Annual Report - CoBank

In accordance with the Farm Credit Act, cooperatives andother eligible borrowers are required to purchase equity inCoBank as a condition of borrowing. Eligible borrowers thatborrow on a patronage basis have voting rights while they areactive borrowers. Generally, for borrowers other thanaffiliated Associations, the minimum initial borrowerinvestment is equal to the lesser of one thousand dollars or2 percent of the amount of the loan. The minimum initialinvestment is generally received by CoBank in cash at thetime the borrower receives the loan proceeds. AffiliatedAssociations provide an initial and ongoing voting stockinvestment of 4 percent of their loan balance. Collectively, thecustomer-owners that hold voting stock elect our Board ofDirectors. We operate on a cooperative basis and return aportion of our earnings to our customer-owners in the form ofpatronage distributions.In March 2009, our voting shareholders approved changesto our bylaws to convert all previously existing classes ofcommon equity, including non-voting participationcertificates, into a single class of common equity – Class Acommon stock – and to afford voting rights to certainborrowers that are not organized as cooperatives. Class Ashareholders that are directly eligible to borrow from CoBank,that borrow on a patronage basis and that are active borrowershave voting rights. All other shareholders do not have votingrights. The number of voting shareholders increased byapproximately 27 percent as a result of these bylaw changes,which were effective April 1, 2009.In conjunction with the annual business and financialplanning process, the Board of Directors reviews and approvesa capital adequacy plan which includes capital targets andcapital ratio baselines. The Board determines a targeted equitylevel based on projected asset levels, earnings, economicconditions, possible credit losses and other contingencies. TheBoard also balances the amount required to properly capitalizethe Bank with the desire to distribute a level of patronage thatprovides appropriate returns to our customer-owners. TheBoard may increase or decrease these patronage levels(provided we remain within the regulatory capital minimums)based on its ongoing evaluation of the Bank’s business. As aresult, there is no assurance that patronage will remain atcurrent levels.When reviewing the capital adequacy plan, the Boardconsiders the following: risk diversification of the loanportfolio, loan seasonality, anticipated future capital needs,equity levels required by the Bank’s proprietary economiccapital model, the Bank’s capital levels in comparison tocommercial banks and the regulatory minimum capitalstandards. As of December 31, 2011, the Board-establishedcapital ratio baselines were 10 percent for the permanentcapital and total surplus ratios, and 5 percent for the coresurplus ratio. As part of our business planning process, weperform stress tests to examine the Bank’s financial conditionand performance under a variety of market and economicenvironments, including unanticipated loan growth andprolonged periods of financial and loan quality stress. Thesetests, which include severe scenarios, illustrate the Bank’sability to continue to maintain compliance with regulatoryrequirements and meet commitments to our stakeholders.Results of these tests are reviewed with the Board ofDirectors.Capital PlansWe have four capital plans that dictate the level of capitalinvestment required by customer-owners. These include a planfor cooperative customers, a plan for affiliated Associations, aplan for nonaffiliated entities and a plan for loan participationspurchased from System entities. The targeted equity level forthe cooperative capital plan is 8 percent of the 10-yearhistorical average loan volume. Additionally, when aborrower’s loans are paid in full, stock is retired over a10-year loan base period beginning in the year following loanpayoff, subject to Board approval and compliance withminimum regulatory capital requirements. The targetedpatronage rate for the cooperative capital plan is expected toremain at 100 basis points of the current year average loanvolume. The cash portion of patronage is 65 percent for allcooperative capital plan members.The capital plan for loan participations purchased fromSystem entities is identical to the cooperative capital plandescribed above.The targeted equity level for the affiliated Associationcapital plan is 4 percent of the one-year historical average loanvolume. There is no stock retirement feature for this capitalplan. The targeted patronage rate for the affiliated Associationcapital plan is expected to remain at 45 basis points of thecurrent year average loan volume with all patronage beingpaid in cash.The targeted equity level for the nonaffiliated entitiescapital plan is 4 percent of the five-year historical averageloan volume. Additionally, when a borrower’s loans are paidin full, stock is retired over a five-year loan base periodbeginning in the year following loan payoff, subject to Boardapproval and compliance with minimum regulatory capitalrequirements. The targeted patronage rate for the nonaffiliatedentity capital plan is expected to remain at 45 basis points ofthe current year average loan volume. The cash portion ofpatronage is 20 percent for all nonaffiliated entity capital planmembers.CoBank 2011 Annual Report58