Annual Report - CoBank

A reconciliation of the beginning and ending amount ofunrecognized tax benefits, excluding interest and penalties, isas follows:Year Ended December 31, 2011Balance at Beginning of Year $ 4,102Additions Based on Tax Positions Related to the Current Year 1,102Additions for Tax Positions of Prior Years 430Reductions for Tax Positions of Prior Years (29)Settlements (115)Lapse of Applicable Statute of Limitations (246)Balance at End of Year $ 5,244Year Ended December 31, 2010Balance at Beginning of Year $ 5,761Additions Based on Tax Positions Related to the Current Year 757Additions for Tax Positions of Prior Years 325Reductions for Tax Positions of Prior Years (2,515)Lapse of Applicable Statute of Limitations (226)Balance at End of Year $ 4,102Year Ended December 31, 2009Balance at Beginning of Year $ 4,901Additions Based on Tax Positions Related to the Current Year 727Additions for Tax Positions of Prior Years 493Reductions for Tax Positions of Prior Years (84)Lapse of Applicable Statute of Limitations (276)Balance at End of Year $ 5,761The total amount of unrecognized tax benefits that, ifrecognized, would affect the effective tax rate is $4.8 million.We do not currently believe that the unrecognized tax benefitswill change significantly within the next 12 months.We recognize interest and penalties accrued related tounrecognized tax benefits as a component of the provision forincome taxes. During the year ended December 31, 2011, werecognized an increase of approximately $0.5 million ininterest and penalties. We had approximately $2.2 million and$1.7 million of interest and penalties accrued at December 31,2011 and 2010, respectively.We file income tax returns in federal and various statejurisdictions. With few exceptions, the Bank is no longersubject to federal, state and local, or non-U.S. income taxexaminations by tax authorities for years before 2008.Note 10 – Financial Instruments WithOff-Balance Sheet Risk2011, outstanding commitments to extend credit andcommercial letters of credit were $27.3 billion and$383.3 million, respectively.Since many of these commitments may expire withoutbeing drawn, the total commitments do not necessarilyrepresent future cash requirements. Our exposure to many ofthese commitments is mitigated by borrowing baserequirements contained in loan agreements. However, thesecredit-related financial instruments have off-balance sheetcredit risk because their amounts are not reflected on theconsolidated balance sheets until funded or drawn upon. Thecredit risk associated with issuing commitments andcommercial letters of credit is substantially the same as thatinvolved in extending loans to borrowers. Therefore,management applies the same credit policies to thesecommitments. The amount of collateral obtained, if deemednecessary upon extension of credit, is based on management’scredit evaluation of the borrower. As discussed in Note 2, wemaintain a reserve for unfunded commitments.For a fee, we provide financial standby letters of credit forborrowers, which are irrevocable commitments to guaranteepayment of a specified financial obligation. We also provideperformance standby letters of credit which are irrevocableagreements by us, as a guarantor, to make payments to theguaranteed party in the event a specified third-party fails toperform under a nonfinancial contractual obligation, such as athird-party failing to timely deliver certain commodities at aspecified time and place. We also issue indemnificationagreements that function like guarantees. Theseindemnification agreements contingently require us, as theindemnifying party (guarantor), to make payments to anindemnified party under certain specified circumstances.Certain recourse provisions would enable us, as a guarantor, torecover from third parties any of the amounts paid underguarantees, thereby limiting our maximum potential exposure.As of December 31, 2011, the maximum potential amountof future payments that we may be required to make under ouroutstanding standby letters of credit was $1.3 billion, with afair value of $9.7 million, which is included in other liabilitiesin the consolidated balance sheet. The current status of thepayment/performance risk of the standby letters of creditguarantee is based on internal customer credit ratings that weuse to manage our credit risk. These outstanding standbyletters of credit have expiration dates ranging from January2012 to February 2033.We utilize various financial instruments with off-balancesheet risk to satisfy the financing needs of our borrowers andto manage our exposure to interest rate risk. Such financialinstruments include commitments to extend credit andcommercial letters of credit. Commitments to extend credit areagreements to lend to a borrower provided that certaincontractual conditions are met. Commercial letters of creditare agreements to pay a beneficiary under conditions specifiedin the letter of credit. Commitments and letters of creditgenerally have fixed expiration dates or other terminationclauses and may require payment of a fee. At December 31,CoBank 2011 Annual Report93