Digital Federal Credit Union and Subsidiaries

Transcription

1 Digital Federal Credit Union and Subsidiaries Consolidated Financial Statements

2 CONSOLIDATED FINANCIAL STATEMENTS C O N T E N T S Page Independent Auditor s Report... 1 Consolidated Financial Statements: Statements of Financial Condition... 2 Statements of Income... 3 Statements of Comprehensive Income... 4 Statements of Members Equity... 5 Statements of Cash Flows

3 INDEPENDENT AUDITOR S REPORT To the Supervisory Committee Marlborough, MA Report on the Financial Statements We have audited the accompanying consolidated financial statements of Digital Federal Credit Union and Subsidiaries which comprise the consolidated statements of financial condition as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, changes in members equity and cash flows for the years then ended and the related notes to the financial statements. Management s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor s Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of as of December 31, 2012 and 2011, and the results of their operations and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. March 1, 2013 Boston, MA

4 Page 2 Consolidated Statements of Financial Condition December 31, 2012 and 2011 ASSETS Cash and cash equivalents $ 262,283 $ 299,894 Investments: Available-for-sale 336, ,537 Other 108,610 56,908 Loans held-for-sale 40,176 6,922 Loans to members, net 3,868,969 3,554,070 Accrued interest receivable 14,860 13,505 Property and equipment, net 52,394 52,300 National Credit Union Share Insurance Fund deposit 35,236 31,649 Other assets 16,096 33,228 Total assets $ 4,735,023 $ 4,231,013 LIABILITIES AND MEMBERS' EQUITY Liabilities: Members shares $ 3,874,856 $ 3,436,507 Borrowed funds 428, ,502 Accrued expenses and other liabilities 35,187 36,550 Total liabilities 4,338,685 3,910,559 Commitments and contingent liabilities Members equity: Retained earnings 399, ,947 Accumulated other comprehensive loss (3,618) (4,493) Total members equity 396, ,454 Total liabilities and members equity $ 4,735,023 $ 4,231,013 The accompanying notes are an integral part of these consolidated financial statements.

5 Page 3 Consolidated Statements of Income Interest income: Loans to members $ 178,165 $ 175,152 Investments and cash equivalents 2,666 1,816 Total interest income 180, ,968 Interest expense: Members' shares 24,933 21,437 Borrowed funds 9,356 10,065 Total interest expense 34,289 31,502 Net interest income 146, ,466 Provision for loan losses 3,000 23,200 Net interest income after provision for loan losses 143, ,266 Noninterest income: Service charges and other fees 12,637 13,033 Interchange income 21,923 16,252 Net gain on sales of loans 6, Net loss on foreclosed assets (2,945) (7,620) Other noninterest income 1,644 2,688 Total noninterest income 39,953 25,199 Noninterest expense: Salaries and benefits 47,347 43,611 Operations 36,946 28,289 Occupancy 14,181 13,243 Loss on prepayment of borrowed funds 6,665 - National Credit Union Administration Stabilization Fund assessment 3,347 7,912 Total noninterest expense 108,486 93,055 Net income $ 75,009 $ 54,410 The accompanying notes are an integral part of these consolidated financial statements.

6 Page 4 Consolidated Statements of Comprehensive Income Net income $ 75,009 $ 54,410 Other comprehensive income (loss): Net change in defined benefit plan gains or losses, transition obligation or asset, and prior service cost or credit (337) (1,368) Net change in unrealized gains on available-for-sale investments 1,212 - Net other comprehensive income 875 (1,368) Comprehensive income $ 75,884 $ 53,042 The accompanying notes are an integral part of these consolidated financial statements.

7 Page 5 Consolidated Statements of Members' Equity Accumulated Retained Earnings Other Total Regular Comprehensive Members' Reserve Unappropriated Total Income (Loss) Equity Balance, December 31, 2010 $ 100,227 $ 170,310 $ 270,537 $ (3,125) $ 267,412 Net income - 54,410 54,410-54,410 Other comprehensive income (1,368) (1,368) Balance, December 31, , , ,947 (4,493) 320,454 Net income - 75,009 75,009-75,009 Other comprehensive income Balance, December 31, 2012 $ 100,227 $ 299,729 $ 399,956 $ (3,618) $ 396,338 The accompanying notes are an integral part of these consolidated financial statements.

8 Page 6 Consolidated Statements of Cash Flows Cash flows from operating activities: Net income $ 75,009 $ 54,410 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of investments, net Amortization of servicing assets 2,150 1,609 Provision for loan losses 3,000 23,200 Net gain on sales of loans (6,694) (846) Proceeds from sales of loans 119,398 36,064 Loans committed for sale (147,858) (34,165) Depreciation and amortization 5,895 5,477 Net change in: Accrued interest receivable (1,355) 333 Other assets 16,882 7,590 Accrued expenses and other liabilities (1,700) 2,070 Net cash provided by operating activities 65,168 95,742 Cash flows from investing activities: Purchases of available-for-sale investments (153,091) - Purchases of trading investments - (161,430) Net change in other investments (51,702) (9,999) Net change in loans to members (317,899) (409,467) Increase in the National Credit Union Share Insurance Fund deposit (3,587) (1,507) Purchases of property and equipment (5,989) (3,175) Net cash used in investing activities (532,268) (585,578) Cash flows from financing activities: Repayment of long-term borrowed funds (203,860) (3,741) Proceeds from long-term borrowed funds 205, ,000 Net change in short-term borrowed funds (10,000) 100,000 Net change in members shares 438, ,350 Net cash provided by financing activities 429, ,609 (Decrease) increase in cash and cash equivalents (37,611) 33,773 Cash and cash equivalents, beginning of year 299, ,121 Cash and cash equivalents, end of year $ 262,283 $ 299,894 Supplemental cash flow information: Foreclosed assets acquired in settlement of loans to members $ 9,118 $ 13,837 Dividends paid on members' shares and interest paid on borrowed funds $ 34,648 $ 33,280 Transfer of investments from trading to available-for-sale $ - $ 182,537 The accompanying notes are an integral part of these consolidated financial statements.

9 Page 7 1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES Nature of Operations Digital Federal Credit Union (the Credit Union ) is a cooperative association holding a corporate charter under the provisions of the Federal Credit Union Act. Participation in the Credit Union is limited to those individuals who qualify for membership as defined in the Credit Union s Charter and Bylaws. Principles of Consolidation The accompanying consolidated financial statements include the accounts of the Credit Union and its subsidiaries, Financial Vision, LLC, organized for the purpose of software development, DCU Insurance, LLC, which provides property and casualty insurance to members and DCU Realty, LLC, which provides brokerage services to members in Massachusetts. The activities in these subsidiaries are insignificant to the Credit Union as a whole. All significant intercompany balances and transactions have been eliminated in consolidation. Significant Accounting Policies The Credit Union follows the accounting standards set by the Financial Accounting Standards Board ( FASB ). The FASB establishes generally accepted accounting principles ( GAAP ) that are followed to ensure consistent reporting of the financial condition, results of operations and cash flows of the Credit Union. References to GAAP issued by the FASB in these notes to the consolidated financial statements are to The FASB Accounting Standards Codification TM commonly referred to as the Codification or ASC. Use of Estimates The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relates to the determination of the allowance for loan losses, the fair value of financial instruments, and post-retirement benefit plans. Concentrations of Credit Risk Most of the Credit Union s business activity is with its members who reside in or are employed in the Northeastern part of the United States of America. The Credit Union may be exposed to credit risk from a regional economic standpoint, since a significant concentration of its borrowers work or reside in the Northeastern part of the United States of America. However, the loan portfolio is well-diversified and the Credit Union does not have any significant concentrations of credit risk except unsecured loans, which by their nature increase the risk of loss compared to those loans that are collateralized. The Credit Union s policy for repossessing collateral is that when all other collection efforts have been exhausted, the Credit Union enforces its lien holder status and repossesses the collateral. Repossessed collateral normally consists of vehicles and real estate.

10 Page 8 1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES continued Fair Value The Codification defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurement. Fair value is a market-based measurement, not an entity-specific measurement, and the hierarchy gives the highest priority to quoted prices in active markets. Fair value measurements are disclosed by level within the fair value hierarchy. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Valuation techniques are to be consistent with the market approach, the income approach and/or the cost approach. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity's own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, the Codification establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows: Level 1 - Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. Level 2 - Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data. Level 3 - Significant unobservable inputs that reflect a reporting entity s own assumptions about the assumptions that market participants would be used in pricing an asset or liability. A summary of the Credit Union s financial instruments, including methodologies and resulting values, is discussed in Note 14 to these consolidated financial statements. Cash and Cash Equivalents For the purpose of the consolidated statements of financial condition and the consolidated statements of cash flows, cash and cash equivalents includes cash on hand, amounts due from financial institutions, and highly liquid debt instruments classified as cash that were purchased with maturities of three months or less. Amounts due from financial institutions may, at times, exceed federally insured limits.

11 Page 9 1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES continued Investments The Credit Union accounts for investment securities in accordance with FASB ASC 320, Investments Debt and Equity Securities. Equity securities are classified into one of three categories: trading securities, securities available-for-sale, or held-to-maturity securities. Securities available for sale include securities which may be sold in response to changes in interest rates, resultant prepayment risk and other related factors, and securities that are intended to be held for indefinite periods of time, but which may not be held to maturity. Investment securities that management has the positive intent and ability to hold to maturity are classified as held-to-maturity and recorded at amortized cost. Any investment not classified as available-forsale or held-to-maturity will be classified as trading. At December 31, 2011 the Credit Union reclassified their trading securities to available-for-sale whereby the securities fair value as of December 31, 2011 became their new cost basis. As of December 31, 2012 and 2011 the Credit Union did not have any trading or held-to-maturity securities. In determining whether other-than-temporary impairment exists for investment securities, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer; (3) the current liquidity and volatility of the market for each of the individual security categories; (4) the projected cash flows from the specific security type; (5) the financial guarantee and financial rating of the issuer; and (6) the intent and ability of the Credit Union to retain its investment in the issue for a period of time sufficient to allow for any anticipated recovery in fair value. For other-than-temporary impairment of debt securities, the Credit Union determines whether it intends to sell or is more likely than not that it will be required to sell a security before recovery of the debt securities amortized cost basis less any current-period credit losses. For impairment of debt securities that are considered other-than-temporary, and the Credit Union does not intend to sell and will not be required to sell prior to recovery of our amortized cost basis, the Credit Union separates the amount of the impairment into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security s fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income. For impaired debt securities that the Credit Union intends to sell, or more likely than not will be required to sell, the full amount of depreciation is recognized through earnings. Other investments are classified separately and are stated at cost. If such investments are deemed to be impaired, the recorded cost is reduced by the amount of impairment. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method. Federal Home Loan Bank ( FHLB ) Stock The Credit Union, as a member of the FHLB of Boston, is required to maintain an investment in capital stock of the FHLB of Boston. No ready market exists for the FHLB of Boston stock and it has no quoted market value. The Credit Union reviews for impairment based on the ultimate recoverability of the cost basis in the stock. As of December 31, 2012, no impairment has been recognized. The FHLB Stock held by the Credit Union is included in other investments at December 31, 2012 and 2011.

12 Page NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES continued Derivatives Loan Commitments The Credit Union enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding (rate lock commitments). Rate lock commitments on mortgage loans to be held for sale are considered to be derivatives. Accordingly, such commitments, on the consolidated statements of financial condition are recorded at fair value, with changes in fair value recorded in the net gain or loss on sale of mortgage loans. Fair value is based on the change in estimated fair value of the underlying mortgage loan. The fair value is subject to change primarily due to changes in interest rates. To hedge the exposure of changes in interest rates impacting the fair value of loans held for sale and related loan commitments, the Credit Union typically enters in to forward sales commitments with its secondary market investors at the time a loan commitment is granted to lock in the ultimate sale and price of the loan. These commitments require the Credit Union to pay a penalty for nonperformance in the event the committed loans are not delivered. As such, these sales commitments are derivative instruments, recorded on the consolidated statements of financial condition at fair value in other assets or liabilities. Changes in fair value are reported in income. Mortgage Loans Held-for-Sale Mortgage loans held-for-sale are those loans the Credit Union has the intent to sell in the foreseeable future. They are carried at the lower of aggregate cost or market value. Net unrealized losses, if any, are recognized through a valuation allowance charged to income. Gains and losses on sales of loans are recognized at settlement dates and are determined by the difference between the sales proceeds and the carrying value of the loans after allocating cost to servicing rights retained. All sales are made without recourse subject to the customary representations and warranties. Loans to Members, Net The Credit Union grants mortgage, commercial and consumer loans. The ability of the borrowers to honor their contracts is dependent upon the real estate and general economic conditions of the lending area. Loans that the Credit Union has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at their outstanding unpaid principal balances, less an allowance for loan losses and net deferred origination fees and costs. Interest income on loans is recognized over the term of the loan and is calculated using the simple interest method on principal amounts outstanding. The accrual of interest income on loans is discontinued at the time the loan is 90 days past due. Other personal loans are typically charged off no later than 180 days past due. Past-due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if the collection of principal and interest is considered doubtful. All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all of the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

13 Page NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES continued Loans to Members, Net continued Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income using the interest method over the contractual life of the loans, adjusted for estimated prepayments based on the Credit Union s historical prepayment experience. The Credit Union offers nontraditional mortgage loans to its members. These loans include hybrid loans that consist of loans that are fixed for an initial period of three, five, seven or 10 years. After this period, the mortgages are converted to variable rate using the fully indexed rate, which can result in significant payment shock to the borrower. Nontraditional mortgage loans may have significantly different credit risk characteristics than traditional fixed and variable rate mortgages. However, the Credit Union believes it has established prudent underwriting standards as well as adequate risk management functions to monitor these additional risks. Allowance for Loan Losses The allowance for loan losses is established as losses are estimated to have occurred though a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is likely. Subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses is evaluated on a regular basis by management and is based upon management s regular review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower s ability to repay, estimated value of the underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Credit Union s allowance for loan losses. When establishing the allowance for loan losses, management categorizes loans into risk categories generally based on the nature of the collateral and the basis of repayment. These risk categories and the relevant risk characteristics are as follows: Commercial Commercial loans primarily consist of non-owner and owner occupied real estate loans. Commercial loans generally have terms of fifteen years or less with interest rates that float (different adjustment periods by product) in accordance with a designated published index. Repayment is expected from the cash flows of the business. Loans are secured by the underlying collateral. Substantially all commercial loans are secured and backed by the personal guarantees of the owners of the business. Residential Loans Generally these loans are smaller in size and are homogenous because they exhibit similar characteristics. The Credit Union has identified home equity loans and lines of credits, and first mortgages in homogenous risk categories. Repayment is dependent on the credit quality of the individual borrower. Most loans are secured by the underlying collateral.

14 Page NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES continued Allowance for Loan Losses continued Consumer Loans The Credit Union has identified auto loans, credit cards, student loans, and other unsecured loans in homogenous risk categories. Repayment is dependent on the credit quality of the individual borrower. A loan is impaired when, based on current information and events, it is probable that the Credit Union will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. These concessions may include rate reductions, principal forgiveness, extension of maturity date and other actions intended to minimize potential losses. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Delinquent home equity, first mortgages, commercial loans and modifications secured by real estate are individually evaluated for impairment once certain conditions have been met. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Credit Union determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses. The general component of the allowance for loan losses covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Credit Union over the most recent year to 2 years. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations.

15 Page NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES continued Transfers of Financial Assets Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Credit Union, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Credit Union does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets. Loan Servicing Servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of financial assets. For sales of loans, a portion of the cost of originating the loan is allocated to the servicing right based on relative fair value. Fair value is based on market prices for comparable servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. Capitalized servicing assets are reported in other assets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights into tranches based on predominant risk characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual tranche, to the extent that fair value is less than the capitalized amount for the tranche. If the Credit Union later determines that all or a portion of the impairment no longer exists for a particular tranche, a reduction of the allowance may be recorded as an increase to income. Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned. The amortization of servicing assets is netted against loan servicing fee income. Property and Equipment, Net Land is carried at cost. Land improvements, building and improvements, furniture, and equipment and leasehold improvements are carried at cost, less accumulated depreciation and amortization. Land improvements, building and improvements, furniture and equipment are depreciated using the straight-line method over the estimated useful lives of the assets. The cost of leasehold improvements is amortized using the straight-line method over the terms of the related leases. Construction in progress is carried at cost and will be depreciated using the straight-line method over the estimated useful life of the asset once placed in service.

16 Page NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES continued Foreclosed Assets Assets acquired through foreclosure or other proceedings are initially recorded at fair value at the date of foreclosure less estimated costs of disposal, which establishes a new cost. After foreclosure, valuations are periodically performed by management of the Credit Union and foreclosed assets held for sale and are carried at the lower of cost or fair value less estimated costs of disposal. Any write-down to fair value at the time of transfer to foreclosed assets is charged to the allowance for loan losses. Property is evaluated regularly to ensure the recorded amount is supported by its current fair value and valuation allowances to reduce the carrying amount to fair value less estimated costs to dispose are recorded as necessary. National Credit Union Share Insurance Fund ( NCUSIF ) Deposit and Assessments The deposit in the NCUSIF is in accordance with National Credit Union Administration ( NCUA ) regulations, which require the maintenance of a deposit by each federally insured credit union in an amount equal to 1 percent of its insured members shares. The deposit would be refunded to the Credit Union if its insurance coverage is terminated, if it converts its insurance coverage to another source or if management of the fund is transferred from the NCUA Board. The Credit Union recognizes NCUSIF premiums and Temporary Corporate Credit Union Stabilization Fund ( TCCUSF ) assessments when approved by the NCUA. During the years ended December 31, 2012 and 2011, there were no NCUSIF premiums due, although a TCCUSF assessment was recognized by the Credit Union of $3,347 and $7,912, respectively. Members Shares Members shares are the savings deposit accounts of the owners of the Credit Union. Share ownership entitles the members to vote in the annual elections of the Board of Directors and on other corporate matters. Irrespective of the amount of shares owned, no member has more than one vote. Members shares are subordinated to all other liabilities of the Credit Union upon liquidation. Dividends on members shares are based on available earnings at the end of a dividend period and are not guaranteed by the Credit Union. Dividend rates are set by the Credit Union s Board of Directors. Income Taxes The Credit Union is exempt, by statute, from federal and state income taxes. Since the Credit Union s subsidiaries are organized as Limited Liability Companies, they effectively pay no taxes. The Credit Union follows the Codification guidance on accounting for uncertainty in income taxes for the years ended December 31, 2012 and Management evaluated the Credit Union s tax positions and concluded that the Credit Union had taken no uncertain tax positions that require adjustment to the financial statements to comply with the provisions of this guidance. With few exceptions, the Credit Union s subsidiaries are no longer subject to income tax examinations by the U.S. federal, state or local tax authorities for years before 2011.

17 Page NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES continued Defined Benefit Plan The Credit Union has a qualified, noncontributory defined benefit pension plan covering certain employees. The Credit Union s policy is to fund an amount in excess of the minimum amount required under ERISA. Defined Contribution Plan The Credit Union has established a contributory 401(k) plan for qualified employees. The Credit Union s policy is to fund contributions as accrued. Comprehensive Income Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Certain changes in assets and liabilities, such as the defined benefit plan net costs and losses and net changes in unrealized gains and losses on available-for-sale investments, are reported as a separate component of members equity on the consolidated statements of financial condition. Reclassifications Certain account reclassifications have been made to the 2012 consolidated financial statements in order to conform to classifications used in the current year with no effect on net income or members equity. Recent Accounting Pronouncements In April 2011, the FASB issued Accounting Standards Update No , Receivables (Topic 310): A Creditor s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The FASB believes the guidance in this ASU will improve financial reporting by creating greater consistency in the way GAAP is applied for various types of debt restructurings. The ASU clarifies which loan modifications constitute troubled debt restructurings. It is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructurings. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties. The amendments to FASB ASC Topic 310, Receivables, clarify the guidance on a creditor s evaluation of whether it has granted a concession and whether a debtor is experiencing financial difficulties. This Update is effective for the Credit Union s fiscal year ending December 31, Management has adopted this Update and it has not had a significant impact on the Credit Union s consolidated financial statements.

18 Page NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES continued Recent Accounting Pronouncements continued In April 2011, the FASB issued Accounting Standards Update , Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements. The amendments change the effective control assessment by removing the criterion that required the transferor to have the ability to repurchase or redeem financial assets on substantially the agreed terms, even in the event of default by the transferee. Instead, the amendments focus the assessment of effective control on the transferor's rights and obligations with respect to the transferred financial assets and not whether the transferor has the practical ability to perform in accordance with those rights or obligations. This Update is effective for the Credit Union s fiscal year ending December 31, Management has adopted this Update and it has not had a significant impact on the Credit Union s consolidated financial statements. In May 2011, the FASB issued ASU , Fair Value Measurement (Topic 820). The amendments in this Update generally represent clarifications of Topic 820, but also include some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This Update results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and International Financial Reporting Standards ( IFRS ). This Update is effective for the Credit Union s fiscal year ending December 31, Management has adopted this Update and it has not had a significant impact on the Credit Union s consolidated financial statements. In June 2011, the FASB issued Accounting Standards Update (ASU) No , Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This ASU amends the Codification to allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders equity. The amendments to the Codification in ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. ASU should be applied retrospectively. This is effective for the Credit Union s fiscal year ending December 31, Management currently follows this guidance. See the consolidated statements of comprehensive income. In December 2011, the FASB issued ASU , Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. The amendments in this Update affect all entities that have financial instruments and derivative instruments that are either (1) offset in accordance with either Section or Section or (2) subject to an enforceable master netting arrangement or similar agreement. The requirements amend the disclosure requirements on offsetting in Section This information will enable users of an entity s financial statements to evaluate the effect or potential effect of netting arrangements on an entity s financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments in the scope of this Update. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. This ASU is not expected to have a significant impact on the Credit Union s consolidated financial statements.

19 Page NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES continued Recent Accounting Pronouncements continued In December 2011, the FASB issued ASU , Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No In order to defer only those changes in Update that relate to the presentation of reclassification adjustments, the paragraphs in this Update supersede certain pending paragraphs in Update Entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before Update All other requirements in Update are not affected by this Update, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. This is effective for the Credit Union s fiscal year ending December 31, This Update did not have a significant impact on the Credit Union s consolidated financial statements. Subsequent Events The Credit Union has evaluated subsequent events through March 1, 2013, the date on which the consolidated financial statements were available to be issued. 2. INVESTMENTS The Credit Union accounts for its investment securities in accordance with ASC 320, which requires the Credit Union to reassess the classification of its investment securities, periodically, to ensure that the classification remains appropriate given the Credit Union s current intentions and abilities to hold the securities. At December 31, 2011 the Credit Union determined that its intentions with respect to its outstanding investments was no longer for trading purposes and determined that classification as available-for-sale was the proper classification. Upon reclassification to available-for-sale, the fair value of the investments was $182,537, including approximately $500 of cumulative unrealized gains, which became the new cost basis of the securities. In accordance with ASC 320, the Credit Union recognized all unrealized gains and losses on its investments recognized as a component of non interest income while the investments were classified as trading securities. Upon reclassification of the securities to available-for-sale all unrealized gains and losses on its investments will be recorded in other comprehensive income. Investments classified as available-for-sale consist of the following: Amortized Unrealized Unrealized Fair Cost Gains Losses Value December 31, 2012 Debt Securities: U.S. government obligations and federal agencies securities $ 51,128 $ 352 $ - $ 51,480 Equity Securities: Mutual funds of U.S government securities 284, ,919 $ 335,187 $ 1,212 $ - $ 336,399

20 Page INVESTMENTS continued December 31, 2011 Amortized Unrealized Unrealized Fair Cost Gains Losses Value Equity Securities: Mutual funds of U.S government securities $ 182,537 $ - $ - $ 182,537 Other investments consist of the following: December 31, Certificates of deposit in corporate credit union $ 64,000 $ 10,000 FHLB of Boston stock 41,605 44,218 Paid-in capital account in a corporate credit union 1,575 1,476 Other 1,430 1,214 Investments by maturity as of December 31, 2012, are summarized as follows: $ 108,610 $ 56,908 December 31, 2012 Available-for-sale Amortized Fair Cost Value Other Less than 1 year maturity $ - $ - $ 52, years maturity 51,128 51,480 12,000 $ 51,128 $ 51,480 $ 64,000 FHLB of Boston stock, mutual funds, paid-in capital accounts in a corporate credit union and other investment accounts have no contractual maturity.

21 Page LOANS TO MEMBERS, NET Loans to members consist of the following: December 31, Commercial: Real estate $ 455,678 $ 405,181 Other 19,899 25,330 Residential: First mortgages 1,523,600 1,432,167 Home equities loans/lines 536, ,946 Consumer: Credit card 330, ,415 Student 104,326 88,823 Auto 907, ,839 Other 30,175 20,739 3,908,111 3,622,440 Deferred net loan origination costs 15,677 13,640 Allowance for loan losses (54,819) (82,010) $ 3,868,969 $ 3,554,070 The following is an aging analysis of the recorded investment of past due loans as of: December 31, 2012: Total Days Days 90 Days Loan Current Past Due Past Due And Greater to Members Commercial: Real estate $ 449,402 $ - $ 5,025 $ 1,251 $ 455,678 Other 19, ,899 Residential: First mortgage 1,502,849-5,303 15,448 1,523,600 Home equity loans/lines 527,604 1,871 1,819 5, ,498 Consumer: Credit card 323,195 2,528 1,020 3, ,714 Auto 891,339 9,945 2,438 3, ,221 Other* 131,885 1, ,501 * This category includes student loans $ 3,846,085 $ 15,754 $ 16,342 $ 29,930 $ 3,908,111

22 Page LOANS TO MEMBERS, NET continued December 31, 2011: Total Days Days 90 Days Loan Current Past Due Past Due And Greater to Members Commercial: Real estate $ 395,864 $ 879 $ 1,516 $ 6,922 $ 405,181 Other 25, ,330 Residential: First mortgage 1,402,169 6,744 3,279 19,975 1,432,167 Home equities loans/lines 590,800 4,323 1,429 7, ,946 Consumer: Auto 721,407 12,168 1,243 5, ,839 Credit card 300,202 2,250 1,114 2, ,415 Other* 108, ,562 * This category includes student loans $ 3,544,284 $ 27,015 $ 8,730 $ 42,411 $ 3,622,440 For the years ended December 31, 2012 and 2011, interest collected on impaired loans for the period of impairment was not significant. There were no loans past due more than 90 days for which the accrual of interest continued. The following table presents the recorded investment in nonaccrual loans by class and the amount of interest not recognized as the loans were on nonaccrual status as of December 31: Balance Interest Balance Interest Commercial Real estate $ 1,251 $ 57 $ 8,443 $ 480 Other Residential: First mortgages 15, , Home equities loans/lines 5, , Consumer: Auto 3, , Credit card 3, , Other, including student loans $ 29,930 $ 1,602 $ 43,932 $ 2,063

23 Page LOANS TO MEMBERS, NET continued As part of the on-going monitoring of the credit quality of the Credit Union s loan portfolio, management categorizes commercial loans into risk categories based on relevant information about the ability of borrowers to service their debt and comply with various terms of their loan agreements. The Credit Union considers current financial information, historical payment experience, credit documentation, public information and current economic trends. Generally, all credits classified as watched assets receive a financial review no less than annually to monitor and adjust, if necessary, the credit s risk profile. For substandard, and doubtful credit classifications, the frequency of review is increased to no less than quarterly in order to determine potential impact on credit loss estimates. A pass asset is well protected by the current worth and paying capacity of the obligator (or guarantors, if any) or by the fair value, less cost to acquire and sell, of any underlying collateral in a timely manner. The Credit Union categorizes loans as pass, watch, substandard or doubtful, based on the relevant information about the ability of borrowers to service their debt. The following table presents the risk category of commercial loans evaluated by internal asset classification based on the most recent analysis performed and the contractual aging as of: December 31, 2012 Commercial Credit Exposure Real Estate Other Pass 1 through 6 $ 435,620 $ 19,562 Watch 7 4,067 - Substandard 8 5, Doubtful 9 10, $ 455,678 $ 19,899 December 31, 2011: Commercial Credit Exposure Real Estate Other Pass 1 through 6 $ 374,872 $ 24,927 Watch 7 7, Substandard 8 18, Doubtful 9 4, $ 405,181 $ 25,330 Residential, consumer and other non-commercial loans are assessed for credit quality based on the contractual aging status of the loan and payment activity. Such assessment is completed at the end of each reporting period and the loans are classified as either performing or nonperforming.