Navy Federal Credit Union 2009 Annual Report Download - page 19

Note 6: Derivative Instruments
and Economic Hedging
Activities
Navy Federal is an active participant in the production
of mortgage loans which are sold to investors in the
secondary market. This mortgage banking activity
involves making mortgage loan commitments to
members at specified interest rates. Navy Federal is
exposed to changes in the value of its mortgage
loan commitments as interest rates may change
between the time that it enters into a mortgage loan
commitment and the time that it ultimately delivers
mortgage loans to investors. To protect against this
interest rate risk, Navy Federal enters into forward
sales contracts at specified prices to deliver mortgage
loans to investors. These forward sales commitments
act as an economic hedge against the risk of changes
in the value of both the mortgage loan commitments
and mortgage loans awaiting sale. As required by
ASC 815, Derivatives and Hedging (formerly known
as SFAS No. 133), Navy Federal accounts for both
the mortgage loan commitments and the forward
sales contracts as derivative instruments on its
Consolidated Statements of Financial Condition
at fair value with changes in fair value included in
current earnings. These derivative instruments are
economic hedges to which Navy Federal does not
receive hedge accounting treatment.
The notional value of the mortgage loan commit-
ments totaled $323.8 million and $240.9 million,
respectively, as of December 31, 2009 and 2008.
Gross gains and losses on these derivatives at
December 31, 2009 and 2008 were as follows:
The notional value of the forward sales contracts
was $288.5 million and $132.5 million, respectively,
as of December 31, 2009 and 2008. Gross gains and
losses on these derivatives at December 31, 2009
and 2008 were as follows:
Navy Federal fair-valued these derivative instru-
ments and recognized a net loss of $1.4 million
and a net gain of $5.3 million during 2009 and
2008, respectively. The net gain/loss was included
in earnings as “Unrealized loss from derivative and
economic hedging activities” in the Consolidated
Statements of Income.
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2009 Financial Section
Loans on which the accrual of interest has been discontinued totaled $305.1 million and $264.6 million at
December 31, 2009 and 2008, respectively. If interest on those loans had been accrued at original contracted
rates, interest income would have been approximately $15.1 million and $9.3 million higher for 2009 and
2008, respectively.
Navy Federal originates mortgage loans both for sale and for its own portfolio. Navy Federal originated
$6.4 billion and $5.7 billion of first mortgage loans for its members in 2009 and 2008, respectively, of which
$1.9 billion and $0.2 billion loans were sold in 2009 and 2008, respectively. At December 31, $28.3 billion
and $26.3 billion of originated mortgages were being serviced by Navy Federal in 2009 and 2008, respectively.
Navy Federal modified an immaterial amount of loans that qualified as a troubled debt restructuring (TDR)
under ASC 310-40 in 2008. However, as a result of current market conditions, this amount increased in 2009.
At December 31, 2009, the amount of loans modified as a TDR and the related impairment is as follows:
TDR impairment is included within the allowance for loan losses.
Note 5: Mortgage Servicing Rights
Navy Federal capitalizes mortgage servicing rights (MSRs) when mortgage loans are sold and Navy Federal
retains the right to service the loans. Navy Federal adopted ASC 860-50-35, Subsequent Measurement for
Servicing Assets and Liabilities (formerly known as SFAS No. 156), in 2006 and elected to record MSRs at
fair value and discontinued amortizing servicing assets and also stopped assessing impairment adjustments
related to the servicing assets.
The changes in fair value of MSRs during 2009 and 2008 were as follows:
Navy Federal obtains the fair value of its MSRs from a third-party service organization. The service organization
determines the fair value by discounting projected net servicing cash flows of the remaining servicing portfolio.
The valuation model used by the service organization considers market loan prepayment predictions and other
economic factors. The fair value of MSRs is mostly affected by changes in mortgage interest rates since rate
changes cause the loan prepayment acceleration factors to increase or decrease.
Navy Federal received mortgage loan servicing fees of $50.1 million and $45.9 million in 2009 and 2008,
respectively. Related late charges and miscellaneous fees totaled $1.1 million in both 2009 and 2008.
Navy Federal Credit Union
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(dollars in thousands) Loan Amount Impairment
Consumer $ 51,280 $ 3,374
Credit card 65,280 10,924
Real estate 200,956 22,528
Total $ 317,516 $ 36,826
(dollars in thousands) 2009 2008
Balance, beginning of period $ 131,194 $ 169,306
Originations 52,045 28,211
(Loss) on changes in value of MSRs (14,540) (66,323)
Balance, end of period $ 168,699 $ 131,194
2009 2008
Weighted average life (years) 6.10 4.97
Prepayment rate 13.38% 16.34%
Yield to maturity discount rate 10.61% 9.83%
2009
(dollars in thousands)
Mortgage
Loan Commitments 2009 2008
Gain $ 1,632 $ 5,229
Loss (1,989) —
Net $ (357) $ 5,229
The key economic assumptions used in determining the fair value of MSRs at December 31, 2009 and 2008
were as follows:
(dollars in thousands)
Forward Sales
Contracts 2009 2008
Gain $ 3,922 $ 151
Loss (59) (445)
Net $ 3,863 $ (294)