Quarterly Financial and Transparency Report

Transcription

1 Quarterly Financial and Transparency Report 2nd Quarter 2013

2 SUMMARY Alloya s net income in the second quarter of 2013 was $3.9 million, including a $2.1 million gain on the merger with CenCorp that was completed during the second quarter. Excluding this gain, net income was slightly higher than projected levels. Net income for the first half of 2013 was $5.5 million. Alloya s total capital to asset ratio was 7.3% and its retained earnings to asset ratio was 1.7% as of June 30, These ratios are in excess of current regulatory requirements, as well as those that go into effect later this year. This document summarizes key aspects of Alloya s operations that are presented in the following sections. 1. Merger 2. Credit Quality 3. Liquidity 4. Asset/Liability Management 5. Financial Results 6. Other Items MERGER Alloya and CenCorp merged effective April 30, In summary, Generally Accepted Accounting Principles (GAAP) require that the balance sheet of the merged entity (CenCorp) be recorded at the estimated fair value of the assets and liabilities, with the net difference recorded as a gain or as goodwill. The fair value of CenCorp s assets exceeded the fair value of its liabilities (primarily member deposits) by approximately $2.1 million as of the merger date. Alloya recorded a one-time gain of this amount. The majority of this gain was attributable to the fair value of CenCorp s investment portfolio being higher than its book value. Under GAAP, the earnings of CenCorp for the first four months of 2013 are not part of Alloya s 2013 income statement. CenCorp s earnings for this four-month period totaled $1.6 million and are captured in the retained earnings of the combined entity. This included a $0.7 million gain on the sale of certain floating-rate Agency securities. The market value of these securities had appreciated and it was economically better to invest the sale proceeds elsewhere. As noted in previous communications, CenCorp members are to transition to Alloya s existing Internet portal (Premier View) and data processing systems over time. A significant portion of this project was completed on June 30, 2013 when the member transaction and wire transfer functions were consolidated. Remaining functions on CenCorp s Internet portal (EDGE On-line) are expected to be transitioned later in 2013 and into

3 CREDIT QUALITY Approximately 89% of Alloya's assets at June 30, 2013 are cash or investments. Member loans (10%) make up most of the remainder. Alloya s cash and investment portfolio (at book value) consisted of the following (dollars in millions). Amount Percent Cash $1, % Motor vehicle asset-backed securities % US Agency securities % FFELP student loan asset-backed securities % Credit card asset-backed securities % Equipment asset-backed securities % Non-US Agency mortgage securities % Total $2, % Substantially all of the over $1.4 billion in cash is deposited at the Federal Reserve Bank (FRB). The remaining portion ($33 million) is held at correspondent banks (JP Morgan, Comerica and US Bank) to facilitate item processing and coin & currency services for Alloya members. By internal policy and regulation, Alloya s investment purchases are restricted to certain sectors. The investment portfolio is concentrated in high-quality asset-backed securities or securities issued or guaranteed by US Agencies. A summary of the securities (excluding cash) by credit rating is presented below. AAA 80% The securities in the Other category are non-us Agency mortgage securities originally purchased in The poor performance of the underlying loans, as well as the deteriorated financial condition of the payment insurer for one security, has resulted in credit rating downgrades of the securities and write-downs to fair value for accounting purposes. Losses incurred on the underlying loans to date have mostly been covered by credit enhancements (such as overcollateralization) in the securities. The performance of the underlying loans has improved in recent years, along with the market values of the securities. Market values reversed to a certain extent in the second quarter of 2013 as market interest rates moved higher. An analysis of the non-us Agency securities at June 30, 2013 is presented on Schedule 1. 1 FFELP stands for Federal Family Education Loan Program. The underlying loans are 97% guaranteed by the US Government. The FFELP student loan asset-backed securities are over collateralized with loans so that the investor (Alloya) has over 100% of principal backed by the US Government. 2 AA 17% Other 3%

4 Alloya lends funds to credit union and affiliate members on a secured basis only. The loans outstanding include fixed-rate term loans, many of which were originated several years ago at rates that are higher than current market rates. Other loans either mature overnight or have an adjustable rate. All loans are current as of June 30, LIQUIDITY Member overnight deposits at Alloya follow a fairly predictable annual pattern of a peak in early April, with low points in late August and late September. Member overnight deposits have been well in excess of overnight loans at Corporates for decades. Established internal funds management practices at Alloya anticipate member liquidity needs, which can be volatile. Alloya maintains a higher amount of liquid investments and/or access to external liquidity sources than other financial institutions to compensate for this volatility. Cash balances alone totaled over $1.4 billion at June 30, External sources of liquidity for Alloya include $695 million in credit lines through financial institutions. Borrowing for liquidity, if any, is typically only for a few days during the low points in the liquidity cycle, or to test the various lines. Excess Balance Accounts (EBAs) at the FRB reduce Alloya s average balance sheet size. EBAs totaled $3.2 billion at June 30, 2013, and provide an additional source of liquidity for Alloya. ASSET/LIABILITY MANAGEMENT The maturity/repricing characteristics of Alloya s interest-earning assets (primarily investments) generally correspond closely with its interest-bearing liabilities (primarily member accounts). Alloya performs regular asset/liability modeling (commonly known as "shock analysis"). The shock analysis quantifies the impact that an instantaneous and sustained change of up to 300 basis points in market interest rates (either up or down) would have on Alloya. This analysis calculates the change in the Net Economic Value (NEV) of Alloya s assets minus liabilities assuming changes in market interest rates. For calculation purposes, Contributed Capital at Alloya is a component of equity. NCUA regulations require Alloya to maintain a NEV ratio (NEV divided by the fair value of assets) in excess of 2.0% in a base and shocked scenarios, as well as limiting the change in NEV in the shocked scenarios to no more than +/- 20.0%. Alloya s NEV ratio exceeded the regulatory requirement, ranging from 8.0% in the base scenario to 7.0% in the up 300 basis point scenario at June 30, Alloya s change (decline) in NEV in the up 300 basis point scenario was -14.5% at June 30, 2013, also in compliance with the regulatory requirement. FINANCIAL RESULTS Alloya s financial results in the second quarter of 2013 were significantly impacted by the merger with CenCorp that was effective on April 30, Condensed financial statements for June 30, 2013 and 2012 are presented on the following pages. The fair value of CenCorp s assets exceeded the fair value of CenCorp s liabilities at the merger date by $2.1 million. This amount was recorded as a gain for accounting purposes in the second quarter of Net interest income, fee income and operating expenses increased due to the two months in the quarter that the two entities operated on a combined basis. Balance sheet items at June 30, 2013 also increased due to the merger. Other comprehensive income (loss) moved lower in the second quarter of 2013 as market interest rates increased, and lowered the value of Alloya s investment portfolio. 3

5 Excluding the impact from the CenCorp merger, Alloya s on-going operational results were comparable to recent quarters. It should be noted that compensation and benefits were substantially lower in the second quarter of last year due to a one-time $0.7 million accrual adjustment for the discontinuance of a post-retirement employee health plan. Alloya is a federally-chartered Corporate credit union subject to regulation by the NCUA. Corporate Credit Union regulations require compliance with various capital ratios. The table below shows Alloya s capital ratios compared to regulatory requirements at June 30, 2013 (note: the retained earnings to assets ratio is not effective until October 2013). Capital Ratio Alloya Regulatory Requirement Total capital to assets 7.3% 4.0% Retained earnings to assets 1.7% 0.45% Total risk based capital 36.8% 8.0% For a more detailed description of those ratios and their calculation, see Note 9 of Alloya s 2012 audited financial statements (page 18). The consolidation of systems and processes from the merger with CenCorp will reduce operating expenses going forward. Although some of the expense reductions are being realized currently, the larger reductions are expected to be realized in the third and fourth quarter of We also anticipate some one-time costs for employee severance in the third quarter of Corporates typically operate on very narrow margins when compared to most other financial institutions. Alloya s net earnings as a percent of assets (return on assets) are lower than other financial institutions for this reason. Exacerbating this effect, Alloya s net interest income has been negatively impacted in recent years by historically low market interest rates, which are anticipated to remain at low levels for an extended period of time. 4

6 ALLOYA CORPORATE FEDERAL CREDIT UNION CONDENSED FINANCIAL STATEMENTS (UNAUDITED) (DOLLARS IN MILLIONS) BALANCE SHEETS 6/30/2013 6/30/2012 Assets Cash and cash equivalents (primarily FRB) $1,428 $858 Investments 1, Loans Other assets Total assets $2,772 $1,702 Liabilities Members' shares $2,359 $1,116 Members' certificates Other liabilities and uncollected funds 13 4 Total liabilities 2,565 1,603 Members' Equity Perpetual contributed capital Non-perpetual contributed capital 8 8 Retained earnings Other comprehensive income (loss) (3) 1 Total members' equity Total liabilities and members' equity $2,772 $1,702 STATEMENTS OF OPERATIONS Quarter-Ended Year-To-Date 6/30/2013 6/30/2012 6/30/2013 6/30/2012 Interest income $4.6 $4.4 $8.4 $8.9 Interest expense Net interest income Bargain purchase gain on acquisition Gain on sale of investments Total non-operating gains Fee income, net Earnings before operating expenses Compensation and benefits Professional and outside services Office operations Office occupancy Training, travel and communications Other expense Total operating expenses Net income $3.9 $1.8 $5.5 $2.9 5

7 ALLOYA CORPORATE FEDERAL CREDIT UNION STATEMENT OF CAPITAL (DOLLARS IN MILLIONS) Perpetual Contributed Capital Nonperpetual Capital Retained Earnings Accumulated Other Comprehensive Gain (Loss) Balances as of January 1, 2013 $69.4 $8.5 $25.8 $1.8 Change in member capital accounts 0.7 (0.2) - - Net income Other comprehensive gain or loss (0.1) Dividends on perpetual contributed capital - - (0.1) - Balances as of March 31, 2013 $70.1 $8.3 $27.3 $1.7 Change in member capital accounts 0.3 (0.1) - - Perpetual contributed capital accounts acquired in merger Equity acquired in merger Net income Other comprehensive gain or loss (5.1) Dividends on perpetual contributed capital - - (0.2) - Balances as of June 30, 2013 $153.1 $8.2 $49.0 ($3.4) OTHER ITEMS Strategic Plan Update Alloya s 2013 Strategic Plan sets out a series of significant goals to be met. The chart below shows the Business Plan Initiatives that are part of the current year s plan. Two have been completed, with the remainder on track for timely competition. All of the financial goals Strategic Plan are materially on track. A summary of Alloya s 2013 Strategic Plan can be found on Alloya s website by clicking here Business Plan Initiative Target Date Comment Upgrade Premier View and core system 3/31/2013 Completed Establish post-merger capital program 5/31/2013 Completed Consolidate to one item processing platform 9/30/2013 Completion expected in Sept. Merger integration 12/31/2013 July 1 conversion completed Establish an enterprise risk management program 12/31/2013 Expert appointed in July Convert Nonperpetual capital to PCC 12/31/2013 Members contacted individually Establish a Members Advisory Council 12/31/2013 Conference call to be scheduled Implement Trusteer (security software) 12/31/2013 Rollout continuing = On track = Project behind target or there are other risks to project = Project substantially behind and/or other problems = Project complete 6

8 Board Summary Since the last transparency report, the Alloya Board met three times and covered a number of topics. A summary follows below. April 11, 2013 Approve Board resolution to increase Board size from 7 to 11 (CenCorp merger) Increase ALCO members by one (CenCorp merger) Appoint Enterprise Risk Management Committee independent expert May 9, 2013 Appoint Nominating and Resolutions Committees Approve post-merger capital program June 6, 2013 Approve sale/leaseback of Alloya s Warrenville, Illinois facility Discuss merger accounting Discuss Alloya Board practices and financial reports Strategic discussion investment strategies Discuss possible future strategic discussion topics Membership Alloya primarily serves members in a ten-state core market consisting of Connecticut, Illinois, Indiana, Massachusetts, Michigan, Minnesota, New Jersey, New York, Rhode Island and South Dakota. Alloya also serves members in an additional 23 states and Puerto Rico. The table below summarizes Alloya s membership. Market Area Members Core Markets 1,466 Other Markets 98 Total 1,564 7

9 Schedule 1 Analysis of Non-Agency Securities June 30, 2013 Alloya owns six non-agency mortgage-backed securities that were acquired as part of the CenCorp merger. The securities were recorded at their estimated values on the merger date. The estimated values were $4.8 million lower than the remaining principal balances of these securities at that time. The difference is being accreted to income over the remaining lives of the securities. Higher delinquency/foreclosures in loans secured by residential real estate that started in 2006 have continued into Housing prices nationally have improved, but remain well below their peak of several years ago. The ratings on the majority of the mortgage-backed securities issued in have been lowered, including the originally AAA-rated securities. Prepayment speeds on existing securities have slowed from historical levels. Mortgage-backed securities often contain a hierarchy of tranches. 1 The most senior tranches, originally rated AAA, are supported by subordinated (lower credit-rated) tranches or other credit enhancements that absorb the first losses on any underlying loans that default. The senior tranches are impacted if the losses exceed the credit enhancement (overcollateralization 2 or excess spread 3 ) and/or subordinated tranches. Three securities purchased in 2006 account for the majority of Alloya s non-agency securities. These three securities were downgraded below investment-grade after they were purchased. A summary of Alloya s nonagency securities outstanding at June 30, 2013 with these three securities shown individually is presented below (dollars in millions). Original Principal Balance Current Principal Balance Book/ Market Value GMAC $40.0 $14.8 $11.3 Soundview Fremont Other (3) Totals $154.6 $37.7 $29.9 The three securities listed separately in the table are discussed on the following pages. 1 A tranche is a separate security within a mortgage-backed security structure. Tranches are allocated specific cash flow (principal and interest) that is received on the underlying collateral. Certain tranches receive cash flow before other tranches. 2 Overcollateralization is the pledge of loans in excess of the original principal amount of the securities sold to investors. This provides additional principal protection to the investors. 3 Excess spread is the interest and fees collected on the underlying loans less (1) the contractual interest due to the security investors and (2) servicing and guarantee fees. These funds are available to the investors to offset principal losses. 8

10 GMAC The GMAC security was originated in March 2006 and is collateralized by home equity loans throughout the United States. The credit enhancements beyond the underlying loans are overcollateralization, excess spread, and payment insurance from Financial Guaranty Insurance Company (FGIC). The delinquency/foreclosures on the underlying loans have been greater than anticipated. Cumulative net losses on the underlying loans have totaled 24% of the original principal balance. Investors in the GMAC security, including Alloya, were initially protected from losses by the overcollateralization structure of the GMAC security and the reimbursement of the collateral losses made by FGIC (later by excess spread). The overcollateralization amount was exceeded in April 2009 and FGIC began paying investors for losses incurred on the underlying loans at that time. The financial condition of FGIC deteriorated as losses on the various securities that it committed to insure have increased beyond the levels estimated when the securities were originated. Higher estimated losses resulted in FGIC s capital falling below the minimum statutory capital requirement set by the New York Insurance Department (NYID), FGIC s regulator, in the third quarter of The NYID ordered FGIC to cease paying claims in November The NYID filed a plan in September 2012 to maintain the operations of FGIC and pay partial claims to policyholders. Alloya estimates that it will ultimately receive $0.3 million as a payment on its portion of claims to FGIC in early Information on the underlying loans is as follows. Average original FICO score of borrowers 713 Average original LTV 75% Owner occupancy 100% Loans over 60 days past due 3.2% Loans in foreclosure 0.3% Excess spread offset substantially all the losses on the underlying loan defaults in the second quarter of The principal repayments to Alloya in the quarter totaled $0.6 million. With the assistance of a third-party, Alloya estimates that future defaults on the underlying collateral of the GMAC security will approximate the excess spread available to investors. No future loss is expected on this security. 9

11 Soundview Soundview is a multi-tranche security collateralized with residential mortgage loans. It had an original total principal value in May 2006 of $2 billion that has been reduced to a principal value of $475 million through June The credit enhancements to the tranche owned by Alloya, beyond the underlying loans, are subordinated tranches, overcollateralization, and excess spread. CenCorp began receiving payments on its tranche in May The delinquency/foreclosure of the loans has been significantly higher than what CenCorp anticipated when the security was purchased. Below is a summary of the security through June 30, 2013 (dollars in millions). Original Current Face Principal Incurred Principal Value Repayments Losses Balance Senior Tranches (including Alloya) $1,526 $(1,257) $ - $269 Subordinated Tranches (240) 203 Excess Spread (124) - Overcollateralization Amount 31 - (31) - Totals $2,000 $(1,133) $(395) $472 As can be seen in the table above, the losses to date (about 20% of the original principal balance) have been absorbed by the original overcollateralization amount, excess spread, and the subordinated tranches. Alloya and the owners of the other senior tranches would share in any losses that exceed the subordinated tranches and future excess spread. If future losses exceed the $203 million in subordinated tranches (43% of the remaining principal balances), the losses would be shared by the senior tranches in proportion to the then outstanding principal amounts of the senior tranches. There are three senior tranches remaining. Two tranches, including the tranche partially-owned by Alloya, are receiving principal repayments today. The third tranche, totaling $41 million, does not receive any principal repayment until the Alloya-owned tranche has been repaid or losses in the future exceed the remaining subordinated tranches. Information on the remaining underlying collateral is as follows. Average original FICO score of borrowers 611 Average original LTV 83% Original owner occupancy 95% Loans over 60 days past due 16.3% Loans in foreclosure/reo 22.2% The remaining collateral has a disproportionately high share of non-performing loans and foreclosures. Whether or not the security owned by Alloya will incur a loss of principal in the future is dependent on many factors, including the severity of losses on the liquidation of collateral, additional non-performing loans, and excess spread. The principal repayments to Alloya in the quarter were about $0.3 million. At a minimum, future losses would have to exceed the $203 million in subordinated tranches before the tranche owned by Alloya is paid-off for Alloya to incur a loss of principal. With the assistance of a third-party, Alloya currently projects that losses on the remaining collateral will not exceed the subordinated tranches until after Alloya receives repayment of the principal owed to it (i.e., no loss would be incurred by Alloya). 10

12 Fremont Fremont is a multi-tranche security collateralized with residential mortgage loans. It had an original total principal value in April 2006 of over $1 billion that has been reduced to a principal value of $173 million through June The credit enhancements to the tranche owned by Alloya, beyond the underlying loans, are subordinated tranches, overcollateralization, and excess spread. Alloya began receiving principal payments on its tranche in September The delinquency/foreclosure of the loans has been significantly higher than what Alloya anticipated when the security was purchased. Below is a summary of the security through June 30, 2013 (dollars in millions). Original Current Face Principal Incurred Principal Value Repayments Losses Balance Senior Tranches (including Alloya) $772 $(659) $ - $113 Subordinated Tranches (163) 60 Excess Spread (102) - Overcollateralization Amount 14 - (14) - Totals $1,010 $(557) $(279) $173 As can be seen in the table above, the losses to date (about 28% of the original principal balance) have been absorbed by the original overcollateralization amount, excess spread, and the subordinated tranches. Alloya and the owners of the other senior tranches would share in any losses that exceed the subordinated tranches and future excess spread. If future losses exceed the $60 million in subordinated tranches (35% of the remaining principal balances), the losses would be shared by the senior tranches in proportion to the then outstanding principal amounts of the senior tranches. There are three senior tranches remaining. Two tranches, including the tranche partially-owned by Alloya, are receiving principal repayments today. The third tranche, totaling $39 million, does not receive any principal repayment until the Alloya-owned tranche has been repaid or losses in the future exceed the remaining subordinated tranches. Information on the remaining underlying collateral is as follows. Average original FICO score of borrowers 632 Average original LTV 81% Original owner occupancy 96% Loans over 60 days past due 13.6% Loans in foreclosure/reo 41.4% The remaining collateral has a disproportionately high share of non-performing loans and foreclosures. Whether or not the security owned by Alloya will incur a loss of principal in the future is dependent on many factors, including the severity of losses on the liquidation of collateral, additional non-performing loans, and excess spread. The principal repayments to Alloya in the quarter were about $0.2 million. At a minimum, future losses would have to exceed the $60 million in subordinated tranches before the tranche owned by Alloya is paid-off for Alloya to incur a loss of principal. With the assistance of a third-party, Alloya currently projects that losses on the remaining collateral will not exceed the subordinated tranches until after Alloya receives repayment of the principal owed to it (i.e., no loss would be incurred by Alloya). Return to Page 2 11