Annual Report - CoBank

All patronage payments and retirements of equity requirethe prior approval of our Board of Directors, which hasincreased or decreased such payments based upon the Bank’scurrent or projected business performance and capital levels.In addition, patronage payments can only be made if the Bankis in compliance with minimum regulatory capitalrequirements.Patronage distributions are made in the form of cash andcommon stock, as shown in the following table. Eligibleshareholders will receive patronage distributions from CoBankfor 2011 in the first quarter of 2012. Patronage distributionsfor 2011 were higher than the prior year primarily due to anincrease in the level of patronage-based agribusiness averageloan volume.Patronage Distributions ($ in Thousands)Year Ended December 31, 201120102009Common Stock $ 109,900 $ 90,450 $ 85,067Cash 230,751 194,110 183,828Total Patronage Distributions $ 340,651 $ 284,560 $ 268,895Patronage Distributions/Total Average Common StockOwned by Active Borrowers 22.65 % 19.77 % 19.68 %Economic CapitalEconomic capital is a measure of risk and is defined asthe amount of capital required to absorb potential lossesresulting from extremely severe events over a one-year timeperiod. “Unexpected losses” are the difference betweenpotential extremely severe losses and the expected (average)loss over a one-year time period. The amount of economiccapital required is based on our risk profile and a targetedsolvency standard. We attribute economic capital to creditrisk, interest rate risk, operational risk and market risk. Creditrisk, interest rate risk and operational risk are described under“Corporate Risk Profile” beginning on page 43. Market riskrepresents exposure to asset residual values related to ourleasing activity. These risks are measured and aggregated toestimate the exposure to potential extremely severe events andany impact to our capital.The economic capital model considers the economiccapital requirements of our affiliated Associations through theevaluation of the Associations’ retail credit risk, operationalrisk and interest rate risk. An economic capital shortfall(which is the difference between available capital and requiredeconomic capital) at any affiliated Association is included inour economic capital requirements.For economic capital modeling purposes, we havetargeted a “AA” solvency standard, which equates to a99.97 percent confidence level. In other words, the likelihoodof incurring losses greater than the required economic capitalamount is estimated to be similar to the likelihood of a AAratedbond defaulting, which is a 0.03 percent probability. AtDecember 31, 2011, the Bank held capital in excess of theamount calculated by its economic capital model.Credit Risk CapitalCredit risk capital requirements are based on the riskprofile of the borrower or counterparty, repayment sources,the nature of underlying collateral and other support, givencurrent events and conditions. Our credit risk ratings processuses a two dimensional loan rating structure, incorporating our14-point risk-rating scale to identify and track the probabilityof borrower default and a separate scale addressing loss givendefault.In assigning credit risk capital, our economic capitalmodel considers retail borrower probability of default, lossgiven default, and portfolio concentrations. Other principaldrivers of credit risk that differentiate capital allocationinclude exposure at default, asset maturity, and asset and intercommoditycorrelations. We have developed standards forprobability of borrower default and loss given default, basedon external benchmarks.Interest Rate Risk CapitalThe amount of capital attributed to interest rate risk isbased on potential changes in our market value of equity,calculated under randomly generated interest rate scenarios.We utilize widely accepted, third-party models to quantify theinterest rate risk and related risk capital requirement.Operational Risk CapitalOur approach to quantifying operational risk capital isbased on the capital of non-financial companies with similarbusiness risks. These non-financial companies hold capitalprimarily for operational risk. Their level of capital and creditrating yields an inferred estimate of the level of capital to beheld for operational risk. Capital as a percent of operatingexpenses is the primary methodology used in determiningoperational risk capital.Market Risk CapitalMarket risk arises primarily from the volatility in theresidual value of leased assets at the maturity of leasecontracts. This risk exists because of the mismatch betweenthe present value of future cash flows, the present value of thereturned leased asset, and the underlying value of theequipment over time. This is because default can occur whenthe inherent value of the leased asset is below that of thepresent value of all future payments. This difference is used tocalculate the exposure.Other RisksOther areas of risk in which we may have exposure arestructural, liquidity, regulatory, reputation, and political risk.While capital is not specifically attributed to these risks, someof the excess capital – the amount by which book capitalexceeds economic capital – is held for these other risks.CoBank 2011 Annual Report59