2012 Annual Report - Meridian - Meridian Credit Union - · PDF file · 2017-07-28Net Interest Income ... Meridian has over $9.5 billion in assets under administration and serves

2012 Annual Report Management’s Discussion

& Analysis

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2012 Annual Report Management’s Discussion & Analysis

Management’s Discussion & Analysis This management discussion and analysis (“MD&A”) is provided to assist readers with interpreting Meridian‟s results of operations and financial condition for the fiscal year 2012, as compared to prior years. The MD&A should be read in conjunction with the audited financial statements, which have been prepared in accordance with International Financial Reporting Standards (“IFRS”). Unless otherwise indicated all amounts in the MD&A are expressed in Canadian dollars.

Overview ................................................. 2

Mission, Vision & Values .............................. 2

2012 Financial Overview .............................. 2

Financial Performance Review ...................... 4

Total Revenue ................................................ 4

Net Interest Income ..................................... 4

Provision for Credit Losses .......................... 6

Credit Portfolio Quality ................................. 6

Non-Interest Income from Operating Activities ......................................................... 7

Non-Interest Income from Investments in Associates and Joint Ventures .................... 8

Non-Interest Expenses ................................. 8

Dividends ........................................................ 9

Balance Sheet Strength ............................... 9

Business Line Results ............................... 10

Retail Banking & Investment Services .... 10

Commercial Banking .................................. 10

Risk Management .................................... 11

Risk Management Philosophy ................... 11

Risk Management Framework .................. 11

Risk Governance ......................................... 13

Management Committees: ........................ 14

Identification and Management of Key Risks .............................................................. 15

Capital Management................................. 17

Capital Management Philosophy .............. 17

Capital Management Framework ............. 17

Capital Management Governance ............ 17

Managing and Monitoring Capital ............ 17

Outlook for 2013 ..................................... 18

Caution Regarding Forward-Looking Statements This MD&A includes forward-looking statements which by their very nature require management to make assumptions and involve inherent risks and uncertainties. Forward-looking statements are typically identified by the words “believe”, “expect”, “anticipate”, “intend”, “estimate”, “may increase”, “may impact”, and other similar expressions, or future or conditional verbs such as “will”, “should”, “would” and “could”. A number of important factors, many of which are beyond management‟s control, could cause actual future results, conditions, actions or events to differ materially from the targets, projections, expectations, estimates or intentions expressed in forward-looking statements. These factors include, but are not limited to, changes in general economic conditions in Canada, particularly those in Ontario; legislative or regulatory developments; changes in accounting standards or policies; and Meridian‟s success in anticipating and managing the risks inherent in these factors. Readers are cautioned that the foregoing list is not exhaustive. Undue reliance should not be placed on forward-looking statements as actual results may differ materially from expectations. Meridian does not undertake to update any forward-looking statements contained in this annual report.

Overview ...............................................................3

Mission, Vision & Values .......................................3

2012 Financial Overview ......................................3

Financial Performance Review ..................................5

Total Revenue ....................................................5

Net Interest Income ............................................5

Provision for Credit Losses ...................................7

Credit Portfolio Quality ........................................7

Non-Interest Income from Operating Activities ...........................................................8

Non-Interest Income from Investments in Associates and Joint Ventures ...............................9

Non-Interest Expenses ........................................9

Dividends ....................................................... 10

Balance Sheet Strength ..................................... 10

Business Line Results ............................................ 11

Retail Banking & Investment Services .................. 11

Commercial Banking ......................................... 11

Risk Management ................................................. 12

Risk Management Philosophy.............................. 12

Risk Management Framework ............................. 12

Risk Governance ............................................... 14

Management Committees .................................. 15

IdentificationandManagementofKeyRisks ......... 16

Capital Management ............................................. 18

Capital Management Philosophy .......................... 18

Capital Management Framework ......................... 18

Capital Management Governance ........................ 18

Managing and Monitoring Capital ........................ 18

Outlook for 2013 .................................................. 19

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Management’s Discussion & Analysis


Overview With more than 70 years of banking history, Meridian is the largest Credit Union in Ontario delivering a full range of financial services to individuals and businesses. Meridian has over $9.5 billion in assets under administration and serves approximately 262,000 Members of which nearly 246,300 are Retail Members and about 15,700 are businesses. Members are served through 61 branches, 2 satellite branches and 8 Commercial Business Centres located in 35 communities across Ontario.

Meridian‟s customer service is rated highly among the top banks and credit unions across North America. We regularly ask our Members how we‟re doing and we act on what they tell us. What sets us apart from other financial institutions is our focus on neighbourhood banking. At Meridian‟s Commercial Business Centres, our local focus enables Members to work with account managers who know the community intimately.

Mission, Vision & Values Meridian is guided by the cooperative principles on which it was founded. It is owned by its Members, who have the right to vote for the Board of Directors and have a say in the Credit Union‟s policies and direction. Our Members‟ money is reinvested in our Members‟ communities, creating jobs and building businesses where our Members live.

Our mission describes who we are, what we do, and how we do it. Our vision helps us develop long-term relationships with our Members, attract and keep engaged employees, and support the communities in which we live and work. Our values guide us in the right direction.

Mission

2012 Financial Overview In 2012, Canada‟s economic activity was restrained by a slowdown in global economic growth coupled with the impact of federal and provincial governments rebalancing their books in the wake of recent economic stimulus. In Ontario, economic activity kept pace with the previous year, with the support of vehicle manufacturing and growth in residential construction, particularly condominiums. Concerns over the level of household debt in Canada resulted in changes to mortgage regulations, making it more difficult for new homebuyers to qualify for mortgages. Conditions remained favourable for borrowers as the Bank of Canada maintained its low interest rate policy throughout the year. The strength of the Canadian dollar persisted on account of developments in commodity prices, while equity markets continued to be volatile but gained strength.

Meridian‟s operational results remained strong in 2012 despite the restrictive economic conditions and persistent low interest rate environment. Total assets grew by $903.7 million to $8.7 billion at the end of 2012, reflecting growth in Retail mortgages and Commercial lending. Assets under management, which include our off-balance sheet wealth management portfolio, rose by $939.1 million or 10.9% year-over-year to $9.6 billion. Growth in our Wealth portfolio was attributable to increased net sales of mutual funds and market appreciation. This strong relationship growth contributed to Meridian‟s pre-tax income of $28.2 million, a decrease of $30.5 million from 2011. It should however be noted that in 2011 Meridian enjoyed a one-time pre-tax gain on acquisition of $27.5 million due to the amalgamation with Desjardins Credit Union (“DCU”).

Total operating revenue increased by $6.8 million or 3.9% to $183.1 million, despite being impacted by higher than usual loan loss provisioning. Provision for credit loss expense rose to $34.2 million in 2012 compared to $14.2 million in 2011, stemming from Commercial loan impairments. Growth in operating revenue is attributable to gains in both net interest income and non-interest income. Net interest income, which is the difference between the income that is generated by Meridian‟s assets and the cost to attract Member deposits and other borrowings, grew by $19.8 million or 12.8% from the previous year to $173.8 million. Non-interest income, inclusive of profits from investments, rose by $7.0 million to $43.5 million on account of loan fees generated from our strong 2012 Commercial lending volume and market appreciation of our investment in the CUCO Cooperative Association.

Mission

We are a full-service partner offering our Members relationship based financial services

Values

Passion for people Do the right thing Get the job done Dare to be different Lead!

Vision

We will reinvent neighbourhood banking to become the dominant leader in outstanding relationship service

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In terms of our balance sheet strength, slower growth in earnings relative to the strong asset growth in 2012 has resulted in a slight decline in our capital ratio and risk weighted capital ratio to 6.4% and 12.8% respectively. Our capital ratios however continue to remain above regulatory and Board policy limits. At the end of 2012 Meridian‟s liquidity ratio improved slightly relative to the end of 2011 to 13.9%. This performance is reflective of strong deposit growth towards the end of the year and a continued conservative approach given the extended economic uncertainty. Meridian‟s leverage ratio rose to 11.0% reflecting an increase in loan securitizations used to fund the strong 2012 lending activity. From a profitability perspective, our after-tax return on average equity declined to 4.8%, with most of the year-over-year reduction driven by the significant one-time gain on acquisition received in 2011. Our efficiency ratio increased to 84.6% due to ongoing integration expenses and the impact of higher than anticipated credit losses.

Current and historical performance metrics are depicted in the charts below. Please note that results stated for 2008 and 2009 are reported on a Canadian Generally Accepted Accounting Principles (“CGAAP”) basis while those for 2010 and beyond are reported on an International Financial Reporting Standards (“IFRS”) basis.

10.6%

13.4% 12.6% 13.1% 12.8%

2008 2009 2010 2011 2012

Risk Weighted Capital Ratio

CGAAP IFRS

7.0% 8.3%

7.1% 6.8% 6.4%

2008 2009 2010 2011 2012

Capital Ratio

IFRS CGAAP

8.2%

15.2% 11.7%

13.7% 13.9%

2008 2009 2010 2011 2012

Liquidity Ratio

CGAAP IFRS

19.6% 15.1%

10.0% 8.3% 11.0%

2008 2009 2010 2011 2012

Leverage Ratio

CGAAP IFRS

Capital ratio above regulatory requirements

Increased leverage to fund strong lending Strong liquidity position

Stable risk weighted capital ratio

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Financial Performance Review Following a significant gain on business acquisition in 2011, as a result of Meridian‟s amalgamation with DCU, pre-tax earnings declined by $30.5 million or 52.0% to $28.2 million in 2012. To assess Meridian‟s true financial performance from core operations, earnings have been normalized by excluding this one-time gain and other unusual charges and adjustments associated with the amalgamation. Normalized pre-tax earnings decreased to $38.7 million in 2012 compared to $43.3 million in 2011. The weaker normalized earnings are attributable to higher than usual loan losses which masks our strong revenue growth. If loan losses were to have remained at 2011 levels, normalized pre-tax earnings would have been $55.7 million. It should also be noted that 2011 earnings only reflects seven months amalgamated DCU operations.

Items excluded from normalized earnings depicted in the chart include: Pre-tax gain on business acquisition of $27.5 million in

2011 Integration expenses including legal and banking

system conversion expenses totalling $3.7 million and $7.2 million in 2012 and 2011 respectively

Expenses related to the amortization of fair value adjustments recorded as part of the amalgamation of $6.8 million and $4.1 million in 2012 and 2011 respectively

Total Revenue Total net interest and non-interest income before provision for credit losses grew by $26.8 million to $217.3 million in 2012. This growth is attributable to income generated from increased overall assets under management coupled with gains from our affiliate investments. New branches acquired through the DCU amalgamation contributed $12.3 million to Meridian‟s overall revenue in 2012, consisting of $10.8 million in interest related income and $1.5 million in non-interest related revenue.

Net Interest Income Net interest income is largely comprised of: the difference, or spread, between the interest income generated on our loan and investment portfolios; net realized or unrealized gains or losses incurred as a result of market valuation of the derivative portfolio; and the interest expense incurred on both our deposit base and wholesale funding sources. In 2012, net interest income increased by $19.8 million or 12.8% from 2011, despite narrower spreads, primarily due to strong volume growth in the retail mortgage and commercial lending portfolios as well as a full twelve months of net interest income from the acquisition of the DCU portfolio on June 1, 2011.

73.6% 70.9% 76.4% 82.4% 84.6%

2008 2009 2010 2011 2012

Efficiency Ratio

CGAAP IFRS

14.2%

10.8%

6.5%

9.8%

4.8%

2008 2009 2010 2011 2012

After-Tax Return on Average Equity

CGAAP IFRS

Higher efficiency ratio, impacted by increased loan loss provisioning

Positive return on Member‟s equity despite challenging loan losses

35.1

58.6

28.2 35.3 42.4 38.7

2010 2011 2012

Normalized Pre-tax Earnings ($ millions)

Pre-tax Earnings Normalized Pre-tax Earnings

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The table that follows summarizes the year-over-year changes in our net interest income, product portfolio mix and yields. It reflects the following trends:

• Stable cash and cash equivalents, a result of successfully managing liquidity despite a competitive deposit market • Higher investment balance as a result of a higher liquidity reserve deposit due to asset growth coupled with short-term

investments held at the beginning of the year which were deployed throughout 2012 to help fund lending growth • Significant reduction in the interest income earned on all lending products - a continuing function of the competitive

landscape and flat yield curve • Sizeable growth in Commercial demand deposits, due to ongoing focus on new deposit account acquisition • A stabilized Member preference between demand and term deposits • An increase in borrowings, primarily a result of higher securitization activity generated to support funding needs

($ millions) 2012 2011

Average balance

Interest Mix Rate Average balance

Interest Mix Rate

Cash and cash equivalents 231.6 1.1 2.8% 0.5% 257.6 1.4 3.8% 0.5%

Investments 748.5 14.1 9.1% 1.9% 557.4 9.3 8.1% 1.7%

Loans 1,842.1 99.0 22.5% 5.4% 1,665.5 90.9 24.3% 5.5%

Lines of credit 1,224.1 49.5 14.9% 4.0% 1,117.7 47.3 16.3% 4.2%

Mortgages 4,041.4 143.2 49.3% 3.5% 3,189.9 125.6 46.4% 3.9%

Other 103.2 - 1.3% 0.0% 79.3 - 1.2% 0.0%

Total assets 8,190.9 306.9 100.0% 3.7% 6,867.4 274.6 100.0% 4.0%

Demands 2,938.4 23.3 35.9% 0.8% 2,480.5 20.1 36.1% 0.8%

Fixed terms 3,782.2 93.4 46.2% 2.5% 3,217.5 86.4 46.9% 2.7%

Borrowings 786.6 16.4 9.6% 2.1% 561.3 14.1 8.2% 2.5%

Other 161.4 - 2.0% 0.0% 140.1 - 2.0% 0.0%

Total liabilities 7,668.6 133.1 93.6% 1.7% 6,399.4 120.6 93.2% 1.9% Members‟ equity 522.3 - 6.4% 0.0% 468.0 - 6.8% 0.0%

Total liabilities and Members‟ equity 8,190.9 133.1 100.0% 1.6% 6,867.4 120.6 100.0% 1.8%

173.8 154.0 Interest income from operating activities, which excludes the net realized and unrealized gains and losses related to derivatives and market investments, ended the year at $180.2 million, an improvement of approximately $17.3 million or 10.6% over 2011.

The low interest rate environment that has persisted since 2010 continued throughout 2012. This effect was compounded by significant competition in the Canadian financial services sector for retail mortgages and deposits. These competing pressures resulted in lower overall lending yields without the benefit of equally reduced deposit yields. As a result, attracting deposits remained a significant challenge throughout 2012. Not only was there competition in the marketplace for deposit money, but the flat yield curve provided little incentive for Members to lock in their money. In the second half of the year, Meridian introduced a special-priced 18-month GIC offer to both source deposits and to encourage Members to lock in some of their demand funds. The success of this product campaign, combined with our 3-year Escalator deposit featuring market-leading rates allowed Meridian to hold the percentage of our deposit book invested in term deposits flat to 2011 as well as exceed our overall 2012 deposit plan.

Meridian continued to securitize residential mortgages throughout 2012 to help fund long-term growth as securitization remained an attractive funding tool by providing low cost and long-term funding, combined with the benefit of stable availability. Included in interest income from operating activities is $26.6 million of interest income on mortgages which had been securitized, an increase of $3.4 million from 2011. Also included in interest income from operating activities is $2.1 million generated through the pledge of Mortgage-backed securities (“MBS”) purchased from third parties in order to meet any reinvestment requirements that are not met through the use of MBS created from Meridian‟s own mortgage portfolio.

The interest expense associated with Meridian‟s securitization activities increased by $2.8 million or 19.7% from 2011 to $16.7 million, largely driven by increased borrowings partially offset by a decrease in interest rates. Although the mortgage securitization liability has grown by 48% year-over-year, Meridian believes that the continued use of mortgage securitization as a funding source is economically advantageous, and continues to weigh it against alternative funding sources to ensure funding is being done in a responsible manner.

Additionally, upon amalgamation with DCU in 2011, Meridian commenced servicing a portfolio of mortgages that had

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previously been sold by DCU. Meridian recognized $0.2 million in servicing income during 2012 compared to $0.3 million in 2011.

Similar to prior years, our net interest income is impacted by fluctuations in capital markets above and beyond what management considers to be our normal operating activities. Occasionally, as circumstances warrant, Meridian undertakes hedging activities which may include the purchase of derivative instruments to protect Meridian and its Members from changes in external market conditions. These hedging activities, in turn, generate their own net interest income or loss, countering the impact on the underlying item. In 2012, interest expense includes $6.4 million of expenses associated with the amortization of the cost of the index-linked options held on our balance sheet. These options are purchased to hedge the future interest payout associated with our Market Secured GIC products and this loss represents the accretion of the upfront cost of the options. This amortization should not be viewed as a true hedging loss because the option cost is comparable to the interest expense associated with other term products of similar duration and effectively replaces the interest expense that would otherwise be reflected as term deposit interest expense.

Provision for Credit Losses The total provision for credit losses was $34.2 million of which $31.9 million relates to the Commercial loan portfolio and $2.3 million to the Retail loan portfolio. This reflects an increase of $20.0 million over 2011 levels attributable almost entirely to an increased level of Commercial loan losses during the year. Commercial losses are comprised of a relatively small number of larger, and sometimes individually significant, losses. This results in volatility from year-to-year and can lead to significant variances from plan levels which are largely determined based on average historical loss rates. New Commercial impairments during 2012 account for $27.1 million with two individually significant accounts making up two-thirds of this amount. Due to the high exposure levels and nature of security on many of the Commercial impairments, impaired accounts can take over a year to close. Revised estimates for losses on pre-2012 impairments resulted in a net increase in provision levels of $2.4 million.

The following section outlines our credit portfolio quality and management‟s response to the high loan losses in 2012.

Credit Portfolio Quality Loan loss provisioning is determined in accordance with an established policy. Management reviews the loan allowance position monthly with a focus on updated forecasts for watchlist accounts, impairment levels and expected net credit losses. Provisioning is adjusted where necessary to ensure compliance with policies and to include management‟s best estimate of losses based on currently available information.

The total allowance for impaired loans, at $45.6 million, has increased by $14.8 million over the prior year. Several large Commercial impairments from previous years remain on the books at year-end. As a result, the volume of write-offs for 2012 is lagging behind 2011 levels. This, combined with the higher provision for credit losses as noted in the previous section, results in a higher allowance balance. Of the total allowance, $32.1 million is attributable to specific impairments, with the remaining $13.5 million attributable to collective reserves. This latter component is based upon a detailed analysis of historical retail portfolio delinquency rates and commercial loan risk rating distribution trends. The total loan allowance as a ratio to total loans increased from 0.46% to 0.61% in 2012. Additional statistics are provided in the following table.

Asset quality coverage

(thousands of Canadian dollars) 2012 2011

Total net loans, December 31 7,470,676 6,619,455

Provision for credit losses (“PCL”) 34,239 14,225

Loan write offs (net of recoveries) 19,444 33,914

Total allowance for impaired loans, December 31 45,552 30,757

Net impaired loans 32,070 20,146

Members‟ equity, December 31 531,464 506,270

PCL as % of total loans 0.46% 0.21%

Net loan write-off as % of total loans 0.26% 0.51%

Net impaired as % of total loans 0.43% 0.30%

Net impaired as % of Members‟ equity 6.03% 3.98%

Total allowance as % of net impaired loans 142.04% 152.67%

Total allowance as % of total loans 0.61% 0.46%

Commercial loans:

% Better than average 42.9% 53.6%

% Average 41.7% 32.1%

84.6% 85.7%

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The Credit Union‟s credit risk policies, processes and methodologies have not changed materially from the prior year, except for the Commercial risk rating model, where the risk rating scale has been expanded from six to nine ratings, and from primarily two input measurements to a mix of twenty-two questions addressing various components of risk.

The Commercial credit risk rating model is premised on a comprehensive assessment of the borrower‟s risk of default, through measurement of industry, business, management and financial risk factors, along with the risk of loss given default based on an assessment of security composition and relative historical recovery experience. The model includes a standard set of questions and answers that align to an implied level of risk. Questions are given varied weightings and an overall borrower risk rating is derived from a cumulative weighting of the answers. The Commercial loan portfolio stratified by risk rating is reviewed monthly. Risk ratings range from “very low” to “impaired”. Most of the portfolio continues to fall into the “better than average” or “average” categories. Collectively, these two ratings account for approximately 84.6% of the total Commercial portfolio.

Over the past several years, the Commercial business has achieved significant growth in its loan portfolio. In an effort to ensure that Meridian proactively manages the credit risk inherent in this portfolio, the Credit Union has initiated a complete Commercial business transformation program with the objectives of enhancing portfolio credit management practices and improving Member experience through new automated processes and other techniques. This multi-year project will establish a target operating model for commercial lending and will establish expanded commercial lending portfolio analytics and reporting systems. It will result in processes and risk management practices appropriate for the ongoing growth in volume and complexity of Meridian‟s Commercial loan portfolio. Management‟s intention is to temper growth in this portfolio in the short term until the above transformation program initiatives are fully implemented.

Non-Interest Income from Operating Activities Compared to 2011, non-interest income increased by $1.6 million or 4.5% to $37.7 million in 2012. The primary contributor was loan servicing fees which totalled $1.0 million more than 2011, reflecting the strong growth in Commercial lending. Foreign exchange revenue also rose by $0.4 million as Members took advantage of the strong Canadian dollar. Mutual fund revenue improved by $0.3 million despite the volatility in capital markets. Net sales of wealth products continued to grow as markets gained strength and Members required more advanced wealth solutions. Revenue from service fees rose by $0.3 million, largely representing growth in income from our Maximiser Convenience Plus product which provides unlimited monthly transactions in addition to a number of free cheque options. Insurance commissions declined $0.5 million attributable to lower Member demand for life insurance policies.

Non-interest income generated by new branches, excluding foreign exchange revenue, decreased from $1.8 million in 2011 to $1.5 million in 2012. Automatic banking machines (“ABM”) of new branches were incorporated into THE EXCHANGE® network in 2012. This is a surcharge free network of ABMs across Canada which Meridian participates in to provide more extensive ABM access to Members. Interac revenue generated by new branches declined by $0.2 million as transactions by cardholders from other financial institution participating in THE EXCHANGE® network switched from Interac to THE EXCHANGE® network.

The following table summarizes the composition of Meridian non-interest income.

Non-interest income

($ millions) 2012 2011

Income Mix % of

average assets

Income Mix % of

average assets

Service fees 11.6 30.8% 0.1% 11.3 31.3% 0.2% Loan servicing fees 7.1 18.8% 0.1% 6.2 17.2% 0.1% Insurance commission 5.6 14.9% 0.1% 6.1 16.9% 0.1% Foreign exchange 4.0 10.6% 0.0% 3.6 10.0% 0.1% Mutual fund revenue 4.8 12.7% 0.1% 4.5 12.5% 0.1% Interac revenue 2.4 6.4% 0.0% 2.5 6.9% 0.0% Credit card revenue 0.9 2.4% 0.0% 0.8 2.2% 0.0% Other 1.3 3.4% 0.0% 1.1 3.0% 0.0% Total 37.7 100.0% 0.5% 36.1 100.0% 0.5%

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Non-Interest Income from Investments in Associates and Joint Ventures Non-interest income from our investments in associates and joint ventures grew $5.4 million to $5.8 million in 2012. This significant increase reflects realized and unrealized gains in the market value of Meridian‟s share of third party asset-backed commercial paper (“ABCP”) held by the CUCO Cooperative Association. The CUCO Cooperative Association was created to hold the ABCP on behalf of Member credit unions, following the merger of Credit Union Central of Ontario and Credit Union Central of British Columbia to form Central 1 on July 1, 2008. In 2011, gains on the ABCP investment were contained due to capital market volatility emanating from the Eurozone debt crisis.

Non-Interest Expenses Non-interest expenses were $154.9 million in 2012, an increase of $9.8 million or 6.7% from the prior year. A key contributor to this increase is the full-year impact of new branch operation expenses, as only seven months of operating expenses were incurred for these branches in 2011. Direct expenses related to new branch operations, excluding corporate expenses, rose by $3.2 million or 41.3% to $11.1 million, reflecting higher personnel and occupancy costs.

Non-interest expenses ($ millions) 2012 2011

Expense Mix % of

average assets

Expense Mix % of

average assets

Salaries and employee benefits

Salaries 63.1 40.7% 0.8% 55.8 38.4% 0.8%

Benefits 12.3 7.9% 0.1% 16.2 11.2% 0.2%

Variable incentive compensation 9.4 6.1% 0.1% 10.5 7.2% 0.2%

Occupancy 12.4 8.0% 0.2% 11.5 7.9% 0.2%

Transaction services 9.9 6.4% 0.1% 8.6 5.9% 0.1%

Deposit insurance 5.2 3.4% 0.1% 4.3 3.0% 0.1%

Software and hardware 4.4 2.8% 0.1% 3.9 2.7% 0.1%

Depreciation of property, plant and equipment

5.3 3.4% 0.1% 5.3 3.7% 0.1%

Amortization of intangible assets 5.7 3.7% 0.1% 4.7 3.2% 0.1%

Marketing 6.0 3.9% 0.1% 4.7 3.2% 0.1%

Human resources 2.3 1.5% 0.0% 2.0 1.4% 0.0%

Enterprise initiatives 2.6 1.7% 0.0% 4.1 2.8% 0.1%

Other expenses 16.3 10.5% 0.2% 13.6 9.4% 0.2%

Total 154.9 100.0% 1.9% 145.2 100.0% 2.1%

Overall, personnel expenses grew by $2.1 million or 2.6% to $84.8 million. The additional expense is attributable to the temporary incremental staff required to complete the DCU integration and the permanent incremental staff needed to support our growing business and delivery of services to our expanded Member base. Key areas of employee growth included new branches, wealth management, lending operations and mortgage broker support. Variable incentive compensation decreased by $1.1 million or 10.5%, reflecting lower earnings results. Employee benefits declined by $3.9 million or 24.1% due a curtailment gain in the legacy DCU defined benefit pension plan, along with lower severance expenses.

One of Meridian‟s strategic focuses is to improve brand awareness. In support of this objective, marketing expenses grew by $1.3 million or 27.6%, associated with radio, television, print and online advertising, community events and implementation of tools to help better understand Meridian‟s Members and market. Occupancy costs for branches and offices rose by $0.9 million or 7.8% reflecting the full-year‟s cost of operating new branches as well as real estate price inflation. The increase in other general operating expenses can be largely attributed to higher transactional costs such as ABM and cheque clearing expenses and the cost of Meridian‟s deposit insurance.

Every year Meridian makes strategic investments in enterprise initiatives to ensure we deliver up-to-date financial services to Members, meet regulatory compliance standards and implement new strategies. In 2012 the amount invested in such initiatives decreased by $1.5 million or 36.9% to $2.6 million. The decline was as a result of limited personnel capacity due to the focus on the integration.

As part of Meridian‟s amalgamation with DCU, the fair value of the DCU assets acquired and liabilities assumed was recorded in 2011. One of the material entries was the recording of core deposit intangibles (“CDI”) which represent the inherent

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value in the deposits acquired, as they are a low-cost source of funding. In 2012 the amortization of the CDI asset increased by $0.8 million partly on account of early redemption of term deposits coupled with the fact that the inherent cost savings from this funding source is reduced as term deposits move closer to maturity.

Amalgamation expenses accounted for $3.7 million of total non-interest expense in 2012, a reduction of $3.4 million or 47.8% from the prior year. The majority of expenses in 2012 were associated with professional services, information technology and operational activities. These activities included ABM changes, issuing statements and replacing cheques. Expenses in 2012 were less than anticipated due to lower severance expense than expected and efficiencies gained in the integration in the areas of information technology, professional services and staff training.

In 2013 amalgamation expenses are expected to total $1.0 million associated with depreciation expenses, pension related consulting and cheque replacement.

Dividends Meridian‟s track record of profitability has enabled the payment of dividends on its various series of investment shares. Meridian has declared and paid a dividend on each series of these shares since inception, with market leading rates for these types of investments. The dividend rate paid on the “50th Anniversary” and the series 98 shares was 4.75% for 2012 (previously 6.0%). The dividend rate paid on the series 01 and series 96 shares was 4.5% for 2012 (previously 6.0% for series 01 and 5.75% for series 96), while the dividend rate paid on the series 09 shares has been 5.75%. The payment track record is illustrated in the table below for the last five years. Dividend history for the past 5 years (thousands of Canadian dollars) 2012 2011 2010 2009 2008 “50th Anniversary” Class A shares 2,582 3,093 2,936 2,784 2,678

Series 96 Class A shares 1,711 2,076 1,971 1,869 1,773

Series 98 Class A shares 152 181 171 162 155

Series 01 Class A shares 2,236 2,831 2,689 2,555 2,427

Series 09 Class A shares 3,648 3,493 1,019 - -

Balance Sheet Strength Meridian‟s total assets grew by 11.5% to $8.7 billion in 2012, an increase of $904 million over 2011. The majority of this growth was driven by lending accompanied by a smaller contribution from short-term investments with other financial institutions and other longer term investments. Liquidity reserve deposits with Central 1 grew in tandem with the Credit Union‟s asset growth, as a statutory requirement. National Housing Act mortgage backed securities held in trust with the Canadian Housing Trust (“CHT”) for reinvestment purposes also increased and the value of third party asset-backed securities managed through the CUCO Cooperative Association rose. The value of Central 1 shares held by Meridian also increased.

Year-over-year, loans to Members grew by 12.9% or $851.2 million. Meridian continued to offer competitive rates on mortgage products in 2012 in order to grow our mortgage portfolio. Growth was diversified across our branch, mobile and broker channels. Members continued to take advantage of low interest rates by refinancing mortgages. This exacerbates Meridian‟s financial margin compression but also generates mortgage prepayment income. Other loans spanned a number of sectors including hospitality, real estate, land development, construction and health care. Outstanding lines of credit rose 6.9% or $76.9 million in 2012 compared to growth of 6.1% in 2011.

Member deposits grew by 8.7% or $571.1 million from the previous year. Term deposits contributed entirely to this growth as demand account balances declined. The decrease in demand deposits can be attributed to some attrition of Members from new branches as well as cannibalization by term offerings as Members attempted to maximize the return on their deposits in a prolonged low interest rate environment. Term deposit balances rose 20.5%, influenced by favourable interest rates offered on two 12 and 18 month product special offers and a strong deposit campaign late in the year. Mortgage securitization liabilities increased by 47.5% or $311.1 million as Meridian relied on this as an inexpensive funding source for loan growth due to the slow deposit growth early in the year. Meridian reduced borrowings from other sources. However, the increased mortgage securitization resulted in the leverage ratio growing from 8.3% in 2011 to 11.0% in 2012. Our liquidity ratio as at the end of the year remained well above target at 13.9%, an increase of 0.2% from 2011. This liquidity position reflects our strong deposit growth towards the end of the year and puts Meridian in a solid starting position to fund lending using internal sources in 2013.

Meridian‟s off-balance sheet assets include our Wealth portfolio which comprises mutual fund assets held by Members. Our Wealth portfolio grew by 18.5% or $122.8 million year-over-year. This strong growth represents an almost even split between net sales of products in 2012 and the appreciation of the market value of Members‟ investments. Although capital markets remained volatile during 2012, markets strengthened as global risks were lower despite much uncertainty.

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Business Line Results

Retail Banking & Investment Services Retail banking, including small business banking, serves Members across Ontario with financial advice and service through 61 branch locations, 2 satellite branches, our Contact Centre, our ABM network, and through Online Banking. We are focused on building long-term relationships with our Members by taking the time to get to know them and their needs, and in turn developing a sound financial plan. We customize our Members‟ banking experience by providing competitively priced products and services that meet their personal, business and wealth banking needs.

In 2012 we continued to invest in building the sales and service capabilities of our employees to better serve our Members. We focused on standardizing processes and procedures at new branches to ensure we deliver a consistent and superb Member experience. We enhanced our Net Promoter program, now called „Voice of Member‟ as a means of soliciting feedback. Our online banking system was also upgraded and we launched our mobile banking application, our mobile banking website and Interac e-Transfers.

Retail banking performance in 2012 can be described as strong on all fronts and across our delivery channels. This performance is against the backdrop of a highly competitive rate environment. Average relationships managed, inclusive of loans and deposits, totalled $10,899 million representing an increase of 7.3% or $742.0 million year-over-year. Average loans grew by 10.0% or $470.3 million while average deposits increased by 5.0% or $271.7 million. Loan growth was largely attributable to mortgages generated by Mobile Mortgage Specialists, Mortgage Brokers and organically in-branch. Despite significant broker mortgage run-off during the year, broker mortgages grew significantly. Retail deposit growth was driven entirely by term deposits, influenced by competitive rates on term products such as the Save Happy GIC. Demand deposits declined primarily on account of attrition from new branches.

Off-balance sheet Wealth portfolio growth was strong in 2012, reflecting an increase in net sales and the market value of mutual funds. The year-over-year growth in net sales of $62.3 million is quite impressive considering some early attrition. Meridian has been able to attract a high quality of wealth management professionals who have grown our Wealth business and delivered more sophisticated wealth solutions and advice to Members.

In setting the stage for 2013, we implemented a new regional retail structure to better align within our markets and ultimately meet the needs of Members. We have also integrated our Mobile Mortgage Specialists, in-branch staff and Wealth professionals to serve Members more seamlessly.

Commercial Banking At Meridian, our approach to business banking is based on making our products and services fit our Members‟ unique business needs. Through our 8 Commercial Business Centres we take the time to get to know each of our Members‟ businesses, anticipate their needs, and provide them with customized solutions. In addition to building customized solutions for our Members‟ businesses, we offer full service commercial banking solutions, including a wide selection of daily banking products, complementary lending services, cash management solutions and investments.

In 2012 relationships managed by our Commercial banking group grew by 16.9% or $487.7 million to a portfolio balance of $3,377 million. This growth reflects an increase of $324.7

671 774

2011 2012

Wealth Average Balance ($ millions)

39

103

2011 2012

Wealth Growth ($ millions)

2,890 3,377

2011 2012

Commercial Relationships Average Balance ($ millions)

356 488

2011 2012

Commercial Relationships Growth ($ millions)

2011 2012

Retail Relationships Average Balance ($ millions)

540

742

2011 2012

Retail Relationships Growth ($ millions)

10,899 10,157

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million in lending and $163.0 million in deposits. Loan growth was most significant in the first half of the year due to momentum generated in 2011, with a number of deals in the pipeline at that time. The strong lending growth surpassed expectations and contributed to the increase in non-interest income by way of loan fees. During the second half of 2012, the Commercial banking team focused on growing Meridian‟s deposits. Deposit growth was mainly generated through competitively priced term deposits.

During 2012, Meridian completed the development of a three year Commercial banking strategy which includes a business banking transformation program. This program will improve Meridian‟s Commercial banking controls and compliance, in addition to our risk management practices. It is anticipated that this will help mitigate some of the significant loan losses as experienced in 2012. A centralized technology solution will be employed to support Commercial banking workflow and enhanced risk management. A people strategy will also be developed for the Commercial banking function, along with a career development path.

Risk Management The Credit Union‟s activities expose it to a number of risks in all aspects of operations. These risks are generally shared by all deposit taking Financial Institutions. In support of the achievement of sustainable growth, a balanced approach must be taken between strategic and operational objectives and the level of risk. This ensures that long-term performance is both sustainable and consistent.

Risk Management Philosophy The Credit Union‟s risk management philosophy is to anticipate risk in all its planning and decision making and to strive to be proactive and accountable in its actions and treatment of outcomes. Risk management is the responsibility of everyone at the Credit Union, including the Board of Directors, management and all employees. Critical to the attainment of the strategic objectives of the Credit Union, it is given a high priority.

This philosophy, combined with the knowledge and experience of the Credit Union‟s operating management and risk management teams, ensures that business strategies and activities are consistent with the Credit Union‟s risk appetite.

Risk Management Framework The risk management framework for Meridian has been developed to provide a basis for confidence among Members, creditors and regulatory agencies, that the Credit Union will manage risk on a prudent basis to achieve business objectives and no single event or combination of events will materially impact the Credit Union.

This framework involves a number of related policies, processes and programs which are performed and managed by various groups within the Credit Union. A critical component to all the elements of the framework is regular reporting to ensure efficient and effective monitoring and oversight.

The Credit Union has established an Enterprise Risk Management (“ERM”) program covering all operating areas that expose the Credit Union to material financial, operational, legal, regulatory or reputational risks. This program is based on The Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) ERM framework, a recognized enterprise risk management framework.

The goal of the ERM program is to ensure that all relevant and emerging risks are identified and that they are managed in a balanced manner. Under ERM, a broad based view of internal and external risks to the Credit Union is taken where risks are identified, assessed on the basis of impact and likelihood and prioritized with appropriate plans implemented to mitigate them to an acceptable level. Progress against these risk mitigation plans is monitored by management on a quarterly basis, with the results reported to the Audit Committee. Consideration is given to emerging risks as they develop, and action is taken as necessary.

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The Credit Union‟s risk management framework includes the following key elements:

•Risk management policies as required by Section B of DICO's By-No. 5 Standards of Sound Business and Financial Practices which are approved by the Board of Directors

Risk Management

Policies

•Risk Appetite statement and metrics with Risk Tolerance ranges for the Credit Union established by the Board of Directors

Risk Appetite and Risk Tolerance

•An ERM program to identify, assess and mitigate significant risk exposures that have an enterprise-wide impact

ERM

•Insurance policies which provide appropriate but cost-effective coverage to protect Credit Union and Member assets

Insurance

•Risk assessments for all projects and initiatives undertaken by the Credit Union to ensure risks have been identified, assessed and plans put in place to mitigate them to an appropriate level

Risk Assessments

•Clearly defined and documented responsibilities and accountabilities for risk management for the Board of Directors and its Committees

Accountabilities and

Responsibilities

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Risk Governance The Credit Union‟s risk governance structure ensures that the responsibilities for oversight and control of risk management are clearly defined. In support of this structure, the risk management group works in partnership with management to identify, assess, mitigate and monitor the risks of the Credit Union. Risk management provides independent oversight and governance for all risk management functions to promote a strong risk management culture.

The Credit Union‟s risk governance model is presented below.

Executive Leadership Team

Board of Directors

President & Chief Executive Off icer

ManagementRisk

Commit tee

Management Capital

Employment

Asset/Liability Commit tee

Senior Leadership Team

C reditRisk

MarketRisk

LiquidityRisk

MemberRisk

C ompetitionRisk

StrategicRisk

Regulatory and Legal Risk

ReputationRisk

OperationalRisk

Business Units

Information Security

Commit tee

Pension Commit tee

Audit Committee

Risk Management Services Internal Audit Services

Emerging Risks

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The Board of Directors has overall responsibility for the establishment and oversight of Meridian‟s risk management framework. The Board has established the Audit Committee and charged them with the responsibility for, among other things, the development and monitoring of risk management policies. The Audit Committee reports regularly to the Board on its activities.

The President & Chief Executive Officer leads the Executive Leadership Team of the Credit Union in the setting of the long-term business strategy, the definition of risk appetite and integration of risk appetite into the business strategies and plans. The President and Chief Executive Officer is supported by five Management Committees in the overall management of risk for the Credit Union.

Management Committees: The Management Risk Committee, which comprises the Executive Leadership Team, Senior Leadership Team members of the Operating Committee and Risk Management, provides a forum for the strategic assessment of risks – identifying, reviewing and advising on current and emerging risk issues and associated mitigation plans.

The Management Capital Employment Committee, which comprises the President and CEO, Chief Financial Officer, Chief Member Services Officer and senior leaders from Delivery and Credit Risk Management, reviews Meridian‟s overall loan portfolio key indicators and monitors performance against established credit policy. Key activities include:

review of key portfolio management indicators (sector/connected party limits, delinquency and impairment trends, and watchlist reports);

review new pipeline reporting relative to managing to established target commercial loan level; reviewing limit proposals and providing input from a business perspective; annual review of loan provisioning policy and review/monitoring of provisioning status and forecasts throughout the

year; approval of commercial deals from a „strategy‟ perspective; and review of macro-economic industry trends that could have systemic impact, positive or negative, upon all or portions of

the loan portfolio

The Asset/Liability Committee, comprised of Finance, Delivery and Marketing Executive Leadership and Senior Leadership, provides strategic direction in the management of interest rate risk, foreign exchange risk, liquidity and funding risk, investment portfolio decisions and capital management. The Committee is also accountable for compliance with policies, guidelines and regulations relative to investments, derivatives and liquidity.

The Information Security Committee, comprised of the Chief Information Officer, Chief Financial Officer, Chief Member Services Officer and IT Governance leaders, is accountable for the governance of Information Security and security of Member information, ensuring that Information Security Policies and activities are integrated and coordinated across all related business operations and providing awareness of Meridian‟s information risk profile and that information security risks are mitigated to an acceptable level in accordance with policy.

The Pension Committee, comprised of the Chief of Staff, Chief Financial Officer and senior leaders from Finance, Risk Management and People Services, is responsible for all communications, investments, actuarial and funding and administration/operations related to Meridian's defined benefit pension plan (the “DB Plan”) and defined contribution pension/savings (RRSP) plan (the “DC Plan) (collectively the “Pension Plan”).

The Senior Leadership Team is accountable for identifying new risks, monitoring existing risks on a continuous basis and providing related reporting, risk mitigation, obtaining and allocating resources for risk mitigation and implementing internal controls and mitigation supporting processes.

Risk Management Services is responsible for the design and application of Meridian‟s risk management framework and provides independent oversight and governance with respect to risk identification, measurement, control, monitoring and reporting. Risk Management Services is independent of Meridian‟s Business Units and works collaboratively with Business Units to: (i) establish policies, procedures and limits that align with Meridian‟s Risk Appetite; (ii) identify, assess, mitigate and monitor the risks associated with business activities and strategies; and (iii) provide education and awareness relative to Meridian‟s risk management framework.

Internal Audit Services provides independent assurance to the Board of Directors through the Audit Committee of the effectiveness of risk management, control and governance processes that are in place to manage the risks that are faced by Meridian.

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Business Units will ensure that processes, procedures and controls that are in place to manage risk are being followed and enhanced where necessary and will implement supporting processes and internal controls identified through the risk mitigation process by the Senior Leadership Team.

Identification and Management of Key Risks The Credit Union has identified ten key risk classes to which specific risks are assigned. Accountability for each risk class and the related specific risks have been assigned through the Enterprise Risk Management Program. A discussion of each risk and how it is managed follows.

Credit Risk Credit risk is the risk of financial loss when a Member or counterparty to a financial instrument fails to meet its contractual obligations, and arises principally from the loan portfolio. Meridian‟s lending philosophy is established by the Credit Risk Management Board policy. The Credit Risk Management Board Policy provides direction to management relative to:

Formulating operational credit policies covering eligible purposes of loans, collateral requirements, credit assessment, risk rating and reporting, documentary and legal procedures, and compliance with regulatory and statutory requirements;

Establishing a lending authority structure for the approval and renewal of credit facilities. Authorization limits are delegated to the Chief Executive Officer who further delegates such lending authority to senior management;

Reviewing and assessing specific and aggregate credit risk. The Credit department assesses and approves where applicable, all credit exposures in excess of delegated limits;

Limits in concentrations of exposure to counterparties; Compliance with agreed exposure limits. Regular reports are provided to the Credit and Investment Committee of the

Board on the credit quality of the portfolio.

A detailed discussion of the management of credit risk is provided in Note 31.1 of the audited consolidated financial statements.

Market Risk Market risk is the risk of loss resulting from changes in financial market factors, most commonly through interest rate changes. Interest rate risk is the sensitivity of the Credit Union‟s financial position to movements in interest rates. It arises from the fact that assets, liabilities and off-balance sheet instruments mature or re-price at various dates. As interest rates change, net interest income can be negatively impacted based on the distribution of these maturity and re-pricing dates. We assess our level of interest rate risk on a monthly basis through the use of a sophisticated income simulation model. Through this model, we run various scenarios based upon expected interest rate levels and we manage our risk tolerance levels based upon a 1% and 2% shock to those rates. The process and procedures surrounding this are governed by a defined policy which is approved by the Board of Directors annually. A detailed discussion of the management of market risk is provided in Note 31.2 of the audited consolidated financial statements.

Liquidity Risk Liquidity risk arises in the course of managing our assets and liabilities. It is the risk that the Credit Union is unable to meet its financial obligations in a timely manner and at reasonable prices. Liquidity levels, prescribed by the Credit Unions and Caisses Populaires Act, state that a class 2 credit union (a credit union with total assets greater than or equal to $50 million or a credit union which makes a commercial loan) shall establish and maintain prudent levels and forms of liquidity that are sufficient to meet its cash flow needs, including depositor withdrawals and other obligations as they come due. As a member of a liquidity pool, however, Meridian is compelled to maintain 6% of deposits in liquid investments. In order to maintain an appropriate level of conservatism our internal liquidity management philosophy is to keep our liquidity level between 7.75% and 15% of assets, and to ensure that we have both adequate capacity and diversity of external funding sources available. Meridian‟s external funding sources consist of credit and contingency credit facilities through Central 1, the CMB securitization program and access to wholesale broker funding. We update our funding requirement levels weekly based upon our forecasted growth rates and balance the use of these funding sources so as to ensure both funding diversification and adequate contingency lines. Within the available balance, early warning limits exist, which trigger required reporting and action plans from the Asset/Liability Management Committee and reporting through the Audit Committee and Board of Directors. A detailed discussion of the management of liquidity risk is provided in Note 31.3 of the audited consolidated financial statements.

Member Risk Member risk is the risk that Meridian cannot meet the expectations of its Members. This risk can arise if Meridian is not aware of changes in pervasive Member needs and/or wants and can lead to a decline in Member confidence regarding Meridian‟s ability to provide a superior or consistent level of service, a loss of Members or the inability to grow the business.

Meridian manages Member risk primarily through its “Promise to Members” which states that Meridian will stand out as a proactive, genuine partner to its Member. In support of this promise and the mitigation of Member risk are the establishment and continual enhancement of its sales and services capabilities, fulfilment and measurement strategies,

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performance of a Member satisfaction survey and a Member Concerns program. These tactics ensure that the expectation of Members are identified, understood and addressed in a timely and effective manner.

Competition Risk Competition risk is the risk that Meridian is not able to build or maintain sustainable competitive advantage in a given market or markets. This risk can arise where changes in opportunities, threats and other conditions in the credit union/financial services industry, and the capabilities of competitors threaten the profitability or long-term viability.

Meridian manages competition risk by developing strategic plans through consideration of an external assessment which provides an analysis of competitors and the credit union system, evolving channel usage, economic outlook and industry growth expectations. This risk is closely linked to Member risk and so the same risk mitigation tactics apply to competition risk.

Strategic Risk Strategic risk is the risk that Meridian is not able to implement appropriate business plans and strategies, or to effectively allocate resources. In addition, this risk may also arise from the inability to adapt to changes in the business environment.

Meridian manages strategic risk through the performance of a comprehensive Enterprise Strategic Planning process which encompasses financial and strategic planning at a business unit and enterprise-wide level. This integrated financial and strategic planning process considers business unit strategies and key initiatives, and ensures alignment between business unit and enterprise strategies. Following the approval of the strategy by the Board of Directors, performance relative to the strategic plan is monitored and reported on, including the effectiveness and risks.

Regulatory and Legal Risk Regulatory and legal risk is the risk that business activities are impeded through non-compliance with regulatory requirements, legal obligations, internal policies and procedures or changes in the regulatory environment.

Meridian manages regulatory and legal risk through the promotion of a strong compliance culture and the integration of effective internal controls. Meridian‟s Code of Ethics outlines expectations for conduct of employees of the Credit Union. In support of the Code of Ethics, the Ethics 1st Program has been established to ensure appropriate and further guidance on honouring the Code of Ethics. Primary responsibility for compliance with all applicable regulatory requirements rests with the Senior Leadership Team and extends to all employees. Business units manage day-to-day regulatory and legal risk primarily through the implementation of appropriate policies, procedures and controls.

Reputation Risk Reputation risk is the risk that Meridian‟s reputation, brand or corporate image is not sufficient to enable it to achieve its vision, mission and goals. This risk may arise if unethical business practices damage Meridian‟s reputation and expose it to losses in Members, revenue and the ability to compete or if Members and the public do not recognize Meridian as a relationship-based financial services brand.

Meridian manages reputation risk primarily through its Code of Ethics which outlines expectations for conduct of employees of the Credit Union and continuous monitoring of the external media. Additionally, a Member satisfaction survey and the Member Concerns program provide management with the ability to identify issues or concerns which have or may lead to reputational impacts. While the Senior Leadership Team is responsible for ensuring that any reputational risk issues related to products and services, transactions, sales and services practices and new and existing business activities are considered, every employee and representative of the Credit Union is responsible for protecting the Credit Union‟s reputation.

Operational Risk Operational risk is the risk of loss resulting from inadequate or failed human performance, processes or technology. The Credit Union is exposed to a broad range of operational risks including talent acquisition, retention, performance and succession, technology/systems failures, fraud/theft/misappropriation of assets, business disruption, information/privacy/fiduciary breaches or failed transaction processing. The failure to manage operational risk can result in direct or indirect financial loss, reputational impact, regulatory censure & penalties or failure in the management of other risks.

Meridian manages operational risk through extensive policies, procedures and internal controls related to human resources, information technology development and change management and business operations. Complementing these policies, procedures and internal controls are centralized departments which focus on the enterprise-wide management of specific operational risks such as financial crime, business continuity/disaster recovery, privacy & confidentiality, vendor management, project management, and information security & information technology governance. These departments have developed specific programs, policies, standards and methodologies to support the management of operational risk.

Emerging Risk The Senior Leadership Team is accountable for identifying and reporting on risks that may develop over time. While these

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risks may not be specifically actionable now, they require monitoring as they may impact the Credit Union‟s operations. Emerging risks are currently identified through the knowledge and experience of senior management. The Credit Union has developed a dashboard of key economic indicators that is used to help identify issues and trends which could lead to emerging risks.

Capital Management The Credit Union is committed to a disciplined approach to capital management and maintaining a strong capital base to support the risks associated with its business activities. Maintaining a strong capital position will contribute to safety for the Credit Union‟s Members, promotes confidence in attracting new Members to the Credit Union, maintains strong returns to the Credit Union‟s Class A Shareholders and allows the Credit Union to take advantage of growth opportunities.

Capital Management Philosophy The Credit Union‟s capital management philosophy is to remain adequately capitalized at all times and to maintain a prudent cushion of equity to ensure its on-going economic stability as well as finance new growth opportunities.

Capital Management Framework The principles and key elements of the Credit Union‟s capital management framework are outlined in the Board Capital Management Policy. This policy establishes and assigns the responsibilities related to capital and sets forth both general and specific policy guidelines related to capital management and the reporting mechanisms.

Capital Management Governance The Board of Directors and its Audit Committee provide ultimate oversight and approval of capital management, including the capital management policy and annual capital plan. They regularly review the Credit Union‟s capital position and key capital management activities. The Asset/Liability Committee provides senior management oversight of the capital management process, including review and discussion of significant capital policies, issues and action items.

Managing and Monitoring Capital The Credit Union has a comprehensive risk management framework to ensure that the risks taken while conducting its business activities are consistent with its risk appetite. In managing the Credit Union‟s capital position, close attention is paid to the cost and availability of the types of capital, desired leverage, changes in both assets and risk weighted assets and the opportunities to profitably deploy capital.

Capital levels are monitored monthly based on our forecasted financial position, on both capital leverage and risk weighted basis. On both measures, current capital levels are well in excess of regulatory minimums. Our monitoring and forecasting procedures track the expected growth rate in risk weighted assets relative to earnings to determine if additional share capital is required. These projections also take full account of any future impact of changes in accounting standards. Meridian‟s capital quality also exceeds regulatory minimum requirements. Provincial regulations require that at least 50% of a credit union‟s capital base be comprised of primary or Tier 1 capital. As of year-end, 87.1% of Meridian‟s capital base consisted of Tier 1 capital. A detailed discussion of capital management is provided in Note 31.5 of the audited consolidated financial statements.

A combination of negative economic factors and new accounting standards on Meridian‟s defined benefit (“DB”) pension plans have contributed to a significant decrease in regulatory capital over the last few years. These factors include the dramatic decline in equity markets in 2008/09 and volatile market performance since that time. In addition, persistent low interest rates have caused the present value of the liabilities of the pension plans to rise. The net negative impact to Meridian‟s capital since 2010 is $14.5MM.

As the economy improves and rates rise in the coming years, this negative impact is expected to be slowly, but not fully, reversed.

At the end of 2012, a plan amendment was made to one of Meridian‟s DB pension plans and as a result, the active plan members became members of Meridian‟s defined contribution (“DC”) pension plan at the beginning of 2013. These members will not accrue benefit under the legacy DB plan for service subsequent to December 31, 2012. Under this arrangement, assets remain in the plan and are paid out when participants retire or terminate employment, but plan members‟ benefits do not grow with additional years of service or salary increases.

A similar plan amendment has been announced in regard to Meridian‟s other DB pension plan, with plan members receiving notification in January 2013 that they will also join the DC plan noted above. Their membership in the legacy DB plan will continue through to December 31, 2014 as part of the notice period. A significant majority of Meridian‟s employees are already members of the DC pension plan. The cessation of future benefit accrual under both DB plans will result in all

18


Meridian employees being part of the same DC pension plan, which harmonizes the pension benefit offering for all employees.

These plan amendments result in equitable treatment of all Meridian employees as it relates to the provision of pension benefits. In addition, this results in immediate cost savings as future benefit accruals are eliminated. The plan amendment in 2012 resulted in a curtailment gain of $2.9MM. Freezing the DB plans also significantly reduces the potential for future volatility in pension funding, pension expense and impacts to Meridian‟s capital position.

Outlook for 2013 Canada‟s near term economic prospects can be described as modest, but will benefit from improvements in US domestic demand and a generally buoyant commodities market in 2013. It is anticipated that economic activity will be driven mainly by business investment and growth in consumption. This is based on the fact that business profits have rebounded and financial conditions are expected to continue to be highly stimulative. The Bank of Canada projects that core inflation will gradually increase to 2% by the second half of 2014 and total inflation will remain around 1% in 2013 before gradually rising. This has prompted expectations that low interest rates will persist throughout 2013. Housing activity is expected to decline in 2013 as a result of the changes in mortgage regulations and rising total cost of ownership relative to income levels. Both home prices and the level of construction activity are anticipated to weaken. Canadian exports are projected to gradually increase but remain below their pre-recession levels due to weak foreign demand and the strength of the Canadian dollar. Given this economic outlook, we expect to be operating under much the same conditions as 2012 with similar challenges such as margin compression, and a very competitive environment with financial institutions vying for a reduced mortgage market and consumers trying to maximize the yield from their deposit dollars.

Meridian‟s focus in 2013 will be on setting the stage for an even more solid and stable financial future. Our 2012 financial results, although positive, highlighted the importance of achieving better balances between deposits and loans, and asset growth and return on equity (“ROE”) in order to enhance our long-term sustainability. Consequently, our top strategic objective for 2013 is sustainable growth. Sustainability will require continued emphasis on growing our Membership and deepening our relationships with all Members. It speaks to the need to be better able to fund our asset growth organically, through cost effective and diversified deposit sources that will provide stable long-term funding. We will be targeting balanced growth between organic loans and deposits and we will focus on ensuring that we are earning a fair return on the value that we offer our Members and the risk that we take on. By sustainability, we also mean achieving an ROE that exceeds our asset growth, and that will improve our capital ratios and quality of capital, reflecting reduced reliance on investment shares over time. The 2013 after-tax ROE target is 7.9% relative to a total asset growth rate of 6.0%. We will also focus our efforts on reducing our efficiency ratio.

Achieving these performance targets means that Meridian must grow profitably. We will do so by exploring new opportunities to generate income while providing value to Members, enhancing our treasury management to more effectively manage our liquidity and interest rate risks and managing our operating expenses. Meridian prides itself on offering a truly differentiated service experience to our Members, one that is founded on respect and on truly looking out for our Members‟ best interests. Literally, our goal is to have our Members‟ back. Our growth in 2013 will be driven by an ongoing focus on targeted marketing to get the “Meridian story” out, as well as new product offerings, an expansion of our branch network and enhanced overall sales and service capabilities.

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Logo and tagline

meridiancu.ca

™Trademarks of Meridian Credit Union Limited.

Documents

2012 Annual Report - Meridian - Meridian Credit Union - · PDF file · 2017-07-28Net Interest Income ... Meridian has over $9.5 billion in assets under administration and serves