Annual Report 2018 - Page 11

Regulatory Capital Requirements and Ratios Capital Conservation Buffer Total 2018 2017 Regulatory Minimums Risk-adjusted: Common equity tier 1 ratio Tier 1 capital ratio Total capital ratio Permanent capital ratio 18.4% 18.4% 18.8% 18.5% 18.2% 18.2% 18.6% 18.3% 4.5% 6.0% 8.0% 7.0% 2.5%* 2.5%* 2.5%* N/A 7.0% 8.5% 10.5% 7.0% Non-risk-adjusted: Tier 1 leverage ratio Unallocated retained earnings and equivalents leverage ratio 19.3% 19.9% 19.1% 19.6% 4.0% 1.5% 1.0% N/A 5.0% 1.5% As of December 31 *The 2.5% capital conservation buffer over risk-adjusted ratio minimums is being phased in over three years under the FCA capital requirements. The phase in period ends on December 31, 2019. Our capital plan is designed to maintain an adequate amount of surplus and allowance for loan losses which represents our reserve for adversity prior to impairment of stock. We manage our capital to allow us to meet member needs and protect member interests, both now and in the future. Additional discussion of these regulatory ratios is included in Note 7 to the accompanying Consolidated Financial Statements. Capital ratios are directly impacted by changes in capital, assets, and off-balance sheet commitments. Refer to the Loan Portfolio section for further discussion of the changes in assets. Additional members’ equity information is included in Note 7 to the accompanying Consolidated Financial Statements. Refer to Note 6 in our Annual Report for the year ended December 31, 2016, for a more complete description of the ratios effective as of December 31, 2016. We were in compliance with the minimum required capital ratios as of December 31, 2016. In addition to these regulatory requirements, we establish an optimum total capital target. This target allows us to maintain a capital base adequate for future growth and investment in new products and services. The target is subject to revision as circumstances change. Our optimum total capital target is to remain above 13.5%, as defined in our 2019 capital plan. If the capital ratios fall below the total requirements, including the buffer amounts, capital distributions (equity redemptions, dividends, and patronage) and discretionary senior executive bonuses are restricted or prohibited without prior FCA approval. We do not foresee any events that would result in this prohibition in 2019. RELATIONSHIP WITH AGRIBANK Borrowing We borrow from AgriBank to fund our lending operations in accordance with the Farm Credit Act. Approval from AgriBank is required for us to borrow elsewhere. A General Financing Agreement (GFA), as discussed in Note 6 to the accompanying Consolidated Financial Statements, governs this lending relationship. The components of cost of funds under the GFA include:    A marginal cost of debt component A spread component, which includes cost of servicing, cost of liquidity, and bank profit A risk premium component, if applicable In the periods presented, we were not subject to the risk premium component. Certain factors may impact our cost of funds, which primarily include market interest rate changes impacting marginal cost of debt as well as changes to pricing methodologies impacting the spread components described above. The marginal cost of debt approach simulates matching the cost of underlying debt with similar terms as the anticipated terms of our loans to borrowers. This approach substantially protects us from market interest rate risk. We may occasionally engage in funding strategies that result in limited interest rate risk with approval by AgriBank’s Asset/Liability Committee. Investment We are required to invest in AgriBank capital stock as a condition of borrowing. This investment may be in the form of purchased stock or stock representing distributed AgriBank surplus. As of December 31, 2018, we were required by AgriBank to maintain an investment equal to 2.25% of the average quarterly balance of our note payable, with an additional amount required on association growth in excess of a targeted growth rate, if the District is also growing above a targeted growth rate. We are also required to hold additional investment in AgriBank based on a contractual agreement under a pool program. As an AgDirect, LLP partnering association, we are required to purchase stock in AgDirect, which purchases an equivalent amount of stock in AgriBank. Specifically, the AgDirect trade credit financing program is required to own stock in AgriBank in the amount of 6.0% of the AgDirect program’s outstanding participation loan balance at quarter end plus 6.0% of the expected balance to be originated during the following quarter. Patronage AgriBank’s 2018 capital plan is intended to provide for adequate capital at AgriBank under capital regulations as well as to create a path to long-term capital optimization within the AgriBank District. The plan optimizes capital at AgriBank; distributing available AgriBank earnings in the form of patronage, 8