Navy Federal Credit Union 2012 Annual Report Download - page 29

Navy Federal Credit Union38 Leading with Vision. Achieving Results. 39
2012 Financial Section
NOTE 20: FAIR VALUE MEASUREMENT
Eective with the adoption of ASC 820-10, Fair Value Measurements and Disclosures, Navy Federal
determines the fair values of its financial instruments based on the fair value hierarchy established
in that standard, which requires an entity to maximize the use of quoted prices and observable inputs
when measuring fair value. A description of the fair value hierarchy is as follows:
> Level 1—Valuation is based upon quoted prices for identical instruments traded in active markets.
> Level 2—Valuation is based upon observable inputs, such as quoted prices for similar instruments in
active markets, quoted prices for identical or similar instruments in markets that are not active, and
model-based valuation techniques for which all significant assumptions are observable in the market.
> Level 3—Valuation is based upon unobservable inputs that are supported by little or no market activity
and are significant to the fair value of the instrument. Valuation is typically performed using pricing
models, discounted cash flow methodologies, or similar techniques, which incorporate management’s
own estimates of assumptions that market participants would use in pricing the instrument or
valuations that require significant management judgment or estimation.
Certain assets and liabilities may be required to be measured at fair value on a non-recurring basis.
These non-recurring fair value measurements usually result from the application of lower of cost or
market accounting or the write-down of individual assets due to impairment.
The following is a description of the valuation methodologies used by Navy Federal for the assets
measured at fair value:
Securities Available-for-Sale (AFS)
Navy Federal receives pricing for AFS securities from a third-party pricing service. These securities
are classified as Level 2 in the fair value hierarchy. The following is a description of the valuation
methodologies used for these securities:
> Residential and Commercial Mortgage-backed Securities—Residential and commercial mortgage-
backed securities are valued either based on similar assets in the marketplace and the vintage of
the underlying collateral, or at the closing price reported in the active market in which the individual
security is traded.
> Federal Agency Securities, Treasury Securities, Municipal Securities, and Bank Notes—Federal agency
securities, treasury securities, municipal securities, and bank notes are valued based on similar assets
in the marketplace and the vintage of the underlying collateral, or at the closing price reported in the
active market in which the individual security is traded.
Mortgage Servicing Rights (MSRs)
MSRs do not trade in an active, open market with readily observable prices. Accordingly, Navy Federal
obtains the fair value of the MSRs using a third-party pricing provider. The provider uses a combination
of market and income valuation methodologies. All assumptions are market driven. Once the preliminary
results are complete, they are further calibrated to observable market transactions, when they exist.
Therefore, MSRs are classified within Level 3 of the fair value hierarchy, as the valuation is model driven
and primarily based on unobservable inputs.
Derivative Commitments—Assets and Liabilities
Navy Federal uses derivative commitments to hedge against interest rate risk. These derivatives (assets
and liabilities) are valued using quoted market prices of similar assets and are classified within Level 2
of the fair value hierarchy.
All benefits are paid from Navy Federal assets and are in compliance with all federal laws and
regulations. Navy Federal accrued $2.9 million and $1.3 million in the years ended December 31, 2012
and 2011, respectively.
NOTE 18: RELATED PARTY TRANSACTIONS
In the normal course of business, Navy Federal extends loans to credit union ocials. The total principal
amount of loans extended to ocials during 2012 and 2011 was $35.3 million and $33.2 million, respectively.
Credit union ocials are defined as volunteer members of the Board of Directors and board committees,
and employees with the title of Vice President and above.
Navy Federal’s wholly owned subsidiary, NFFG, had $25.5 million and $29.6 million on deposit with
Navy Federal as of December 31, 2012 and 2011, respectively.
NOTE 19: RESERVES AND UNDIVIDED EARNINGS
Navy Federal is subject to regulatory capital requirements administered by the NCUA. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly additional discretionary
actions by regulators that, if undertaken, could have a direct material eect on Navy Federal’s
consolidated financial statements. Under capital adequacy regulations and the regulatory framework
for prompt corrective action, Navy Federal must meet specific capital requirements that involve
quantitative measures of Navy Federal’s assets, liabilities, and certain commitments as calculated under
GAAP. Navy Federal’s capital amounts and net worth classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require Navy Federal to
maintain minimum amounts and ratios of net worth to total assets. Credit unions are also required to
calculate a risk-based net worth (RBNW) requirement that establishes whether the credit union will
be considered “complex” under the regulatory framework. A credit union is defined as “complex” if
the credit union’s quarter-end total assets exceed ten million dollars ($10,000,000) and its RBNW
requirement exceeds six percent (6.0%). Navy Federal’s RBNW requirement as of December 31, 2012
and 2011 was 6.1% and 6.4%, respectively, which exceeds the regulatory threshold of 6.0% and places
Navy Federal in the “complex” category. There is no impact to Navy Federal based on the complex
designation because their statutory net worth ratio qualifies us as “well capitalized” by NCUA standards,
and our statutory net worth exceeds their RBNW requirement.
The NCUA categorized Navy Federal as “well capitalized” under the regulatory framework for prompt
corrective action with a net worth-to-assets ratio of 10.9% and 10.6% as of December 31, 2012 and 2011,
respectively. Net worth for this calculation is defined as undivided earnings plus regular and capital
reserves. To be categorized as “well capitalized,” Navy Federal must maintain a minimum net worth
ratio of 7.0%. There are no conditions or events since that notification that management believes have
changed the institution’s category.