary impairment losses (31,525,736) Portion of loss recognized in other comprehensive income 27,681,787
24,443,958
Net impairment losses recognized in earnings Net gain on sales of securities
22,252,640 2,191,318
18,714,333 11,393,658
(38,562,409) 31,027,762
(3,843,949)
(7,534,647)
118,053
5,696,214
TOTAL NET LOSS ON INVESTMENTS (3,725,896) Operating expenses: Salaries and employee benefits 10,137,514 Office operations and occupancy expense 5,641,197 Other operating expenses 1,268,198
(1,838,433)
TOTAL OPERATING EXPENSES NET INCOME
17,046,909
16,166,656
1,770,499 $
12,102,902
See accompanying notes to financial statements.
$
9,523,705 5,713,816 929,135
Statements of Changes in Members’ Equity Balance at January 1, 2010
Paid-In Capital $
Perpetual Contributed Capital
25,681,996
Reserves and Undivided Earnings $
23,648,496
Accumulated Other Comprehensive Loss $
Total Members’ Equity (Restated)
(255,742,755) $ (206,412,263)
Comprehensive income (loss): Net income 12,102,902 Other comprehensive income: Change in net unrealized loss on available-for-sale securities 87,553,724 Reclassification adjustment recognized in earnings for other- than-temporary declines in values of securities 7,534,647
12,102,902 87,553,724 7,534,647
Reclassification adjustment recognized in earnings for gain from sales of securities (5,696,214) (5,696,214) Comprehensive income 101,495,059 Release of paid-in capital due to liquidation of member credit union (350,000) (350,000) Dividends on paid-in capital (320,342) (320,342) Balance at December 31, 2010 $ 25,331,996 $ 35,431,056 $ (166,350,598) $ (105,587,546) Comprehensive income (loss): 1,770,499 Net income Other comprehensive income: (7,050,101) Change in net unrealized loss on available-for-sale securities
(7,050,101)
3,843,949
Reclassification adjustment recognized in earnings for other-than-temporary declines in values of securities
3,843,949
1,770,499
Reclassification adjustment recognized in earnings for gain from sale of a security (118,053) (118,053) Comprehensive LOSS (1,553,706) Conversion of paid-in capital to perpetual contributed capital (25,311,996) $ 25,311,996 Conversion of membership capital shares to perpetual contributed capital 101,805,421 101,805,421 Issuance of perpetual contributed capital, 14,799,858 14,799,858 net of issuance costs ($72,070) Dividends on perpetual contributed capital and paid-in capital (420,579) Balance at December 31, 2011 $ 20,000 $ 141,917,275 $ 36,780,976 $ (169,674,803) $
38
See accompanying notes to financial statements.
(420,579) 9,043,448
39
Statements of Cash Flows
Year ended December 31, 2011
Year ended December 31, 2010
Cash flows from operating activities: Net income $ 1,770,499 $ 12,102,902 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 1,050,324 1,175,058 Net accretion (3,786,484) (7,288,115) Net impairment losses on investments 3,843,949 7,534,647 Net gain on sales of securities (118,053) (5,696,214) Net gain on disposals of assets (41,462) (17,499) Net change in accrued interest receivable 341,689 3,249,550 Net change in dividends and interest payable (413,161) (5,574,664) Other, net 370,911 26,061
NET CASH PROVIDED BY OPERATING ACTIVITIES 3,018,212 5,511,726 Cash flows from investing activities: Net change in investments in financial institutions 349,843,219 234,236,017 Available-for-sale securities: Sales 10,012,500 168,794,864 Maturities and principal pay downs 266,671,609 457,866,241 Purchases (96,763,714) (123,991,024) Held-to-maturity securities: Maturities and principal paydowns 264,642 487,947 Net change in loans to members (3,540,304) 2,580,709 Net change in NCUA share insurance deposit (9,672) (71,438) Net purchase of property and equipment (1,941,932) (612,772) Proceeds from sale of property and equipment 47,250 17,499 NET CASH PROVIDED BY INVESTING ACTIVITIES 524,583,598 739,308,043 Cash flows from financing activities: Net change in borrowed funds (30,000,000) Change in shares and deposits 232,702,174 (512,440,243) Release of membership capital shares and paid-in capital due to liquidation of member credit union (900,000) Issuance of non-perpetual capital accounts 82,700,000 Issuance of perpetual contributed capital, net of issuance costs 14,799,858 Dividends on paid-in capital and perpetual contributed capital (420,579) (320,342) NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 299,781,453 Net increase in cash and cash equivalents 827,383,263 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 895,130,835
(513,660,585) 231,159,184 663,971,651
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 1,722,514,098 $ 895,130,835 Supplemental disclosure: Dividends on share accounts and interest paid $ 15,695,286 $ 30,338,964 Conversion of MCS and PIC to PCC
See accompanying notes to financial statements.
$
127,117,417
Notes to Financial Statements
(Table dollar amounts in thousands)
(1) Organization The purpose of Corporate One Federal Credit Union (Corporate One) is to foster and promote the economic well-being, growth and development of our membership base through fiscally responsible and effective funds management, along with loan, investment, and correspondent services for the ultimate benefit of our credit union members. Corporate One’s national field of membership includes state- and federally chartered credit unions and other credit union organizations throughout the United States. Corporate One’s Board of Directors is composed of executive management from Corporate One’s member credit unions. (2) Summary of Significant Accounting Policies The following is a description of the more significant accounting policies Corporate One follows in preparing and presenting our financial statements. (a) Use of Estimates The accounting and reporting policies of Corporate One conform with accounting principles generally accepted in the United States of America (GAAP) and prevailing practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Specifically, management has made assumptions in estimating the fair value of financial instruments, the assessment of other-than-temporary impairment and the amortization/accretion of premiums/discounts on investments subject to prepayment. Actual results could differ from those estimates. (b) Cash and Cash Equivalents Cash and cash equivalents include cash, amounts due from depository institutions, overnight amounts at U.S. Central and federal funds sold. Net cash flows are reported on the accompanying statements of cash flows for loans, shares and certain other items. To further diversify our liquidity options, we have elected to voluntarily hold Reg D reserves in order to gain access to the Federal Reserve Discount Window. Accordingly, Corporate One is required to maintain cash or deposits with the Federal Reserve Bank. At December 31, 2011, cash held prior to month-end was sufficient; therefore, no reserve was required. The required amount at December 31, 2010 was $152.0 million. (c) Investments in Financial Institutions Investments in financial institutions are carried at cost and reviewed for impairment. These investments consist of interest-bearing term deposits primarily in U.S. Central and other federally insured depository institutions, and Federal Home Loan Bank (FHLB) of Cincinnati stock. Corporate One is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income. (d) Securities Debt securities are classified as held-to-maturity and carried on the balance sheet at amortized cost when management has the positive intent and ability to hold them to maturity. Debt securities are classified as available-for-sale when they might be sold before maturity. Available-for-sale securities are carried on the balance sheet at fair value. Unrealized gains and losses on available-for-sale securities are
40
41
excluded from earnings, and are reported as a separate component of members’ equity. Such securities may be sold in response to changes in interest rates, changes in prepayment risk or other factors. Amortization of premiums and accretion of discounts are recorded as adjustments to interest income from securities using the interest method. Realized gains and losses on the sale of available-for-sale securities are credited or charged to earnings when realized based on the specific-identification method. Management evaluates securities for other-than-temporary impairment (OTTI) on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the statement of income and 2) OTTI related to other factors, which is recognized in other comprehensive income (loss). The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. (e) Loans to Members Loans to members consist of settlement loans, demand loans and term loans. Loans are stated at the current principal amount outstanding. Interest income is accrued on the daily balance outstanding at the borrowing rate. Corporate One evaluates each member’s creditworthiness on a case-by-case basis. Loans are generally collateralized by member’s share accounts and other member assets. An allowance for loan losses was not considered necessary at December 31, 2011 and 2010, based on management’s continuing review and evaluation of the loan portfolio and its judgment as to the effect of economic conditions on the portfolio. The evaluation by management includes consideration of past loan loss experience, changes in the composition of the loan portfolio, the current financial condition of the borrower, quality of the collateral and the amount of loans outstanding. Corporate One incurred no loan losses in either 2011 or 2010, and considers no loans impaired as of, or during the years ended December 31, 2011 and 2010. (f) Property and Equipment Property and equipment, included in other assets on the balance sheets, are stated at cost net of accumulated depreciation. Depreciation is computed using the straight-line method and is based on the estimated useful lives of the assets. Maintenance and repairs are expensed as incurred. (g) Internal Use Software Corporate One capitalizes certain costs for software that is internally developed for use in the business. Development costs generally include salaries and benefits of employees or consultants involved in the development, coding, testing and related project management of software intended for internal use. Costs are capitalized when the development stage begins until the software is substantially complete and ready for its intended use. During 2011 and 2010, capitalized costs related to internally developed software were $252,000
Notes to Financial Statements
(Table dollar amounts in thousands)
and $302,000, respectively. Amortization begins when the software is ready for service and continues on the straight-line method over the estimated useful life of the software. (h) Income Taxes Corporate One is exempt from federal and state income tax pursuant to Section 501(c)(1) of the Internal Revenue Code and Section 122 of the Federal Credit Union Act, respectively. (i) Financial Instruments and Concentrations of Credit Risk Financial instruments that potentially subject Corporate One to concentrations of credit risk consist of federal funds sold, securities purchased under agreements to resell (repurchase), deposits and capital investments at U.S. Central and investment securities. Corporate One invests in and borrows from highly rated domestic banks, and uses nationally recognized broker/dealers in the execution of trades for financial instruments. Exposure to individual counterparties or asset classes may be significant. Corporate One’s exposure to U.S. Central is discussed in Note 3 and investment securities in Note 4. Additionally, in providing financial services solely to the credit union industry, Corporate One is dependent upon the viability of that industry and the industry’s support of corporate credit unions. Corporate One mitigates risks related to these concentrations through thorough evaluation of credit quality of the assets it purchases and the creditworthiness of its business partners. Counterparty risk is managed by ensuring that market counterparties are institutions of high credit quality and appropriate levels of collateral are maintained, if necessary. (j) Members’ Capital Share Accounts Credit unions transacting business with Corporate One are required to be a Partner member or an Associate member. Partner members enjoy Corporate One’s most favorable rates on their investments and enjoy the lowest fees on settlement services. Associate members may earn lower rates than Partner members on their investments with Corporate One and pay fees on settlement services with Corporate One according to the Associate member fee schedules. Additionally, certain products and services, such as committed lines of credit and fee-free advised lines of credit, are available to Partner members only. On October 20, 2010, the National Credit Union Administration (NCUA) published the final revisions to the NCUA Rules and Regulations, Part 704, the rule governing corporate credit unions, in the Federal Register. The revisions establish a new capital framework including riskbased capital requirements. The old capital instruments, Paid-In Capital (PIC) and Membership Capital Shares (MCS), will be phased out and two new capital instruments are established. The new capital instruments are Perpetual Contributed Capital (PCC) and Non-perpetual Capital Accounts (NCA). PCC is required for Partner membership in Corporate One. During 2011, Corporate One offered its Partner members the opportunity to convert their MCS and/or PIC to PCC in order to continue to be considered Partner members of Corporate One. In addition, Corporate One offers PCC to new members and Associate members who want to invest in PCC to become Partner members of Corporate One. PCC is defined in Part 704.2 as accounts or other interests of a corporate credit union that: are perpetual, non-cumulative dividend accounts; are available to cover losses that exceed retained earnings, PIC and MCS; are not insured by the National Credit Union Share Insurance Fund (NCUSIF) or other share or deposit insurers; and cannot be pledged against borrowings. PCC is classified as equity in the financial statements. During 2011, Corporate One offered its members the opportunity to purchase a five year term NCA. The offering was open to all members
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43
who converted their MCS and/or PIC to PCC and Associate members who converted to Partner status by purchasing PCC. This offering resulted in $82.7 million of NCA and the offering for NCA is now closed. NCA is defined in Part 704.2 as funds contributed by members or nonmembers that: are term certificates with an original minimum term of five years or that have an indefinite term with a minimum withdrawal notice of five years; are available to cover losses that exceed retained earnings, PIC, MCS and PCC; are not insured by the NCUSIF or other share or deposit insurers; and cannot be pledged against borrowings. NCA is classified as a liability in the financial statements. Previously, MCS was required for Partner membership in Corporate One. MCS do not have a stated maturity. Notice of intent by the Partner member to de-capitalize is required and once notification is given, the shares will be redeemed in three years. These shares are not subject to share insurance coverage by the NCUSIF and are available to cover losses that exceed retained earnings and PIC. MCS are classified as a liability in the financial statements and are being phased out. As of October 21, 2011, all remaining MCS not already on notice were automatically put on notice by Corporate One as required by the final revisions to Regulation Part 704. At December 31, 2011 and 2010, there were $24.0 million and $10.2 million of shares on notice, respectively. PIC is investments by member credit unions and denote their ownership interest in Corporate One. PIC has no stated maturity date. Notice of intent to de-capitalize by the Partner member is required and once notification is given, the shares are redeemed in 20 years. PIC earns dividends that are non-cumulative, is not subject to share insurance coverage by the NCUSIF and is available to cover losses that exceed retained earnings. PIC is classified as equity in the financial statements and is being phased out. As of October 21, 2011, all PIC not already on notice was automatically put on notice by Corporate One as required by the final revisions to Regulation Part 704. At December 31, 2011 and 2010, there was $20,000 and $375,000 of shares on notice, respectively. (k) Reserves and Undivided Earnings Reserves and undivided earnings (RUDE) represent earnings not distributed as dividends to members. Portions of earnings are set aside as reserves in accordance with Corporate One’s policy and the NCUA’s rules and regulations. (l) Comprehensive Income (Loss) Comprehensive income (loss) consists of net income and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on available-for-sale securities. Comprehensive income (loss) also includes non-credit losses on available-forsale and held-to-maturity securities related to other-than-temporary impairment. (m) Service Fees Service fees are earned on various services provided to credit unions and their affiliates. These services include ACH and ATM/Debit programs, depository services, share draft processing, and certificate of deposit and securities brokering. Revenue is recognized in the period in which services are rendered. Gross service fee income for the years ending December 31, 2011 and 2010, was $17.0 million and $18.0 million, respectively. Revenues on the accompanying statements of income are reduced by third-party costs incurred to provide these services. These third-party costs were $6.5 million and $6.6 million for the years ended December 31, 2011 and 2010, respectively. (n) Loss Contingencies Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there currently are such matters that will have a material effect on the financial statements.
Notes to Financial Statements
(Table dollar amounts in thousands)
(o) Reclassifications Certain reclassifications have been made in the prior year’s financial statements to conform to the presentation for the year ended December 31, 2011. These reclassifications had no impact on net income (loss). (p) Subsequent Events Management has performed an analysis of activities and transactions subsequent to December 31, 2011, to determine the need for any adjustments to and/or disclosures within the audited financial statements for the year ended December 31, 2011. Management has performed such analysis through March 22, 2012. (q) Regulatory Pronouncements On October 20, 2010, the NCUA published the final revisions to the NCUA Rules and Regulations, Part 704, the rule governing corporate credit unions, in the Federal Register. The major revisions involve corporate credit union capital, investments, asset/liability management, governance and credit union service organization (CUSO) activities. The new regulation establishes a new capital framework, including risk-based capital requirements; imposes new prompt corrective action requirements; places various new limits on corporate investments; imposes new asset/liability management controls; amends some corporate governance provisions; and limits a corporate CUSO to categories of services pre-approved by the NCUA. Most of the new investment prohibitions and other credit and asset/liability management requirements were effective January 18, 2011. The NCUA recognized that some corporates may hold investments that are in violation of one or more of these new prohibitions and have directed such corporates to follow the investment action plan provisions of the NCUA Rules and Regulations Part 704.10. Corporate One holds securities that do not meet certain requirements of the new regulation. During this time of transition to the new investment prohibitions, Corporate One is adhering to Part 704.10 and has filed the required Investment Action Plans (IAP) with the NCUA. In a letter dated March 22, 2012, the NCUA confirmed that they have permitted Corporate One to hold non-compliant securities under a number of IAP. The NCUA also stated that as of March 22, 2012, they do not intend to require Corporate One to sell any securities. The new capital requirements went into effect October 20, 2011. The new Regulation Part 704 defined new capital instruments and set forth a process for phasing out MCS and PIC. It also established new capital ratio requirements. These requirements are discussed more specifically in Note 12. Restatement Related to Classification of Members’ Share Accounts (r) GAAP requires savings accounts to be classified as liabilities. In fact, the American Institute of Certified Public Accountants published a guide opining that credit union’s savings accounts should be classified as liabilities, which is “consistent with the prevailing practice of mutually owned savings and loan associations and savings banks”. We believe that credit unions are fundamentally dissimilar to mutually owned savings and loan associations and savings banks, which, for example, accept deposits from the general public and usually are not democratically controlled by their members. As a result, we have historically classified members’ share accounts as equity to denote the ownership interest of the members. This classification previously conformed to the regulatory requirements of the NCUA. However, with the final revisions to Regulation Part 704.15, the NCUA explicitly stated
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45
that corporate credit unions must follow GAAP. Accordingly, beginning in 2011, we have classified members’ share accounts as liabilities. To present comparable financial statements, we restated the accompanying 2010 Balance Sheet and Statement of Changes in Members’ Equity. This restatement in 2010 increased total liabilities and decreased members’ equity by $2.9 billion. (3) Investments in Financial Institutions Investments in financial institutions at December 31 are summarized as follows:
2011
2010
U.S. Central: Share certificates
$
9,615
$
313,902
Other shares
2,668
14,458
Federal Home Loan Bank stock
15,702
15,702
Certificates of deposit
16,434
50,200
TOTAL INVESTMENTS IN FINANCIAL INSTITUTIONS
$
44,419
$
394,262
On January 29, 2009, the NCUA Board approved the Temporary Corporate Credit Union Share Guarantee Program (TCCUSGP), under which the NCUSIF guaranteed member shares in excess of the $250,000 share insurance already provided. On March 20, 2009, in accordance with the Federal Credit Union Act, the NCUA placed U.S. Central into conservatorship and appointed itself as conservator. On April 21, 2009, the NCUA approved revisions to the TCCUSGP. The revised TCCUSGP extended the share guarantee and allows the NCUA the option for quarterly extensions, as deemed necessary. Certificates issued under the revised TCCUSGP are guaranteed only if they have a maturity of two years or less. Existing certificates issued under the original TCCUSGP guarantee are covered under the original guarantee until the guarantee expires, or the maturity of the certificate, whichever occurs first. U.S. Central is participating in the share guarantee program. During 2010, the revised TCCUSGP was extended by the NCUA to December 31, 2012. Pursuant to a Congressional amendment of the Federal Credit Union Act that established the Temporary Corporate Credit Union Stabilization Fund (TCCUSF) – a separate fund under the control of the NCUA – in June 2009, the NCUA legally transferred the obligation to pay claims under the TCCUSGP to the TCCUSF. All share certificates we hold at U.S. Central mature during 2012. All U.S. Central share certificates held as of December 31, 2011, are guaranteed by the NCUA and therefore not considered impaired. Other shares consist of an account in which U.S. Central directs the associated dividends to the National Credit Union Foundation Community Investment Fund (CIF). Funds can be withdrawn from this account upon demand.
Notes to Financial Statements
(Table dollar amounts in thousands)
Corporate One also maintains overnight and federal funds accounts at U.S. Central, which are classified as cash and cash equivalents in the accompanying balance sheets. At December 31, 2011 and 2010, overnight and federal funds at U.S. Central totaled $37.2 million and $614.9 million, respectively. These funds are fully guaranteed by the NCUA. All shares and certificates with U.S. Central are pledged under our advised line of credit agreement as further discussed in Note 7. As a member of the FHLB of Cincinnati, Corporate One is required to own a certain amount of stock based on its level of borrowings and other factors. Corporate One views its investment in the FHLB as a long term investment. Accordingly, when evaluating for impairment, the value is determined based on the ultimate recovery of the par value rather than recognizing temporary declines in value. Based on our review of the financial condition of the FHLB of Cincinnati, Corporate One does not believe that its investment in the FHLB was impaired as of or for the year ended December 31, 2011. As of December 31, 2011, certificates of deposit are all with domestic banks. As of December 31, 2010, Corporate One had certificates of deposit with both domestic banks and the FHLB of Cincinnati. The certificates through the domestic banks are all within the insurance limits as set forth by the Federal Deposit Insurance Corporate (FDIC). Certificates of deposit by maturity at December 31, 2011, are summarized as follows: Year of Maturity
Balance
2012
$
2,490
2013
13,944
$
16,434
TOTAL CERTIFICATES OF DEPOSIT
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47
(4) Securities The amortized costs and fair values of securities at December 31 are summarized as follows: 2011 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses
Fair Value
Available-for-sale securities: Government-sponsored enterprises $ 78,179 $ 317 $ 78,496 Corporate debt securities 189,658 241 $ (3,376) 186,523 338,724 869 (78,985) 260,608 Mortgage-related securities Asset-backed securities 941,661 4,729 (90,912) 855,478 TOTAL AVAILABLE-FOR-SALE SECURITIES $ 1,548,222 $ $ (173,273) $ 1,381,105 6,156 Amortized Cost Gross Unrecognized Gains Gross Unrecognized Losses Fair Value Held-to-maturity securities: Mortgage-related securities $ 2,370 $ 31 $ (677) $ 1,724 TOTAL HELD-TO-MATURITY SECURITIES $ 2,370 $ 31 $ (677) $ 1,724 2010
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Fair Value
Available-for-sale securities: Government-sponsored enterprises $ 81,288 $ 530 $ (1) $ 81,817 Corporate debt securities 192,757 172 (1,381) 191,548 423,469 585 (81,381) 342,673 Mortgage-related securities Asset-backed securities 1,031,494 7,056 (88,005) 950,545 TOTAL AVAILABLE-FOR-SALE SECURITIES $ 1,729,008 $ 8,343 $ (170,768) $ 1,566,583 Amortized Cost Gross Unrecognized Gains Gross Unrecognized Losses Fair Value Held-to-maturity securities: Mortgage-related securities $ 1,266 $ 1,104 $ 2,370 TOTAL HELD-TO-MATURITY SECURITIES $ 1,266 $ 1,104 $ 2,370
Notes to Financial Statements
(Table dollar amounts in thousands)
Proceeds from the sale of an available-for-sale security were $10.0 million in 2011. A gross gain of $118,000 was recorded on the security sale during 2011. Proceeds from the sale of available-for-sale securities were $168.8 million in 2010. Gross gains of $5.7 million and gross losses of $6,000 were recorded on securities during 2010. Mortgage-related securities consist of: private-label mortgage-backed securities, mortgage-backed securities issued by Fannie Mae or Freddie Mac and asset-backed home equity securities. Asset-backed securities consist primarily of securitized credit card, student loan and automobile receivables. The expected distributions of securities at December 31, 2011, are reflected in the following table. Because the actual lives of mortgage-related securities, certain asset-backed securities, and investments in government-sponsored entities can differ from contractual maturities due to call or prepayment features, these items are presented separately with their related expected weighted average lives (WAL).
Available-for-Sale Held-to-Maturity Amortized Cost Fair Value WAL Amortized Cost Fair Value WAL Securities with contractual maturities: Due in one year or less $ 413,280 $ 413,514 Due after one year through five years 101,372 98,956 Due after five years through 10 years 56,946 58,673 Securities with prepayment features: Residential mortgage-backed securities: Agency 62,915 62,989 3.07 Non-agency 275,809 197,616 4.74 $ 2,370 $ Asset-backed securities 629,708 540,921 5.15 Government-sponsored enterprises 8,192 8,436 0.48 TOTAL $ 1,548,222 $ 1,381,105 $ 2,370 $
1,724
4.24
1,724
Certain securities are pledged as collateral to secure certain lines of credit with financial institutions. See Note 7 for further details. At December 31, 2011, approximately 87 percent of the par value amount, or $1.4 billion, of Corporate One’s securities, with a fair market value of $1.2 billion, were variable-rate securities, the majority of which had interest rates that reset monthly or quarterly, predominantly based upon LIBOR. Of these variable-rate securities, 11 percent of the par value amount, or $156.3 million of such securities, with a fair market value of $115.0 million, had interest rate caps that were fixed at the time of issuance and the caps range from 7 percent to 18 percent. Approximately 2.9 percent of the dollar amount of variable-rate securities had interest rate caps that fluctuate depending on the resetting of the interest rate on the underlying collateral of the security.
48
49
The gross unrealized and unrecognized losses on investment securities that have been in loss positions less than 12 months and longer than 12 months at December 31 are summarized as follows:
2011
Less Than 12 Months
12 Months or Longer
Fair Value
Fair Value
Unrealized Losses
Total
Unrealized Losses
Fair Value
Unrealized Losses
Available-for-sale: Corporate debt securities $ 54,911 $ (88) $ 46,634 $ (3,288) $ Mortgage-related securities 34,849 (95) 207,527 (78,890) Asset-backed securities 88,323 (157) 510,434 (90,755) TOTAL AVAILABLE-FOR-SALE 178,083 (340) 764,595 (172,933)
942,678
Fair Value
Fair Value
Unrecognized Losses
Fair Value
Unrecognized Losses
101,545 $ (3,376) 242,376 (78,985) 598,757 (90,912) (173,273) Unrecognized Losses
Held-to-maturity: Mortgage-related securities 1,182 (677) 1,182 (677) TOTAL HELD-TO-MATURITY 1,182 (677) 1,182 (677) TOTAL TEMPORARILY $ 179,265 $ (1,017) $ 764,595 $ (172,933) $ 943,860 $ (173,950) IMPAIRED SECURITIES
2010
Less Than 12 Months
Fair Value
Unrealized Losses
12 Months or Longer Fair Value
Unrealized Losses
Total Fair Value
Unrealized Losses
Available-for-sale: Government-sponsored enterprises $ 69,972 $ (1) $ 69,972 $ (1) Corporate debt securities $ 158,214 $ (1,381) 158,214 (1,381) Mortgage-related securities 17,165 (53) 304,553 (81,328) 321,718 (81,381) 24,888 (5) 624,822 (88,000) 649,710 (88,005) Asset-backed securities TOTAL TEMPORARILY IMPAIRED SECURITIES
$
112,025
$
(59)
$ 1,087,589
$ (170,709)
As of December 31, 2010, there were no gross unrecognized losses on the held-to-maturity securities.
$ 1,199,614
$ (170,768)
Notes to Financial Statements
(Table dollar amounts in thousands)
Corporate One believes the decline in fair values of our corporate debt and asset-backed securities are primarily attributable to the deterioration of liquidity and larger risk premiums in the market consistent with the broader credit markets and are not a result of the performance of the underlying collateral or credit quality supporting the securities. Management believes the unrealized losses on the mortgage-related securities are the result of historically high defaults, delinquencies and loss severities on mortgages underlying the mortgage-related securities, as well as the deterioration of liquidity due to an imbalance between the supply and demand for these securities. We expect the fair value to recover as the securities approach their maturity date or as the credit markets stabilize. Corporate One does not intend to sell nor is it more likely than not that we will be required to sell these securities prior to a price recovery or maturity. Accordingly, Corporate One determined that there was no additional other-than-temporary impairment of its securities at December 31, 2011, above the $3.8 million recorded in the accompanying statements of income. The new NCUA Rules and Regulations Part 704 contain new investment prohibitions and other credit and asset liability management requirements. These new requirements became effective January 18, 2011. The NCUA recognized that some corporates may hold investments that are in violation of one or more of these new prohibitions and have directed such corporates to follow the investment action plan provisions of the NCUA Rules and Regulations Part 704.10. Corporate One holds securities that do not meet certain requirements of the new regulation. During this time of transition to the new investment prohibitions, Corporate One is adhering to Part 704.10 and has filed the required IAP with the NCUA. In a letter dated March 22, 2012, the NCUA confirmed that they have permitted Corporate One to hold non-compliant securities under a number of IAP. The NCUA also stated that as of March 22, 2012, they do not intend to require Corporate One to sell any securities. At December 31, 2011, 1.9 percent of our gross unrealized losses is related to corporate debt securities. Our corporate debt holdings represent seven securities, three of which were rated AA, three rated A, and one was split-rated A/BBB by Nationally Recognized Statistical Rating Organizations (NRSRO). Unrealized losses on asset-backed securities represent 52.5 percent of our gross unrealized losses at December 31, 2011. The amortized costs, fair values, credit grades and WAL of asset-backed securities at December 31, 2011, are summarized as follows: Gross Gross Highest Lowest Amortized Unrealized Unrealized Credit Credit Cost Fair Value Gain Loss Grade Grade WAL Student loans: FFELP* $ 387,350 $ 313,474 $ (73,876) AAA BB 7.17 Private 183,707 168,781 $ 1,693 (16,619) AAA BB 2.40 Credit cards 311,953 314,559 2,985 (379) AAA A 1.61 58,651 58,664 51 (38) AAA AA 0.47 Automobiles ASSET-BACKED SECURITIES $ 941,661 $ 855,478 $ 4,729 $ (90,912) *Federal Family Education Loan Program
50
51
Of the approximately 101 asset-backed securities we own that are not mortgage related, 69 of those bonds are dual rated A or better. The remaining 32 had at least one rating of BBB or below. We continue to receive principal and interest payments on these securities. Due to the large unrealized losses in our student loan portfolio, Corporate One hired an independent third party consultant to evaluate the portfolio for estimated credit losses. The consultant reported no credit losses in their base or stressed case scenarios as of December 31, 2011. The remaining 45.6 percent of the gross unrealized losses on available-for-sale securities at December 31, 2011, is related to residential mortgage-backed securities and home equity asset-backed securities. The amortized costs, fair values and credit grades of mortgage-related securities at December 31, 2011, are summarized as follows: Gross Gross Highest Lowest Amortized Unrealized Unrealized Credit Credit Cost Fair Value Gain Loss Grade Grade Government-sponsored enterprises $ 62,915 $ 62,990 $ 373 $ (298) Private: Prime collateral 585 583 (2) A CC Near-prime collateral* 109,033 78,894 491 (30,630) AAA D 52,026 (23,589) AAA C Sub-prime collateral** 75,615 Insured 90,576 66,115 5 (24,466) AAA D MORTGAGE-RELATED SECURITIES $ 338,724 $ 260,608 $ 869 $ (78,985) *Based on the definition used on offering circulars ** Based on 660 or lower FICO score At December 31, 2011, of the approximately 152 mortgage-related available-for-sale securities we own, 24 were rated D by at least one NRSRO. In addition to these 24, we determined another 30 available-for-sale mortgage-related securities to be other-than-temporarily impaired. Twenty-six of those bonds are dual rated between CCC and C. The remaining 4 had at least one rating of BB or above. A portion of Corporate One’s securities have insurance coverage to further support the senior classes in the event of deteriorating collateral performance. The insurance coverage provided by the monoline insurers increases the existing credit enhancement provided to the senior class owned by Corporate One. The monoline insurance companies that insure Corporate One bonds are: Syncora Guarantee Inc. (SGI), Financial Guaranty Insurance Company (FGIC), Assured Guaranteed Municipal (AGM), MBIA, Inc. (MBIA) and Ambac Assurance Corporation (AAC). SGI and FGIC stopped paying claims in April 2009 and November 2009, respectively. As a result, Corporate One has recorded OTTI charges on all securities which were dependent upon SGI and FGIC for the payment of future principal and interest claims. Beginning in July 2010, SGI resumed the payment of claims. However, accounting rules do not allow for immediate reversals of prior OTTI taken. Corporate One has placed reliance on AGM and MBIA. These insurers are currently paying principal and interest claims timely and management believes they will continue to pay future claims. However, deterioration of these monoline insurers could result in additional OTTI charges.
Notes to Financial Statements
(Table dollar amounts in thousands)
Corporate One has 15 bonds that are insured by AAC, a subsidiary company of Ambac Financial Group, Inc. One of the bonds is a student loan asset-backed security and the remaining 14 bonds are mortgage-backed securities. The underlying borrowers are making principal and interest payments, so we only require support from AAC to cover shortfalls. We receive an analysis from a third party consultant on a monthly basis to help us quantify our expected losses on the mortgage-backed securities. Due to the economic downturn that began in 2007, claims made against AAC for principal shortfalls on insured bonds escalated to a point where its ability to pay on such claims was in question. On March 24, 2010, the Ambac Financial Group, Inc.’s Board of Directors voted to create a segregated account and consented to rehabilitation of that account by the Wisconsin Office of the Commissioner of Insurance (OCI), AAC’s primary regulator. Under Wisconsin law, the segregated account is treated as a separate insurer from AAC. All of Corporate One’s AAC-insured bonds have been allocated to the segregated account by OCI. OCI has implemented a temporary moratorium on claims payments to segregated account policyholders to provide a measured transition into rehabilitation and to conserve claims-paying resources while the plan of rehabilitation is finalized. Through this plan, the segregated account policies should receive a combination of cash and interest-bearing surplus notes in consideration for claims made. On October 8, 2010, OCI, as the rehabilitator of the segregated account, filed the final plan of rehabilitation of the segregated account. While the overall aspects of this final plan were largely consistent with the one filed in March 2010, the final plan included detailed financial projections that provide a range of potential outcomes for policyholders. The plan calls for 25 percent of claims to be paid in cash and 75 percent in surplus notes. The detailed financial projections show recoveries on the surplus notes ranging from 100 percent in the best scenario to 45 percent in the most stressful scenario. Therefore, according to OCI’s estimates, even in the most stressful scenario the ultimate recovery on policy claims would be 58.75 percent (the result of 100 percent recovery on the 25 percent paid in cash and 45 percent recovery on the 75 percent paid in surplus notes). OCI has made available a copy of the plan and other valuable information regarding the segregated account at http://www.Ambacpolicyholders.com. On January 24, 2011, the OCI’s motion for confirmation of the final rehabilitation plan was granted and the plan was confirmed by State of Wisconsin’s Circuit Court for Dane County (the Court). While the rehabilitation plan for the segregated account was approved, no payments or surplus notes have been issued to the segregated account policyholders. During 2011, the rehabilitator for the segregated account disclosed that amendments to or modifications of the rehabilitation plan are possible, however, no specific timeline or deadline were given. We continue to believe ultimate recovery on policy claims to be between 100 percent and 58.75 percent as originally presented in the final rehabilitation plan. However, recent financial statements of AAC and the segregated account lead us to believe that our recovery may be lower than our originally projected 75 percent. Therefore, we adjusted our reliance from 75 percent to 67 percent beginning in December 2011. Through December 31, 2011, we have recorded $1.9 million in OTTI charges on AAC-insured bonds. We are currently placing reliance on AAC to cover $3.8 million of expected principal shortfalls on our AAC-insured bonds. Should the rehabilitator make amendments to the plan of rehabilitation that have an adverse effect on the segregated account or if there is further deterioration of AAC or the underlying insured securities, it could result in additional OTTI charges.
52
53
The following table details our exposure to each monoline insurer for mortgage and non-mortgage securities at December 31, 2011: Monoline Insurer
Par Value
Amortized Cost
Fair Value
FGIC $ 46,111 $ 36,693 $ MBIA 36,042 36,042 AAC 28,557 27,415 SGI 6,877 6,118 1,801 1,801 AGM TOTAL $ 119,388 $ 108,069 $
29,151 28,762 18,869 3,803 1,761
I nsurer Rating S&P NR B NR NR AA-
Moody’s WR B3 WR Ca A1
82,346
In order to determine if the declines in fair value below amortized cost represented OTTI, management considered various impairment indicators such as: securities on our internal watchlist, securities that have had ratings downgrades, securities that have been underwater for greater than 12 months and securities that have severe unrealized losses. We also utilize outside services to assist management in performing detailed cash flow analyses to determine if all principal and interest cash flows will be received. The analyses performed required assumptions about the collateral underlying the securities, including default rates, loss severities on defaulted loans and prepayments. It is possible that the underlying loan collateral of these securities may perform at a level worse than our expectations, which may result in adverse changes in cash flows for these securities and potential OTTI writedowns in the future. For the securities where we believe not all principal and interest will be received, OTTI charges were recorded. As of December 31, 2011, we had 56 mortgage-related securities (54 available-for-sale and two held-to-maturity securities) that were considered other-thantemporarily impaired. These securities had a total par value of approximately $198.7 million at December 31, 2011. The estimated credit losses of $3.8 million during the year ended December 31, 2011, recognized in the accompanying statements of income, are a calculation of the difference between the discounted cash flows of the securities with OTTI and their current amortized cost. Total other-than-temporary impairment recognized in accumulated other comprehensive income was approximately $27.7 million for available-for-sale securities for December 31, 2011. In 2010, we had 58 mortgage-related securities that were considered other-than-temporarily impaired. These securities had a par value at December 31, 2010, of approximately $224.4 million. OTTI charges, during the year ended December 31, 2010, equal to the difference between the discounted cashflows and their current amortized cost for these securities, totaled $7.5 million. Total other-than-temporary impairment recognized in accumulated other comprehensive income was approximately $28.8 million and $2.2 million for available-for-sale securities and held-to-maturity securities for December 31, 2010.
Notes to Financial Statements
(Table dollar amounts in thousands)
The following table details losses, both net impairment losses recognized in earnings and accumulated other comprehensive income (loss), as of and for the years ended December 31, 2011 and 2010.
Net Impairment Losses Recognized in Earnings for the Year Ended December 31, 2011
Accumulated Other Comprehensive Income (Loss) as of December 31, 2011
Net Impairment Losses Recognized in Earnings for the Year Ended December 31, 2010
Accumulated Other Comprehensive Income (Loss) as of December 31, 2010
Available-for-sale securities: Corporate debt securities $ (3,135) $ Mortgage-related securities – $ 3,844 (47,852) $ 7,221 other-than-temporarily impaired Mortgage-related securities – temporarily impaired (30,264) Government-sponsored enterprises 317 Asset-backed securities (86,183) TOTAL AVAILABLE-FOR-SALE SECURITIES 3,844 (167,117) 7,221 Held-to-maturity securities: Mortgage-related securities – other-than-temporarily impaired (2,558) 313 TOTAL HELD-TO-MATURITY (2,558) 313 SECURITIES TOTAL $ 3,844 $ (169,675) $ 7,534 $
(1,209) (50,565) (30,231) 529 (80,949) (162,425)
(3,926) (3,926) (166,351)
Through December 31, 2010, we had total cumulative principal shortfalls of approximately $11.0 million on 22 securities. In 2011, we had an additional $6.5 million in principal shortfalls, resulting in total cumulative principal shortfalls of $17.5 million on 30 securities through December 31, 2011. Of these 30 securities, 11 are insured by FGIC and four are insured by AAC. We had anticipated these principal shortfalls and had taken OTTI charges on these securities previously.
54
55
The following table details cumulative credit losses on other-than-temporarily impaired debt securities for the periods ended December 31, 2011 and 2010. Cumulative Credit Losses on Debt Securities 2011 2010 Cumulative credit losses on debt securities previously recognized in earnings at January 1, $ (57,526) $ (50,342) Credit losses recognized in earnings on debt securities not previously determined to be other-than-temporarily impaired (2,693) Additional credit losses recognized in earnings on debt securities previously determined to be other-than-temporarily impaired (3,844) (4,841) Reductions due to sales of securities 205 Reduction due to increases in expected cash flows 146 145 CUMULATIVE CREDIT LOSSES ON DEBT SECURITIES PREVIOUSLY RECOGNIZED IN EARNINGS AT DECEMBER 31, $ (57,526) $ (61,224) (5) Equity Investments Investments in non-marketable equity securities, which are included in other assets in the accompanying balance sheets, at December 31, are summarized as follows:
2011
Primary Financial Company LLC
$
2010 2,064
$
1,666
Processing Alliance LLC
78
83
eDoc Innovations, Inc.
2,041
2,059
4,183
3,808
TOTAL EQUITY INVESTMENTS
$
$
Notes to Financial Statements
(Table dollar amounts in thousands)
Corporate One has a 9.76 percent investment in Primary Financial Company LLC (Primary Financial). Primary Financial is a corporate CUSO and brokers non-negotiable and negotiable certificates of deposit. This investment meets the criteria outlined in FASB ASC 272-10-05-05-3, Limited Liability Entities, and is accounted for using the equity method. Our investment in Primary Financial was 6.72 percent during 2010. Our total units owned has not changed, however during 2011 Primary Financial redeemed units from liquidated/conserved corporates. As a result, there are fewer outstanding units of Primary Financial. Accordingly, our ownership percentage has increased to 9.76 percent at December 31, 2011. Corporate One’s portion of Primary Financial’s current period net income or loss, recognized as a component of service fee income in the accompanying statements of income, was $398,000 and $436,000 in 2011 and 2010 respectively. Corporate One is a co-broker of Primary Financial and, as such, earns a spread on certificates placed by Corporate One. Corporate One recognized income of $475,000 in 2011 and $768,000 in 2010 on the certificates placed by Corporate One. Corporate One also earns additional spreads on certificates it places, as well as royalties on certificates placed by other co-brokers. These additional spreads and royalties represent additional consideration related to Corporate One’s sale of Primary Financial in 2003. The additional spread earned on certificates Corporate One placed were $238,000 in 2011 and $384,000 in 2010. These additional spreads continue through 2015. In February 2010, because of certain other rights exercised, Corporate One no longer earns royalties on certificates placed by other co-brokers. Corporate One recognized $110,000 in 2010 related to royalties on certificates placed by other co-brokers. All such spreads and royalties are included as a component of net service fee income in the accompanying statements of income. Corporate One performs accounting and marketing services for Primary Financial under a support services contract. The contract is a oneyear contract with provisions for automatic annual renewals. Corporate One recognized, as a component of net service fee income in the accompanying statements of income, $193,000 in 2011 and $185,600 in 2010 related to this agreement. Corporate One owns 50 percent of Processing Alliance LLC (Processing Alliance). Processing Alliance is a corporate CUSO that holds certain contracts for the purpose of being able to “white-label” and re-market services of Corporate One. Corporate One does not have a majority voting interest and does not maintain a controlling interest in Processing Alliance. This investment, therefore, is accounted for using the equity method. This company was formed in December 2006 to provide forward cash collection services as well as other services to credit unions. Corporate One’s portion of Processing Alliance’s current period net loss, recognized as a component of service fee income in the accompanying statements of income, was a loss of $5,400 and $5,200 in 2011 and 2010, respectively. Corporate One has an approximately 28 percent investment in eDoc Innovations, Inc. (eDoc). eDoc is a corporate CUSO that provides to credit unions e-document management technology as well as technology and services related to check clearing and forward check collection. Corporate One does not have a majority voting interest and does not maintain a controlling interest in eDoc. This investment, therefore, is accounted for using the equity method. Corporate One’s portion of eDoc’s current period net loss or income, recognized as a component of net service fee income in the accompanying statements of income, was a loss of $6,800 in 2011 and income of $500 in 2010. In March 2011, eDoc paid a dividend of approximately $11,600 to Corporate One. As part of the revisions to Regulation Part 704, beginning on April 18, 2011, all corporate CUSOs must agree to limit their activities to: (i) brokerage services, (ii) investment advisory services, and (iii) other categories of activities as approved in writing by the NCUA and published on the NCUA’s web site. Corporate credit unions must divest from any CUSO that is engaged in activities not approved by the NCUA. While all of the CUSOs in which Corporate One is invested are engaged in activities approved by the NCUA, the NCUA also published activity conditions with respect to certain approved activities. As a result of these activity conditions, Corporate One must divest of its minority investment in eDoc and is actively working to do so. Corporate One believes that the fair value of its investment in eDoc is greater than its cost.
56
57
(6) Other Assets Included in other assets is a deposit with the NCUA for share insurance, accounts receivable, prepaid accounts and net property and equipment. Equity investments are also included in other assets and are discussed in Note 5. Property and equipment, valued at cost less accumulated depreciation, at December 31 are summarized as follows: Buildings and improvements
$
2011
2010 4,503
$
4,503
Equipment
11,987
12,906
16,490
17,409
Less: Accumulated depreciation
10,419
12,178
NET PROPERTY AND EQUIPMENT
$
6,071
$
5,231
(7) Borrowed Funds As a member of the FHLB of Cincinnati, Corporate One is eligible to take advantage of the FHLB’s numerous credit products and advances. Advances and borrowings from the FHLB are required to be collateralized by securities held in safekeeping by the FHLB. At December 31, 2011 and 2010, Corporate One had securities held in safekeeping at the FHLB with fair values of approximately $138.8 million and $252.4 million, respectively, which provided a borrowing capacity of $133.2 million and $220.5 million, respectively. During August 2011, we were granted primary credit with the Federal Reserve Bank. Primary credit is available to generally sound depository institutions on a very short term basis, typically overnight, at a rate above the Federal Open Market Committee’s (FOMC) target rate for federal funds. All extensions of credit must be secured to the satisfaction of the lending Reserve Bank by collateral that is acceptable for that purpose. Corporate One’s borrowing capacity at the Fed Discount Window was approximately $177.0 million at December 31, 2011. Corporate One also maintains reverse repurchase agreements with certain parties allowing for additional liquidity of approximately $500.0 million. These agreements use some of our asset-backed securities as collateral. Corporate One had no outstanding reverse repurchase agreements at December 31, 2011 or 2010. Average borrowings under reverse repurchase agreements were approximately $233,000 during 2011 and $295,000 during 2010. There was no amount outstanding at any month-end during 2011 or 2010. We also maintain $55.0 million of federal funds lines with various financial institutions. The federal funds lines do not require collateral for overnight borrowing. No amount was outstanding at December 31, 2011.
Notes to Financial Statements
(Table dollar amounts in thousands)
In addition, Corporate One has an advised line of credit with U.S. Central that, by its nature, may be withdrawn by U.S. Central. Corporate One may take advances on this line of credit up to the amount of eligible collateral available to support such advances. Eligible collateral consists of all shares and certificates with U.S. Central. In September 2011, due to our decreasing term certificates held at U.S. Central, our line decreased so significantly that we no longer include U.S. Central as a source of liquidity. The following table provides a summary of our outstanding borrowings at December 31:
2011
2010
Balance Rate Balance Rate FHLB: Due in one year or less $ 10,000 4.39% Due after one year through five years $ 20,000 3.99% 20,000 3.99% U.S. Central: Due after one year through five years 20,000 4.45-4.99% TOTAL BORROWED FUNDS $ 20,000 $ 50,000 During January 2011, Corporate One prepaid the entire $20.0 million of borrowings, at par, from U.S. Central. (8) Share Accounts and Member Capital Accounts Balances and weighted average rates of share accounts and member capital accounts at December 31 are summarized as follows:
2011
Balance Settlement and regular shares $ 2,566,605 Share certificates 472,912
2010 Rate
Balance
0.16% $ 2,203,543 0.98% 602,176
Rate 0.18% 1.53%
TOTAL SHARE ACCOUNTS $ 3,039,517 $ 2,805,719 MCS $ 24,023 0.00% $ 126,924 0.31% NCA 82,700 4.00% PIC 20 0.00% 25,332 1.25% PCC 141,917 0.35% TOTAL MEMBER CAPITAL ACCOUNTS $ 248,660 $ 152,256
58
59
Settlement and regular share accounts are available to members on demand and pay dividends either daily or monthly. Share certificate accounts have specific maturities and dividend rates. Dividend payments on share certificate accounts vary according to the type of share certificate issued and the length of maturity. Share certificates can be redeemed by members prior to maturity at fair value, as determined by Corporate One. Share certificates of $100,000 or more were $472.1 million and $600.7 million at year-end 2011 and 2010. Total share certificate accounts by maturity at December 31, 2011 are summarized as follows: Year of Maturity 2012
Balance $
376,002
2013
74,150
2014
22,760
TOTAL SHARE CERTIFICATES
$
472,912
Eligible accounts of members are insured by the NCUSIF up to $250,000 per member. As of December 31, 2011, insured member accounts totaled $131.4 million. On January 29, 2009, the NCUA Board approved the TCCUSGP, under which the NCUSIF guaranteed Corporate One’s member shares in excess of the $250,000 share insurance already provided. Pursuant to a Congressional amendment of the Federal Credit Union Act that established the TCCUSF – a separate fund under the control of the NCUA – in June 2009, the NCUA legally transferred the obligation to pay claims under the TCCUSGP to the TCCUSF. During 2010, the TCCUSGP was extended by the NCUA to December 31, 2012. The maximum maturity for shares subject to the guarantee is two years. During 2011, Corporate One offered its Partner members the opportunity to convert their MCS and/or PIC to the new qualifying capital instrument, PCC, in order to continue to be considered Partner members of Corporate One. Corporate One also offers PCC to new members and/or Associate members who want to invest in PCC to become Partner members of Corporate One. Additionally, during 2011, Corporate One offered its Partner members the ability to invest in NCA. The purpose of the NCA offering was to raise between $50 million to $75 million of new regulatory capital in the form of NCA. In addition to counting toward certain capital ratios, this new regulatory capital will serve to increase our Net Economic Value (NEV) to a level that will allow us to achieve the minimum regulatory NEV ratio of 2.0 percent. The response to our capital offering resulted in it being over-subscribed. We raised a total of $82.7 million of NCA and that offering is now closed. Corporate One continues to offer PCC to Associate members and new members who want to become Partner members of Corporate One.
Notes to Financial Statements
(Table dollar amounts in thousands)
(9) Commitments and Contingencies Corporate One is a party to various financial instruments with off-balance-sheet risk that are used in the normal course of business to meet the financing needs of our members and to manage our exposure to market risks. These financial instruments involve, to varying degrees, elements of credit risk that are not recognized in the balance sheets. These financial instruments include committed and advised lines of credit. The contractual amounts of these instruments represent the extent of Corporate One’s exposure to credit loss. Corporate One uses the same credit policies in making these commitments and obligations as it does for on-balance-sheet instruments. In extending commitments, Corporate One evaluates each member’s creditworthiness on a case-by-case basis. All outstanding commitments are subject to collateral agreements and have termination clauses. At December 31, 2011 and 2010, these financial instruments included outstanding advised lines of credit of approximately $1.4 billion and $1.1 billion, respectively. Outstanding committed lines of credit, which have a 364-day term, at December 31, 2011 and 2010, were approximately $15.0 million. Commitments to extend credit to members remain effective as long as there is no violation of any condition established in the agreement. Advances on these commitments generally require repayment within one year of the advance. Since a portion of the commitments are expected to terminate without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Retirement Plan (10) Corporate One sponsors a defined-contribution plan (Plan) established under Section 401(k) of the Internal Revenue Code which covers substantially all employees. The Plan allows employees to contribute up to the Internal Revenue Service maximum allowable percentage of their compensation. Employees also have the option to contribute a portion of their compensation on a pre- or post-tax basis. Corporate One matches 150 percent of the first 3 percent employee contribution and 75 percent on the next 2 percent employee contribution. In addition, Corporate One may elect to make discretionary contributions to the Plan. This election requires approval by the Board of Directors. During 2010 and 2011, the Board of Directors suspended all discretionary contributions. Retirement expense was approximately $414,000 in 2011 and $378,000 in 2010. Fair Value of Financial Instruments (11) The estimated fair values of financial instruments have been determined by Corporate One using available market information and appropriate valuation methodologies. Due to their short term nature, the fair values of cash and cash equivalents, accrued interest receivable, and dividends and interest payable approximate carrying values. The fair value of the NCUSIF deposit approximates the carrying value because, if redeemed, it would be redeemed at cost. The fair value of MCS and NCA approximates the carrying value because, when redeemed, they would be redeemed at cost. The fair values of loan commitments are determined based on the fees currently charged to enter into similar agreements, taking into consideration the remaining terms of the agreements and the present creditworthiness of the counterparty. Neither the fees earned during the year on these instruments nor their fair value at year-end are material to the financial statements.
60
61
The assumptions used by Corporate One in estimating fair-value disclosures for its remaining financial instruments are described below. • Investments in financial institutions are based on discounted cash flow analyses using current market rates, except FHLB stock. It was not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability. • The fair values for securities are generally determined by discounting the future cash flows using rates currently available for similar securities, or based on quoted market prices or dealer quotations, if available. • The estimated fair value of loans is determined by discounting future cash flows using interest rates currently being offered to members for loans with similar terms. • The fair value of borrowed funds is based on discounted cash flow analyses using current market rates. • The fair values approximate carrying values for settlement and regular share accounts payable on demand at the balance sheet date. • The fair value of fixed-maturity share certificates is estimated by discounting the future cash flows using the rates currently offered for share certificates of similar remaining maturities. The fair values of Corporate One’s financial instruments at December 31 are summarized as follows:
2011
2010
Carrying Fair Carrying Fair Value Value Value Value Assets: Cash and cash equivalents $ 1,722,514 $ 1,722,514 $ 895,131 $ 895,131 Investments in financial institutions 44,419 44,454 394,263 395,420 Available-for-sale securities 1,381,105 1,381,105 1,566,583 1,566,583 2,370 1,724 1,266 2,370 Held-to-maturity securities Loans to members 7,825 7,825 4,284 4,302 Accrued interest receivable 2,111 2,111 2,452 2,452 NCUSIF deposit 1,263 1,263 1,273 1,273 Liabilities: Borrowed funds $ 20,000 $ 21,788 $ 50,000 $ 53,907 Dividends and interest payable 1,443 1,443 1,856 1,856 Settlement and regular shares 2,566,605 2,566,605 2,203,543 2,203,543 Share certificates 472,912 472,588 602,176 607,544 MCS 24,023 24,023 126,924 126,924 NCA 82,700 82,700
Notes to Financial Statements
(Table dollar amounts in thousands)
Accounting guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy exists in this guidance, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value: Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that Corporate One has the ability to access as of the measurement date. Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data. Level 3: Significant unobservable inputs that reflect Corporate One’s own assumptions about the assumptions that market participants would use in pricing an asset or liability. The guidance requires that the highest level of valuation available be used. This statement describes inactive markets as characterized by few transactions for the asset, prices that are not current, prices that vary substantially, or some combination thereof, and while an entity should not assume a market is inactive; it should also not assume the prices available are from active markets. The determination of market participation requires a significant amount of judgment by management. The fair value of available-for-sale securities other than residential mortgage-backed or home equity asset-backed securities are determined by obtaining quoted prices from brokers or pricing services, or market listings as of the last day of the year. For securities where there is limited trading due to current market conditions, we believe the pricing services likely utilized matrix pricing to determine the price. Matrix pricing is a mathematical technique used widely in the industry to value debt securities without relying on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities. We have classified the pricing for such securities as Level 2. For asset-backed securities where pricing is not available from a pricing service, management utilizes internal models for pricing these securities. For these securities, the fair values are highly sensitive to assumption changes and market volatility and are therefore classified as Level 3. Those asset-backed securities which were classified as Level 3 are LIBOR-based and have a current month weighted average coupon of .976 percent. These securities have a weighted average life of 10 years, a current weighted average prepayment speed and a 12-month weighted average default rate of 2.1 and 2.7, respectively. None of these securities are deemed other-than-temporarily impaired. Corporate One engages an independent third-party expert to value our residential mortgage-backed and home equity asset-backed securities. The third-party expert uses their internal models for pricing these securities. Information such as historical and current performance of the underlying collateral, deferral/default rates, collateral coverage ratios, cash flow projections, and liquidity and credit premiums required by a market participant, are utilized in determining individual security valuations. For residential mortgage-backed and home equity asset-backed securities where we see limited trading due to current market conditions, we classify the pricing for such securities as Level 3. For these securities, the fair value is highly sensitive to assumption changes and market volatility. These securities are a mix of fixed and floating-rate securities with a current month weighted average coupon of 3.2 percent. These securities have a weighted average life of 4.9 years, a current weighted average prepayment speed and a 12-month weighted average default rate of 4.6 and 9.7, respectively. Fifty-six of these securities with an amortized cost of $153.8 million and market value of $103.4 million have had other-than-temporary losses which resulted in $59.1 million in other-than-temporary charges to date.
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Assets measured at fair value on a recurring basis are summarized below as of December 31, 2011:
Fair Value Using
Quoted Prices Significant in Active Other Significant Markets for Observable Unobservable Total Fair Identical Assets Inputs Inputs Value (Level 1) (Level 2) (Level 3) Available-for-sale securities: Corporate debt securities $ 186,523 $ 186,523 Government-sponsored enterprises 78,496 70,060 $ 8,436 Mortgage-related securities - agency 62,990 62,990 Mortgage-related securities - private 197,618 34,029 $ 163,589 Asset-backed securities: Student loans – FFELP 313,474 262,951 50,523 Student loans – private 168,781 163,703 5,078 Credit cards 314,559 314,559 Automobiles 58,664 58,664 TOTAL AVAILABLE-FOR-SALE SECURITIES
$ 1,381,105
$ 256,583 $ 905,332 $
219,190
Notes to Financial Statements
(Table dollar amounts in thousands)
Assets measured at fair value on a recurring basis are summarized below as of December 31, 2010:
Fair Value Using
Quoted Prices Significant in Active Other Significant Markets for Observable Unobservable Total Fair Identical Assets Inputs Inputs Value (Level 1) (Level 2) (Level 3) Available-for-sale securities: Corporate debt securities $ 191,548 $ 191,548 81,817 69,972 $ 11,845 Government-sponsored enterprises 93,020 93,020 Mortgage-related securities - agency 42,122 $ 207,531 Mortgage-related securities - private 249,653 Asset-backed securities: Student loans – FFELP 337,808 282,530 55,278 Student loans – private 214,677 211,442 3,235 Credit cards 363,397 363,397 34,663 34,664 Automobiles TOTAL AVAILABLE-FOR-SALE SECURITIES
64
$ 1,566,583
$
261,520
$ 1,039,020 $
266,044
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The table below presents a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2011 and 2010.
Total Fair Value of Available-for-Sale Securities Priced Using Significant Unobservable Inputs (Level 3)
2011 Beginning balance January 1, $ 266,044 $ Changes in fair values of Level 3 securities due to change in price: Mortgage-related securities – private (4,695) Student loans – FFELP (5,560) Student loans – private (482) Decreases due to net losses on investments: Total other-than-temporary impairment losses – private mortgage (31,526) Portion of loss recognized in other comprehensive income – private mortgage 27,682 Net gain on sales of securities Decreases due to sales, maturities and paydowns: Mortgage-related securities – private (35,404) Student loans – FFELP (501) Student loans – private (650) Credit cards Net transfers in and/or (out) of Level 3: Student loans – FFELP 1,307 Student loans – private 2,975 Automobiles ENDING BALANCE DECEMBER 31,
$
219,190
$
2010 409,675
30,747 2,714 109
(38,562) 31,028 214 (68,384) (93) (4,465) (6,018) (47,069) (22,653) (21,199) 266,044
We classify the fair value of those securities where there is a lack of observable market data as Level 3. During 2011, three securities, previously classified Level 2, were transferred into Level 3 because observable market data was no longer available. Also during 2011 and 2010, market activity began to increase and as of December 31, 2011 and 2010, certain securities were transferred out of Level 3
Notes to Financial Statements
(Table dollar amounts in thousands)
and into Level 2 because observable market data for these investments once again became available. The fair value for these securities was transferred on December 31, 2011 and 2010, respectively. There were no transfers between Level 1 and Level 2 during 2011. Regulatory Capital and Net Economic Value Requirements (12) On October 20, 2010, the NCUA published the final revisions to the NCUA Rules and Regulations, Part 704, the rule governing corporate credit unions, in the Federal Register. The revisions establish a new capital framework including risk-based capital requirements. The old capital instruments, PIC and MCS, will be phased out and two new capital instruments are established. The new capital instruments are PCC and NCA. PCC is defined in Part 704.2 as accounts or other interests of a corporate credit union that: are perpetual, non-cumulative dividend accounts; are available to cover losses that exceed retained earnings, PIC and MCS; are not insured by the NCUSIF or other share or deposit insurers; and cannot be pledged against borrowings. NCA is defined in Part 704.2 as funds contributed by members or nonmembers that: are term certificates with an original minimum term of five years or that have an indefinite term with a minimum withdrawal notice of five years; are available to cover losses that exceed retained earnings, PIC, MCS and PCC; are not insured by the NCUSIF or other share or deposit insurers; and cannot be pledged against borrowings. The regulation contains a multi-step, multi-year phase in of the new capital requirements. The new requirements went into effect on October 20, 2011; however, certain definitions change over time as various requirements are phased in. The following table presents the ratios, definitions of the numerators and denominators for each of the ratios and the required minimum levels for well capitalized and adequately capitalized designations under the new regulation. The definitions of the numerators are simplifications, as the new regulation contains certain adjustments to each capital calculation. Numerator Denominator Retained earnings ratio
Well Capitalized
Adequately Capitalized
RUDE
MDANA*
RUDE+PCC+NCA+PIC+MCS
MDANA
5.00%
4.00%
RUDE+PCC
MDANA
5.00%
4.00%
Tier 1 risk-based capital ratio
RUDE+PCC
MDANRA**
6.00%
4.00%
Total risk-based capital ratio
RUDE+PCC+NCA
MDANRA
10.00%
8.00%
Interim leverage ratio Permanent leverage ratio
0.45/1.00/2.00%
The retained earnings ratio has multi-year requirements per the new Regulation Part 704 — 0.45% by October 2013, 1.00% by October 2016 and 2.00% by October 2020. The permanent leverage ratio is not effective until October 2013. *Moving Daily Average Assets **Moving Daily Average Net Risk Weighted Assets
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During 2011, Corporate One offered its Partner members the opportunity to convert their MCS and/or PIC to the new qualifying capital instrument, PCC, in order to continue to be considered Partner members of Corporate One. Corporate One also offers PCC to new members and/or Associate members who want to invest in PCC to become Partner members of Corporate One. Additionally, during 2011, Corporate One offered its Partner members the ability to invest in NCA. The purpose of the NCA offering was to raise between $50 million to $75 million of new regulatory capital in the form of NCA. In addition to counting toward certain capital ratios, this new regulatory capital will serve to increase our NEV to a level that will allow us to achieve the minimum regulatory NEV ratio of 2.0 percent. The response to our capital offering resulted in it being over-subscribed. We raised a total of $82.7 million of NCA and that offering is now closed. Corporate One continues to offer PCC to Associate members or new members who want to become Partner members of Corporate One. The following table outlines the components of regulatory capital at December 31: RUDE $
2011
2010
36,781 $
35,431
PIC
20
25,332
MCS
24,023
126,924
NCA
82,700
PCC
141,917
TOTAL REGULATORY CAPITAL ACCOUNT BALANCES
285,441
187,687
Less: Amortized PIC, MCS and NCA
(24,119)
(4,781)
REGULATORY CAPITAL $ 261,322
$ 182,906
As of December 31, 2011, MDANA and MDANRA were $3.11 billion and $1.23 billion, respectively. Due to a successful capital raise, Corporate One exceeds all regulatory capital ratios at the “well capitalized� level as outlined in the recently updated regulations governing corporate credit unions, as well as meets all NEV ratios in both base- and stressed-case scenarios. In addition, beginning in October 2013, a corporate credit union is also required to report its ratio of retained earnings or RUDE to its MDANA. If this ratio is less than 0.45 percent, the corporate credit union must submit a retained earnings accumulation plan to the NCUA for approval. As of December 31, 2011, Corporate One exceeds this requirement, as our retained earnings ratio is 1.18 percent. In fact, at this level, our retained earnings ratio exceeds the 1.00 percent minimum required by the new regulation in October 2016.
Notes to Financial Statements
(Table dollar amounts in thousands)
The following summarizes Corporate One’s capital ratios as of December 31, 2011, under the new regulation that became effective in October 2011. Well Adequately December 31, 2011 Capitalized Capitalized RUDE ratio
1.18%
0.45%
0.45%
Interim leverage ratio
8.27%
5.00%*/7.00%**
4.00%
Tier 1 risk-based capital ratio
14.19%
6.00%
4.00%
Total risk-based capital ratio
20.90%
10.00%
8.00%
* Base Plus Expanded Authority Requirement. Under Base Plus, a 20% maximum decline in the Net Economic Value in the stress test required per Reg. 704 is permissible. ** Part I Expanded Authority. Under Part I, a 28% maximum decline in the Net Economic Value in the stress test required per Reg. 704 is permissible. There are a number of remedies available to a corporate credit union should its regulatory ratios fall below the required minimum. However, despite such remedies, the NCUA could restrict the corporate’s ability to, among other things, accept additional deposits, open new accounts, make loans or pay dividends. As of December 31, 2011, Corporate One exceeded all the regulatory capital ratio requirements. The prior regulation required corporate credit unions to maintain a minimum capital ratio (capital divided by MDANA) based upon the corporate’s investment authority as authorized by the NCUA. The NCUA defined capital as retained earnings, PIC and MCS less the amortized portion of PIC and MCS on notice. As of December 31, 2010, Corporate One’s regulatory capital ratio was 5.39 percent, which met the regulatory capital ratio requirement of 5.00 percent. As of December 31, 2010, Corporate One’s retained earnings ratio was 1.04 percent, which did not meet the regulatory requirement in effect at that time of 2.00 percent. Corporate One’s NEV sensitivity is limited by Part 704 of the NCUA rules and regulations to a 28 percent change from base and an NEV ratio greater than the minimum regulatory ratio of 2.0 percent. If Corporate One fails to meet its NEV requirements for 30 calendar days, a detailed, written action plan that sets forth the time needed and means by which it intends to correct the violation must be submitted to the NCUA. In addition, discretionary actions by the NCUA are possible that could have a material effect on Corporate One’s financial position and operations. During all of 2010 we did not comply with the NEV sensitivity requirement or the NEV ratio requirement. We submitted the required plan to the NCUA and the plan was approved by the NCUA. In 2011, we raised new capital as discussed previously. Accordingly, beginning in April 2011 and continuing through December 31, 2011, we comply with the NEV sensitivity requirement and the NEV ratio requirement.
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(13) Potential Merger with Southeast Corporate Federal Credit Union On February 16, 2012, the NCUA approved Corporate One’s application to merge with Southeast Corporate Federal Credit Union (Southeast). As a condition to the closing of the merger, Southeast must obtain PCC subscriptions from their member credit unions, either by conversion of existing Southeast MCS and/or by purchase and subscription of PCC. Corporate One may terminate the merger agreement if Southeast does not obtain the targeted $75 million of PCC subscriptions. However, Corporate One has sole discretion to reduce the amount of PCC subscriptions required to effectuate the merger. Accordingly, Southeast has distributed a Confidential Information Memorandum for the Issuance of Perpetual Contributed Capital Through Conversion of Existing Membership Capital Shares to Perpetual Contributed Capital and New Subscriptions dated February 17, 2012. Southeast is also conducting a member vote which is expected to be completed May 22, 2012. The capital offering is expected to close on May 31, 2012, which is also the expected date for the legal merger of Corporate One and Southeast.
Notes to Financial Statements
(Table dollar amounts in thousands)
8700 Orion Place Columbus, Ohio 43240-2078
70 70
P.O. Box 2770 Columbus, Ohio 43216-2770
866/MyCorp1 www.corporateone.coop