Prospera Credit Union. Consolidated Financial Statements December 31, 2008 (expressed in thousands of dollars)

Transcription

1 Consolidated Financial Statements

2 February 19, 2009 Auditors Report To the Members of We have audited the consolidated balance sheet of as at and the consolidated statements of income and comprehensive income, members equity and cash flows for the year then ended. These financial statements are the responsibility of the Credit Union s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Credit Union as at and the results of its operations and its cash flows for the year then ended in accordance with Canadian generally accepted accounting principles. Chartered Accountants

3 Consolidated Balance Sheet As at Assets Cash resources 139, ,519 Loans to members (note 3) 1,607,015 1,525,902 Investments (note 5) 5,732 6,223 Property, premises and equipment (note 6) 13,598 16,724 Other assets (note 7) 14,196 24,442 Future income taxes (note 14) 1,298 1,488 Income taxes receivable 145 1,651 1,781,214 1,708,949 Liabilities Borrowings (note 8) 63, ,800 Member deposits (note 9) 1,634,385 1,497,204 Accounts payable and accrued liabilities (note 13) 13,280 15,857 1,711,165 1,644,861 Members Equity Members equity shares (note 10(c)) 5,894 6,358 Retained earnings 64,155 57,730 Accumulated other comprehensive income ,049 64,088 1,781,214 1,708,949 Approved by the Board of Directors: Director Director See accompanying notes to financial statements.

4 Consolidated Statement of Members Equity Members equity shares Retained earnings Accumulated other comprehensive income Members equity Balance - September 30, 2006 As previously reported 6,750 50,847-57,597 Transitional adjustments on adoption of CICA Financial Instruments Standards (note 2) - (46) - (46) As restated 6,750 50,801-57,551 Net income and other comprehensive income for the 15 month period ended December 31, - 7,242-7,242 Dividends on members equity shares - (313) - (313) Share redemptions - net (392) - - (392) Balance - December 31, 6,358 57,730-64,088 Net income and other comprehensive income for the year ended - 6,628-6,628 Dividends on members equity shares (203) - (203) Share redemptions - net (464) - - (464) Balance - 5,894 64,155-70,049 See accompanying notes to financial statements.

5 Consolidated Statements of Income and Comprehensive Income Year ended December 31, Fifteen-month period ended December 31, Interest income Loans 88, ,561 Cash resources and investments 5,601 8,499 94, ,060 Interest expense Deposits 47,574 65,353 Borrowings 4,384 6,242 51,958 71,595 Net interest income 42,328 52,465 Provision for credit losses (note 3) 1,150 1,169 Net interest income after provision for credit losses 41,178 51,296 Other income (note 11) 21,730 27,838 Net interest income and other income 62,908 79,134 Non-interest expenses Salaries and employee benefits 29,540 37,350 Occupancy 7,755 9,162 Administration 5,443 7,739 Amortization 3,750 4,900 Other (note 12) 3,162 4,489 Clearing charges 2,020 2,515 Communication and marketing 1,456 1,844 Data processing 872 1,227 53,998 69,226 Income before dividends on member deposit shares 8,910 9,908 Dividends on member deposit shares 1,159 1,395 Income before income taxes 7,751 8,513 Provision for (recovery of) income taxes (note 14) Current 839 1,723 Future 284 (452) 1,123 1,271 Net income for the period 6,628 7,242 Other comprehensive income for the period - - Comprehensive income 6,628 7,242 See accompanying notes to financial statements.

6 Consolidated Statement of Cash Flows Year ended December 31, Fifteen-month period ended December 31, Cash flows from operating activities Net income for the period 6,628 7,242 Items not affecting cash Amortization 3,750 4,900 Provision for credit losses 1,150 1,169 Provision for losses on property held for resale - 29 Gain on disposal of subsidiaries (note 1) (3,118) (1,933) Gain on sale of property held for resale - (312) Loss (gain) on sale of property, premises and equipment 32 (1,492) Gain on sale of insurance license - (125) Securitization (gain) loss on sale (note 11) (758) 449 Amortization of servicing liability (494) (724) Net change in fair value of derivative financial instruments (note 18) 75 - Future income taxes 284 (452) 7,549 8,751 Change in non-cash working capital items Income taxes 1,498 (1,315) Other assets 6, Accounts payable and accrued liabilities (1,592) (3,312) 13,750 4,986 Cash flows from investing activities Decrease (increase) in Central 1 term deposits (4,447) 8,837 Net change in loans to members (108,083) (96,894) Proceeds from loan securitizations 25,909 23,201 Net proceeds from sale of subsidiary 7,452 7,727 Decrease in Central 1 equity shares Decrease in other investments (83) (237) Proceeds on sale of property held for resale - 4,068 Additions to property held for resale - (61) Net proceeds on sale of insurance license Proceeds on sale of property, premises and equipment - 1,657 Additions to property, premises and equipment (1,022) (4,012) (79,700) (54,938) Cash flows from financing activities (Decrease) increase in borrowings (68,300) 34,800 Net increase in member deposits 134,714 10,249 Net increase of member deposit shares and members equity shares 1, Income tax reduction related to dividend ,214 45,386 Increase (decrease) in cash 2,264 (4,566) Cash - Beginning of period 13,165 17,731 Cash - End of period 15,429 13,165 Cash resources consists of Cash 15,429 13,165 Central 1 term deposits 123, , , ,519 Supplementary cash flow information (note 21) See accompanying notes to financial statements.

7 1 General (the Credit Union ) is incorporated under the laws of British Columbia and is regulated under the Financial Institutions Act of British Columbia. The Credit Union s primary business activities include providing financial services to its members and the general public across British Columbia. The Credit Union has locations in Greater Vancouver, the Fraser Valley and the Okanagan. It provides financial services through 16 retail banking centres, 7 insurance offices, 6 commercial banking centres, on-line banking and a contact centre. On September 29,, the Credit Union acquired upon windup all assets of its wholly owned subsidiary, Prospera Insurance Agencies Okanagan Ltd. On September 30,, the Credit Union sold 100% of the shares of its wholly owned subsidiaries, Kelowna Valley Insurance Services Ltd. and Vernon Insurance Services Inc. (note 11). During the fifteen-month period ended December 31,, the Credit Union sold its subsidiary, Ubiquity Bank of Canada (note 11). Consolidated within the Credit Union s statement of income for the year ended is net income before taxes from Kelowna Valley Insurance Services Ltd. of 287 and from Vernon Insurance Services Inc. of 212 up to the date of disposition. 2 Significant accounting policies Basis of presentation These consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles and include the assets, liabilities, results of operations and cash flows of all subsidiary entities. All inter-entity balances and transactions are eliminated. The consolidated financial statements include the accounts of and its wholly owned subsidiaries, Prospera Insurance Agencies Ltd., Prospera Technologies Inc., B.C. Ltd., Prospera Holdings Ltd. and the results of Vernon Insurance Services Inc. and Kelowna Valley Insurance Services Ltd. until the date of their disposition on September 30,. Use of estimates The preparation of the consolidated financial statements in accordance with Canadian generally accepted accounting principles 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 balance sheet date and the reported amounts of revenues and expenses during the reporting period. Significant areas requiring the use of estimates include accounting for financial instruments, provision for credit losses, accounting for securitization transactions and the values of retained interests, income taxes and employee future benefits. Actual results may differ from these estimates. (1)

8 Changes in accounting policies On October 1, 2006, the Credit Union adopted the Canadian Institute of Chartered Accountants ( CICA ) Handbook Section 3855, Financial Instruments - Recognition and Measurement, Section 3865, Hedges, Section 1530, Comprehensive Income and Section 3861, Financial Instruments - Disclosure and Presentation. Under these new standards, an entity s financial assets may be classified as available-for-sale ( AFS ), held-for-trading ( HFT ), held-to-maturity ( HTM ), or loans and receivables, and all financial liabilities are classified as HFT or other financial liabilities. All financial instruments classified as AFS or HFT are required to be measured at fair value on the balance sheet while financial instruments classified as loans and receivables, HTM or other financial liabilities are measured at amortized cost using the effective interest method. Unrealized gains and losses on financial instruments that are classified as AFS are reported in other comprehensive income ( OCI ). When gains or losses become realized through sale or other than temporary impairment, they are reclassified from accumulated other comprehensive income ( AOCI ) to income. Interest income earned on debt instruments classified as AFS financial assets is recorded directly to the statement of income using the effective interest method. Unrealized gains and losses on financial instruments that are classified as HFT are recognized along with income earned directly in the consolidated statement of income. Financial assets and liabilities are presented on a net basis when the Credit Union has a legally enforceable right of offset of the recognized amounts and an intention to settle on a net basis. These changes were applied retrospectively without restatement of comparative figures. Management assessed the impact of the new standards and determined that a net adjustment of 46 was recorded to reduce opening retained earnings at October 1, 2006 as a result of the new standards. Current year accounting policy changes a) Capital disclosures The new CICA Handbook Section 1535, Capital Disclosures, requires that an entity disclose information that enables users of its financial statements to evaluate an entity s objectives, policies and processes for managing capital, including disclosures of any externally imposed capital requirements and the consequences of non-compliance. The new standard applies to annual financial statements relating to fiscal years beginning on or after October 1,, specifically January 1, for the Credit Union. This standard impacts the disclosures the Credit Union provides but does not affect the Credit Union s consolidated statement of income or balance sheet. The Credit Union has included capital disclosures in note 16. (2)

9 b) Financial Instruments disclosure The new CICA Handbook Sections 3862 and 3863 replace Handbook Section 3861, Financial Instruments - Disclosure and Presentation, revising and enhancing its disclosure requirements, and carrying forward unchanged its presentation requirements. These new sections place increased emphasis on disclosures about the nature and extent of risks arising from financial instruments and how the entity manages those risks. The new standards apply to annual financial statements relating to fiscal years beginning on or after October 1,, specifically January 1, for the Credit Union. The Credit Union has included additional financial instrument disclosures in note 16. Future year accounting policy changes International Financial Reporting Standards The CICA has issued a plan for publicly accountable entities to converge with International Financial Reporting Standards ( IFRS ) effective for fiscal periods beginning on or after January 1, The Credit Union s transition date of January 1, 2011 will require the restatement for comparative purposes of amounts reported by the Credit Union for the year ending December 31, Management has established a change-over plan to adopt IFRS in 2011 and has assigned resources to implement the plan. While the Credit Union has begun assessing the impact of IFRS for 2011, the financial reporting impact of the transition to IFRS cannot be reasonably estimated at this time. Cash resources For the purposes of the consolidated statement of cash flows, cash comprises highly liquid balances with less than 90 days maturity from the date of acquisition, including cash and deposits with Central 1, and balances held with other financial institutions. Loans to members Loans to members are stated at unpaid principal and accrued interest, net of deferred transaction costs and fees on an amortized cost basis using the effective interest method. Loans are recorded net of specific provisions for estimated losses on impaired loans and a general provision. Interest income is accounted for on an accrual basis using the effective interest method, except for loans classified as impaired. Loans are generally considered impaired when, in the opinion of management, there is reasonable doubt as to the collectability of principal and interest, or when principal or interest is 90 days past due. Accrued but uncollected interest is provided for when a loan is determined to be impaired. When a loan is classified as impaired, interest income is recognized on a cash basis only after any specific provision or partial write-offs have been recovered and provided there is no further doubt as to the collectability of the principal. Loans considered uncollectable are written off. (3)

10 Fees charged and related transaction costs incurred in connection with loan origination and renewals are recognized as an integral part of the yield earned on a loan and are recognized in interest income and expense using the effective interest method, unless a loan is repaid in full. In instances where a loan is refinanced and a prepayment fee is charged, the fee and any related transaction costs are recognized in income unless only minor modifications (based on a present value of future cash flows test) were made to the loan in which case they are deferred and amortized over the estimated remaining loan payment period using the effective interest method. Provision for credit losses The Credit Union maintains a provision for credit losses, which, in management s estimation, is considered adequate to provide for credit-related losses. The provision for loan losses consists of specific and general provisions. The specific provision is determined on the basis of specific loans, which, in management s opinion, may not be fully collectible. The specific provision is the amount required to reduce the carrying value of an impaired loan to its estimated net realizable amount. Specific provisions are supplemented by general provisions determined by judgement of management based on historical credit loss experience, known risks in the portfolio and current economic conditions and trends. The general allowance is maintained to absorb credit losses that management estimates have occurred at the balance sheet date for which specific allowances cannot yet be determined. Loan securitizations The Credit Union periodically securitizes loans by selling to independent special purpose trusts that issue securities to investors. Securitizations of loans are accounted for as sales when the Credit Union surrenders control of the transferred assets and receives consideration other than beneficial interests in the transferred assets. When such sales occur the Credit Union accounts for gains or losses in the statement of income. The amount of the gain or loss is based on the carrying value of the loans being transferred, allocated between the loans sold and retained interests based on their relative fair values at the date of transfer. As market prices are not available for such asset sales, the Credit Union estimates fair value based on the present value of expected future cash flows. Fair values are determined making the maximum use of market-based inputs and taking consideration of discount rates, forward yield curves and loan specific factors such as expected credit losses and rates of prepayments. The Credit Union also calculates an estimated servicing liability for the ongoing administration of securitized loans, where ongoing administrative services are provided to the special purpose trust. The deferred servicing liability is recorded as an accrued expense and amortized to the consolidated statement of income over the estimated rate of loan prepayments. (4)

11 The Credit Union has designated its retained interests in securitized loans as AFS and HFT assets. The retained interest, HFT, is accounted for at its estimated fair value on the balance sheet with changes in fair value recorded through net interest income. The retained interest, AFS, is accounted for at its estimated fair value on the balance sheet with changes in fair value recorded through other comprehensive income, net of interest income being recorded through the statement of income. The retained interest is amortized over the estimated remaining life of the underlying loans sold. Changes in estimated future cash flows are re-estimated at each balance sheet date and discounted to the estimated present value using the original effective interest rate with any adjustments recognized as increases or decreases to interest income. Investments Investments in equity shares are designated as AFS securities. The equity shares held by the Credit Union do not have quoted market values in an active market and are accounted for at cost. Realized gains and losses on sale and writedowns to reflect other-than-temporary impairments in value are included in net income. Dividends from equity securities are included in other income. Property, premises and equipment Land is reported at cost. Property, premises and equipment are initially stated at cost. Amortization is provided on the straight-line basis over the estimated useful life: Office equipment and furniture Computer equipment and software Leasehold improvements 3-7 years 3-10 years 1-10 years Property held for resale is valued at the lower of cost and estimated net realizable value. Goodwill Goodwill arose on the acquisition of various insurance brokerage businesses and represents the excess of the purchase price of the acquired business over the amount allocated to assets acquired less liabilities assumed, based on their fair values. Goodwill is not amortized but is tested annually for impairment at a business reporting unit level. Goodwill is determined to be impaired when the fair value of a reporting unit is less than its carrying amount. If impaired, the Credit Union would recognize an impairment loss by writing down the goodwill to its fair value. Client lists Client lists are initially recorded at fair value on acquisition. Client lists are subject to a periodic impairment review which compares estimated fair value to carrying value. If a client list is identified as impaired, the asset is written down to its fair value and the writedown recorded in the statement of income. Amortization is provided over the estimated useful life of the lists on a straight-line basis over fifteen years. As at December 31,, the Credit Union has no client lists as a result of the disposition of certain insurance subsidiaries. (5)

12 Derivative financial instruments Derivative financial instruments are financial contracts whose value is derived from interest rates, foreign exchange rates, or other financial indices. In the ordinary course of business, the Credit Union enters into various derivative contracts, including interest rate swaps. Derivative financial instruments may be used to manage risk from the Credit Union s interest rate exposures as part of the Credit Union s asset/liability management program. For derivative instruments accounted for as hedges, the Credit Union formally documents all relationships between hedging instruments and hedged items as well as the risk management objective and strategy for undertaking various hedge transactions. The Credit Union also formally assesses, at both hedge inception and on an ongoing basis, whether the derivatives that are used in the hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. The Credit Union designates instruments as fair value hedges where derivatives are used to hedge exposure to changes in the fair value of financial instruments with fixed interest rates. Changes in fair value attributed to the hedged risk are recognized in net interest income. Changes in fair value of the hedging derivative are also recognised in net interest income. Accordingly, any hedging ineffectiveness is also recognized in net interest income. The Credit Union designates instruments as cash flow hedges where derivatives are used to hedge exposures to instruments with exposure to variable cash flows by effectively converting variable rate financial instruments to fixed rate financial instruments. The effective portion of the change in fair value of the derivative instrument is offset through OCI until the variability in cash flows being hedged is recognized in income at which time an equivalent portion of the amount within OCI is adjusted into income. Any ineffective portion of the change in fair value of the hedging derivative is accounted for within net interest income. Derivative transactions which do not meet the hedge documentation and effectiveness criteria are accounted for at fair value on the balance sheet with changes in fair value being recorded in the consolidated statement of income. Embedded derivatives All derivatives embedded in other financial instruments are valued as separate derivatives when their economic characteristics and risks are not closely related to the host contract; the terms of the embedded derivatives are not the same as those of a free-standing derivative; and the combined instrument is not measured at fair value, with changes in fair value recorded through the consolidated statement of income. Embedded derivatives related to index-linked deposit obligations are measured at estimated fair value with changes in fair value recorded through interest expense fully offset by an option contract to hedge the Credit Union s exposure to pay index-linked returns. (6)

13 Income taxes The Credit Union uses the asset and liability method of accounting for income taxes. Under the asset and liability method, future income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Future income tax assets and liabilities are measured using enacted or substantively enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on future income tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the date of enactment or substantive enactment. Foreign currency translation Monetary assets and liabilities denominated in foreign currencies are translated into Canadian dollars at prevailing exchange rates at the consolidated balance sheet date. Revenue and expenses are translated using average monthly exchange rates. Realized and unrealized gains and losses arising from translation are included in the consolidated statement of income. Defined benefit plans The Credit Union accrues its obligations under employee benefit plans (including pension plans and post-retirement plans) and the related costs, net of plan assets for defined benefit plans. The accrued benefit assets (liabilities) are included in other assets (accounts payable and accrued liabilities). The Credit Union has adopted the following policies: a) the cost of pensions and other post-retirement benefits earned by employees is actuarially determined using the projected benefit method prorated on service and management s best estimate of expected plan investment performance, salary escalation, retirement ages of employees, mortality and expected health care costs. The discount rate used to measure liabilities is derived from market rates as at the measurement date; b) the expected return on plan assets is based on management s best estimate of the long-term expected rate of transitional obligations on adoption of Section 3461, Employee Future Benefits ( Section 3461 ) and return on plan assets and a market related value of plan assets; c) transitional obligations on adoption of Section 3461 are amortized over the estimated average remaining service period of employees active on adoption of the accounting standard; d) past service costs from plan amendments are amortized on a straight-line basis over the estimated average remaining service period of employees active at the date of amendment; (7)

14 e) the excess of net actuarial gains (losses) over 10 percent of the greater of the benefit obligation and the fair value of plan assets are amortized over the estimated average remaining service period of active employees. The estimated average remaining service period of the active employees covered by the pension plans is 10 years ( - 10 years). The estimated average remaining service period of the active employees covered by the post-retirement benefit plan is five years ( - six years); and f) when the restructuring of a benefit plan gives rise to both a curtailment and a settlement of obligations, the curtailment is accounted for prior to the settlement. Defined contribution plan The Credit Union is a member of a multi-employer plan which is accounted for as a defined contribution plan. Contributions are expensed as incurred. Fees and commission income Service charges and foreign exchange transaction fees are recognized on an accrual basis when the service is performed. Commission income is earned on the sale of insurance policies and is recognized as at the related insurance policy s effective date. The Credit Union is also entitled to contingent profit commission from insurance companies which is recorded at the earlier of the period in which amounts can be reasonably estimated or the period in which the amounts are received. The Credit Union maintains an allowance, if required, for estimated policy cancellations and commission returns based upon the application of historical policy cancellation and commission return rates adjusted for any known derivations. Investment management fees, mutual fund fees and financial planning fees are recorded at the date of sale on an accrual basis. Equity and non-equity shares Upon opening an account at the Credit Union, new members are required to purchase a minimum of 25 Membership equity shares (junior members - 5 shares). Membership shares are redeemable on demand by the member. Periodically members may purchase Class F, G, H, or I Preferred shares, as authorized by the Board of Directors, which are redeemable at the end of the time periods stated for that particular class of share. Accordingly, these classes of shares are recorded as member deposits. Membership, Investment, Class E Equity, and Preferred shares of the Credit Union are not subject to guarantee by the Credit Union Deposit Insurance Corporation of British Columbia ( CUDIC ). No Class H or I Preferred shares are issued. Dividends may be declared annually on Membership, Investment, and Class E Equity shares at the discretion of the Board of Directors. Members, periodically, as authorized by the Board of Directors, are permitted to purchase Investment and Class E Equity shares. Redemption of Investment and Class E Equity shares is subject to certain conditions and approval of the Board of Directors. Accordingly they are recorded as members equity. (8)

15 Comparative figures Certain prior year comparative figures have been reclassified to conform to the presentation adopted in the current period. In, the Credit Union s members approved a special resolution to change the Credit Union s year-end from September 30 to December 31,. Accordingly, the comparative information presented in the financial statements represents the fifteen-month period ended December 31,. 3 Loans to members Residential mortgages 871, ,889 Commercial mortgages and loans 454, ,649 Personal loans 283, ,165 Net deferred transaction fees and related costs (769) (118) Accrued interest 4,479 4,605 1,613,357 1,532,190 Total provision for credit losses 6,342 6,288 Change in provision for credit losses 1,607,015 1,525,902 Residential mortgages and personal loans Commercial mortgages and loans Total Total Balance - Beginning of period 4,256 2,032 6,288 6,539 Transfer of provisions with net assets of subsidiary sold (447) Loans written off in the period (805) (291) (1,096) (973) Provisions made in the period ,150 1,169 Balance - End of period 4,080 2,262 6,342 6,288 (9)

16 Total provision for credit losses Residential mortgages and personal loans Commercial mortgages and loans Total Total Specific provision , General provision 3,637 1,595 5,232 5,626 Loans past due but not impaired 4,080 2,262 6,342 6,288 A loan is considered past due when a counterparty has not made a payment by the contractual due date. The following table presents the carrying value of loans that are past due but not classified as impaired because they are either (i) less than 90 days past due, or (ii) fully secured and collection efforts are reasonably expected to result in repayment days days 90 days and greater Total Retail Residential mortgages 15,899 4,468 2,297 22,664 Personal 1,494 1, ,263 Business 356 6, ,134 17,749 12,181 3,131 33,061 The fair value of the collateral held by the Credit Union as security for the above loans was 62,242. The Credit Union has estimated the fair value of collateral based on an updated assessment of the security appraisal undertaken at the original funding assessment or management s knowledge of the fair value of securities. The principal collateral and other credit enhancements the Credit Union holds as security for loans include (i) insurance, mortgages over residential lots and properties, (ii) recourse to business assets such as real estate, equipment, inventory and accounts receivable, (iii) recourse to the commercial real estate properties being financed, and (iv) recourse to liquid assets, guarantees and securities. Valuations of collateral are updated periodically depending on the nature of the collateral. The Credit Union has policies in place to monitor the existence of undesirable concentration in the collateral supporting its credit exposure. (10)

17 4 Loan securitizations During the year, the Credit Union securitized residential mortgages with principal outstanding of 25,820 ( - 23,635) and recognized gains on sale of 685 ( - 108). The gains are included in other income (note 11). Changes in estimated future cash flows re-estimated at the balance sheet date and discounted to the estimated present value using the original effective interest rate was 2,332 and was recognized in net interest income. During, the Credit Union entered into an agreement with Central 1 to sell mortgages for participation in the Canada Mortgage Bond Program which are used by Central 1 to create mortgage-backed securities sold to Canada Mortgage Housing Trust, an independent special purpose entity. In past years, the Credit Union also securitized loans through other securitization vehicles and sold them directly to a special purpose entity. The Credit Union s retained interests in securitized loans consist of a right to receive future cash flows arising after the investors in the special purpose entity have received the return for which they contracted and from credit enhancement provided to the special purpose entity in the form of cash collateral accounts. The investors and special purpose entities, as holders of the securitized mortgages, have recourse only to a cash collateral account, the mortgages securitized and cash flows from the securitized mortgages. The investors and the third parties have no recourse to the Credit Union s other assets for failure of debtors to pay when due. The Credit Union s retained interests are subject to credit, prepayment and interest rate risks on the securitized mortgages. As part of these securitizations of mortgage receivables, the Credit Union retained servicing responsibilities. A servicing liability of 209 ( - 177) was recognized initially on new securitizations during the year. Servicing liabilities amortized to income during the year amounted to 494 ( - 724). The fair value of retained interests amounts to 3,235 at ( - 994). The carrying value of recognized servicing liabilities amounted to 754 at ( - 1,040). Key assumptions used in measuring the Credit Union s retained interests in securitized residential mortgages include the following: % % Prepayment rate Expected credit losses Residual cash flows discount rate (floating) Weighted average life (in years) (11)

18 The following table presents the sensitivity of the fair value of retained interests resulting from two adverse changes in each key assumption as at. The sensitivity analysis is hypothetical and should be used with caution as changes in fair value based as variations in assumptions generally cannot be extrapolated because the relationship of the change in assumption may not be exact. Furthermore, the effect of a change in assumption on the fair value of retained interests is calculated without changing any other assumptions. Changes in one estimate may result in changes in another assumption which may impact on the estimate of fair value: Potential decrease in fair value due to the following hypothetical adverse changes Discount rate +10% 200 1, % 406 2,645 Repayment rate +10% % Expected credit losses +10% % Investments Central 1 equity shares and accrued dividends 4,648 5,222 Other investments 1,084 1,001 5,732 6,223 (12)

19 6 Property, premises and equipment Cost Accumulated amortization Net Net Office equipment and furniture 23,930 17,291 6,639 8,856 Leasehold improvements 8,633 2,866 5,767 6,669 Property held for resale Land and buildings Automotive equipment ,888 20,290 13,598 16,724 7 Other assets Accounts receivable 7,110 12,328 Retained interests in securitized loans (note 4) 3, Prepaid expenses 3,012 2,599 Goodwill 839 6,762 Client lists - 1,346 Other ,196 24,442 8 Borrowings Weighted average interest rate % Amount Weighted average interest rate % Amount Central 1 Call loans , ,800 The Credit Union has available approved lines of credit aggregating 156,200 ( - 156,200). The available lines of credit are secured by an assignment of loans to members, accounts receivable and a demand debenture in favour of Central 1. (13)

20 9 Member deposits Term deposits 920, ,865 Demand deposits 392, ,133 Registered savings plans 273, ,391 Member deposit shares (note 10(b)) 25,477 23,224 Deferred transaction costs (459) (426) Accrued interest 22,686 23,017 1,634,385 1,497, Member deposit and members equity shares a) Authorized shares (expressed in thousands of dollars except for value per share) Unlimited Class A Membership voting equity shares with a par value and redemption value of 1 each Unlimited Class B Patronage voting equity shares with a par value and redemption value of 1 each Unlimited Class C Investment non-voting equity shares with a par value and redemption value of 1 each Unlimited Class D Non-equity shares with a par value and redemption value of 1 each Unlimited Class E Equity voting, non-redeemable, non-cumulative, equity shares with a par value of 1 each Unlimited Class F, G, H, and I Preferred shares. Each class of Preferred share is issuable in Series (Series 1, 2, or 3). Each Series of each class can be offered in three, five, seven or 10-year terms. Each class of Preferred share is redeemable at the end of its term, is non-voting and is entitled to cumulative dividends at a rate set when issued. (14)

21 b) Issued shares classified as member deposits (note 9) consist of the following: (expressed in thousands except for number of shares) 5,280,137 ( - 5,409,599) Class A Membership equity shares 5,280 5,410 66,134 ( -76,994) Class D Non-equity shares ,812,626 ( - 15,851,728) Class F, Series 1-3 and Class G, Series 1, 3 to 10 year Preferred shares; the shares have cumulative dividends of 4.29% to 7.00% 17,813 15,852 Accrued dividends on Preferred shares 2,436 2,058 25,595 23,397 Deferred transaction costs (118) (173) 25,477 23,224 The Class F, Series 1, 2 and 3 and Class G, Series 1 Preferred shares are subject to redemption: - 4, ,254 6, ,614 4, , ,745 1,648 Less: Accrued dividends (2,436) (2,058) c) Issued shares classified as members equity consist of the following: (expressed in thousands of dollars except for number of shares) 17,813 15,852 5,601,905 ( - 6,065,683) Class C Investment equity shares 5,602 6, ,990 ( - 291,990) Class E Equity shares ,894 6,358 (15)

22 11 Other income Year ended December 31, Fifteen-month period ended December 31, Service charges 7,555 9,212 Insurance commissions 7,387 10,738 Gain on disposal of subsidiaries (note 1) 3,118 1,933 Investment management 1,435 2,115 Foreign exchange 1,050 1,098 Securitization gain (loss) on sale of loans Loan fees Rental Gain on disposal of property, premises and equipment - 1,492 Gain on sale of property held for resale Gain on sale of insurance license ,730 27, Other expenses Year ended December 31, Fifteen-month period ended December 31, Other 827 1,274 Professional services B.C. capital tax 683 1,217 Deposit insurance and other fees Central 1 dues ,162 4,489 (16)

23 13 Pension plans The Credit Union sponsors a number of pension plans and a post-retirement benefit plans covering eligible employees of the Credit Union and its subsidiaries. The Multi-Employer Plan is administered on behalf of the Credit Union by Central 1 and accounted for as a defined contribution plan. Pension expense of 862 ( - 894) in respect to the Multi-Employer Plan has been charged to salaries and employee benefits in the consolidated statement of income. A group RSP is administered by the Credit Union and accounted for as a defined contribution plan. Pension expense of 140 ( - 180) in respect to the group RSP has been charged to salaries and employee benefits in the consolidated statement of income. The other pension plans are defined benefit plans and are referred to as the Prospera Plan, the Multiple Employer Plan and the Supplemental Retirement Plan. The Prospera Plan does not have any active members and accordingly a valuation allowance has been recorded against the accrued benefit asset. The Post-Retirement Benefit Plan is also a defined benefit plan. Prospera Plan Multiple Employer Plan Supplemental Retirement Plan Post Retirement Benefit Plan Accrued benefit obligation Balance at beginning of year 1,573 1,822 10,490 9, ,845 1,780 Current service cost Interest cost Benefits paid (249) (294) (333) (444) (9) (7) (43) (110) Actuarial (gain) loss (276) (67) (4,050) (557) (235) (209) (513) 29 Balance at end of year 1,131 1,573 7,532 10, ,404 1,845 Plan assets Fair value at beginning of year 1,940 2,040 9,145 7, Actual return on plan assets (274) 194 (1,497) Employer contributions Benefits paid (249) (294) (333) (444) Fair value at end of year 1,417 1,940 8,149 9, Fund surplus (deficit) (1,345) (816) (870) (1,404) (1,845) Unamortized net actuarial loss (gain) (315) 1,646 (377) (169) (250) 283 Unamortized past service costs Unamortized transitional (asset) obligation (62) (78) (247) (313) Accrued benefit asset (liability) before valuation allowance ( 12) (1,193) (1,039) (1,119) (833) Valuation allowance against accrued benefit asset (286) (352) Accrued benefit asset (liability) net of valuation allowance (12) (1,193) (1,039) (1,119) (833) (17)

24 The accrued benefit liability for the Supplemental Retirement Plan is secured by an irrevocable letter of credit issued by the Credit Union in the amount of 1,559 ( - 1,497). The significant weighted average actuarial assumptions adopted in measuring the Credit Union s accrued benefit obligations are: Prospera Plan Multiple Employer Plan Supplemental Retirement Plan Post Retirement Benefit Plan % % % % % % % % Discount rate Expected long-term rate of return on plan assets n/a n/a n/a n/a Rate of compensation increase n/a n/a The net benefit expense (recovery) is: Prospera Plan Multiple Employer Plan Supplemental Retirement Plan Post Retirement Benefit Plan Current service cost Interest cost Difference between actual and expected return on plan assets (127) (168) (652) (722) Difference between actuarial gain (loss) recognized and actual actuarial loss on accrued benefit obligations (27) (5) Amortization of past service costs Amortization of transitional asset 16 (21) (66) (82) Net benefit plan (recovery) expense 60 (77) (18)

25 14 Income taxes Income tax expense differs from the amount that would be computed by applying the combined federal and provincial statutory income tax rates of 31.0% ( %) to income before income taxes. The reasons for the differences are: Year ended December 31, Fifteen-month period ended December 31, Computed tax expense 2,403 2,905 (Decrease) increase resulting from Preferred rate amount deduction for credit unions (1,233) (1,405) Non-taxable gains (224) (380) Effect of tax rate changes Other (36) (64) 1,123 1,271 The tax effects of temporary differences that give rise to significant portions of the future income tax assets and future income tax liabilities are: Future income tax assets: Provision for credit losses Deferred revenue Pension, severance and long-term incentive accruals Property, premises and equipment - differences between net book value and undepreciated capital cost Loss carry-forwards Other ,677 2,222 Future income tax liabilities Prepaid expenses Retained interest on securitizations Goodwill, client lists and licences Net future income tax asset ,298 1,488 (19)

26 15 Commitments a) Leases Most of the Credit Union s premises are leased for varying terms. Current minimum annual payments are approximately 5,509 ( - 5,662) for each of the next five years and 24,089 ( - 28,711) in aggregate thereafter. b) Letters of credit and other guarantees Arising through its normal course of business, the Credit Union has outstanding letters of credit issued on behalf of members totalling 8,916 ( - 12,357) and has guaranteed credit card accounts on behalf of members totalling 721 ( - 752), which are secured by member term deposits or property mortgages. The Credit Union has issued a letter of credit to the City of Surrey of 2 million. 16 Risk management The Credit Union s risk management policies are designed to identify and analyse risks, to set appropriate risk limits and controls, and to monitor the risks and adherence to limits by means of reliable and up-to-date information systems. The Credit Union follows an enterprise risk management framework which involves identifying particular events or circumstances relevant to its objectives, assessing them in terms of probability and magnitude, determining a response strategy and monitoring progress. The Credit Union regularly reviews its risk management policies and systems to take account of changes in markets, products and emerging best practice. Risk management is carried out by a number of delegated committees reporting to the Board of Directors. The Board provides written principles for risk tolerance and overall risk management and management report to the Board on compliance with the risk management policies of the Credit Union. In addition, the Credit Union maintains an Internal Audit function which is responsible for independent review of risk management and the Credit Union s control environment. Financial instruments comprise the majority of the Credit Union s assets and liabilities. The Credit Union accepts deposits from members at both fixed and floating rates for various periods and seeks to earn an interest rate margin by investing these funds in high quality financial instruments - principally mortgages. The primary types of financial risk which arise from this activity are interest rate risk, credit risk, liquidity risk, price risk and foreign exchange risk. (20)

27 The following table describes the significant financial instrument activity undertaken by the Credit Union, the risks associated with such activities and the types of method used in managing those risks: Activity Risk Method Fixed rate savings products and funding activities involving fixed rate instruments Fixed rate mortgages Equity linked deposit products Foreign currencies Interest rate risk Sensitivity to changes in interest rates Sensitivity to changes in interest rates Sensitivity to changes in Canadian equity indices Sensitivity to changes in foreign currency Asset-liability matching and periodic use of derivatives Asset-liability matching periodic use of derivatives Options Asset-liability matching and investment limits Cashflow interest rate risk is the risk that the future cash flows of the Credit Union s financial instruments will fluctuate due to changes in market interest rates. Fair value interest rate risk is the risk that the value of a financial instrument will fluctuate because of changes in prevailing market interest rates. Interest margins reported in the consolidated statement of income may increase or decrease in response to changes in market interest rates. Accordingly, the Credit Union sets limits on the level of mis-match of interest rate repricing that may be undertaken, which is monitored by the Credit Union s Treasury department and reported to the Asset and Liability committee ( ALCO ) which is responsible for managing interest rate risk. In managing interest rate risk, the Credit Union relies primarily upon use of asset-liability and interest rate sensitivity simulation models. Periodically, the Credit Union may enter into interest rate swaps to adjust the exposure to interest rate risk by modifying the repricing of the Credit Union s financial instruments. The Credit Union s derivative instruments as at the period end are disclosed in note 18 of the financial statements. Sensitivity analysis is used to assess the change in value of the Credit Union s financial instruments against a range of incremental basis point changes in interest rates over a twelve-month period. Interest rate shock analysis is calculated in a similar manner to sensitivity analysis but involves a more significant change of 100 basis points or greater in interest rates. Sensitivity analysis and interest rate shock analysis are calculated on a monthly basis and are reported to ALCO. Based on current differences between financial assets and financial liabilities as at, the Credit Union estimates that an immediate and sustained 100 basis point increase in interest rates would increase net interest income by 573 over the next 12 months while an immediate and sustained 100 basis point decrease in interest rates would decrease net interest income by 243 over the next 12 months. (21)

28 Other types of interest rate risk may involve basis risk. The risk of loss arising from changes in the relationship of interest rates which have similar but not identical characteristics, for example the difference between Prime rates and the Canadian Deposit Offering Rate ( CDOR ) and prepayment risk (the risk of loss of interest income arising from the early repayment of fixed rate mortgages and loans) are also monitored on a regular basis and are reported to ALCO. Credit risk Credit risk is the risk of a financial loss occurring due to Credit Union member or counterparty inability or refusal to fully honour the contractual obligations of a balance sheet or off-balance sheet financial instrument. This risk results from being a party to a financial operation with a counterparty. Provisions for credit losses are made for losses that have been incurred at the balance sheet date. Significant changes in the economy of British Columbia, specifically the Greater Vancouver, Fraser Valley and Okanagan areas of British Columbia or deteriorations in lending sectors which represent a concentration within the Credit Union s loan portfolio may result in losses that are different from those provided for at the balance sheet date. At, the maximum credit risk exposure of the Credit Union approximates the carrying value of all assets except for undrawn lines of credit which amounted to 207,348 as at year-end. The classes of financial instrument to which the Credit Union is most exposed are loans to members, cash resources and derivatives. Credit risk exposure Outstanding Undrawn commitments Other Total exposure Cash resources 139, ,230 Residential Mortgages 871,354 6, ,546 Loans 56, ,043 Line of credit and overdraft 227, , ,543 Commercial Mortgages 396,716 11, ,582 Loans 20, ,469 Line of credit and overdraft 37,543 41,347-78,890 Accrued interest on loans 4, ,479 Loan transaction costs (769) - - (769) Other assets 14, ,196 Total exposure 1,766, ,426-1,993,209 (22)