MAKING A. Difference Making It COUNT 2012 ANNUAL REPORT

Transcription

1 FEDERALLY INSURED BY NCUA MAKING A Difference Making It COUNT 2012 ANNUAL REPORT

2

3 TABLE OF CONTENTS CHAIRMAN S REPORT PRESIDENT S REPORT BOARD OF DIRECTORS & EXECUTIVE STAFF TREASURER & FINANCIAL MANAGEMENT COMMITTEE REPORT SUPERVISORY COMMITTEE REPORT INDEPENDENT AUDITOR S REPORT CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION As of December 31, 2012 and 2011 CONSOLIDATED STATEMENTS OF INCOME For the Years Ended December 31, 2012 and 2011 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME For the Years Ended December 31, 2012 and 2011 CONSOLIDATED STATEMENTS OF MEMBERS EQUITY For the Years Ended December 31, 2012 and 2011 CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2012 and 2011 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NORTHWEST FEDERAL CREDIT UNION 2012 ANNUAL REPORT

4 CHAIRMAN S REPORT THOMAS CONROY Making It COUNT Northwest Federal treats me like family. Though there are countless members, each time I visit a branch I feel like I am your most important customer and that is a great feeling! Kimberly E. I came from a commercial bank that did nothing but literally fee me to death. I just signed up with Northwest Federal and I m thrilled with the services and the pleasant, helpful people that I ve met so far. Shame on me that I didn t switch sooner. Ricky H. Nearly a year and a half ago and after extensive deliberations, your Board and management committed to a relatively simple but powerful threefold principle for the strategic operation of Northwest Federal. This operational principle has become ingrained in the focus of the organization and establishes a consistent gauge against which our long-term goals can be measured. The three components of this principle are operational safety and soundness, profi tability, and sustainability. We are very pleased to report to you that signifi cant strides were made in 2012 toward each of these three objectives. Northwest Federal s third consecutive year of improved fi nancial performance was recorded in 2012 as the organization increased its capital position by $30 million, a measure of excellent profi tability. This increase in capital enabled the Credit Union to grow its asset base while continuing to maintain a very favorable net worth ratio, a key measure of our safety and soundness. Our asset growth of $413 million or nearly 20% in 2012 was signifi cantly higher than the two preceding years and successfully placed Northwest Federal in the top 50 credit unions in the country by asset size. This growth benefi ted our membership as it helped diversify the credit risk in our loan portfolio and strengthened our core share deposits, funding sources and liquidity. Our organic growth during the year was augmented through the merger of REALTORS Federal Credit Union into Northwest Federal. This marked the second merger in the institution s 65 year history and is considered a key element in the future growth and sustainability of the organization as REALTORS FCU brought with it over one million potential members to further strengthen and diversify the Northwest Federal family. Another fundamental aspect of developing strategic plans for the organization s future is that of evaluating and prudently managing the array of risks inherent in any fi nancial institution. In the current ultra-low interest rate environment, the potential for rising interest rates has been identifi ed as a substantial risk to be addressed. Fiscal 2012 marked the culmination of a multi-year project aimed at reducing our exposure to an eventual rise in interest rates. This was undertaken to provide additional protection for the organization should future interest rate increases be either signifi cant, rapid or both. This initiative has resulted in a material reduction in the institution s exposure to rising rates and has strengthened all three components of our strategic operational principle. The potential impact on the Credit Union of a possible Federal Government sequestration also presents a different kind of environmental risk for which plans are evolving. We are very cognizant of the possible effect on our members represented by such government actions. And as always, Northwest Federal will be there to assist our members to our fullest capability. As essential to Northwest Federal s long-term vibrancy as these successes may be, they remain a product of achieving our foremost goal of providing our members an excellent value in our products and services delivered with an unsurpassed excellence. This is the aim and commitment of your Board. I thank you for your ongoing support of and loyalty to Northwest Federal Credit Union. THOMAS CONROY Chairman, Board of Directors 2 NORTHWEST FEDERAL CREDIT UNION

5 PRESIDENT S REPORT In Northwest Federal Credit Union s 65 years of service to its members, 2012 will stand out as one of its most momentous. A number of significant events transpired during the past year that merit attention here in our annual report. First of all, Gerrianne Winky Burks, our President and CEO for the past five years retired in January 2013 after 42 years of service to Northwest Federal and its members. Winky s untold contributions to our organization over more than four decades have played a tremendous part in developing Northwest Federal into one of the strongest and most influential credit unions in the country. I am honored to have been afforded the privilege of succeeding Winky in leading the Northwest Federal team. The great legacy that has been built at Northwest Federal is something we are resolutely committed to continuing and building upon. As we are all acutely aware, the past several years have been challenging for all fi nancial institutions. Northwest Federal has been able to not only weather the economic storm, but has thrived during this period, which is a testament to the vision of the organization s management and Board. We believe that as we go forward, challenges will remain, but with these will come a signifi cant number of opportunities for continued growth and development of our Credit Union. This means growing our convenience to members, growing our menu of products and services, growing and expanding both our retail branch network as well as our electronic delivery channels, and, growing the positive impact Northwest Federal has in the communities we serve and in the lives of our members. Northwest Federal has already begun looking toward what we believe will be exciting changes for the organization and for the credit union movement as a whole. We are in the midst of implementing a broad array of new initiatives, the most recent of which has been the launch of our new mobile service that provides smartphone users direct access to the Credit Union and their accounts. In the fi rst half of 2012 we also expanded our retail branch network with the opening of a new offi ce in Gainesville, VA. Over the coming months and years, we intend to continue to bring more new products and services such as these on a recurring basis with the aim of increasing the value of your membership in Northwest Federal. As I begin my tenure as President and CEO of Northwest Federal, I look forward to meeting more of you and I welcome and invite your questions, comments and suggestions. Our goal is to provide you, our members, with the fi nest experience to be found anywhere in the fi nancial services industry. We are committed to a process of continual improvement with this as our aim. I would like to thank each of you for being a part of Northwest Federal and encourage you to spread the word about your Credit Union to all your family, friends and acquaintances as we continue to build a very special organization. CHRIS McDONALD President/Chief Executive Officer CHRIS McDONALD Making It COUNT I am very thankful for Northwest Federal providing me access to BALANCE SM. After my very informative initial session by phone, I felt equipped to fully tackle my debt in a proper, educated manner. Kathryn F. I have always had a great experience with Northwest Federal Credit Union from my savings account to my mortgage. I just opened an account for my son and I m sure that he will have just as great an experience through his life with Northwest Federal. Richard P ANNUAL REPORT 3

6 BOARD OF DIRECTORS & EXECUTIVE STAFF BOARD OF DIRECTORS Making It COUNT Northwest Federal is, to me, what the Bailey Building & Loan was to its customers in the old movie It s a Wonderful Life always courteous, patient and helpful in the extreme. John L. LEFT TO RIGHT Jeffrey Barrett Associate Director Leo Cardillo Director Jeannette Moore Director Chuck Molina Treasurer Dawn Eilenberger Secretary David Eldred Vice Chairman Thomas Conroy Chairman Jeanne Tisinger Director Martin Edwards Director Mary Corrado Director Lisa Miller Associate Director NOT PICTURED: Bob Goldberg Associate Director EXECUTIVE STAFF SEATED, LEFT TO RIGHT Gerrianne Winky Burks President/Chief Executive Officer (Retired December 2012) Chris McDonald President/Chief Executive Officer (Began December 2012) STANDING, LEFT TO RIGHT Colleen Daly Senior Vice President of Lending Greg Gibson Senior Vice President/Chief Operating Officer/Chief Financial Officer Chris Meese Senior Vice President/Chief Information Officer Jesse Boyer Senior Vice President/Division Executive for REALTORS Federal Credit Union Brand Phyllis Ziakas Senior Vice President of Human Resources and Organizational Development 4 NORTHWEST FEDERAL CREDIT UNION

7 TREASURER & FINANCIAL MANAGEMENT COMMITTEE REPORT From a fi nancial performance perspective, 2012 was quite an oustanding year for your Credit Union. The moderate growth rate we experienced in 2010 and 2011 was signifi cantly overshadowed by our nearly 20% growth during the year. This substantive growth boosted total assets by $413 million to over $2.5 billion for the fi rst time in the organization s history. Also, this increase was supported by another exceptional earnings performance that grew our capital base by $30 million for the year again a fi rst for Northwest Federal. At the close of 2012, the Credit Union was very well-capitalized with a net worth ratio of 9.44%. Regulators consider a credit union to be well-capitalized at 7%. Components critical to the overall success achieved in 2012 included continued superior asset quality with credit losses totaling only 0.50% for the year as delinquencies at year end amounted to only 0.71% of total loans. Additionally, with continued low interest rates, our mortgage lending division originated over $500 million in home fi nancing for our members during fi scal We increased our support of the small business community through our lending efforts, increasing outstanding loans to this constituency by more than 30% to over $100 million. Finally, our wholly owned subsidiary, NW Capital Management, Inc., also recorded its best fi nancial performance in 2012, earning over $2.5 million. We are especially pleased that our newest branch offi ces in Leesburg and Gainesville have provided added convenience for our members. This branch expansion helped propel the signifi cant share growth we experienced in Especially noteworthy is the increase in the number of members who have chosen Northwest Federal to be their primary fi nancial institution as is refl ected in our superior growth in checking accounts, total balances of which increased well over 20% during the year. Although our Credit Union has performed well during one of the most difficult economies in generations, we know that a significant portion of our ongoing job is managing our risks. Historically low interest rates have continued to be fostered by the Federal Reserve s current monetary policy and we believe the risk of rising interest rates has been elevated substantially as a result. Accordingly, management and the Board of Directors has collectively developed and executed a number of initiatives over the past few years aimed at significantly reducing Northwest Federal s exposure to such risk. We believe that we have taken prudent steps to position Northwest Federal well as interest rates eventually begin to rise. And while there are many other uncertainties that present challenges which also must be managed, we deem our balance sheet to be safe, sound and sustainable. We believe that the strength of our balance sheet and our financial performance during the past several years of economic turmoil places us in a very advantageous position to continue to grow and provide more services, value and convenience to more and more members. We are pleased to present this report to you and thank you for the part you have played in helping us deliver what we believe to be a tremendous performance in Again, thank you for your continued patronage and for choosing to be a vital part of Northwest Federal Credit Union. CHUCK MOLINA Treasurer, Board of Directors Chairman, Financial Management Committee CHUCK MOLINA Making It COUNT It s nice to feel member loyalty, at a fair rate, in today s times. I will recommend Northwest Federal to any and everyone who asks. Marc M. I want to thank you from the bottom of my heart for all of your help refi nancing my car. I m thinking of switching all of my banking to Northwest Federal because of what the Credit Union has to offer. Thank you for taking the extra steps to help me save. Kimberly W ANNUAL REPORT 5

8 SUPERVISORY COMMITTEE REPORT DAVID McCUE Making It COUNT I have worked with Northwest Federal Credit Union for roughly 15 years and continue to be impressed with your growth in services and location. Your auto services, credit card and mortgage rates are outstanding and have saved us significant money over the years. Mike C. Not only are Northwest Federal s services wonderful, but the people that you deal with are fantastic as well. Everyone knows you by name at the branch. It s a real hometown feeling. Roselle S. The Supervisory Committee is a Board-appointed volunteer organization that works on behalf of the membership to monitor the fi nancial health of the Credit Union as well the internal control environment that is in place to mitigate fi nancial, operational, and compliance risks. The Committee meets regularly to execute, coordinate, review, and assess the effectiveness of its charter responsibilities. The Supervisory Committee performs the following key activities as part of its responsibilities: INTERNAL AUDIT The Supervisory Committee meets regularly with the Internal Audit executive to review the Internal Audit function s risk assessment and audit planning process, the results of ongoing and completed audits, progress against the annual audit plan, management s responsiveness in addressing internal audit recommendations, and the adequacy of the resources, executive support, and training the Internal Audit function needs to execute its mission. EXTERNAL AUDITS & EXAMINATIONS The Supervisory Committee engages an independent audit fi rm, Orth, Chakler, Murnane & Company, CPAs, to conduct an annual audit of the Credit Union s fi nancial statements. In addition, the National Credit Union Administration (NCUA) conducts regular examinations of the Credit Union. NCUA s most recent examination completed during December 2012, as well as our FY2012 fi nancial statement audit, confi rm the outstanding fi nancial health of the Credit Union and the strong internal control environment that is in place. SPECIAL FOCUS AREAS The Supervisory Committee continuously meets with the Board and management to identify emerging initiatives, issues, and challenges that could impact the Credit Union s internal control environment and warrant ongoing Supervisory Committee attention and monitoring. Examples of these special focus areas that the Supervisory Committee is currently focusing on include the REALTORS Federal Credit Union merger, and technology improvements such as mobile and online banking. CONTINUOUS LEARNING & IMPROVEMENT In order to maintain and improve the effectiveness of the Supervisory Committee, Committee members regularly participate in credit union-related training opportunities. In addition, the Supervisory Committee receives regular briefings from management to better learn about and understand the various operations and activities within the Credit Union. The Committee also recently added a new member who has an extensive information security background which will enhance the Committee s ability to monitor technology risks impacting the Credit Union. The Supervisory Committee would like to thank the membership for its outstanding support of the Credit Union. Likewise, we commend the Credit Union s volunteer Board for their diligence and guidance in the oversight of the Credit Union as well as their support of the Supervisory Committee and its activities. I would also like to use this opportunity to thank my volunteer colleagues who serve with me on the Supervisory Committee for their dedication and hard work: Maureen Wingfi eld, Sandera Oliver, Christine Perritt, Margaret Augustine, and Cedric Deal, as well as Lisa Wood-Mitchell, who leads the Credit Union s internal audit function. The Supervisory Committee is working for the best interest of all Credit Union members. If you have a question relating to the fi nancial soundness or management of this organization, please do not hesitate to contact us. DAVID McCUE Chair, Supervisory Committee 6 NORTHWEST FEDERAL CREDIT UNION

9 INDEPENDENT AUDITOR S REPORT ORTH, CHAKLER, MURNANE & COMPANY, CPAs A Professional Association SW 129th Court, Suite 201, Miami, FL Telephone Fax Website: Douglas J. Orth, CPA, CFE Managing Partner Hugh S. Chakler, CPA, CISA, CITP, CFE John J. Murnane, CPA Independent Auditor s Report James A. Griner, CPA Lori J. Carmichael, CPA Daniel C. Moulton, CPA Jack D. Kenney, CPA March 26, 2013 To the Supervisory Committee of Northwest Federal Credit Union We have audited the accompanying consolidated fi nancial statements of Northwest Federal Credit Union and its subsidiary, which comprise the consolidated statements of fi nancial condition as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, members equity, and cash fl ows for the years then ended, and the related notes to the consolidated fi nancial statements. MANAGEMENT S RESPONSIBILITY FOR THE FINANCIAL STATEMENTS Management is responsible for the preparation and fair presentation of these consolidated fi nancial 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 fi nancial 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 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 from 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 consolidated financial position of Northwest Federal Credit Union and its subsidiary as of December 31, 2012 and 2011, and the results of their consolidated operations and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. Orth, Chakler, Murnane & Co. ORTH, CHAKLER, MURNANE & COMPANY Certified Public Accountants Miami, FL 2012 ANNUAL REPORT 7

10 CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (DOLLARS IN THOUSANDS) As of December 31, ASSETS Cash and cash equivalents $ 127,662 $ 50,098 Investments: Available-for-sale 1,008, ,165 Other 5,299 3,518 Loans held for sale 47,899 27,871 Loans to members, net allowance for loan losses 1,230,017 1,190,932 Accrued interest receivable 9,151 7,731 Prepaid and other assets 21,297 18,970 Property and equipment 50,166 42,431 NCUSIF deposit 18,034 16,022 Total assets $2,518,046 $2,104,738 As of December 31, LIABILITIES AND MEMBERS EQUITY LIABILITIES: Members share and savings accounts $ 2,171,127 $ 1,874,485 Borrowed funds 65,000 Accrued expenses and other liabilities 32,062 27,067 Interest payable 2,041 2,286 Total liabilities 2,270,230 1,903,838 Commitments and contingent liabilities MEMBERS EQUITY: Regular reserve 18,008 18,008 Undivided earnings 219, ,502 Accumulated other comprehensive income/(loss) 10,018 (2,610) Total members equity 247, ,900 Total liabilities and members equity $ 2,518,046 $ 2,104,738 8 NORTHWEST FEDERAL CREDIT UNION The accompanying notes are an integral part of these consolidated financial statements.

11 CONSOLIDATED STATEMENTS OF INCOME & COMPREHENSIVE INCOME (DOLLARS IN THOUSANDS) CONSOLIDATED STATEMENTS OF INCOME For the years ended December 31, INTEREST INCOME: Loans to members $ 59,300 $ 67,089 Investments 24,493 13,923 Total interest income 83,793 81,012 INTEREST EXPENSE: Members accounts and savings accounts 17,222 18,784 Interest on borrowed funds 14 6 Total interest expense 17,236 18,790 Net interest income 66,557 62,222 PROVISION FOR LOAN LOSSES 6,184 8,143 Net interest income after provision for loan losses 60,373 54,079 NON-INTEREST INCOME: Fees and service charges 22,591 19,133 Gain on sale of mortgage loans, net 8,323 2,442 Other non-operating income 1,820 1,627 Gain on sale of investments 1,749 1,965 Total non-interest income 34,483 25,167 94,856 79,246 NON-INTEREST EXPENSE: Compensation and employee benefi ts 32,936 28,756 Other expenses 17,071 14,807 Operating and occupancy expenses 12,957 11,547 Corporate credit union stabilization fund assessments 1,651 4,005 Total non-interest expense 64,615 59,115 Net income $ 30,241 $ 20,131 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME For the years ended December 31, NET INCOME $ 30,241 $ 20,131 OTHER COMPREHENSIVE INCOME/(LOSS): Unrealized holding gains/(losses) on available-for-sale investments arising during the period 14,377 (1,746) Reclassifi cation adjustments for gains included in net income (1,749) (1,965) Other comprehensive income/(loss) 12,628 (3,711) Comprehensive income $ 42,869 $ 16,420 The accompanying notes are an integral part of these consolidated financial statements ANNUAL REPORT 9

12 CONSOLIDATED STATEMENTS OF MEMBERS EQUITY (DOLLARS IN THOUSANDS) For years ended December 31, 2012 and 2011 Accumulated Other Regular Undivided Comprehensive Reserve Earnings Income/(Loss) Total Balance, December 31, 2010 $ 18,008 $ 165,371 $ 1,101 $ 184,480 Net income 20,131 20,131 Other comprehensive loss (3,711) (3,711) Balance, December 31, , ,502 (2,610) 200,900 Net income 30,241 30,241 Equity acquired through merger 4,047 4,047 Other comprehensive income 12,628 12,628 Balance, December 31, 2012 $ 18,008 $ 219,790 $ 10,018 $ 247, NORTHWEST FEDERAL CREDIT UNION The accompanying notes are an integral part of these consolidated financial statements.

13 CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS) For the years ended December 31, CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 30,241 $ 20,131 Adjustments: Provision for loan losses 6,184 8,143 Depreciation and amortization 3,757 3,868 Amortization/accretion of premiums and discounts 7,248 6,762 Amortization of servicing rights 1,284 1,891 Capitalization of servicing rights (1,710) (1,868) Gain on sale of investments (1,749) (1,965) Changes in operating assets and liabilities: Loans held for sale (20,028) (26,389) Accrued interest receivable (1,420) (868) Prepaid and other assets (1,901) (2,968) Interest payable (245) (912) Accrued expenses and other liabilities 4,995 4,786 Net cash provided by operating activities 26,656 10,611 CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from maturities, sales and repayment of available-for-sale investments 278, ,882 Purchase of available-for-sale investments (409,725) (489,751) Change in other investments (1,781) 2,948 Net change in loans, net of charge-offs (169,540) 68,954 Recoveries on loans charged off 1, Allowance acquired through merger 401 Equity acquired through merger 4,047 Expenditures for property and equipment (11,492) (8,714) Change in NCUSIF deposit (2,012) (967) Net cash used in investing activities (310,734) (94,985) CASH FLOWS FROM FINANCING ACTIVITIES: Net change in members share and savings accounts 296,642 37,473 Proceeds from borrowings 65,000 Net cash provided by fi nancing activities 361,642 37,473 Net change in cash and cash equivalents 77,564 (46,901) Cash and cash equivalents at beginning of year 50,098 96,999 Cash and cash equivalents at end of year $ 127,662 $ 50,098 SUPPLEMENTAL CASH FLOWS DISCLOSURES: Interest paid $ 17,481 $ 19,702 SCHEDULE OF NON-CASH TRANSACTIONS: Other comprehensive (loss)/income $ 12,628 $ (3,711) Loans securitized to investments $ 122,819 $ The accompanying notes are an integral part of these consolidated financial statements ANNUAL REPORT 11

14 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE 1: SIGNIFICANT ACCOUNTING POLICIES Organization and Nature of Operations Northwest Federal Credit Union (the Credit Union) is a cooperative association organized in accordance with the provisions of the Federal Credit Union Act for the purpose of promoting thrift among, and creating a source of credit for, its members. The principal operations of the Credit Union are located in the Washington, D.C. metropolitan area. Participation in the Credit Union is limited to those individuals who qualify for membership. The fi eld of membership is defi ned in the Credit Union s Charter and Bylaws. Consolidated Financial Statements/Use of Estimates The preparation of consolidated fi nancial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the dates of the consolidated fi nancial statements and the reported amounts of revenues and expenses for the periods then ended. Actual results could differ from those estimates. Estimates that are particularly susceptible to change relate to the determination of the allowance for loan losses (ALL) and the fair value of fi nancial instruments. The signifi cant accounting principles and policies used in the preparation of these consolidated fi nancial statements, together with certain related information, are summarized below. Principles of Consolidation The consolidated fi nancial statements include the accounts of the Credit Union and the accounts of its wholly owned Credit Union Service Organization (CUSO), Northwest Capital Management, LLC. The CUSO provides insurance and fi nancial services to Credit Union members. All signifi cant intercompany accounts and transactions have been eliminated. Cash and Cash Equivalents Cash and cash equivalents consist of cash on hand, due from banks, due from corporate credit unions and federal funds sold. Amounts due from banks and corporate credit unions may, at times, exceed federally insured limits. Investments Investments are classifi ed into the following categories: available-for-sale and other. Investment securities classifi ed as available-for-sale are measured at fair value as of the consolidated statement of fi nancial condition date. Unrealized gains and losses for available-for-sale investments are reported as a separate component of members equity. Investments classifi ed as other are measured at amortized cost. The Credit Union has elected to classify certain cash equivalents as other investments in accordance with the terms of the Statement of Cash Flows Topic of the Financial Accounting Standards Board (FASB) Accounting Standards Codifi cation (ASC). Realized gains and losses on disposition, if any, are computed using the specifi c identifi cation method. Investments are adjusted for amortization of premiums and accretion of discounts as an adjustment to interest income on investments over the terms of the investment by a method which approximates the interest method. Federal Home Loan Bank (FHLB) Stock As a member of the FHLB of Atlanta, the Credit Union is required to invest in stock of the FHLB. The Credit Union s minimum stock investment is based on a formula developed by the FHLB that considers the Credit Union s total assets and outstanding advances from the FHLB. The FHLB stock is carried at cost within other investments and its disposition is restricted. No ready market exists for the FHLB stock, and it has no quoted market value. Loans Held for Sale Loans originated and intended for sale in the secondary market are carried at the lower of cost of estimated market value in aggregate. All sales are made without recourse. Loans to Members and Allowance for Loan Losses Loans to members are stated at the amount of unpaid principal, net of an ALL and certain deferred loan origination fees and costs. The ALL is increased by a provision for loan losses charged to expense and decreased by charge-offs (net of recoveries). The ALL is maintained at a level considered adequate to provide for incurred loan losses in the loan portfolio by applying a historical loan loss rate to loan pools which have similar risk characteristics. Management s periodic evaluation of the adequacy of the ALL also considers such factors as changes in the nature and volume of the loan portfolio, review of specifi c problem loans, and current economic conditions that may affect the borrower s ability to repay. Loans are charged against the ALL when management believes that collection of principal is unlikely. Interest on loans to members is recognized over the terms of the loans and is calculated on principal amounts outstanding. The accrual of interest is discontinued when a loan exceeds 90 days delinquent or when management believes that collection of interest is doubtful. Direct loan origination costs are recognized in expense when incurred; however, real estate loan origination fees are deferred over the average life of the loan as an adjustment to loan yield using a method that approximates the interest method. Credit card fees are recognized as fee income when assessed. This is not materially different from fees and expenses that would have been recognized under the provisions of the Nonrefundable Fees and Other Costs Topic of the FASB ASC. ALL Methodology Management has an established methodology to determine the adequacy of the ALL that assesses the risks and losses inherent in the loan portfolio. Management applies judgment to develop its own view of loss probability within that range, using both external and internal parameters, with the objective of establishing an ALL inherent within the portfolio as of the reporting date. This amount is the result of the Credit Union s judgment or risks inherent in the portfolio, economic uncertainties, historical loss experience and other subjective factors, including industry trends, general trends of real estate values, the trends of existing borrower s FICO scores and other data incorporated into the Credit Union s judgment of the adequacy of the ALL which is intended to better refl ect management s view of risk in each loan portfolio. No single statistic or measurement determines the adequacy of the ALL. For purposes of determining the ALL, the Credit Union has segmented certain loans in the portfolio by product type. Loans are divided into the following segments: Consumer, Real Estate and Commercial. The Credit Union also disaggregates these segments into classes based on the associated risks within those segments. Consumer loans are divided into fi ve classes: New Vehicle, Used Vehicle, Unsecured, Credit Cards and Other Secured. Real estate loans are divided into three classes: First Mortgages, Second Mortgages, and Home Equity Loans. Commercial loans are divided into the following four classes: Real Estate, Industrial and Other, Construction, and SBA/USDA loans. Each class of loans requires signifi cant judgment to determine the estimation method that fi ts the credit risk characteristics of its portfolio segment. The Credit Union uses an internally developed model in the process. Management must use judgment in establishing additional input metrics for the modeling processes. The models and assumptions used to determine the ALL are independently validated and reviewed to ensure that their theoretical foundation, assumptions, data integrity, computational processes, reporting practices, and end-user controls are appropriate and properly documented. The following is how management determines the balance of the ALL for each segment or class of loans. Consumer Portfolio Segment ALL Methodology For consumer loans not identifi ed as impaired, the Credit Union determines the ALL on a collective basis utilizing historical and forecasted losses to represent the best estimate of inherent losses at the measurement date. Loans are pooled, generally by loan types with similar risk characteristics. As of December 31, 2012 and 2011, the Credit Union used industry standard loss factors for each loan class. The consumer ALL model primarily uses historic delinquency and default experience, loss severity, unemployment trends, and other key economic variables that may infl uence the frequency and severity of losses for each class of loan within the consumer segment. The consumer ALL also includes an amount for the estimated losses on individually evaluated impaired loans. Real Estate Portfolio Segment ALL Methodology For real estate loans not identifi ed as impaired, the Credit Union determines the ALL on a collective basis utilizing historical and forecasted losses to represent the best estimate of inherent losses at the measurement date. Loans are pooled, generally by loan types with similar risk characteristics. As of December 31, 2012 and 2011, the Credit Union used industry standard loss factors for each loan class. The real estate ALL model primarily uses historic delinquency and default experience, loss severity, home price trends, unemployment trends, and other key economic variables that may infl uence the frequency and severity of losses for each class of loan within the real estate segment. The real estate ALL also includes an amount for the estimated losses on individually evaluated impaired loans. Commercial Portfolio Segment ALL Methodology Upon being originated, or in the case of loan participations, when they are purchased, commercial loans are evaluated assessed and graded based on their estimated risk of potential loss. Periodically, the evaluation of these loans is updated and the loan s grade is affi rmed or changed as dictated by current information analyzed in the periodic review. Based on credit risk assessment and management s analysis of leading predictors of losses, additional loss multipliers are applied to loan balances. These loss estimates are adjusted as appropriate based on additional analysis of long-term average loss experience compared to previously forecasted losses, external loss data or other risks identifi ed from current economic conditions and credit quality trends. The commercial ALL also includes an amount for the estimated losses on individually evaluated impaired loans. 12 NORTHWEST FEDERAL CREDIT UNION

15 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Loan Charge-Off Policies The Credit Union s quality control process includes preparing lists to monitor and track delinquent loans and special mention loans. Tracking the loans on these lists enables management to assess the performance of the loan portfolio and act to mitigate risk therein through necessary changes in policy and procedures. The quality control process also serves as a tool to assist the Credit Union in identifying loans for charge-off on a timely basis. The following is a description of the Credit Union s loan charge-off policies: Consumer, real estate and commercial loans are generally charged off when: A loan is deemed uncollectible, where additional collection efforts are nonproductive regardless of the number of days delinquent; A non-performing loan is more than 180 days past due; Management judges the asset to be uncollectible; A skip where the Credit Union has had no contact for 90 days; An estimated loan loss, where the Credit Union has repossessed, but not yet sold, collateral on hand; A loan of a deceased person where the loss is determined; The asset has been classifi ed as a loss by either the internal loan review process or external examiners. Mortgage Servicing Rights Servicing assets are recognized as separate assets when rights are acquired through the sale of fi nancial assets. Fair value is based on market prices for comparable mortgage 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 infl ation rate, ancillary income, prepayment speeds and default rates and losses. Capitalized servicing rights are reported in other assets and are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying fi nancial assets. Service fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income. Property and Equipment Land is carried at cost. Property and equipment are carried at cost less accumulated depreciation. Buildings, furniture and equipment, and computer 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 term of the lease, or the estimated life of the asset, whichever is less. The Credit Union reviews property and equipment (long-lived assets) for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. National Credit Union Share Insurance Fund (NCUSIF) Deposit The deposit in the National Credit Union Share Insurance Fund (NCUSIF) is in accordance with National Credit Union Administration (NCUA) regulations, which require the maintenance of a deposit by each insured credit union. The deposit would be refunded to the Credit Union if its insurance coverage is terminated, it converts to insurance coverage from another source, or the operations of the fund are transferred from the NCUA Board. Corporate Credit Union Stabilization Fund Assessments In September 2011 and July 2012, the NCUA Board approved 25 and 9.5 basis point assessments to fund the corporate credit union stabilization fund. These assessments were based on the Credit Union s insured shares as of June 30, 2011 and 2012, respectively. (See Note 14) Members Share and Savings Accounts Members shares are subordinated to all other liabilities of the Credit Union upon liquidation. Interest on members share and savings accounts is based on available earnings at the end of an interest period and is not guaranteed by the Credit Union. Interest rates on members share accounts are set by the Board of Directors, based on an evaluation of current and future market conditions. Borrowed Funds The Credit Union has borrowed funds outstanding from the FHLB and PNC Bank as of December 31, All borrowings from PNC Bank are unsecured while borrowings from the FHLB are collateralized by eligible loans and certain investment securities owned by the Credit Union. Regular Reserve The Credit Union is required to maintain a statutory reserve (regular reserve) in accordance with the Federal Credit Union Act. This statutory reserve represents a regulatory restriction and is not available for the payment of interest. Federal and State Tax Exemption The Credit Union is exempt from most federal, state, and local taxes. The Income Taxes Topic of the FASB ASC clarifi es accounting for uncertainty in income taxes reported in the fi nancial statements. The interpretation provides criteria for assessment of individual tax positions and a process for recognition and measurement of uncertain tax positions. Tax positions are evaluated on whether they meet the more likely than not standard for sustainability on examination by tax authorities. Federal credit unions are tax-exempt under Internal Revenue Code sections 501(c) (14)(a) and 501(c)(1)(a)(I). As such, the Credit Union has no uncertain tax positions that qualify for either recognition or disclosure in the fi nancial statements. Additionally, no interest or penalties have been recorded in the accompanying fi nancial statements related to uncertain tax positions. Subsequent Events Management has evaluated subsequent events through March 26, 2013, the date the fi nancial statements were available to be issued. Management had not identifi ed any items requiring recognition or disclosure. NOTE 2: INVESTMENTS The amortized cost and estimated fair value of investments are as follows (dollars in thousands): As of December 31, 2012 Gross Gross Available-for-sale: Amortized Unrealized Unrealized Fair Cost Gains Losses Value SBA pools $ 841,785 $ 4,134 $ (1,248) $ 844,671 Federal agency securities 102,589 6,593 (177) 109,005 Mutual fund 54,129 1,115 (399) 54,845 $ 998,503 $ 11,842 $ (1,824) $1,008,521 As of December 31, 2011 Gross Gross Available-for-sale: Amortized Unrealized Unrealized Fair Cost Gains Losses Value SBA pools $ 666,905 $ 791 $ (2,501) $ 665,195 Federal agency securities 55, (315) 56,083 Mutual fund 26, (1,139) 25,887 $ 749,775 $ 1,345 $ (3,955) $ 747,165 As of December 31, Other investments: FHLB stock $ 5,299 $ 3,518 The amortized cost and estimated fair value of investments by contractual maturity are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay certain obligations without call or prepayment penalties (dollars in thousands). As of December 31, 2012 Amortized Fair Available-for-sale: Cost Value No maturity $ 54,129 $ 54,845 Within 1 year 1 5 years Mortgage-backed securities 102, ,005 SBA pools 841, ,671 $ 998,503 $1,008,521 The proceeds from the sale of investments classifi ed as available-for-sale approximated $161,602,000 and $196,800,000 during the years ended December 31, 2012 and 2011, respectively. Gross gains of approximately $1,810,000 and $1,965,000 were realized from these sales during the years ended December 31, 2012 and 2011, respectively. Gross losses of approximately $61,000 were realized from these sales during the year ended December 31, As of December 31, 2012, investment securities with a fair value of approximately $262,571,000 were pledged as security for the Credit Union s borrowed funds with the FHLB. The following tables show the gross unrealized losses and fair value of investments, aggregated by length of time individual securities have been in a continuous unrealized loss position (dollars in thousands) ANNUAL REPORT 13

16 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2012 Available-for-sale Less than 12 Months 12 Months or Longer Total Gross Gross Gross Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses SBA pools $122,583 $ 675 $111,702 $ 573 $234,285 $ 1,248 Federal agency securities 8, , , Mutual fund 3, , , $134,438 $ 1,042 $134,637 $ 782 $269,075 $ 1,824 As of December 31, 2011 Available-for-sale Less than 12 Months 12 Months or Longer Total Gross Gross Gross Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses SBA pools $394,944 $ 2,000 $ 71,242 $ 501 $466,186 $ 2,501 Federal agency securities 7, , , Mutual fund 2, , ,914 1,139 $405,663 $ 2,362 $109,904 $ 1,593 $515,567 $ 3,955 Unrealized losses on securities issued by the U.S. Government and its Agencies have not been recognized into income because the principal balances of these securities are guaranteed by the U.S. Government. Additionally, the decline in these fair values are expected to be recovered as these securities approach their maturity dates. Management has the ability and intent to hold these securities to recovery of fair value, which may be maturity. NOTE 3: LOANS TO MEMBERS The composition of loans to members is as follows (dollars in thousands): As of December 31, Consumer: New vehicle $ 73,915 $ 74,555 Used vehicle 183, ,962 Unsecured 91,074 77,210 Credit cards 91,252 90,353 Other secured 7,888 7,598 Total consumer 447, ,678 Real estate: First mortgage 392, ,763 Second mortgage 59,705 82,369 Home equity 87,881 95,924 Total real estate 539, ,056 Commercial: Real estate 47,604 34,951 Industrial and other 50,702 23,265 Construction 5,501 6,555 SBA and USDA 154,338 75,502 Total commercial 258, ,273 Total loans 1,245,586 1,206,007 Less ALL (15,569) (15,075) $1,230,017 $1,190,932 A summary of the activity in the ALL by portfolio segment is as follows (dollars in thousands): For the years ended December 31, 2012 and 2011 Consumer Real Estate Commercial Total Balance, December 31, 2010 $ 6,303 $ 2,762 $ 5,163 $ 14,228 Provision for loan losses 2,432 2,461 2,250 8,143 Recoveries Loans charged off (3,678) (2,341) (1,940) (7,959) Balance, December 31, ,510 3,092 5,473 15,075 Provision for loan losses 2,110 5,105 (1,031) 6,184 Allowance acquired through merger Recoveries ,051 Loans charged off (4,371) (1,858) (913) (7,142) Balance, December 31, 2012 $ 5,331 $ 6,561 $ 3,667 $ 15,569 As of December 31, 2012 Consumer Real Estate Commercial Total Individually evaluated for impairment $ 1,525 $ 4,958 $ 1,379 $ 7,862 Collectively evaluated for impairment $ 3,806 $ 1,603 $ 2,298 $ 7,707 As of December 31, 2011 Consumer Real Estate Commercial Total Individually evaluated for impairment $ 1,534 $ 2,160 $ 624 $ 4,318 Collectively evaluated for impairment $ 4,976 $ 932 $ 4,849 $ 10,757 A summary of the recorded investment in loans by portfolio segment is as follows (dollars in thousands): As of December 31, 2012 Consumer Real Estate Commercial Total Ending balance $ 447,570 $ 539,871 $ 258,145 $1,245,586 Individually evaluated for impairment $ 3,051 $ 12,820 $ 8,584 $ 24,455 Collectively evaluated for impairment $ 444,519 $ 527,051 $ 249,561 $1,221,131 As of December 31, 2011 Consumer Real Estate Commercial Total Ending balance $ 383,678 $ 682,056 $ 140,273 $1,206,007 Individually evaluated for impairment $ 3,068 $ 4,842 $ 7,874 $ 15,784 Collectively evaluated for impairment $ 380,610 $ 677,214 $ 132,399 $1,190,223 Impaired Loans A loan is impaired when it is probable, based on current information and events, that the Credit Union will be unable to collect all contractual principal and interest payments due to in accordance with the terms of the loan agreements. When management identifi es a loan as impaired, the impairment is measured based on the present value of expected future cash fl ows, discounted at the loan s effective interest rate, except when the sole (remaining) source of repayment for the loan is the operations or liquidation of the collateral. In these cases, management uses the current fair value of the collateral, less selling costs, when foreclosure is probable, instead of discounted cash fl ows. If management determined that the value of the impaired loan is less than the recorded investment in the loan, impairment is recognized through an ALL estimate or a charge-off to the ALL. The following tables include the recorded investment and unpaid principal balances for impaired loans with the associated ALL amount, if applicable. Also presented are the average recorded investments in the impaired loans and the related amount of interest recognized during the time within the period that the impaired loans were impaired. The average balances are calculated based on the quarter end balances of the loans for the period reported. Payments received on impaired loans are recorded as a reduction of principal or as interest income depending on the modified terms of the loan. The tables below summarizes key information for impaired loans (dollars in thousands): As of For the Year Ended December 31, 2012 December 31, 2012 Unpaid Average Interest With an Recorded Principal Specific Recorded Income allowance recorded: Investment Balance Allowance Investment Recognized Consumer: New auto $ 207 $ 207 $ 103 $ 207 $ 3 Used auto $ 883 $ 883 $ 441 $ 883 $ 14 Unsecured $ 1,961 $ 1,961 $ 981 $ 1,961 $ 30 Real Estate: First mortgage $ 9,729 $ 9,729 $ 3,199 $ 9,729 $ 170 Second mortgage $ 1,984 $ 1,984 $ 1,371 $ 1,005 $ 18 Home equity $ 1,107 $ 1,107 $ 388 $ 2,086 $ Commercial: Real estate $ 5,124 $ 5,124 $ 906 $ 5,124 $ Other secured $ 3,460 $ 3,460 $ 473 $ 3,460 $ Construction $ $ $ $ $ Totals: Consumer $ 3,051 $ 3,051 $ 1,525 $ 3,051 $ 47 Real estate 12,820 12,820 4,958 12, Commercial 8,584 8,584 1,379 8,584 $ 24,455 $ 24,455 $ 7,862 $ 24,455 $ NORTHWEST FEDERAL CREDIT UNION

17 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS As of For the Year Ended December 31, 2011 December 31, 2011 Unpaid Average Interest With an Recorded Principal Specific Recorded Income allowance recorded: Investment Balance Allowance Investment Recognized Consumer: New auto $ 251 $ 251 $ 125 $ 251 $ 4 Used auto $ 847 $ 847 $ 423 $ 847 $ 13 Unsecured $ 1,970 $ 1,970 $ 986 $ 1,970 $ 30 Real Estate: First mortgage $ 4,414 $ 4,414 $ 1,969 $ 4,414 $ 77 Second mortgage $ 383 $ 383 $ 171 $ 383 $ 7 Home equity $ 45 $ 45 $ 20 $ 45 $ Commercial: Real estate $ 7,826 $ 7,826 $ 614 $ 7,826 $ Construction $ 48 $ 48 $ 10 $ 48 $ Totals: Consumer $ 3,068 $ 3,068 $ 1,534 $ 3,068 $ 47 Real estate 4,842 4,842 2,160 4, Commercial 7,874 7, ,874 $ 15,784 $ 15,784 $ 4,318 $ 15,784 $ 131 The tables below provide an age analysis of past due loans by class (dollars in thousands): As of December 31, 2012 Total Total Days Delinquent Delinquent Current Total or more Loans Loans Loans Consumer: New auto $ 336 $ 47 $ 44 $ 427 $ 73,488 $ 73,915 Used auto 1, , , ,441 Unsecured ,188 89,886 91,074 Credit cards 1, ,525 89,727 91,252 Other secured 7,888 7,888 Real estate: First mortgage 1,879 3,421 5, , ,285 Second mortgage 3, ,335 55,370 59,705 Home equity 1, ,051 85,830 87,881 Commercial: Real estate 2,016 2,016 45,588 47,604 Industrial and other 50,702 50,702 Construction 5,501 5,501 SBA and USDA 154, ,338 Total $ 9,823 $ 1,357 $ 7,466 $18,646 $1,226,940 $1,245,586 As of December 31, 2011 Total Total Days Delinquent Delinquent Current Total or more Loans Loans Loans Consumer: New auto $ 740 $ 251 $ 141 $ 1,132 $ 73,423 $ 74,555 Used auto 1, , , ,962 Unsecured ,144 76,066 77,210 Credit cards 441 1,831 2,272 88,081 90,353 Other secured 7,598 7,598 Real estate: First mortgage 16,806 8,513 6,380 31, , ,763 Second mortgage 3,282 1, ,960 77,409 82,369 Home equity 1, ,875 93,049 95,924 Commercial: Real estate 2,900 2,900 32,051 34,951 Industrial and other 23,265 23,265 Construction 6,555 6,555 SBA and USDA 2,421 2,421 73,081 75,502 Total $26,790 $11,756 $13,131 $51,677 $1,154,330 $1,206,007 The Credit Union places loans on non-accrual status when the loan reaches 90 days past due or when the collection of interest or principal becomes uncertain. Loans on which the accrual of interest has been discontinued or reduced approximated $7,466,000 and $13,131,000 as of December 31, 2012 and 2011, respectively. There were no loans 90 days or more past due and still accruing interest as of December 31, 2012 or Troubled Debt Restructuring The Credit Union s loan portfolio also includes certain loans that have been modified in a Troubled Debt Restructuring (TDR), where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from the Credit Union s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. When the Credit Union modifies a loan, management evaluates impairment based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement. Or in certain cases, management uses the current fair value of the collateral, less selling costs. The loan is further analyzed for consideration of the risk of re-default. If management determines that the value of the modified loan is less than the recorded investment in the loan, impairment is recognized by segment or class of loan, as applicable, through the ALL. The following tables include the recorded financial impact of TDRs. Below is the recorded investment in TDRs modified within the last year that subsequently defaulted in the current reporting period. The Credit Union defines a TDR as subsequent default when the TDR is 90 days past due, the member fails to complete six consecutive payments, or the member files bankruptcy. The following tables present the activity on TDRs (dollars in thousands). As of December 31, 2012 TDRs Approved TDRs which During the Subsequently Period Defaulted Consumer: New auto $ 84 $ Used auto Unsecured Real estate: First mortgage 3,900 2,400 Second mortgage Home equity Total $ 5,140 $ 2,737 As of December 31, 2012 TDRs Approved TDRs which During the Subsequently Period Defaulted Consumer: New auto $ 335 $ Used auto 847 Unsecured 1,886 Real estate: First mortgage 926 Second mortgage 181 Home equity 168 Commercial: Contructions 48 Total $ 4,210 $ 181 Consumer Credit Quality Indicators Consumer credit quality is measured, assessed and quantified through analysis of current delinquencies and credit losses within each segment of the consumer loan portfolio as well as on the portfolio as a whole. Additionally, historical loss trends are factored into management s evaluation of credit performance along with local and regional economic trends and other external variables that may impact portfolio performance. The adequacy of the ALL allocated to the consumer loan portfolio is then evaluated on these various sets of data. Real Estate Credit Quality Indicators The following tables represent real estate credit exposures by credit score. The use of creditworthiness categories to grade loans permits management to estimate a portion of credit risk. Category ratings are reviewed each quarter, at which time management analyzes the resulting scores, as well as other external statistics and factors, to track loan performance. Loans that trend upward toward higher levels generally have a lower risk factor associated. Whereas, loans that migrate toward lower rating generally will result in a higher risk factor being applied to those related loan balances ANNUAL REPORT 15

18 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS The Credit Union s internal risk ratings are as follows: 800 and above Member poses little to no risk. 750 to 799 Member poses a nominal risk of loss. 650 to 749 Member poses an average risk of loss. 600 to 649 Member is experiencing some degree of fi nancial diffi culty. 599 and below Member is showing above average risk. No score No credit score was available. The table below summarizes key information for real estate credit quality (dollars in thousands): Real Estate Credit Quality Indicators As of December 31, 2012 First Second Home Mortgage Mortgage Equity Total 800 and above $ 112,554 $ 17,617 $ 33,806 $ 163, to ,699 13,656 23, , to ,786 20,636 22, , to ,476 3,638 4,936 22, and below 11,164 3,496 2,633 17,293 No score 101, , ,354 $ 392,285 $ 59,705 $ 87,881 $ 539,871 Real Estate Credit Quality Indicators As of December 31, 2011 First Second Home Mortgage Mortgage Equity Total 800 and above $ 226,895 $ 24,511 $ 37,391 $ 288, to ,998 19,617 25, , to ,731 27,456 24, , to ,730 4,503 3,934 25, and below 19,409 6,282 4,470 30,161 $ 503,763 $ 82,369 $ 95,924 $ 682,056 Commercial Credit Quality Indicators The Credit Union categorizes commercial loans into risk categories based on relevant information about the ability of the borrowers to service their debt such as: current financial information, historical payment experience, credit documentation and current economic trends among other factors. These credit quality indicators are used to assign a risk rating to each individual credit. The risk ratings can be grouped into six major categories, defi ned as follows: Pass. A pass loan is a strong credit with no existing or known potential weaknesses deserving management s close attention. Watch. A watch credit is a loan that otherwise meets the defi nition of a standard or minimum acceptable quality loan, but which requires more than normal attention due to any of the following items: deterioration of borrower fi nancial condition less severe than those warranting more adverse grading, deterioration of repayment ability and/or collateral value, increased leverage, adverse effects from a downturn in the economy, local market or industry, adverse changes in local or regional employer, management changes (including illness, disability, and death), and adverse legal action. Payments are current per the terms of the agreement. If conditions persist or worsen, a more severe risk grade may be warranted. Special Mention. A special mention credit is a loan that has potential weaknesses that deserve management s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the credit or in the Credit Union s position at some future date. Special Mention credits are not adversely classifi ed and do not expose the Credit Union to suffi cient risk to warrant adverse classifi cation. Substandard. A substandard credit is a loan that is not adequately protected by the current sound worth and paying capacity of the borrower or the value of the collateral pledged, if any. Credits classifi ed as substandard have a well-defi ned weakness or weaknesses that jeopardize the liquidation of the debt. Well defi ned weaknesses include a project s lack of marketability, inadequate cash fl ow or collateral support, failure to complete construction on time or a project s failure to fulfi ll economic expectations. They are characterized by the distinct possibility that the Credit Union will sustain some loss if the defi ciencies are not corrected. Loss. Credits classifi ed as loss are loans considered uncollectible and charged off immediately. The following table summarizes the credit risk profi le of the commercial loan portfolio by class (dollars in thousands): Commercial Credit Quality Indicators As of December 31, 2012 Credit Real Industrial SBA and Grade Estate and Other Construction USDA Total Pass $ 42,481 $ 47,241 $ 5,501 $154,338 $249,561 Watch 2,071 1,726 3,797 Special mention Substandard 1,182 1,182 Doubtful 3, ,605 Loss Total $ 47,604 $ 50,702 $ 5,501 $154,338 $258,145 Commercial Credit Quality Indicators As of December 31, 2011 Credit Real Industrial SBA and Grade Estate and Other Construction USDA Total Pass $ 27,125 $ 23,265 $ 6,555 $ 73,081 $130,026 Watch 3,363 2,421 5,784 Special mention 1,563 1,563 Substandard Doubtful 2,900 2,900 Loss Total $ 34,951 $ 23,265 $ 6,555 $ 75,502 $140,273 Methodology Change The Credit Union implemented changes to its ALL methodology during the year ended December 31, In prior years, management used a historical loss period of 12 months for all segments or class of loans when estimating the historical chargeoff rates. In 2011, management changed its ALL calculation from using historical loss rates to industry rates related to each individual segment or class of loans. The following is a list of the changes made to each segment: The following table represents the effects of changes to methodology from the prior period on the current period provision. Calculated Calculated Provision Provision based on based on Prior Year Current Year Methodology Methodology Difference Portfolio Segment: Consumer $3,086,810 $4,691,770 $1,604,960 Real estate 1,911,175 1,987,007 75,832 Commercial Total $4,997,985 $6,678,777 $1,680,792 NOTE 4: PROPERTY AND EQUIPMENT A summary of the Credit Union s property and equipment is as follows (dollars in thousands): As of December 31, Land $ 15,632 $ 4,271 Buildings 38,239 38,184 Computer equipment 21,174 16,713 Furniture and equipment 5,655 5,340 Leasehold improvements 8,308 8,527 Construction in progress 4,481 89,008 77,516 Less accumulated depreciation and amortization (38,842) (35,085) $ 50,166 $ 42,431 Doubtful. Credits classifi ed as doubtful are loans that have all the weaknesses inherent in those classifi ed as substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable. 16 NORTHWEST FEDERAL CREDIT UNION

19 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE 5: MEMBERS SHARE AND SAVINGS ACCOUNTS Members share and savings accounts are summarized as follows (dollars in thousands): As of December 31, Share drafts $ 267,618 $ 228,764 Shares and equivalents 379, ,920 Money market 864, ,842 IRA shares 64,553 61,669 Share and IRA certificates 594, ,290 $2,171,127 $1,874,485 The aggregate balance of members individual time deposit accounts in denominations of $100,000 or more was approximately $363,004,000 and $299,626,000 as of December 31, 2012 and 2011, respectively. The aggregate balance of overdraft accounts reclassifi ed to loans to members was approximately $176,000 and $171,000 as of December 31, 2012 and 2011, respectively. Scheduled maturities of certifi cates are as follows (dollars in thousands): As of December 31, 2012 Within 1 year $ 293,030 1 to 2 years 145,567 2 to 3 years 65,397 3 to 4 years 62,429 4 to 5 years 28,539 $ 594,962 Share Insurance Members shares are generally insured by the NCUSIF to a maximum of $250,000 for each member. Individual Retirement Accounts are insured by the NCUSIF to a maximum of $250,000. Additionally, non-interest bearing share accounts are fully insured by the NCUSIF until December 31, NOTE 6: EMPLOYEE BENEFITS 401(k) Profit Sharing Plan Participation in the 401(k) profi t sharing plan is available to all employees who are 21 years of age. Employee contributions to the plan are subject to certain limits established by the Internal Revenue Service. Participants are always 100% vested in their voluntary contributions. The Credit Union may make a discretionary matching contribution equal to a uniform percentage of an employee s salary deferral and/or a discretionary profi t sharing contribution. Credit Union contributions vest at 33% after one year of service, 67% after two years of service and 100% after three years of service. During the years ended December 31, 2012 and 2011, the Credit Union contributed a matching contribution equal to 5% and 4% of employee contributions, respectively. The Credit Union s expense for the 401(k) profi t sharing plan for the years ended December 31, 2012 and 2011 was approximately $997,000 and $821,000, respectively. Post-Retirement Benefit Plan The Credit Union has a post-retirement benefi t plan which pays for certain medical benefi ts for employees retiring after age 55 with at least 20 years of service. Participation in the plan is limited to those full-time employees who have participated in the Credit Union s health insurance plan for a minimum of fi ve years prior to retirement. The Credit Union is not required to, and has not funded the plan. Management has determined that the accrued benefi ts related to this postretirement benefi t plan are not material to the Credit Union s consolidated fi nancial condition as of December 31, 2012 and 2011; therefore, no amounts have been recognized in the accompanying consolidated fi nancial statements. Deferred Compensation The Credit Union maintains a deferred compensation plan which will be payable in accordance with terms of the underlying agreement. The liability under this plan was approximately $1,000,000 and $858,000 as of December 31, 2012 and 2011, respectively. The plan is funded via the earnings from investments made by the Credit Union specifi cally related to this plan. NOTE 7: BORROWED FUNDS The Credit Union is a member of the FHLB of Atlanta. As of December 31, 2012, the Credit Union had access to a pre-approved secured line of credit with the capacity to borrow up to a certain percentage of value of its eligible collateral comprised of 1 4 family fi rst mortgage loans and investment securities, as defi ned in the FHLB Statement of Credit Policy. Additionally, as of December 31, 2012, the Credit Union maintained an unsecured line-of-credit agreement with PNC Bank. The following table represents the FHLB and PNC advances outstanding (dollars in thousands): Interest Interest Final Payment As of December 31, Issuer Type Rate Maturity Date Description FHLB Daily 0.355% Overnight Daily $20,000 $ FHLB Fixed 0.210% January 14, 2013 Maturity $25,000 PNC Bank Fixed 0.450% Overnight Daily $20,000 $65,000 $ NOTE 8: COMMITMENTS AND CONTINGENT LIABILITIES Lease Commitments The Credit Union leases several branch offi ces. The minimum noncancellable lease obligations approximate the following as of December 31, 2012 (dollars in thousands): Year ending December 31, Amount 2013 $ 815, , , , ,000 Thereafter 460,000 $3,534,000 Rental expense under operating leases was approximately $734,000 and $711,000 for the years ended December 31, 2012 and 2011, respectively. Lines of Credit: In aggregate, the Credit Union maintained $60,000,000 in unsecured line-of-credit agreements with SunTrust, Wells Fargo and PNC Bank as of December 31, As of December 31, 2012, $20,000,000 was outstanding on these line-of-credit agreements. The Credit Union also maintains a $100,000,000 secured line of credit with SunTrust Robinson Humphrey as of December 31, This line of credit is secured by a blanket security interest in the Credit Union s investment portfolio. No amount was outstanding on this line-of-credit agreement as of December 31, As of December 31, 2012, the Credit Union had access to a pre-approved lineof-credit from the FHLB, secured by both investment securities and eligible 1 4 family fi rst mortgage loans, as defi ned in the FHLB Statement of Credit Policy. The aggregate unused line of credit under this agreement was approximately $194,000,000 as of December 31, Miscellaneous Litigation: The Credit Union is a party to various miscellaneous legal actions normally associated with fi nancial institutions, the aggregate effect of which, in management s opinion, would not be material to the Credit Union s consolidated fi nancial statements. NOTE 9: OFF-BALANCE-SHEET RISK AND CONCENTRATION OF CREDIT RISK Off-Balance-Sheet Risk The Credit Union is a party to fi nancial instruments with off-balance-sheet risk in the normal course of business to meet the fi nancing needs of its members and to reduce its own exposure to fl uctuations in interest rates. These fi nancial instruments include commitments to extend credit. These instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the consolidated statements of fi nancial condition. The Credit Union s exposure to credit loss in the event of non performance by the other party to the fi nancial instrument for commitments to extend credit is represented by the contractual amount of these instruments. Commitments to extend credit are agreements to lend to a member as long as there is no violation of any condition established in the contract. Commitments generally have fi xed expiration dates or other termination clauses. Since many of the commitments may expire without being fully drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Credit Union 2012 ANNUAL REPORT 17

20 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS evaluates each member s creditworthiness on a case-by-case basis. The amount of collateral obtained, if any, is based on management s credit evaluation of the member. Unused lines of credit approximated the following (dollars in thousands): As of December 31, 2012 Credit card $ 197,712 Home equity 114,266 Unsecured 20,297 Business 6,899 $ 339,174 Concentrations of Credit Risk The Credit Union may be exposed to credit risk from a regional economic standpoint, since a signifi cant concentration of its borrowers work or reside in the Washington D.C. area. However, the loan portfolio is well diversifi ed and the Credit Union does not have any signifi cant concentrations of credit risk, except unsecured loans, when by their nature, increase the risk of loss compared to those loans that are collateralized. NOTE 10: REGULATORY CAPITAL The Credit Union is subject to various regulatory capital requirements administered by the NCUA. Failure to meet minimum capital requirements can initiate certain mandatory actions, and possibly additional discretionary actions, by regulators that, if undertaken, could have a direct material effect on the Credit Union s consolidated fi nancial statements. Under capital adequacy regulations and the regulatory framework for prompt corrective action, the Credit Union must meet specifi c capital regulations that involve quantitative measures of the Credit Union s assets, liabilities, and certain off-balance-sheet items as calculated under generally accepted accounting principles. The Credit Union s capital amounts and net worth classifi cation are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Credit Union to maintain minimum amounts and ratios (set forth in the table below) of net worth (as defi ned in NCUA s Regulations) to total assets (as defi ned in NCUA s Regulations). Credit unions are also required to calculate a Risk-Based Net Worth Requirement (RBNWR) which establishes whether or not the Credit Union will be considered complex under the regulatory framework. The Credit Union s RBNWR as of December 31, 2012 and 2011 was 5.07% and 4.63%, respectively. The minimum requirement to be considered complex under the regulatory framework is 6.00%. Management believes, as of December 31, 2012 and 2011, that the Credit Union meets all capital adequacy requirements to which it is subject. As of December 31, 2012, the most recent call reporting period, the NCUA categorized the Credit Union as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Credit Union must maintain a minimum net worth ratio of 7.00% of assets. There are no conditions or events since that notifi cation that management believes have changed the Credit Union s category. The Credit Union s actual and required net worth amounts and ratios are as follows (dollars in thousands): As of As of December 31, 2012 December 31, 2011 Ratio/ Ratio/ Amount Requirement Amount Requirement Actual net worth $ 237, % $ 203, % Amount needed to be classifi ed as adequately capitalized $ 151, % $ 126, % Amount needed to be classifi ed as well capitalized $ 176, % $ 147, % Because the RBNWR is less than the net worth ratio, the Credit Union retains its original category. Further, in performing its calculation of total assets, the Credit Union used the quarter end option, as permitted by regulation. NOTE 11: LOAN SERVICING Mortgage loans serviced for others are not included in the accompanying consolidated statements of fi nancial condition. The unpaid principal balances of these loans are summarized as follows (dollars in thousands): As of December 31, Mortgage loan portfolio serviced for: Federal National Mortgage Association $1,291,160 $1,028,461 Charlie Mac $ 4,897 $ 7,200 Custodial escrow balances: Federal National Mortgage Association $ 5,545 $ 4,378 Charlie Mac $ 14 $ 15 NOTE 12: MORTGAGE SERVICING RIGHTS The components of capitalized mortgage servicing rights, included in prepaid and other assets are as follows: (dollars in thousands): As of December 31, Mortgage servicing rights: Balance, beginning of year $ 4,493 $ 4,516 Additions 1,710 1,868 Amortization (1,284) (1,891) Balance, end of year $ 4,919 $ 4,493 As of December 31, 2012 and 2011, the fair value of servicing rights was determined by an independent third party using market value discount rates and prepayment speeds based on the specifi c characteristics of each pool of loans to be approximately $8,274,000 and $5,726,000, respectively. NOTE 13: FAIR VALUES OF FINANCIAL INSTRUMENTS The Fair Value Measurements and Disclosures Topic of the FASB ASC provides a framework for measuring fair value that requires an entity to derive fair value from the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date within its principal market for the asset or liability, or in the absence of a principal market, the most advantageous market for the asset or liability. To increase consistency and comparability in fair value measurements and related disclosures, a three-level hierarchy prioritizes the inputs to valuation techniques used to measure fair value with the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3) as further described below: Level 1 Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Credit Union has the ability to access at the measurement date. An active market for the asset or liability is a market in which transactions for the asset or liability occur with suffi cient frequency and volume to provide pricing information on an ongoing basis. Level 2 Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. If the asset or liability has a specifi ed (contractual) term, a Level 2 input must be observable for substantially the full term of the asset or liability. Level 2 inputs include: quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are inactive; inputs other than quoted prices that are observable for the asset or liability; inputs that are derived principally from or corroborated by observable market data by correlation or other means. Level 3 Level 3 inputs are unobservable inputs for the asset or liability which refl ect the Credit Union s own assumptions about the assumptions that market participants would use in pricing the asset or liability. Assumptions about risk include risk inherent in a particular valuation technique used to measure fair value, typically pricing models and/or discounted cash fl ow methodologies. The methodologies and associated inputs used may produce a fair value calculation that may not be indicative of net realizable value or refl ective of future fair values. While the Credit Union believes its valuation methods and associated inputs are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain fi nancial instruments could result in a different fair value measurement at the reporting date. 18 NORTHWEST FEDERAL CREDIT UNION

21 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS The following tables set forth by level, within the fair value hierarchy, the Credit Union s fi nancial instruments at fair value (dollars in thousands): Assets at Fair Value as of December 31, 2012 Level 1 Level 2 Level 3 Total Assets: Available-for-sale securities: SBA pools $ 843,730 $ 9,941 $ $ 844,671 Federal agency securities 109, ,005 Mutual fund 54,845 54,845 $ 889,575 $ 118,949 $ $1,008,521 Assets at Fair Value as of December 31, 2011 Level 1 Level 2 Level 3 Total Assets: Available-for-sale securities: SBA pools $ 660,807 $ 4,388 $ $ 665,195 Federal agency securities 2,396 53,687 56,083 Mutual fund 25,887 25,887 $ 689,090 $ 58,075 $ $ 747,165 The estimated fair value amounts have been determined using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented are not necessarily indicative of amounts that could be realized in a market exchange. The use of different assumptions and estimation methodologies may have a material effect on the estimated fair value amounts. The following methods and assumptions were used to estimate fair value of each of the fi nancial instruments for which it was practicable to estimate. Cash and Cash Equivalents The carrying amount is a reasonable estimation of fair value. Investments Estimated fair values for investments are obtained from quoted market prices where available. Loans to Members The fair value of loans to members was estimated by discounting the estimated cash flows using the current rate at which similar loans would be issued. The impact of delinquent loans on the estimation of the fair value is not considered to have a material effect and, accordingly, delinquent loans have been disregarded in the valuation methodologies used. Loans Held for Sale The carrying amount is a reasonable estimation of fair value. Accrued Interest Receivable The carrying of accrued interest receivable approximates fair value. Mortgage Servicing Rights Fair values of mortgage servicing rights are obtained from an independent third party evaluation. The carrying value and estimated fair value of the Credit Union s fi nancial instruments are as follows (dollars in thousands): As of As of December 31, 2012 December 31, 2011 Carrying Fair Carrying Fair Amount Value Amount Value Financial assets: Cash $127,662 $127,662 $50,098 $50,098 Investments: Available-for-sale $1,008,521 $1,008,521 $747,165 $747,165 Other $5,299 $5,299 $3,518 $3,518 Loans held for sale $ 47,899 $47,899 $27,871 $27,871 Loans to members, net $1,230,017 $1,140,382 $1,190,932 $1,211,405 Accrued interest receivable $9,151 $9,151 $7,731 $7,731 Mortgage servicing rights $4,919 $8,274 $4,493 5,726 Financial liabilities: Members share and savings accounts $2,171,127 $2,138,996 $1,874,485 $1,880,954 Borrowed funds $65,000 $64,962 $ $ Unrecognized fi nancial instruments: Commitments to extend credit $ $339,174 $ $334,495 NOTE 14: INDUSTRY EVENTS In January 2009, the NCUA informed federally-insured credit unions that it was taking actions to enhance and support the corporate credit union system as well as the NCUSIF. During June 2009, legislation was created to establish a Temporary Corporate Credit Union Stabilization Fund (Stabilization Fund) to absorb the corporate stabilization costs by borrowing money from the U.S. Treasury. During September 2010, the NCUA received approval from the U.S. Treasury to extend the life of the Stabilization Fund to June The funds borrowed from the U.S. Treasury will be repaid from assessments authorized by the NCUA Board. The NCUA Board has levied assessments during 2009, 2010, 2011 and 2012 to repay borrowed funds to the U.S. Treasury. It is anticipated that the NCU Board will be making annual assessments over the next several years to cover costs associated with the corporate credit union system. NOTE 15: MERGER On August 1, 2012, the Credit Union acquired REALTORS Federal Credit Union (REALTORS FCU) through merger. The balances of REALTORS FCU at the time of the merger approximated the following: Description Balances Acquired Total assets $72,913,000 Total loans $32,826,000 Total allowance for loan losses $401,000 Total shares $68,672,000 Total equity $4,047,000 Members Share and Savings Accounts The estimated fair value of demand deposit accounts is the carrying amount. The fair value of fi xed-rate certifi cates was estimated by discounting the estimated cash fl ows using the current rate at which similar certifi cates would be issued. Borrowed Funds The estimated fair value of borrowed funds was estimated by discounting the estimated cash fl ows using the current rate at which similar borrowings would be granted. Commitments to Extend Credit The fair value of commitments to extend credit is equivalent to the amount of credit extended since the Credit Union does not charge fees to enter into these commitments and the commitments are not stated at fi xed rates ANNUAL REPORT 19

22 20 NORTHWEST FEDERAL CREDIT UNION GERRIANNE WINKY BURKS LEADERSHIP OF AND SERVICE to Northwest Federal Credit Union had been steadfast for more than 42 years. Upon her retirement in 2012, we honored her faithful commitment to this organization and acknowledged the many contributions she made toward molding Northwest Federal into one of the foremost credit unions in America. Winky has been the heart of Northwest Federal for many years and her caring for our members and staff is indelibly etched into the core of this organization. Winky s consistent vision for Northwest Federal was to create an organization that makes a positive difference in the lives of our members. So, our most heartfelt best wishes go out to Winky on her retirement, and we offer her this commendation: Well done, Winky. You have made a tremendous difference.

23

24 YOUR LIFETIME FINANCIAL PARTNER 200 Spring Street Herndon, VA