Annual Report - CoBank

Investment Securities ($ in Millions)December 31, 2011AmortizedCostFairValueUnrealizedGains(Losses)U.S. Treasury and Agency Debt $ 3,549 $ 3,638 $ 89U.S. Agency Mortgage-Backed 8,899 9,061 162Non-Agency Mortgage-Backed 265 242 (23)Asset-Backed 78 54 (24)Total $ 12,791 $ 12,995 $ 204December 31, 2010U.S. Treasury and Agency Debt $ 3,311 $ 3,358 $ 47U.S. Agency Mortgage-Backed 8,673 8,739 66Non-Agency Mortgage-Backed 424 402 (22)Asset-Backed 143 118 (25)Total $ 12,551 $ 12,617 $ 66We regularly perform impairment assessments of ourinvestment securities based on evaluations of both current andfuture market and credit conditions and expected cash flows ofthese securities. Subsequent changes in market and creditconditions or expected cash flows could change theseevaluations.As all of our investment securities are classified as“available for sale”, we recognize changes in the fair value ofour investment securities in accumulated other comprehensiveincome (loss), a component of shareholders’ equity, unlesslosses are credit-related and considered other-than-temporary,in which case that portion of the loss is recorded in earnings.We recorded unrealized gains on our investment securities of$138.8 million and $69.6 million in 2011 and 2010,respectively. The unrealized gains in both years primarilyrelate to the impact of interest rate changes on the values ofcertain fixed-rate securities.Credit risk in our investment portfolio is primarily limitedto the 2 percent of investment securities that do not containeither an implicit or explicit guarantee of the U.S. government,consisting of Non-Agency securities and ABS. The unrealizedlosses on such securities primarily relate to decreased marketliquidity and widened credit spreads. We recorded impairmentlosses in earnings of $10.0 million in 2011 and $44.0 millionin 2010. The impairment losses in 2011 related to four Non-Agency securities and four ABS, and totaled $5.5 million and$4.5 million, respectively. Increasing levels of defaults andforeclosures on residential mortgages, continued highunemployment, and weak economic conditions may result infurther downward adjustments to the fair value of our Non-Agency securities and ABS and the need to record additionalimpairment losses in earnings.As of December 31, 2011, all of our ABS are composedof home equity securities. These securities are supported byfirst- or second-lien mortgages and the substantial majority ofthem are insured by two bond insurance companies that havecome under financial stress. During 2010 and 2009, wedetermined that we could no longer rely on these two bondinsurers to fulfill their obligations related to certain ABS theyinsure, which resulted in $23.0 million of the 2010 impairmentlosses and $11.0 million of the 2009 impairment losses.DerivativesAs noted previously, we use derivatives in part to manageour liquidity position. Derivatives are recorded at fair value asassets or liabilities in the accompanying consolidated balancesheets. Changes in the fair value of these derivatives areaccounted for as gains or losses through current periodearnings or as a component of accumulated othercomprehensive income (loss), depending on the use of thederivatives and whether they qualify for hedge accountingtreatment. Net changes in the fair value of derivatives andhedged items recorded in the accompanying consolidatedstatements of income totaled gains of $12.3 million and$2.7 million for 2011 and 2010, respectively. Changes in thefair value of derivatives recorded as other comprehensiveincome (loss) totaled losses of $0.5 million and $6.3 million in2011 and 2010, respectively.CapitalWe believe that a sound capital position is critical to ourlong-term financial success and future growth. We areprimarily capitalized by common and preferred stock and byunallocated retained earnings. Our shareholders’ equityincreased by $489.3 million during 2011. This increase wasprimarily due to $706.6 million of earnings and a$101.9 million increase in accumulated other comprehensiveincome, primarily resulting from unrealized gains in ourinvestment portfolio, net of tax. These factors were partiallyoffset by $230.8 million in cash patronage, $63.8 million inpreferred stock dividends and $24.6 million of common stockretirements, net of stock issuances.As of December 31, 2011, we had $700.0 million ofpreferred stock outstanding. In 2008, our shareholdersapproved a measure allowing CoBank to issue preferred stock,subject to FCA approval, up to the then bylaw limit of$1.0 billion outstanding, at any time through September 2018.This measure allows us to access outside capital more quicklyand efficiently in response to dynamic market conditions,without the necessity of obtaining shareholder approval foreach issuance. In September 2011, in connection with themerger with AgBank, shareholders approved an increase to thelimits of both the preferred stock authorization and the bylawsto $1.5 billion. In conjunction with the merger, on January 1,2012, AgBank’s $225.0 million (par value) of preferred stockwas converted into $225.0 million (par value) of a new seriesof CoBank preferred stock with substantially the same termsand conditions.CoBank 2011 Annual Report56