ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSOn November 17, 2006, the Bank completed its director election process for directorships commencing on January 1, 2007. This process took place in accordance with the rules governing the election of Federal Home Loan Bank directors as specified in the FHLB Act, as amended, and the related regulations of the Finance Board. For a description of the Bank’s director election process, see Item 10 – Directors, Executive Officers and Corporate Governance.
For the elective directorships commencing on January 1, 2007, there were 11 nominees for two elective directorships representing the state of Texas, two nominees for one elective directorship representing the state of Arkansas, and one nominee for one elective directorship representing the state of Louisiana. With one nominee for the elective directorship representing the state of Louisiana, no election was held for that position. There were no open elective directorships for the states of Mississippi or New Mexico.
Two new directors, Tyson T. Abston and H. Gary Blankenship, each representing the state of Texas, were elected to serve on the Bank’s Board of Directors. In addition, Charles G. Morgan, Jr. and Anthony S. Sciortino were re-elected to the Bank’s Board of Directors to represent the states of Arkansas and Louisiana, respectively. Each of these directors was elected to serve a three-year term that will expire on December 31, 2009. The election of these directors was reported under Item 5.02 of the Bank’s Current Report on Form 8-K dated November 15, 2006 and filed with the Commission on November 21, 2006.
There were 471 member institutions in Texas that were eligible to vote, of which 185 institutions cast a total of 2,647,357 votes. In Arkansas, there were 137 member institutions eligible to vote, of which 77 institutions cast a total of 420,871 votes. Member institutions may only cast votes for a nominee or abstain from voting and may not cast votes against a nominee or indicate that they are withholding votes from a nominee.
The results of the election, by state, were as follows:
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| | | | | | | | | | | Number of | | | | Member | | Votes | | Nominee | | Institution | | Received | | Arkansas
| | | | | | | | | | | | | | Charles G. Morgan, Jr. | | Pine Bluff National Bank | | | 329,249 | | President and Chief Executive Officer | | Pine Bluff, AR | | | | | | | | | | | | Stephen C. Davis | | Riverside Bank | | | 91,622 | | Chief Executive Officer, Director and Chief | | Sparkman, AR | | | | | Financial Officer | | | | | | | | | | | | | | Texas
| | | | | | | | | | | | | | Tyson T. Abston | | Guaranty Bond Bank | | | 474,866 | | President and Chief Executive Officer | | Mount Pleasant, TX | | | | | | | | | | | | H. Gary Blankenship | | Bank of the West | | | 421,871 | | Chairman and Chief Executive Officer | | Irving, TX | | | | | | | | | | | | Anthony J. Nocella | | Franklin Bank | | | 402,608 | | Chairman, Chief Executive Officer and President | | Houston, TX | | | | | | | | | | | | Kert Moore | | Town North National Bank | | | 269,857 | | Chief Financial Officer | | Dallas, TX | | | | | | | | | | | | Mays Davenport | | LegacyTexas Bank | | | 232,730 | | Executive Vice President | | Plano, TX | | | | | | | | | | | | Larry Johnson | | First Bank & Trust of Childress | | | 166,731 | | President | | Childress, TX | | | | | | | | | | | | Peter Fisher | | Prosperity Bank | | | 166,495 | | Vice Chairman and General Counsel | | El Campo, TX | | | | | | | | | | | | Lynn Krauss | | Texas National Bank | | | 162,861 | | Director | | Tomball, TX | | | | | | | | | | | | Michaux Nash, Jr. | | Dallas National Bank | | | 142,469 | | Chairman, Chief Executive Officer and | | Dallas, TX | | | | | President | | | | | | | | | | | | | | Ellen Messick | | Mobiloil Federal Credit Union | | | 135,386 | | Vice President | | Beaumont, TX | | | | | | | | | | | | Steve Holt | | State Bank of Texas | | | 71,483 | | Executive Vice President and | | Dallas, TX | | | | | Chief Operating Officer | | | | | | RESERVED |
Information regarding the Bank’s other directors whose terms of office continued after the election process is provided in Item 10 – Directors, Executive Officers and Corporate Governance.
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PART II ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The Bank is a cooperative and all of its outstanding capital stock, which is known as Class B stock, is owned by its members or, in some cases, by non-member institutions that have acquired stock by virtue of acquiring a member institution, or by former members that retain capital stock to support advances or other activity that remains outstanding.outstanding or until any applicable stock redemption or withdrawal notice period expires. All of the Bank’s shareholders are financial institutions; no individual ownsmay own any of the Bank’s capital stock. The Bank’s capital stock is not publicly traded, nor is there an established market for the stock. The Bank’s capital stock has a par value of $100 per share and it may be purchased, redeemed, repurchased and transferred only at its par value. By regulation, the parties to a transaction involving the Bank’s stock can include only the Bank and its member institutions (or non-member institutions or former members, as described above). While a member could transfer stock to another member of the Bank, such a transfer could occur only upon approval of the Bank and then only at par value. The Bank does not issue options, warrants or rights relating to its capital stock, nor does it provide any type of equity compensation plan. As of February 28, 2007,2010, the Bank had 900940 shareholders and 22,484,26824,894,275 shares of capital stock outstanding. Subject to Finance BoardAgency directives, the Bank is permitted by statute and regulation to pay dividends on members’ capital stock in either cash or capital stock only from previously retained earnings or current net earnings. DividendsThe Bank’s Board of Directors may be paidnot declare or pay a dividend based on projected or anticipated earnings, nor may it declare or pay a dividend if the Bank is not in compliance with its minimum capital requirements or if the Bank would fail to meet its minimum capital requirements after paying such dividend (for a discussion of the Bank’s minimum capital requirements, see Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Risk-Based Capital Rules and Other Capital Requirements). Further, the Bank may not declare or pay any dividends in the form of cash or capital stock as authorizedif excess stock held by its shareholders is greater than one percent of the Bank’s Boardtotal assets or if, after the issuance of Directors.such shares, excess stock held by its shareholders would be greater than one percent of the Bank’s total assets. Shares of Class B stock issued as dividend payments have the same rights, obligations, and restrictions as all other shares of Class B stock, including rights, privileges, and restrictions related to the repurchase and redemption of Class B stock. To the extent such shares represent excess stock, they may be repurchased or redeemed by the Bank in accordance with the provisions of the Bank’s capital plan. The Bank has had a long-standing practice of paying quarterly dividends in the form of capital stock. The Bank has also had a long-standing practice of benchmarking the dividend rate that it pays on its capital stock to the average effective federal funds rate. When stock dividends are paid, capital stock is issued in full shares and any fractional shares are paid in cash. Through the second quarter of 2006, dividends wereDividends are typically paid on the last business day of each quarter and were based upon the average capital stock held by each of the Bank’s shareholders during the period from the last dividend payment date (which was generally the last business day of the preceding quarter) through the date immediately preceding the last business day of the current quarter. Following this process, dividends were declared during a calendar quarter prior to the date on which the Bank’s actual earnings for that quarter were known. On June 25, 2006, the Board of Directors approved a change to the Bank’s dividend declaration and payment process. Effective with the third quarter 2006 dividend, the Bank changed its dividend declaration and payment process such that the Bank now declares and pays dividends only after the close of the calendar quarter to which the dividend pertains and the earnings for that quarter have been calculated. Since this change was made, the Bank has continued to pay dividends on the last business day of each quarter, but now bases those dividends on the Bank’s operating results, shareholders’ average capital stock holdings and the average effective federal funds rate for the preceding calendar quarter. The third quarter 2006 dividend, which was paid on September 29, 2006, wasare based upon the Bank’s operating results, shareholders’ average capital stock holdings and the average effective federal funds rate for the second quarter of 2006. Similarly, the fourth quarter 2006 dividend, which was paid on December 29, 2006, was based upon the Bank’s operating results, shareholders’ average capital stock holdings and the average effective federal funds rate for the third quarter of 2006. The Bank intends to continue this pattern (including the timing of its dividend payments) in future periods.
On December 22, 2006, the Finance Board adopted a final rule requiring the FHLBanks to declare and pay dividends only out of known income. Under this rule, which became effective on January 29, 2007, the Bank’s Board of Directors may not declare or pay a dividend based on projected or anticipated earnings, nor may it declare or pay a dividend if the par value of the Bank’s stock is impaired or is projected to become impaired after paying such dividend. In addition, the Bank may not declare or pay any dividends in the form of capital stock if its members’ holdings of excess stock are greater than 1 percent of the Bank’s total assets or if, after the issuance of such shares, members’ holdings of excess stock would be greater than 1 percent of the Bank’s total assets.preceding calendar quarter.
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The Bank’s recently modified dividend declaration and payment process conforms with the timing provisions of the final rule. In addition, partly because the Bank has limited members’ accumulation of excess stock by periodically repurchasing a portion of shareholders’ excess stock, aggregate excess stock held by shareholders has been less than 1 percent of the Bank’s total assets throughout the period since the implementation of its capital plan. Therefore, the Bank does not currently expect that the excess stock limitations will impact its ability to pay dividends in the form of capital stock.
The following table sets forth certain information regarding the quarterly dividends that were declared and paid by the Bank during the years ended December 31, 20062009 and 2005.2008. In those years, the Bank paid dividends based on the average effective federal funds rate. All dividends were paid in the form of capital stock except for fractional shares, which were paid in cash. DIVIDENDS PAID (dollars in thousands) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 2006 | | 2005 | | 2009 | | 2008 | | | | Annualized | | Annualized | | Annualized | | Annualized | | | | Amount(1) | | Rate(3) | | Amount(2) | | Rate(3) | | Amount(1) | | Rate(3) | | Amount(2) | | Rate(3) | | First Quarter | | $ | 27,827 | | | 4.45 | % | | $ | 20,550 | | | 2.95 | % | | $ | 4,204 | | | 0.50 | % | | $ | 26,787 | | | 4.50 | % | | | Second Quarter | | 30,258 | | 4.91 | | 24,373 | | 3.44 | | | 1,343 | | 0.18 | | 20,043 | | 3.18 | | | | Third Quarter | | 30,258 | | 4.91 | | 28,342 | | 3.93 | | | 1,302 | | 0.18 | | 15,253 | | 2.09 | | | | Fourth Quarter | | 32,558 | | 5.25 | | 28,190 | | 3.98 | | | 1,116 | | 0.16 | | 15,043 | | 1.94 | |
| | | (1) | | Amounts include (in thousands) $3,027, $2,727, $2,726$61, $37, $35 and $2,372$25 of dividends paid on mandatorily redeemable capital stock for the first, second, third and fourth quarters of 2009, respectively. For financial reporting purposes, these dividends were classified as interest expense. | | (2) | | Amounts include (in thousands) $2,350, $2,813, $3,234$927, $541, $361 and $3,247$219 of dividends paid on mandatorily redeemable capital stock for the first, second, third and fourth quarters of 2008, respectively. For financial reporting purposes, these dividends were classified as interest expense. | | (3) | | Reflects the annualized rate paid on all of the Bank’s average capital stock outstanding regardless of its classification for financial reporting purposes as either capital stock or mandatorily redeemable capital stock. |
The Bank has a retained earnings policy that is designedcalls for the Bank to maintain retained earnings in an amount sufficient to protect the par value of members’ capital stock investments fromagainst potential identified economic or accounting losses and fluctuations in earnings caused by SFAS 133 accounting requirementsdue to specified interest rate, credit or other factors.operations risks. With certain exceptions, the Bank’s policy calls for the Bank to maintain its retained earnings balance at or above its policy target when determining the amount of funds available to pay dividends. Taking into consideration its current retained earnings policy target, as well as its current earnings expectations and anticipated market conditions, the Bank currently expects to pay dividends in 20072010 at approximately 0 to 25 basis pointsor slightly above the average effective federal funds rate for the period from October 1, 20062009 through September 30, 2007.2010. For a discussion of the Bank’s current retained earnings policy target, see Item 7 –— Management’s Discussion and Analysis of Financial Condition and Results of Operations.Operations — Financial Condition — Retained Earnings and Dividends. The Bank’s Board of Directors recently declaredapproved a dividend in the form of capital stock for the first quarter of 20072010 at an annualized rate of 5.250.375 percent (which equates toexceeds the average effectiveupper end of the Federal Reserve’s target for the federal funds rate for the fourth quarter of 2006)2009 by 12.5 basis points). The first quarter 20072010 dividend, to be applied to average capital stock held during the period from October 1, 20062009 through December 31, 2006,2009, is payable on March 30, 2007.31, 2010. 29
Pursuant to the terms of an SEC no-action letter dated September 13, 2005, the Bank is exempt from the requirements to report: (1) sales of its equity securities under Item 701 of Regulation S-K and (2) repurchases of its equity securities under Item 703 of Regulation S-K. In addition, the HER Act specifically exempts the Bank from periodic reporting requirements under the securities laws pertaining to the disclosure of unregistered sales of equity securities. 43
ITEM 6. SELECTED FINANCIAL DATA SELECTED FINANCIAL DATA (dollars in thousands) | | | | | | | | | | | | | | | | | | | | | | | Year Ended December 31, | | | 2006 | | 2005 | | 2004 | | 2003(4) | | 2002(4) | Balance sheet(at year end) | | | | | | | | | | | | | | | | | | | | | Advances | | $ | 41,168,141 | | | $ | 46,456,958 | | | $ | 47,112,017 | | | $ | 40,595,327 | | | $ | 36,868,743 | | Investments(1) | | | 13,428,864 | | | | 17,161,270 | | | | 15,808,508 | | | | 16,060,275 | | | | 15,589,454 | | Mortgage loans, net(10) | | | 449,626 | | | | 542,478 | | | | 706,203 | | | | 971,500 | | | | 1,395,913 | | Total assets | | | 55,650,458 | | | | 64,852,010 | | | | 64,612,350 | | | | 58,416,909 | | | | 55,166,371 | | Consolidated obligations — discount notes | | | 8,225,787 | | | | 11,219,806 | | | | 7,085,710 | | | | 11,627,075 | | | | 12,872,681 | | Consolidated obligations — bonds | | | 41,684,138 | | | | 46,121,709 | | | | 51,452,135 | | | | 40,679,238 | | | | 35,862,458 | | Total consolidated obligations(9) | | | 49,909,925 | | | | 57,341,515 | | | | 58,537,845 | | | | 52,306,313 | | | | 48,735,139 | | Mandatorily redeemable capital stock(8) | | | 159,567 | | | | 319,335 | | | | 327,121 | | | | — | | | | — | | Capital stock — putable | | | 2,248,147 | | | | 2,298,622 | | | | 2,492,789 | | | | 2,661,133 | | | | 2,470,518 | | Retained earnings (accumulated deficit) | | | 190,625 | | | | 178,494 | | | | 25,920 | | | | 5,214 | | | | (49,057 | ) | Dividends paid(8) | | | 110,049 | | | | 89,813 | | | | 43,961 | | | | 58,740 | | | | 68,648 | | | | | | | | | | | | | | | | | | | | | | | Income statement | | | | | | | | | | | | | | | | | | | | | Interest income | | $ | 2,889,202 | | | $ | 2,292,736 | | | $ | 1,300,067 | | | $ | 1,156,485 | | | $ | 1,332,585 | | Net interest income | | | 216,292 | | | | 222,559 | | | | 220,776 | | | | 210,246 | | | | 222,136 | | Income (loss) before cumulative effect of change in accounting principle(10) | | | 122,180 | | | | 241,479 | | | | 64,667 | | | | 113,011 | | | | (50,276 | ) | Net income (loss)(10) | | | 122,180 | | | | 242,387 | | | | 64,667 | | | | 113,011 | | | | (50,276 | ) | | | | | | | | | | | | | | | | | | | | | | Performance ratios(8) | | | | | | | | | | | | | | | | | | | | | Net interest margin(2) | | | 0.37 | % | | | 0.34 | % | | | 0.36 | % | | | 0.37 | % | | | 0.46 | % | Return on average assets(10) | | | 0.21 | | | | 0.37 | | | | 0.10 | | | | 0.20 | | | | (0.10 | ) | Return on average equity(10) | | | 4.98 | | | | 8.90 | | | | 2.55 | | | | 4.15 | | | | (2.01 | ) | Return on average capital stock(5)(10) | | | 5.42 | | | | 9.66 | | | | 2.73 | | | | 4.31 | | | | (2.15 | ) | Total average equity to average assets | | | 4.29 | | | | 4.20 | | | | 4.10 | | | | 4.87 | | | | 5.02 | | Weighted average dividend rate(3) | | | 4.88 | | | | 3.58 | | | | 1.86 | | | | 2.24 | | | | 2.93 | | Dividend payout ratio(6) | | | 90.07 | | | | 37.05 | | | | 67.98 | | | | 51.98 | | | | (136.54 | ) | | | | | | | | | | | | | | | | | | | | | | Ratio of earnings to fixed charges(11) | | | 1.06 | X | | | 1.16 | X | | | 1.08 | X | | | 1.16 | X | | | 0.94 | X | | | | | | | | | | | | | | | | | | | | | | Average effective federal funds rate(7) | | | 4.97 | % | | | 3.22 | % | | | 1.35 | % | | | 1.13 | % | | | 1.67 | % |
| | | | | | | | | | | | | | | | | | | | | | | Year Ended December 31, | | | 2009 | | 2008 | | 2007 | | 2006 | | 2005 | Balance sheet(at year end) | | | | | | | | | | | | | | | | | | | | | Advances | | $ | 47,262,574 | | | $ | 60,919,883 | | | $ | 46,298,158 | | | $ | 41,168,141 | | | $ | 46,456,958 | | Investments(1)(2) | | | 13,491,819 | | | | 17,388,015 | | | | 16,400,655 | | | | 13,429,450 | | | | 17,161,557 | | Mortgage loans(3) | | | 259,857 | | | | 327,320 | | | | 381,731 | | | | 449,893 | | | | 542,772 | | Allowance for credit losses on mortgage loans | | | 240 | | | | 261 | | | | 263 | | | | 267 | | | | 294 | | Total assets(2) | | | 65,092,076 | | | | 78,932,898 | | | | 63,458,256 | | | | 55,457,966 | | | | 64,519,215 | | Consolidated obligations — discount notes | | | 8,762,028 | | | | 16,745,420 | | | | 24,119,433 | | | | 8,225,787 | | | | 11,219,806 | | Consolidated obligations — bonds | | | 51,515,856 | | | | 56,613,595 | | | | 32,855,379 | | | | 41,684,138 | | | | 46,121,709 | | Total consolidated obligations(4) | | | 60,277,884 | | | | 73,359,015 | | | | 56,974,812 | | | | 49,909,925 | | | | 57,341,515 | | Mandatorily redeemable capital stock(5) | | | 9,165 | | | | 90,353 | | | | 82,501 | | | | 159,567 | | | | 319,335 | | Capital stock — putable | | | 2,531,715 | | | | 3,223,830 | | | | 2,393,980 | | | | 2,248,147 | | | | 2,298,622 | | Retained earnings | | | 356,282 | | | | 216,025 | | | | 211,762 | | | | 190,625 | | | | 178,494 | | Accumulated other comprehensive income (loss) | | | (65,965 | ) | | | (1,435 | ) | | | (570 | ) | | | 748 | | | | (2,677 | ) | Total capital | | | 2,822,032 | | | | 3,438,420 | | | | 2,605,172 | | | | 2,439,520 | | | | 2,474,439 | | Dividends paid(5) | | | 7,807 | | | | 75,078 | | | | 108,641 | | | | 110,049 | | | | 89,813 | | | | | | | | | | | | | | | | | | | | | | | Income statement | | | | | | | | | | | | | | | | | | | | | Net interest income(6) | | $ | 76,476 | | | $ | 150,358 | | | $ | 223,026 | | | $ | 216,292 | | | $ | 222,559 | | Provision (release of allowance) for credit losses | | | — | | | | — | | | | — | | | | — | | | | (56 | ) | Other income | | | 200,355 | | | | 22,580 | | | | 9,505 | | | | 1,279 | | | | 157,585 | | Other expense | | | 75,290 | | | | 64,813 | | | | 55,296 | | | | 49,820 | | | | 50,223 | | Assessments | | | 53,477 | | | | 28,784 | | | | 47,457 | | | | 45,571 | | | | 88,498 | | Income before cumulative effect of change in accounting principle(3) | | | 148,064 | | | | 79,341 | | | | 129,778 | | | | 122,180 | | | | 241,479 | | Net income (3) | | | 148,064 | | | | 79,341 | | | | 129,778 | | | | 122,180 | | | | 242,387 | | | | | | | | | | | | | | | | | | | | | | | Performance ratios | | | | | | | | | | | | | | | | | | | | | Net interest margin(7) | | | 0.11 | % | | | 0.20 | % | | | 0.40 | % | | | 0.37 | % | | | 0.34 | % | Return on average assets(2)(3) | | | 0.21 | | | | 0.11 | | | | 0.24 | | | | 0.21 | | | | 0.37 | | Return on average equity(3) | | | 4.92 | | | | 2.52 | | | | 5.58 | | | | 4.98 | | | | 8.90 | | Return on average capital stock(3)(8) | | | 5.39 | | | | 2.73 | | | | 6.18 | | | | 5.42 | | | | 9.66 | | Total average equity to average assets(2) | | | 4.30 | | | | 4.23 | | | | 4.22 | | | | 4.29 | | | | 4.20 | | Regulatory capital ratio(2)(9) | | | 4.45 | | | | 4.47 | | | | 4.24 | | | | 4.69 | | | | 4.33 | | Dividend payout ratio(5)(10) | | | 5.27 | | | | 94.63 | | | | 83.71 | | | | 90.07 | | | | 37.05 | | | | | | | | | | | | | | | | | | | | | | | Ratio of earnings to fixed charges | | | 1.26 | X | | | 1.05 | X | | | 1.07 | X | | | 1.06 | X | | | 1.16 | X | | | | | | | | | | | | | | | | | | | | | | Average effective federal funds rate(11) | | | 0.16 | % | | | 1.92 | % | | | 5.02 | % | | | 4.97 | % | | | 3.22 | % |
| | | (1) | | Investments consist of federal funds sold, loans to other FHLBanks, interest-bearing deposits and securities classified as held-to-maturity, available-for-sale and trading. | | (2) | | Net interest marginIn accordance with new accounting guidance that became effective on January 1, 2008, the Bank offsets the fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral against the fair value amounts recognized for derivative instruments executed with the same counterparty under a master netting arrangement. Prior to the adoption of this guidance, the Bank offset only the fair value amounts recognized for derivative instruments executed with the same counterparty under a master netting arrangement. The investments and total asset balances at December 31, 2007, 2006 and 2005 have been adjusted to reflect the retrospective application of this guidance. The Bank has determined that it is net interest income asimpractical to retrospectively restate the average balances in periods prior to 2008; further, the Bank has determined that any such adjustments would not have had a percentagematerial impact on the average total asset balances for those periods. Accordingly, the asset-based performance ratios for periods prior to 2008 do not reflect any adjustments for the retrospective application of average earning assets.this guidance. | | (3) | | Weighted average dividend rates are dividends paid in cash and stock divided by average capital stock outstanding excluding mandatorily redeemable capital stock. | | (4) | | Certain amounts in 2003 and 2002 were reclassified to conform with the 2004, 2005 and 2006 presentation. | | (5) | | Return on average capital stock is derived by dividing net income (loss) by average capital stock balances excluding mandatorily redeemable capital stock. | | (6) | | Dividend payout ratio is computed by dividing dividends paid by net income (loss) for the year. | | (7) | | Rates obtained from the Federal Reserve Statistical Release. | | (8) | | The Bank adopted Statement of Financial Accounting Standards No. 150 (“SFAS 150”) as of January 1, 2004. In accordance with the provisions of that standard, $159.6 million, $319.3 million and $327.1 million of the Bank’s capital stock was classified as a liability (“mandatorily redeemable capital stock”) at December 31, 2006, 2005 and 2004, respectively. In addition, $13.0 million, $ 11.7 million and $6.6 million of dividends paid on mandatorily redeemable capital stock were recorded as interest expense during the years ended December 31, 2006, 2005 and 2004, respectively. These amounts are excluded from dividends paid in those years. Due to the adoption of SFAS 150, the Bank’s performance ratios for the years ended December 31, 2006, 2005 and 2004 are not comparable to prior years. | | (9) | | The Bank is jointly and severally liable with the other FHLBanks for the payment of principal and interest on the consolidated obligations of all of the FHLBanks. At December 31, 2006, 2005, 2004, 2003 and 2002, the outstanding consolidated obligations (at par value) of all 12 FHLBanks totaled approximately $952 billion, $937 billion, $869 billion, $760 billion and $681 billion, respectively. As of those dates, the Bank’s outstanding consolidated obligations (at par value) were $50.2 billion, $57.8 billion, $58.7 billion, $52.3 billion and $48.2 billion, respectively. | | (10) | | Effective January 1, 2005, the Bank changed its method of accounting for the amortization and accretion of premiums and discounts on mortgage loans from the retrospective method to the contractual method under Statement of Financial Accounting Standards No. 91.method. This change resulted in a $1.2 million cumulative increase in the balance of mortgage loans at that date. Net of assessments, the cumulative effect of this change in accounting principle increased 2005 earnings by $908,000. | | (11)(4) | | The deficit in earnings to fixed chargesBank is jointly and severally liable with the other FHLBanks for the yearpayment of principal and interest on the consolidated obligations of all of the FHLBanks. At December 31, 2009, 2008, 2007, 2006 and 2005, the outstanding consolidated obligations (at par value) of all 12 FHLBanks totaled approximately $0.931 trillion, $1.252 trillion, $1.190 trillion, $0.952 trillion and $0.937 trillion, respectively. As of those dates, the Bank’s outstanding consolidated obligations (at par value) were $59.9 billion, $72.9 billion, $57.0 billion, $50.2 billion and $57.8 billion, respectively. | | (5) | | Mandatorily redeemable capital stock represents capital stock that is classified as a liability under GAAP. Dividends on mandatorily redeemable capital stock are recorded as interest expense and excluded from dividends paid. Dividends paid on mandatorily redeemable capital stock totaled $0.2 million, $2.0 million, $6.6 million, $10.8 million and $11.6 million for the years ended December 31, 20022009, 2008, 2007, 2006 and 2005, respectively. | | (6) | | Net interest income excludes the net interest income/expense associated with interest rate exchange agreements that do not qualify for hedge accounting. The net interest income (expense) associated with such agreements totaled $68.4 million.$107.6 million, $5.0 million, ($0.4 million), ($2.2 million) and ($28.4 million) for the years ended December 31, 2009, 2008, 2007, 2006 and 2005, respectively. | | (7) | | Net interest margin is net interest income as a percentage of average earning assets. | | (8) | | Return on average capital stock is derived by dividing net income by average capital stock balances excluding mandatorily redeemable | | | | capital stock. | | (9) | | The regulatory capital ratio is computed by dividing regulatory capital (the sum of capital stock — putable, mandatorily redeemable capital stock and retained earnings) by total assets. | | (10) | | Dividend payout ratio is computed by dividing dividends paid by net income for the year. | | (11) | | Rates obtained from the Federal Reserve Statistical Release. |
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of financial condition and results of operations should be read in conjunction with the annual audited financial statements and notes thereto for the years ended December 31, 2006, 20052009, 2008 and 20042007 beginning on page F-1 of this Annual Report on Form 10-K. Forward-Looking Information This annual report contains forward-looking statements that reflect current beliefs and expectations of the Bank about its future results, performance, liquidity, financial condition, prospects and opportunities.opportunities, including the prospects for the payment of future dividends. These statements are identified by the use of forward-looking terminology, such as “anticipates,” “plans,” “believes,” “could,” “estimates,” “may,” “should,” “would,” “will,” “might,” “expects,” “intends” or their negatives or other similar terms. The Bank cautions that forward-looking statements involve risks or uncertainties that could cause the Bank’s actual future results to differ materially from those expressed or implied in these forward-looking statements, or could affect the extent to which a particular objective, projection, estimate, or prediction is realized. As a result, undue reliance should not be placed on such statements. These risks and uncertainties include, without limitation, evolving economic and market conditions, political events, and the impact of competitive business forces. The risks and uncertainties related to evolving economic and market conditions include, but are not limited to, potentially adverse changes in interest rates, adverse changes in the Bank’s access to the capital markets, material adverse changes in the cost of the Bank’s debt, adverse consequences resulting from a significant regional or national economic downturn, credit and prepayment risks, or changes in the financial health of the Bank’s members or non-member borrowers. Among other things, political events could possibly lead to changes in the Bank’s regulatory environment or its status as a GSE,government-sponsored enterprise (“GSE”), or to changes in the regulatory environment for the Bank’s members or non-member borrowers. Risks and uncertainties related to competitive business forces include, but are not limited to, the potential loss of large members or large borrowers through acquisitions or other means or changes in the relative competitiveness of the Bank’s products and services for member institutions. For a more detailed discussion of the risk factors applicable to the Bank, see Item 1A –— Risk Factors. The Bank undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances, or any other reason. Overview The Bank is one of 12 district FHLBanks.Federal Home Loan Banks (each individually a “FHLBank” and collectively the “FHLBanks” and, together with the Federal Home Loan Banks Office of Finance, a joint office of the FHLBanks, the “FHLBank System”) that were created by the Federal Home Loan Bank Act of 1932, as amended (the “FHLB Act”). The FHLBanks serve the public by enhancing the availability of credit for residential mortgages, community lending, and targeted community development. As independent, member-owned cooperatives, the FHLBanks seek to maintain a balance between their public purpose and their ability to provide adequate returns on the capital supplied by their members. ThePrior to July 30, 2008, the Federal Housing Finance Board (“Finance Board”) was responsible for the supervision and regulation of the FHLBanks and the Office of Finance. Effective with the enactment of the Housing and Economic Recovery Act of 2008 (the “HER Act”) on July 30, 2008, the Federal Housing Finance Agency (“Finance Agency”), an independent agency in the executive branch of the United States Government, supervisesassumed responsibility for supervising and regulatesregulating the FHLBanks and the Office of Finance, a joint office of the FHLBanks.Finance. The Finance Board ensuresAgency has responsibility to ensure that the FHLBanksFHLBanks: (i) operate in a safe and sound manner (including the maintenance of adequate capital and internal controls); (ii) foster liquid, efficient, competitive and resilient national housing finance markets; (iii) comply with applicable laws, rules, regulations, guidelines and orders (including the HER Act and the FHLB Act); (iv) carry out their housing financestatutory mission only through authorized activities; and (v) operate and conduct their activities in a manner that is consistent with the public interest. Consistent with these responsibilities, the Finance Agency establishes policies and regulations covering the operations of the FHLBanks. The HER Act provided that all regulations, orders, directives and determinations issued by the Finance Board prior to enactment of the HER Act immediately transferred to the Finance Agency and remain adequately capitalized,in force unless modified, terminated, or set aside by the Director of the Finance Agency. For additional discussion regarding the Finance Agency, see Item 1 — Business — Legislative and are able to raise funds in the capital markets.Regulatory Developments. 45
The Bank serves eligible financial institutions in Arkansas, Louisiana, Mississippi, New Mexico and Texas (collectively, the Ninth District of the Federal Home Loan BankFHLBank System). The Bank’s primary business is lending relatively low cost funds (known as advances) to its member institutions, which include commercial banks, thrifts, insurance companies and credit unions. Effective with the enactment of the HER Act, Community Development Financial Institutions that are certified under the Community Development Banking and Financial Institutions Act of 1994 are also eligible for membership in the Bank. While not members of the Bank, state and local housing authorities that meet certain statutory criteria may also borrow from the Bank. The Bank also maintains a portfolio of highly rated investments for liquidity purposes and to provide additional earnings. Additionally, the Bank holds interests in a portfolio of government-guaranteedgovernment-guaranteed/insured and conventional mortgage loans that were acquired through the Mortgage Partnership Finance® (“MPF”®) Program offered by the FHLBank of Chicago. Shareholders’ return on their investment includes dividends (which are typically paid quarterly in the form of capital stock) and the value derived from access to the Bank’s products and services. TheHistorically, the Bank balanceshas balanced the financial rewards to shareholders by payingseeking to pay a dividend that generally meets or exceeds the return on alternative short-term money market investments available to shareholders, while lending funds at the lowest rates expected to be compatible with that objective and its objective to build retained earnings over time. During each quarter of 2009, the Bank paid dividends at the average effective federal funds rate for the immediately preceding quarter. The average effective federal funds rate of 0.51 percent for the fourth quarter of 2008 was below the Federal Reserve’s average federal funds target rate of 1.06 percent, while the average effective federal funds rate for each of the first three quarters of 2009 was below the upper end of the Federal Reserve’s target range of 0.25 percent for the federal funds rate for those periods, which was also the rate that depository institutions could earn on both required and excess reserves maintained at the Federal Reserve during those periods. 31
The Bank’s capital stock is not publicly traded and can only be held by members of the Bank, or by non-member institutions that acquire stock by virtue of acquiring member institutions, andor by former members of the Bank that retain capital stock to support advances or other activity that remains outstanding or until any applicable stock redemption or withdrawal notice period expires. All members must purchasehold stock in the Bank. The Bank’s capital stock has a par value of $100 per share and is purchased, redeemed, repurchased and, transferred (withwith the prior approval of the Bank)Bank, transferred only at its par value. Members may redeem excess stock, or withdraw from membership and redeem all outstanding capital stock, with five years’ written notice to the Bank. The FHLBanks’ debt instruments (known as consolidated obligations) are their primary source of funds and are the joint and several obligations of all 12 FHLBanks (see Item 1 –— Business). Consolidated obligations are issued through the Office of Finance acting as agent for the FHLBanks and generally are publicly traded in the over-the-counter market. The Bank records on its balance sheet only those consolidated obligations for which it is the primary obligor. Consolidated obligations enjoy GSE status; however, they are not obligations of the United States Government and the United States Government does not guarantee them. Consolidated obligations are rated Aaa/P-1 by Moody’s Investors Service (“Moody’s”) and AAA/A-1+ by Standard and Poor’s (“S&P,&P”), which are the highest ratings available from these NRSROs.nationally recognized statistical rating organizations (“NRSROs”). These ratings indicate that Moody’s and S&P have concluded that the FHLBanks have an extremely strong capacity to meet their commitments to pay principal and interest on consolidated obligations, and that consolidated obligations are judged to be of the highest quality, with minimal credit risk. The ratings also reflect the FHLBank System’s status as a GSE. Shareholders, bondholders and prospective members should understand that these ratings are not a recommendation to buy, hold or sell securities and they may be subject to revision or withdrawal at any time by the NRSRO. The ratings from each of the NRSROs should be evaluated independently. Historically, the FHLBanks’ GSE status and highest available credit ratings on consolidated obligations have provided the FHLBanks with excellent capital markets access. Deposits, other borrowings and the proceeds from capital stock issued to members provide otherare also sources of funds tofor the Bank. In addition to ratings on the FHLBanks’ consolidated obligations, each FHLBank is rated individually by both S&P and Moody’s. These individual FHLBank ratings apply to obligations of the respective FHLBanks, such as interest rate derivatives, deposits, and letters of credit issued by the FHLBank.credit. As of February 28, 2007,2010, Moody’s had assigned a deposit rating of Aaa/P-1 to each individual FHLBank and nonone of the FHLBanks were on its Watchlist (which would indicate that ratings were under review for possible change).Watchlist. At that same date, S&P had assigned long-term counterparty credit ratings of AAA/A-1+ to 10 of the FHLBanks (including the Bank) and AA+/A-1+ to two FHLBanks.the FHLBanks of Seattle and Chicago. In addition, as of February 28, 2010, S&P had assigned negativestable outlooks to one FHLBank rated AAA/A-1+ and one FHLBank rated AA+/A-1+. On September 21, 2006, S&P revised its outlook on the Bank from negative to stable. In taking this action, S&P cited the positive resolutionall 12 of the Bank’s accounting restatementsFHLBanks. Shareholders, bondholders and continued stable performance from its low risk strategy. The Bank’s outlook had been revised from stable to negative in August 2005 in response to the Bank’s announcement on August 22, 2005 that it would restate its previously issued financial statements for the three months ended March 31, 2005prospective shareholders and the years ended December 31, 2004, 2003, 2002 and 2001 and that it had sold approximately $1.2 billion (par value) of investment securities. For additional information regarding the Bank’s accounting restatements, see the Bank’s Amended Registration Statement on Form 10 filed with the SEC on April 14, 2006 (the “Amended Form 10”). Currently, one FHLBank is operating under a written agreement with the Finance Board that addresses what the agency described as “certain shortcomings” in various of its practices. The written agreement is available on the Finance Board’s web site at www.fhfb.gov.
Neither the ratings actions or the written agreement described above, nor the events or developments at the affected FHLBanks that precipitated those actions, have had or are expected to have an impact on the FHLBanks’ ability to issue debt in the financial markets, nor have they raised or are they expected to raise concerns regarding potential losses under the Bank’s joint and several liability. Therefore, while there can be no assurances about the future, based on the information available at this time, the Bank has no reason to believebondholders should understand that these developments will haveratings are not a material impact onrecommendation to buy, hold or sell securities and they may be subject to revision or withdrawal at any time by the Bank’s financial condition or liquidity inNRSRO. The ratings from each of the foreseeable future.NRSROs should be evaluated independently.
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The Bank conducts its business and fulfills its public purpose primarily by acting as a financial intermediary between its members and the capital markets. The intermediation of the timing, structure, and amount of its members’ credit needs with the investment requirements of the Bank’s creditors is made possible by the extensive use of interest rate exchange agreements, including interest rate swaps caps and floors.caps. The Bank’s interest rate exchange agreements are accounted for in accordance with the provisions of Statement of Financial Accounting 32
Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities,”as amended by SFAS No. 137, “Accounting for Derivative Instruments and Hedging Activities – DeferralTopic 815 of the Effective Date of FASB Statement No. 133,” SFAS No. 138,Financial Accounting Standards Board Accounting Standards Codification entitled “Accounting for Certain Derivative InstrumentsDerivatives and Certain Hedging Activities,”Hedging”SFAS No. 149,(“Amendment of Statement 133 on Derivative Instruments and Hedging Activities”and SFAS No. 155,“Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140”and as interpreted by the Derivatives Implementation Group (hereinafter collectively referred to as “SFAS 133”ASC 815”). For a discussion of SFAS 133,ASC 815, see the sections below entitled “Financial Condition — Derivatives and Hedging Activities” and “Critical Accounting Policies and Estimates.”
The Bank’sBank considers its “core earnings” to be net earnings exclusive ofof: (1) gains or losses on the sales of investment securities, if any, andany; (2) gains or losses on the retirement or transfer of debt, if any; (3) prepayment fees on advances; (4) fair value adjustments required by SFAS 133,ASC 815 (except for net interest payments associated with derivatives); and (5) realized gains and losses associated with early terminations of derivative transactions. The Bank’s core earnings are generated almost entirelyprimarily from net interest income and typically tend to rise and fall with the overall level of interest rates, particularly short-term money market rates. Because the Bank is a cooperatively owned wholesale institution, operating on aggregate net interest spreads typically in the 15 to 20 basis point range (including net interest payments on interest rate exchange agreements that hedge identifiable portfolio risks but that do not qualify for hedge accounting under SFAS 133 and excluding the effects of interest expense on mandatorily redeemable capital stock and fair value basis adjustments required by SFAS 133), the spread component of its net interest income is much smaller than a typical commercial bank, and a muchrelatively larger portion of its net interest income is derived from the investment of its capital. Because the Bank’sThe Bank endeavors to maintain a fairly neutral interest rate risk profile is typically fairly neutral, which means that itsprofile. As a result, the Bank’s capital is effectively invested in shorter-term assets the Bank’sand its core earnings and returns on capital (exclusive of gainsstock (based on the sales of investment securities, if any, and fair value adjustments required by SFAS 133)core earnings) generally tend to follow short-term interest rates. As a result, theThe Bank’s profitability objective has beenis to achieve a rate of return on members’ capital stock investment sufficient to allow the Bank to meet its retained earnings targetsgrowth objectives and pay dividends on capital stock at rates that equal or exceed the average effective federal funds rate. The following table summarizes the Bank’s return on average capital stock (based on reported results), the average effective federal funds rate the Bank’s return on capital stock and the Bank’s dividend payment rate for the years ended December 31, 2006, 20052009, 2008 and 2004.2007. | | | | | | | | | | | | | | | Year Ended December 31, | | | 2006 | | 2005 | | 2004 | Return on capital stock | | | 5.42 | % | | | 9.66 | % | | | 2.73 | % | Average effective federal funds rate | | | 4.97 | % | | | 3.22 | % | | | 1.35 | % | Weighted average dividend rate | | | 4.88 | % | | | 3.58 | % | | | 1.86 | % | Reference average effective federal funds rate (reference rate) | | | 4.88 | % | | | 3.22 | % | | | 1.35 | % | Dividend spread over reference rate | | | — | | | | 0.36 | % | | | 0.51 | % |
| | | | | | | | | | | | | | | Year Ended December 31, | | | | 2009 | | | 2008 | | | 2007 | | Earnings | | | | | | | | | | | | | | | | | | | | | | | | | | Return on average capital stock | | | 5.39 | % | | | 2.73 | % | | | 6.18 | % | | | | | | | | | | | | | | Average effective federal funds rate | | | 0.16 | % | | | 1.92 | % | | | 5.02 | % | | | | | | | | | | | | | | Dividends | | | | | | | | | | | | | | | | | | | | | | | | | | Weighted average of dividend rates paid(1) | | | 0.25 | % | | | 2.92 | % | | | 5.21 | % | | | | | | | | | | | | | | Reference average effective federal funds rate (reference rate)(2) | | | 0.25 | % | | | 2.92 | % | | | 5.21 | % |
| | | (1) | | Computed as the average of the dividend rates paid in each quarter during the year weighted by the number of days in each quarter. | | (2) | | See discussion below for a description of the reference rate. |
For a discussion of the Bank’s annual returns on capital stock and the reasons for the variability in those returns from year to year, see the section below entitled “Results of Operations.” Effective with the third quarter 2006 dividend, which was paid on September 29, 2006, the Bank changed its dividend declaration and payment process such thatThe Bank’s quarterly dividends are now based upon the Bank’sits operating results, shareholders’ average capital stock holdings and the average effective federal funds rate for the immediately preceding quarter. While the Bank has had a long-standing practice of paying quarterly dividends, future dividend payments cannot be assured.
To provide more meaningful comparisons between the average effective federal funds rate and the Bank’s dividend rate, the above table sets forth a “reference average effective federal funds rate.” For the yearyears ended December 31, 2006, 47
2009, 2008 and 2007, the reference average effective federal funds rate was computed by includingreflects the average effective federal funds rate for the first quarter ofperiods from October 1, 2008 through September 30, 2009, from October 1, 2007 through September 30, 2008 and from October 1, 2006 once, the average effective federal funds rate for the second quarter of 2006 twice and the average effective federal funds rate for the third quarter of 2006 once. For the years ended December 31, 2005 and 2004, the reference average effective federal funds rate is equal to the average effective federal funds rate for those years.through September 30, 2007, respectively. For additional discussion regarding the modifications to the Bank’s 33
dividend declaration and payment process, see the section entitled “Financial Condition — Retained Earnings and Dividends.” The Bank operates in only one reportable segment as defined by SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.”segment. All of the Bank’s revenues are derived from U.S. operations. Financial Market Conditions Although capital markets have not returned to pre-credit crisis conditions, credit market conditions during 2009 continued the trend of noticeable improvement that began in late 2008. Capital market participants were cautious throughout 2008 about the creditworthiness and liquidity of their investments, which curtailed overall market liquidity throughout most of that year. The impact of this caution was particularly acute during the last half of the third quarter and the first half of the fourth quarter of 2008. In 2008, the U.S. and other governments and their central banks developed and implemented aggressive initiatives in an effort to provide support for and to restore the functioning of the global credit markets. Those programs included the implementation by the United States Department of the Treasury (the “Treasury”) of the Troubled Asset Relief Program (“TARP”) authorized by Congress in October 2008 and the Federal Reserve’s purchases of commercial paper, agency debt securities (including FHLBank debt) and mortgage-backed securities. In addition, the Federal Reserve’s discount window lending and Term Auction Facility (“TAF”) for auctions of short-term liquidity, the expansion of insured deposit limits and the Federal Deposit Insurance Corporation’s Temporary Liquidity Guarantee Program (“TLGP”) provided additional liquidity support for depository institutions. As conditions improved in 2009, the level of support provided by some of these government programs stabilized or contracted. For instance, direct lending by the Federal Reserve to depository institutions reached approximately $530 billion by December 31, 2008 and remained at about that level through April 2009 before declining to about $320 billion at the end of June 2009, $206 billion at September 30, 2009 and $96 billion at December 31, 2009. Otherwise unsecured debt issued by commercial banks and guaranteed by the Federal Deposit Insurance Corporation (“FDIC”) reached approximately $330 billion by March 31, 2009, remained near that level at June 30, 2009 and declined to approximately $309 billion at both September 30, 2009 and December 31, 2009. The TARP, TLGP and TAF programs are scheduled to expire in 2010. In addition to those actions to provide additional direct liquidity to the markets, the Federal Reserve Board, through its Federal Open Market Committee, reduced its target for the federal funds rate first from 2.00 percent to 1.00 percent in two steps during October 2008, and then subsequently reduced the target to a range between 0 and 0.25 percent. The Federal Open Market Committee maintained its target for the federal funds rate at a range between 0 and 0.25 percent throughout 2009. The government programs discussed above increased the amount of liquidity in the market, thereby reducing the demand for federal funds which in turn resulted in an effective federal funds rate below the upper end of the targeted range for all of 2009 (the targeted rate was zero to 25 basis points). In October 2008, the Federal Reserve began paying interest on required and excess reserves held by depository institutions, and throughout 2009 the rate was equivalent to the upper boundary of the targeted range for federal funds. As a result, most commercial banks began to retain their excess liquidity at the Federal Reserve rather than selling federal funds in the market, substantially reducing the volume of overnight federal funds trading. Because GSEs cannot earn interest on their reserves at the Federal Reserve, these institutions have continued to sell their excess liquidity in the federal funds market. However, the lack of demand for such funds has resulted in the effective funds rate remaining below the upper end of the target range for the federal funds rate. One- and three-month LIBOR rates fell from 3.93 percent and 4.05 percent, respectively, at September 30, 2008 to 0.44 percent and 1.43 percent, respectively, as of December 31, 2008. One- and three-month LIBOR rates stabilized and the spread between those rates shrank during 2009, with one- and three-month LIBOR ending the year at 0.23 percent and 0.25 percent, respectively. More stable one- and three-month LIBOR rates, combined with smaller spreads between those two indices and between those indices and overnight lending rates, suggest some degree of general improvement in the inter-bank lending markets. 48
The following table presents information on various market interest rates at December 31, 2009 and 2008 and various average market interest rates for the years ended December 31, 2009, 2008 and 2007. | | | | | | | | | | | | | | | | | | | | | | | | Ending Rate | | | Average Rate | | | | | December 31, | | | | December 31, | | | | For the Year Ended December 31, | | | | | 2009 | | | | 2008 | | | | 2009 | | | | 2008 | | | | 2007 | | Federal Funds Target(1) | | | 0.25% | | | | 0.25% | | | | 0.25% | | | | 2.08% | | | | 5.05% | | Average Effective Federal Funds Rate(2) | | | 0.05% | | | | 0.14% | | | | 0.16% | | | | 1.92% | | | | 5.02% | | 1-month LIBOR(1) | | | 0.23% | | | | 0.44% | | | | 0.33% | | | | 2.68% | | | | 5.25% | | 3-month LIBOR (1) | | | 0.25% | | | | 1.43% | | | | 0.69% | | | | 2.93% | | | | 5.30% | | 2-year LIBOR (1) | | | 1.42% | | | | 1.48% | | | | 1.41% | | | | 2.94% | | | | 4.91% | | 5-year LIBOR (1) | | | 2.98% | | | | 2.13% | | | | 2.65% | | | | 3.69% | | | | 5.01% | | 10-year LIBOR (1) | | | 3.97% | | | | 2.56% | | | | 3.44% | | | | 4.24% | | | | 5.24% | | 3-month U.S. Treasury (1) | | | 0.06% | | | | 0.08% | | | | 0.15% | | | | 1.45% | | | | 4.46% | | 2-year U.S. Treasury (1) | | | 1.14% | | | | 0.77% | | | | 0.96% | | | | 2.00% | | | | 4.36% | | 5-year U.S. Treasury (1) | | | 2.69% | | | | 1.55% | | | | 2.20% | | | | 2.79% | | | | 4.42% | | 10-year U.S. Treasury (1) | | | 3.85% | | | | 2.21% | | | | 3.26% | | | | 3.64% | | | | 4.63% | |
| | | (1) | | Source: Bloomberg | | (2) | | Source: Federal Reserve Statistical Release |
During late 2008 and early 2009, the variety of government initiatives, the different types of support those initiatives provided the markets, and the announced sunset dates for those support mechanisms also had the effect of creating uncertainty around the appropriate relationship of prices for different types of financial instruments issued by different types of institutions. Pricing uncertainty, in combination with volatile conditions in the credit markets, motivated many investors to substantially limit their exposure to credit and liquidity risk. This led to increased demand for U.S. Treasury securities and short-term agency investments and diminished investors’ demand for any longer term investments, including callable and non-callable debt issued by the FHLBanks and the secondary market housing GSEs. These market dynamics were reflected in a variety of yield relationships between different benchmark market yields, including increases in the spreads between yields on short-term Treasury securities and other short-term rates such as one- and three-month LIBOR. Economic conditions appear to be showing some early signs of eventual improvement, including positive growth in the gross domestic product (“GDP”) for the third and fourth quarters of 2009. While much of the significant deterioration in economic conditions that followed the disruptive financial market events of September 2008, including unemployment rates, has not reversed, and the economy has remained weak since that time, policy makers have interpreted recent data and the third and fourth quarter GDP data to indicate that the pace of economic decline has begun to reverse itself. Those early signs of improvement notwithstanding, the prospects for and potential timing of renewed economic growth (and employment growth in particular) remain very uncertain. 2009 In Summary The Bank ended 2009 with total assets of $65.1 billion and total advances of $47.3 billion, a decrease from $78.9 billion and $60.9 billion, respectively, at the end of 2008. The decrease in advances for 2009 was attributable in large part to the repayment of approximately $8.2 billion of advances by three large borrowers, as further discussed in the section below entitled “Financial Condition — Advances.” The remaining decline in advances during 2009 was attributable to a decline in member demand which the Bank believes was due, at least in part, to increases in members’ deposit levels and reduced lending activity due to the economic recession, as well as the availability of federal government programs that provided members with more attractively priced sources of funding and liquidity than were available earlier in the credit crisis. 49
The Bank’s net income for 2009 was $148.1 million. Net interest income was $76.5 million and net gains on derivatives and hedging activities were $193.1 million. | • | | The Bank’s net interest income excludes net interest payments associated with economic hedge derivatives, which contributed significantly to the Bank’s income before assessments of $201.5 million for 2009. Had the net interest income on economic hedge derivatives been included in net interest income, the Bank’s net interest income would have been higher (and its net gains on derivatives and hedging activities would have been lower) by $107.6 million for the year ended December 31, 2009. | | | | | The Bank’s net interest income for 2009 was adversely impacted by actions the Bank took in late 2008 to ensure its ability to provide liquidity to its members during a period of unusual market disruption. At the height of the credit market disruptions in the early part of the fourth quarter of 2008, and in order to ensure that the Bank would have sufficient liquidity on hand to fund member advances throughout the year-end period, the Bank issued debt with maturities that extended into 2009 instead of issuing very short-maturity debt. As yields subsequently declined sharply on the Bank’s short-term assets, including overnight federal funds sold and short-term advances to members, this debt was carried at a negative spread. Due in large part to the negative spread associated with the investment of the remaining portion of this debt in low-yielding short-term assets, the Bank’s net interest income was negative in the first quarter of 2009. The negative impact of this debt was minimal during the remainder of 2009 as much of the relatively high cost debt issued in late 2008 matured in the first quarter of 2009. | | | • | | The $193.1 million in net gains on derivatives and hedging activities for the year included $107.6 million of net interest income on interest rate swaps accounted for as economic hedge derivatives, $62.5 million of net ineffectiveness-related gains on fair value hedges related to consolidated obligation bonds and $26.2 million of net gains on economic hedge derivatives (excluding net interest settlements). | | | | | During 2008, the Bank recognized $55.4 million of net ineffectiveness-related losses related to hedge ineffectiveness on interest rate swaps used to convert most of its fixed rate consolidated obligation bonds to LIBOR floating rates. Those losses were largely attributable to the unusual (and significant) decrease in three-month LIBOR rates during the fourth quarter of 2008. With relatively stable three-month LIBOR rates during the first quarter of 2009, these previous ineffectiveness-related losses reversed (in the form of ineffectiveness-related gains) during the three months ended March 31, 2009. Three-month LIBOR rates remained relatively stable during the remainder of 2009, resulting in significantly lower ineffectiveness-related gains and losses during those periods. | | | | | The net gains on the Bank’s economic hedge derivatives during 2009 included gains on interest rate swaps used to hedge the risk of changes in spreads between the daily federal funds rate and three-month LIBOR. These gains, totaling $10.3 million, were due to the tightening of the spread between the two indices and changes in the future expectations for such spread. The net gains on economic hedge derivatives were also significantly impacted by net gains on the Bank’s portfolio of interest rate basis swaps that are used to hedge the risk of changes in spreads between one- and three-month LIBOR and net gains on interest rate caps that are used to hedge the impact that rising rates would have on its portfolio of collateralized mortgage obligation (“CMO”) LIBOR floaters with embedded caps. During 2009, net gains of $9.0 million and $14.3 million were recognized on interest rate basis swaps and interest rate caps, respectively. | | | | | The Bank held $24.3 billion (notional) of interest rate swaps recorded as economic hedge derivatives with a net positive fair value of $32.1 million (excluding accrued interest) at December 31, 2009. If these swaps are held to maturity, these net unrealized gains will ultimately reverse in future periods in the form of unrealized losses, which will negatively impact the Bank’s earnings in those periods. The timing of this reversal will depend on the relative level and volatility of future interest rates. In addition, as of December 31, 2009, the Bank held $3.75 billion (notional) of stand-alone interest rate cap agreements with a fair value of $51.1 million that hedge CMO LIBOR floaters with embedded caps. If these agreements are held to |
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| | | maturity, the value of the caps will ultimately decline to zero and be recorded as a loss in net gains (losses) on derivatives and hedging activities in future periods. |
| • | | During 2009, unrealized losses on the Bank’s holdings of non-agency residential mortgage-backed securities classified as held-to-maturity decreased from $277.0 million (40.9 percent of amortized cost) to $135.3 million (26.5 percent of amortized cost). Based on its year-end 2009 analysis of the securities in this portfolio, the Bank believes that the unrealized losses were principally the result of significant (albeit reduced) liquidity risk-related discounts in the non-agency mortgage-backed securities market and do not accurately reflect the actual historical or currently likely future credit performance of the securities. In assessing the expected credit performance of these securities, the Bank determined that it is likely that it will not fully recover the amortized cost basis of seven of its non-agency residential mortgage-backed securities and, accordingly, these securities (with an aggregate unpaid principal balance of $148.0 million as of December 31, 2009) were deemed to be other-than-temporarily impaired during 2009. In accordance with guidance issued by the Financial Accounting Standards Board (“FASB”) in April 2009, which the Bank early adopted effective January 1, 2009, the credit components of the impairment losses ($4.0 million) were recognized in earnings while the non-credit components of the impairment losses ($75.9 million) were recognized in other comprehensive income. Prospects for future housing market conditions, which will influence whether the Bank will record any additional other-than-temporary impairment charges on these or any other securities in the future, remain uncertain. | | | • | | At all times during 2009, the Bank was in compliance with all of its regulatory capital requirements. In addition, the Bank’s retained earnings increased to $356.3 million at December 31, 2009 from $216.0 million at December 31, 2008. | | | • | | During 2009, the Bank paid dividends totaling $7.8 million; the quarterly dividends during the year were paid at rates that equaled the benchmark average effective federal funds rate for the applicable reference periods. While there can be no assurances about 2010 earnings, dividends, or regulatory actions, the Bank currently anticipates that its 2010 earnings will be sufficient both to pay quarterly dividends at a rate equal to or slightly above the average federal funds rate and to continue building retained earnings. In addition, the Bank currently expects to continue its quarterly repurchases of surplus stock. |
Financial Condition The following table provides selected period-end balances as of December 31, 20062009, 2008 and 2005,2007, as well as selected average balances for the years ended December 31, 20062009, 2008 and 2005. In addition, the table provides the percentage increase or decrease in each of these balances from year-to-year.2007. As shown in the table, the Bank’s total assets decreased by 14.217.5 percent (or $9.2$13.8 billion) during the year ended December 31, 20062009 after growingincreasing by 0.424.4 percent (or $0.2$15.5 billion) during the year ended December 31, 2005.2008. The decrease in total assets during the year ended December 31, 20062009 was primarily attributable to a $5.3$13.7 billion declinedecrease in advances, a $2.4 billion decline in the Bank’s short-term investments and a $1.3 billion decline in long-term investments.advances. As the Bank’s assets decreased, the funding for those assets also declined.decreased. During the year ended December 31, 2006,2009, total consolidated obligations decreased by $7.4 billion;$13.1 billion, as consolidated obligation bonds decreased by $5.1 billion and consolidated obligation discount notes declined by $4.4 billion and $3.0 billion, respectively.$8.0 billion. During the year ended December 31, 2005,2008, total assets increased by $15.5 billion, due primarilylargely to a $5.2$14.6 billion increase in advances. The funding for those assets also increased during the Bank’s short-term investments, which was partially offsetyear ended December 31, 2008, as consolidated obligation bonds increased by the sale of $4.1$23.8 billion (par value) of available-for-sale securities. The increase in short-term investments was due in large part to the investment of the proceeds from the sale of the available-for-sale securities.and consolidated obligation discount notes declined by $7.4 billion. The activity in each of the major balance sheet captions is discussed in the sections following the table. 51
SUMMARY OF CHANGES IN FINANCIAL CONDITION (dollars in millions) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | December 31, | | December 31, | | | | 2006 | | 2005 | | 2004 | | 2009 | | 2008 | | 2007 | | | | Percentage | | Percentage | | | | Percentage | | Percentage | | | | | | Increase | | Increase | | | | Increase | | Increase | | | | | | Balance | | (Decrease) | | Balance | | (Decrease) | | Balance | | Balance | | (Decrease) | | Balance | | (Decrease) | | Balance | | Advances | | $ | 41,168 | | | (11.4 | )% | | $ | 46,457 | | | (1.4 | )% | | $ | 47,112 | | | $ | 47,263 | | | (22.4) | % | | $ | 60,920 | | | 31.6 | % | | $ | 46,298 | | Short-term investments (federal funds sold) | | 5,495 | | | (30.4 | ) | | 7,896 | | 194.6 | | 2,680 | | | Long-term investments(1) | | 7,934 | | | (14.4 | ) | | 9,265 | | | (29.4 | ) | | 13,129 | | | Short-term liquidity holdings | | | Non-interest bearing excess cash balances(1) | | | 3,600 | | * | | — | | — | | — | | Interest-bearing deposits | | | — | | | (100.0 | ) | | 3,684 | | * | | 1 | | Federal funds sold(2) | | | 2,063 | | 10.2 | | 1,872 | | | (75.0 | ) | | 7,500 | | Commercial paper | | | — | | — | | — | | | (100.0 | ) | | 994 | | Long-term investments(3) | | | 11,425 | | | (3.4 | ) | | 11,829 | | 49.7 | | 7,902 | | Mortgage loans, net | | 450 | | | (17.0 | ) | | 542 | | | (23.2 | ) | | 706 | | | 260 | | | (20.5 | ) | | 327 | | | (14.2 | ) | | 381 | | Total assets | | 55,650 | | | (14.2 | ) | | 64,852 | | 0.4 | | 64,612 | | | 65,092 | | | (17.5 | ) | | 78,933 | | 24.4 | | 63,458 | | Consolidated obligations — bonds | | 41,684 | | | (9.6 | ) | | 46,122 | | | (10.4 | ) | | 51,452 | | | 51,516 | | | (9.0 | ) | | 56,614 | | 72.3 | | 32,855 | | Consolidated obligations — discount notes | | 8,226 | | | (26.7 | ) | | 11,220 | | 58.3 | | 7,086 | | | 8,762 | | | (47.7 | ) | | 16,745 | | | (30.6 | ) | | 24,120 | | Total consolidated obligations | | 49,910 | | | (13.0 | ) | | 57,342 | | | (2.0 | ) | | 58,538 | | | 60,278 | | | (17.8 | ) | | 73,359 | | 28.8 | | 56,975 | | Mandatorily redeemable capital stock | | 160 | | | (49.8 | ) | | 319 | | | (2.4 | ) | | 327 | | | 9 | | | (90.0 | ) | | 90 | | 8.4 | | 83 | | Capital stock | | 2,248 | | | (2.2 | ) | | 2,299 | | | (7.8 | ) | | 2,493 | | | 2,532 | | | (21.5 | ) | | 3,224 | | 34.7 | | 2,394 | | Retained earnings | | 191 | | 7.3 | | 178 | | 584.6 | | 26 | | | 356 | | 64.8 | | 216 | | 1.9 | | 212 | | Average total assets | | 57,172 | | | (12.0 | ) | | 64,933 | | 5.1 | | 61,760 | | | 70,018 | | | (6.2 | ) | | 74,641 | | 35.6 | | 55,056 | | Average capital stock | | 2,253 | | | (10.2 | ) | | 2,508 | | 6.0 | | 2,365 | | | 2,749 | | | (5.6 | ) | | 2,911 | | 38.6 | | 2,101 | | Average mandatorily redeemable capital stock | | 211 | | | (35.3 | ) | | 326 | | | (10.9 | ) | | 366 | | | 56 | | | (1.8 | ) | | 57 | | | (45.2 | ) | | 104 | |
| | | (1)* | | IncludesThe percentage increase is not meaningful. | | (1) | | Represents excess cash held at the Federal Reserve Bank of Dallas. This amount is classified as “Cash and Due From Banks” in the Bank’s statement of condition. | | (2) | | The balance at December 31, 2007 includes $400 million of federal funds sold to another FHLBank. | | (3) | | Consists of securities classified as trading, available-for-saleheld-to-maturity (other than short-term commercial paper) and held-to-maturity.available-for-sale. |
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Advances The following table presents advances outstanding, by type of institution, as of December 31, 2006, 20052009, 2008 and 2004.2007. ADVANCES OUTSTANDING BY BORROWER TYPE (par value, dollars in millions) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | December 31, | | | December 31, | | | | 2006 | | 2005 | | 2004 | | | 2009 | | 2008 | | 2007 | | | | Amount | | Percent | | Amount | | Percent | | Amount | | Percent | | | Amount | | Percent | | Amount | | Percent | | Amount | | Percent | | Commercial banks | | $ | 13,747 | | | 33 | % | | $ | 14,361 | | | 31 | % | | $ | 15,593 | | | 33 | % | | $ | 41,924 | | | 89 | %(1) | | $ | 29,889 | | | 50 | % | | $ | 14,797 | | | 32 | % | Thrift institutions | | 21,717 | | 53 | | 22,906 | | 49 | | 22,476 | | 48 | | | 3,249 | | | 7 | (1) | | 27,687 | | 46 | | 27,825 | | 60 | | Credit unions | | 1,897 | | 4 | | 1,307 | | 3 | | 1,032 | | 2 | | | 1,347 | | 3 | | 1,565 | | 3 | | 1,966 | | 4 | | Insurance companies | | 215 | | 1 | | 213 | | 1 | | 237 | | 1 | | | 301 | | 1 | | 243 | | — | | 208 | | 1 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total member advances | | 37,576 | | 91 | | 38,787 | | 84 | | 39,338 | | 84 | | | 46,821 | | 100 | | 59,384 | | 99 | | 44,796 | | 97 | | | | | Housing associates | | 9 | | — | | 49 | | — | | 11 | | — | | | 11 | | — | | 131 | | — | | 5 | | — | | Non-member borrowers | | 3,601 | | 9 | | 7,652 | | 16 | | 7,668 | | 16 | | | 76 | | — | | 730 | | 1 | | 1,338 | | 3 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total par value of advances | | $ | 41,186 | | | 100 | % | | $ | 46,488 | | | 100 | % | | $ | 47,017 | | | 100 | % | | $ | 46,908 | | | 100 | % | | $ | 60,245 | | | 100 | % | | $ | 46,139 | | | 100 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total par value of advances outstanding to CFIs(2) | | $ | 5,896 | | | 14 | % | | $ | 6,989 | | | 15 | % | | $ | 7,695 | | | 16 | % | | $ | 9,758 | | | 21 | % | | $ | 11,530 | | | 19 | % | | $ | 6,401 | | | 14 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | (1) | | During 2009, the thrift charter of Wachovia Bank, FSB was converted to a national bank charter and then merged into Wells Fargo Bank South Central, National Association. This institution had outstanding advances of $18.2 billion at December 31, 2009. These actions were the primary reason for the significant increase in advances to commercial banks (and corresponding decrease in advances to thrift institutions) between December 31, 2008 and December 31, 2009. | | (2) | | The figures presented above reflect the advances outstanding to Community Financial Institutions (“CFIs”) as of December 31, 2009, 2008 and 2007 based upon the definitions of CFIs that applied as of those dates. At December 31, 2007, CFIs were defined as FDIC-insured institutions with average total assets over the three prior years of less than $599 million. With the enactment of the HER Act on July 30, 2008, CFIs were redefined as FDIC-insured institutions with average total assets over the three-year period preceding measurement of less than $1 billion, as adjusted annually for inflation. For additional discussion, see Item 1 — Business — Legislative and Regulatory Developments. |
At December 31, 2006,2009, the carrying value of the Bank’s advances portfolio totaled $41.2$47.3 billion, compared to $46.5$60.9 billion and $47.1$46.3 billion at December 31, 20052008 and 2004,2007, respectively. The par value of advances outstanding at December 31, 2006, 20052009, 2008 and 20042007 was $41.2$46.9 billion, $46.5$60.2 billion and $47.0$46.1 billion, respectively. The $5.3 billion declineAdvances to members grew steadily over the course of the first nine months of 2008, peaking near the end of the third quarter when conditions in the par valuefinancial markets were particularly unsettled. Advances growth during this period was generally spread across all segments of the Bank’s membership base, as the then prevailing credit market conditions appeared to lead members to increase their borrowings in order to increase their liquidity, to take advantage of borrowing rates that were relatively attractive compared with alternative wholesale funding sources, to take advantage of investment opportunities and/or to lengthen the maturity of their liabilities at a relatively low cost. Advances subsequently declined during the fourth quarter of 2008 and the year ended December 31, 2009 as market conditions calmed and the economy weakened.
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During the year ended December 31, 2008, the Bank’s outstanding advances during 2006increased by $14.1 billion, a significant portion of which was attributable to increases in large partadvances to two borrowers. In February 2008, Comerica Bank, which had recently relocated its charter to the repaymentNinth District, became a member of approximately $4.0the Bank. As of December 31, 2008, Comerica Bank had outstanding advances of $8.0 billion of advances by Washington Mutual Bank, as discussed below. The remainderand was due primarily to lower balances ofthe Bank’s second largest borrower. In addition, advances to the Bank’s smalllargest borrower, Wells Fargo Bank South Central, National Association (“WFSC”), formerly Wachovia Bank, FSB, increased by $5.0 billion during 2008. The increase in advances to these borrowers was partially offset by a $2.1 billion decrease in advances to Franklin Bank, S.S.B during 2008. On November 7, 2008, the Texas Department of Savings and mid-sized customers.Mortgage Lending closed Franklin Bank, S.S.B., and the FDIC was named receiver. At that time, Franklin Bank, S.S.B. had outstanding advances totaling $1.0 billion. On November 12, 2008, these advances were fully repaid. During 2005,2009, advances to the Bank’s ten largest borrowers increaseddecreased by approximately $1.0 billion; however, a net decrease$9.1 billion, contributing significantly to the overall decline in advances balances during the year. Advances to other segmentsWFSC, Comerica Bank and Guaranty Bank (“Guaranty”) declined by $4.0 billion, $2.0 billion and $2.2 billion, respectively, during 2009. On August 21, 2009, the Office of Thrift Supervision closed Guaranty and the FDIC was named receiver. Guaranty was the Bank’s membership resulted in a $0.5third largest borrower and shareholder at August 21, 2009, with $2.0 billion decline in the par value of total advances outstanding at December 31, 2005.that date; all of these advances were repaid in August and September 2009. The remaining decline in advances during 2009 was spread broadly across the Bank’s members. The Bank believes the decline in advances was due, at least in part, to increases in members’ deposit levels and reduced lending activity due to the economic recession, as well as the availability of federal government programs that provided members with more attractively priced sources of funding and liquidity than were available earlier in the credit crisis. At December 31, 2006,2009, advances outstanding to the Bank’s ten largest borrowers totaled $28.7$30.1 billion, representing 69.564.2 percent of the Bank’s total outstanding advances as of that date. The following table presents the Bank’s ten largest borrowers as of December 31, 2006.2009. 35
TEN LARGEST BORROWERS AS OF DECEMBER 31, 20062009 (Par value, dollars in millions) | | | | | | | | | | | | | | | | | | | | | | | Percent of | | Name | | City | | State | | Advances | | | Total Advances | | World Savings Bank, FSB Texas | | Houston | | TX | | $ | 11,763 | | | | 28.6 | % | Guaranty Bank | | Austin | | TX | | | 5,076 | | | | 12.3 | | Washington Mutual Bank | | Henderson | | NV | | | 3,513 | | | | 8.5 | | Franklin Bank, SSB | | Austin | | TX | | | 2,309 | | | | 5.6 | | Capital One, National Association * | | New Orleans | | LA | | | 2,147 | | | | 5.2 | | International Bank of Commerce | | Laredo | | TX | | | 1,722 | | | | 4.1 | | Southwest Corporate FCU | | Plano | | TX | | | 826 | | | | 2.0 | | Charter Bank | | Santa Fe | | NM | | | 517 | | | | 1.3 | | Southside Bank | | Tyler | | TX | | | 451 | | | | 1.1 | | BancorpSouth Bank | | Tupelo | | MS | | | 336 | | | | 0.8 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | $ | 28,660 | | | | 69.5 | % | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | Percent of | | Name | | City | | State | | | Advances | | | Total Advances | | Wells Fargo Bank South Central, National Association (1) | | Houston | | TX | | $ | 18,247 | | | | 38.9 | % | Comerica Bank | | Dallas | | TX | | | 6,000 | | | | 12.8 | | International Bank of Commerce | | Laredo | | TX | | | 1,244 | | | | 2.7 | | Bank of Texas, N.A. | | Dallas | | TX | | | 901 | | | | 1.9 | | Southside Bank | | Tyler | | TX | | | 855 | | | | 1.8 | | Beal Bank Nevada(2) | | Las Vegas | | NV | | | 721 | | | | 1.5 | | First National Bank | | Edinburg | | TX | | | 595 | | | | 1.3 | | Arvest Bank | | Rogers | | AR | | | 586 | | | | 1.2 | | First Community Bank | | Taos | | NM | | | 497 | | | | 1.1 | | Renasant Bank | | Tupelo | | MS | | | 458 | | | | 1.0 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | $ | 30,104 | | | | 64.2 | % | | | | | | | | | | | | | |
| | | *(1) | | Previously known as Hibernia NationalFormerly Wachovia Bank, FSB | | (2) | | Beal Bank Nevada is chartered in Las Vegas, NV, but maintains its home office in Plano, TX. |
As of December 31, 20052008 and 2004,2007, advances outstanding to the Bank’s ten largest borrowers comprised $32.2$39.2 billion (69.3(65.1 percent) and $31.2$30.2 billion (66.4(65.3 percent), respectively, of the total advances portfolio. AtEffective December 31, 2006,2008, Wells Fargo & Company (“Wells Fargo”) acquired Wachovia Corporation, the holding company for Wachovia Bank, FSB (“Wachovia”), the Bank’s third largest borrower and shareholder. Wells Fargo is headquartered in the Eleventh District of the FHLBank System and affiliates of Wells Fargo have historically maintained charters in the Fourth, Eighth, Eleventh and Twelfth Districts of the FHLBank System, which are served by the FHLBanks of Atlanta, Des Moines, San Francisco and Seattle, respectively. Following a
54
reorganization and relocation of charters in the fourth quarter of 2009, Wachovia became part of WFSC, whose charter was Washington Mutualrelocated to Texas and whose application for membership in the Bank a California-based institution with $3.5was approved on December 30, 2009. As indicated in the table above, WFSC had $18.2 billion of advances outstanding. On February 13, 2001, Washington Mutual Bank acquired Bank United, thenoutstanding as of December 31, 2009, which represented 38.9 percent of the Bank’s largest shareholder and borrower, and dissolved Bank United’s Ninth District charter. Washington Mutual Bank assumed Bank United’stotal outstanding advances the remainder of which mature during 2007 and 2008, and in so doing became a non-member borrower. Advances to non-member borrowers may not be renewed at maturity. The balance of Washington Mutual’sthat date. WFSC’s advances are scheduled to mature as follows: $901 million inbetween March 2010 and October 2013. While Wells Fargo has maintained a membership relationship with the first quarterBank, the Bank is currently unable to predict whether WFSC will alter its predecessor’s borrowing relationship with the Bank. During the years ended December 31, 2009, 2008 and 2007, Wachovia/WFSC accounted for 29.7 percent, 38.6 percent and 37.2 percent, respectively, of 2007, $1.257 billion in the second quarter of 2007, $987 million in the third quarter of 2007 and $368 million in the third quarter of 2008.Bank’s total interest income from advances. A larger balanceThe loss of advances helps provide a critical mass ofto one or more large borrowers, if not offset by growth in advances and capital over which to spread the Bank’s overhead, which helps maintain dividends and relatively lower advance pricing. Therefore, the loss of Washington Mutual’s advances has had and is expected to continue toother institutions, could have a modestly negative impact on the Bank’s return on capital stock. A similar outcome would result inlarger balance of advances helps to provide a critical mass of advances and capital to support the event that one or morefixed component of the Bank’s other large borrowers repays itscost structure, which helps maintain returns on capital stock, dividends and relatively lower advances and ceases to be a member of the Bank. Two recently completed acquisitions could contribute to such an outcome.
In November 2005, Capital One Financial Corp. (domiciled in the Fourth District of the FHLBank System) acquired Hibernia National Bank (now known as Capital One, National Association), the Bank’s fifth largest borrower and fourth largest shareholder at December 31, 2006. Currently, the Bank is unable to predict whether, and for how long, Capital One, National Association will continue to maintain its Ninth District charter.
On October 1, 2006, Wachovia Corporation (NYSE:WB) acquired Golden West Financial Corporation (NYSE:GDW), the holding company for World Savings Bank, FSB Texas (World Savings), the Bank’s largest borrower and stockholder as of December 31, 2006. As indicated in the table above, World Savings had $11.8 billion of advances outstanding as of December 31, 2006, which represented 28.6 percent of the Bank’s total
36
outstanding advances at that date. These advances are scheduled to mature between March 2007 and August 2011.
At the time that Wachovia Corporation acquired World Savings’ holding company, World Savings was borrowing from the Bank pursuant to an advances and security agreement that granted the Bank a “blanket lien” on certain categories of eligible collateral. Subsequent to the acquisition, World Savings entered into a new advances and security agreement with the Bank, under which World Savings is now on “specific collateral only status” and has granted to the Bank a security interest in specifically identified collateral only. For more detail on the “blanket lien” and “specific collateral only status,” see the section entitled “Products and Services – Advances” in Item 1 – Business. Since the acquisition, World Savings has maintained an active relationship with the Bank; however, it is possible that Wachovia Corporation (domiciled in the Fourth District of the FHLBank System) could terminate World Savings’ Ninth District charter in the future. While this is a possibility, the Bank has received no indication to date that this will occur.
pricing. In the event the Bank were to lose one or more large borrowers that represent a significant proportion of its business, it could, depending onupon the magnitude of the impact, lower dividend rates, raise advances rates, attempt to reduce operating expenses (which could cause a reduction in service levels), or undertake some combination of these actions. For the reasons cited above, the Bank would expect the impact of a significant reduction in advances to WFSC (or any other large borrower) to be negative. However, the Bank believes its ability to adjust its capital levels in response to any reduction in advances outstanding would mitigate to some extent the negative impact on the Bank’s shareholders. The following table presents information regarding the composition of the Bank’s advances by remaining term to maturity as of December 31, 20062009 and 2005.2008. COMPOSITION OF ADVANCES (Dollars in millions) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | December 31, 2006 | | December 31, 2005 | | | December 31, 2009 | | December 31, 2008 | | | | Percentage | | Percentage | | | Percentage | | Percentage | | | | Balance | | of Total | | Balance | | of Total | | | Balance | | of Total | | Balance | | of Total | | Fixed rate advances | | | Maturity less than one month | | $ | 11,801 | | | 28.7 | % | | $ | 10,515 | | | 22.6 | % | | $ | 5,164 | | | 11.0 | % | | $ | 10,745 | | | 17.8 | % | Maturity 1 month to 12 months | | 2,642 | | 6.4 | | 3,680 | | 7.9 | | | 4,232 | | 9.0 | | 3,404 | | 5.6 | | Maturity greater than 1 year | | 3,287 | | 8.0 | | 3,487 | | 7.5 | | | 5,602 | | 12.0 | | 7,446 | | 12.4 | | Fixed rate, amortizing | | 4,604 | | 11.2 | | 5,662 | | 12.2 | | | 3,282 | | 7.0 | | 3,654 | | 6.1 | | Fixed rate, putable | | 1,043 | | 2.5 | | 1,375 | | 3.0 | | | 4,037 | | 8.6 | | 4,201 | | 7.0 | | | | | | | | | | | | | | | | | | | | | Total fixed rate advances | | 23,377 | | 56.8 | | 24,719 | | 53.2 | | | 22,317 | | 47.6 | | 29,450 | | 48.9 | | | | | | | | | | | | | Floating rate advances | | | Maturity less than one month | | 160 | | 0.4 | | 837 | | 1.8 | | | 11 | | — | | 390 | | 0.6 | | Maturity 1 month to 12 months | | 4,741 | | 11.5 | | 6,641 | | 14.3 | | | 5,052 | | 10.8 | | 5,695 | | 9.5 | | Maturity greater than 1 year | | 12,908 | | 31.3 | | 14,291 | | 30.7 | | | 19,528 | | 41.6 | | 24,710 | | 41.0 | | | | | | | | | | | | | | | | | | | | | Total floating rate advances | | 17,809 | | 43.2 | | 21,769 | | 46.8 | | | 24,591 | | 52.4 | | 30,795 | | 51.1 | | | | | | | | | | | | | | | | | | | | | Total par value | | $ | 41,186 | | | 100.0 | % | | $ | 46,488 | | | 100.0 | % | | $ | 46,908 | | | 100.0 | % | | $ | 60,245 | | | 100.0 | % | | | | | | | | | | | | | | | | | | | |
The Bank is required by statute and regulation to obtain sufficient collateral from members to fully secure all advances. The Bank’s collateral arrangements with its members and the types of collateral it accepts to secure advances are described in Item 1 — Business. To ensure the value of collateral pledged to the Bank is sufficient to secure its advances, the Bank applies various haircuts, or discounts, to determine the value of the collateral against which members may borrow. From time to time, the Bank reevaluates the adequacy of its collateral haircuts under a range of stress scenarios to ensure that its collateral haircuts are sufficient to protect the Bank from credit losses on advances. In addition, as described in Item 1 — Business, the Bank reviews the financial condition of its depository institution members on at least a quarterly basis to identify any members whose financial condition indicates they might pose 55
an increased credit risk and, as needed, takes appropriate action. The Bank has not experienced any credit losses on advances since it was founded in 1932 norand, based on its credit extension and collateral policies, management currently does management currentlynot anticipate any credit losses on advances. Accordingly, the Bank has not provided any allowance for losses on advances. 37
Investment SecuritiesShort-Term Liquidity Portfolio
At December 31, 2006 and 2005,2009, the Bank’s short-term investments, which wereliquidity portfolio was comprised entirelyof $2.1 billion of overnight federal funds sold to domestic counterparties totaled $5.5and $3.6 billion and $7.9 billion, respectively. Duringof non-interest bearing excess cash balances held at the year endedFederal Reserve Bank of Dallas. At December 31, 2006,2008, the balanceBank’s short-term liquidity portfolio was comprised of $1.9 billion of overnight federal funds sold to domestic counterparties and $3.6 billion of interest-bearing deposits at the Federal Reserve Bank of Dallas. The amount of the Bank’s short-term investments fluctuatedliquidity portfolio fluctuates in response to several factors, including the level of maturingprojected demand for advances, from time to time, changes in the Bank’s deposit balances, andthe Bank’s pre-funding activities, changes in the returns provided by short-term investment returnsalternatives relative to the Bank’s discount note funding costs. costs, and the level of liquidity needed to satisfy Finance Agency requirements. (For a discussion of the Finance Agency’s liquidity requirements, see the section below entitled “Liquidity and Capital Resources.”) Long-Term Investments At December 31, 2006,2009 and 2008, the Bank’s long-term investment portfolio was comprised of approximately $7.7$11.3 billion and $11.7 billion, respectively, of MBSmortgage-backed securities (“MBS”) and $0.2$0.1 billion and $0.1 billion, respectively, of U.S. agency debentures. At December 31, 2005, the Bank’s long-term investment portfolio was comprised of $9.0 billion of MBS and $0.3 billion of U.S. agency debentures. The Bank’s long-term investment portfolio includes securities that are classified for balance sheet purposes as either held-to-maturity available-for-sale or tradingavailable-for-sale as set forth in the following tables and as further described below.tables. 56
COMPOSITION OF LONG-TERM INVESTMENT PORTFOLIO (In millions of dollars) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Balance Sheet Classification | | | | | | | Balance Sheet Classification | | Total Long-Term | | | | | | Held-to-Maturity | | Available-for-Sale | | Trading | | Total Investments | | Held-to-Maturity | | | Held-to-Maturity | | Available-for-Sale | | Investments | | Held-to-Maturity | | December 31, 2006 | | (at amortized cost) | | (at fair value) | | (at fair value) | | (at carrying value) | | (at fair value) | | | December 31, 2009 | | | (at carrying value) | | (at fair value) | | (at carrying value) | | (at fair value) | | U.S. agency debentures | | | U.S. government guaranteed obligations | | $ | 87 | | $ | — | | $ | — | | $ | 87 | | $ | 87 | | | $ | 59 | | $ | — | | $ | 59 | | $ | 59 | | Government-sponsored enterprises | | — | | 51 | | — | | 51 | | — | | | FHLBank consolidated obligations(1) | | | FHLBank of Boston (primary obligor) | | — | | 35 | | — | | 35 | | — | | | FHLBank of San Francisco (primary obligor) | | — | | 7 | | — | | 7 | | — | | | | | | | | | | | | | | | | | | | Total U.S. agency debentures | | 87 | | 93 | | — | | 180 | | 87 | | | | | | | | | | | | | | | | | | | MBS portfolio | | | U.S. government guaranteed obligations | | 44 | | — | | — | | 44 | | 44 | | | 24 | | — | | 24 | | 24 | | Government-sponsored enterprises | | 5,163 | | 433 | | 22 | | 5,618 | | 5,186 | | | 10,838 | | — | | 10,838 | | 10,863 | | Non-agency residential MBS | | 1,135 | | — | | — | | 1,135 | | 1,136 | | | 445 | | — | | 445 | | 376 | | Non-agency commercial MBS | | 760 | | 189 | | — | | 949 | | 781 | | | 56 | | — | | 56 | | 57 | | | | | | | | | | | | | | | | | | | | | | | | | | Total MBS | | 7,102 | | 622 | | 22 | | 7,746 | | 7,147 | | | 11,363 | | — | | 11,363 | | 11,320 | | | | | | | | | | | | | | | | | | | | | | | | | | State or local housing agency debentures | | 6 | | — | | — | | 6 | | 6 | | | Other | | — | | — | | 2 | | 2 | | — | | | State housing agency debenture | | | 3 | | — | | 3 | | 3 | | | | | | | | | | | | | | | | | | | | | | | | | | Total long-term investments | | $ | 7,195 | | $ | 715 | | $ | 24 | | $ | 7,934 | | $ | 7,240 | | | $ | 11,425 | | $ | — | | $ | 11,425 | | $ | 11,382 | | | | | | | | | | | | | | | | | | | | | | | | | | | | Balance Sheet Classification | | Total Long-Term | | | | | | | Held-to-Maturity | | Available-for-Sale | | Investments | | Held-to-Maturity | | December 31, 2008 | | | (at carrying value) | | (at fair value) | | (at carrying value) | | (at fair value) | | U.S. agency debentures | | | U.S. government guaranteed obligations | | | $ | 66 | | $ | — | | $ | 66 | | $ | 66 | | | | | MBS portfolio | | | U.S. government guaranteed obligations | | | 29 | | — | | 29 | | 28 | | Government-sponsored enterprises | | | 10,629 | | 99 | | 10,728 | | 10,386 | | Non-agency residential MBS | | | 677 | | — | | 677 | | 400 | | Non-agency commercial MBS | | | 297 | | 28 | | 325 | | 287 | | | | | | | | | | | | | | | | Total MBS | | | 11,632 | | 127 | | 11,759 | | 11,101 | | | | | | | | | | | | | | | | State housing agency debenture | | | 4 | | — | | 4 | | 3 | | | | | | | | | | | | | | | | Total long-term investments | | | $ | 11,702 | | $ | 127 | | $ | 11,829 | | $ | 11,170 | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | Balance Sheet Classification | | | | | | | | | | Held-to-Maturity | | | Available-for-Sale | | | Trading | | | Total Investments | | | Held-to-Maturity | | December 31, 2005 | | (at amortized cost) | | | (at fair value) | | | (at fair value) | | | (at carrying value) | | | (at fair value) | | U.S. agency debentures | | | | | | | | | | | | | | | | | | | | | U.S. government guaranteed obligations | | $ | 165 | | | $ | — | | | $ | — | | | $ | 165 | | | $ | 164 | | Government-sponsored enterprises | | | — | | | | 88 | | | | — | | | | 88 | | | | — | | FHLBank consolidated obligations(1) | | | | | | | | | | | | | | | | | | | | | FHLBank of Boston (primary obligor) | | | — | | | | 36 | | | | — | | | | 36 | | | | — | | FHLBank of San Francisco (primary obligor) | | | — | | | | 7 | | | | — | | | | 7 | | | | — | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total U.S. agency debentures | | | 165 | | | | 131 | | | | — | | | | 296 | | | | 164 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | MBS portfolio | | | | | | | | | | | | | | | | | | | | | U.S. government guaranteed obligations | | | 61 | | | | — | | | | — | | | | 61 | | | | 61 | | Government-sponsored enterprises | | | 5,575 | | | | 643 | | | | 44 | | | | 6,262 | | | | 5,589 | | Non-agency residential MBS | | | 1,606 | | | | — | | | | — | | | | 1,606 | | | | 1,607 | | Non-agency commercial MBS | | | 791 | | | | 241 | | | | — | | | | 1,032 | | | | 831 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total MBS | | | 8,033 | | | | 884 | | | | 44 | | | | 8,961 | | | | 8,088 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | State or local housing agency debentures | | | 7 | | | | — | | | | — | | | | 7 | | | | 7 | | Other | | | — | | | | — | | | | 2 | | | | 2 | | | | — | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total long-term investments | | $ | 8,205 | | | $ | 1,015 | | | $ | 46 | | | $ | 9,266 | | | $ | 8,259 | | | | | | | | | | | | | | | | | |
Prior to June 30, 2008, the Bank was precluded from purchasing additional MBS if such purchase would cause the aggregate book value of its MBS holdings to exceed 300 percent of the Bank’s total regulatory capital (an amount equal to the Bank’s retained earnings plus amounts paid in for Class B stock, regardless of its classification as equity or liabilities for financial reporting purposes). On March 24, 2008, the Board of Directors of the Finance Board passed a resolution that authorizes each FHLBank to temporarily invest up to an additional 300 percent of its total capital in agency mortgage securities. The resolution required, among other things, that a FHLBank notify the Finance Board (now Finance Agency) prior to its first acquisition under the expanded authority and include in its notification a description of the risk management practices underlying its purchases. The expanded authority is limited to MBS issued by, or backed by pools of mortgages guaranteed by, the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac”), including CMOs or real estate mortgage investment conduits backed by such MBS. The mortgage loans underlying any securities that are purchased under this expanded authority must be originated after January 1, 2008, and underwritten to conform to standards imposed by the federal banking agencies in theInteragency Guidance on Nontraditional Mortgage Product Risksdated October 4, 2006, and theStatement on Subprime Mortgage Lendingdated July 10, 2007.On April 23, 2008, the Bank’s Board of Directors authorized an increase in the Bank’s MBS investment authority of 100 percent of its total regulatory capital. In accordance with the provisions of the resolution and Advisory Bulletin 2008-AB-01,“Temporary Increase in Mortgage-Backed Securities Investment Authority”dated April 3, 2008 (“AB 2008-01”), the Bank notified the Finance Board’s Office of Supervision on April 29, 2008 of its intent to exercise the new investment authority in an amount up to an additional 100 percent of capital. On June 30, 2008, the Office of Supervision approved the Bank’s submission, thereby raising the Bank’s MBS investment authority from 300 percent to 400 percent of its total regulatory capital. | | | (1) | | Represents consolidated obligations acquired in the secondary market for which the named FHLBank is the primary obligor, and for which each of the FHLBanks, including the Bank, is jointly and severally liable. |
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AtThe Bank’s expanded investment authority granted by this authorization is scheduled to expire on March 31, 2010, after which the Bank may not purchase additional mortgage securities if such purchases would cause the aggregate book value of its MBS holdings to exceed an amount equal to 300 percent of its total capital provided, however, that the expiration of the expanded investment authority will not require the Bank to sell any agency mortgage securities it had purchased in accordance with the terms of the resolution. The Bank has submitted a request to the Finance Agency seeking to maintain its investment authority at an amount equal to 400 percent of its total regulatory capital for a period up to an additional three years. The Bank is unable to predict whether the Finance Agency will approve this request.
As of December 31, 20062009, the Bank held $11.3 billion (carrying value) of MBS, which represented 392 percent of its total regulatory capital at that date. While the Bank currently has capacity under applicable policies and 2005, the Bank’s portfolio ofregulations to purchase additional U.S. agency debentures, included $42 million and $43 million, respectively, of FHLBank consolidated obligations, the primary obligors of which are other FHLBanks and for which the Bank is jointly and severally liable (see Item 1 - Business). From time to time, the Bank purchasesit does not currently anticipate purchasing such consolidated obligationssecurities in the secondary market when the returns available on these securities meet the Bank’s investment criteria. This occurs, albeit infrequently, when net returns in the secondary market for certain consolidated obligations issued by other FHLBanks, combined with offsetting interest rate swaps that convert the consolidated obligation coupons to LIBOR floating rates, exceed the net cost of newly issued consolidated obligations likewise converted to LIBOR floating rates with interest rate swaps. All of the Bank’s investments in these securities occurred in the mid to late 1990s when a significant amount of consolidated obligations were frequently made available for purchase in the secondary market. The Bank purchased some of those securities and simultaneously entered into interest rate swaps to convert the coupons to LIBOR floating rates. The Bank’s current holdings of consolidated obligations issued by other FHLBanks include approximately $7 million of bonds with complex coupons swapped to an average yield of three-month LIBOR plus 8 basis points, and $35 million of a fixed rate, non-callable bond swapped to a yield of three-month LIBOR minus 5 basis points.
Finance Board regulations prohibit the direct placement of consolidated obligations with any FHLBank at issuance. A related regulatory interpretation issued by the Finance Board on March 30, 2005 clarifies that this prohibition applies equally to purchases of consolidated obligations directly from the Office of Finance or indirectly from an underwriter of FHLBank debt. All of the Bank’s purchases of consolidated obligations were made in the secondary market. The Bank has never purchased consolidated obligations issued by another FHLBank at issuance, either directly through the Office of Finance or indirectly from an underwriter of FHLBank debt. Therefore, this prohibition does not affect the Bank’s existing investments in FHLBank consolidated obligations. The Regulatory Interpretation also notes that investing in consolidated obligations is not a core mission activity for the FHLBanks as such activities are defined by the regulations. However, neither Finance Board regulations nor related guidance currently limit the amount of the Bank’s investments in consolidated obligations, and the regulations specifically exclude obligations of other FHLBanks from the limits that otherwise apply to unsecured extensions of credit to GSEs. Because investments in consolidated obligations are not a part of the Bank’s current investment strategy, the Bank does not believe that this regulatory interpretation will have a material impact on either its current or future investment activities.
At December 31, 2006, all of the Bank’s holdings of mortgage-backed securities retained the highest investment grade rating.foreseeable future.
During the year ended December 31, 2006,2009, the Bank acquired $575 million$2.9 billion ($3.0 billion par value) of long-term investments, all of which were capped LIBOR-indexed floating rate Collateralized Mortgage Obligations (“CMOs”)CMOs issued by either Fannie Mae or Freddie Mac that the Bank designated as held-to-maturity;held-to-maturity. As further described below, the floating rate coupons of these securities are subject to interest rate caps. During the year, proceeds from maturities of long-term securities designated as held-to-maturity and available-for-sale totaled approximately $3.2 billion and $42.5 million, respectively. In March 2009, the Bank sold an available-for-sale security (specifically, a government-sponsored enterprise mortgage-backed security) with an amortized cost (determined by the specific identification method) of $86.2 million. Proceeds from the sale totaled $87.0 million, resulting in a gross realized gain of $0.8 million. The Bank did not sell any other long-term investments during the year ended December 31, 2009. During the year ended December 31, 2008, the Bank acquired (based on trade date) $6.180 billion of long-term investments, all of which had settled as of December 31, 2008. The Bank acquired $5.830 billion ($5.996 billion par value) of LIBOR-indexed floating rate CMOs issued by either Fannie Mae or Freddie Mac that it designated as held-to-maturity and one LIBOR-indexed floating rate CMO issued by Fannie Mae (a $97.7 million par value security that the Bank acquired in June 2008 at a cost of $93.3 million), which the Bank classified as available-for-sale. In addition, during the first quarter of 2008, the Bank purchased $257 million ($250 million par value) of U.S. agency debentures; these investments were classified as available-for-sale and hedged with fixed-for-floating interest rate swaps. In April 2008, the Bank sold all of the U.S. agency debentures that it had acquired during the first quarter of 2008 and terminated the associated interest rate swaps. The realized gains on the sales of these available-for-sale securities totaled $2.8 million. This action was taken in response to favorable opportunities in the market at that time. In addition, on October 29, 2008, the Bank sold a U.S. agency debenture classified as available-for-sale. Proceeds from the sale totaled $56.5 million, resulting in a realized loss at the time of sale of $3.7 million, of which $2.5 million had been recognized in the third quarter of 2008 as an other-than-temporary impairment charge because the Bank no longer had the intent as of September 30, 2008 to hold this security through to recovery of the unrealized loss. At September 30, 2008, the amortized cost of this security exceeded its estimated fair value at that date by $2.5 million. The Bank did not sell any other long-term investments during the year ended December 31, 2008; during this same period, the proceeds from maturities of long-term securities designated as held-to-maturity and available-for-sale totaled approximately $1.6 billion. $1.7 billion and $268 million, respectively. During the year ended December 31, 2005,2007, the Bank acquired $2.7(based on trade date) $1.6 billion of long-term investments, all of which were capped LIBOR-indexed floating rate CMOs issued by either Fannie Mae or Freddie Mac that it designated as held-to-maturity; during this same year, the proceeds from maturities of long-term securities designated as held-to-maturity and available-for-sale totaled approximately $1.7 billion. In 2004, the$1.2 billion and $354 million, respectively. The Bank purchased $2.1 billion of capped LIBOR-indexed floating rate CMOs designated as held-to-maturity. During 2004, the proceeds from maturities of securities designated as held-to-maturity totaled approximately $1.9 billion. When purchasing securities to add to its investment portfolio, the Bank generally purchases floating rate CMOs and other floating rate MBS whose coupons are indexed to LIBOR because their coupons better match the coupons of the Bank’s debt after it is swapped to LIBOR. During the third quarter of 2005, the Bank sold $4.1 billion (par value) of U.S. agency debentures classified as available-for-sale. Proceeds from these sales totaled $4.5 billion, resulting in net realized gains of $245.4 million. Prior to their sale, all of these available-for-sale securities had been hedged with fixed-for-floating interest rate swaps. Concurrent with the sales, the Bank terminated the associated interest rate swaps. Prior to termination, the losses associated with the interest rate swaps were already reflected in the Bank’s earnings; at the date of termination, these previously unrealized losses were realized. There were no sales ofdid not sell any available-for-sale securities during 2006 or 2004.
As discussed more fully in its Amended Form 10, the Bank determined in August 2005 that it was necessary to restate certain of its previously issued financial statements to correct errors relating to the application of SFAS 133.
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Among other corrections, the Bank reversed the periodic changes in fair value attributable to the hedged risk on $1.440 billion (par value) of available-for-sale securities (specifically, U.S. agency debentures) that had previously been recognized in earnings and recorded such changes in fair value in other comprehensive income. The gains that were reclassified from earnings to other comprehensive income through March 31, 2005 and the subsequent accounting for the related interest rate swaps as stand-alone derivatives caused the Bank’s retained earnings to be negative as of June 30, 2005. In order to restore the Bank’s retained earnings to a positive balance, the Bank sold substantially all of the then remaining subject available-for-sale securities ($1.2 billion par value) in August 2005. These transactions allowed the Bank to recognize in earnings the gains on the available-for-sale securities that had become trapped (i.e., recorded) in other comprehensive income as a result of the loss of hedge accounting. The sale of these securities produced a net realized gain of $195.5 million.
In September 2005, the Bank determined that it was economically advantageous to sell an additional $2.9 billion (par value) of available-for-sale securities which, at that time, represented a substantial portion of its then remaining U.S. agency debentures. These transactions produced a net realized gain of $49.9 million.2007.
The following table provides the par amounts and carrying values of the Bank’s MBS portfolio as of December 31, 20062009 and 2005.2008. 58
COMPOSITION OF MBS PORTFOLIO (In millions of dollars) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | December 31, 2006 | | December 31, 2005 | | | December 31, 2009 | | December 31, 2008 | | | | Par(1) | | Carrying Value | | Par(1) | | Carrying Value | | | Par(1) | | Carrying Value | | Par(1) | | Carrying Value | | Floating rate MBS | | | Floating rate CMOs | | | U.S. government guaranteed | | $ | 44 | | $ | 44 | | $ | 61 | | $ | 61 | | | $ | 24 | | $ | 24 | | $ | 29 | | $ | 29 | | Government-sponsored enterprises | | 5,157 | | 5,156 | | 5,567 | | 5,566 | | | 10,985 | | 10,835 | | 10,880 | | 10,714 | | AAA rated non-agency residential | | 1,135 | | 1,135 | | 1,606 | | 1,606 | | | Non-agency RMBS | | | 515 | | 445 | | 677 | | 677 | | | | | | | | | | | | | | | | | | | | | Total floating rate CMOs | | 6,336 | | 6,335 | | 7,234 | | 7,233 | | | 11,524 | | 11,304 | | 11,586 | | 11,420 | | | | | | | | | | | | | | | | | | | | | | | | Interest rate swapped MBS(2) | | | AAA rated non-agency CMBS(3) | | 186 | | 189 | | 233 | | 241 | | | Triple-A rated non-agency CMBS (3) | | | — | | — | | 29 | | 28 | | Government-sponsored enterprise DUS(4) | | 400 | | 403 | | 579 | | 592 | | | — | | — | | 10 | | 10 | | Government-sponsored enterprise CMOs | | 52 | | 52 | | 93 | | 95 | | | | | | | | | | | | | | | | | | | | | | Total swapped MBS | | 638 | | 644 | | 905 | | 928 | | | — | | — | | 39 | | 38 | | | | | | | | | | | | | | | | | | | | | Total floating rate MBS | | 6,974 | | 6,979 | | 8,139 | | 8,161 | | | 11,524 | | 11,304 | | 11,625 | | 11,458 | | | | | | | | | | | | | | | | | | | | | | | | Fixed rate MBS | | | Government-sponsored enterprises | | 7 | | 7 | | 9 | | 9 | | | 3 | | 3 | | 4 | | 4 | | AAA rated non-agency CMBS(5) | | 759 | | 760 | | 791 | | 791 | | | Triple-A rated non-agency CMBS(5) | | | 56 | | 56 | | 297 | | 297 | | | | | | | | | | | | | | | | | | | | | Total fixed rate MBS | | 766 | | 767 | | 800 | | 800 | | | 59 | | 59 | | 301 | | 301 | | | | | | | | | | | | | | | | | | | | | | | | Total MBS | | $ | 7,740 | | $ | 7,746 | | $ | 8,939 | | $ | 8,961 | | | $ | 11,583 | | $ | 11,363 | | $ | 11,926 | | $ | 11,759 | | | | | | | | | | | | | | | | | | | | |
| | | (1) | | Balances represent the principal amounts of the securities. | | (2) | | In the interest rate swapped MBS transactions, the Bank hashad entered into balance guaranteedbalance-guaranteed interest rate swaps in which it payspaid the swap counterparty the coupon payments of the underlying security in exchange for LIBOR indexedLIBOR-indexed coupons. | | (3) | | CMBS = Commercial mortgage-backed securities. | | (4) | | DUS = Designated Underwriter Servicer. | | (5) | | The Bank match funded these CMBS at the time of purchase with fixed rate debt securities. |
The Bank may purchase mortgage-backed securities issued by a shareholder or an affiliate thereof.Unrealized losses on the Bank’s MBS classified as held-to-maturity decreased from $557 million at December 31, 2008 to $188 million at December 31, 2009. The Bank did not purchasehave any securities classified as available-for-sale at December 31, 2009. At December 31, 2008, unrealized losses on the Bank’s MBS classified as available-for-sale totaled $1.7 million. The following table sets forth the unrealized losses on the Bank’s MBS portfolio as of December 31, 2009 and 2008.
UNREALIZED LOSSES ON MBS PORTFOLIO (dollars in millions) | | | | | | | | | | | | | | | | | | | December 31, 2009 | | | December 31, 2008 | | | | Gross | | | Unrealized Losses | | | Gross | | | Unrealized Losses | | | | Unrealized | | | as Percentage of | | | Unrealized | | | as Percentage of | | | | Losses | | | Amortized Cost | | | Losses | | | Amortized Cost | | Government guaranteed | | $ | — | | | | 0.3% | | | $ | 1 | | | | 2.8% | | Government-sponsored enterprises | | | 53 | | | | 0.5% | | | | 270 | | | | 2.5% | | Non-agency residential MBS | | | 135 | | | | 26.5% | | | | 277 | | | | 40.9% | | Non-agency commercial MBS | | | — | | | | 0.0% | | | | 11 | | | | 3.4% | | | | | | | | | | | | | | | | | | | | | | | | | �� | | | | | | | | | | | $ | 188 | | | | | | | $ | 559 | | | | | | | | | | | | | | | | | | | | |
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The Bank evaluates outstanding available-for-sale and held-to-maturity securities in an unrealized loss position as of the end of each quarter for other-than-temporary impairment (“OTTI”). An investment security is impaired if the fair value of the investment is less than its amortized cost. All of the Bank’s held-to-maturity securities are rated by one or more of the following NRSROs: Moody’s, S&P and/or Fitch Ratings, Ltd. (“Fitch”). With the exception of 20 non-agency (i.e., private label) residential mortgage-backed securities, issuedas presented below, none of these organizations had rated any of the securities held by shareholders or their affiliates during the years endedBank lower than the highest investment grade credit rating at December 31, 20062009. Based upon the Bank’s assessment of the creditworthiness of the issuers of the debentures held by the Bank, the credit ratings assigned by the NRSROs and the strength of the government-sponsored enterprises’ guarantees of the Bank’s holdings of agency mortgage-backed securities, the Bank expects that its holdings of U.S. government guaranteed debentures, state housing agency debentures, U.S. government guaranteed MBS and government-sponsored enterprise MBS that were in an unrealized loss position as of December 31, 2009 would not be settled at an amount less than the Bank’s amortized cost bases in these investments. Because the declines in market value for these securities are not attributable to credit quality, and because the Bank does not intend to sell the investments and it is not more likely than not that the Bank will be required to sell the investments before recovery of their amortized cost bases, the Bank does not consider any of these investments to be other-than-temporarily impaired at December 31, 2009. As of December 31, 2009, the gross unrealized losses on the Bank’s holdings of non-agency residential MBS (“RMBS”) totaled $135 million, which represented 26.5 percent of the securities’ amortized cost at that date. The deterioration in the U.S. housing markets, as reflected by declines in the values of residential real estate and increasing levels of delinquencies, defaults and losses on residential mortgages, including the mortgages underlying the Bank’s non-agency RMBS, has generally elevated the risk that the Bank may not ultimately recover the entire cost bases of some of its non-agency RMBS. Despite the elevated risk, based on its analysis of the securities in this portfolio, the Bank believes that the unrealized losses noted above were principally the result of significant (albeit reduced) liquidity risk-related discounts in the non-agency RMBS market and do not accurately reflect the actual historical or 2004. Duringcurrently likely future credit performance of the securities. As noted above, all of the Bank’s held-to-maturity securities are rated by one or more NRSROs. The following table presents the credit ratings assigned to the Bank’s non-agency RMBS as of December 31, 2009 (dollars in thousands). The credit ratings presented in the table represent the lowest rating assigned to the security by Moody’s, S&P or Fitch and remain unchanged as of March 15, 2010. | | | | | | | | | | | | | | | | | | | | | Credit Rating | | Number of Securities | | | Amortized Cost | | | Carrying Value | | | Estimated Fair Value | | | Unrealized Losses | | Triple-A | | | 20 | | | $ | 205,906 | | | $ | 205,906 | | | $ | 184,462 | | | $ | 21,444 | | Double-A | | | 5 | | | | 51,717 | | | | 51,717 | | | | 35,511 | | | | 16,206 | | Single-A | | | 2 | | | | 38,623 | | | | 38,623 | | | | 25,932 | | | | 12,691 | | Triple-B | | | 5 | | | | 72,033 | | | | 61,374 | | | | 40,583 | | | | 31,450 | | Double-B | | | 4 | | | | 40,376 | | | | 29,529 | | | | 23,300 | | | | 17,076 | | Single-B | | | 3 | | | | 58,804 | | | | 29,035 | | | | 33,042 | | | | 25,762 | | Triple-C | | | 1 | | | | 43,923 | | | | 28,614 | | | | 33,286 | | | | 10,637 | | | | | | | | | | | | | | | | | | Total | | | 40 | | | $ | 511,382 | | | $ | 444,798 | | | $ | 376,116 | | | $ | 135,266 | | | | | | | | | | | | | | | | | |
At December 31, 2009, the Bank’s portfolio of non-agency RMBS was comprised of 40 securities with an aggregate unpaid principal balance of $515 million: 21 securities with an aggregate unpaid principal balance of $267 million are backed by fixed rate loans and 19 securities with an aggregate unpaid principal balance of $248 million are backed by option adjustable-rate mortgage (“option ARM”) loans. In comparison, as of December 31, 2008, the Bank’s non-agency RMBS portfolio was comprised of 42 securities with an aggregate unpaid principal balance of $677 million (the securities backed by fixed rate loans had an aggregate unpaid principal balance of $395 million while the securities backed by option ARM loans had an aggregate unpaid principal balance of $282 million). All of these investments are classified as held-to-maturity securities. The following table provides a summary of the Bank’s non-agency RMBS as of December 31, 2009 by collateral type and year of securitization. 60
NON-AGENCY RMBS BY UNDERLYING COLLATERAL TYPE (dollars in millions) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Credit Enhancement Statistics | | | | | | | | Unpaid | | | | | | | | | | | | | | | Weighted Average | | | Current | | | Original | | | | | | | Number of | | | Principal | | | Amortized | | | Estimated | | | Unrealized | | | Collateral | | | Weighted | | | Weighted | | | Minimum | | Year of Securitization | | Securities | | | Balance | | | Cost | | | Fair Value | | | Losses | | | Delinquency(1)(2) | | | Average (1)(3) | | | Average(1) | | | Current(4) | | Fixed Rate Collateral 2006 | | | 1 | | | $ | 46 | | | $ | 44 | | | $ | 33 | | | $ | 11 | | | | 12.04 | % | | | 8.58 | % | | | 8.89 | % | | | 8.58 | % | 2005 | | | 1 | | | | 31 | | | | 31 | | | | 22 | | | | 9 | | | | 8.80 | % | | | 10.33 | % | | | 6.84 | % | | | 10.33 | % | 2004 | | | 5 | | | | 37 | | | | 37 | | | | 34 | | | | 3 | | | | 4.14 | % | | | 18.38 | % | | | 6.00 | % | | | 16.14 | % | 2003 | | | 11 | | | | 141 | | | | 141 | | | | 130 | | | | 11 | | | | 0.87 | % | | | 6.74 | % | | | 3.98 | % | | | 5.01 | % | 2002 and prior | | | 3 | | | | 12 | | | | 12 | | | | 11 | | | | 1 | | | | 6.40 | % | | | 20.92 | % | | | 4.46 | % | | | 16.73 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 21 | | | | 267 | | | | 265 | | | | 230 | | | | 35 | | | | 4.41 | % | | | 9.71 | % | | | 5.45 | % | | | 5.01 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Option ARM Collateral 2005 | | | 17 | | | | 234 | | | | 232 | | | | 138 | | | | 94 | | | | 31.94 | % | | | 47.98 | % | | | 42.56 | % | | | 30.13 | % | 2004 | | | 2 | | | | 14 | | | | 14 | | | | 8 | | | | 6 | | | | 31.02 | % | | | 37.41 | % | | | 30.08 | % | | | 34.10 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 19 | | | | 248 | | | | 246 | | | | 146 | | | | 100 | | | | 31.89 | % | | | 47.39 | % | | | 41.86 | % | | | 30.13 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total non-agency RMBS | | | 40 | | | $ | 515 | | | $ | 511 | | | $ | 376 | | | $ | 135 | | | | 17.65 | % | | | 27.86 | % | | | 22.99 | % | | | 5.01 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | (1) | | Weighted average percentages are computed based upon unpaid principal balances. | | (2) | | Collateral delinquency reflects the percentage of underlying loans that are 60 or more days past due, including loans in foreclosure and real estate owned; as of December 31, 2009, actual cumulative loan losses in the pools of loans underlying the Bank’s non-agency RMBS portfolio ranged from 0 percent to 5.71 percent. | | (3) | | Current credit enhancement percentages reflect the ability of subordinated classes of securities to absorb principal losses and interest shortfalls before the senior classes held by the Bank are impacted (i.e., the losses, expressed as a percentage of the outstanding principal balances, that could be incurred in the underlying loan pools before the securities held by the Bank would be impacted, assuming that all of those losses occurred on the measurement date). Depending upon the timing and amount of losses in the underlying loan pool, it is possible that the senior classes held by the Bank could bear losses in scenarios where the cumulative loan losses do not exceed the current credit enhancement percentage. | | (4) | | Minimum credit enhancement reflects the security in each vintage year with the lowest current credit enhancement. |
The following table provides the geographic concentration by state of the loans underlying the Bank’s non-agency RMBS as of December 31, 2009. GEOGRAPHIC CONCENTRATION OF LOANS UNDERLYING NON-AGENCY RMBS BY COLLATERAL TYPE | | | | | Fixed Rate Collateral | | | | | California | | | 38.6 | % | New York | | | 5.9 | | Florida | | | 5.4 | | Texas | | | 3.6 | | Virginia | | | 2.3 | | All other | | | 44.2 | | | | | | | | | | | | | | 100.0 | % | | | | |
| | | | | Option ARM Collateral | | | | | California | | | 61.7 | % | Florida | | | 9.8 | | New York | | | 3.3 | | Nevada | | | 2.1 | | Virginia | | | 2.0 | | All other | | | 21.1 | | | | | | | | | | | | | | 100.0 | % | | | | |
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As of December 31, 2009, the Bank held six non-agency RMBS with an aggregate unpaid principal balance of $92 million that were labeled as Alt-A at the time of issuance. Four of the six Alt-A securities (with an aggregate unpaid principal balance of $51 million) are backed by fixed rate loans while the other two securities (with an aggregate unpaid principal balance of $41 million) are backed by option ARM loans. The Bank does not hold any MBS that were labeled as subprime at the time of issuance. The following table provides a summary as of December 31, 2009 of the Bank’s non-agency RMBS that were classified as Alt-A at the time of issuance. SECURITIES LABELED AS ALT-A AT THE TIME OF ISSUANCE (dollars in millions) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Credit Enhancement Statistics | | | | | | | | Unpaid | | | | | | | | | | | | | | | Weighted Average | | | Current | | | Original | | | | | | | Number of | | | Principal | | | Amortized | | | Estimated | | | Unrealized | | | Collateral | | | Weighted | | | Weighted | | | Minimum | | Year of Securitization | | Securities | | | Balance | | | Cost | | | Fair Value | | | Losses | | | Delinquency(1)(2) | | | Average (1)(3) | | | Average | | | Current(4) | | 2005 | | | 3 | | | $ | 72 | | | $ | 71 | | | $ | 44 | | | $ | 27 | | | | 28.14 | % | | | 29.44 | % | | | 25.41 | % | | | 10.33 | % | 2004 | | | 1 | | | | 8 | | | | 8 | | | | 8 | | | | — | | | | 8.69 | % | | | 23.65 | % | | | 6.85 | % | | | 23.65 | % | 2002 and prior | | | 2 | | | | 12 | | | | 12 | | | | 11 | | | | 1 | | | | 6.65 | % | | | 20.22 | % | | | 4.55 | % | | | 16.73 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total | | | 6 | | | $ | 92 | | | $ | 91 | | | $ | 63 | | | $ | 28 | | | | 23.65 | % | | | 27.74 | % | | | 21.08 | % | | | 10.33 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | (1) | | Weighted average percentages are computed based upon unpaid principal balances. | | (2) | | Collateral delinquency reflects the percentage of underlying loans that are 60 or more days past due, including loans in foreclosure and real estate owned; as of December 31, 2009, actual cumulative loan losses in the pools of loans underlying the securities presented in the table ranged from 0.18 percent to 3.12 percent. | | (3) | | Current credit enhancement percentages reflect the ability of subordinated classes of securities to absorb principal losses and interest shortfalls before the senior classes held by the Bank are impacted (i.e., the losses, expressed as a percentage of the outstanding principal balances, that could be incurred in the underlying loan pools before the securities held by the Bank would be impacted, assuming that all of those losses occurred on the measurement date). Depending upon the timing and amount of losses in the underlying loan pool, it is possible that the senior classes held by the Bank could bear losses in scenarios where the cumulative loan losses do not exceed the current credit enhancement percentage. | | (4) | | Minimum credit enhancement reflects the security in each vintage year with the lowest current credit enhancement. |
Because the ultimate receipt of contractual payments on the Bank’s non-agency RMBS will depend upon the credit and prepayment performance of the underlying loans and the credit enhancements for the senior securities owned by the Bank, the Bank closely monitors these investments in an effort to determine whether the credit enhancement associated with each security is sufficient to protect against potential losses of principal and interest on the underlying mortgage loans. The credit enhancement for each of the Bank’s non-agency RMBS is provided by a senior/subordinate structure, and none of the securities owned by the Bank are insured by third party bond insurers. More specifically, each of the Bank’s non-agency RMBS represents a single security class within a securitization that has multiple classes of securities. Each security class has a distinct claim on the cash flows from the underlying mortgage loans, with the subordinate securities having a junior claim relative to the more senior securities. The Bank’s non-agency RMBS have a senior claim on the cash flows from the underlying mortgage loans. To assess whether the entire amortized cost bases of its non-agency RMBS will be recovered, the Bank performed a cash flow analysis for each of its non-agency RMBS with adverse risk characteristics as of March 31, 2009 and June 30, 2009 (including those securities that were determined to be other than temporarily impaired as of March 31, 2009) and for all of its non-agency RMBS holdings as of September 30, 2009 and December 31, 2009. The adverse risk characteristics used to select securities for cash flow analysis as of March 31, 2009 and June 30, 2009 included: the duration and magnitude of the unrealized fair value loss, NRSRO credit ratings below investment grade, and criteria related to the credit performance of the underlying collateral, including the ratio of credit enhancement to expected collateral losses and the ratio of seriously delinquent loans to credit enhancement. For these purposes, expected collateral losses were those that were implied by current delinquencies taking into account an assumed default probability based on the state of delinquency and a loss severity assumption based on product and vintage; seriously delinquent loans were those that were 60 or more days past due, including loans in foreclosure and real estate owned. In performing the quarterly cash flow analyses for its non-agency RMBS, the Bank used two third party models. The first model considers borrower characteristics and the particular attributes of the loans underlying the Bank’s securities, in conjunction with assumptions about future changes in home prices and interest rates, to project prepayments, defaults and loss severities. A significant input to the first model is the forecast of future housing price changes for the relevant states and core based statistical areas (“CBSAs”), which are based upon an assessment of the individual housing markets. (The term “CBSA” refers collectively to metropolitan and micropolitan statistical 62
areas as defined by the United States Office of Management and Budget; as currently defined, a CBSA must contain at least one urban area of 10,000 or more people.) The Bank’s housing price forecast as of December 31, 2009 assumed current-to-trough home price declines ranging from 0 percent to 15 percent over the next 9 to 15 months. Thereafter, home prices are projected to increase 0 percent in the first six months, 0.5 percent in the next six months, 3 percent in the second year and 4 percent in each subsequent year. The month-by-month projections of future loan performance derived from the first model, which reflect projected prepayments, defaults and loss severities, are then input into a second model that allocates the projected loan level cash flows and losses to the various security classes in the securitization structure in accordance with its prescribed cash flow and loss allocation rules. In a securitization in which the credit enhancement for the senior securities is derived from the presence of subordinate securities, losses are generally allocated first to the subordinate securities until their principal balance is reduced to zero. Based on the results of its cash flow analyses, the Bank determined that it is likely that it will not fully recover the amortized cost bases of seven of its non-agency RMBS and, accordingly, these securities were deemed to be other-than-temporarily impaired during 2009. The difference between the present value of the cash flows expected to be collected from these seven securities and their amortized cost bases (i.e., the credit losses) aggregated $4.0 million in 2009. Because the Bank does not intend to sell the investments and it is not more likely than not that the Bank will be required to sell the investments before recovery of their remaining amortized cost bases (that is, the previous amortized cost basis reduced by the amount of the credit loss), only the amounts related to the credit losses were recognized in earnings. The net non-credit portion of the other-than-temporary impairments, totaling $75.9 million, was recorded in other comprehensive income. The following tables set forth additional information for each of the securities that were deemed to be other-than-temporarily impaired during 2009 (in thousands). The information is as of and for the year ended December 31, 2005,2009. The credit ratings presented in the Bank purchased from a third party $283 millionfirst table represent the lowest rating assigned to the security by Moody’s, S&P or Fitch as of mortgage-backed securities issued by an affiliate of Washington Mutual Bank, a non-member borrower/shareholder. At December 31, 2006 and 2005, the Bank held previously acquired mortgage-backed securities with par values of $26 million and $30 million, respectively, that were issued by one or more entities that2009. SUMMARY OF OTTI LOSSES FOR THE YEAR ENDED DECEMBER 31, 2009 (dollars in thousands) | | | | | | | | | | | | | | | | | | | Period of | | | | | | | | Credit | | | Non-Credit | | | | Initial | | Credit | | Total | | | Component | | | Component | | | | Impairment | | Rating | | OTTI | | | of OTTI | | | of OTTI | | Security #1 | | Q1 2009 | | Single-B | | $ | 13,139 | | | $ | 1,369 | | | $ | 11,770 | | Security #2 | | Q1 2009 | | Double-B | | | 13,076 | | | | 16 | | | | 13,060 | | Security #3 | | Q2 2009 | | Triple-C | | | 19,358 | | | | 1,978 | | | | 17,380 | | Security #4 | | Q2 2009 | | Triple-B | | | 8,585 | | | | 77 | | | | 8,508 | | Security #5 | | Q3 2009 | | Single-B | | | 11,738 | | | | 284 | | | | 11,454 | | Security #6 | | Q3 2009 | | Single-B | | | 10,502 | | | | 277 | | | | 10,225 | | Security #7 | | Q3 2009 | | Triple-B | | | 3,544 | | | | 21 | | | | 3,523 | | | | | | | | | | | | | | | | Totals | | | | | | $ | 79,942 | | | $ | 4,022 | | | $ | 75,920 | | | | | | | | | | | | | | | |
4063
are now partSUMMARY OF OTTI SECURITIES AS OF DECEMBER 31, 2009 (dollars in thousands)
| | | | | | | | | | | | | | | | | | | | | | | Amortized Cost After | | | | | | | Accretion of | | | | | | | | | | Credit Component | | | Non-Credit | | | Non-Credit | | | Carrying | | | Estimated | | | | of OTTI | | | Component of OTTI | | | Component of OTTI | | | Value | | | Fair Value | | Security #1 | | $ | 16,391 | | | $ | 11,770 | | | $ | 2,163 | | | $ | 6,784 | | | $ | 9,434 | | Security #2 | | | 19,984 | | | | 13,060 | | | | 2,214 | | | | 9,138 | | | | 11,336 | | Security #3 | | | 43,923 | | | | 17,380 | | | | 2,069 | | | | 28,612 | | | | 33,286 | | Security #4 | | | 13,769 | | | | 8,508 | | | | 1,151 | | | | 6,412 | | | | 7,406 | | Security #5 | | | 22,773 | | | | 11,454 | | | | 807 | | | | 12,126 | | | | 13,353 | | Security #6 | | | 19,640 | | | | 10,225 | | | | 711 | | | | 10,126 | | | | 10,254 | | Security #7 | | | 7,508 | | | | 3,523 | | | | 221 | | | | 4,206 | | | | 4,169 | | | | | | | | | | | | | | | | | | Totals | | $ | 143,988 | | | $ | 75,920 | | | $ | 9,336 | | | $ | 77,404 | | | $ | 89,238 | | | | | | | | | | | | | | | | | |
Several factors contributed to the recognition of Citigroup. An affiliate of Citigroup isprojected credit losses on the Bank’s non-agency RMBS during 2009, including lower forecasted housing prices followed by a non-member shareholderslower anticipated housing price recovery, lower expected voluntary prepayment rates and higher projected losses on defaulted loans. For those securities for which an other-than-temporary impairment was determined to have occurred during the year ended December 31, 2009, the following table presents a summary of the Bank. In addition,significant inputs used to measure the amount of the most recent credit loss recognized in earnings (dollars in thousands): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Quarterly | | Significant Inputs(2) | | | | | | | | | | | Unpaid Principal | | | Period of | | Projected | | | Projected | | | Projected | | | Current Credit | | | | Year of | | Collateral | | Balance as of | | | Most Recent | | Prepayment | | | Default | | | Loss | | | Enhancement as of | | | | Securitization | | Type(1) | | December 31, 2009 | | | Impairment | | Rate | | | Rate | | | Severity | | | December 31, 2009(3) | | Security #1 | | 2005 | | Alt-A/Option ARM | | $ | 17,764 | | | Q3 2009 | | | 6.4% | | | | 77.1% | | | | 48.2% | | | | 37.5% | | Security #2 | | 2005 | | Alt-A/Option ARM | | | 20,000 | | | Q3 2009 | | | 8.4% | | | | 61.0% | | | | 51.3% | | | | 51.0% | | Security #3 | | 2006 | | Alt-A/Fixed Rate | | | 45,905 | | | Q4 2009 | | | 13.0% | | | | 31.3% | | | | 41.2% | | | | 8.6% | | Security #4 | | 2005 | | Alt-A/Option ARM | | | 13,846 | | | Q4 2009 | | | 6.5% | | | | 73.0% | | | | 42.9% | | | | 49.5% | | Security #5 | | 2005 | | Alt-A/Option ARM | | | 23,058 | | | Q4 2009 | | | 7.5% | | | | 75.9% | | | | 49.2% | | | | 49.1% | | Security #6 | | 2005 | | Alt-A/Option ARM | | | 19,919 | | | Q4 2009 | | | 8.2% | | | | 65.1% | | | | 38.1% | | | | 30.1% | | Security #7 | | 2004 | | Alt-A/Option ARM | | | 7,520 | | | Q3 2009 | | | 10.0% | | | | 55.0% | | | | 42.0% | | | | 34.1% | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total | | | | | | $ | 148,012 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | (1) | | Security #1 and Security #5 are the only securities presented in the table above that were labeled as Alt-A at the time of issuance; however, based upon their current collateral or performance characteristics, all of the other-than-temporarily impaired securities presented in the table above were analyzed using Alt-A assumptions. | | (2) | | Prepayment rates reflect the weighted average of projected future voluntary prepayments. Default rates reflect the total balance of loans projected to default as a percentage of the current unpaid principal balance of the underlying loan pool. Loss severities reflect the total projected loan losses as a percentage of the total balance of loans that are projected to default. | | (3) | | Current credit enhancement percentages reflect the ability of subordinated classes of securities to absorb principal losses and interest shortfalls before the senior class held by the Bank is impacted (i.e., the losses, expressed as a percentage of the outstanding principal balances, that could be incurred in the underlying loan pool before the security held by the Bank would be impacted, assuming that all of those losses occurred on the measurement date). Depending upon the timing and amount of losses in the underlying loan pool, it is possible that the senior classes held by the Bank could bear losses in scenarios where the cumulative loan losses do not exceed the current credit enhancement percentage. |
Because the Bank currently expects to recover the entire amortized cost basis of each of its other non-agency RMBS holdings, and because the Bank does not intend to sell the investments and it is not more likely than not that the Bank will be required to sell the investments before recovery of their amortized cost bases, the Bank does not consider any of its other non-agency RMBS to be other-than-temporarily impaired at December 31, 20062009. 64
In addition to evaluating its non-agency RMBS under a base case (or best estimate) scenario, a cash flow analysis was also performed for each of these securities under a more stressful housing price scenario. The more stressful scenario was based on a housing price forecast that was 5 percentage points lower at the trough than the base case scenario followed by a flatter recovery path. Under the more stressful scenario, current-to-trough home price declines were projected to range from 5 percent to 20 percent over the next 9 to 15 months. Thereafter, home prices were projected to increase 0 percent in the first year, 1 percent in the second year, 2 percent in each of the third and 2005,fourth years and 3 percent in each subsequent year. As set forth in the table below, under the more stressful housing price scenario, 11 of the Bank’s non-agency RMBS would have been deemed to be other-than-temporarily impaired as of December 31, 2009 (including the 7 securities that were determined to be other-than-temporarily impaired during 2009). The stress test scenario and associated results do not represent the Bank’s current expectations and therefore should not be construed as a prediction of the actual performance of these securities. Rather, the results from this hypothetical stress test scenario provide a measure of the credit losses that the Bank might incur if home price declines (and subsequent recoveries) are more adverse than those projected in its OTTI assessment. NON-AGENCY RMBS STRESS-TEST SCENARIO (dollars in thousands) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Hypothetical | | | | | | | | | | | | | | | | | | | | | Credit Losses | | | Credit | | | | | | | | | | | | | | | | | | | | | Recorded | | | Losses Under | | | | | | | Current | | | | Year of | | Collateral | | Carrying | | | Fair | | in Earnings | | | Stress-Test | | | Collateral | | | Credit | | | | Securitization | | Type(1) | | Value | | | Value | | During 2009 | | | Scenario(2) | | | Delinquency(3) | | | Enhancement(4) | | Security #1 | | 2005 | | Alt-A/Option ARM | | $ | 6,784 | | | $9,434 | | $ | 1,369 | | | $ | 2,395 | | | | 41.8% | | | | 37.5% | | Security #2 | | 2005 | | Alt-A/Option ARM | | | 9,138 | | | 11,336 | | | 16 | | | | 43 | | | | 39.0% | | | | 51.0% | | Security #3 | | 2006 | | Alt-A/Fixed Rate | | | 28,612 | | | 33,286 | | | 1,978 | | | | 3,143 | | | | 12.0% | | | | 8.6% | | Security #4 | | 2005 | | Alt-A/Option ARM | | | 6,412 | | | 7,406 | | | 77 | | | | 567 | | | | 24.2% | | | | 49.5% | | Security #5 | | 2005 | | Alt-A/Option ARM | | | 12,126 | | | 13,353 | | | 284 | | | | 1,190 | | | | 43.9% | | | | 49.1% | | Security #6 | | 2005 | | Alt-A/Option ARM | | | 10,126 | | | 10,254 | | | 277 | | | | 1,074 | | | | 27.0% | | | | 30.1% | | Security #7 | | 2004 | | Alt-A/Option ARM | | | 4,206 | | | 4,169 | | | 21 | | | | 264 | | | | 23.8% | | | | 34.1% | | Security #8 | | 2005 | | Alt-A/Option ARM | | | 11,908 | | | 6,599 | | | — | | | | 146 | | | | 32.3% | | | | 49.5% | | Security #9 | | 2004 | | Alt-A/Option ARM | | | 6,364 | | | 3,745 | | | — | | | | 42 | | | | 39.5% | | | | 41.3% | | Security #10 | | 2005 | | Alt-A/Option ARM | | | 5,164 | | | 3,125 | | | — | | | | 7 | | | | 31.0% | | | | 48.2% | | Security #11 | | 2005 | | Alt-A/Option ARM | | | 7,316 | | | 4,306 | | | — | | | | 1 | | | | 29.4% | | | | 49.4% | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | $ | 108,156 | | | $107,013 | | $ | 4,022 | | | $ | 8,872 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | (1) | | Security #1 and Security #5 are the only securities presented in the table above that were labeled as Alt-A at the time of issuance; however, based upon their current collateral or performance characteristics, all of the securities presented in the table above were analyzed using Alt-A assumptions. | (2) | | Represents the credit losses that would have been recorded in earnings during the year ended December 31, 2009 if the more stressful housing price scenario had been used in the Bank’s OTTI assessment as of December 31, 2009. | | (3) | | Collateral delinquency reflects the percentage of underlying loans that are 60 or more days past due, including loans in foreclosure and real estate owned; as of December 31, 2009, actual cumulative loan losses in the pools of loans underlying the securities presented in the table ranged from 1.40 percent to 4.33 percent. | | (4) | | Current credit enhancement percentages reflect the ability of subordinated classes of securities to absorb principal losses and interest shortfalls before the senior classes held by the Bank are impacted (i.e., the losses, expressed as a percentage of the outstanding principal balances, that could be incurred in the underlying loan pools before the securities held by the Bank would be impacted, assuming that all of those losses occurred on the measurement date). Depending upon the timing and amount of losses in the underlying loan pool, it is possible that the senior classes held by the Bank could bear losses in scenarios where the cumulative loan losses do not exceed the current credit enhancement percentage. |
In addition to its holdings of non-agency RMBS, as of December 31, 2009, the Bank held $133three non-agency commercial MBS with an aggregate unpaid principal balance, amortized cost and estimated fair value of $56.0 million, $56.1 million and $258$57.2 million, (par values), respectively,respectively. All of mortgage-backedthese securities were issued by entities thatin 2000 and are affiliated with Washington Mutual Bank. Decisions relating toclassified as held-to-maturity. As of December 31, 2009, the purchase of such securities are made independent ofportfolio’s weighted average collateral delinquency was 2.99 percent; at this same date, the issuer’s membership status or affiliation with the Bank.current weighted average credit enhancement approximated 32.5 percent. While themost of its MBS portfolio is dominated bycomprised of floating rate securitiesCMOs ($11.5 billion par value at December 31, 2009) that limitdo not expose the Bank’sBank to interest rate risk all of the Bank’s floating rate CMOs ($6.3 billion par value)if interest rates rise moderately, such securities include caps that willwould limit increases in the floating rate coupons if short-term interest rates rise dramatically. In addition, if interest rates rise, prepayments on the underlying mortgage loans underlying the securities would likely decline, thus lengthening the time that the securities would remain outstanding with their coupon rates capped. As of December 31, 2006,2009, one-month LIBOR was 0.23 percent and the effective interest rate caps on one-month LIBOR (the interest cap rate minus the stated spread on the coupon) embedded in the CMO floaters ranged from 6.66.0 percent to 15.3 percent. The 65
largest concentration of embedded effective caps ($5.19.5 billion) fell within the 6.6 to 7.5was between 6.0 percent range. Althoughand 7.0 percent. As of December 31, 2009, one-month LIBOR rates were approximately 125577 basis points below the lowest effective interest rate cap embedded in the CMO floaters asfloaters. To hedge a portion of December 31, 2006, the Bank has offset a significant amount of this potential cap risk with $5.3embedded in these securities, the Bank held (i) $2.5 billion of interest rate caps with remaining maturities ranging from 739 months to 5259 months as of December 31, 2006,2009 and strike rates ranging from 6.756.0 percent to 8.06.5 percent and (ii) five forward-starting interest rate caps, each of which has a notional amount of $250 million. Two of the forward-starting caps have terms that commence in June 2012; these forward-starting caps mature in June 2015 and June 2016 and have strike rates of 6.5 percent and 7.0 percent, respectively. The other three forward-starting caps have terms that commence in October 2012; these forward-starting caps mature in October 2014 and October 2015 and have strike rates ranging from 6.0 percent to 7.0 percent. If interest rates rise above thesethe strike rates specified in these interest rate cap agreements, the Bank will be entitled to receive interest payments according to the terms and conditions of such agreements. Such payments would be based upon the notional amounts of those agreements and the interest rate cap agreements. Duringdifference between the year ended December 31, 2006, the Bank entered into four stand-alone interest rate cap agreements with notional amounts totaling $2.5 billion. On February 21, 2006, the Bank entered into a $1.0 billion (notional) interest rate cap agreement. The premium paid for this cap was $4.1 million. The agreement has aspecified strike rate of 7.0 percent and expires in February 2011. On April 19, 2006, the Bank entered into three additional interest rate cap agreements, each having a $500 million notional amount and a strike rate of 6.75 percent. The agreements expire in April 2009, April 2010 and April 2011, respectively. The premiums paid for these caps totaled $5.5 million.
During the year ended December 31, 2005, the Bank did not enter into any stand-alone interest rate cap agreements.
The Bank entered into five interest rate cap agreements during the year ended December 31, 2004. The premiums paid for these caps totaled $14.0 million. Those agreements have an aggregate notional amount of $1.2 billion and strike rates of 7.0 percent. The agreements expire on various dates in April and May 2009.one-month LIBOR.
The following table provides a summary of the notional amounts, strike rates and expiration periods of the Bank’s stand-alone CMO-related interest rate cap agreements as of December 31, 2006.2009. SUMMARY OF CMO-RELATED INTEREST RATE CAP AGREEMENTS (dollars in millions) | | | | | | | | | Expiration | | Notional Amount | | | Strike Rate | | Third quarter 2007 | | $ | 500 | | | | 8.00 | % | Second quarter 2008 | | | 1,000 | | | | 8.00 | % | Second quarter 2009 | | | 500 | | | | 6.75 | % | Second quarter 2009 | | | 1,250 | | | | 7.00 | % | Second quarter 2010 | | | 500 | | | | 6.75 | % | First quarter 2011 | | | 1,000 | | | | 7.00 | % | Second quarter 2011 | | | 500 | | | | 6.75 | % | | | | | | | | | | | | | | | | | | | | $ | 5,250 | | | | | | | | | | | | | |
| | | | | | | | | Expiration | | Notional Amount | | | Strike Rate | | Second quarter 2013 | | $ | 500 | | | | 6.25 | % | Second quarter 2013 | | | 250 | | | | 6.50 | % | First quarter 2014 | | | 500 | | | | 6.00 | % | First quarter 2014 | | | 500 | | | | 6.50 | % | Third quarter 2014 | | | 500 | | | | 6.50 | % | Fourth quarter 2014 | | | 250 | | | | 6.00 | % | Fourth quarter 2014(1) | | | 250 | | | | 6.50 | % | Second quarter 2015(2) | | | 250 | | | | 6.50 | % | Fourth quarter 2015(1) | | | 250 | | | | 6.00 | % | Fourth quarter 2015(1) | | | 250 | | | | 7.00 | % | Second quarter 2016(2) | | | 250 | | | | 7.00 | % | | | | | | | | | | | | | | | | | | | | $ | 3,750 | | | | | | | | | | | | | |
As stand-alone derivatives, the changes in the fair values of the interest rate caps are recorded in earnings with no offsetting changes in the fair values of the hedged items (i.e., the variable rate CMOs with embedded caps) and therefore can be and have been a source of considerable earnings volatility. See further discussion of the impact of these interest rate caps in the sections below entitled “Derivatives and Hedging Activities” and “Results of Operations – Other Income (Loss).”41
The Bank generally holds all long-term investment securities until their contractual maturities. For interest rate risk management purposes, the Bank typically enters into interest rate exchange agreements in connection with the purchase of fixed rate investments in order to convert the fixed coupons to a floating rate. Because SFAS 133 does not allow hedge accounting treatment for fair value hedges of investment securities designated as held-to-maturity, the Bank has classified such securities as available-for-sale. Since the implementation of SFAS 133 on January 1, 2001, the Bank has not classified any new securities as trading, other than those associated with a grantor trust that was created in October 2004 to hold assets associated with the Bank’s deferred compensation plans. As of December 31, 2006, the carrying value of assets held in the trust (and classified as trading securities) totaled approximately $2.3 million.
Excluding those assets associated with the grantor trust described above, all of the securities that the Bank has classified as available-for-sale or trading are part of specific fair value hedges that were implemented with offsetting interest rate swaps. Under SFAS 133, qualifying hedging relationships related to the Bank’s available-for-sale securities receive fair value hedge accounting treatment, while hedging relationships related to the Bank’s trading securities do not receive fair value hedge accounting treatment.
In accordance with SFAS 133, for those hedged securities that have been designated as available-for-sale and that qualify as being in a SFAS 133 fair value hedging relationship, the gain or loss (that is, the change in fair value) attributable to changes in LIBOR (the designated benchmark interest rate) is recorded as an adjustment of the carrying amount of the hedged item (i.e., the available-for-sale security) and recognized currently in earnings. Because the Bank is hedging fair value risk attributable to changes in LIBOR, periodic changes in the fair value of these securities for purposes of SFAS 133 are calculated based solely upon changes in the interest rate swap curve. The change in fair value attributable to the risk being hedged is reported in the statement of income in “net gains (losses) on derivatives and hedging activities” together with the related change in fair value of the associated interest rate exchange agreement. In accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities”(“SFAS 115”), the change in fair value of the Bank’s available-for-sale securities that is unrelated to the hedged risk is reported in other comprehensive income/loss (OCI) as a net unrealized gain (loss) on available-for-sale securities in the Bank’s statement of capital. The change in fair value of the Bank’s available-for-sale securities reported in OCI is dependent upon changes in the value of the securities unrelated to changes in LIBOR (i.e., changes in credit spreads). For those hedged available-for-sale securities that do not qualify for hedge accounting under SFAS 133, the entire change in fair value of the securities (that is, the change in fair value attributable to changes in both credit spreads and interest rates) is reported in OCI.
The change in the Bank’s OCI was considerably less in 2006 than the changes in 2005 and 2004. The Bank believes that the activity in OCI will continue to be less volatile than it was in 2005 and 2004, due to the substantial reduction in the available-for-sale securities portfolio during August and September 2005 and, in particular, the disposition of substantially all securities for which hedge accounting was lost in connection with the Bank’s restatement. With the exception of $6.7 million in securities, all of the Bank’s remaining available-for-sale securities are in SFAS 133 hedging relationships as of December 31, 2006. To the extent these and any newly acquired securities remain in SFAS 133 hedging relationships, the activity in OCI will reflect changes in the fair values of the Bank’s available-for-sale securities attributable to changes in credit spreads, rather than changes in both credit spreads and interest rates as was the case in 2005 and 2004.
For those securities that have been designated as trading, the Bank records the entire change in their fair value in the statement of income through “net gains (losses) on trading securities” in accordance with the provisions of SFAS 115. In accordance with SFAS 133, the changes in the fair values of the interest rate exchange agreements associated with the trading securities are reported in the statement of income through “net gains (losses) on derivatives and hedging activities.” As a result, while not in a SFAS 133 hedging relationship, some offset does occur for the Bank’s trading securities and their associated (designated) derivatives by virtue of the accounting prescribed by both SFAS 115 and SFAS 133. While some of its securities are classified as trading, the Bank does not engage in active or speculative trading practices.
| | | (1) | | These caps are effective beginning in October 2012. | | (2) | | These caps are effective beginning in June 2012. |
Finance BoardAgency regulations and Bank policies govern the Bank’s investments in unsecured money market instruments such as overnight and term federal funds, commercial paper and bank notes. Those regulations and policies establish limits on the amount of 42
unsecured credit that may be extended to borrowers or to affiliated groups of borrowers, and require the Bank to base its investment limits on a counterparty’sthe long-term credit rating.ratings of its counterparties. Mortgage Loans Held for Portfolio The Bank began offeringoffered the MPF Program to its members infrom 1998 through July 31, 2008 as an additional method of promoting housing finance in its five-state region. The MPF Program, which was developed by the FHLBank of Chicago, allowsallowed members to retain responsibility for managing the credit risk of the residential mortgage loans that they originateoriginated while allowing the Bank (and/or, as described below, the FHLBank of Chicago) to manage the funding, interest rate, and prepayment risk of the loans. As further described below, participating members retain a portion of the credit risk in the originated mortgage loans and, in return, receive a credit enhancement fee from the purchasing FHLBank. Participating Financial Institutions (“PFIs”), which are Bank members that have joined the MPF Program, totaled 59, 57 and 53 at December 31, 2006, 2005 and 2004, respectively. 66
Under its initial agreement with the FHLBank of Chicago, the Bank retained an interest (ranging from 1 percent to 49 percent) in loans that were delivered by its PFIs; aParticipating Financial Institutions (“PFIs”), which are Bank members that joined the MPF Program. A participation interest equal to the remaining interest in the loans was acquired by the FHLBank of Chicago. In December 2002, the Bank and the FHLBank of Chicago agreed to modify the terms of the Bank’s participation in the MPF Program. Under the terms of the revised agreement, the Bank receivesreceived a participation fee for mortgage loans that arewere delivered by Ninth District PFIs and the FHLBank of Chicago acquiresacquired a 100 percent interest in the loans. The Bank hasOn April 23, 2008, the optionFHLBank of Chicago announced that it would no longer enter into new master commitments or renew existing master commitments to purchase mortgage loans from FHLBank members under the revised agreementMPF Program. In its announcement, the FHLBank of Chicago indicated that it would acquire loans through July 31, 2008 and, as a result, it would only enter into new delivery commitments under existing master commitments that funded no later than that date. In addition, the FHLBank of Chicago indicated that it will continue to retain upprovide programmatic and operational support for loans already purchased through the program. As a result of this action and the Bank’s decision not to a 50 percent interest inacquire any of the mortgage loans that are originated by Ninth District PFIs without receivingwould have been delivered to the FHLBank of Chicago under the terms of its previous arrangement, the Bank expects the balance of its mortgage loan portfolio to continue to decline as a result of principal amortization and loan payoffs. In addition, after July 31, 2008, the Bank no longer receives participation fee, provided certain conditions are met. The agreement had an initial termfees from the FHLBank of 3 years; thereafter, it continues indefinitely unless terminated by either party upon 90 days’ prior notice. The termsChicago. For a more complete description of the Bank’s participation in the MPF Program, are more fully described insee Item 1 – Business. During the years ended December 31, 2006, 20052008 and 2004, the Bank received $242,000, $385,000 and $684,000 of participation fees, respectively. The amount of participation fee income that the Bank will receive in the future is dependent primarily upon the volume of loans delivered by Ninth District PFIs into the MPF Program. The volume of loans delivered by Ninth District PFIs will depend, in part, on conditions in the residential mortgage market including, but not limited to, the volume of home sales and the level of mortgage refinancing activity, as well as competition from other financial institutions that purchase residential mortgage loans. During the years ended December 31, 2006, 2005 and 2004,2007, the Bank’s PFIs delivered $224 million, $332$190 million and $569$179 million of mortgage loans, respectively, into the MPF Program.Program, all of which were acquired by the FHLBank of Chicago. In connection with these mortgage loan deliveries, the Bank received participation fees from the FHLBank of Chicago of $200,000 and $187,000, respectively. No interest in loans was retained by the Bank during the years ended December 31, 2006, 20052008 or 2004.2007. At December 31, 20062009 and 2005,2008, the Bank held $450$260 million and $542$327 million, respectively, of residential mortgage loans originated under the MPF Program. As of these dates, 46 percent and 4745 percent, respectively, of the outstanding balances were government guaranteed.guaranteed/insured. The Bank’s allowance for loan losses decreased from $294,000$261,000 at the end of 20052008 to $267,000$240,000 at December 31, 2006,2009, reflecting charge-offs. The Bank did not have any impaired loans at December 31, 20062009 or 2005.2008. In accordance with the guidelines of the MPF Program, the mortgage loans held by the Bank were underwritten pursuant to traditional lending standards for conforming loans. All of the Bank’s mortgage loans were acquired between 1998 and mid-2003 and the portfolio has exhibited a satisfactory payment history. As of December 31, 2009, loans 90 or more days past due that are not government guaranteed/insured approximated 0.4 percent of the portfolio, including loans in foreclosure, which represented 0.1 percent of the portfolio. Based in part on these attributes, as well as the Bank’s loss experience with these loans, the Bank believes that its allowance for loan losses is adequate.
For those loans in which the Bank has a retained interest, the Bank and the PFIs share in the credit risk of the retained portion of such loans with the Bank assuming the first loss obligation limited by the First Loss Account (“FLA”), and the PFIs assuming credit losses in excess of the FLA, up to the amount of the credit enhancement obligation as specified in the master agreement (“Second Loss Credit Enhancement”). The Bank assumes all losses in excess of the Second Loss Credit Enhancement. The PFI’s credit enhancement obligation (“CE Amount”) arises under its PFI Agreement while the amount and nature of the obligation are determined with respect to each master commitment. Under the Finance Board’sAgency’s Acquired Member Asset regulation (12 C.F.R. part 955) (“AMA Regulation”), the PFI must “bear the economic consequences” of certain credit losses with respect to a master commitment based upon the MPF product and other criteria. Under the MPF program, the PFI’s credit enhancement protection (“CEP Amount”) may take the form of the CE Amount, which represents the direct liability to pay credit losses incurred with respect to that master commitment, or may require the PFI to obtain and pay for a supplemental mortgage insurance (“SMI”) policy insuring the Bank for a portion of the credit losses arising from the master commitment, and/or the PFI may contract for a contingent performance-based credit enhancement fee whereby such fees are reduced by losses up to a certain amount arising under the master commitment. Under the AMA Regulation, any portion of the CE Amount that is a 43
PFI’s direct liability must be collateralized by the PFI in the same way that advances are collateralized. The PFI Agreement provides that the PFI’s obligations under the PFI Agreement are secured along with other obligations of the PFI under its regular advances agreement with the Bank and, further, that the Bank may request additional 67
collateral to secure the PFI’s obligations. PFIs are paid a credit enhancement fee (“CE fee”) as an incentive to minimize credit losses, to share in the risk of loss on MPF loans and to pay for SMI, rather than paying a guaranty fee to other secondary market purchasers. CE fees are paid monthly and are determined based on the remaining unpaid principal balance of the MPF loans. The required CE Amount may vary depending on the MPF product alternatives selected. The Bank also pays performance-based CE fees whichthat are based on the actual performance of the pool of MPF loans under each individual master commitment. To the extent that losses in the current month exceed accrued performance-based CE fees, the remaining losses may be recovered from future performance-based CE fees payable to the PFI. During the years ended December 31, 2006, 20052009, 2008 and 2004,2007, the Bank paid CE fees totaling $318,000, $419,000$120,000, $174,000 and $545,000,$276,000, respectively. During these same periods, performance-based credit enhancement fees that were forgone and not paid to the Bank’s PFIs totaled $41,000, $25,000$80,000, $85,000 and $32,000,$27,000, respectively. In some cases, a portion of the credit support for MPF loans is provided under a primary and/or supplemental mortgage insurance policy. Currently, nine mortgage insurance companies provide primary and/or supplemental mortgage insurance for loans in which the Bank has a retained interest. As of February 28, 2010, seven of the mortgage insurance providers were rated between single-A and single-B. S&P, Fitch and Moody’s no longer rate the other two mortgage insurance providers. Given the small amount of loans that are insured by the nine mortgage insurance companies and the historical performance of those loans, the Bank believes its credit exposure to these insurance companies, both individually and in the aggregate, was not significant as of December 31, 2009. PFIs must comply with the requirements of the PFI agreement, MPF guides, applicable law and the terms of mortgage documents. If a PFI fails to comply with any of these requirements, it may be required to repurchase the MPF loans whichthat are affectedimpacted by thatsuch failure. The reasons that a PFI could be required to repurchase an MPF loan include, but are not limited to, the failure of the loan to meet underwriting standards, subsequent modification of the loan terms, the PFI’s failure to perfect collateral withdeliver a qualifying promissory note and certain other relevant documents to an approved custodian, a servicing breach, fraud or other misrepresentations by the PFI. In addition, a PFI may, under the terms of the MPF servicing guide, elect to repurchase any government-guaranteed loan for an amount equal to the loan’s then current scheduled principal balance and accrued interest thereon, provided no payment has been made by the borrower for three consecutive months. This policy allows PFIs to comply with loss mitigation requirements of the applicable government agency in order to preserve the insurance guaranty coverage. During the years ended December 31, 2006, 20052009, 2008 and 2004,2007, the principal amount of mortgage loans required to beheld by the Bank that were repurchased by the Bank’s PFIs totaled $724,000, $289,000$1,759,000, $1,644,000 and $237,000,$1,327,000, respectively. Given its current arrangement with the FHLBank of Chicago, the Bank expects the balance of its mortgage loan portfolio to continue to decline as the Bank does not currently intend to exercise its option to retain any interests in mortgage loans delivered by its PFIs.
Consolidated Obligations and Deposits At December 31, 2006,2009, the carrying values of consolidated obligation bonds and discount notes totaled $41.7$51.5 billion and $8.2$8.8 billion, respectively, and the par values of the Bank’s outstanding bonds and discount notes totaled $41.9$51.2 billion and $8.3$8.8 billion, respectively. At December 31, 2005,2008, the carrying values of consolidated obligation bonds and discount notes totaled $46.1$56.6 billion and $11.2$16.7 billion, respectively. As of December 31, 2005,respectively, and the par values of the Bank’s outstanding bonds and discount notes totaled $46.6$56.0 billion and $16.9 billion, respectively. 68
During the par value ofyear ended December 31, 2009, the Bank’s consolidated obligations (at par value) decreased by $12.9 billion, in line with the decrease in outstanding advances during the year; consolidated obligation bonds and discount notes approximated their carrying values. decreased by $4.8 billion and $8.1 billion, respectively. The following table presents the composition of the Bank’s outstanding bonds at December 31, 20062009 and 2005.2008. COMPOSITION OF CONSOLIDATED OBLIGATION BONDS OUTSTANDING (Par value, dollars in millions) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | December 31, 2006 | | December 31, 2005 | | | December 31, 2009 | | December 31, 2008 | | | | Percentage | | Percentage | | | Percentage | | Percentage | | | | Balance | | of Total | | Balance | | of Total | | | Balance | | of Total | | Balance | | of Total | | Fixed rate, non-callable | | | $ | 23,371 | | | 45.7 | % | | $ | 31,767 | | | 56.7 | % | Single-index floating rate | | | 20,560 | | 40.2 | | 13,093 | | 23.4 | | Callable step-up | | | 3,473 | | 6.8 | | 78 | | 0.1 | | Fixed rate, callable | | $ | 22,091 | | | 52.7 | % | | $ | 15,954 | | | 34.2 | % | | 3,277 | | 6.4 | | 11,054 | | 19.8 | | Fixed rate, non-callable | | 10,858 | | 25.9 | | 13,356 | | 28.7 | | | Callable step-up | | 7,320 | | 17.5 | | 8,939 | | 19.2 | | | Single-index floating rate | | 1,003 | | 2.4 | | 7,643 | | 16.4 | | | Conversion | | 550 | | 1.3 | | 625 | | 1.3 | | | 365 | | 0.7 | | — | | — | | Comparative-index | | 80 | | 0.2 | | 80 | | 0.2 | | | Callable step-up/step-down | | 15 | | — | | 15 | | — | | | Callable step-down | | | 125 | | 0.2 | | 15 | | — | | | | | | | | | | | | | | | | | | | | | Total par value | | $ | 41,917 | | | 100.0 | % | | $ | 46,612 | | | 100.0 | % | | $ | 51,171 | | | 100.0 | % | | $ | 56,007 | | | 100.0 | % | | | | | | | | | | | | | | | | | | | |
44
Fixed rate bonds have coupons that are fixed over the life of the bond. Some fixed-ratefixed rate bonds contain provisions that enable the Bank to call the bonds at its option on predetermined call dates. Single-index floating rate bonds have variable rate coupons that generally reset based on either one-month or three-month LIBOR or the daily federal funds rate; these bonds may contain caps that limit the increases in the floating rate coupons. Callable step-up bonds pay interest at increasing fixed rates for specified intervals over the life of the bond and contain provisions enabling the Bank to call the bonds at its option on predetermined dates. Single-index floating rate bonds have variable rate coupons that generally reset based on either one-month or three-month LIBOR; typically, these bonds contain caps that limit the increases in the floating rate coupons. Conversion bonds have coupons that convert from fixed to floating, or from floating to fixed, on predetermined dates. Comparative-index bonds have coupon rates determined by the difference between two or more market indices, typically a Constant Maturity Treasury rate and LIBOR. Callable step-up/step-down bonds pay interest at increasing fixed rates and then at decreasing fixed rates for specified intervals over the life of the bond and contain provisions enabling the Bank to call the bonds at its option on predetermined dates. Conversion bonds have coupons that convert from fixed to floating, or from floating to fixed, on predetermined dates. Consolidated obligations generally trade at yields that are higher than the yields of comparable maturity U.S. Treasury securities, and at yields that are lower than the rates on comparable maturity interest rate swaps. The FHLBanks rely extensively on the approved underwriters of their securities, including investment banks, money center banks and large commercial banks, to source investors for consolidated obligations. Investors may be located in the United States or overseas.
The features of consolidated obligations are structured to meet the requirements of investors. The various types of consolidated obligations included in the table above reflect the features of the Bank’s outstanding bonds as of year-end 2006December 31, 2009 and 2008 and do not represent all of the various types and styles of consolidated obligation bonds that may be issued by other FHLBanks.FHLBanks or that may be issued from time to time by the Bank. Consistent with its risk management philosophy, the Bank uses interest rate exchange agreements (i.e., interest rate swaps) to convert many of the fixed rate consolidated obligations that it issues to floating rate instruments that periodically reset to an index such as one-month or three-month LIBOR. Generally, the Bank receives a coupon on the interest rate swap that is identical to the coupon it pays on the consolidated obligation bond while paying a variable rate coupon on the interest rate swap that resets to either 1-monthone-month or 3-monththree-month LIBOR. Typically, the calculation of the variable rate coupon also includes a spread;spread to the index; for instance, the Bank may pay a coupon on the interest rate swap equal to 3-monththree-month LIBOR minus 1815 basis points. The primary benchmark the Bank uses to analyze the effectiveness of its debt issuance efforts and trends in its debt issuance costs is the spread to LIBOR that the Bank pays on interest rate swaps used to convert its fixed rate consolidated obligations to LIBOR. The costs of the Bank’s consolidated obligations, when expressed relative to LIBOR, are impacted by many factors. These include factors that may influence all credit market spreads, such as investors’ perceptions of general economic conditions, changes in investors’ risk tolerances or maturity preferences, or, in the case of overseas investors, changes in preferences for holding dollar-denominated assets. They also include factors that primarily influence the yields of GSE debt, such as a marked change in the debt issuance 69
patterns of GSEs stemming from a rapid change in the growth of their balance sheets or changes in market interest rates or the potential impactavailability of which is discussed below.debt with similar perceived credit quality, such as debt guaranteed by the U.S. government under programs implemented to support the banking industry and the financial markets. Finally, the specific features of consolidated obligations and the associated interest rate swaps influence the spread to LIBOR that the Bank pays on its interest rate swaps. A majorityHistorically, a significant portion of the consolidated obligations that the Bank issues arehas issued have been callable bonds. Callable bonds provide the Bank with the right to redeem the instrument on predetermined call dates in the future. When hedging callable consolidated obligation bonds, the Bank sells an option to the interest rate swap counterparty that offsets the option the Bank owns to call the bond. If market interest rates decline, the swap counterparty will generally exercise its right to cancel the interest rate swap and the Bank will then typically call the consolidated obligation bond. Conversely, if market interest rates increase, the swap counterparty generally elects to keep the interest rate swap outstanding and the Bank will then elect not to call the consolidated obligation bond.
From April 2004 through mid-2006, market interest ratesIn mid-2007, developments in the credit markets began to alter the relationships between the cost of consolidated obligation bonds and other instruments. During the first half of 2007, the yields for consolidated obligation bonds were generally rising.lower than the rates for interest rate swaps having the same maturity and features as the consolidated obligation bonds. The steadyrelationship between the yield on newly issued consolidated obligation bonds relative to rates on interest rate swaps having the same maturity and features did not change significantly during this period. However, during the second half of 2007 and the first half of 2008, this relationship generally widened as consolidated obligation bond yields trended lower relative to interest rate swap rates. Similarly, during this same period, the yield on consolidated obligation discount notes declined relative to LIBOR. These decreases were due primarily to increased demand, as investors shifted their available funds away from asset-backed investments to government-guaranteed and agency debt. These market conditions and the relatively wide spread between LIBOR and other market rates generally resulted in lower costs relative to LIBOR for the Bank’s consolidated obligations that were issued during the first half of 2008.
As discussed in the section above entitled “Financial Market Conditions,” market developments during the second half of 2008 stimulated investors’ demand for short-term GSE debt and limited their demand for longer term debt. As a result, during the second half of 2008, the Bank’s potential funding costs associated with issuing long-maturity debt rose sharply relative to short-term debt, each as compared to three-month LIBOR on a swapped cash flow basis. These market conditions continued into early 2009 and, as a result, the Bank relied in large part on the issuance of short-term debt to meet its funding needs during the first half of 2009. The Bank’s access to debt with a wider range of maturities, and the pricing of those bonds, improved during the second half of 2009 and, therefore, the Bank relied on the issuance of short-maturity debt to a lesser extent during the second half of 2009 as compared to the previous 12 months. During 2008 and 2009, the proportion of outstanding callable bonds (relative to years prior to 2008) decreased as existing callable bonds were called or matured, and demand for new callable bonds was limited due to strong investor preferences for short-term, high-quality assets. These preferences also contributed to an increase in market interest rates had, in comparison to earlier periods marked by declining market interest rates, the general effectproportion of reducing the number of callable swaps being cancelled by the Bank’s swap counterparties. This, in turn, reduced the volume of callablenon-callable, short-term bullet and floating-rate bonds that the Bank redeemed prior to maturity, thereby reducing the portionover this same period. At December 31, 2009 and 2008, 66.3 percent and 74.9 percent, respectively, of the Bank’s funding needs that are driven byconsolidated obligations were due in one year or less. By comparison, as of December 31, 2007, 59.9 percent of the refunding of redeemed callable bonds. During this time period, other FHLBanks and government-sponsored mortgage agencies experienced similar declinesBank’s consolidated obligations were due in the volume ofone year or less. 4570
their issuance of callable bonds (not all of which were converted to LIBOR). Further contributing to the decline in the housing GSE’s debt issuance volume was the slower growth of these enterprises over that same time period. In 2006, 2005 and 2004, the Bank issued $12.2 billion, $8.7 billion and $22.0 billion, respectively, of callable bonds.
During this period of lower bond issuance by the FHLBanks and government-sponsored mortgage agencies, investor demand for GSE debt (including both callable and non-callable bonds) remained relatively constant. At the same time, inThe following table is a continuation of a trend that has been developing for several years, overall conditions in the credit markets improved, resulting in a general tightening of most credit spreads. These two factors contributed to a slight improvement in the costsummary of the Bank’s consolidated bonds that the Bank issued that were indexed to LIBOR or converted to LIBOR using interest rate swaps. In 2006, the monthly weighted average cost of such consolidated obligation bonds that the Bank issued (after consideration of any associated interest rate exchange agreements) ranged from approximately LIBOR minus 15.5 basis points to approximately LIBOR minus 23.0 basis points compared to a range of approximately LIBOR minus 12.8 basis points to approximately LIBOR minus 20.7 basis pointsand discount notes outstanding at December 31, 2009 and 2008, by contractual maturity (at par value):
CONSOLIDATED OBLIGATION BONDS AND DISCOUNT NOTES BY CONTRACTUAL MATURITY (dollars in 2005.millions) As the Bank’s outstanding debt matures (or is called) and is replaced with newly-issued bonds, this improvement in the Bank’s marginal cost of funds, if it continues, will gradually lower the Bank’s overall average cost of funds. In the future, the cost of debt raised in this manner will depend on several factors, including the direction and level of market interest rates, competition from other issuers of government-sponsored agency debt, changes in the investment preferences of potential buyers of government-sponsored agency debt securities, and technical market factors. | | | | | | | | | | | | | | | | | | | December 31, 2009 | | | December 31, 2008 | | Contractual Maturity | | Amount | | | Percentage | | | Amount | | | Percentage | | Due in one year or less | | $ | 39,716 | | | | 66.3 | % | | $ | 54,610 | | | | 74.9 | % | Due after one year through two years | | | 9,164 | | | | 15.3 | | | | 9,784 | | | | 13.4 | | Due after two years through three years | | | 5,569 | | | | 9.3 | | | | 2,239 | | | | 3.1 | | Due after three years through four years | | | 1,085 | | | | 1.8 | | | | 1,689 | | | | 2.3 | | Due after four years through five years | | | 1,191 | | | | 2.0 | | | | 944 | | | | 1.3 | | Thereafter | | | 3,211 | | | | 5.3 | | | | 3,665 | | | | 5.0 | | | | | | | | | | | | | | | Total | | $ | 59,936 | | | | 100.0 | % | | $ | 72,931 | | | | 100.0 | % | | | | | | | | | | | | | |
Demand overnight, and term deposits were $2.4$1.5 billion, $3.8$1.4 billion and $2.0$3.1 billion at December 31, 2006, 20052009, 2008 and 2004,2007, respectively. The Bank has a deposit auction program under which deposits with varying maturities and terms are offered for competitive bid at periodic auctions. The deposit auction program offers the Bank’s members an alternative way to invest their excess liquidity at competitive rates of return, while providing an alternative source of funds for the Bank. The size of the Bank’s deposit base varies as market factors change, including the attractiveness of the Bank’s deposit pricing relative to the rates available to members on alternative money market instruments,investments, members’ investment preferences with respect to the maturity of their investments, and member liquidity. Capital Stock The Bank’s outstanding capital stock (excluding mandatorily redeemable capital stock) decreased from $3.2 billion at December 31, 2008 to $2.5 billion at December 31, 2009, while the Bank’s average outstanding capital stock (for financial reporting purposes) decreased from $2.3 billion at December 31, 2005 to $2.2 billion at December 31, 2006, and its average outstanding capital stock decreased from $2.5$2.9 billion for the year ended December 31, 20052008 to $2.3$2.7 billion for the year ended December 31, 2006. These declines2009. The decreases were attributable primarilydue in large part to reductionsthe decline in members’ required investment in the Bank that were implemented in late 2005 and April 2006, a change in the definition of surplus stock, and lower averageoutstanding advances balances. These changes are discussed below.balances during 2009. On September 29, 2005, the Bank’s Board of Directors approved several changes to members’ required investment in the Bank which, by design, reduced the Bank’s outstanding capital stock from and after November 30, 2005. As described in Item 1 – Business, members are required to maintain an investment in Class B stock equal to the sum of a membership investment requirement and an activity-based investment requirement. Effective November 1, 2005,On February 22, 2007, the Bank’s Board of Directors approved a reduction in the membership investment requirement was reduced from 0.140.08 percent to 0.090.06 percent of each member’s total assets as of June 30, 2005December 31, 2006 (and as of each December 31 thereafter), subject to a minimum of $1,000 and a maximum of $25,000,000. Concurrently,This change became effective on April 16, 2007 and there have been no changes in the membership investment requirement percentage since that date. The activity-based investment requirement was reduced from 4.25 percent tois currently 4.10 percent of outstanding advances, plus 4.10 percent of the outstanding principal balance of any MPF loans that were delivered pursuant to master commitments executed after September 2, 2003 and retained on the Bank’s balance sheet (of which there are none). On February 23, 2006, the Bank’s Board of Directors approved an additional reductionThere were no changes in the membershipactivity-based investment requirement from 0.09 percent to 0.08 percent of members’ total assets as ofpercentages during the years ended December 31, 2005 (and each December 31 thereafter). This change became effective on April 14, 2006.
2009, 2008 or 2007. The Bank’s Board of Directors reviews these requirements at least annually and has the authority to adjust these requirementsthem periodically within ranges established in the capital plan, as amended from time to time, to ensure that the Bank remains adequately capitalized. On February 22, 2007, Periodically, the Bank’s Board of Directors approved a reduction in the membership investment requirement from 0.08 percent to 0.06 percent of members’ total assets as of the preceding December 31 (and as of each December 31 thereafter); this change will become effective on April 16, 2007. 46
The Bank has a policy under which it periodically repurchases a portion of members’ excess capital stock. Excess stock is defined as the amount of stock held by a member (or former member) in excess of that institution’s minimum investment requirement. The portion of members’ excess capital stock subject to repurchase is known as surplus stock. Under the policy, theThe Bank generally repurchases surplus stock on the last business day of the month following the end of each calendar quarter (e.g., January 31, April 30, July 31 and October 31). From the implementation of this practice in October 2003 throughFor the repurchase that occurred on November 30, 2005,January 31, 2007, surplus stock was defined as the amount of stock held by a member in excess of 120110 percent of the member’s minimum investment requirement. For the quarterly repurchases that occurred from April 30, 2007 through October 31, 2008, surplus stock was defined as stock in excess of 105 percent of the member’s minimum investment requirement. For the repurchases that occurred on
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from January 31, 2006 and April 28, 2006,30, 2009 through January 29, 2010, surplus stock was defined as stock in excess of 115 percent of the member’s minimum investment requirement. Beginning with the repurchase that occurred on July 31, 2006, surplus stock has been defined as stock in excess of 110120 percent of the member’s minimum investment requirement. The Bank’s practice has been that a member’s surplus stock will not be repurchased if the amount of thethat member’s surplus stock is $250,000 or less.less or if, subject to certain exceptions, the member is on restricted collateral status. From time to time, the Bank may further modify the definition of surplus stock or the timing and/or frequency of surplus stock repurchases. Beginning with At December 31, 2009, excess stock held by the repurchase that is scheduled to occur on April 30, 2007, the Bank expects to define surplus stock as stock in excess of 105Bank’s members and former members totaled $292.2 million, which represented 0.4 percent of the member’s minimum investment requirement.Bank’s total assets as of that date. The following table sets forth the repurchases of surplus stock whichthat have occurred since January 1, 2004.2007. The significant increase in the number of shares repurchased on NovemberApril 30, 20052007 was attributable to the reduction in the membership and activity-based investment requirementsrequirement discussed above. The increases in the number of shares repurchased on July 31, 2008 and October 31, 2008 were due to repurchases associated with reductions in advances to one of the Bank’s largest borrowers. REPURCHASES OF SURPLUS STOCK REPURCHASED UNDER QUARTERLY REPURCHASE PROGRAM
(dollars in thousands) | | | | | | | | | | | | | | | | | | | | | | | Amount Classified as | | | | | | | | | | | | Mandatorily Redeemable | | Date of Repurchase | | Shares | | Amount of | | | Capital Stock at Date of | | by the Bank | | Repurchased | | Repurchase | | | Repurchase | | January 30, 2004 | | | 989,662 | | | $ | 98,966 | | | $ | — | | April 30, 2004 | | | 1,013,226 | | | | 101,323 | | | | — | | July 30, 2004 | | | 457,943 | | | | 45,794 | | | | — | | October 29, 2004 | | | 762,076 | | | | 76,208 | | | | — | | January 31, 2005 | | | 615,938 | | | | 61,594 | | | | — | | April 30, 2005 | | | 682,754 | | | | 68,275 | | | | — | | July 29, 2005 | | | 576,874 | | | | 57,687 | | | | — | | November 30, 2005 | | | 2,792,806 | | | | 279,281 | | | | — | | January 31, 2006 | | | 1,045,478 | | | | 104,548 | | | | — | | April 28, 2006 | | | 910,775 | | | | 91,078 | | | | 1,665 | | July 31, 2006 | | | 1,202,407 | | | | 120,241 | | | | 2,242 | | October 31, 2006 | | | 1,769,144 | | | | 176,914 | | | | 589 | | January 31, 2007 | | | 1,442,916 | | | | 144,292 | | | | — | |
| | | | | | | | | | | | | | | | | | | | | | | Amount Classified as | | | | | | | | | | | Mandatorily Redeemable | Date of Repurchase | | Shares | | Amount of | | Capital Stock at Date of | by the Bank | | Repurchased | | Repurchase | | Repurchase | January 31, 2007 | | | 1,442,916 | | | $ | 144,292 | | | $ | 263 | | April 30, 2007 | | | 2,862,664 | | | | 286,266 | | | | 7,391 | | July 31, 2007 | | | 1,242,655 | | | | 124,266 | | | | 2,305 | | October 31, 2007 | | | 1,291,685 | | | | 129,169 | | | | 1,531 | | January 31, 2008 | | | 1,917,546 | | | | 191,755 | | | | 24,982 | | April 30, 2008 | | | 1,088,892 | | | | 108,889 | | | | 2,913 | | July 31, 2008 | | | 2,007,883 | | | | 200,788 | | | | 24,988 | | October 31, 2008 | | | 3,064,496 | | | | 306,450 | | | | 394 | | January 30, 2009 | | | 1,683,239 | | | | 168,324 | | | | 7,602 | | April 30, 2009 | | | 1,016,045 | | | | 101,605 | | | | — | | July 31, 2009 | | | 1,368,402 | | | | 136,840 | | | | — | | October 30, 2009 | | | 1,065,165 | | | | 106,517 | | | | — | | January 29, 2010 | | | 1,065,595 | | | | 106,560 | | | | — | |
The Bank adopted StatementAccounting principles generally accepted in the United States of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”(“SFAS 150”America (“GAAP”) as of January 1, 2004. SFAS 150 establishes standards for how issuers classify and measure certain financial instruments with characteristics of both liabilities and equity. Among other things, it requiresrequire issuers to classify as liabilities certain financial instruments that embody obligations for the issuer (hereinafter referred to as “mandatorily redeemable financial instruments”). UnderPursuant to these requirements, the provisions of SFAS 150, the Bank generally reclassifies shares of capital stock from the capital section to the liability section of its balance sheet at the point in time when a member exerciseseither a written redemption right, givesor withdrawal notice of its intent to withdrawis received from a member or a membership withdrawal or attains non-member status by merger or acquisition, charter termination or involuntary termination from membership, sinceis otherwise initiated, because the shares of capital stock then typically meet the SFAS 150 definition of a mandatorily redeemable financial instrument. Shares of capital stock meeting this definition are reclassified to liabilities at fair value. Following reclassification of the stock, any dividends paid or accrued on such shares are recorded as interest expense in the statement of income. As the repurchases presented in the table above
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are made at the sole discretion of the Bank, the repurchase, in and of itself, does not cause the shares underlying such repurchases to meet the definition of mandatorily redeemable financial instruments. On January 1, 2004, the Bank reclassified $394.7 million of its outstanding capital stock to “mandatorily redeemable capital stock” in the liability section of the statement of condition. Mandatorily redeemable capital stock outstanding at December 31, 2006, 20052009, 2008 and 20042007 was $159.6$9.2 million, $319.3$90.4 million and $327.1$82.5 million, respectively. For the years ended December 31, 2006, 20052009, 2008 and 2004,2007, average mandatorily redeemable capital stock was $210.7$56.2 million, $326.2$57.5 million and $365.9$103.9 million, respectively.
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Since January 1, 2004, the majority of the mandatorily redeemable capital stock outstanding has been held by Washington Mutual Bank, a non-member borrower as described in the “Advances” section above. The following table presents mandatorily redeemable capital stock outstanding, by reason for classification as a liability, as of December 31, 2006, 20052009, 2008 and 2004.2007. HOLDINGS OF MANDATORILY REDEEMABLE CAPITAL STOCK (dollars in thousands) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | December 31, 2006 | | December 31, 2005 | | December 31, 2004 | | | December 31, 2009 | | December 31, 2008 | | December 31, 2007 | | | | Number of | | Number of | | Number of | | | | | Number of | | Number of | | Number of | | | | Capital Stock Status | | Institutions | | Amount | | Institutions | | Amount | | Institutions | | Amount | | | Institutions | | Amount | | Institutions | | Amount | | Institutions | | Amount | | Held by the FDIC, as receiver of Franklin Bank, S.S.B. | | | 1 | | $ | 29 | | 1 | | $ | 57,432 | | — | | $ | — | | Held by Capital One, National Association | | | 1 | | 976 | | 1 | | 26,350 | | 1 | | 60,719 | | Held by Washington Mutual Bank | | 1 | | $ | 146,267 | | 1 | | $ | 309,486 | | 1 | | $ | 319,502 | | | — | | — | | 1 | | 103 | | 1 | | 15,436 | | Subject to withdrawal notice | | 4 | | 881 | | 3 | | 759 | | 2 | | 147 | | | 8 | | 1,900 | | 5 | | 1,198 | | 4 | | 920 | | Held by other non-member borrowers | | 8 | | 8,254 | | 6 | | 8,250 | | 4 | | 7,295 | | | Held by non-member acquirers | | 1 | | 4,165 | | 1 | | 840 | | 2 | | 177 | | | | | | | | | | | | | | | | | | Held by other non-members | | | 14 | | 6,260 | | 10 | | 5,270 | | 10 | | 5,426 | | | | | | | | | | | | | | | | | Total | | 14 | | $ | 159,567 | | 11 | | $ | 319,335 | | 9 | | $ | 327,121 | | | 24 | | $ | 9,165 | | 18 | | $ | 90,353 | | 16 | | $ | 82,501 | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Although mandatorily redeemable capital stock is excluded from capital (equity) for financial reporting purposes, such stock is considered capital for regulatory purposes (see the section below entitled “Risk-Based Capital Rules and Other Capital Requirements” for further information). Total outstanding capital stock for regulatory purposes (i.e., capital stock classified as equity for financial reporting purposes plus mandatorily redeemable capital stock) decreased from $2.6$3.3 billion at the end of 20052008 to $2.4$2.5 billion at December 31, 2006.2009. At December 31, 2006,2009, the Bank’s ten largest shareholders (most of which were among the Bank’s ten largest borrowers) held $1.4 billion of capital stock, (including mandatorily redeemable capital stock), which represented 58.353.4 percent of the Bank’s total outstanding capital stock (including mandatorily redeemable capital stock) as of that date. The following table presents the Bank’s ten largest shareholders as of December 31, 2006.2009. 48
TEN LARGEST SHAREHOLDERS AS OF DECEMBER 31, 20062009 (Dollars in thousands) | | | | | | | | | | | | | | | | | | | | | | | | | | | Percent of | | | | | | | | | | Capital | | | Total | | Name | | City | | State | | | Stock | | | Capital Stock | | World Savings Bank, FSB Texas | | Houston | | TX | | $ | 574,622 | | | | 23.9 | % | Guaranty Bank | | Austin | | TX | | | 262,072 | | | | 10.9 | | Washington Mutual Bank | | Henderson | | NV | | | 146,267 | | | | 6.1 | | Capital One, National Association* | | New Orleans | | LA | | | 113,138 | | | | 4.7 | | Franklin Bank, SSB | | Austin | | TX | | | 99,406 | | | | 4.1 | | International Bank of Commerce | | Laredo | | TX | | | 86,023 | | | | 3.5 | | Southwest Corporate FCU | | Plano | | TX | | | 44,946 | | | | 1.8 | | BancorpSouth Bank | | Tupelo | | MS | | | 28,654 | | | | 1.2 | | Southside Bank | | Tyler | | TX | | | 25,614 | | | | 1.1 | | Charter Bank | | Santa Fe | | NM | | | 24,023 | | | | 1.0 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | $ | 1,404,765 | | | | 58.3 | % | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Percent of | | | | | | | | | | | | Capital | | | Total | | Name | | City | | | State | | | Stock | | | Capital Stock | | Wells Fargo Bank South Central, National Association (1) | | Houston | | TX | | $ | 799,097 | | | | 31.4 | % | Comerica Bank | | Dallas | | TX | | | 271,140 | | | | 10.7 | | International Bank of Commerce | | Laredo | | TX | | | 61,908 | | | | 2.4 | | Beal Bank Nevada (2) | | Las Vegas | | NV | | | 41,999 | | | | 1.7 | | Bank of Texas, N.A. | | Dallas | | TX | | | 39,540 | | | | 1.6 | | Southside Bank | | Tyler | | TX | | | 38,629 | | | | 1.5 | | Arvest Bank | | Rogers | | AR | | | 30,239 | | | | 1.2 | | First National Bank | | Edinburg | | TX | | | 27,101 | | | | 1.1 | | BancorpSouth Bank | | Tupelo | | MS | | | 23,465 | | | | 0.9 | | First Community Bank | | Taos | | NM | | | 23,103 | | | | 0.9 | | | | | | | | | | | | | | | | | | | | | | | | | | | $ | 1,356,221 | | | | 53.4 | % | | | | | | | | | | | | | | | |
| | | *(1) | | Previously known as Hibernia NationalFormerly Wachovia Bank, FSB | | (2) | | Beal Bank Nevada is chartered in Las Vegas, NV, but maintains its home office in Plano, TX. |
For a discussion of the status of Washington Mutual Bank, a non-member borrower, see the sub-section above entitled“Advances.”As of December 31, 2006,2009, all of the stock held by Washington Mutual Bank was classified as mandatorily redeemable capital stock (liability) in the statement of condition. The stock held by the other nineten institutions shown in the table above was classified as capital in the statement of condition at December 31, 2006.condition.
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Retained Earnings and Dividends During the year ended December 31, 2006,2009, the Bank’s retained earnings increased by $12.1$140.3 million, from $178.5$216.0 million to $190.6$356.3 million. During 2006,2009, the Bank paid dividends on capital stock totaling $110.0$7.8 million which equated to a(excluding dividends that were classified as an increase in the mandatorily redeemable capital stock liability). The weighted average of the dividend rate (for financial reporting purposes)rates paid during the year (computed as the average of 4.88the rates paid in each quarter weighted by the number of days in each quarter) was 0.25 percent. The Bank’sIn comparison, the weighted average of the dividend raterates paid for 2008 and 2007 were 2.92 percent and 5.21 percent, reflecting dividends of $75.1 million and $108.6 million, respectively. The weighted average of the dividend rates paid was equal to the reference average effective federal funds rate for the yearyears ended December 31, 2006.2009, 2008 and 2007. (For a discussion of the calculation of the reference rate, for 2006, see the section above entitled “Overview”“Overview.”). In comparison, the Bank’s weighted average dividend rates for 2005 and 2004 were 3.58 percent and 1.86 percent, respectively. These dividend rates, reflecting dividends of $89.8 million and $44.0 million, respectively, exceeded the average effective federal funds rate for those years by 36 basis points and 51 basis points, respectively. For purposes of deriving the average rates for the years ended December 31, 2006, 2005 and 2004, mandatorily redeemable capital stock and dividends thereon (totaling $10.9 million, $11.7 million and $6.6 million, respectively) were excluded from the calculations as they are treated as liabilities and interest expense, respectively, for financial reporting purposes. However, the Bank pays dividends on all outstanding capital stock at the same rate regardless of the accounting classification of the stock. The Bank is permitted by regulation to pay dividends only from previously retained earnings or current net earnings. Additional restrictions regarding the payment of dividends are discussed in Item 5 — Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Dividends may be paid in the form of cash or capital stock as authorized by the Bank’s Board of Directors. Because the Bank’s returns (exclusive of gains on the sales of investment securities, if any, and fair value adjustments required by SFAS 133) generally track short-term interest rates, theThe Bank has had a long-standing practice of benchmarking the dividend rate that it pays on capital stock to the average effective federal funds rate. As discussed in the Bank’s Amended Form 10, in light of earnings volatility related to the accounting requirements of SFAS 133, Consistent with that practice, the Bank had been exploring alternative ways to modifymanages its dividend declaration and payment processbalance sheet so that it could declare and pay dividends with the benefit of knowing its actual earnings for the dividend period. Prior to the third quarter of 2006, dividends had been declared during a calendar quarter prior to the datereturns (based on whichcore earnings) generally track short-term interest rates.
49
the Bank’s actual earnings for that quarter were known. On June 25, 2006, the Board of Directors approved a change to the Bank’s dividend declaration and payment process. Effective with the third quarter 2006 dividend, theThe Bank changed its dividend declaration and payment process such that the Bank now declares and pays dividends only after the close of the calendar quarter to which the dividend pertains and the earnings for that quarter have been calculated. The third quarter 2006Each quarterly dividend which was paid on September 29, 2006,in 2009, 2008 and 2007 was based upon the Bank’s operating results, shareholders’ average capital stock holdings and the average effective federal funds raterates for the second quarter of 2006. The fourth quarter 2006 dividend, which was paid on December 29, 2006, was based upon the Bank’s operating results, shareholders’ average capital stock holdings and the average effective federal funds rate for the third quarter of 2006. The Bank anticipates that this pattern will continue for future periods.immediately preceding quarter.
The Bank has a retained earnings policy that is designedcalls for it to maintain retained earnings in an amount sufficient to protect the par value of members’ capital stock investments fromagainst potential identified accounting or economic losses due to specified interest rate, credit and fluctuations in earnings caused by SFAS 133 accounting requirements or other factors.operations risks. The Bank’s current retained earnings policy target, which was last revisedupdated in December 2006,2009, calls for the Bank to maintain a retained earnings balance of at least $170 million.$243 million to protect against the risks identified in the policy. Notwithstanding the fact that the Bank’s December 31, 20062009 retained earnings balance of $190.6$356.3 million exceeds the policy target balance, the Bank may electexpects to retain a portion of its earnings in ordercontinue to build its retained earnings balance further beyondin keeping with its current policy target.long-term strategic objectives. With certain exceptions, the Bank’s retained earnings policy calls for the Bank to maintain its retained earnings balance at or above its policy target when determining the amount of funds available to pay dividends. TakingOn March 23, 2010, the Bank’s Board of Directors approved a dividend in the form of capital stock for the first quarter of 2010 at an annualized rate of 0.375 percent, which exceeds the upper end of the Federal Reserve’s target for the federal funds rate for the fourth quarter of 2009 by 12.5 basis points. The first quarter dividend, applied to average capital stock held during the period from October 1, 2009 through December 31, 2009, will be paid on March 31, 2010.
While there can be no assurances, taking into consideration its current earnings expectations and anticipated market conditions, the Bank currently expects to pay dividends in 2007for the remainder of 2010 at approximately 0 to 25 basis pointsor slightly above the reference average effective federal funds rate for the yearapplicable dividend period (i.e., for each calendar quarter during this period, the average effective federal funds rate for the period from October 1, 2006 through September 30, 2007)preceding quarter). Consistent with its long-standing practice, the Bank expects to pay these dividends in the form of capital stock. When dividends are paid, capital stock is issued in full shares andwith any fractional shares are paid in cash. Stock dividends paid on capital stock that is classified as equity are reported as an issuance of capital stock. Stock dividends paid on capital stock that is classified as mandatorily redeemable capital stock are reported as either an issuance of capital stock or as an increase in the mandatorily redeemable capital stock liability depending upon the event that caused the stock on which the dividend is being paid to be classified as a liability. Stock dividends paid on stock subject to a written redemption notice are reported as an issuance of capital stock as such dividends are not covered by the original redemption notice. Stock dividends paid on stock that is subject to a withdrawal notice (or its equivalent) are reported as an increase in the mandatorily redeemable capital stock liability. Since January 1, 2004,During the years ended December 31, 2009, 2008 and 2007, the Bank hasdid not receivedreceive any stock redemption notices. 74
Derivatives and Hedging Activities The Bank functions as a financial intermediary by channeling funds provided by investors in its consolidated obligations to member institutions. During the course of a business day, all member institutions may obtain advances through a variety of product types that include features as diverse as variable and fixed coupons, overnight to 30-year maturities, and bullet (principal due at maturity) or amortizing redemption schedules. The Bank funds advances primarily through the issuance of consolidated obligation bonds and discount notes. The terms and amounts of these consolidated obligation bonds and discount notes and the timing of their issuance is determined by the Bank and is subject to investor demand as well as FHLBank System debt issuance policies. The intermediation of the timing, structure, and amount of Bank members’ credit needs with the investment requirements of the Bank’s creditors is made possible by the extensive use of interest rate exchange agreements. The Bank’s general practice is to contemporaneously execute interest rate exchange agreements when acquiring assets and/or issuing liabilities in order to convert the instruments’ cash flows to a floating rate that is indexed to LIBOR. By doing so, the Bank reduces its interest rate risk exposure and preserves the value of, and earns more stable returns on, its members’ capital investment. This use of derivatives is integral to the Bank’s financial management strategy, and the impact of these interest rate exchange agreements permeates the Bank’s financial statements. Management has put in place a risk management framework that outlines the permitted uses of interest rate derivatives and that requires frequent reporting of their values and impact on the Bank’s financial statements. All interest rate derivatives employed by the Bank hedge 50
identifiable risks and none are used for speculative purposes. All of the Bank’s derivative instruments that are designated in SFAS 133ASC 815 hedging relationships are hedging fair value risk attributable to changes in LIBOR, the designated benchmark interest rate. Since the adoption of SFAS 133 on January 1, 2001, theThe Bank hasdoes not hadhave any derivative instruments classifieddesignated as cash flow hedges. SFAS 133ASC 815 requires that all derivative instruments be recorded in the statements of condition at their fair values. Changes in the fair values of the Bank’s derivatives are recorded each period in current earnings. SFAS 133ASC 815 also sets forth conditions that must exist in order for balance sheet items to qualify for hedge accounting. If an asset or liability qualifies for hedge accounting, changes in the fair value of the hedged item that are attributable to the hedged risk are also recorded in earnings. As a result, the net effect is that only the “ineffective” portion of a qualifying hedge has an impact on current earnings.
Under SFAS 133,ASC 815, periodic earnings variability occurs in the form of the net difference between changes in the fair values of the hedge (the derivative instrument) and the hedged item (the asset or liability), if any, for accounting purposes. For the Bank, two types of hedging relationships are primarily responsible for creating earnings volatility. The first type involves transactions in which the Bank enters into interest rate swaps with coupon cash flows identical or nearly identical to the cash flows of the hedged item (e.g., an advance, investment security or consolidated obligation). In some cases involving hedges of this type, an assumption of “no ineffectiveness” can be made and the changes in the fair values of the derivative and the hedged item are considered identical and offsetting (hereinafter referred to as the short-cut method). However, if the derivative or the hedged item do not have certain characteristics defined in SFAS 133,ASC 815, the assumption of “no ineffectiveness” cannot be made, and the derivative and the hedged item must be marked to fair value independently (hereinafter referred to as the long-haul method). Under the long-haul method, the two components of the hedging relationship are marked to fair value using different discount rates, and the resulting changes in fair value are generally slightly different from one another. Even though these differences are generally relatively small when expressed as prices, their impact can become more significant when multiplied by the principal amount of the transaction and then evaluated in the context of the Bank’s net income. Further, during periods in which short-term interest rates are volatile, the Bank may experience increased earnings variability related to differences in the timing between changes in short-term rates and interest rate resets on the floating rate leg of its interest rate swaps. The floating legs of most of the Bank’s fixed-for-floating interest rate swaps reset every three months and are then fixed until the next reset date. When short-term rates change significantly between the reset date and the valuation date, discounting the cash flows of the floating rate leg at current market rates until the swap’s next reset date can cause near-term volatility in the Bank’s earnings. Nonetheless, the impact of these types of ineffectiveness-related adjustments on earnings is transitory as the net 75
earnings impact will be zero over the life of the hedging relationship if the derivative and hedged item are held to maturity or their call dates, which is generally the case for the Bank. The second type of hedging relationship that creates earnings volatility involves transactions in which the Bank enters into interest rate exchange agreements to hedge identifiable portfolio risks that either do not qualify for hedge accounting under SFAS 133ASC 815 or are not designated in an ASC 815 hedging relationship (hereinafter referred to as a “non-SFAS 133”“non-ASC 815” or “economic” hedge). For instance, as described above, the Bank holds interest rate caps as a hedge against embedded caps in its floating rate CMOs classified as held-to-maturity securities. The changes in fair value of the interest rate caps flow through current earnings without an offsetting change in the fair value of the hedged items (i.e., the variable rate CMOs with embedded caps), which increases the volatility of the Bank’s earnings. The impact of these changes in value on earnings over the life of the transactions will equal the purchase price of the caps assumingif these instruments are held until their maturity. As discussed in the Amended Form 10, In addition, from time-to-time, the Bank determined, for a varietyuses interest rate basis swaps to reduce its exposure to changes in spreads between one-month and three-month LIBOR and it uses interest rate swaps to convert variable-rate consolidated obligations from one index rate (e.g., the daily federal funds rate) to another index rate (e.g., one- or three-month LIBOR). The Bank also uses fixed-for-floating interest rate swaps to hedge its fair value risk exposure associated with some of reasons, that several typesits longer-term discount notes. The impact of highly effective hedging relationships originally believed to qualify as SFAS 133 hedges did not, upon further review, meet the requirements for hedge accounting, although many of the subject transactions would have qualified if they had been documented properly at their inception. To correct these errors, the Bank reversed the periodic (offsetting) changes in fair value of these stand-alone interest rate swaps on earnings over the hedged items that had previously been recognized in earnings. Withlife of the transactions will be zero if these particular hedging relationships accounted for as economic hedges (rather than SFAS 133 hedges), the Bank’s results for 2005instruments are held until their maturity. The Bank generally holds its discount note swaps and 2004 reflect significantly more volatility than its results for 2006 (for additional discussion, see the section below entitled “Results of Operations”).federal funds floater swaps to maturity.
Because the use of interest rate derivatives enables the Bank to better manage its economic risks, and thus run its business more effectively and efficiently, the Bank will continue to use them during the normal course of its balance sheet management. The Bank views the accounting consequences of using interest rate derivatives as being an important, but secondary, consideration. 51
As a result of using interest rate exchange agreements extensively to fulfill its role as a financial intermediary, the Bank has a large notional amount of interest rate exchange agreements relative to its size. As of December 31, 2006, 20052009, 2008 and 2004,2007, the Bank’s notional balance of interest rate exchange agreements was $51.7$66.7 billion, $46.8$70.1 billion and $64.4$41.0 billion, respectively, while its total assets were $55.7$65.1 billion, $64.9$78.9 billion and $64.6$63.5 billion, respectively. The notional amount of interest rate exchange agreements does not reflect the Bank’s credit risk exposure which, as discussed below, is much less than the notional amount. See discussion of credit risk in Item 7A – Quantitative and Qualitative Disclosures About Market Risk under the section entitled “Counterparty Credit Risk.” The following table provides the notional balances of the Bank’s derivative instruments, by balance sheet category, as of December 31, 2006, 20052009, 2008 and 2004,2007, and the net fair value changes recorded in earnings for each of those categories during the years ended December 31, 2006, 20052009, 2008 and 2004.2007. 76
COMPOSITION OF DERIVATIVES | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total Notional at December 31, | | Net Change in Fair Value(6) | | | Total Notional at December 31, | | Net Change in Fair Value(7) | | | | (In millions of dollars) | | (In thousands of dollars) | | | (In millions of dollars) | | (In thousands of dollars) | | | | 2006 | | 2005 | | 2004 | | 2006 | | 2005 | | 2004 | | | 2009 | | 2008 | | 2007 | | 2009 | | 2008 | | 2007 | | Advances | | | Short-cut method(1) | | $ | 4,930 | | $ | 6,532 | | $ | 7,815 | | $ | — | | $ | — | | $ | — | | | $ | 9,397 | | $ | 9,959 | | $ | 7,161 | | $ | — | | $ | — | | $ | — | | Long-haul method(2) | | 890 | | 991 | | 1,505 | | 125 | | 1,313 | | 822 | | | 1,556 | | 1,164 | | 910 | | | (3,061 | ) | | 3,063 | | 723 | | Economic hedges(3) | | — | | 4 | | — | | 57 | | 91 | | 27 | | | 15 | | 5 | | 22 | | | (36 | ) | | 321 | | | (1 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total | | 5,820 | | 7,527 | | 9,320 | | 182 | | 1,404 | | 849 | | | 10,968 | | 11,128 | | 8,093 | | | (3,097 | ) | | 3,384 | | 722 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Investments | | | Short-cut method(1) | | 55 | | 55 | | 2,641 | | — | | — | | �� | — | | | Long-haul method(2) | | 615 | | 899 | | 1,340 | | | (871 | ) | | 3,346 | | | (2,090 | ) | | — | | 40 | | 315 | | | (102 | ) | | 4,077 | | 2,195 | | Economic hedges(4) | | 23 | | 40 | | 1,376 | | 50 | | | (55,338 | ) | | | (3,930 | ) | | — | | — | | 7 | | — | | 1,037 | | | (127 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total | | 693 | | 994 | | 5,357 | | | (821 | ) | | | (51,992 | ) | | | (6,020 | ) | | — | | 40 | | 322 | | | (102 | ) | | 5,114 | | 2,068 | | | | | | | | | | | | | | | | | | | �� | | | | | | | | | | Consolidated obligations | | | Consolidated obligation bonds | | | Short-cut method(1) | | 3,075 | | 6,257 | | 12,405 | | — | | — | | — | | | 95 | | 95 | | 1,075 | | — | | — | | — | | Long-haul method(2) | | 36,353 | | 25,812 | | 27,775 | | 3,973 | | | (6,882 | ) | | | (2,437 | ) | | 27,519 | | 37,795 | | 24,819 | | 62,462 | | | (55,368 | ) | | | (1,349 | ) | Economic hedges(3) | | 467 | | 204 | | 883 | | 177 | | | (6,338 | ) | | | (12,374 | ) | | 8,195 | | 110 | | 160 | | 10,337 | | | (926 | ) | | 533 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total | | 39,895 | | 32,273 | | 41,063 | | 4,150 | | | (13,220 | ) | | | (14,811 | ) | | 35,809 | | 38,000 | | 26,054 | | 72,799 | | | (56,294 | ) | | | (816 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | | | Other economic | | | Caps/floors(5) | | 5,250 | | 3,915 | | 3,915 | | | (7,802 | ) | | | (3,428 | ) | | | (16,560 | ) | | Basis swaps(7) | | — | | 2,050 | | 4,710 | | 115 | | | (67 | ) | | | (48 | ) | | Consolidated obligation discount notes | | | Economic hedges(3) | | | 6,414 | | 5,270 | | — | | | (7,395 | ) | | 9,216 | | — | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Other economic hedges | | | Interest rate caps(5) | | | 3,750 | | 3,500 | | 6,500 | | 14,316 | | | (2,243 | ) | | | (1,509 | ) | Basis swaps(6) | | | 9,700 | | 12,200 | | — | | 8,994 | | 42,530 | | — | | Member swaps (including offsetting swaps) | | | 24 | | 7 | | — | | 30 | | 16 | | — | | Total | | 5,250 | | 5,965 | | 8,625 | | | (7,687 | ) | | | (3,495 | ) | | | (16,608 | ) | | 13,474 | | 15,707 | | 6,500 | | 23,340 | | 40,303 | | | (1,509 | ) | | | | | | | | | | | | | | | | | | | Total derivatives | | $ | 51,658 | | $ | 46,759 | | $ | 64,365 | | $ | (4,176 | ) | | $ | (67,303 | ) | | $ | (36,590 | ) | | $ | 66,665 | | $ | 70,145 | | $ | 40,969 | | $ | 85,545 | | $ | 1,723 | | $ | 465 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total short-cut method | | $ | 8,060 | | $ | 12,844 | | $ | 22,861 | | $ | — | | $ | — | | $ | — | | | $ | 9,492 | | $ | 10,054 | | $ | 8,236 | | $ | — | | $ | — | | $ | — | | Total long-haul method | | 37,858 | | 27,702 | | 30,620 | | 3,227 | | | (2,223 | ) | | | (3,705 | ) | | 29,075 | | 38,999 | | 26,044 | | 59,299 | | | (48,228 | ) | | 1,569 | | Total economic hedges | | 5,740 | | 6,213 | | 10,884 | | | (7,403 | ) | | | (65,080 | ) | | | (32,885 | ) | | 28,098 | | 21,092 | | 6,689 | | 26,246 | | 49,951 | | | (1,104 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total derivatives | | $ | 51,658 | | $ | 46,759 | | $ | 64,365 | | $ | (4,176 | ) | | $ | (67,303 | ) | | $ | (36,590 | ) | | $ | 66,665 | | $ | 70,145 | | $ | 40,969 | | $ | 85,545 | | $ | 1,723 | | $ | 465 | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | (1) | | The short-cut method allows the assumption of no ineffectiveness in the hedging relationship. | | (2) | | The long-haul method requires the hedge and hedged item to be marked to fair value independently. | | (3) | | Interest rate derivatives that are matched to advances or consolidated obligations, orbut that hedge identified portfolio risks, but thateither do not qualify for hedge accounting under SFAS 133.or were not designated in a hedging relationship for accounting purposes. | | (4) | | Interest rate derivatives that arewere matched to investment securities designated as trading or available-for-sale, but that dodid not qualify for hedge accounting under SFAS 133.accounting. | | (5) | | Interest rate derivatives that hedge identified portfolio risks, but that do not qualify for hedge accounting under SFAS 133.accounting. The Bank’s interest rate caps hedge embedded caps in floating rate CMOs.CMOs designated as held-to-maturity. | | (6) | | At December 31, 2009, the Bank held $9.7 billion (notional) of interest rate basis swaps that were entered into to reduce the Bank’s exposure to changes in spreads between one-month and three-month LIBOR; $1.0 billion, $2.0 billion, $1.0 billion, $4.7 billion and $1.0 billion of these agreements expire in the first quarter of 2011, the second quarter of 2013, the second quarter of 2014, the fourth quarter of 2018, and the first quarter of 2024, respectively. | | (7) | | Represents the difference in fair value adjustments for the derivatives and their hedged items. In cases involving economic hedges (other than those relatingrelated to trading securities), the net change in fair value reflected abovein this table represents a one-sided mark, meaning that the net change in fair value represents the change in fair value of the derivative only. Gains and losses in the form of net interest payments on economic hedge derivatives are excluded from the amounts reflected above. | | (7) | | In June 2004, the Bank entered into $4.7 billion (notional) of interest rate basis swaps to reduce the Bank’s exposure to widening spreads between one-month and three-month LIBOR. The agreements expired in March 2005. The Bank entered into $2.05 billion and $3.0 billion (notional) of interest rate basis swaps in November 2005 and February 2006, respectively; $1.7 billion and $3.35 billion (notional) of such agreements expired in June 2006 and August 2006, respectively. |
By entering into interest rate exchange agreements with highly rated financial institutions (with which it has in place master swap agreements and credit support addendums), the Bank generally exchanges a defined market risk for the risk that the counterparty will not be able to fulfill its obligation in the future. The Bank manages this credit risk by spreading its transactions among as many highly rated counterparties as is practicable, by entering into collateral exchange agreements with all counterparties that include minimum collateral thresholds, and by monitoring its exposure to each counterparty at least monthly and as often as daily. In addition, all of the Bank’s collateral exchange agreements include master netting arrangements whereby the fair values of all interest rate derivatives (including accrued interest receivables and payables) with each counterparty are offset for purposes of measuring credit exposure. The collateral exchange agreements require the delivery of collateral consisting of cash or very liquid, highly rated securities (generally consisting of U.S. government guaranteed or agency debt securities) if credit risk exposures rise above the minimum thresholds. As of December 31, 2009 and 2008, only cash collateral had been delivered under the terms of these collateral exchange agreements. 5277
The maximum credit risk exposure is the estimated cost, on a present value basis, of replacing at current market rates all interest rate exchange agreements with a counterparty with which the Bank is in a net gain position, if the counterparty were to default. Maximum credit risk exposure, as defined in the preceding sentence, does not consider the existence of any collateral held by the Bank. The Bank’s collateral exchange agreements with its counterparties generally establish maximum unsecured credit exposure thresholds (typically ranging from $100,000 to $500,000) that one party may have to the other. Once the counterparties agree to the valuations of the interest rate exchange agreements, and it is determined that the unsecured credit exposure exceeds the threshold, then, upon a request made by the unsecured counterparty, the party that has the unsecured obligation to the counterparty bearing the risk of the unsecured credit exposure generally must deliver sufficient collateral to reduce the unsecured credit exposure to zero. The following table provides information regarding the Bank’s derivative counterparty credit exposure as of December 31, 2009 and 2008. DERIVATIVES COUNTERPARTY CREDIT EXPOSURE (Dollars in millions) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Maximum | | | Cash | | | Cash | | | | | Credit | | Number of | | | Notional | | | Credit | | | Collateral | | | Collateral | | | Net Exposure | | Rating(1) | | Counterparties | | | Principal(2) | | | Exposure | | | Held | | | Due(3) | | | After Collateral | | December 31, 2009 | | | | | | | | | | | | | | | | | | | | | | | | | Aaa | | | 1 | | | $ | 543.0 | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | Aa(4) | | | 10 | | | | 51,897.1 | | | | 198.0 | | | | 187.6 | | | | 8.7 | | | | 1.7 | | A(5) | | | 4 | | | | 14,212.7 | | | | 25.9 | | | | 17.0 | | | | 8.9 | | | | — | | Excess collateral | | | — | | | | — | | | | — | | | | 0.1 | | | | — | | | | — | | | | | | | | | | | | | | | | | | | | | Total | | | 15 | | | $ | 66,652.8 | (6) | | $ | 223.9 | | | $ | 204.7 | | | $ | 17.6 | | | $ | 1.7 | | | | | | | | | | | | | | | | | | | | | December 31, 2008 | | | | | | | | | | | | | | | | | | | | | | | | | Aaa | | | 3 | | | $ | 17,099.2 | | | $ | 35.2 | | | $ | 27.3 | | | $ | 7.9 | | | $ | — | | Aa(4) | | | 9 | | | | 43,239.8 | | | | 341.9 | | | | 288.5 | | | | 52.4 | | | | 1.0 | | A(5) | | | 4 | | | | 9,802.8 | | | | 27.8 | | | | 19.1 | | | | 8.7 | | | | — | | | | | | | | | | | | | | | | | | | | | Total | | | 16 | | | $ | 70,141.8 | (6) | | $ | 404.9 | | | $ | 334.9 | | | $ | 69.0 | | | $ | 1.0 | | | | | | | | | | | | | | | | | | | | |
| | | (1) | | Credit ratings shown in the table are obtained from Moody’s and are as of December 31, 2009 and December 31, 2008, respectively. | | (2) | | Includes amounts that had not settled as of December 31, 2009 and December 31, 2008. | | (3) | | Amount of collateral to which the Bank had contractual rights under counterparty credit agreements based on December 31, 2009 and December 31, 2008 credit exposures. Cash collateral totaling $17.6 million and $68.5 million was delivered under these agreements in early January 2010 and early January 2009, respectively. | | (4) | | The figures for Aa-rated counterparties as of December 31, 2009 and December 31, 2008 include transactions with a counterparty that is affiliated with a member institution. Transactions with this counterparty had an aggregate notional principal of $753 million and $128 million as of December 31, 2009 and December 31, 2008, respectively. These transactions represented a credit exposure of $1.9 million and $3.7 million to the Bank as of December 31, 2009 and December 31, 2008, respectively. | | (5) | | The figures for A-rated counterparties as of December 31, 2009 and December 31, 2008 include transactions with one counterparty that is affiliated with a non-member shareholder of the Bank. Transactions with that counterparty had an aggregate notional principal of $3.2 billion and $1.4 billion as of December 31, 2009 and December 31, 2008, respectively. These transactions represented a credit exposure of $2.2 million to the Bank as of December 31, 2009 and did not represent a credit exposure to the Bank as of December 31, 2008. | | (6) | | Excludes $12.1 million and $3.5 million (notional amounts) of interest rate derivatives with members at December 31, 2009 and December 31, 2008, respectively. This product offering is discussed in the paragraph below. |
In addition to the activities described above, the Bank offers interest rate swaps, caps and floors to its members to assist them in meeting their risk management objectives. In derivative transactions with its members, the Bank acts as an intermediary by entering into an interest rate exchange agreement with the member and then entering into an offsetting interest rate exchange agreement with one of the Bank’s derivative counterparties discussed above. When entering into interest rate exchange agreements with its members, the Bank requires the member to post eligible collateral in an amount equal to the sum of the net market value of the member’s derivative transactions with the Bank (if the value is positive to the Bank) plus a percentage of the notional amount of any interest rate swaps, with market values determined on at least a monthly basis. Eligible collateral for derivative transactions consists of collateral that is eligible to secure advances and other obligations under the member’s Advances and Security Agreement with the Bank (for a description of eligible collateral, see Item 1 — Business — Products and Services — Advances). 78
Market Value of Equity The ratio of the Bank’s estimated market value of equity to its book value of equity was 100 percent at December 31, 2009. In comparison, this ratio was 75 percent as of December 31, 2008. The improvement in the Bank’s market value to book value of equity ratio was due in large part to increases in the values of its MBS holdings. The increase in fair value of these securities was due primarily to reduced liquidity discounts in the MBS market. For additional discussion, see Item 7A — Quantitative and Qualitative Disclosures About Market Risk — Interest Rate Risk. Results of Operations Net Income Net income for 2006, 20052009, 2008 and 20042007 was $122.2$148.1 million, $242.4$79.3 million and $64.7$129.8 million, respectively. The Bank’s net income for 20062009 represented a return on average capital stock (ROCS)(“ROCS”) of 5.425.39 percent, which was 45523 basis points above the average effective federal funds rate for the year. In comparison, the Bank’s ROCS was 9.66 percent in 2005 and 2.73 percent in 2004;2008 and 6.18 percent in 2007; these rates of return exceeded the average effective federal funds rate for those years by 64481 basis points and 138116 basis points, respectively. To derive the Bank’s ROCS, net income is divided by average capital stock outstanding excluding stock that is classified as a liability under the provisions of SFAS 150. mandatorily redeemable capital stock. The Bank’s net income and ROCS were significantly higher in 2005 than in 2006 and 2004 due in large part to gains on the sales of available-for-sale (AFS) securities in 2005 and the Bank’s inability to apply hedge accounting to some of the associated hedging relationships in prior years. As discussed in its Amended Form 10 and in the immediately preceding section entitled “Financial Condition – Derivatives and Hedging Activities,” the Bank lost hedge accounting on, among other things, certain of its AFS securities, which caused the Bank to restate its previously issued financial statements. Accordingly, while the periodic changes in fair value of the related interest rate swaps (predominately losses) were recognized in earnings as incurred, the offsetting gains on the AFS securities that were attributable to changes in LIBOR (the designated benchmark interest rate) were accumulated in OCI and not recognized in earnings until the sale of such securities in August and September 2005. In comparing the Bank’s operating results over the last three years, management believes it is important to understand that the Bank’s operating results for 2005 and 2004 would have been significantly different if the Bank had been able to apply SFAS 133 hedge accountingfactors contributing to the aforementioned hedging relationships. The majority of these hedging relationships would have qualified as SFAS 133 hedges (usingfluctuation in ROCS compared to the long-haul method of accounting) if they had been documented properly at their inception and the Bank had periodically tested such hedging relationships for effectiveness. If this had been the case, the portion of the gains on the AFS securities attributable to changes in the designated benchmark interestaverage federal funds rate would have been recognized in earnings as incurred and would have largely offset the losses recognized on the interest rate swaps in 2005 and prior years and, as a result, the gains on the sales of the AFS securities in 2005 would have been substantially lower. Had the changes in the fair values of the AFS securities attributable to changes in the designated benchmark interest rate and the periodic changes in fair values of the related interest rate swaps been recognized in the same periods (reflecting the economic substance of the transactions), the trend in the Bank’s net income and ROCS from 2004 to 2006, excluding the gains on the sales of the AFS securities, would have been more consistent with the increase in short-term money market rates over this same period. In addition, in 2005 and 2004, the net interest income/expense associated with the interest rate swaps included in these hedging relationships and several other types of highly effective hedging relationships for which the Bank lost hedge accounting caused significant variability in the Bank’s net interest spread (and, correspondingly, in “net gain/(loss) on derivatives and hedging activities”), as furtherare discussed below in the sections entitled “Net Interest Income” and “Other Income (Loss).”
Substantially all of the interest rate swaps for which the Bank lost hedge accounting had either expired or been terminated by the end of 2005, resulting in significantly lower volatility in the Bank’s net interest spread, net gains (losses) on derivatives and hedging activities and net income in 2006. With the exception of its interest rate cap portfolio and the periodic use of basis swaps, the Bank does not typically hold a significant portfolio of economic hedges. Accordingly, the Bank expects future volatility in “net gain/(loss) on derivatives and hedging activities” to more closely approximate the lower volatility experienced in 2006 rather than the amounts reflected in 2005 and 2004.below.
While the Bank is exempt from all Federal, Statefederal, state and local taxation (except for real property taxes), it is obligated to set aside amounts for its AHPAffordable Housing Program (“AHP”) and generally to make quarterly payments to REFCORP.the Resolution Funding Corporation (“REFCORP”). Assessments for AHP and REFCORP, which are more fully described below, equate to a minimum 26.5 percent effective income tax rate for the Bank. Because interest expense on mandatorily redeemable capital stock is not deductible for purposes of computing the Bank’s AHP assessment, the effective rate may exceed 26.5 percent. In 2006, 20052009, 2008 and 2004,2007, the effective rates were 27.226.5 percent, 26.826.6 percent and 27.126.8 percent, respectively. In 2006, 20052009, 2008 and 2004,2007, the combined AHP and REFCORP assessments were $45.6$53.5 million, $88.5$28.8 million and $24.1$47.5 million, respectively. 53
Cumulative Effect of Change in Accounting Principle
Effective January 1, 2005, the Bank changed its method of accounting for the amortization and accretion of mortgage loan premiums and discounts under SFAS No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases.” Previously, amortization and accretion of premiums and discounts associated with the Bank’s mortgage loans held for portfolio were computed using the retrospective method. Under this method, the income effects of premiums and discounts were recognized using the interest method over the estimated lives of the assets, which required a retrospective adjustment of the effective yield each time the Bank changed its estimate of the loan life, based on actual prepayments received and changes in expected future prepayments. Under the retrospective method, the net investment in the loans was adjusted as if the new estimate had been known since the original acquisition of the assets. In 2005, the Bank began amortizing premiums and accreting discounts using the contractual method. The contractual method uses the cash flows required by the loan contracts, as adjusted for any actual prepayments, to apply the interest method. Under the new method, future prepayments of principal are not anticipated. While both methods are acceptable under generally accepted accounting principles, the Bank believes that the contractual method is preferable to the retrospective method because, under the contractual method, the income effects of premiums and discounts are recognized in a manner that is reflective of the actual behavior of the mortgage loans during the period in which the behavior occurs while also reflecting the contractual terms of the assets without regard to changes in estimated prepayments based upon assumptions about future borrower behavior.
As a result of the change in method of amortizing premiums and accreting discounts on mortgage loans, the Bank recorded a cumulative effect of a change in accounting principle effective January 1, 2005. Net of assessments, this change increased net income for the year ended December 31, 2005 by $908,000.
If the contractual method had been used to amortize premiums and accrete discounts in prior years, the Bank’s net income would not have been materially different from the reported amounts.
Income Before Assessments During 2006, 20052009, 2008 and 2004,2007, the Bank’s income before assessments was $167.8$201.5 million, $330.0$108.1 million and $88.8$177.2 million, respectively. The $162.2$93.4 million increase in income before assessments for 2009 as compared to 2008 was attributable primarily to a $177.8 million increase in other income (which was due largely to the Bank’s derivative and hedging activities), offset by a $73.9 million decrease in net interest income and a $10.5 million increase in other expenses. The $69.1 million decrease in income before assessments for 20062008 as compared to 20052007 was attributable to a $72.7 million decline in net interest income and a $9.5 million increase in other expenses, partially offset by a $13.1 million gain in other income (which was due primarily to a $7.5 million increase in gains on the saleextinguishment of available-for-sale securities totaling $245.4debt and a $6.6 million in 2005. There were no sales of available-for-sale securities during 2006. This variance was offset by an $85.8 million reductionincrease in the Bank’s lossesgains on derivatives and hedging activities from $91.3 million in 2005 to $5.5 million in 2006. The $241.2 million increase in income before assessments for 2005 as compared to 2004 was attributable primarily to the $245.4 million gains on the sale of available-for-sale securities discussed above.activities).
The components of income before assessments (net interest income, other income (loss) and other expenses)expense) are discussed in more detail in the following sections. Net Interest Income In 2006, 20052009, 2008 and 2004,2007, the Bank’s net interest income was $216.3$76.5 million, $222.6$150.4 million and $220.8$223.0 million, respectively, and its net interest margin (based on these results) was 3711 basis points, 3420 basis points and 3640 basis points, respectively. Net interest margin, or net interest income as a percent of average earning assets, is a function of net interest spread and the rates of return on assets funded by the investment of the Bank’s capital. Net interest spread is the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities. Net interest income, net interest margin and net interest spread are impacted positively or negatively, as the case may be, by the inclusion or exclusion of net interest income/expense associated with the Bank’s interest rate exchange agreements. To the extent such agreements qualify for SFAS 133 fair value hedge accounting, the net interest income/expense associated with the 79
agreements is included in net interest income and the calculations of net interest margin and net interest spread. Conversely, if such agreements do not qualify for SFAS 133 fair value hedge accounting (“economic hedges”), the net interest income/expense associated with the agreements is excluded from net interest income and the calculations of the Bank’s net interest margin and net interest spread. As the Bank’s portfolio of economic hedges has grown, the effects of this accounting treatment have become more significant. 54
The following table presents average balance sheet amounts together with the total dollar amounts of interest income and expense and the weighted average interest rates of major earning asset categories and the funding sources for those earning assets for 2006, 20052009, 2008 and 2004.2007. YIELD AND SPREAD ANALYSIS (Dollars in millions) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Year Ended December 31, | | | | 2006 | | 2005 | | 2004 | | | 2009 | | 2008 | | 2007 | | | | Interest | | Interest | | Interest | | | | | Interest | | Interest | | Interest | | | | | | Average | | Income/ | | Average | | Average | | Income/ | | Average | | Average | | Income/ | | Average | | | Average | | Income/ | | Average | | Average | | Income/ | | Average | | Average | | Income/ | | Average | | | | Balance | | Expense | | Rate(a) | | Balance | | Expense | | Rate(a) | | Balance | | Expense | | Rate(a) | | | Balance | | Expense(d) | | Rate(a)(d) | | Balance | | Expense(d) | | Rate(a)(d) | | Balance | | Expense(d) | | Rate(a)(d) | | Assets | | | Interest-bearing deposits | | $ | 364 | | $ | 19 | | | 5.22 | % | | $ | 459 | | $ | 14 | | | 3.15 | % | | $ | 465 | | $ | 7 | | | 1.47 | % | | Federal funds sold | | 3,929 | | 197 | | | 5.01 | % | | 3,867 | | 132 | | | 3.41 | % | | 2,371 | | 33 | | | 1.37 | % | | Interest-bearing deposits(b) | | | $ | 335 | | $ | 1 | | | 0.20 | % | | $ | 174 | | $ | 3 | | | 1.69 | % | | $ | 137 | | $ | 8 | | | 5.79 | % | Federal funds sold(c) | | | 3,908 | | 5 | | | 0.13 | % | | 4,946 | | 96 | | | 1.94 | % | | 5,447 | | 277 | | | 5.09 | % | Investments | | | Trading(b) | | 34 | | 2 | | | 6.91 | % | | 62 | | 6 | | | 9.75 | % | | 102 | | 12 | | | 11.69 | % | | Available-for-sale(c) | | 849 | | 42 | | | 4.96 | % | | 4,068 | | 153 | | | 3.75 | % | | 5,710 | | 155 | | | 2.71 | % | | Held-to-maturity | | 7,540 | | 417 | | | 5.53 | % | | 7,752 | | 308 | | | 3.97 | % | | 7,132 | | 171 | | | 2.39 | % | | Advances(c)(d) | | 43,623 | | 2,184 | | | 5.01 | % | | 47,617 | | 1,645 | | | 3.45 | % | | 44,604 | | 875 | | | 1.96 | % | | Trading | | | 3 | | — | | — | | 3 | | — | | | 0.00 | % | | 9 | | 1 | | | 6.13 | % | Available-for-sale(e) | | | 28 | | — | | | 1.70 | % | | 331 | | 10 | | | 3.13 | % | | 524 | | 26 | | | 5.08 | % | Held-to-maturity (e) | | | 11,901 | | 150 | | | 1.26 | % | | 10,003 | | 349 | | | 3.49 | % | | 7,707 | | 437 | | | 5.67 | % | Advances(f) | | | 53,536 | | 665 | | | 1.24 | % | | 58,671 | | 1,816 | | | 3.10 | % | | 40,405 | | 2,114 | | | 5.23 | % | Mortgage loans held for portfolio | | 493 | | 28 | | | 5.58 | % | | 622 | | 34 | | | 5.54 | % | | 827 | | 47 | | | 5.69 | % | | 292 | | 16 | | | 5.51 | % | | 353 | | 20 | | | 5.60 | % | | 414 | | 23 | | | 5.57 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total earning assets | | 56,832 | | 2,889 | | | 5.08 | % | | 64,447 | | 2,292 | | | 3.56 | % | | 61,211 | | 1,300 | | | 2.12 | % | | 70,003 | | 837 | | | 1.20 | % | | 74,481 | | 2,294 | | | 3.08 | % | | 54,643 | | 2,886 | | | 5.28 | % | Cash and due from banks | | 72 | | 62 | | 134 | | | 102 | | 80 | | 85 | | Other assets | | 269 | | 287 | | 281 | | | 408 | | 414 | | 327 | | Derivatives netting adjustment(b) | | | | (458 | ) | | | (330 | ) | | — | | Fair value adjustment on available-for-sale securities (e) | | | — | | | (4 | ) | | 1 | | Adjustment for non-credit portion of other-than-temporary impairments on held-to-maturity securities (e) | | | | (37 | ) | | — | | — | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total assets | | $ | 57,173 | | 2,889 | | | 5.05 | % | | $ | 64,796 | | 2,292 | | | 3.54 | % | | $ | 61,626 | | 1,300 | | | 2.11 | % | | $ | 70,018 | | 837 | | | 1.20 | % | | $ | 74,641 | | 2,294 | | | 3.07 | % | | $ | 55,056 | | 2,886 | | | 5.24 | % | | | | | | | | | | | | | | | | | | | Liabilities and Capital | | | Interest-bearing deposits | | $ | 2,991 | | 146 | | | 4.87 | % | | $ | 2,118 | | 70 | | | 3.30 | % | | $ | 2,194 | | 29 | | | 1.31 | % | | Interest-bearing deposits (b) | | | $ | 1,445 | | 1 | | | 0.10 | % | | $ | 2,965 | | 58 | | | 1.97 | % | | $ | 2,920 | | 144 | | | 4.94 | % | Consolidated obligations | | | Bonds(c) | | 42,776 | | 2,123 | | | 4.96 | % | | 50,382 | | 1,717 | | | 3.41 | % | | 46,931 | | 924 | | | 1.97 | % | | Discount notes(c) | | 7,807 | | 390 | | | 5.00 | % | | 8,237 | | 271 | | | 3.29 | % | | 8,547 | | 119 | | | 1.40 | % | | Mandatorily redeemable capital stock and other borrowings | | 221 | | 14 | | | 6.14 | % | | 330 | | 12 | | | 3.58 | % | | 375 | | 7 | | | 1.81 | % | | Bonds | | | 50,424 | | 553 | | | 1.10 | % | | 49,110 | | 1,564 | | | 3.18 | % | | 37,634 | | 1,958 | | | 5.20 | % | Discount notes | | | 14,752 | | 207 | | | 1.40 | % | | 18,851 | | 521 | | | 2.77 | % | | 11,336 | | 556 | | | 4.90 | % | Mandatorily redeemable capital stock and | | | other borrowings | | | 58 | | — | | | 0.15 | % | | 68 | | 1 | | | 2.02 | % | | 109 | | 5 | | | 5.10 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total interest-bearing liabilities | | 53,795 | | 2,673 | | | 4.97 | % | | 61,067 | | 2,070 | | | 3.39 | % | | 58,047 | | 1,079 | | | 1.86 | % | | 66,679 | | 761 | | | 1.14 | % | | 70,994 | | 2,144 | | | 3.02 | % | | 51,999 | | 2,663 | | | 5.12 | % | Other liabilities | | 922 | | 1,142 | | 1,178 | | | 785 | | 822 | | 733 | | Derivatives netting adjustment(b) | | | | (458 | ) | | | (330 | ) | | — | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total liabilities | | 54,717 | | 2,673 | | | 4.88 | % | | 62,209 | | 2,070 | | | 3.33 | % | | 59,225 | | 1,079 | | | 1.82 | % | | 67,006 | | 761 | | | 1.14 | % | | 71,486 | | 2,144 | | | 3.00 | % | | 52,732 | | 2,663 | | | 5.05 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total capital | | 2,456 | | 2,587 | | 2,401 | | | 3,012 | | 3,155 | | | 2,324 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total liabilities and capital | | $ | 57,173 | | | 4.68 | % | | $ | 64,796 | | | 3.20 | % | | $ | 61,626 | | | 1.75 | % | | $ | 70,018 | | | 1.09 | % | | $ | 74,641 | | | 2.87 | % | | $ | 55,056 | | | 4.84 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Net interest income | | $ | 216 | | $ | 222 | | $ | 221 | | | $ | 76 | | $ | 150 | | $ | 223 | | | | | | | | | | | | | | | | | Net interest margin | | | 0.37 | % | | | 0.34 | % | | | 0.36 | % | | | 0.11 | % | | | 0.20 | % | | | 0.40 | % | Net interest spread | | | 0.11 | % | | | 0.17 | % | | | 0.26 | % | | | 0.06 | % | | | 0.06 | % | | | 0.16 | % | | | | | | | | | | | | | | | | Impact of non-interest bearing funds | | | 0.26 | % | | | 0.17 | % | | | 0.10 | % | | | 0.05 | % | | | 0.14 | % | | | 0.24 | % | | | | | | | | | | | | | | | |
| | | (a) | | Amounts used to calculate average rates are based on numbers in the thousands.whole dollars. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results. | | (b) | | Interest income andSince January 1, 2008, the Bank offsets the fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral against the fair value amounts recognized for derivative instruments executed with the same counterparty under a master netting arrangement. The average rates exclude the effectbalances of associated interest rate exchange agreements as the net interest expense associated with such agreements is recorded in other income (loss) in the statements of income and therefore excluded from the Yield and Spread Analysis. Net interest expense on derivatives related to trading securities was $0.9 million, $4.5 million and $10.8 million duringinterest-bearing deposit assets for the years ended December 31, 2006, 20052009 and 2004, respectively.2008 in the table above include $179 million and $130 million, respectively, which are classified as derivative assets/liabilities on the statements of condition. In addition, the average balances of interest-bearing deposit liabilities for the years ended December 31, 2009 and 2008 in the table above include $280 million and $200 million, respectively, which are classified as derivative assets/liabilities on the statements of condition. Prior to 2008, the Bank offset only the fair value amounts recognized for derivative instruments executed with the same counterparty under a master netting arrangement. The Bank has determined that it is impractical to retrospectively restate the average balances prior to 2008; further, the Bank has determined that any such adjustments would not have had a material impact on the average total asset balances for those periods. Accordingly, the average total asset balance for the year ended December 31, 2007 does not reflect any adjustments to offset cash collateral against the derivative balances. | | (c) | | Includes overnight federal funds sold to other FHLBanks. | | (d) | | Interest income/expense and average rates include the effecteffects of associated interest rate exchange agreements to the extent such agreements qualify for SFAS 133 fair value hedge accounting. If the agreements do not qualify for hedge accounting or were not designated in a hedging relationship for accounting purposes, the net interest income/expense associated with such agreements is recorded in other income (loss) in the statements of income and therefore excluded from the Yield and Spread Analysis. Net interest income (expense) on economic hedge derivatives related to available-for-sale securities that did not qualify for hedge accounting was $98,000, ($26.7 million)totaled $107.6 million, $5.0 million and ($61.70.4 million) during the years ended December 31, 2006, 2005 and 2004, respectively. For these same periods, net interest income (expense) on derivatives related to consolidated obligation bonds that did not qualify for hedge accounting was ($1.0 million), $3.4 million and $8.8 million, respectively. Net interest income (expense) on derivatives related to consolidated obligation discount notes that did not qualify for hedge accounting was ($0.7 million) and $1.4 million for the years ended December 31, 20052009, 2008 and 2004, respectively. There were no derivatives related to consolidated obligation discount notes that did not qualify for hedge accounting during 2006. 2007, respectively, the components of which are presented below in the sub-section entitled “Other Income (Loss).” | | (e) | | Average balances for available-for-sale and held-to-maturity securities are calculated based upon amortized cost. | | (d)(f) | | Interest income and average rates include prepayment fees on advances. |
5580
20062009 versus 20052008
The average effective federal funds rate increased from 3.22 percent for the year ended December 31, 2005 to 4.97 percent for the year ended December 31, 2006. Due to risinglower short-term interest rates in 2006,2009, the contribution of the Bank’s invested capital to the net interest margin (the impact of non-interest bearing funds) increaseddecreased from 1714 basis points in 20052008 to 265 basis points in 2006. Conversely, the2009. The Bank’s net interest spread (based on reported results) declined from 17results, which exclude net interest payments on economic hedge derivatives) was 6 basis points duringin both 2009 and 2008.
As noted above, the Bank’s net interest income excludes net interest payments on economic hedge derivatives. In 2009, the Bank used approximately $11.3 billion (average notional balance) of interest rate basis swaps to hedge the risk of changes in spreads between one- and three-month LIBOR, approximately $6.4 billion (average notional balance) of fixed-for-floating interest rate swaps to hedge some of its longer-term discount notes, and approximately $6.8 billion (average notional balance) of interest rate swaps to convert variable-rate consolidated obligations from the daily federal funds rate to three-month LIBOR (“federal funds floater swaps”). During 2008, the Bank was a party to approximately $6.2 billion (average notional balance) of interest rate basis swaps, approximately $5.9 billion (average notional balance) of discount note swaps, and approximately $12 million (average notional balance) of federal funds floater swaps. These swaps are accounted for as economic hedges. Net interest income associated with economic hedge derivatives is recorded in other income in the statements of income and therefore excluded from net interest income, net interest margin and net interest spread. Net interest income on the Bank’s economic hedge derivatives totaled $107.6 million for the year ended December 31, 20052009, compared to 11 basis points during$5.0 million for the year ended December 31, 2006. The decrease2008. Had this interest income on economic hedge derivatives been included in net interest spread was due primarily toincome, the following factors. First, as discussed previously, the Bank reports realized gains and losses in the form ofBank’s net interest payments on derivative instruments used to hedge interest-earning assetsmargin and interest-bearing liabilities as part of net interest income when the hedging relationships qualify for hedge accounting under SFAS 133. Conversely, net interest payments on derivatives used in economic hedges are reported in “net gains (losses) on derivatives and hedging activities” together with the unrealized changes in fair value of the derivatives. For most of the first nine months of 2005, the Bank held approximately $1.4 billion of fixed rate available-for-sale securities that were in economic hedging relationships. The net interest expense on the associated interest rate swaps totaling approximately $26.7 million was included in net gain (loss) on derivatives and hedging activities and therefore excluded from the net interest spread calculation (representing approximately 4would have been 27 basis points). During the third quarter of 2005, the Bank sold substantially all of the subject available-for-sale securitiespoints and terminated the associated interest rate swaps, resulting in a reduction of interest income on available-for-sale securities and a corresponding reduction in losses on derivatives and hedging activities.
Second, as discussed above under the section entitled “Financial Condition — Retained Earnings and Dividends,” the Bank changed its dividend declaration and payment process beginning with the third quarter 2006 dividend so that it can declare and pay its quarterly dividends with the benefit of knowing its actual earnings22 basis points, respectively, for the dividend reference period. The third quarter 2006 dividend was paid on September 29, 2006,year ended December 31, 2009, compared to 21 basis points and was based upon the Bank’s operating results, shareholders’ average capital stock holdings and the average effective federal funds rate7 basis points, respectively, for the second quarter of 2006. Because the dividend paid in the third quarter of 2006 was based upon average capital stock holdings for the second quarter of 2006, the portion of this dividend that was paid on mandatorily redeemable capital stock was recognized as interest expense in the second quarter of 2006. Because the dividend paid in the fourth quarter of 2006 and the dividend that has been declared for the first quarter of 2007 are similarly based upon the Bank’s operating results, shareholders’ average capital stock holdings and the average effective federal funds rate for the third and fourth quarter of 2006, respectively, the portion of these dividends that relates to mandatorily redeemable capital stock was recognized in the third and fourth quarters of 2006, respectively. Under the Bank’s dividend practices that existed through June 30, 2006, interest expense on mandatorily redeemable capital stock was recorded in the calendar quarter in which the dividend was paid. year ended December 31, 2008.
The inclusion of this additional interest expense (that is, the additional amount recorded in the second quarter of 2006) reduced the Bank’s net interest spread for the yearfourth quarter of 2008 and the first quarter of 2009 (and therefore its net interest spread for the years ended December 31, 20062009 and 2008) was adversely impacted by approximately 1 basis point. In addition, netactions the Bank took in late 2008 to ensure its ability to provide liquidity to its members during a period of assessments, it reducedunusual market disruption. At the height of the credit market disruptions in the early part of the fourth quarter of 2008, and in order to ensure that the Bank would have sufficient liquidity on hand to fund member advances throughout the year-end period, the Bank issued debt with maturities that extended into 2009 instead of issuing very short-maturity debt. As yields subsequently declined sharply on the Bank’s ROCS forshort-term assets, including overnight federal funds sold and short-term advances to members, this debt was carried at a negative spread. The negative impact of this debt on the year ended December 31, 2006 by approximately 10 basis points. Third,Bank’s net interest income, net interest margin and net interest spread was minimal in the net spread earned on fixed rate assets which were funded with floating ratelast nine months of 2009, as much of the relatively high cost debt duringissued in late 2008 matured in the first half of 2005 declined due to the substitution during the third quarter of 2005 of higher rate fixed rate debt for the floating rate debt that had previously funded those assets.
Fourth, the Bank’s balance sheet participation in the MPF Program is continuing to decline. As a result, the Bank held a smaller balance of relatively higher yielding fixed rate mortgage loans during the year ended December 31, 2006 as compared to the year ended December 31, 2005.2009.
20052008 versus 20042007
The average effective federal funds rate increased from 1.35 percent for the year ended December 31, 2004 to 3.22 percent for the year ended December 31, 2005. Due to risingdecreasing short-term interest rates in 2005,2008, the contribution of the Bank’s invested capital to the net interest margin (the impact of non-interest bearing funds) increaseddecreased from 1024 basis points in 20042007 to 1714 basis points in 2005.
56
Despite the increase in interest rates and the $3.2 billion increase in the Bank’s total average assets from 2004 to 2005, the Bank’s net interest income for 2005 of $222.6 million was only slightly higher than its net interest income of $220.8 million for 2004. This was primarily due to a decline in the2008. The Bank’s net interest spread (based on reported results which, as discussed above, exclude net interest payments on economic hedge derivatives) declined from 2616 basis points during 2004the year ended December 31, 2007 to 176 basis points during 2005.the year ended December 31, 2008. The decrease in net interest spread was due primarilyfrom 2007 to 2008 resulted largely from the following factors.
First,actions the Bank took to ensure its ability to provide liquidity to its members as discussed previously, during 2004 and the first nine months of 2005, the Bank held approximately $1.4 billion of fixed rate available-for-sale securities that were in economic hedging relationships and funded by floating rate debt. The increase in interest expense on the floating rate debt (which resulted in a decrease of approximately 6 basis points in the Bank’s net interest spread) was substantially offset by a $35.0 million reduction of net interest expense on the derivatives associated with the available-for-sale securities, which was recorded in other income (loss) and therefore excluded from the net interest spread calculation.above.
Second, the net spread earned on approximately $750 million of fixed rate assets funded with floating rate debt declined by about 187 basis points due to the increase in short-term interest rates.
Third, as discussed previously, the Bank’s balance sheet participation in the MPF program has been declining since 2003. As a result, the Bank held a smaller balance of relatively higher yielding fixed rate mortgage loans during 2005 as compared to 2004.
Rate and Volume Analysis Changes in both volume (i.e., average balances) and interest rates influence changes in net interest income and net interest margin. The following table summarizes changes in interest income and interest expense between 20062009 and 20052008 and between 20052008 and 2004.2007 and excludes net interest income on economic hedge derivatives as discussed above. Changes in interest income and interest expense that cannot be attributed to either volume or rate have been allocated to the volume and rate categories based upon the proportion of the absolute value of the volume and rate changes. 5781
RATE AND VOLUME ANALYSIS (In millions of dollars) | | | | | | | | | | | | | | | | | | | | | | | | | | | 2006 vs. 2005 | | | 2005 vs. 2004 | | | | Increase (Decrease) Due To | | | Increase (Decrease) Due To | | | | Volume | | | Rate | | | Total | | | Volume | | | Rate | | Total | | Interest income: | | | | | | | | | | | | | | | | | | | | | | | | | Interest-bearing deposits | | $ | (4 | ) | | $ | 9 | | | $ | 5 | | | $ | (1 | ) | | $ | 8 | | | $ | 7 | | Federal funds sold | | | 2 | | | | 63 | | | | 65 | | | | 30 | | | | 69 | | | | 99 | | Investments | | | | | | | | | | | | | | | | | | | | | | | | | Trading | | | (2 | ) | | | (2 | ) | | | (4 | ) | | | (4 | ) | | | (2 | ) | | | (6 | ) | Available-for-sale | | | (148 | ) | | | 37 | | | | (111 | ) | | | (52 | ) | | | 50 | | | | (2 | ) | Held-to-maturity | | | (8 | ) | | | 117 | | | | 109 | | | | 16 | | | | 121 | | | | 137 | | Advances | | | (148 | ) | | | 687 | | | | 539 | | | | 63 | | | | 707 | | | | 770 | | Mortgage loans held for portfolio | | | (6 | ) | | | — | | | | (6 | ) | | | (12 | ) | | | (1 | ) | | | (13 | ) | | | | | | | | | | | | | | | | | | | | Total interest income | | | (314 | ) | | | 911 | | | | 597 | | | | 40 | | | | 952 | | | | 992 | | | | | | | | | | | | | | | | | | | | | Interest expense: | | | | | | | | | | | | | | | | | | | | | | | | | Interest-bearing deposits | | | 35 | | | | 41 | | | | 76 | | | | (1 | ) | | | 42 | | | | 41 | | Consolidated obligations: | | | | | | | | | | | | | | | | | | | | | | | | | Bonds | | | (289 | ) | | | 695 | | | | 406 | | | | 72 | | | | 721 | | | | 793 | | Discount notes | | | (15 | ) | | | 134 | | | | 119 | | | | (4 | ) | | | 156 | | | | 152 | | Mandatorily redeemable capital stock and other borrowings | | | (5 | ) | | | 7 | | | | 2 | | | | (1 | ) | | | 6 | | | | 5 | | | | | | | | | | | | | | | | | | | | | Total interest expense | | | (274 | ) | | | 877 | | | | 603 | | | | 66 | | | | 925 | | | | 991 | | | | | | | | | | | | | | | | | | | | | Changes in net interest income | | $ | (40 | ) | | $ | 34 | | | $ | (6 | ) | | $ | (26 | ) | | $ | 27 | | | $ | 1 | | | | | | | | | | | | | | | | | | | | |
As previously discussed, the Bank reports income/expense from its trading securities, certain of its available-for-sale securities, and certain of its consolidated obligations in interest income/expense without the offsetting effects of the associated interest rate swaps. In 2006, 2005 and 2004, the net interest expense associated with economic hedge derivatives related to trading securities was $0.9 million, $4.5 million and $10.8 million, respectively, while the net interest income (expense) associated with economic hedge derivatives related to available-for-sale securities was $98,000, ($26.7 million) and ($61.7 million), respectively. For these same periods, the net interest income (expense) associated with economic hedge derivatives related to consolidated obligations was ($1.0 million), $2.7 million and $10.2 million, respectively. The changes in interest income on trading and available-for-sale securities and the changes in interest expense on consolidated obligations reflected in the foregoing Yield and Spread and Rate and Volume Analyses have been offset to varying degrees by changes in the net interest income/expense on the associated interest rate exchange agreements recorded in other income (loss). Because the Bank has synthetically converted the instruments’ cash flows through interest rate swap agreements, management considers the effects of the associated interest rate exchange agreements when evaluating changes in the Bank’s net interest income across different time periods and in relation to the movement in short-term interest rates. When combined with the associated interest rate exchange agreements, the average rates earned on the trading and available-for-sale securities are substantially lower during 2005 and 2004 than the rates shown in the Yield and Spread Analysis while the average rates paid on the consolidated obligations are somewhat higher in 2006 and lower in 2005 and 2004 than the rates shown in the Yield and Spread Analysis. Further, when the effects of these interest rate exchange agreements are considered, the Bank’s net interest margin and net interest spread for 2005 and 2004 are significantly lower than the rates shown in the Yield and Spread Analysis. The effects of the interest rate exchange agreements on the Bank’s net interest margin and net interest spread were insignificant in 2006. While significant, the effects of the interest rate exchange agreements on the Bank’s net interest margin and net interest spread were smaller in 2005 than in 2004 as many of the Bank’s economic hedge derivatives had either expired or been terminated. | | | | | | | | | | | | | | | | | | | | | | | | | | | 2009 vs. 2008 | | | 2008 vs. 2007 | | | | Increase (Decrease) Due To | | | Increase (Decrease) Due To | | | | Volume | | | Rate | | | Total | | | Volume | | | Rate | | | Total | | Interest income: | | | | | | | | | | | | | | | | | | | | | | | | | Interest-bearing deposits | | $ | 2 | | | $ | (4 | ) | | $ | (2 | ) | | $ | — | | | $ | (5 | ) | | $ | (5 | ) | Federal funds sold | | | (17 | ) | | | (74 | ) | | | (91 | ) | | | (24 | ) | | | (157 | ) | | | (181 | ) | Investments | | | | | | | | | | | | | | | | | | | | | | | | | Trading | | | — | | | | — | | | | — | | | | (1 | ) | | | — | | | | (1 | ) | Available-for-sale | | | (7 | ) | | | (3 | ) | | | (10 | ) | | | (8 | ) | | | (8 | ) | | | (16 | ) | Held-to-maturity | | | 57 | | | | (256 | ) | | | (199 | ) | | | 108 | | | | (196 | ) | | | (88 | ) | Advances | | | (147 | ) | | | (1,004 | ) | | | (1,151 | ) | | | 751 | | | | (1,049 | ) | | | (298 | ) | Mortgage loans held for portfolio | | | (3 | ) | | | (1 | ) | | | (4 | ) | | | (3 | ) | | | — | | | | (3 | ) | | | | | | | | | | | | | | | | | | | | Total interest income | | | (115 | ) | | | (1,342 | ) | | | (1,457 | ) | | | 823 | | | | (1,415 | ) | | | (592 | ) | | | | | | | | | | | | | | | | | | | | Interest expense: | | | | | | | | | | | | | | | | | | | | | | | | | Interest-bearing deposits | | | (20 | ) | | | (37 | ) | | | (57 | ) | | | 2 | | | | (88 | ) | | | (86 | ) | Consolidated obligations: | | | | | | | | | | | | | | | | | | | | | | | | | Bonds | | | 40 | | | | (1,051 | ) | | | (1,011 | ) | | | 495 | | | | (889 | ) | | | (394 | ) | Discount notes | | | (96 | ) | | | (218 | ) | | | (314 | ) | | | 272 | | | | (307 | ) | | | (35 | ) | Mandatorily redeemable capital stock and other borrowings | | | — | | | | (1 | ) | | | (1 | ) | | | (2 | ) | | | (2 | ) | | | (4 | ) | | | | | | | | | | | | | | | | | | | | Total interest expense | | | (76 | ) | | | (1,307 | ) | | | (1,383 | ) | | | 767 | | | | (1,286 | ) | | | (519 | ) | | | | | | | | | | | | | | | | | | | | Changes in net interest income | | $ | (39 | ) | | $ | (35 | ) | | $ | (74 | ) | | $ | 56 | | | $ | (129 | ) | | $ | (73 | ) | | | | | | | | | | | | | | | | | | | |
5882
Other Income (Loss) The following table presents the various components of other income (loss) for the years ended December 31, 2006, 20052009, 2008 and 2004.2007. OTHER INCOME (LOSS) (In thousands of dollars) | | | | | | | | | | | | | | | 2006 | | | 2005 | | | 2004 | | Net losses on trading securities | | $ | (893 | ) | | $ | (4,442 | ) | | $ | (7,860 | ) | Gains on economic hedge derivatives related to trading securities | | | 956 | | | | 4,585 | | | | 8,126 | | | | | | | | | | | | Hedge ineffectiveness on trading securities | | | 63 | | | | 143 | | | | 266 | | | | | | | | | | | | | | | | | | | | | | | | | Net interest expense associated with economic hedge derivatives related to trading securities | | | (947 | ) | | | (4,458 | ) | | | (10,777 | ) | Net interest income (expense) associated with economic hedge derivatives related to available-for-sale securities | | | 98 | | | | (26,698 | ) | | | (61,742 | ) | Net interest income (expense) associated with economic hedge derivatives related to consolidated obligations | | | (991 | ) | | | 2,688 | | | | 10,217 | | Net interest income (expense) associated with stand-alone economic hedge derivatives (basisswaps) | | | (283 | ) | | | 128 | | | | 390 | | Net interest expense associated with economic hedge derivatives related to advances | | | (51 | ) | | | (86 | ) | | | (37 | ) | | | | | | | | | | | Total net interest expense associated with economic hedge derivatives | | | (2,174 | ) | | | (28,426 | ) | | | (61,949 | ) | | | | | | | | | | | | | | | | | | | | | | | | Losses related to stand-alone economic hedge derivatives (caps and floors) | | | (7,802 | ) | | | (3,428 | ) | | | (16,560 | ) | Gains (losses) related to other stand-alone derivatives (basis swaps) | | | 115 | | | | (67 | ) | | | (48 | ) | Gains (losses) related to other economic hedge derivatives (advance / AFS(1)/ CO(2)swaps) | | | 221 | | | | (61,728 | ) | | | (16,543 | ) | | | | | | | | | | | Total fair value losses related to economic hedge derivatives | | | (7,466 | ) | | | (65,223 | ) | | | (33,151 | ) | | | | | | | | | | | | | | | | | | | | | | | | Gains (losses) related to SFAS 133 fair value hedge ineffectiveness | | | | | | | | | | | | | Net gains on advances and associated hedges | | | 125 | | | | 1,313 | | | | 822 | | Net gains (losses) on debt and associated hedges | | | 3,973 | | | | (6,882 | ) | | | (2,437 | ) | Net gains (losses) on AFS(1) securities and associated hedges | | | (871 | ) | | | 3,346 | | | | (2,090 | ) | | | | | | | | | | | Total SFAS 133 fair value hedge ineffectiveness | | | 3,227 | | | | (2,223 | ) | | | (3,705 | ) | | | | | | | | | | | | | | | | | | | | | | | | Gains on early extinguishment of debt | | | 746 | | | | 2,475 | | | | 857 | | Net realized gains on sales of AFS securities | | | — | | | | 245,395 | | | | — | | Service fees | | | 3,438 | | | | 2,841 | | | | 2,470 | | Other, net | | | 3,445 | | | | 2,603 | | | | 2,526 | | | | | | | | | | | | Total other | | | 7,629 | | | | 253,314 | | | | 5,853 | | | | | | | | | | | | Total other income (loss) | | $ | 1,279 | | | $ | 157,585 | | | $ | (92,686 | ) | | | | | | | | | | |
| | | | | | | | | | | | | | | 2009 | | | 2008 | | | 2007 | | Net gains (losses) on unhedged trading securities (1) | | $ | 586 | | | $ | (627 | ) | | $ | 9 | | | | | | | | | | | | | | | Net losses on hedged trading securities | | | — | | | | — | | | | (11 | ) | Losses on economic hedge derivatives related to trading securities | | | — | | | | — | | | | (15 | ) | | | | | | | | | | | Hedge ineffectiveness on trading securities | | | — | | | | — | | | | (26 | ) | | | | | | | | | | | | | | | | | | | | | | | | Net interest income (expense) associated with: | | | | | | | | | | | | | Economic hedge derivatives related to trading securities | | | — | | | | — | | | | (134 | ) | Economic hedge derivatives related to available-for-sale securities | | | — | | | | (87 | ) | | | 42 | | Economic hedge derivatives related to consolidated obligation federal funds floater bonds | | | 14,919 | | | | (61 | ) | | | — | | Economic hedge derivatives related to other consolidated obligation bonds | | | — | | | | 1,328 | | | | (320 | ) | Economic hedge derivatives related to consolidated obligation discount notes | | | 27,066 | | | | (2,300 | ) | | | — | | Stand-alone economic hedge derivatives (basis swaps) | | | 65,939 | | | | 6,579 | | | | — | | Stand-alone economic hedge derivatives (forward rate agreement) | | | (304 | ) | | | — | | | | — | | Member/offsetting swaps | | | 4 | | | | — | | | | — | | Economic hedge derivatives related to advances | | | (60 | ) | | | (503 | ) | | | (31 | ) | | | | | | | | | | | Total net interest income (expense) associated with economic hedge derivatives | | | 107,564 | | | | 4,956 | | | | (443 | ) | | | | | | | | | | | | | | | | | | | | | | | | Gains (losses) related to economic hedge derivatives | | | | | | | | | | | | | Gains related to stand-alone derivatives (basis swaps) | | | 8,994 | | | | 42,530 | | | | — | | Gains on federal funds floater swaps | | | 10,337 | | | | 75 | | | | — | | Gains (losses) on interest rate caps related to held-to-maturity securities | | | 14,316 | | | | (2,243 | ) | | | (1,509 | ) | Gains (losses) on discount note swaps | | | (7,395 | ) | | | 9,216 | | | | — | | Net gains on member/offsetting swaps | | | 30 | | | | 16 | | | | — | | Gains (losses) related to other economic hedge derivatives (advance / AFS(2)/ CO(3)swaps) | | | (36 | ) | | | 357 | | | | 431 | | | | | | | | | | | | Total fair value gains (losses) related to economic hedge derivatives | | | 26,246 | | | | 49,951 | | | | (1,078 | ) | | | | | | | | | | | | | | | | | | | | | | | | Gains (losses) related to fair value hedge ineffectiveness | | | | | | | | | | | | | Net gains (losses) on advances and associated hedges | | | (3,061 | ) | | | 3,063 | | | | 723 | | Net gains (losses) on CO(3)bonds and associated hedges | | | 62,462 | | | | (55,368 | ) | | | (1,349 | ) | Net gains (losses) on AFS(2) securities and associated hedges | | | (102 | ) | | | 4,077 | | | | 2,195 | | | | | | | | | | | | Total fair value hedge ineffectiveness | | | 59,299 | | | | (48,228 | ) | | | 1,569 | | | | | | | | | | | | | | | | | | | | | | | | | Credit component of other-than-temporary impairment losses on held-to-maturity securities | | | (4,022 | ) | | | — | | | | — | | Gains on early extinguishment of debt | | | 553 | | | | 8,794 | | | | 1,255 | | Net realized gains (losses) on sales of AFS(2) securities | | | 843 | | | | (919 | ) | | | — | | Service fees | | | 3,074 | | | | 3,510 | | | | 3,713 | | Other, net | | | 6,212 | | | | 5,143 | | | | 4,506 | | | | | | | | | | | | Total other | | | 6,660 | | | | 16,528 | | | | 9,474 | | | | | | | | | | | | Total other income | | $ | 200,355 | | | $ | 22,580 | | | $ | 9,505 | | | | | | | | | | | |
| | | (1) | | Available-for-saleUnhedged trading securities consist solely of mutual fund investments associated with the Bank’s non-qualified deferred compensation plans. | | (2) | | Available-for-sale | | (3) | | Consolidated obligations |
As discussed above, the Bank uses interest rate swaps to hedge the risk of changes in the fair value of its trading securities. The difference between the change in fair value of these securities and the change in fair value of the associated interest rate swaps (representing economic hedge ineffectiveness) was a net gain of $63,000, $143,000 and $266,000 in 2006, 2005 and 2004, respectively. The change in fair value of the trading securities and the change in fair value of the associated interest rate swaps are reported separately in the statements of income as “net gain (loss) on trading securities” and “net gains (losses) on derivatives and hedging activities,” respectively.
5983
NetDuring the fourth quarter of 2008 and the year ended December 31, 2009, the Bank issued some consolidated obligation bonds that are indexed to the daily federal funds rate, some of which have since matured. The Bank uses federal funds floater swaps to convert its interest payments with respect to these bonds from the daily federal funds rate to three-month LIBOR. As of December 31, 2009, the Bank’s federal funds floater swaps had an aggregate notional amount of $8.2 billion. As economic hedge derivatives, the changes in the fair values of the federal funds floater swaps are recorded in earnings with no offsetting changes in the fair values of the hedged items (i.e., the consolidated obligation federal funds floater bonds) and therefore can be a source of volatility in the Bank’s earnings. The fair values of federal funds floater swaps generally fluctuate based on the timing of the interest rate reset dates, the relationship between the federal funds rate and three-month LIBOR at the time of measurement, the projected relationship between the federal funds rate and three-month LIBOR for the remaining term of the interest rate swap and the relationship between the current coupon and the prevailing rates at the valuation date. The recorded fair value changes and the net interest income associated with these interest rate swaps totaled $10.3 million and $14.9 million, respectively, for the year ended December 31, 2009. In 2008, the fair value changes and net interest expense associated with economic hedge derivatives related to trading securities fluctuates as a functionthese swaps were not significant. At December 31, 2009, the carrying values of the balanceBank’s federal funds floater swaps totaled $10.1 million, excluding net accrued interest receivable.
During 2008, the Bank began hedging some of the trading securities and changes inits longer-term consolidated obligation discount notes using fixed-for-floating interest rates. Theserate swaps. Net interest income (expense) associated with these interest rate swaps are structured so that their notional balances mirrortotaled $27.1 million and ($2.3 million) during 2009 and 2008, respectively. As stand-alone derivatives, the balancechanges in the fair values of the related trading securities and their pay leg coupons mirrorBank’s discount note swaps are recorded in earnings with no offsetting changes in the variable rate couponsfair values of the related securities. Nethedged items (i.e., the consolidated obligation discount notes) and therefore can be a source of volatility in the Bank’s earnings. During 2009 and 2008, the recorded fair value changes in the Bank’s discount note swaps were gains (losses) of ($7.4 million) and $9.2 million, respectively. At December 31, 2009, the carrying values of the Bank’s discount note swaps totaled $1.8 million, excluding net accrued interest expensepayable. From time to time, the Bank enters into interest rate basis swaps to reduce its exposure to changing spreads between one- and three-month LIBOR. Under these agreements, the Bank generally receives three-month LIBOR and pays one-month LIBOR. As of December 31, 2009, the Bank was a party to 11 interest rate basis swaps with an aggregate notional amount of $9.7 billion; these agreements were entered into in 2008 and 2009. The Bank accounts for interest rate basis swaps as stand-alone derivatives and, as such, the fair value changes associated with economic hedge derivatives related to trading securities declined by $3.5 million from 2005 to 2006 and by $6.3 million from 2004 to 2005, due primarily tothese instruments can be a reductionsource of considerable volatility in the notional balanceBank’s earnings, particularly when one-month and/or three-month LIBOR, or the spreads between these two indices, are volatile. The fair values of LIBOR basis swaps generally fluctuate based on the timing of the interest rate swaps. The reductions inreset dates, the notional balances corresponded to reductionsrelationship between one-month LIBOR and three-month LIBOR at the time of $28 millionmeasurement, the projected relationship between one-month LIBOR and $40 million, respectively, inthree-month LIBOR for the average balances of the trading securities portfolio, which were in turn attributable to principal repayments on the securities. As discussed above, the net interest payments associated with all economic hedge derivatives, including those hedging the Bank’s trading securities, are considered by management when analyzing the Bank’s net interest income as these derivative instruments convert the cash flows of assets and liabilities whose interest payments are reported in net interest income under generally accepted accounting principles. Net interest expense associated with economic hedge derivatives related to available-for-sale securities declined by $26.8 million from 2005 to 2006 and by $35.0 million from 2004 to 2005 due primarily to the fact that substantially allremaining term of the interest rate basis swap and the relationship between the current coupon and the prevailing LIBOR rates at the valuation date. The recorded fair value changes in the Bank’s interest rate basis swaps that gave rise to this interest expense were terminated in Augustnet gains of $9.0 million and September 2005 in connection with$42.5 million for the sale of the hedged items.years ended December 31, 2009 and 2008, respectively. In addition, since2009 and 2008, the Bank paid a fixedterminated six interest rate basis swaps with an aggregate notional amount of $4.5 billion and received a floatingsix interest rate basis swaps with an aggregate notional amount of $7.2 billion, respectively. Proceeds from these terminations totaled $20 million and $12 million, respectively, which reflected the cumulative life-to-date gains (excluding net interest settlements) realized on these interest rate swaps, the increase in average interest rates also contributed to the reduction in the amount of net interest expense from 2004 to 2005.
transactions. Net interest income associated with economic hedge derivatives related to consolidated obligations declined by $3.7 million from 2005 to 2006 and by $7.5 million from 2004 to 2005. For most of thesethe Bank’s interest rate basis swaps thetotaled $65.9 million and $6.6 million during 2009 and 2008, respectively. The Bank pays (or paid)was not a floatingparty to any interest rate and receives (or received) a fixed rate; therefore, the increase in average interest rates reduced the net amount of interest earned from period to period (forbasis swaps during the year ended December 31, 2006,2007. At December 31, 2009, the net amount became an expense forcarrying values of the Bank). In addition, the notional amount ofBank’s stand-alone interest rate basis swaps giving risetotaled $20.1 million, excluding net accrued interest payable. If the Bank holds its discount note swaps, interest rate basis swaps and federal funds floater swaps to maturity, the cumulative life-to-date unrealized gains associated with these instruments will ultimately reverse in future periods in the form of unrealized losses, which will negatively impact the Bank’s earnings in those periods. The timing of this reversal will depend upon a number of factors including, but not limited to, the level and volatility of short-term interest income declined from 2004rates. The Bank typically holds its discount note swaps and federal funds floater swaps to 2005 as a result of maturities.maturity. As discussed previously in the section entitled “Financial Condition — Long-Term Investments,” to reduce the impact that rising rates wouldcould have on its portfolio of capped CMO LIBOR floaters with embedded caps, the Bank had (as of December 31, 2006)2009) entered into 1513 interest rate cap agreements having a total notional amount of $5.3$3.75 billion. The premiums paid for these caps totaled $33.5 million, of which $14.0 million (for caps having$42.7 million. During the year ended December 31, 2009, the Bank 84
terminated one interest rate cap with a notional amount of $1.2 billion) was paid during 2004 and $9.6$0.5 billion; proceeds from this termination were $0.2 million, (for caps having a notional amount of $2.5 billion) was paid during 2006. None of these caps were purchased during 2005. The Bank also had a $500 million notional interest rate floor agreement that it entered intoresulting in October 2002 in order to hedge prepayment exposure related to its MPF portfolio. The premium paid for this interest rate floor agreement was $5.2 million. The interest rate floor had a strike rate of 3.75 percent and was scheduled to expire in October 2007. Although market rates remained low subsequent to the Bank’s purchase of this floor agreement, mortgage loan prepayments were less than the Bank would have anticipated in the relatively low interest rate environment. Based on this evidence that its fixed rate mortgage loan portfolio had become relatively insensitive to declining interest rates, the Bank determined that the interest rate floor was no longer needed and the position was terminated in April 2004 at a realized loss of $4.1$0.8 million. Based on its carrying value atDuring the year ended December 31, 2003,2008, the sale of theBank terminated five interest rate floor generated a losscaps with an aggregate notional amount of approximately $392,000 during 2004.
$3.75 billion; proceeds from these terminations totaled $8.2 million, resulting in realized gains of $3.4 million. The Bank did not terminate any interest rate cap agreements in 2007. The fair valuevalues of interest rate options, such as caps and floors, iscap agreements are dependent upon the level of interest rates, volatilities and remaining term to maturity. In general (assuming constant volatilities and no erosion in value attributable to the passage of time), interest rate caps will increase in value as market interest rates rise and will diminish in value as market interest rates decline. Conversely (under the same set of assumptions), interest rate floors will increase in value as market interest rates decline and will diminish in value as market interest rates increase. The value of interest rate caps and floors will increase as volatilities increase and will decline as volatilities decrease. Absent changes in volatilities or interest rates, the value of interest rate caps and floors will decline with the passage of time. As stand-alone derivatives, the changes in the fair values of the Bank’s interest rate cap and floor agreements are (or were, in the case of the floor) recorded in earnings with no offsetting changes in the fair values of the hedged items (i.e., the capped CMO LIBOR floaters and MPF loans)with embedded caps and therefore can also be a source of considerable volatility as wasin the case particularly during the year ended December 31, 2004.Bank’s earnings. 60
At December 31, 2006 and 2005,2009, the carrying values of the Bank’s stand-alone interest rate cap agreements totaled $3.3 million$51.1 million. If these agreements are held to maturity, the value of the caps will ultimately decline to zero and $1.5 million, respectively. Thebe recorded fair value changes in the Bank’s cap and floor agreements wereas a loss of $7.8 million for the year ended December 31, 2006, compared to losses of $3.4 millionin net gains (losses) on derivatives and $16.6 million for the years ended December 31, 2005 and 2004, respectively. In 2006 and 2005, the losses relating to the Bank’s interest rate caps were attributable primarily to lower interest rate volatility and the passage of time. In 2004, the losses relating to the Bank’s interest rate caps were attributable primarily to lower interest rate volatility. From time to time, the Bank enters into interest rate basis swaps to reduce its exposure to widening spreads between one-month and three-month LIBOR. In June 2004, the Bank entered into $4.7 billion (notional) of interest rate basis swaps that expiredhedging activities in March 2005. In November 2005 and February 2006, the Bank entered into interest rate basis swaps with aggregate notional amounts of $2.05 billion and $3.0 billion, respectively. Agreements with aggregate notional balances of $1.7 billion and $3.35 billion expired in June 2006 and August 2006, respectively. The fair values of one-month LIBOR to three-month LIBOR basis swaps generally fluctuate based on the timing of the interest rate reset dates, the current relationship between one-month LIBOR and three-month LIBOR, and the projected relationship between one-month LIBOR and three-month LIBOR for the remaining term of the basis swap. The Bank accounts for interest rate basis swaps as stand-alone derivatives.future periods. The recorded fair value changes in the Bank’s interest rate basis swaps wascap agreements were a gain of $115,000$14.3 million for the year ended December 31, 2006,2009, compared to losses of $67,000 and $48,000 for the years ended December 31, 2005 and 2004, respectively.
During 2006, 2005 and 2004, market conditions were such from time to time that the Bank was able to extinguish certain consolidated obligation bonds at a gain, while new consolidated obligations could be issued and then converted (through the use of interest rate exchange agreements) to approximately the same terms as the extinguished debt. As a result, during these periods, the Bank repurchased $419 million, $3.1 billion and $138 million, respectively, of its consolidated obligations in the secondary market and terminated the related interest rate exchange agreements. The gains on these debt extinguishments totaled $0.7 million, $2.5$2.2 million and $0.9$1.5 million for the years ended December 31, 2006, 20052008 and 2004,2007, respectively.
The Bank uses interest rate swaps to hedge the risk of changes in the fair value of its available-for-sale securities, as well as some of its advances and consolidated obligations.obligation bonds. Prior to their sale or maturity, substantially all of the Bank’s available-for-sale securities were also hedged with interest rate swaps. These hedging relationships are (or were in the case of the Bank’s available-for-sale securities) designated as fair value hedges. To the extent these relationships qualify for hedge accounting, under SFAS 133, changes in the fair values of both the derivative (the interest rate swap) and the hedged item (limited to changes attributable to the hedged risk) are recorded in earnings. For those relationships that qualified as SFAS 133 hedges,for hedge accounting, the differencedifferences between the change in fair value of the hedged items and the change in fair value of the associated interest rate swaps (representing hedge ineffectiveness) was awere net gaingains of $3.2$59.3 million and $1.6 million in 20062009 and 2007, respectively, and a net loss of $2.2 million and $3.7$48.2 million in 2005 and 2004, respectively.2008. To the extent thatthese hedging relationships do not qualify for SFAS 133 hedge accounting, or cease to qualify because they are determined to be ineffective, only the change in fair value of the derivative is recorded in earnings (in this case, there is no offsetting change in fair value of the hedged item). In 2006, 20052009, 2008 and 2004,2007, the change in fair value of derivatives associated with specific advances, available-for-sale securities and consolidated obligation bonds that were not in SFAS 133qualifying hedging relationships (excluding derivatives associated with consolidated obligation bonds indexed to the daily federal funds rate) was $0.2 million, ($61.7 million)36,000), $357,000 and ($16.5 million), respectively;$431,000, respectively. As set forth in the vast majority oftable on page 83, the Bank’s fair value hedge ineffectiveness gains and losses associated with its consolidated obligation bonds were significantly higher in 20042009 and 2005 were attributable2008 as compared to 2007. A substantial portion of the Bank’s fixed rate consolidated obligation bonds are hedged with fixed-for-floating interest rate swaps relatingin long-haul hedging relationships. The floating legs of most of these interest rate swaps reset every three months and are then fixed until the next reset date. These hedging relationships have been, and are expected to certain available-for-sale securitiescontinue to be, highly effective in achieving offsetting changes in fair values attributable to the hedged risk. However, during periods in which short-term rates are volatile (as they were in the latter part of 2008), the Bank can experience increased earnings variability related to differences in the timing between changes in short-term rates and consolidated obligationsinterest rate resets on the floating legs of its interest rate swaps. While changes in the values of the fixed rate leg of the interest rate swap and the fixed rate bond being hedged substantially offset each other, when three-month LIBOR rates increase (or decrease) dramatically between the reset date and the valuation date (as they did during the third and fourth quarters of 2008, respectively), discounting the lower (or higher) coupon rate cash flows being paid on the floating rate leg at the prevailing higher (or lower) rate until the swap’s next reset date can result in ineffectiveness-related gains (or losses) that, had either expired or been terminated bywhile relatively small when expressed as prices, can be significant when evaluated in the context of the Bank’s net income. As of September 30, 2005. The expiration/termination2008, the Bank had $40.2 billion of its consolidated obligation bonds in long-haul fair value hedging relationships. Between September 15, 2008 and September 30, 2008, three-month LIBOR rates increased by 123 basis points, from 2.82 percent to 4.05 percent, which resulted in ineffectiveness-related gains of $60.9 million for the three months ended September 30, 2008. Because the Bank typically holds its consolidated 85
obligation bond interest rate swaps to call or maturity, the impact of these economic hedge derivatives resultedineffectiveness-related adjustments on earnings are generally transitory, as they were in this case. As a result of the unusual (and significant) decrease in three-month LIBOR rates during the fourth quarter of 2008 (three-month LIBOR rates decreased by 262 basis points, from 4.05 percent at October 1, 2008 to 1.43 percent at December 31, 2008), the Bank recognized ineffectiveness-related losses during that period of $122.4 million. With relatively stable three-month LIBOR rates during the first quarter of 2009, these net ineffectiveness-related losses of $61.5 million for the third and fourth quarters of 2008 substantially reversed (in the form of ineffectiveness-related gains) during the first quarter of 2009. Three-month LIBOR rates remained relatively stable during the remainder of 2009, resulting in significantly lower earnings volatilityineffectiveness-related gains during the last nine months of the year. As of December 31, 2008, the Bank had $37.8 billion of its consolidated obligation bonds in 2006.long-haul fair value hedging relationships. As a result of calls and maturities, the Bank’s consolidated obligation bonds in long-haul fair value hedging relationships had declined to $27.5 billion as of December 31, 2009. Because the Bank has a much smaller balance of swapped assets than liabilities and a significant portion of those assets qualify for and are designated in short-cut hedging relationships, the Bank did not experience similar offsetting variability from its asset hedging activities during the third and fourth quarters of 2008 and the first quarter of 2009. As of December 31, 2009 and 2008, the Bank had approximately $11.0 billion and $11.1 billion, respectively, of its assets in fair value hedge relationships, of which $9.4 billion and $10.0 billion, respectively, qualified for the short-cut method of accounting, in which an assumption can be made that the change in fair value of the hedged item exactly offsets the change in value of the related derivative. During the third quarter of 2005,2009, 2008 and 2007, market conditions were such from time to time that the Bank sold $4.1was able to extinguish certain consolidated obligation bonds and simultaneously terminate the associated interest rate exchange agreements at net amounts that were profitable for the Bank, while new consolidated obligations could be issued and then converted (through the use of interest rate exchange agreements) to a floating rate that approximated the cost of the extinguished debt including any associated interest rate swaps. As a result, during 2009, 2008 and 2007, the Bank repurchased $1.7 billion, (par value)$3.7 billion and $134 million, respectively, of securities classified as available-for-sale, including $1.3 billion (par value) that had been partits consolidated obligations in the secondary market and terminated the related interest rate exchange agreements. The gains on these debt extinguishments totaled $0.6 million, $4.3 million and $0.7 million, respectively. In addition, during 2008 and 2007, the Bank transferred consolidated obligations with aggregate par values of economic hedging relationships. Proceeds from$465 million and $461 million, respectively, to three of the other FHLBanks. In connection with these transfers (i.e., debt extinguishments), the assuming FHLBanks became the primary obligors for the transferred debt. The gains on these transactions with other FHLBanks totaled $4.5 million and $0.5 million during the years ended December 31, 2008 and 2007, respectively. No consolidated obligations were transferred to other FHLBanks during 2009. For a discussion of the sales totaled $4.5 billion, resultingof available-for-sale securities in net realized gains2009 and 2008 and the other-than-temporary impairment losses on seven of $245.4 million.the Bank’s held-to-maturity securities during 2009, see the section above entitled “Financial Condition — Long-Term Investments.” There were no sales of available-for-sale securities during the year ended December 31, 2007, nor were there any other-than-temporary impairment losses on the Bank’s held-to-maturity securities during the years ended December 31, 20062008 or 2004.2007. In the table above,on page 83, the caption entitled “Other, net” (consistent with the term used in the statements of income) is comprised principally of MPF participation and letter of credit fees. As previously discussed,For the Bank modified the terms of its participation in the MPF program in 2003 whereby it now receives fees for mortgage loans that are delivered by its PFIs to the FHLBank of Chicago. In 2006, 2005years ended December 31, 2009, 2008 and 2004, the Bank received $0.2 million, $0.4 million and $0.7 million, respectively, of participation fees under this arrangement. From 2005 to 2006 and from 2004 to 2005,2007, letter of credit fees increased by $0.8totaled $6.1 million, $6.0 million and $0.4$4.1 million, respectively, as a result of increased use of this product.respectively. At December 31, 2006, 20052009, 2008 and 2004,2007, outstanding letters of credit totaled $3.5$4.6 billion, $2.8$5.2 billion and $1.7$3.9 billion, respectively. In 2008, “other, net” was reduced by a $1.0 million charge to fully reserve amounts owed to the Bank by Lehman Brothers Special Financing, Inc. (“Lehman”) following Lehman’s bankruptcy in September 2008. Prior to its bankruptcy, Lehman had served as one of the Bank’s derivative counterparties. 61
Other ExpensesExpense Total other expenses,expense, which includeincludes the Bank’s compensation and benefits, other operating expenses and its proportionate share of the costs of operating the Finance BoardAgency (previously the Finance Board) and the Office of Finance totaled $49.8$75.3 million, $50.2$64.8 million and $39.4$55.3 million in 2006, 20052009, 2008 and 2004,2007, respectively. 86
Compensation and benefits were $23.6totaled $42.0 million for the year ended December 31, 2006,2009, compared to $21.9$34.5 million for the year ended December 31, 2005.2008. The increase in salaries and benefits of $1.7 million was due primarilylargely to an increasea $7.5 million supplemental contribution that the Bank made in the Bank’s average headcount, which rose from 138 employees during the year ended December 31, 2005 to 157 employees during the year ended December 31, 2006. At December 31, 2006, the Bank employed 168 people, a net increasethird quarter of 23 employees from the prior year end. The increase in expenses associated with higher headcount was partially offset by a $0.9 million decline in awards earned under the Bank’s Variable Pay Program, which was due to a lower level of goal achievement during 2006 as compared to 2005. In addition, the Bank capitalized approximately $0.7 million of compensation and benefits related to the development of internal use computer software during 2006. No compensation and benefits were capitalized during 2005. On August 17, 2006, the Pension Protection Act was signed into law. The major provisions of this statute will take effect January 1, 2008. Among other things, the statute is designed to ensure timely and adequate funding of qualified pension plans by shortening the time period within which employers must fully fund pension benefits. The Bank has not determined the exact effect that this statute will have on the timing or amount of payments it is required to make2009 to the Pentegra Defined Benefit Plan for Financial Institutions, (the “Pentegra DB Plan”), a multiemployer defined benefit plan in which the Bank participates. The Bank expects, however, thatsupplemental contribution was made to improve the amountfunded status of its required annual contributionsthe plan in response to the Pentegra DB Plan will increase in at least the first several years after the legislation becomes effective. Based in part on the provisions of this legislation,the Pension Protection Act. In addition, compensation and benefits expense increased due to increases in the Bank’s Board of Directors elected in late 2006average headcount and cost-of-living and merit adjustments. The Bank’s average headcount increased from 183 employees during the year ended December 31, 2008 to freeze192 employees during the Pentegra DB Planyear ended December 31, 2009. At December 31, 2009, the Bank employed 194 people. These increases were partially offset by closing it to new participants effective January 1, 2007. As a result of this change, employees hired on or after January 1, 2007 are not eligible to participate in the Pentegra DB Plan. Employees hired prior to January 1, 2007 remain in the Pentegra DB Plan and continue to accrue benefits in accordancelower expenses associated with the provisions thereof. For employees hired on or after January 1, 2007,Bank’s short-term incentive compensation plan (known as the Bank offers an enhanced defined contribution plan.Variable Pay Program), which was due to a lower level of goal achievement in 2009, as compared to 2008.
Compensation and benefits totaled $21.9$34.5 million for the year ended December 31, 2005,2008, compared to $18.7$31.0 million for the year ended December 31, 2004.2007. The increase of $3.2$3.5 million was due in part to an increase in costs relatingprimarily to: (1) increased expenses related to the Bank’s participation in the Pentegra DB Plan. From 2004 to 2005, expenses associated with this plan increased by $2.0 million, from $1.2 million to $3.2 million. The balance of the increase was due primarily to merit and cost-of-living adjustments, as well as a slightVariable Pay Program; (2) an increase in the Bank’s average headcount (which rose from 134176 employees in 20042007 to 138183 employees in 2005. These increases were partially offset by a $0.3 million reduction2008); and (3) cost-of-living and merit increases. The increase in expenses relatedrelating to the Bank’s retirement benefits programVariable Pay Program was due to a changehigher level of goal achievement in 2008 (as compared to 2007) and, to a lesser extent, the eligibility requirements relating to retiree health care continuation benefits. Prior to January 1, 2005, retirees were eligible to remain enrolledincrease in the Bank’s health care benefits plan if age 50 or older with at least 10 years of service at the time of retirement. Effective January 1, 2005, retirees are eligible to remain enrolled in the Bank’s health care benefits plan if age 55 or older with at least 15 years of service at the time of retirement, subject to certain grandfathering provisions.headcount. Other operating expenses for the yearyears ended December 31, 20062009, 2008 and 2007 were $22.8$28.9 million, a $1.8 million decrease from other operating expenses of $24.6 million for the year ended December 31, 2005. In September 2005, the Bank established a special $5.0 million Disaster Relief Grant Program to support members’ efforts to fund redevelopment in areas impacted by Hurricanes Katrina and Rita. Under this program, the Bank disbursed approximately $4.5$26.6 million and $0.5$20.9 million, in grants during 2005 and 2006, respectively. This $4.0 million reduction in expenses from 2005 to 2006 was partially offset by higher professional fees in 2006 related to an internal project designed to streamline and enhance management decision-making processes. The costs associated with this project totaled $1.9 million in 2006. Other operating expenses for 2009 included approximately $1.2 million and $0.4 million of grants that were funded under the year ended December 31, 2005Bank’s Homebuyer Equity Leverage Partnership program and its Special Needs Assistance Program, respectively. These one-time, special fundings were $24.6in addition to the monies that were set aside for these programs under the Bank’s AHP. The Bank’s Special Needs Assistance Program is designed to assist income-qualified special needs households with home rehabilitation and modification costs while its Homebuyer Equity Leverage Partnership program provides down payment and closing cost assistance to income-qualified first-time homebuyers. In addition, the increase in expenses from 2008 to 2009 was due in part to $0.9 million compared to $17.4of fees associated with two third-party models that are used in the Bank’s periodic OTTI evaluations. The remaining net increase of $2.9 million (as adjusted for the year ended December 31, 2004. absence of merger-related expenses in 2009, as discussed below) was attributable to general increases in many of the Bank’s other operating expenses, none of which were individually significant. The increase of $7.2 millionin other operating expenses from 2007 to 2008 was due largely attributable to the $4.5costs associated with the Bank’s previously considered merger with the FHLBank of Chicago and its financial support of the relief efforts relating to Hurricanes Gustav and Ike. From mid-2007 to April 2008, the Bank and the FHLBank of Chicago were engaged in discussions to determine the possible benefits and feasibility of combining their business operations. On April 4, 2008, those discussions were terminated. As a result, during the three months ended March 31, 2008, the Bank expensed $3.1 million of direct costs associated with the potential combination. During 2008, the Bank made charitable donations of $500,000 each to The Salvation Army and the American Red Cross. These donations were made to support the relief efforts in areas affected by Hurricanes Gustav and Ike. Similar donations were not made during 2007. In late September 2008, the Bank also announced that it would make $5 million in funds available for special disaster relief grants discussed above. In addition, in 2005,for homes and businesses affected by these hurricanes. Approximately $2.4 million and $2.6 million of these funds were disbursed during the Bank incurred higher professional fees resulting from its efforts to register withfourth quarter of 2008 and the SEC and prepare for eventual compliance with Section 404first half of the Sarbanes-Oxley Act.2009, respectively. 62
The Bank, together with the other FHLBanks, is assessed for the cost of operating the Finance BoardAgency (previously the Finance Board) and the Office of Finance. The Bank’s share of these expenses totaled $3.4$4.4 million, $3.7 million and $3.3$3.4 million in 2006, 20052009, 2008 and 2004,2007, respectively. AHP and REFCORP Assessments As required by statute, each year the Bank contributes 10 percent of its earnings (after the REFCORP assessment discussed below and as adjusted for interest expense on mandatorily redeemable capital stock) to its AHP. The AHP 87
provides grants that members can use to support affordable housing projects in their communities. Generally, the Bank’s AHP assessment is derived by adding interest expense on mandatorily redeemable capital stock to income before assessments and then subtracting the REFCORP assessment; the result of this calculation is then multiplied by 10 percent. For the years ended December 31, 2006, 20052009, 2008 and 2004,2007, the Bank’s AHP assessments totaled $15.0$16.5 million, $28.1$8.9 million and $7.9$15.0 million, respectively. Also as required by statute, the Bank contributes 20 percent of its reported earnings (after its AHP contribution) toward the payment of interest on REFCORP bonds that were issued to provide funding for the resolution of failed thrifts following the savings and loan crisis in the 1980s. To compute the REFCORP assessment, the Bank’s AHP assessment is subtracted from reported income before assessments and the result is multiplied by 20 percent. During the years ended December 31, 2006, 20052009, 2008 and 2004,2007, the Bank charged $30.5$37.0 million, $60.4$19.8 million and $16.2$32.4 million, respectively, of REFCORP assessments to earnings. For the fourth quarter of 2008, the Bank and certain of the other FHLBanks requested refunds of amounts paid for the year ended December 31, 2008 that were in excess of their calculated annual obligations. Based on its calculated annual obligation for the year ended December 31, 2008, the Bank was due $16.9 million as of December 31, 2008; such amount was credited against amounts due for the Bank’s 2009 REFCORP assessments. Liquidity and Capital Resources In order to meet members’ credit needs and the Bank’s financial obligations, the Bank maintains a portfolio of money market instruments consisting of overnight federal funds term federal funds, and, from time-to-time, short-term commercial paper, all of which are issued by highly rated entities. Beyond those amounts that are required to meet members’ credit needs and its own obligations, the Bank typically holds additional balances of short-term investments that fluctuate as the Bank invests the proceeds of debt issued to replace maturing and called liabilities, and as the balance of deposits changes, as the returns provided by short-term investments vary relative to the costs of the Bank’s discount notes, and as the level of liquidity needed to satisfy Finance Agency requirements changes. Overnight federal funds typically comprise the large majority of the portfolio. At December 31, 2006,2009, the Bank’s short-term investments, which wereliquidity portfolio was comprised entirelyof $2.1 billion of overnight federal funds sold to domestic counterparties totaled $5.5 billion.and $3.6 billion of non-interest bearing deposits maintained at the Federal Reserve Bank of Dallas. The Bank’s primary source of funds is the proceeds it receives from the issuance of consolidated obligation bonds and discount notes in the capital markets. The market forHistorically, the FHLBanks’ consolidated obligations is very active and liquid. The FHLBanks issuehave issued debt throughout the business day in the form of discount notes and bonds with a wide variety of maturities and structures. Generally, the Bank has access to this market on a continual basisas needed during the business day to acquire funds to meet its needs. However, during the second half of 2008, market conditions reduced investor demand for long-term debt issued by the FHLBanks, which led to substantially increased costs and significantly reduced availability of this funding source. At the same time, demand increased for short-term, high-quality assets such as FHLBank discount notes and short-term bonds. As a result, the Bank relied more heavily on the issuance of discount notes and short-term bullet and floating-rate bonds in order to meet its funding needs during the latter part of 2008 and the first half of 2009. The FHLBank’s access to debt with a wider range of maturities, and the pricing of those bonds, improved during the second half of 2009 and, therefore, the Bank relied on the issuance of short-maturity debt to a lesser extent during the second half of 2009 as compared to the previous 12 months. In addition to the liquidity provided from the proceeds of the issuance of consolidated obligations, the Bank also maintains access to wholesale funding sources such as federal funds purchased and securities sold under agreements to repurchase (e.g., borrowings secured by its MBS investments). Furthermore, the Bank has access to borrowings (typically short-term) from the other FHLBanks. On June 23, 2006, the 12 FHLBanks and the Office of Finance entered into the Federal Home Loan Banks P&I Funding and Contingency Plan Agreement (the “Contingency Agreement”). The Contingency Agreement and related procedures were entered into in response to a revision that the Board of Governors of the Federal Reserve System had made to its Policy Statement on Payments System Risk (“PSR Policy”) and are designed to facilitate the timely funding of principal and interest payments on FHLBank System consolidated obligations in the event that a FHLBank is not able to meet its funding obligations in a timely manner. The Contingency Agreement and related procedures provide for the issuance of overnight consolidated obligations directly to one or more FHLBanks that provide funds to avoid a shortfall in the timely payment of principal and interest on any consolidated obligations for 88
which another FHLBank is the primary obligor. Specifically, in the event that one or more FHLBanks does not fund its principal and interest payments under a consolidated obligation by deadlines agreed upon by the FHLBanks and the Office of Finance (for purposes of the Contingency Agreement, a “Delinquent Bank”), the non-Delinquent Banks will be obligated to fund any shortfall in funding to the extent that any of the non-Delinquent Banks has a net positive settlement balance (i.e., the amount by which end-of-day proceeds received by such non-Delinquent Bank from the sale of consolidated obligations on one day exceeds payments by such non-Delinquent Bank on consolidated obligations on the same day) in its account with the Office of Finance on the day the shortfall occurs. A FHLBank that funds the shortfall of a Delinquent Bank is referred to in the Contingency Agreement as a “Contingency Bank.” The non-Delinquent Banks would fund the shortfall of the Delinquent Bank sequentially in accordance with an agreed-upon funding matrix as provided in the Contingency Agreement. Additionally, a non-Delinquent Bank could choose to voluntarily fund any shortfall not funded on a mandatory basis by another non-Delinquent Bank. To fund the shortfall of a Delinquent Bank, the Office of Finance will issue to the Contingency Bank on behalf of the Delinquent Bank a consolidated obligation with a maturity of one business day in the amount of the shortfall funded by the Contingency Bank (a “Plan CO”). On the day that a Plan CO is issued, each non-Delinquent Bank (other than the Contingency Bank that purchased the Plan CO) becomes obligated to purchase a pro rata share of the Plan CO from the Contingency Bank (each such non-Delinquent Bank being a “Reallocation Bank”). The pro rata share for each Reallocation Bank will be calculated based upon the aggregate amount of outstanding consolidated obligations for which each Reallocation Bank and the Contingency Bank were primarily liable as of the preceding month-end. Settlement of the purchase by the Reallocation Banks of their pro rata shares of the Plan CO will occur on the second business day following the date on which the Plan CO was issued only if the Plan CO is not repaid on the first business day following its issuance, either by the Delinquent Bank or by another FHLBank. The Finance Board granted a waiver requested by the Office of Finance to allow the direct placement by a FHLBank of consolidated obligations with another FHLBank in those instances when direct placement of consolidated obligations is necessary to ensure that sufficient funds are available to timely pay all principal and interest on FHLBank System consolidated obligations due on a particular day. In connection with this waiver, the terms of which became effective July 1, 2006, the Finance Board imposed a requirement that the interest rate to be paid on any consolidated obligation issued under such circumstances must be at least 500 basis points above the then current federal funds rate. Under the terms of the Contingency Agreement, Plan COs will bear interest calculated on an actual/360 basis at a rate equal to (i) the overnight federal funds quote obtained by the Office of Finance or (ii) the actual cost if the Contingency Bank purchases funds in the open market for delivery to the Office of Finance. Additionally, a Delinquent Bank will be required to pay additional interest on the amount of any Plan CO based on the number of times that FHLBank has been a Delinquent Bank. The interest is 500 basis points per annum for the first delinquency, 750 basis points per annum for the second delinquency and 1,000 basis points per annum for subsequent delinquencies. The first 100 basis points of additional interest will be paid to the Contingency Banks that purchased the Plan CO. Additional interest in excess of 100 basis points will be paid to the non-Delinquent Banks in equal shares. The initial term of the Contingency Agreement commenced on July 20, 2006 and ended on December 31, 2008, at which time it automatically renewed for a three-year term. The Contingency Agreement will automatically renew for successive three-year terms (each a “Renewal Term”) unless at least one year prior to the end of any Renewal Term at least one-third of the FHLBanks give notice to the other FHLBanks and the Office of Finance of their intention to terminate the Contingency Agreement at the end of such Renewal Term. The notice must include an explanation from those FHLBanks of their reasons for taking such action. Under the terms of the Contingency Agreement, the FHLBanks and the Office of Finance have agreed to endeavor in good faith to address any such reasons by amending the Contingency Agreement so that all FHLBanks and the Office of Finance agree that the Contingency Agreement, as amended, will remain in effect. To date, no FHLBank has given notice of its desire to terminate the Contingency Agreement. Through the date of this report, no Plan COs have been issued pursuant to the terms of the Contingency Agreement. On September 9, 2008, the Bank and each of the other 11 FHLBanks entered into separate but identical lending agreements with the Treasury in connection with the Treasury’s establishment of a Government Sponsored 89
Enterprise Credit Facility (“GSECF”). The HER Act provided the Treasury with the authority to establish the GSECF, which was designed to serve as a contingent source of liquidity for the housing government-sponsored enterprises, including the FHLBanks. The lending agreements terminated on December 31, 2009 and none of the FHLBanks ever borrowed under the GSECF. On occasion, and as an alternative to issuing new debt, the Bank may assume the outstanding consolidated obligations for which other FHLBanks are the original primary obligors. This occurs in cases where the original primary obligor may have participated in a large consolidated obligation issue to an extent that exceeded its immediate funding needs in order to facilitate better market execution for the issue. The original primary obligor might then warehouse the funds until they were needed, or make the funds available to other FHLBanks. Transfers may also occur when the original primary obligor’s funding needs change, and that FHLBank offers to transfer debt that is no longer needed to other FHLBanks. Transferred debt is typically fixed rate, fixed term, non-callable debt, and may be in the form of discount notes or bonds. The Bank participates in such transfers of funding from other FHLBanks when the transfer represents favorable pricing relative to a new issue of consolidated obligations with similar features. During the years ended December 31, 2005, and 2004, the Bank assumed consolidated obligations from the FHLBank of Chicago with par amounts of $425 million and $375 million, respectively. The Bank did not assume any consolidated obligations from other FHLBanks during the year ended December 31, 2006. The2009. During the year ended December 31, 2008, the Bank also maintains access to wholesale funding sources such as federal funds purchased and securities sold under agreements to repurchase (e.g., borrowings secured by its MBS investments).assumed consolidated obligation bonds from the FHLBank of Seattle with a par value of $136 million. During the year ended December 31, 2007, the Bank assumed consolidated obligation bonds from the FHLBank of New York with a par value of $323 million.
The Bank manages its liquidity to ensure that, at a minimum, it has sufficient funds to meet operational and contingent liquidity requirements. When measuring its liquidity for these purposes, the Bank includes only contractual cash flows and the amount of funds it estimates would be available in the event the Bank were to use securities held in its long-term investment portfolio as collateral for repurchase agreements. While it believes purchased federal funds might be available as a source of funds, it does not include this potential source of funds in its calculations of available liquidity. The Bank’s operational liquidity requirement stipulates that it have sufficient funds to meet its obligations due on any given day plus an amount equal to the statistically estimated (at the 99-percent confidence level) cash and credit needs of its 63
members and associates for one business day without accessing the capital marketmarkets for the sale of consolidated obligations. As of December 31, 2006,2009, the Bank’s estimated operational liquidity requirement was $4.5$1.5 billion. At that date, the Bank estimated that its operational liquidity exceeded this requirement by approximately $8.9$13.6 billion. The Bank’s contingent liquidity policyrequirement further requires that it maintain adequate balance sheet liquidity and access to other funding sources should it be unable to issue consolidated obligations for five business days. The combination of funds available from these sources must be sufficient for the Bank to meet its obligations as they come due and the cash and credit needs of its members, with the potential needs of members statistically estimated at the 99-percent confidence level. As of December 31, 2006,2009, the Bank’s estimated contingent liquidity requirement was $5.5 billion. At that date, the Bank estimated that its contingent liquidity exceeded this requirement by approximately $7.9$9.6 billion. When measuring itsIn addition to the liquidity for these purposes,measures described above, the Bank includes onlyis required, pursuant to guidance issued by the amountFinance Agency on March 6, 2009, to meet two daily liquidity standards, each of funds it estimates would be available in the eventwhich assumes that the Bank wereis unable to pledge securities heldaccess the market for consolidated obligations during a prescribed period. The first standard requires the Bank to maintain sufficient funds to meet its obligations for 15 days under a scenario in which it is assumed that members do not renew any maturing, prepaid or called advances. The second standard requires the Bank to maintain sufficient funds to meet its long-term investment portfolio. Whileobligations for 5 days under a scenario in which it believes purchased federal funds might be available, it does not include this potential sourceis assumed that members renew all maturing and called advances, with certain exceptions for very large, highly rated members. These requirements are more stringent than the 5-day contingent liquidity requirement discussed above. The Bank has been in compliance with both of funds in its calculations of available liquidity.these liquidity requirements since March 6, 2009.
The Bank’s access to the capital markets has never been interrupted to an extent that the Bank’s ability to meet its obligations was compromised and the Bank does not currently has no reason to believe that its ability to issue consolidated obligations will be impeded to that extent. However, ifextent in the capital marketsfuture. If, however, the Bank were inaccessibleunable to issue consolidated 90
obligations for an extended period of time, (i.e., beyond five days), the Bank would eventually exhaust the availability of purchased federal funds (including borrowings from other FHLBanks) and repurchase agreements as sources of funds, and the Bank would be able to finance its operations only to the extent that the cash inflows from its interest-earning assets and proceeds from maturing assets exceeded the balance of principal and interest that came due on its debt obligations and the funds needed to pay its operating expenses. Once these sources of funds had been exhausted, and if access to the capital markets were not again available, the Bank’s ability to conduct its operations would be compromised.funds. It is also possible that an event (such as a natural disaster) that might impede the Bank’s ability to raise funds by issuing consolidated obligations would also limit the Bank’s ability to access the markets for federal funds purchased and/or repurchase agreements. Under those circumstances, to the extent that the balance of principal and interest that came due on the Bank’s debt obligations and the funds needed to pay its operating expenses exceeded the cash inflows from its interest-earning assets and proceeds from maturing assets, and if access to the market for consolidated obligations was not again available, the Bank would seek to access funding under the Contingency Agreement to repay any principal and interest due on its consolidated obligations. However, if the Bank were unable to raise funds by issuing consolidated obligations, it is likely that the other FHLBanks would have similar difficulties issuing debt. If thisfunds were not available under the case,Contingency Agreement, the Bank’s ability to conduct its operations would be compromised even earlier than if thesethis funding sources weresource was available. The following table summarizes the Bank’s contractual cash obligations and off-balance-sheet lending-related financial commitments by due date or remaining maturity as of December 31, 2006.2009. CONTRACTUAL OBLIGATIONS
(In millions of dollars) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Payments due by Period | | | Payments due by Period | | | | | | <1 Year | | 1-3 Years | | 3-5 Years | | >5 Years | | Total | | | < 1 Year | | 1-3 Years | | 3-5 Years | | > 5 Years | | Total | | Long-term debt | | $ | 10,157.3 | | $ | 18,261.6 | | $ | 5,695.4 | | $ | 7,802.9 | | $ | 41,917.2 | | | $ | 30,951.3 | | $ | 14,733.1 | | $ | 2,276.5 | | $ | 3,210.6 | | $ | 51,171.5 | | Mandatorily redeemable capital stock | | — | | 150.1 | | 9.5 | | — | | 159.6 | | | 1.4 | | 3.2 | | 4.6 | | — | | 9.2 | | Operating leases | | 0.3 | | 0.6 | | 0.2 | | — | | 1.1 | | | 0.3 | | 0.6 | | 0.1 | | — | | 1.0 | | Purchase obligations | | | Advances | | 70.4 | | 4.0 | | — | | — | | 74.4 | | | 38.0 | | — | | — | | — | | 38.0 | | Letters of credit | | 3,296.5 | | 184.0 | | 0.4 | | 12.2 | | 3,493.1 | | | 4,251.6 | | 292.6 | | 104.2 | | — | | 4,648.4 | | | | | | | | | | | | | | | | | | | | | | | | | Total contractual obligations | | $ | 13,524.5 | | $ | 18,600.3 | | $ | 5,705.5 | | $ | 7,815.1 | | $ | 45,645.4 | | | $ | 35,242.6 | | $ | 15,029.5 | | $ | 2,385.4 | | $ | 3,210.6 | | $ | 55,868.1 | | | | | | | | | | | | | | | | | | | | | | | | |
In theThe table above long-term debt excludes derivatives and obligations (other than certain consolidated obligation discount notes andbonds) with contractual payments having an original maturity of one year or less. The distribution of long-term debt is based upon contractual maturities. The actual distributionrepayments of long-term debt could be impacted by factors affecting redemptions such as call options.
The above table presents the Bank’s mandatorily redeemable capital stock by year of earliest mandatory redemption, which is the earliest time at which the Bank is required to repurchase the shareholder’s capital stock. The earliest mandatory redemption date is based on the assumption that the advances and/or other activities associated with the activity-based stock 64
will behave matured or otherwise concluded by the time the notice of redemption or withdrawal expires. However, theThe Bank expects to redeemrepurchase activity-based stock as the associated advances and/or other activities are reduced, which may be before or after the expiration of the five-year redemption/withdrawal notice period. As discussed above in the section entitled “Financial Condition – Advances,” the Bank’s third largest shareholder (and borrower) is a non-member institution that acquired a Bank member and dissolved such member’s charter on February 13, 2001. As of December 31, 2006, the shareholder held $146.3 million of mandatorily redeemable capital stock and had advances outstanding of approximately $3.5 billion, which have final maturities in 2007 and 2008. While most of this non-member borrower’s stock is not mandatorily redeemable until 2008, the Bank expects to repurchase $128.9 million of such stock in 2007 as the institution’s advances are repaid. In addition, $2.2 million of stock owned by this shareholder, which was not required to be redeemed until 2011, was repurchased in January 2007. In addition to the capital stock repurchase and redemption related events noted above, shareholders may, at any time, request the Bank to repurchase excess capital stock. Excess stock is defined as the amount of stock held by a member (or former member) in excess of that institution’s minimum investment requirement (i.e., the amount of stock held in excess of theirits activity-based investment requirement and, in the case of a member, theirits membership investment requirement). Although the Bank is not obligated to repurchase excess stock prior to the expiration of a five-year redemption or withdrawal notification period, it will typically endeavor to honor such requests within a reasonable period of time (generally not exceeding 30 days) so long as the Bank will continue to meet its regulatory capital requirements following the repurchase. Excess capital stock totaled $382.6 million atAt December 31, 2006,2009, excess stock held by the Bank’s members and former members totaled $292.2 million, of which $9.4$5.0 million was classified as mandatorily redeemable. In September 2004, the Board of Governors of the Federal Reserve System announced that it had revised its Policy Statement on Payments System Risk (“PSR Policy”) concerning interest and principal payments on securities issued by GSEs and certain international organizations. Prior to July 20, 2006, the Federal Reserve Banks processed and posted these payments to depository institutions’ Federal Reserve accounts by 9:15 a.m. Eastern Time, the same posting time as for U.S. Treasury securities’ interest and principal payments, even if the issuer had not fully funded its payments. Under its revised PSR Policy, beginning July 20, 2006, Federal Reserve Banks began releasing these interest and principal payments as directed by the issuer only if the issuer’s Federal Reserve account contains sufficient funds to cover the payments. While the issuer determines the timing of these payments during the day, each issuer is required to fund its interest and principal payments by 4:00 p.m. Eastern Time in order for the payments to be processed that day.
The revised PSR Policy changed the timing of principal and interest payments on consolidated obligations, which typically are now made later in the day. In response to the revised PSR Policy, the 12 FHLBanks and the Office of Finance entered into the Federal Home Loan Banks P&I Funding and Contingency Plan Agreement (the “Agreement”) on June 23, 2006. The Agreement and related procedures were entered into in order to facilitate the timely funding of principal and interest payments on FHLBank System consolidated obligations in the event that a FHLBank is not able to meet its funding obligations in a timely manner. The Agreement and related procedures provide for the issuance of overnight consolidated obligations directly to one or more FHLBanks that provide funds to avoid a shortfall in the timely payment of principal and interest on any consolidated obligations for which another FHLBank is the primary obligor. Specifically, in the event that one or more FHLBanks does not fund its principal and interest payments under a consolidated obligation by deadlines agreed upon by the FHLBanks and the Office of Finance (for purposes of the Agreement, a “Delinquent Bank”), the non-Delinquent Banks will be obligated to fund any shortfall in funding to the extent that any of the non-Delinquent Banks has a net positive settlement balance (i.e., the amount by which end-of-day proceeds received by such non-Delinquent Bank from the sale of consolidated obligations on one day exceeds payments by such non-Delinquent Bank on consolidated obligations on the same day) in its account with the Office of Finance on the day the shortfall occurs. A FHLBank that funds the shortfall of a Delinquent Bank is referred to in the Agreement as a “Contingency Bank.” The non-Delinquent Banks would fund the shortfall of the Delinquent Bank sequentially in accordance with an agreed-upon funding matrix as provided in the Agreement. Additionally, a non-Delinquent Bank could choose to voluntarily fund any shortfall not funded on a mandatory basis by another non-Delinquent Bank. To fund the shortfall of a Delinquent Bank, the Office of Finance will issue to the Contingency Bank on behalf of the Delinquent Bank a consolidated obligation with a maturity of one business day in the amount of the shortfall funded by the Contingency Bank (a “Plan CO”).
On the day that a Plan CO is issued, each non-Delinquent Bank (other than the Contingency Bank that purchased the Plan CO) becomes obligated to purchase a pro rata share of the Plan CO from the Contingency Bank (each such
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non-Delinquent Bank being a “Reallocation Bank”). The pro rata share for each Reallocation Bank will be calculated based upon the aggregate amount of outstanding consolidated obligations for which each Reallocation Bank and the Contingency Bank were primarily liable as of the preceding month-end. Settlement of the purchase by the Reallocation Banks of their pro rata shares of the Plan CO will occur on the second business day following the date on which the Plan CO was issued only if the Plan CO is not repaid on the first business day following its issuance, either by the Delinquent Bank or by another FHLBank.
The Finance Board has granted a waiver requested by the Office of Finance to allow the direct placement by a FHLBank of consolidated obligations with another FHLBank in those instances when direct placement of consolidated obligations is necessary to ensure that sufficient funds are available to timely pay all principal and interest on FHLBank System consolidated obligations due on a particular day. In connection with this waiver, the terms of which became effective July 1, 2006, the Finance Board imposed a requirement that the interest rate to be paid on any consolidated obligation issued under such circumstances must be at least 500 basis points above the then current federal funds rate.
Under the terms of the Agreement, Plan COs will bear interest calculated on an actual/360 basis at a rate equal to (i) the overnight fed funds quote obtained by the Office of Finance or (ii) the actual cost if the Contingency Bank purchases funds in the open market for delivery to the Office of Finance. Additionally, a Delinquent Bank will be required to pay additional interest on the amount of any Plan CO based on the number of times that FHLBank has been a Delinquent Bank. The interest is 500 basis points per annum for the first delinquency, 750 basis points per annum for the second delinquency and 1,000 basis points per annum for subsequent delinquencies. The first 100 basis points of additional interest will be paid to the Contingency Banks that purchased the Plan CO. Additional interest in excess of 100 basis points will be paid to the non-Delinquent Banks in equal shares.
The initial term of the Agreement commenced on July 20, 2006 and ends on December 31, 2008 (the “Initial Term”). The Agreement will then automatically renew for successive three-year terms (each a “Renewal Term”) unless at least one year prior to the end of the Initial Term or any Renewal Term at least one-third of the FHLBanks give notice to the other FHLBanks and the Office of Finance of their intention to terminate the Agreement at the end of such Initial Term or Renewal Term. The notice must include an explanation from those FHLBanks of their reasons for taking such action. Under the terms of the Agreement, the FHLBanks and the Office of Finance have agreed to endeavor in good faith to address any such reasons by amending the Agreement so that all FHLBanks and the Office of Finance agree that the Agreement, as amended, will remain in effect.
The change to the PSR Policy has thus far not had a significant impact on the Bank’s operations, nor is it expected to have a significant impact on its future operations. Through the date of this report, no Plan COs have been issued pursuant to the terms of the Agreement.
Risk-Based Capital Rules and Other Capital Requirements Upon implementation of its capital plan on September 2, 2003, theThe Bank became subject to the Finance Board’s new risk-based capital rules and other capital requirements. This regulatory framework requires each FHLBank that has implemented its new capital planis required to maintain at all times permanent capital (defined under the Finance Board’sAgency’s rules as retained earnings and amounts paid in for Class B stock, regardless of its classification as equity or liabilities for financial reporting purposes, as further described above in the section entitled “Financial Condition –— Capital Stock”) in an amount at least equal to its risk-based capital requirement, which is the sum of its credit risk capital requirement, its market risk capital requirement, and its operations risk capital requirement, as further described below. For reasons of safety and soundness, the Finance BoardAgency may require the Bank, or any other FHLBank that has already converted to its new capital structure, to maintain a greater amount of permanent capital than is required by the risk-based capital requirements as defined.
The Bank’s credit risk capital requirement is determined by adding together the credit risk capital charges for advances, investments, mortgage loans, derivatives, other assets and off-balance-sheet commitment positions (e.g., outstanding letters of credit and commitments to fund advances). Among other things, these charges are computed based upon the credit risk percentages assigned to each item as required by Finance BoardAgency rules, taking into account the time to maturity and credit ratings of certain of the items. These percentages are applied to the book value of assets or, in the case of off-balance-sheet commitments, to their balance sheet equivalents. 66
The Bank’s market risk capital requirement is determined by estimating the potential loss in market value of equity under a wide variety of market conditions and adding the amount, if any, by which the Bank’s current market value of total capital is less than 85 percent of its book value of total capital. The potential loss component of the market risk capital requirement employs a “stress test” approach, using a 99-percent confidence interval. Simulations of over 300370 historical market interest rate scenarios dating back to January 1978 (using changes in interest rates and volatilities over each six-month period since that date) are generated and, under each scenario, the hypothetical impact on the Bank’s current market value of equity is determined. The hypothetical impact associated with each historical scenario is calculated by simulating the effect of each set of rate and volatility conditions upon the Bank’s current risk position, each of which reflects current actual assets, liabilities, derivatives and off-balance-sheet commitment positions as of the measurement date. From the complete set of resulting simulated scenarios, the fourth worst estimated deterioration in market value of equity is identified as that scenario associated with a probability of occurrence of not more than one percent (i.e., the 99-percent confidence limit). The hypothetical deterioration in market value of equity derived under the methodology described above typically represents the market risk component of the Bank’s regulatory risk-based capital requirement which, in conjunction with the credit risk and operations risk components, determines the Bank’s overall risk-based capital requirement. The Bank’s operations risk capital requirement is equal to 30 percent of the sum of its credit risk capital requirement and its market risk capital requirement. At December 31, 2006,2009, the Bank’s credit risk, market risk and operations risk capital requirements were $148$151 million, $195$239 million and $103$117 million, respectively. These requirements were $179$163 million, $229$552 million and $123$215 million, respectively, at December 31, 2005.2008. At December 31, 2008, the Bank’s market risk capital requirement also included $364 million that represented the amount by which the Bank’s market value of equity was less than 85 percent of its book value of total capital at that date. In addition to the risk-based capital requirement, the Bank is subject to two other capital requirements. First, the Bank must, at all times, maintain a minimum total capital to assetscapital-to-assets ratio of four4.0 percent. For this purpose, total capital is defined by Finance BoardAgency rules and regulations as the Bank’s permanent capital and the amount of any general allowance for losses (i.e., those reserves that are not held against specific assets). Second, the Bank is required to maintain at all times a minimum leverage capital to assetscapital-to-assets ratio in an amount at least equal to five5.0 percent of its total assets. In applying this requirement to the Bank, leverage capital includes the Bank’s permanent capital multiplied by a factor of 1.5 plus the amount of any general allowance for losses. The Bank did not have any general reserves at December 31, 20062009 or December 31, 2005.2008. Under the regulatory definitions, total capital and permanent capital exclude accumulated other comprehensive income (loss). The Bank is required to submit monthly capital compliance reports to the Finance Board.Agency. At all times during the three years ended December 31, 2006,2009, the Bank was in compliance with theseall of its regulatory capital requirements. The following table summarizes the Bank’s compliance with the Finance Board’sAgency’s capital requirements as of December 31, 20062009 and 2005.2008. 92
REGULATORY CAPITAL REQUIREMENTS
(In millions of dollars, except percentages) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | December 31, 2006 | | December 31, 2005 | | December 31, 2009 | | December 31, 2008 | | | | Required | | Actual | | Required | | Actual | | Required | | Actual | | Required | | Actual | | Risk-based capital | | $ | 446 | | $ | 2,598 | | $ | 531 | | $ | 2,796 | | | $ | 507 | | $ | 2,897 | | $ | 930 | | $ | 3,530 | | | | | Total capital | | $ | 2,226 | | $ | 2,598 | | $ | 2,594 | | $ | 2,796 | | | $ | 2,604 | | $ | 2,897 | | $ | 3,157 | | $ | 3,530 | | Total capital-to-assets ratio | | | 4.00 | % | | | 4.67 | % | | | 4.00 | % | | | 4.31 | % | | | 4.00 | % | | | 4.45 | % | | | 4.00 | % | | | 4.47 | % | | | | Leverage capital | | $ | 2,783 | | $ | 3,898 | | $ | 3,243 | | $ | 4,195 | | | $ | 3,255 | | $ | 4,346 | | $ | 3,947 | | $ | 5,295 | | Leverage capital-to-assets ratio | | | 5.00 | % | | | 7.00 | % | | | 5.00 | % | | | 6.47 | % | | | 5.00 | % | | | 6.68 | % | | | 5.00 | % | | | 6.71 | % |
From January 1, 2004 through September 29, 2005, theThe Bank’s Risk Management Policy containedcontains a minimum total regulatory capital-to-assets target ratio of 4.254.1 percent, higher than the 4.004.0 percent ratio required under the Finance Board’sAgency’s capital rules. The target ratio is subject to change by the Bank as it deems appropriate, subject to the Finance Board’sAgency’s minimum requirements. The Bank was in compliance with its operating target capital ratio at all times during the years ended December 31, 2009, 2008 and 2007.
In connection with its authority under the HER Act, on January 30, 2009, the Finance Agency adopted an interim final rule establishing capital classifications and critical capital levels for the FHLBanks. On September 29, 2005,August 4, 2009, the Finance Agency adopted the interim final rule as a final regulation (the “Capital Classification Regulation”), subject to amendments meant to clarify certain provisions. The Capital Classification Regulation establishes criteria for four capital classifications for the FHLBanks: adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. An adequately capitalized FHLBank meets all existing risk-based and minimum capital requirements. An undercapitalized FHLBank does not meet one or more of its risk-based or minimum capital requirements, but nevertheless has total capital equal to or greater than 75 percent of all capital requirements. A significantly undercapitalized FHLBank does not have total capital equal to or greater than 75 percent of all capital requirements, but the FHLBank does have total capital greater than 2 percent of its total assets. A critically undercapitalized FHLBank has total capital that is less than or equal to 2 percent of its total assets. The Director of the Finance Agency will determine each FHLBank’s capital classification no less often than once a quarter; the Director may make a determination more often than quarterly. The Director may reclassify a FHLBank one category below the otherwise applicable capital classification (e.g., from adequately capitalized to undercapitalized) if the Director determines that (i) the FHLBank is engaging in conduct that could result in the rapid depletion of permanent or total capital, (ii) the value of collateral pledged to the FHLBank has decreased significantly, (iii) the value of property subject to mortgages owned by the FHLBank has decreased significantly, (iv) after notice to the FHLBank and opportunity for an informal hearing before the Director, the FHLBank is in an unsafe and unsound condition, or (v) the FHLBank is engaging in an unsafe and unsound practice because the FHLBank’s asset quality, management, earnings or liquidity were found to be less than satisfactory during the most recent examination, and any deficiency has not been corrected. Before classifying or reclassifying a FHLBank, the Director must notify the FHLBank in writing and give the FHLBank an opportunity to submit information relative to the proposed classification or reclassification. Since the adoption of the Capital Classification Regulation as an interim final rule, the Bank reducedhas been classified as adequately capitalized for each quarterly period for which the Director has made a final determination. In addition to restrictions on capital distributions by a FHLBank that does not meet all of its risk-based and minimum total capital-to-assets target ratiocapital requirements, a FHLBank that is classified as undercapitalized, significantly undercapitalized or critically undercapitalized is required to 4.10 percent.take certain actions, such as submitting a capital restoration plan to the Director of the Finance Agency for approval. Additionally, with respect to a FHLBank that is less than adequately capitalized, the Director of the Finance Agency may take other actions that he or she determines will help ensure the 6793
Throughoutsafe and sound operation of the FHLBank and its compliance with its risk-based and minimum capital requirements in a reasonable period from January 1, 2004of time.
The Director may appoint the Finance Agency as conservator or receiver for any FHLBank that is classified as critically undercapitalized. The Director may also appoint the Finance Agency as conservator or receiver of any FHLBank that is classified as undercapitalized or significantly undercapitalized if the FHLBank fails to July 31, 2005 (priorsubmit a capital restoration plan acceptable to the restatement describedDirector within the time frames established by the Capital Classification Regulation or materially fails to implement any capital restoration plan that has been approved by the Director. At least once in each 30-day period following classification of a FHLBank as critically undercapitalized, the Director must determine whether during the prior 60 days the FHLBank had assets less than its obligations to its creditors and others or if the FHLBank was not paying its debts on a regular basis as such debts became due. If either of these conditions apply, then the Director must appoint the Finance Agency as receiver for the FHLBank. A FHLBank for which the Director appoints the Finance Agency as conservator or receiver may bring an action in the Bank’s Amended Form 10),United States District Court for the Bank’s total capital, as defined by Finance Board regulations, exceeded the Bank’s target operating capital ratio based upon the Bank’s pre-restatement capital and total assets for those periods. However, based upon its restated results, the Bank’s total capital-to-assets ratio at June 30, 2005 and July 31, 2005 was 4.09 percent and 4.10 percent, respectively. These ratios would suggest retrospectively that the Bank’s target capital-to-assets ratio was not met at all times during the subject period, although the Bank’s total capital-to-assets ratio, based on its restated financial results, never fell below the regulatory minimum during that period. In August 2005 (immediately after discovering the errors that gave rise to the restatement and determining the required accounting corrections), the Bank sold/terminated substantially all of the financial instruments tojudicial district in which the errors related, which restoredFHLBank is located or in the Bank’s retained earningsUnited States District Court for the District of Columbia for an order requiring the Finance Agency to a positive balance. Therefore, on a restated basis,remove itself as conservator or receiver. A FHLBank that is not critically undercapitalized may also seek judicial review of any final capital classification decision or of any final decision to take supervisory action made by the Bank was in complete compliance with bothDirector under the regulatory minimum capital requirement and its operating target capital ratio as of August 31, 2005 and has been in complete compliance ever since. While there can be no assurances, the Bank believes that it will not be subject to any regulatory sanctions as a result of having retrospectively fallen below its operating target capital ratio for these two monthly periods.Capital Classification Regulation.
Critical Accounting Policies and Estimates The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make a number of judgements, estimates and assumptions that affect the reported amounts of assets, liabilities, income and expenses. To understand the Bank’s financial position and results of operations, it is important to understand the Bank’s most significant accounting policies and the extent to which management uses judgment and estimates in applying those policies. TheseThe Bank’s critical accounting policies include those relating toand estimates involve the Bank’s accounting for derivatives and hedging activities, its estimation of the fair value of certain financial instruments, and the amortization of premiums and accretion of discounts associated with certain investment securities.following: | • | | Derivatives and Hedging Activities; | | | • | | Estimation of Fair Values; | | | • | | Other-Than-Temporary Impairment Assessments; and | | | • | | Amortization of Premiums and Accretion of Discounts. |
The Bank considers these policies to be critical because they require management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. Management bases its judgments and estimates on current market conditions and industry practices, historical experience, changes in the business environment and other factors that it believes to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions and/or conditions. For additional discussion regarding the application of these and other accounting policies, see Note 1 to the Bank’s audited financial statements included in this report. Derivatives and Hedging Activities The Bank enters into interest rate swap, cap and, on occasion, floor agreements to manage its exposure to changes in interest rates. Through the use of these derivatives, the Bank may adjust the effective maturity, repricing index and/or frequency or option characteristics of financial instruments to achieve its risk management objectives. By regulation, the Bank may only use derivatives to mitigate identifiable risks. Accordingly, all of the Bank’s derivatives are positioned to offset interest rate risk exposures inherent in its investment, funding and member lending activities. SFAS 133ASC 815 requires that all derivatives be recorded on the statement of condition at their fair value. Since the Bank does not have any cash flow hedges, changes in the fair value of all derivatives are recorded each period in current earnings. Under SFAS 133,ASC 815, the Bank is required to recognize unrealized gains and losses on derivative positions
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whether or not the transaction qualifies for hedge accounting, in which case offsetting losses or gains on the hedged assets or liabilities may also be recognized. Therefore, to the extent certain derivative instruments do not qualify for hedge accounting under SFAS 133,ASC 815, or changes in the fair values of derivatives are not exactly offset by changes in their hedged items, the accounting framework imposed by SFAS 133ASC 815 introduces the potential for a considerable mismatch between the timing of income and expense recognition for assets or liabilities being hedged and their associated hedging instruments. As a result, during periods of significant changes in market prices and interest rates, the Bank’s earnings may exhibit considerable volatility. The judgments and assumptions that are most critical to the application of this accounting policy are those affecting whether a hedging relationship qualifies for hedge accounting under SFAS 133ASC 815 and, if so, whether an assumption of no ineffectiveness can be made. In addition, the estimation of fair values (discussed below) has a significant impact on the actual results being reported. 68
At the inception of each hedge transaction, the Bank formally documents the hedge relationship and its risk management objective and strategy for undertaking the hedge, including identification of the hedging instrument, the hedged item, the nature of the risk being hedged, and how the hedging instrument’s effectiveness in offsetting the exposure to changes in the hedged item’s fair value attributable to the hedged risk will be assessed. In all cases involving a recognized asset, liability or firm commitment, the designated risk being hedged is the risk of changes in its fair value attributable to changes in the designated benchmark interest rate (LIBOR). Therefore, for this purpose, changes in the fair value of the hedged item (e.g., an advance, investment security or consolidated obligation) reflect only those changes in value that are attributable to changes in the designated benchmark interest rate (hereinafter referred to as “changes in the benchmark fair value”). For hedging relationships that are designated as hedges and qualify for hedge accounting, under SFAS 133, the change in the benchmark fair value of the hedged item is recorded in earnings, thereby providing some offset to the change in fair value of the associated derivative. The difference in the change in fair value of the derivative and the change in the benchmark fair value of the hedged item represents “hedge ineffectiveness.” If a hedging relationship qualifies for the short-cut method of accounting, the Bank can assume that the change in the benchmark fair value of the hedged item is equal and offsetting to the change in the fair value of the derivative and, as a result, no ineffectiveness is recorded in earnings. However, SFAS 133ASC 815 limits the use of the short-cut method to hedging relationships of interest rate risk involving a recognized interest-bearing asset or liability and an interest rate swap, and then only if nine specific conditions are met. If the hedging relationship qualifies for hedge accounting but does not meet all nine conditions specified in SFAS 133,ASC 815, the assumption of no ineffectiveness cannot be made and the long-haul method of accounting is used. Under the long-haul method, the change in the benchmark fair value of the hedged item is calculated independently from the change in fair value of the derivative. As a result, the net effect is that the hedge ineffectiveness has an impact on earnings. In all cases where the Bank is applying fair value hedge accounting, it is hedging interest rate risk through the use of interest rate swaps and caps. For those interest rate swaps and caps that are in fair value hedging relationships that do not qualify for the short-cut method of accounting, the Bank uses regression analysis to assess hedge effectiveness. Effectiveness testing is performed at the inception of each hedging relationship to determine whether the hedge is expected to be highly effective in offsetting the identified risk, and at each month-end thereafter to ensure that the hedge relationship has been effective historically and to determine whether the hedge is expected to be highly effective in the future. Hedging relationships accounted for under the short-cut method are not tested for hedge effectiveness. A hedge relationship is considered effective only if certain specified criteria are met. If a hedge fails the effectiveness test at inception, the Bank does not apply hedge accounting. If the hedge fails the effectiveness test during the life of the transaction, the Bank discontinues hedge accounting prospectively. In that case, the Bank continues to carry the derivative on its statement of condition at fair value, recognizes the changes in fair value of that derivative in current earnings, ceases to adjust the hedged item for changes in its benchmark fair value and amortizes the cumulative basis adjustment on the formerly hedged item into earnings over its remaining term. Unless and until the derivative is redesignated in a SFAS 133qualifying fair value hedging relationship for accounting 95
purposes, changes in its fair value are recorded in current earnings without an offsetting change in the benchmark fair value from a hedged item. Changes in the fair value of derivative positions that do not qualify for hedge accounting under SFAS 133ASC 815 (economic hedges) are recorded in current earnings without an offsetting change in the benchmark fair value of the hedged item. As of December 31, 2006,2009, the Bank’s derivatives portfolio included $8.1$9.5 billion (notional amount) that was accounted for using the short-cut method, $37.9$29.1 billion (notional amount) that was accounted for using the long-haul method, and $5.7$28.1 billion (notional amount) that did not qualify for hedge accounting. By comparison, at December 31, 2005,2008, the Bank’s derivatives portfolio included $12.8$10.1 billion (notional amount) that was accounted for using the short-cut method, $27.7$39.0 billion (notional amount) that was accounted for using the long-haul method, and $6.2$21.1 billion (notional amount) that did not qualify for hedge accounting. During 2009, the increase in derivatives that did not qualify for hedge accounting was due primarily to the increased usage of federal funds floater swaps to convert the Bank’s interest payments with respect to consolidated obligation bonds that are indexed to the daily federal funds rate to three-month LIBOR. These types of derivatives are classified as economic derivatives. See further discussion in the sections entitled “Financial Condition — Derivatives and Hedging Activities” and “Results of Operations — Other Income.” 69
Estimation of Fair Values Certain of theThe Bank’s assets and liabilities, including derivatives and investments classified as available-for-sale and trading are presented in the statements of condition at fair value. Under U.S. generally accepted accounting principles,Fair value is defined under GAAP as 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. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. GAAP establishes a fair value hierarchy and requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The fair value hierarchy prioritizes the inputs used to measure fair value into three broad levels:
Level 1 Inputs— Quoted prices (unadjusted) in active markets for identical assets and liabilities. The fair values of the Bank’s trading securities were determined using Level 1 inputs. Level 2 Inputs— Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the asset or liability. Level 2 inputs include the following: (1) quoted prices for similar assets or liabilities in active markets; (2) quoted prices for identical or similar assets or liabilities in markets that are not active or in which little information is released publicly; (3) inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates and yield curves that are observable at commonly quoted intervals, volatilities and prepayment speeds); and (4) inputs that are derived principally from or corroborated by observable market data (e.g., implied spreads). Level 2 inputs were used to determine the estimated fair values of the Bank’s derivative contracts and, prior to their sale or maturity, investment securities classified as available-for-sale. Level 3 Inputs— Unobservable inputs for the asset or liability that are supported by little or no market activity and that are significant to the fair value measurement of ansuch asset or liability isliability. None of the amountBank’s assets that are carried at whichfair value on a recurring basis were measured using Level 3 inputs. Other than its derivative contracts (which were measured using Level 2 inputs), the Bank does not carry any of its liabilities at fair value. The fair values of the Bank’s assets and liabilities that asset could be bought or sold, or that liability could be incurred or settled in a current transaction between willing parties (that is, other than in a forced or liquidation sale). Fair valuesare carried at fair value are estimated based upon quoted market prices where available. However, most of the Bank’s financialthese instruments lack an available trading market characterized by frequent transactions between a willing buyer and willing seller engaging in an exchange transaction. In these cases, and in those instances where the Bank is calculating periodic changes in the benchmark fair values of hedged items for purposes of SFAS 133, such values are generally estimated using a pricing modelsmodel and inputs that use discounted cash flowsare observable for the asset or liability, either directly or indirectly. In those limited cases where a pricing model is not used, non-binding fair value estimates are obtained from dealers and othercorroborated using a pricing techniques. Pricing modelsmodel and their underlying assumptions are based upon management’s best estimates for appropriate discount rates, prepayments, market volatility and other factors, taking into account current observable market datadata. The assumptions and experience. These assumptions mayinputs used have a significant effect on the reported carrying values of assets and liabilities including derivatives, and the 96
related income and expense. The use of different assumptionsassumptions/inputs could result in materially different net income and reported carrying values. Management uses available market data from multiple sources whenever possible to validate its model assumptions. In addition,The Bank also estimates the fair values reportedof certain assets on a nonrecurring basis in periods subsequent to their initial recognition (for example, impaired assets). During the year ended December 31, 2009, the Bank recorded other-than-temporary impairments on seven of its non-agency residential MBS classified as held-to-maturity. The fair values of these securities were estimated as described below. Based upon the reduced level of market activity for non-agency residential MBS, all of the nonrecurring fair value measurements for these impaired securities fell within Level 3 of the fair value hierarchy.
In addition to those items that are carried at fair value, the Bank estimates fair values for its other financial instruments for disclosure purposes and, in applying ASC 815, it calculates the periodic changes in the financial statements (exclusivefair values of hedged items (e.g., certain advances, available-for-sale securities and consolidated obligations) that are attributable solely to changes in LIBOR, the designated benchmark interest rate. For most of these instruments (other than the Bank’s MBS holdings, as described below), such values are estimated using a pricing model that employs discounted cash flows or other similar pricing techniques. Significant inputs to the pricing model (e.g., yield curves, estimated prepayment speeds and volatility) are based on current observable market data. To the extent this model is used to calculate changes in the benchmark fair values) are comparedvalues of hedged items, the inputs have a significant effect on the reported carrying values of assets and liabilities and the related income and expense; the use of different inputs could result in materially different net income and reported carrying values. Prior to independentSeptember 30, 2009, the Bank obtained non-binding fair value estimates obtained from various dealers for its mortgage-backed securities (for each MBS, one dealer estimate was received). These dealer estimates were reviewed for reasonableness using the Bank’s pricing model and/or by comparing the dealer estimates to pricing service quotations or dealer estimates for similar securities. During the third parties. Significant differences,quarter of 2009, in an effort to achieve consistency among all FHLBanks, the 12 FHLBanks collectively developed a common methodology for estimating the fair values of non-agency RMBS. Based on its analysis, the Bank concluded that this common methodology (discussed below) would produce measurements that were equally representative of fair value and, accordingly, the Bank adopted the methodology effective September 30, 2009. The Bank also concurrently adopted this same methodology for all of its other MBS as its analysis of the pricing for those securities supported the same conclusion. The Bank’s new valuation technique incorporates prices from up to four designated third-party pricing vendors when available. A price is established for each MBS using a formula that is based upon the number of prices received. If four prices are received, the average of the middle two prices is used; if any,three prices are investigated. In addition,received, the middle price is used; if two prices are received, the average of the two prices is used; and if one price is received, it is used subject to some type of validation. The computed prices are tested for reasonableness using specified tolerance thresholds. Prices within the established thresholds are generally accepted unless strong evidence suggests that using the formula-driven price would not be appropriate. Preliminary estimated fair values that are outside the tolerance thresholds, or that management believes may not be appropriate based on all available information, are subject to further analysis including comparison to the prices for similar securities and/or to non-binding dealer estimates. As of December 31, 2009, four vendor prices were received for substantially all of the Bank’s MBS holdings (all of which are classified as held-to-maturity). This change in valuation technique did not have a significant impact on the estimated fair values of the Bank’s mortgage-backed securities as of September 30, 2009. The Bank’s pricing model is subject to annual independent validation. Thevalidation and the Bank continuallyperiodically reviews and refines, as appropriate, its assumptions and valuation methodologies to reflect market indications more effectively. as closely as possible. The Bank believes it has the appropriate personnel, technology, and policies and procedures in place to enable it to value its financial instruments in a reasonable and consistent manner. The Bank’s fair value measurement methodologies for its assets and liabilities are more fully described in the audited financial statements accompanying this report (specifically, Note 16 beginning on page F-43). 97
Other-Than-Temporary Impairment Assessments The Bank evaluates outstanding available-for-sale and held-to-maturity securities in an unrealized loss position (i.e., impaired securities) for other-than-temporary impairment on at least a quarterly basis. In doing so, the Bank considers many factors including, but not limited to: the credit ratings assigned to the securities by the NRSROs; other indicators of the credit quality of the issuer; the strength of the provider of any guarantees; the duration and magnitude of the unrealized loss; and whether the Bank has the intent to sell the security or more likely than not will be required to sell the security before its anticipated recovery. In the case of its non-agency residential and commercial MBS, the Bank also considers prepayment speeds, the historical and projected performance of the underlying loans and the credit support provided by the subordinate securities. These evaluations are inherently subjective and consider a number of quantitative and qualitative factors. In the case of its non-agency RMBS, the Bank employs third-party models to determine the cash flows that it is likely to collect from the securities. These models consider borrower characteristics and the particular attributes of the loans underlying the securities, in conjunction with assumptions about future changes in home prices and interest rates, to predict the likelihood a loan will default and the impact on default frequency, loss severity and remaining credit enhancement. In general, because the ultimate receipt of contractual payments on these securities will depend upon the credit and prepayment performance of the underlying loans and the credit enhancements for the senior securities owned by the Bank, the Bank uses these models to assess whether the credit enhancement associated with each security is sufficient to protect against potential losses of principal and interest on the underlying mortgage loans. The development of the modeling assumptions requires significant judgment and the Bank believes its assumptions are reasonable. However, valuations are subject to change as a resultthe use of external factors beyonddifferent assumptions could impact the Bank’s controlconclusions as to whether an impairment is other than temporary as well as the amount of the credit portion of any impairment. The credit portion of an impairment is defined as the amount by which the amortized cost basis of a debt security exceeds the present value of cash flows expected to be collected from that security. In addition to evaluating its non-agency RMBS under a base case (or best estimate) scenario, a cash flow analysis was also performed for each of these securities under a more stressful housing price scenario to determine the impact that such a change would have on the credit losses recorded in earnings at December 31, 2009. The results of that analysis are presented on page 65 of this report. If the Bank intends to sell an impaired debt security, or more likely than not will be required to sell the security before recovery of its amortized cost basis, the impairment is other than temporary and is recognized currently in earnings in an amount equal to the entire difference between fair value and amortized cost. In instances in which the Bank determines that a substantial degreecredit loss exists but the Bank does not intend to sell the security and it is not more likely than not that the Bank will be required to sell the security before the anticipated recovery of uncertainty.its remaining amortized cost basis, the other-than-temporary impairment is separated into (i) the amount of the total impairment related to the credit loss and (ii) the amount of the total impairment related to all other factors (i.e., the non-credit portion). The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings and the amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income. The total other-than-temporary impairment is presented in the statement of income with an offset for the amount of the total other-than-temporary impairment that is recognized in other comprehensive income. If a credit loss does not exist, any impairment is not considered to be other-than-temporary. Regardless of whether an other-than-temporary impairment is recognized in its entirety in earnings or if the credit portion is recognized in earnings and the non-credit portion is recognized in other comprehensive income, the estimation of fair values (discussed above) has a significant impact on the amount(s) of any impairment that is recorded. The non-credit portion of any other-than-temporary impairment losses recognized in other comprehensive income for debt securities classified as held-to-maturity is accreted over the remaining life of the debt security (in a prospective manner based on the amount and timing of future estimated cash flows) as an increase in the carrying value of the security unless and until the security is sold, the security matures, or there is an additional other-than-temporary impairment that is recognized in earnings. In instances in which an additional other-than-temporary 98
impairment is recognized in earnings, the amount of the credit loss is reclassified from accumulated other comprehensive income to earnings. Further, if an additional other-than-temporary impairment is recognized in earnings and the held-to-maturity security’s then-current carrying amount exceeds its fair value, an additional non-credit impairment is concurrently recognized in other comprehensive income. Conversely, if an additional other-than-temporary impairment is recognized in earnings and the held-to-maturity security’s then-current carrying value is less than its fair value, the carrying value of the security is not increased. In periods subsequent to the recognition of an other-than-temporary impairment loss, the other-than-temporarily impaired debt security is accounted for as if it had been purchased on the measurement date of the other-than-temporary impairment at an amount equal to the previous amortized cost basis less the other-than-temporary impairment recognized in earnings. For debt securities for which other-than-temporary impairments are recognized in earnings, the difference between the new cost basis and the cash flows expected to be collected is accreted into interest income over the remaining life of the security in a prospective manner based on the amount and timing of future estimated cash flows. Amortization of Premiums and Accretion of Discounts The Bank estimates prepayments for purposes of amortizing premiums and accreting discounts associated with certain investment securities. SFAS No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases”(“SFAS 91”) requiresUnder GAAP, premiums and discounts are required to be recognized in income at a constant effective yield over the life of the instrument. Because actual prepayments often deviate from the estimates, the Bank periodically recalculates the effective yield to reflect actual prepayments to date and anticipated future prepayments. Anticipated future prepayments are estimated using externally developed mortgage prepayment models. These models consider past prepayment patterns and current and past interest rate environments to predict future cash flows. Adjustments are recorded on a retrospective basis, meaning that the net investment in the instrument is adjusted to the amount that would have existed had the new effective yield been applied since the acquisition of the instrument. As interest rates (and thus prepayment speeds) change, SFAS 91these accounting requirements can be thea source of income volatility. Reductions in interest rates generally accelerate prepayments, which accelerate the amortization of premiums and reduce current earnings. Typically, declining interest rates also accelerate the accretion of discounts, thereby increasing current earnings. Conversely, in a rising interest rate environment, prepayments will generally extend over a longer period, shifting some of the premium amortization and discount accretion to future periods. As of December 31, 2006,2009, the unamortized premiums and discounts associated with investment securities for which prepayments are estimated totaled $3.4$0.9 million and $3.9$150.9 million, respectively. At that date, the carrying values of these investment securities totaled $2.3$1.1 billion and $2.7$6.0 billion, respectively. Prior to January 1, 2005, theThe Bank also estimated prepayments for purposes of amortizing premiums and accreting discounts associated with its mortgage loans held for portfolio. Effective January 1, 2005, the Bank began usinguses the contractual method to amortize premiums and accrete discounts on mortgage loans. The contractual method recognizes the income effects of premiums and discounts in a manner that is reflective of the actual behavior of the mortgage loans during the period in which the behavior occurs while also reflecting the contractual terms of the
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assets without regard to changes in estimated prepayments based upon assumptions about future borrower behavior. For more information regarding this change in accounting method, see the section above entitled “Results of Operations.” Recently Issued Accounting Standards and InterpretationsGuidance SFAS 154
In May 2005,For a discussion of recently issued accounting guidance, see the Financial Accounting Standards Board (“FASB”) issued SFAS No. 154,“Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3”(“SFAS 154”). Among other things, SFAS 154 requires retrospective application, unless impracticable, to prior periods’audited financial statements of voluntary changes in accounting principle and changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. SFAS 154 also makes a distinction between “retrospective application” of a change in accounting principle and the “restatement” of previously issued financial statements to reflect the correction of an error. SFAS 154 carries forward without change the guidance contained in APB Opinion No. 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal yearsaccompanying this report (specifically, Note 2 beginning after December 15, 2005. The Bank adopted SFAS 154 on January 1, 2006. The adoption of SFAS 154 has thus far not had any impact on the Bank’s results of operations or financial condition as no accounting changes have been made since January 1, 2006.
DIG Issues B38 and B39
In June 2005, the FASB’s Derivatives Implementation Group (“DIG”) issued DIG Issue B38,“Embedded Derivatives: Evaluation of Net Settlement with Respect to the Settlement of a Debt Instrument through Exercise of an Embedded Put Option or Call Option”(“DIG B38”), and DIG Issue B39,“Embedded Derivatives: Application ofParagraph 13(b) to Call Options That Are Exercisable Only by the Debtor”(“DIG B39”)page F-15). Both issues provide additional guidance in applying the provisions of SFAS 133. The guidance in DIG B38 clarifies that the potential settlement of an obligation upon exercise of a put option or call option (including a prepayment option) meets the net settlement criterion of a derivative. DIG B39 clarifies that a right to accelerate the settlement of an obligation is considered clearly and closely related to the debt host contract if the respective embedded call option can be exercised only by the debtor (issuer/borrower). The Bank adopted both DIG issues as of January 1, 2006 and the adoption did not have a material impact on the Bank’s results of operations or financial condition.
FASB Staff Position (“FSP”) FAS 115-1 and FAS 124-1
In November 2005, the FASB issued FSP FAS 115-1 and FAS 124-1,“The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”(“FSP FAS 115-1 and FAS 124-1”) which addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. FSP FAS 115-1 and FAS 124-1 clarifies that an investor should recognize an impairment loss no later than when the impairment is deemed other than temporary, even if a decision to sell has not been made. FSP FAS 115-1 and FAS 124-1 also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The Bank adopted FSP FAS 115-1 and FAS 124-1 as of January 1, 2006 and the adoption did not have a material impact on the Bank’s results of operations or financial condition.
SFAS 155
In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140”(“SFAS 155”). SFAS 155 amends SFAS 133 to simplify the accounting for certain hybrid financial instruments by permitting (through an irrevocable election) fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, provided the hybrid financial instrument is measured in its entirety at fair value (with changes in fair value recognized currently in earnings). SFAS 155 also establishes the requirement to evaluate beneficial interests in securitized financial assets to determine whether they are freestanding derivatives or whether they are
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hybrid instruments that contain embedded derivatives requiring bifurcation. This guidance replaces the interim guidance in DIG Issue D1,“Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.”SFAS 155 amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of FASB Statement No. 125”to allow a qualifying special-purpose entity to hold a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS 155 is effective for all financial instruments acquired or issued after the beginning of the first fiscal year that begins after September 15, 2006, with earlier adoption permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued financial statements, including financial statements for any interim period for that fiscal year. The Bank elected to adopt SFAS 155 as of January 1, 2006. The adoption of SFAS 155 has thus far not had any impact on the Bank’s results of operations or financial condition.
SFAS 157
In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements”(“SFAS 157”).SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. In defining fair value, SFAS 157 retains the exchange price notion in earlier definitions of fair value. However, the definition focuses on the price that would be received to sell an asset or paid to transfer a liability (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price). SFAS 157 applies whenever other accounting pronouncements require or permit fair value measurements. Accordingly, SFAS 157 does not expand the use of fair value in any new circumstances. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 (January 1, 2008 for the Bank), and interim periods within those fiscal years. Early adoption is permitted, provided an entity has not yet issued financial statements for that fiscal year, including financial statements for an interim period within that fiscal year. The Bank has not yet determined the effect, if any, that the adoption of SFAS 157 will have on its results of operations or financial condition. The Bank intends to adopt SFAS 157 on January 1, 2008.
SAB 108
In September 2006, the SEC released Staff Accounting Bulletin No. 108“Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”(“SAB 108”). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The SEC staff believes that registrants should quantify errors using both a balance sheet and an income statement approach and evaluate whether either approach results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. SAB 108 is effective for annual financial statements covering the first fiscal year ending after November 15, 2006 (the year ended December 31, 2006 for the Bank), with earlier application encouraged for any interim period of the first fiscal year ending after November 15, 2006, filed after the publication of SAB 108. The initial application of SAB 108 did not have any impact on the Bank’s results of operations or financial condition.
SFAS 158
In September 2006, the FASB issued SFAS No. 158,“Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“SFAS 158”). SFAS 158 requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. SFAS 158 also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. Further, SFAS 158 requires disclosure in the footnotes to the financial statements of the impact of specified events on the net periodic benefit cost for the next fiscal year. The recognition and disclosure provisions of SFAS 158 are effective as of the end of the fiscal year ending after December 15, 2006 for entities with publicly traded equity securities, and as of the end of the fiscal year ending after June 15, 2007 for all other entities. Early adoption is permitted. The requirement to measure plan assets and benefit obligations as of the date of the entity’s fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. The Bank elected to adopt SFAS 158 effective December 31, 2006. The adoption of SFAS
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158 did not have any impact on the Bank’s results of operations, nor did it materially impact the Bank’s financial condition.
DIG B40
In January 2007, the DIG issued DIG Issue B40,“Application ofParagraph 13(b) to Securitized Interests in Prepayable Financial Assets”(“DIG B40”), which provides a narrow scope exception for certain securitized interests from the interest rate related embedded derivative tests required under paragraph 13(b) of SFAS 133. The guidance in DIG B40 is to be applied upon adoption of SFAS 155; however, an entity that adopted SFAS 155 prior to December 31, 2006 must apply the guidance in DIG B40 in the first reporting period beginning before December 31, 2006 for which financial statements have not yet been issued (the quarterly reporting period that began October 1, 2006 for the Bank). Additionally, if an entity had previously adopted SFAS 155 and, in doing so, had treated derivatives embedded in securitized financial assets in a manner consistent with the guidance in DIG B40, then that entity would not be required to retrospectively apply the guidance in DIG B40 to prior periods. The Bank adopted SFAS 155 on January 1, 2006. Subsequent to the date of adoption and prior to October 1, 2006, the Bank did not acquire any securitized interests to which DIG B40 would have applied. Accordingly, the Bank was not required to retrospectively apply the guidance in DIG B40. The implementation of DIG B40 has thus far not had a material impact on the Bank’s results of operations or financial condition.
SFAS 159
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115”(“SFAS 159”).SFAS 159 allows entities to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and financial liabilities that are not otherwise required to be measured at fair value, with changes in fair value recognized in earnings as they occur. SFAS 159 also requires entities to report those financial assets and financial liabilities measured at fair value in a manner that separates those reported fair values from the carrying amounts of similar assets and liabilities measured using another measurement attribute on the face of the statement of financial position. Lastly, SFAS 159 establishes presentation and disclosure requirements designed to improve comparability between entities that elect different measurement attributes for similar assets and liabilities. SFAS 159 is effective for fiscal years beginning after November 15, 2007 (January 1, 2008 for the Bank), with early adoption permitted if an entity also early adopts the provisions of SFAS 157. The Bank intends to adopt SFAS 159 on January 1, 2008. The Bank has not yet determined if, or to what extent, it will elect to use the fair value option to value its financial assets and liabilities or the impact that the implementation of SFAS 159 will have on the Bank’s results of operations or financial condition.
Statistical Financial Information Investment Portfolio The following table summarizesAs of December 31, 2009, 2008 and 2007, the Bank’s trading securities were $4.0 million, $3.4 million and $2.9 million, respectively, and were comprised solely of mutual fund investments, which do not have contractual maturities. The average yield on these securities was 1.96% at December 31, 2006, 2005 and 2004.
TRADING SECURITIES PORTFOLIO
(at carrying value, in thousands of dollars)
| | | | | | | | | | | | | | | December 31, | | | | 2006 | | | 2005 | | | 2004 | | Mortgage-backed securities | | | | | | | | | | | | | Government-sponsored enterprises | | $ | 22,204 | | | $ | 43,837 | | | $ | 76,976 | | Other | | | 2,295 | | | | 1,907 | | | | 1,607 | | | | | | | | | | | | Total carrying value | | $ | 24,499 | | | $ | 45,744 | | | $ | 78,583 | | | | | | | | | | | |
2009.7399
The following table presents supplemental information regarding the maturities and yields of the Bank’s tradingBank did not hold any securities that were classified as ofavailable-for-sale at December 31, 2006. Maturities are based on the contractual maturities of the securities. TRADING SECURITIES
MATURITIES AND YIELD
(in thousands of dollars)
| | | | | | | | | | | Book Value | | | Yield | | Mortgage-backed securities | | | | | | | | | Within one year | | $ | 1,419 | | | | 7.65 | % | After one year through five years | | | 20,785 | | | | 6.86 | | | | | | | | | | | $ | 22,204 | | | | 6.42 | % | | | | | | | | | | | | | | | | | Other | | | | | | | | | Within one year | | $ | 2,295 | | | | 2.94 | % | | | | | | | | | | $ | 2,295 | | | | 2.94 | % | | | | | | | |
2009. The following table summarizes the Bank’s available-for-sale securities at December 31, 2006, 20052008 and 2004.2007. AVAILABLE-FOR-SALE SECURITIES PORTFOLIO (at carrying value, in thousands of dollars) | | | | | | | | | | | | | | | | | | | | | | | December 31, | | | December 31, | | | | 2006 | | 2005 | | 2004 | | | 2008 | | 2007 | | U.S. government guaranteed obligations | | $ | — | | $ | — | | $ | 81,115 | | | Government-sponsored enterprises(1) | | 51,290 | | 88,056 | | 4,487,350 | | | FHLBank consolidated obligations(2) | | | Government-sponsored enterprises | | | $ | — | | $ | 56,930 | | FHLBank consolidated obligations(1) | | | FHLBank of Boston (primary obligor) | | 35,266 | | 35,713 | | 37,251 | | | — | | 35,423 | | FHLBank of San Francisco (primary obligor) | | 6,675 | | 6,674 | | 15,228 | | | — | | 6,766 | | | | | | | | | | | | | 93,231 | | 130,443 | | 4,620,944 | | | | | | | | | | | | | | | | — | | 99,119 | | | | | | | | | Mortgage-backed securities | | | Government-sponsored enterprises | | 432,391 | | 643,347 | | 904,562 | | | 98,884 | | 169,180 | | Other | | 189,149 | | 241,094 | | 260,086 | | | 28,648 | | 93,791 | | | | | | | | | | | | | | | | | 621,540 | | 884,441 | | 1,164,648 | | | 127,532 | | 262,971 | | | | | | | | | | | | | | | | | | Total carrying value | | $ | 714,771 | | $ | 1,014,884 | | $ | 5,785,592 | | | $ | 127,532 | | $ | 362,090 | | | | | | | | | | | | | | |
| | | (1) | | The reduction from December 31, 2004 to December 31, 2005 was attributable to sales of securities that occurred during the third quarter of 2005. See section above entitled “Financial Condition – Investment Securities.” | | (2) | | Represents consolidated obligations acquired in the secondary market for which the named FHLBank iswas the primary obligor, and for which each of the FHLBanks, including the Bank, iswas jointly and severally liable. |
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The following table presents supplemental information regarding the maturities and yields of the Bank’s available-for-sale securities as of December 31, 2006. Maturities are based on the contractual maturities of the securities.
AVAILABLE-FOR-SALE SECURITIES
MATURITIES AND YIELD
(in thousands of dollars)
| | | | | | | | | | | Book Value | | | Yield | | Government-sponsored enterprises | | | | | | | | | After ten years | | $ | 51,290 | | | | 19.02 | % | | | | | | | | | | $ | 51,290 | | | | 19.02 | % | | | | | | | | FHLBank consolidated obligations | | | | | | | | | After one year through five years | | $ | 41,941 | | | | 6.17 | % | | | | | | | | | | $ | 41,941 | | | | 6.17 | % | | | | | | | | Mortgage-backed securities | | | | | | | | | Within one year | | $ | 18,466 | | | | 6.65 | % | After one year through five years | | | 508,202 | | | | 6.21 | | After ten years | | | 94,872 | | | | 6.75 | | | | | | | | | | | $ | 621,540 | | | | 6.31 | % | | | | | | | |
The following table summarizes the Bank’s held-to-maturity securities at December 31, 2006, 20052009, 2008 and 2004.2007. HELD-TO-MATURITY SECURITIES PORTFOLIO (at carrying value, in thousands of dollars) | | | | | | | | | | | | | | | | | | | | | | | | | | | December 31, | | | December 31, | | | | 2006 | | 2005 | | 2004 | | | 2009 | | 2008 | | 2007 | | Commercial paper | | | $ | — | | $ | — | | $ | 993,629 | | U.S. government guaranteed obligations | | $ | 87,125 | | $ | 164,513 | | $ | 178,869 | | | 58,812 | | 65,888 | | 75,342 | | State or local housing agency obligations | | 5,965 | | 6,810 | | 7,825 | | | State housing agency obligation | | | 2,945 | | 3,785 | | 4,810 | | | | | | | | | | | | | | | | | | | 93,090 | | 171,323 | | 186,694 | | | 61,757 | | 69,673 | | 1,073,781 | | | | | | | | | | | | | | | | | Mortgage-backed securities | | | U.S. government guaranteed obligations | | 43,556 | | 61,107 | | 94,691 | | | 24,075 | | 28,632 | | 34,066 | | Government-sponsored enterprises | | 5,163,238 | | 5,574,518 | | 5,307,058 | | | 10,837,865 | | 10,629,290 | | 5,910,467 | | Other | | 1,894,710 | | 2,397,694 | | 1,675,890 | | | 500,855 | | 973,909 | | 1,516,353 | | | | | | | | | | | | | | | | | | | 7,101,504 | | 8,033,319 | | 7,077,639 | | | 11,362,795 | | 11,631,831 | | 7,460,886 | | | | | | | | | | | | | | | | | | | | Total carrying value | | $ | 7,194,594 | | $ | 8,204,642 | | $ | 7,264,333 | | | $ | 11,424,552 | | $ | 11,701,504 | | $ | 8,534,667 | | | | | | | | | | | | | | | | |
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The following table presents supplemental information regarding the maturities and yields of the Bank’s held-to-maturity securities as of December 31, 2006.2009. Maturities are based on the contractual maturities of the securities. HELD-TO-MATURITY SECURITIES MATURITIES AND YIELD (in thousands of dollars) | | | | | | | | | | | | | | | | | | | Book Value | | Yield | | | Book Value | | Yield | | U.S. government guaranteed obligations | | | Within one year | | $ | 167 | | | 6.67 | % | | $ | 249 | | | 0.90 | % | After one year through five years | | 8,487 | | 5.19 | | | 3,607 | | 2.95 | | After five years through ten years | | 6,875 | | 6.93 | | | 31,703 | | 0.72 | | After ten years | | 71,596 | | 5.13 | | | 23,253 | | 0.67 | | | | | | | | | | | | | | | $ | 87,125 | | | 5.28 | % | | $ | 58,812 | | | 0.84 | % | | | | | | | | | | | | State or local housing agency obligations | | | | | | State housing agency obligation | | | After ten years | | $ | 5,965 | | | 5.65 | % | | $ | 2,945 | | | 0.57 | % | | | | | | | | | | | | | | $ | 5,965 | | | 5.65 | % | | $ | 2,945 | | | 0.57 | % | | | | | | | | | | | | | | | Mortgage-backed securities | | | Within one year | | $ | 126 | | | 5.99 | % | | After one year through five years | | 430,991 | | 6.67 | | | 1,803 | | | 0.54 | % | After five years through ten years | | 28,309 | | 5.73 | | | 232,110 | | 0.64 | | After ten years | | 6,642,078 | | 5.78 | | | 11,128,882 | | 0.87 | | | | | | | | | | | | | | | $ | 7,101,504 | | | 5.83 | % | | $ | 11,362,795 | | | 0.87 | % | | | | | | | | | | | |
U.S. Government and government-sponsored agencies were the only issuers whose securities exceeded ten10 percent of the Bank’s total capital at December 31, 2006.2009. Loan Portfolio Analysis The Bank’s outstanding loans, nonaccrual loans, and loans 90 days or more past due and accruing interest for each of the five years in the period ended December 31, 20062009 were as follows: COMPOSITION OF LOANS (In thousands of dollars) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Year ended December 31, | | | | Year ended December 31, | | | 2009 | | 2008 | | 2007 | | 2006 | | 2005 | | | | 2006 | | 2005 | | 2004 | | 2003 | | 2002 | | Advances | | $ | 41,168,141 | | $ | 46,456,958 | | $ | 47,112,017 | | $ | 40,595,327 | | $ | 36,868,743 | | | $ | 47,262,574 | | $ | 60,919,883 | | $ | 46,298,158 | | $ | 41,168,141 | | $ | 46,456,958 | | | | | | | | | | | | | | | | | | | | | | | | | | | | Real estate mortgages | | $ | 449,626 | | $ | 542,478 | | $ | 706,203 | | $ | 971,500 | | $ | 1,395,913 | | | $ | 259,617 | | $ | 327,059 | | $ | 381,468 | | $ | 449,626 | | $ | 542,478 | | | | | | | | | | | | | | | | | | | | | | | | | | | | Nonperforming real estate mortgages | | $ | 466 | | $ | 2,375 | | $ | 938 | | $ | 1,133 | | $ | 796 | | | $ | 1,115 | | $ | 370 | | $ | 312 | | $ | 466 | | $ | 2,375 | | | | | | | | | | | | | | | | | | | | | | | | | | | | Real estate mortgages past due 90 days or more and still accruing interest(1) | | $ | 4,557 | | $ | 6,418 | | $ | 11,510 | | $ | 19,975 | | $ | 17,020 | | | $ | 2,515 | | $ | 2,295 | | $ | 2,854 | | $ | 4,557 | | $ | 6,418 | | | | | | | | | | | | | | | | | | | | | | | | | | | | Interest contractually due during the year on nonaccrual loans | | $ | 32 | | | $ | 57 | | | | | | | | | | | | Interest actually received during the year on nonaccrual loans | | $ | 16 | | | $ | 30 | | | | | | | | |
| | | (1) | | Only government guaranteedguaranteed/insured loans continue to accrue interest after they become ninety90 days past due. |
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Allowance for Credit Losses Activity in the allowance for credit losses for each of the five years in the period ended December 31, 20062009 is presented below. All activity relates to domestic real estate mortgage loans. ALLOWANCE FOR CREDIT LOSSES (In thousands of dollars) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 2006 | | 2005 | | 2004 | | 2003 | | 2002 | | | 2009 | | 2008 | | 2007 | | 2006 | | 2005 | | Balance, beginning of year | | $ | 294 | | $ | 355 | | $ | 387 | | $ | 437 | | $ | 311 | | | $ | 261 | | $ | 263 | | $ | 267 | | $ | 294 | | $ | 355 | | Chargeoffs | | | (27 | ) | | | (5 | ) | | | (6 | ) | | | (23 | ) | | — | | | | (21 | ) | | | (2 | ) | | | (4 | ) | | | (27 | ) | | | (5 | ) | Provision (release of allowance) for credit losses | | — | | | (56 | ) | | | (26 | ) | | | (27 | ) | | 126 | | | — | | — | | — | | — | | | (56 | ) | | | | | | | | | | | | | | | | | | | | | | | | Balance, end of year | | $ | 267 | | $ | 294 | | $ | 355 | | $ | 387 | | $ | 437 | | | $ | 240 | | $ | 261 | | $ | 263 | | $ | 267 | | $ | 294 | | | | | | | | | | | | | | | | | | | | | | | | |
Geographic Concentration of Mortgage Loans The following table presents the geographic concentration of the Bank’s mortgage loan portfolio as of December 31, 2006.2009. GEOGRAPHIC CONCENTRATION OF MORTGAGE LOANS | | | | | Midwest (IA, IL, IN, MI, MN, ND, NE, OH, SD, and WI) | | | 12.312.7 | % | Northeast (CT, DE, MA, ME, NH, NJ, NY, PA, PR, RI, VI, and VT) | | | 1.00.9 | | Southeast (AL, DC, FL, GA, KY, MD, MS, NC, SC, TN, VA, and WV) | | | 13.512.8 | | Southwest (AR, AZ, CO, KS, LA, MO, NM, OK, TX, and UT) | | | 70.971.6 | | West (AK, CA, GU, HI, ID, MT, NV, OR, WA, and WY) | | | 2.32.0 | | | | | | | | | | 100.0 | % | | | | | |
Deposits Time deposits in denominations of $100,000 or more totaled $44.7$155.9 million at December 31, 2006.2009. These deposits mature as follows: $43.7$154.8 million in less than three months, $0.8$0.9 million in three to six months and the remaining $0.2 million in six to twelve months. Short-term Borrowings Borrowings (other than consolidated obligation bonds) with original maturities of one year or less are classified as short-term. Supplemental information regarding the Bank’s short-term borrowingsdiscount notes for the years ended December 31, 2006, 20052009, 2008 and 20042007 is provided in the following table. All short-term borrowings during these periods were discount notes. SHORT-TERMDISCOUNT NOTE BORROWINGS (In millions of dollars)
| | | | | | | | | | | | | | | | | | | | | | | | | | | December 31, | | | December 31, | | | | 2006 | | 2005 | | 2004 | | | 2009 | | 2008 | | 2007 | | Outstanding at year-end | | $ | 8,226 | | $ | 11,220 | | $ | 7,086 | | | $ | 8,762 | | $ | 16,745 | | $ | 24,120 | | Weighted average rate at year-end | | | 5.11 | % | | | 3.83 | % | | | 2.15 | % | | | 0.27 | % | | | 2.65 | % | | | 4.20 | % | Daily average outstanding for the year | | $ | 7,807 | | $ | 8,237 | | $ | 8,548 | | | $ | 14,752 | | $ | 18,851 | | $ | 11,336 | | Weighted average rate for the year | | | 5.00 | % | | | 3.29 | % | | | 1.38 | % | | | 1.40 | % | | | 2.77 | % | | | 4.90 | % | Highest outstanding at any month-end | | $ | 12,173 | | $ | 14,516 | | $ | 12,576 | | | $ | 21,926 | | $ | 23,084 | | $ | 24,120 | | | | |
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest Rate Risk As a financial intermediary, the Bank is subject to interest rate risk. Changes in the level of interest rates, the slope of the interest rate yield curve, and/or in the relationships (or spreads) between interest yields for different instruments have an impact on the Bank’s estimated market value of equity and its net earnings. This risk arises from a variety of instruments that the Bank enters into on a regular basis in the normal course of its business. In addition, discounts in the market prices of securities held by the Bank that are related primarily to credit concerns and a lack of market liquidity rather than interest rates have had an impact on the Bank’s estimated market value of equity and related risk metrics during 2009 and 2008. The terms of member advances, investment securities and the Bank’s consolidated obligations may present interest rate risk and/or embedded option risk. As discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations, the Bank makes extensive use of derivative financial instruments, primarily interest rate swaps and caps, to hedgemanage the risk arising from these sources. The Bank has investments in MBSresidential mortgage-related assets, primarily CMOs and, to a much smaller extent, MPF mortgage loans, both of which present prepayment risk. This risk arises from the uncertainty of when the mortgagees will repaymortgagors’ option to prepay their mortgages, making the effective maturities of these mortgage-based assets relatively more sensitive to changes in interest rates. Arates and other factors that affect the mortgagors’ decisions to repay their mortgages as compared to other long-term investment securities that do not have prepayment features. Historically, a decline in interest rates has generally resultsresulted in accelerated prepaymentmortgage refinancing activity, thus increasing prepayments and thereby shortening the effective maturity of the mortgage-related assets. Conversely, rising rates generally slow prepayment activity and lengthen ana mortgage-related asset’s effective maturity. Recent economic and credit market conditions appear to have had an impact on mortgage prepayment activity, as borrowers whose mortgage rates are above current market rates and who might otherwise refinance or repay their mortgages more rapidly may not be able to obtain new mortgage loans at current lower rates due to reductions in their incomes, declines in the values of their homes, tighter lending standards, a general lack of credit availability, and/or delays in obtaining approval of new loans. The Bank has managed the potential prepayment risk embedded in these mortgage assets is managedby purchasing almost exclusively floating rate securities, by purchasing highly structured tranches of mortgage securities that substantially limit the effects of prepayment risk, by purchasing floating rate securities, andand/or by using interest rate derivative instruments to offset prepayment risk specific both to particular securities and to the overall mortgage portfolio. Since the Bank generally purchases mortgage-backed securities with the intent and expectation of holding them to maturity, the Bank’s risk management activities related to these securities are focused on those interest rate factors that pose a risk to the Bank’s future earnings. As current liquidity discounts in the price for some of these securities indicate, these interest rate factors may not be the same factors that are driving the market prices of the securities. The Bank utilizes a variety of risk measurements to monitor these risks.its interest rate risk. The Bank has made a substantial investment in sophisticated financial modeling systems to measure and analyze interest rate risk. These systems enable the Bank to routinely and formallyregularly measure its market value of equity and income sensitivity profiles under numerousa variety of interest rate scenarios, including scenarios of significantscenarios. Since the Bank’s valuation models are not necessarily intended to differentiate between reductions in market stress.value arising from liquidity discounts, such as those reflected in the market prices for many securities in 2009 and 2008, and those arising from changes in interest rate related factors, management routinely performs further analysis to separate interest rate risk related factors from liquidity discount factors. Management regularly monitors thisthe information derived from these models and provides the Bank’s Board of Directors with risk measurement reports. The Bank develops and implementsutilizes these periodic assessments, in combination with its evaluation of the factors influencing the results, when developing its funding and hedging strategies based on these periodic assessments.strategies. The Bank’s Risk Management Policy provides a risk management framework for the financial management of the Bank consistent with the strategic principles outlined in its Strategic Business Plan. The Risk Management Policy restricts the amount of overall interest rate risk the Bank may assume by limiting the maximum estimated loss in market value of equity that the Bank would incur under simulated 200 basis point changes in interest rates to 15 percent. The Bank develops its funding and hedging strategies to ensure compliance with thesemanage its interest rate risk limits.within the risk limits established in its Risk Management Policy. 103
Business Objectives The Bank serves as a financial intermediary between the capital markets and its members. In its most basic form, this intermediation process involves raising funds by issuing consolidated obligations in the capital markets and lending the proceeds to member institutions at slightly higher rates. The interest spread between the cost of the Bank’s liabilities and the yield on its assets, combined with the earnings on its invested capital, are the Bank’s primary sources of earnings. The Bank’s primary asset liability management goal is to manage its assets and liabilities in such a way that its aggregatecurrent and projected net interest spread is consistent across a wide range of interest rate environments.environments, although the Bank may occasionally take actions that are not necessarily consistent with this objective for short periods of time in response to unusual market conditions. The objective of maintaining a stable interest spread is complicated under normal conditions by the fact that the intermediation process outlined above cannot be executed for all of the Bank’s assets and liabilities on an individual basis. In the course of a typical business day, the Bank continuously offers a wide range of fixed and floating rate advances with maturities ranging from overnight to 30 years that members can borrow in amounts that meet their specific funding needs at any given point in time. At the same time, the Bank issues consolidated obligations to investors who have their own set of investment objectives and preferences for the terms and maturities of securities that they are willing to purchase. 78
Since it is not possible to consistently issue debt simultaneously with the issuance of an advance to a member in the same amount and with the same terms as the advance, or to predict ahead of time what types of advances members might want or what types of consolidated obligations investors might be willing to buy on any particular day, the Bank must have a ready supply of funds on hand at all times to meet member advance demand. As conditions in the credit markets deteriorated in late 2008, the importance of the Bank having a ready supply of funds on hand to meet member advances demand became even more evident. In order to have a ready supply of funds, the Bank typically issues debt as opportunities arise in the market, and makes the proceeds of those debt issuances (many of which bear fixed interest rates) available for members to borrow in the form of advances. HoldingDuring the early part of the fourth quarter of 2008, as credit market conditions deteriorated, the Bank decided to issue a sufficient quantity of discount notes and bonds with terms ranging from three to twelve months to ensure the Bank would have adequate liquidity throughout the year-end period to meet member advance demand. A consequence of this decision was a temporary increase in the Bank’s interest rate risk. As yields on the Bank’s short-term assets fell sharply later in the fourth quarter, the impact of that interest rate risk was realized in the form of negative carry on the short-term assets (short-term advances and federal funds sold) funded by those liabilities in the fourth quarter of 2008 and the first quarter of 2009. The negative impact of this debt was minimal during the last nine months of 2009 as much of the relatively high cost debt issued in late 2008 matured in the first quarter of 2009. As indicated by the Bank’s experience in the fourth quarter of 2008, holding fixed rate liabilities in anticipation of member borrowing subjects the Bank to interest rate risk, however, and there is no assurance in any event that members will borrow from the Bank in quantities or maturities that will match these warehoused liabilities. Therefore, in order to intermediate the mismatches between advances with a wide range ofcertain terms on the one hand,and features, and consolidated obligations with an equally wide rangea different set of terms on the other,and features, the Bank typically converts both assets and liabilities to a LIBOR floating rate index, and attempts to manage the interest spread between the pools of floating rate assets and liabilities. This process of intermediating the timing, structure, and amount of Bank members’ credit needs with the investment requirements of the Bank’s creditors is made possible by the extensive use of interest rate exchange agreements. The Bank’s general practice is, as often as practical, to contemporaneously execute interest rate exchange agreements when acquiring assets and/or issuing liabilities in order to convert the cash flows to LIBOR floating rates. Doing so reduces the Bank’s interest rate risk exposure, which allows it to preserve the value of, and earn more stable returns on, members’ capital investment. However, in the normal course of business, the Bank also acquires assets with structural characteristics that reduce the Bank’s ability to enter into interest rate exchange agreements having mirror image terms. These assets include small fixed rate, fixed term advances,advances; small fixed schedule amortizing advancesadvances; and floating rate mortgage-related assets.securities with embedded caps. These assets require the Bank to employ risk management strategies in which the 104
Bank hedges against aggregated risks. The Bank may use fixed rate, callable or non-callable debt or interest rate exchange agreements, such as fixed-for-floating interest rate swaps, floating rate basis swaps or interest rate caps, to manage these aggregated risks. Interest Rate Risk Measurement As discussed above, the Bank measures and managesits market risk by adhering to limitationsregularly and generally manages its market risk within its Risk Management Policy limits on estimated market value of equity losses under 200 basis point interest rate shock scenarios. The Risk Management Policy restrictsarticulates the Bank’s tolerance for the amount of overall interest rate risk the Bank maywill assume by limiting the maximum estimated loss in market value of equity that the Bank would incur under simulated 200 basis point changes in interest rates to 15 percent.percent of the estimated base case market value. This limitation was adopted concurrently with the Bank’s conversion to its new capital structure in September 2003. Since that time, theThe Bank has beenwas in compliance with this limit at all times.times from its adoption in September 2003 through October 2008. As discussed in more detail below, this risk metric exceeded the Bank’s policy limit at several month ends in 2009 and late 2008 due in part to factors other than interest rate risk. As part of its ongoing risk management process, the Bank calculates an estimated market value of equity for a base case interest rate scenario and for interest rate scenarios that reflect parallel interest rate shocks. These calculations are made primarily for the purpose of analyzing and managing the Bank’s interest rate risk and, accordingly, have been designed for that purpose rather than for purposes of fair value disclosure under GAAP. The base case market value of equity is calculated by determining the estimated fair value of each instrument on the Bank’s balance sheet, and subtracting the estimated aggregate fair value of the Bank’s liabilities from the estimated aggregate fair value of the Bank’s assets. For purposes of these calculations, mandatorily redeemable capital stock is treated as equity rather than as a liability. The fair values of the Bank’s financial instruments (both assets and liabilities) are calculateddetermined using vendor prices, dealer estimates or a pricing model. These calculations include values for MBS based on estimated current market prices, some of which reflect discounts that the Bank believes are largely related to credit concerns and a lack of market liquidity rather than the level of interest rates. For those instruments for which a pricing model is used, the calculations are based upon parameters derived from market conditions existing at the time of measurement, and are generally determined by discounting estimated future cash flows at the replacement (or similar) rate for new instruments of the same type with the same or very similar characteristics. The market value of equity calculations include non-financial assets and liabilities, such as premises and equipment, excess REFCORP contributions, other assets, payables for AHP and REFCORP, and other liabilities at their recorded carrying amounts. For purposes of compliance with the Bank’s Risk Management Policy limit on estimated losses in market value, market value of equity losses are defined as the estimated net sensitivity of the value of the Bank’s equity (the net value of its portfolio of assets, liabilities and interest rate derivatives) to 200 basis point parallel shifts in interest rates. In addition, the Bank routinely performs projections of its future earnings over a rolling horizon that includes the current year and at least the next two calendar years under a variety of interest rate and business environments. Between December 20052008 and December 2006,2009, under scenarios that estimateestimated the market value of equity under downup 200 basis point interest rate shocks, the percentage increase (decrease) in the estimated market value of equity from the base case has ranged from (0.61 percent) to 1.05 percent. Under scenarios that estimate the market value of 79
equity under up 200 basis pointparallel interest rate shocks, the percentage decrease in the estimated market value of equity from the base case has ranged from 3.2811.14 percent to 5.8820.57 percent. The percentage decrease in the estimated market value of equity from the base case exceeded the Bank’s policy limits in December 2008, January 2009, February 2009, May 2009, June 2009 and July 2009. As discussed below, the Bank believes the magnitude of these changes was related primarily to liquidity discounts in the market values of its MBS and did not represent a change in the Bank’s interest rate risk position.
The following table provides the Bank’s estimated base case market value of equity and its estimated market value of equity under up and down 200 basis point interest rate shock scenarios (and, for comparative purposes, its estimated market value of equity under up and down 100 basis point interest rate shock scenarios) for each month during the period from December 2005 to2008 through December 2006.2009. In addition, the table provides the percentage change in estimated market value of equity under each of these shock scenarios for the indicated periods. 105
MARKET VALUE OF EQUITY (dollars in billions) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Up 200 Basis Points | | | Down 200 Basis Points | | | Up 100 Basis Points | | | Down 100 Basis Points | | | | Base Case | | | Estimated | | | Percentage | | | Estimated | | | Percentage | | | Estimated | | | Percentage | | | Estimated | | | Percentage | | | | Market | | | Market | | | Change | | | Market | | | Change | | | Market | | | Change | | | Market | | | Change | | | | Value | | | Value | | | from | | | Value | | | from | | | Value | | | from | | | Value | | | from | | | | of Equity | | | of Equity | | | Base Case | | | of Equity | | | Base Case | | | of Equity | | | Base Case | | | of Equity | | | Base Case | | December 2005 | | | 2.804 | | | | 2.647 | | | | -5.59 | % | | | 2.808 | | | | 0.17 | % | | | 2.747 | | | | -2.01 | % | | | 2.819 | | | | 0.56 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | January 2006 | | | 2.685 | | | | 2.531 | | | | -5.76 | % | | | 2.688 | | | | 0.11 | % | | | 2.631 | | | | -2.02 | % | | | 2.699 | | | | 0.53 | % | February 2006 | | | 2.683 | | | | 2.560 | | | | -4.57 | % | | | 2.678 | | | | -0.16 | % | | | 2.643 | | | | -1.48 | % | | | 2.689 | | | | 0.23 | % | March 2006 | | | 2.668 | | | | 2.511 | | | | -5.88 | % | | | 2.681 | | | | 0.47 | % | | | 2.612 | | | | -2.10 | % | | | 2.687 | | | | 0.70 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | April 2006 | | | 2.571 | | | | 2.448 | | | | -4.79 | % | | | 2.576 | | | | 0.19 | % | | | 2.526 | | | | -1.75 | % | | | 2.585 | | | | 0.56 | % | May 2006 | | | 2.641 | | | | 2.495 | | | | -5.53 | % | | | 2.669 | | | | 1.05 | % | | | 2.585 | | | | -2.14 | % | | | 2.667 | | | | 1.00 | % | June 2006 | | | 2.605 | | | | 2.467 | | | | -5.31 | % | | | 2.626 | | | | 0.79 | % | | | 2.554 | | | | -1.98 | % | | | 2.627 | | | | 0.85 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | July 2006 | | | 2.528 | | | | 2.422 | | | | -4.20 | % | | | 2.522 | | | | -0.24 | % | | | 2.490 | | | | -1.48 | % | | | 2.536 | | | | 0.32 | % | August 2006 | | | 2.589 | | | | 2.504 | | | | -3.28 | % | | | 2.573 | | | | -0.61 | % | | | 2.561 | | | | -1.06 | % | | | 2.590 | | | | 0.04 | % | September 2006 | | | 2.655 | | | | 2.565 | | | | -3.39 | % | | | 2.653 | | | | -0.09 | % | | | 2.624 | | | | -1.18 | % | | | 2.662 | | | | 0.27 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | October 2006 | | | 2.434 | | | | 2.346 | | | | -3.61 | % | | | 2.423 | | | | -0.47 | % | | | 2.405 | | | | -1.17 | % | | | 2.436 | | | | 0.09 | % | November 2006 | | | 2.476 | | | | 2.380 | | | | -3.88 | % | | | 2.469 | | | | -0.28 | % | | | 2.444 | | | | -1.29 | % | | | 2.480 | | | | 0.16 | % | December 2006 | | | 2.575 | | | | 2.471 | | | | -4.05 | % | | | 2.567 | | | | -0.34 | % | | | 2.540 | | | | -1.37 | % | | | 2.580 | | | | 0.17 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Up 200 Basis Points(1) | | Down 200 Basis Points(2) | | Up 100 Basis Points(1) | | Down 100 Basis Points(2) | | | Base Case | | Estimated | | Percentage | | Estimated | | Percentage | | Estimated | | Percentage | | Estimated | | Percentage | | | Market | | Market | | Change | | Market | | Change | | Market | | Change | | Market | | Change | | | Value | | Value | | from | | Value | | from | | Value | | from | | Value | | from | | | of Equity | | of Equity | | Base Case(3) | | of Equity | | Base Case(3) | | of Equity | | Base Case(3) | | of Equity | | Base Case(3) | December 2008 | | | 2.635 | | | | 2.093 | | | -20.57% | | | * | | | | * | | | | 2.391 | | | -9.26% | | | * | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | January 2009 | | | 2.525 | | | | 2.089 | | | -17.27% | | | * | | | | * | | | | 2.312 | | | -8.44% | | | * | | | | * | | February 2009 | | | 2.552 | | | | 2.154 | | | -15.60% | | | * | | | | * | | | | 2.352 | | | -7.84% | | | * | | | | * | | March 2009 | | | 2.685 | | | | 2.304 | | | -14.19% | | | * | | | | * | | | | 2.513 | | | -6.41% | | | * | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | April 2009 | | | 2.606 | | | | 2.264 | | | -13.12% | | | * | | | | * | | | | 2.449 | | | -6.02% | | | * | | | | * | | May 2009 | | | 2.558 | | | | 2.165 | | | -15.36% | | | * | | | | * | | | | 2.367 | | | -7.47% | | | * | | | | * | | June 2009 | | | 2.713 | | | | 2.246 | | | -17.21% | | | * | | | | * | | | | 2.492 | | | -8.15% | | | * | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | July 2009 | | | 2.545 | | | | 2.119 | | | -16.74% | | | * | | | | * | | | | 2.350 | | | -7.66% | | | * | | | | * | | August 2009 | | | 2.793 | | | | 2.412 | | | -13.64% | | | * | | | | * | | | | 2.623 | | | -6.09% | | | * | | | | * | | September 2009 | | | 2.842 | | | | 2.452 | | | -13.72% | | | * | | | | * | | | | 2.667 | | | -6.16% | | | * | | | | * | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | October 2009 | | | 2.721 | | | | 2.382 | | | -12.46% | | | * | | | | * | | | | 2.576 | | | -5.33% | | | * | | | | * | | November 2009 | | | 2.789 | | | | 2.472 | | | -11.37% | | | 2.895 | | | | 3.80 | % | | | 2.656 | | | -4.77% | | | 2.865 | | | | 2.72 | % | December 2009 | | | 2.836 | | | | 2.520 | | | -11.14% | | | 2.947 | | | | 3.91 | % | | | 2.700 | | | -4.80% | | | 2.908 | | | | 2.54 | % |
| | | * | | Due to the low interest rate environments that existed during these time periods, the down 100 and 200 basis point parallel shifts in interest rates were not considered meaningful. | | (1) | | In the up 100 and 200 scenarios, the estimated market value of equity is calculated under assumed instantaneous +100 and +200 basis point parallel shifts in interest rates. | | (2) | | Pursuant to guidance issued by the Finance Agency, the estimated market value of equity was calculated for November 2009 and December 2009 under assumed instantaneous -100 and -200 basis point parallel shifts in interest rates, subject to a floor of 0.35 percent. | | (3) | | Amounts used to calculate percentage changes are based on numbers in the thousands. Accordingly, recalculations based upon the disclosed amounts (billions) may not produce the same results. |
InAs reflected in the up 100preceding table, the Bank’s estimated market value of equity was less sensitive to changes in interest rates at December 31, 2009 than at December 31, 2008. This reduced sensitivity, which is also reflected by a decrease in the Bank’s estimated duration of equity over the same period as shown in the table below, is primarily attributable to modest improvements in financial market conditions, which have contributed to a reduction in the liquidity discounts for the Bank’s MBS.
The elevated level of sensitivity of the Bank’s estimated market value of equity to changes in interest rates, which was also reflected by a relatively high estimated duration of equity as shown in the table below, was primarily attributable to low estimated values for the Bank’s MBS and up 200 scenarios,the related sensitivity of the estimated value of its MBS portfolio to changes in interest rates. Although the Bank’s MBS portfolio is comprised predominantly of securities with coupons that float at a fixed spread to one-month LIBOR, the estimated market value of equity is calculated under assumed instantaneous + 100 and + 200 basis point parallel shiftsthese securities was sensitive to changes in interest rates. Inrates due to the down 100combination of low estimated base case market values, historically wide market spreads for similar securities relative to their repricing index, the low absolute level of short-term interest rates, increases in the sensitivity of estimated prepayments and down 200 simulations,the corresponding sensitivity in market value related to the timing of equity is calculated under the assumptionrecapture of discounts, and changes in the value of embedded coupon caps. The Bank’s analyses indicated that the elevated level of its market value sensitivity measures was due in large part to the liquidity discounts for its MBS as opposed to an increase in the level of its interest rates instantaneously decline by 100rate risk. Because the Bank has the intent and 200 basis points, respectively.ability to hold the securities in its MBS portfolio to maturity, and because the elevated level of sensitivity was generally attributable to non-interest rate risk related factors, the Bank’s management and Board of Directors determined that the exceptions to its policy guidelines in 2009 and 2008 were temporary and did not represent a significant change in the Bank’s interest rate risk profile. A related measure of interest rate risk is duration of equity. Duration is the weighted average maturity (typically measured in months or years) of an instrument’s cash flows, weighted by the present value of those cash flows. As such, duration provides an estimate of an instrument’s sensitivity to small changes in market interest rates. The duration of assets is generally expressed as a positive figure, while the duration of liabilities is generally expressed 106
as a negative number. The change in value of a specific instrument for given changes in interest rates will generally vary in inverse proportion to the instrument’s duration. As market interest rates decline, instruments with a positive duration are expected to increase in value, while instruments with a negative duration are expected to decrease in value. Conversely, as interest rates rise, instruments with a positive duration are expected to decline in value, while instruments with a negative duration are expected to increase in value. The values of instruments having relatively longer (or higher) durations are more sensitive to a given interest rate movement than instruments having shorter durations; that is, risk increases as the absolute value of duration lengthens. For instance, the value of an instrument with a duration of three years will theoretically change by three percent for every one percentage point change in interest rates, while the value of an instrument with a duration of five years will theoretically change by five percent for every one percentage point change in interest rates. The duration of individual instruments may be easily combined to determine the duration of a portfolio of assets or liabilities by calculating a weighted average duration of the instruments in the portfolio. Such combinations provide a single straightforward metric that describes the portfolio’s sensitivity to interest rate movements. These additive properties can be applied to the assets and liabilities on the Bank’s balance sheet. The difference between the 80
combined durations of the Bank’s assets and the combined durations of its liabilities is sometimes referred to as duration gap and provides a measure of the relative interest rate sensitivities of the Bank’s assets and liabilities. Duration gap is a useful measure of interest rate sensitivity but does not account for the effect of leverage, or the effect of the absolute duration of the Bank’s assets and liabilities, on the sensitivity of its estimated market value of equity to changes in interest rates. The inclusion of these factors results in a measure of the sensitivity of the value of the Bank’s equity to changes in market interest rates referred to as the duration of equity. Duration of equity is the market value weighted duration of assets minus the market value weighted duration of liabilities divided by the market value of equity. The significance of an entity’s duration of equity is that it can be used to describe the sensitivity of the entity’s market value of equity and future profitability to movements in interest rates. A duration of equity equal to zero would mean, within a narrow range of interest rate movements, that the Bank had neutralized the impact of changes in interest rates on the market value of its equity. A positive duration of equity would mean, within a narrow range of interest rate movements, that for each one year of duration the estimated market value of the Bank’s equity would be expected to decline by about 0.01 percent for every positive 0.01 percent change in the level of interest rates. A positive duration generally indicates that the value of the Bank’s assets is more sensitive to changes in interest rates than the value of its liabilities (i.e., that the duration of its assets is greater than the duration of its liabilities). Conversely, a negative duration of equity would mean, within a narrow range of interest rate movements, that for each one year of negative duration the estimated market value of the Bank’s equity would be expected to increase by about 0.01 percent for every positive 0.01 percent change in the level of interest rates. A negative duration generally indicates that the value of the Bank’s liabilities is more sensitive to changes in interest rates than the value of its assets (i.e., that the duration of its liabilities is greater than the duration of its assets). The following table provides information regarding the Bank’s base case duration of equity as well as its duration of equity in up and down 100 and 200 basis point interest rate shock scenarios for each month during the period from December 20052008 through December 2006.2009. 107
DURATION ANALYSIS (Expressed in Years) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Base Case Interest Rates | | | | | | | Asset | | | Liability | | | Duration | | | Duration | | | Duration of Equity | | | | Duration | | | Duration | | | Gap | | | of Equity | | | Up 100 | | | Up 200 | | | Down 100 | | | Down 200 | | December 2005 | | | 0.43 | | | | (0.40 | ) | | | 0.04 | | | | 1.25 | | | | 3.25 | | | | 4.77 | | | | (0.18 | ) | | | (0.45 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | January 2006 | | | 0.46 | | | | (0.43 | ) | | | 0.03 | | | | 1.22 | | | | 2.93 | | | | 5.02 | | | | (0.01 | ) | | | (0.47 | ) | February 2006 | | | 0.43 | | | | (0.42 | ) | | | 0.01 | | | | 0.79 | | | | 2.29 | | | | 4.28 | | | | (0.15 | ) | | | (0.34 | ) | March 2006 | | | 0.45 | | | | (0.41 | ) | | | 0.04 | | | | 1.36 | | | | 2.97 | | | | 4.91 | | | | 0.18 | | | | (0.30 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | April 2006 | | | 0.43 | | | | (0.40 | ) | | | 0.03 | | | | 1.15 | | | | 2.42 | | | | 3.86 | | | | 0.06 | | | | (0.46 | ) | May 2006 | | | 0.44 | | | | (0.38 | ) | | | 0.06 | | | | 1.58 | | | | 2.80 | | | | 4.16 | | | | 0.49 | | | | (0.08 | ) | June 2006 | | | 0.42 | | | | (0.37 | ) | | | 0.05 | | | | 1.43 | | | | 2.67 | | | | 4.07 | | | | 0.35 | | | | (0.15 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | July 2006 | | | 0.41 | | | | (0.39 | ) | | | 0.02 | | | | 0.88 | | | | 2.12 | | | | 3.41 | | | | (0.15 | ) | | | (0.63 | ) | August 2006 | | | 0.40 | | | | (0.40 | ) | | | 0.00 | | | | 0.53 | | | | 1.64 | | | | 2.95 | | | | (0.36 | ) | | | (0.63 | ) | September 2006 | | | 0.38 | | | | (0.37 | ) | | | 0.01 | | | | 0.71 | | | | 1.71 | | | | 2.88 | | | | (0.09 | ) | | | (0.33 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | October 2006 | | | 0.40 | | | | (0.39 | ) | | | 0.01 | | | | 0.62 | | | | 1.83 | | | | 3.28 | | | | (0.28 | ) | | | (0.50 | ) | November 2006 | | | 0.39 | | | | (0.38 | ) | | | 0.02 | | | | 0.70 | | | | 1.95 | | | | 3.37 | | | | (0.19 | ) | | | (0.37 | ) | December 2006 | | | 0.38 | | | | (0.37 | ) | | | 0.02 | | | | 0.74 | | | | 2.05 | | | | 3.47 | | | | (0.23 | ) | | | (0.47 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Base Case Interest Rates | | | | | Asset | | Liability | | Duration | | Duration | | Duration of Equity | | | Duration | | Duration | | Gap | | of Equity | | Up 100(1) | | Up 200(1) | | Down 100(2) | | Down 200(2) | December 2008 | | | 0.56 | | | | (0.37 | ) | | | 0.19 | | | | 6.36 | | | | 13.42 | | | | 14.38 | | | * | | | * | | | January 2009 | | | 0.58 | | | | (0.36 | ) | | | 0.22 | | | | 7.04 | | | | 10.31 | | | | 10.52 | | | * | | | * | | February 2009 | | | 0.55 | | | | (0.33 | ) | | | 0.22 | | | | 6.78 | | | | 8.89 | | | | 9.06 | | | * | | | * | | March 2009 | | | 0.52 | | | | (0.35 | ) | | | 0.17 | | | | 4.64 | | | | 8.42 | | | | 9.00 | | | * | | | * | | | April 2009 | | | 0.53 | | | | (0.34 | ) | | | 0.19 | | | | 5.24 | | | | 8.31 | | | | 9.08 | | | * | | | * | | May 2009 | | | 0.53 | | | | (0.30 | ) | | | 0.23 | | | | 6.57 | | | | 8.87 | | | | 9.69 | | | * | | | * | | June 2009 | | | 0.58 | | | | (0.30 | ) | | | 0.28 | | | | 7.53 | | | | 9.76 | | | | 11.88 | | | * | | | * | | | July 2009 | | | 0.58 | | | | (0.33 | ) | | | 0.25 | | | | 7.04 | | | | 10.21 | | | | 12.39 | | | * | | | * | | August 2009 | | | 0.52 | | | | (0.33 | ) | | | 0.19 | | | | 5.04 | | | | 7.74 | | | | 9.67 | | | * | | | * | | September 2009 | | | 0.53 | | | | (0.33 | ) | | | 0.20 | | | | 5.15 | | | | 7.91 | | | | 9.54 | | | * | | | * | | | October 2009 | | | 0.51 | | | | (0.34 | ) | | | 0.17 | | | | 4.30 | | | | 7.01 | | | | 9.09 | | | * | | | * | | November 2009 | | | 0.45 | | | | (0.30 | ) | | | 0.15 | | | | 3.92 | | | | 6.21 | | | | 8.25 | | | 2.16 | | | 1.30 | | December 2009 | | | 0.46 | | | | (0.31 | ) | | | 0.15 | | | | 3.65 | | | | 6.04 | | | | 7.90 | | | 2.49 | | | 1.73 | |
| | | * | | Due to the low interest rate environments that existed during these time periods, the down 100 and 200 basis point parallel shifts in interest rates were not considered meaningful. | | (1) | | In the up 100 and up 200 scenarios, the duration of equity is calculated under assumed instantaneous +100 and +200 basis point parallel shifts in interest rates. | | (2) | | Pursuant to guidance issued by the Finance Agency, the duration of equity was calculated for November 2009 and December 2009 under assumed instantaneous -100 and -200 basis point parallel shifts in interest rates, subject to a floor of 0.35 percent. |
As shown above, the Bank’s duration of equity decreased from 6.36 years at December 31, 2008 to 3.65 years at December 31, 2009, indicating that the Bank’s market value of equity is less sensitive to changes in interest rates at December 31, 2009. This contraction is consistent with the reduction in the sensitivity of the Bank’s market value of equity to 200 basis point interest rate shocks as discussed above, and is primarily attributable to the reductions in the liquidity discounts cited above. Duration of equity measures the impact of a parallel shift in interest rates on an entity’s market value of equity but may not be a good metric for measuring changes in value related to non-parallel rate shifts. An alternative measure for that purpose uses key rate durations, which measure portfolio sensitivity to changes in interest rates at particular points on a yield curve. Key rate duration is a specialized form of duration. It is calculated under assumed instantaneous +100 and + 200by estimating the change in value due to changing the market rate for one specific maturity point on the yield curve while holding all other variables constant. The sum of the key rate durations across an applicable yield curve is approximately equal to the overall portfolio duration. The duration of equity measure represents the expected percentage change in the Bank’s market value of equity for a one percentage point (100 basis pointspoint) parallel shiftschange in interest rates. InThe key rate duration measure represents the down 100 and down 200 simulations, durationexpected percentage change in the Bank’s market value of equity is calculated under the assumption thatfor a one percentage point (100 basis point) parallel change in interest rates instantaneously decline by 100 or 200 basisfor a given maturity point on the yield curve, holding all other rates constant. The Bank has established a key rate duration limit of 7.5 years, measured as the difference between the maximum and minimum key rate durations calculated for 7 defined individual maturity points respectively.on the yield curve. In addition, for the 10-year maturity point key rate duration, the Bank has established a separate limit of 15 years. The Bank calculates these metrics monthly and was in compliance with these policy limits at each month end during the year ended December 31, 2009. 81
Interest Rate Risk Components The Bank manages the interest rate risk of a significant percentage of its assets and liabilities on a transactional basis. Using interest rate exchange agreements, the Bank pays (in the case of an asset) or receives (in the case of a liability) a coupon that is identical or nearly identical to the balance sheet item, and receives or pays in return, 108
respectively, a floating rate typically indexed to LIBOR in return.LIBOR. The combination of the interest rate exchange agreement with the balance sheet item has the effect of reducing the duration of the asset or liability to the term to maturity of the LIBOR index, which is typically either one month or three months. After converting the assets and liabilities to LIBOR, the Bank can then focus on managing the spread between the assets and liabilities while remaining relatively insensitive to overall movements in market interest rates. Because individual assets and liabilities are typically converted to floating rates at the time they are acquired, mismatches can develop between the reset dates for aggregate balances of floating rate assets and floating rate liabilities. The mismatch between the average time to repricing of the assets and the liabilities converted to floating rates in this manner can, however, cause the Bank’s duration of equity to fluctuate by as much as 0.50 years from month to month. While the realization of these reset timing differences is generally not material to the Bank’s results of operations under normal market conditions in which one- and three-month LIBOR rates change in relatively modest increments, these reset timing differences had a more significant impact during early 2009 and at various times during 2008 due to the greatly increased volatility of short-term LIBOR rates. As a result, the Bank analyzes these reset timing differences and periodically enters into hedging transactions, such as basis swaps or forward rate agreements, to reduce the risk they pose to the Bank’s periodic earnings. In the normal course of business, the Bank also acquires assets whose structural characteristics and/or size limit the Bank’s ability to enter into interest rate exchange agreements having mirror image cash flows. These assets include fixed rate, fixed-schedule, amortizing advances and mortgage-related assets. The Bank manages the interest rate risk of these assets by issuing non-callable liabilities, and by entering into interest rate exchange agreements that are not designated against specific assets or liabilities for accounting purposes (stand-alone or economic derivatives). These hedging transactions serve to preserve the value of the asset and minimize the impact of changes in interest rates on the spread between the asset and liability due to maturity mismatches. In the normal course of business, the Bank may issue fixed rate advances in relatively small blocks (e.g., $1.0 — $5.0 million) that are too small to efficiently hedge on an individual basis. These advances may require repayment of the entire principal at maturity or may have fixed amortization schedules that require repayment of portions of the original principal each month or at other specified intervals over their term. This activity tends to extend the Bank’s duration of equity. To monitor and hedge this risk, the Bank periodically evaluates the volume of such advances and issues a corresponding amount of fixed rate debt with similar maturities or enters into interest rate swaps to offset the interest rate risk created by the pool of fixed rate assets. As of December 31, 2006,2009, the Bank also holdsheld approximately $6.3$11.5 billion of floating rate CMOs that reset monthly in accordance with one monthone-month LIBOR, but that contain terms that will cap their interest rates at levels predominantly between 7.06.0 and 8.07.0 percent. To offset a portion of the potential risk that the couponcoupons on these securities might reach their caps at some point in the future, the Bank currently holds a total of $5.3$3.75 billion of stand-alone interest rate caps with strike rates of 6.75ranging from 6.0 percent to 7.0 percent and 8.0 percent and maturities ranging from 20072013 to 2011.2016. The Bank periodically evaluates the residual risk of the caps embedded in the CMOs and determines whether to purchase additional caps. In addition,Because the majority of the Bank’s floating rate debt is indexed to three-month LIBOR, the Bank’s portfolio of floating rate CMOs and other assets indexed to one-month LIBOR also presents risk to periodic changes in the spread between one- and three-month LIBOR. To offset this risk, the Bank holdsmaintains a substantial portfolio of mortgage loans acquired through the MPF program which are funded with a combination of floating and fixed rate, non-callable debt. In orderbasis swaps that convert three-month repricing debt to more fully hedge the prepayment risk associated with these loans and offset the fair value losses that would have occurred on these loans had interest rates fallen, the Bank previously held an interest rate floor. Based on evidence that its fixed rate mortgage portfolio had become relatively insensitive to declining interest rates, the Bank determined that the interest rate floor was no longer needed and the position was terminated in 2004.one-month repricing frequency.
In practice, management analyzes a variety of factors in order to assess the suitability of the Bank’s interest rate exposure within the established risk limits. These factors include current and projected market conditions, including possible changes in the level, shape, and volatility of the term structure of interest rates, possible changes to the composition of the Bank’s balance sheet, and possible changes in the delivery channels for the Bank’s assets, liabilities, and hedging instruments. Many of these same variables are also included in the Bank’s income modeling processes. While management considered the Bank’s interest rate risk profile to be appropriate given market conditions during 20052008 and 2006,2009, including, as discussed above, at times when certain risk metrics exceeded the Bank’s policy guidelines, the Bank may adjust its exposure to market interest rates based on the results of its analyses of the impact of these conditions on future earnings. 109
As noted above, the Bank typically manages interest rate risk on a transaction by transaction basis as much as possible. To the extent that the Bank finds it necessary or appropriate to modify its interest rate risk position, it would normally do so through one or more cash or interest rate derivative transactions, or a combination of 82
both. For instance, if the Bank wished to shorten its duration of equity, it would typically do so by issuing additional fixed rate debt with maturities that correspond to the maturities of specific assets or pools of assets that have not previously been hedged. This same result might also be implemented by executing one or more interest rate swaps to convert specific assets from a fixed rate to a floating rate of interest. A similar approach would be taken if the Bank determined it was appropriate to extend rather than shorten its duration. Counterparty Credit Risk
By entering into interest rate exchange agreements, the Bank generally exchanges a defined market risk for the risk that the counterparty will not be able to fulfill its obligation in the future. The Bank manages this credit risk by spreading its transactions among many highly rated counterparties, by entering into collateral exchange agreements with all counterparties that include minimum collateral thresholds based on credit ratings, and by monitoring its exposure to each counterparty at least monthly. In addition, all of the Bank’s collateral exchange agreements include master netting arrangements whereby the fair values of all interest rate derivatives with each counterparty are offset for purposes of determining credit exposure. The collateral exchange agreements require the delivery of collateral generally consisting of very liquid, highly rated asset types if maximum credit risk exposures rise above the minimum thresholds. The maximum credit risk exposure is the cost, on a present value basis, of replacing at current market rates all interest rate exchange agreements with a counterparty with whom the Bank is in a net gain position. These agreements generally establish a maximum unsecured credit exposure threshold of $1 million that one party may have to the other. Once the counterparties agree to the valuations of the interest rate exchange agreements, and it is determined that the unsecured credit exposure exceeds the threshold, then, upon a request made by the unsecured counterparty, the party that has the unsecured obligation to the counterparty bearing the risk of the unsecured credit exposure must deliver sufficient collateral to reduce the unsecured credit exposure to zero.
As of December 31, 2006 and 2005, the Bank had outstanding interest rate derivative contracts with 18 and 19 different counterparties, respectively, all of which had long-term credit ratings of A3 or higher. None of these counterparties are member institutions, and none were affiliated with a member prior to March 31, 2005. Affiliates of two of the Bank’s counterparties (Citigroup and Wachovia) acquired member institutions on March 31, 2005 and October 1, 2006, respectively. The Bank has continued to enter into interest rate exchange agreements with Citigroup and Wachovia in the normal course of business and under the same terms and conditions since the member acquisitions were completed.
A large percentage of the transactions, representing 88 percent and 90 percent, respectively, of the notional principal of the derivatives and 100 percent of the maximum credit exposure, were with counterparties having ratings of Aa3or higher. As of December 31, 2006 and 2005, the Bank’s maximum credit exposure to its interest rate derivative counterparties was $95.2 million and $0.6 million, respectively. At December 31, 2006, the Bank held $53.3 million of collateral and had rights to an additional $44.3 million of collateral which was not yet received, reducing the maximum credit exposure to zero. At December 31, 2005, the Bank held $0.4 million of collateral and had rights to an additional $0.2 million of collateral which was not yet received, reducing the maximum credit exposure to zero. The credit ratings referred to above were provided by Moody’s. The following table provides additional information regarding the Bank’s derivative counterparty credit exposure as of December 31, 2006 and 2005.
83
DERIVATIVES COUNTERPARTY CREDIT EXPOSURE
(Dollars in millions)
| | | | | | | | | | | | | | | | | | | | | | | | | Credit | | Number of | | | Notional | | | Maximum Credit | | | Collateral | | | Collateral | | | Net Exposure | | Rating(1) | | Counterparties | | | Principal(2) | | | Exposure | | | Held | | | Due(3) | | | After Collateral | | December 31, 2006 | | | | | | | | | | | | | | | | | | | | | | | | | Aa(4) | | | 16 | | | $ | 45,670.8 | | | $ | 95.2 | | | $ | 53.3 | | | $ | 44.3 | | | $ | — | | A | | | 2 | | | | 5,987.3 | | | | — | | | | — | | | | — | | | | — | | | | | | | | | | | | | | | | | | | | | Total | | | 18 | | | $ | 51,658.1 | | | $ | 95.2 | | | $ | 53.3 | | | $ | 44.3 | | | $ | — | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | December 31, 2005 | | | | | | | | | | | | | | | | | | | | | | | | | Aa(4) | | | 17 | | | $ | 41,885.8 | | | $ | 0.6 | | | $ | 0.4 | | | $ | 0.2 | | | $ | — | | A | | | 2 | | | | 4,873.1 | | | | — | | | | — | | | | — | | | | — | | | | | | | | | | | | | | | | | | | | | Total | | | 19 | | | $ | 46,758.9 | | | $ | 0.6 | | | $ | 0.4 | | | $ | 0.2 | | | $ | — | | | | | | | | | | | | | | | | | | | | |
| | | (1) | | Credit ratings provided by Moody’s. | | (2) | | Includes amounts that had not settled as of December 31, 2006 and 2005. | | (3) | | Amount of collateral to which the Bank had contractual rights under counterparty credit agreements based on December 31, 2006 and 2005 credit exposures. Collateral valued at $44.0 million was delivered under these agreements in January 2007. No collateral was delivered under these agreements in January 2006 as the amount due was less than the minimum call amount. | | (4) | | The figures for Aa-rated counterparties as of December 31, 2006 and 2005 include transactions with one counterparty that became affiliated with a member institution in 2005. This member’s Ninth District Charter was terminated on October 1, 2006 and as of December 31, 2006 the counterparty is affliated with a non-member shareholder of the Bank. Transactions with that counterparty as of December 31, 2006 and 2005 had an aggregate notional principal of $2.2 billion and $2.6 billion, respectively. The transactions did not represent a credit exposure to the Bank as of December 31, 2006 and 2005. In addition, the figures for Aa-rated counterparties as of December 31, 2006 and 2005 include transactions with a counterparty that became affiliated with a member institution in 2006. Transactions with this counterparty as of both December 31, 2006 and 2005 had an aggregate notional principal of $0.4 billion and did not represent a credit exposure to the Bank. |
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Bank’s annual audited financial statements for the years ended December 31, 2006, 20052009, 2008 and 2004,2007, together with the notes thereto and the report of PricewaterhouseCoopers LLP thereon, are included in this Annual Report on pages F-1 through F-44.F-51. The following is a summary of the Bank’s unaudited quarterly operating results for the years ended December 31, 20062009 and 2005.2008. 84110
SELECTED QUARTERLY FINANCIAL DATA (Unaudited, in thousands)
| | | | | | | | | | | | | | | | | | | | | | | Year Ended December 31, 2006 | | | First | | Second | | Third | | Fourth | | | | | Quarter | | Quarter | | Quarter | | Quarter | | Total | Interest income | | $ | 676,154 | | | $ | 702,557 | | | $ | 757,911 | | | $ | 752,580 | | | $ | 2,889,202 | | | | | | | | | | | | | | | | | | | | | | | Net interest income | | | 51,918 | | | | 51,672 | | | | 55,328 | | | | 57,374 | | | | 216,292 | | | | | | | | | | | | | | | | | | | | | | | Other income (loss) | | | | | | | | | | | | | | | | | | | | | Net gains (losses) on trading securites | | | (657 | ) | | | (395 | ) | | | 231 | | | | (72 | ) | | | (893 | ) | Net gains (losses) on derivatives and hedging activities | | | (3,024 | ) | | | (1,034 | ) | | | (4,622 | ) | | | 3,223 | | | | (5,457 | ) | Gains (losses) on early extinguishment of debt | | | 856 | | | | 267 | | | | 145 | | | | (522 | ) | | | 746 | | Other, net | | | 1,639 | | | | 1,671 | | | | 1,787 | | | | 1,786 | | | | 6,883 | | | | | | | | | | | | | | | | | | | | | | | Other expense | | | 12,885 | | | | 13,605 | | | | 11,162 | | | | 12,168 | | | | 49,820 | | | | | | | | | | | | | | | | | | | | | | | Net income | | | 27,560 | | | | 27,896 | | | | 30,448 | | | | 36,276 | | | | 122,180 | |
| | | | | | | | | | | | | | | | | | | | | | | Year Ended December 31, 2009 | | | | First | | | Second | | | Third | | | Fourth | | | | | | | Quarter | | | Quarter | | | Quarter | | | Quarter | | | Total | | Interest income | | $ | 304,088 | | | $ | 232,314 | | | $ | 170,073 | | | $ | 130,989 | | | $ | 837,464 | | | | | | | | | | | | | | | | | | | | | | | Net interest income (expense) | | | (22,827 | ) | | | 14,753 | | | | 33,510 | | | | 51,040 | | | | 76,476 | | | | | | | | | | | | | | | | | | | | | | | Other income (loss) | | | | | | | | | | | | | | | | | | | | | Realized gain on sale of available-for-sale security | | | 843 | | | | — | | | | — | | | | — | | | | 843 | | Credit component of other-than temporary impairment losses on held-to-maturity securities | | | (17 | ) | | | (654 | ) | | | (2,312 | ) | | | (1,039 | ) | | | (4,022 | ) | Net gain (loss) on trading securities | | | (79 | ) | | | 257 | | | | 286 | | | | 122 | | | | 586 | | Net gains on derivatives and hedging activities | | | 126,831 | | | | 33,903 | | | | 14,080 | | | | 18,295 | | | | 193,109 | | Gains on early extinguishment of debt | | | — | | | | 176 | | | | — | | | | 377 | | | | 553 | | Service fees and other, net | | | 2,304 | | | | 2,419 | | | | 2,332 | | | | 2,231 | | | | 9,286 | | | | | | | | | | | | | | | | | | | | | | | Other expense | | | 18,392 | | | | 15,832 | | | | 23,880 | | | | 17,186 | | | | 75,290 | | | | | | | | | | | | | | | | | | | | | | | Net income | | | 65,139 | | | | 25,727 | | | | 17,643 | | | | 39,555 | | | | 148,064 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Year Ended December 31, 2005 | | Year Ended December 31, 2008 | | | | First | | Second | | Third | | Fourth | | | | First | | Second | | Third | | Fourth | | | | | | Quarter | | Quarter | | Quarter | | Quarter | | Total | | Quarter | | Quarter | | Quarter | | Quarter | | Total | | Interest income | | $ | 471,289 | | $ | 538,517 | | $ | 626,535 | | $ | 656,395 | | $ | 2,292,736 | | | $ | 636,972 | | $ | 529,393 | | $ | 547,794 | | $ | 580,577 | | $ | 2,294,736 | | | | | Net interest income | | 54,696 | | 58,916 | | 55,776 | | 53,171 | | 222,559 | | | Net interest income (expense) | | | 47,449 | | 52,377 | | 62,106 | | | (11,574 | ) | | 150,358 | | | | | Other income (loss) | | | Net loss on trading securites | | | (2,096 | ) | | | (337 | ) | | | (1,315 | ) | | | (694 | ) | | | (4,442 | ) | | Net gains (losses) on available-for-sale securities | | | — | | 2,794 | | | (2,476 | ) | | | (1,237 | ) | | | (919 | ) | Net losses on trading securities | | | | (133 | ) | | — | | | (157 | ) | | | (337 | ) | | | (627 | ) | Net gains (losses) on derivatives and hedging activities | | | (9,273 | ) | | | (139,413 | ) | | 56,577 | | 822 | | | (91,287 | ) | | 4,904 | | 9,826 | | 56,314 | | | (64,365 | ) | | 6,679 | | Gains on early extinguishment of debt | | 238 | | 564 | | 683 | | 990 | | 2,475 | | | 5,656 | | 1,910 | | — | | 1,228 | | 8,794 | | Net realized gains on sales of available-for-sale securities | | — | | — | | 245,395 | | — | | 245,395 | | | Other, net | | 1,342 | | 1,322 | | 1,472 | | 1,308 | | 5,444 | | | Service fees and other, net | | | 2,304 | | 2,484 | | 1,509 | | 2,356 | | 8,653 | | | | | Other expense | | 10,488 | | 11,260 | | 11,923 | | 16,552 | | 50,223 | | | 17,579 | | 14,125 | | 15,093 | | 18,016 | | 64,813 | | | | | Income (loss) before cumulative effect of change in accounting principle | | 25,105 | | | (66,493 | ) | | 254,445 | | 28,422 | | 241,479 | | | | | | Net income (loss) | | 26,013 | | | (66,493 | ) | | 254,445 | | 28,422 | | 242,387 | | | 31,254 | | 40,575 | | 75,070 | | | (67,558 | ) | | 79,341 | |
Effective January 1, 2005,The decrease in net interest income and resulting negative net interest income during the Bank changed its methodfourth quarter of accounting for the amortization2008 and accretion of mortgage loan premiums and discounts from the retrospective method to the contractual method under SFAS 91. As a result of this change, which is more fully described in Note 2 to the Bank’s audited financial statements, the Bank recorded a cumulative effect of a change in accounting principle effective January 1, 2005. Net of assessments, the cumulative adjustment increased net income for the first quarter of 2005 by $908,000.2009 resulted largely from actions the Bank took to ensure its ability to provide liquidity to its members during a period of unusual market disruption. At the height of the credit market disruptions in the early part of the fourth quarter of 2008, and in order to ensure that the Bank would have sufficient liquidity on hand to fund member advances throughout the year-end period, the Bank issued debt with maturities that extended into 2009 instead of issuing very short-maturity debt. As yields subsequently declined sharply on the Bank’s short-term assets, including overnight federal funds sold and short-term advances to members, this debt was carried at a negative spread. The negative impact of this debt was minimal in the last nine months of 2009 as much of the relatively high cost debt issued in late 2008 matured in the first quarter of 2009.
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The fluctuations in net gains (losses) on derivatives and hedging activities during the third and fourth quarters of 2008 and the first quarter of 2009 were due in part to fair value hedge ineffectiveness gains and losses associated with the Bank’s consolidated obligation bonds. During these periods, the hedge ineffectiveness gains (losses) associated with its consolidated obligation bonds totaled $60.9 million, ($122.4 million) and $55.5 million, respectively. A substantial portion of the Bank’s fixed rate consolidated obligation bonds are hedged with fixed-for-floating interest rate swaps in long-haul hedging relationships. The floating legs of most of these interest rate swaps reset every three months and are then fixed until the next reset date. These hedging relationships have been, and are expected to continue to be, highly effective in achieving offsetting changes in fair values attributable to the hedged risk. However, during periods in which short-term rates are volatile (as they were in the latter part of 2008), the Bank can experience increased earnings variability related to differences in the timing between changes in short-term rates and interest rate resets on the floating legs of its interest rate swaps. While changes in the values of the fixed rate leg of the interest rate swap and the fixed rate bond being hedged substantially offset each other, when three-month LIBOR rates increase or decrease dramatically between the reset date and the valuation date (three-month LIBOR rates rose dramatically at the end of the third quarter of 2008 and decreased dramatically during the fourth quarter of 2008), discounting the coupon rate cash flows being paid on the floating rate leg at the prevailing market rate until the swap’s next reset date can result in ineffectiveness-related gains and losses that, while relatively small when expressed as prices, can be significant when evaluated in the context of the Bank’s earnings. Because the Bank typically holds its interest rate swaps to call or maturity, the impact of these ineffectiveness-related adjustments on earnings are generally transitory, as they were in this case. With relatively stable three-month LIBOR rates during the first quarter of 2009, the previous net ineffectiveness-related losses of $61.5 million for the third and fourth quarters of 2008 substantially reversed (in the form of ineffectiveness-related gains) during the first quarter of 2009. Because a large proportion of the assets funded with swapped floating rate debt have floating rate coupons, the Bank has a much smaller balance of swapped assets than liabilities, and a substantial portion of those assets qualify for and are designated in short-cut hedging relationships. Consequently, the Bank did not experience similar offsetting hedge ineffectiveness variability from its asset hedging activities. In addition, as discussed previously in Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations, changes in the fair values of the Bank’s stand-alone derivatives can be a source of considerable volatility in the Bank’s earnings and were so particularly in the latter half of 2008 and early 2009. In aggregate, the recorded fair value changes in the Bank’s stand-alone derivatives were ($17.3 million), $60.0 million and $26.4 million during the third quarter of 2008, the fourth quarter of 2008 and the first quarter of 2009, respectively. The aggregate fair value changes in these derivatives were not as significant in the other quarterly periods presented. Net interest income (expense) associated with the Bank’s stand-alone derivatives is recorded in net gains (losses) on derivatives and hedging activities. During the third and fourth quarters of 2008 and the first, second, third and fourth quarters of 2009, net interest income (expense) associated with these derivatives totaled $7.4 million, ($2.8 million), $46.1 million, $27.2 million, $19.7 million and $14.6 million, respectively. In response to the provisions of the Pension Protection Act, the Bank made a $7.5 million supplemental contribution to improve the funded status of its defined benefit pension plan in the third quarter of 2009. This contribution is included in other expense for such period. 112
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures The Bank’s management, under the supervision and with the participation of its Chief Executive Officer and Chief AccountingFinancial Officer, (performing the function of the principal financial officer of the Bank), conducted an evaluation of the effectiveness of the Bank’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of the end of the period covered by this report. Based upon that evaluation, the Bank’s Chief Executive Officer and Chief AccountingFinancial Officer concluded that, as of the end of the period covered by this report, the Bank’s disclosure controls and procedures were effective in: (1) recording, processing, summarizing and reporting information required to be disclosed by the Bank in the reports that it files or submits under the Exchange Act within the time periods specified in the SEC’s rules and forms and (2) ensuring that information required to be disclosed by the Bank in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Bank’s management, including its Chief Executive Officer and Chief AccountingFinancial Officer, as appropriate to allow timely decisions regarding required disclosures. Management’s Report on Internal Control over Financial Reporting Management’s Report on Internal Control over Financial Reporting as of December 31, 2009 is included herein on page F-2. The Bank’s independent registered public accounting firm, PricewaterhouseCoopers LLP, has also issued a report regarding the effectiveness of the Bank’s internal control over financial reporting as of December 31, 2009, which is included herein on page F-3. Changes in Internal Control Overover Financial Reporting There were no changes in the Bank’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended December 31, 20062009 that have materially affected, or are reasonably likely to materially affect, the Bank’s internal control over financial reporting. ITEM 9B. OTHER INFORMATION Director Elections On October 20, 2009, the Bank completed its director election process for directorships commencing on January 1, 2010. This process took place in accordance with the rules governing the election of FHLBank directors as specified in the FHLB Act and the related regulations of the Finance Agency. For a description of the Bank’s director election process, see Item 10 – Directors, Executive Officers and Corporate Governance. For the member directorships commencing on January 1, 2010, there were seven nominees for two member directorships representing the state of Texas, two nominees for one member directorship representing the state of Arkansas and one nominee for one member directorship representing the state of Louisiana. With one nominee for the member directorship representing the state of Louisiana, members were not requested to cast votes for that position. There were no open member directorships for the states of Mississippi or New Mexico. In addition, there were three nominees for the three independent directorships commencing on January 1, 2010. Julie A. Cripe and Robert M. Rigby, each representing the state of Texas, Charles G. Morgan, Jr., representing the state of Arkansas, and Anthony S. Sciortino, representing the state of Louisiana, were elected to serve as member directors. In addition, C. Kent Conine, James W. Pate, II and John P. Salazar were elected to serve as independent directors. Ms. Cripe and Messrs. Conine, Morgan, Pate and Sciortino will each serve a four-year term that will expire on December 31, 2013. Messrs. Rigby and Salazar will each serve a two-year term that will expire on 86113
December 31, 2011. The election of these directors was reported under Item 5.02 of the Bank’s Current Report on Form 8-K dated October 20, 2009 and filed with the SEC on October 26, 2009. Member institutions may only cast votes for a nominee or abstain from voting and may not cast votes against a nominee or indicate that they are withholding votes from a nominee. There were 514 member institutions in Texas that were eligible to vote for member directors, of which 173 institutions cast a total of 3,058,113 votes. The results of the election for the state of Texas were as follows: | | | | | | | | | Member | | Number of Votes | Nominee | | Institution | | Received | Julie A. Cripe | | OMNIBANK, N.A. | | | 1,030,872 | | President/Chief Executive Officer | | Houston, TX | | | | | | | | | | | | Robert M. Rigby | | Liberty Bank | | | 841,871 | | Market President | | North Richland Hills, TX | | | | | | | | | | | | H. Gary Blankenship | | Bank of the West | | | 828,606 | | Chairman/Chief Executive Officer | | Grapevine, TX | | | | | | | | | | | | W. Don Ellis | | Patriot Bank | | | 105,958 | | Chairman/Chief Executive Officer | | Houston, TX | | | | | | | | | | | | Bramlet Beard | | Ennis State Bank | | | 101,574 | | President | | Ennis, TX | | | | | | | | | | | | Jim Sturgeon | | Founders Bank, SSB | | | 78,856 | | President/Chief Executive Officer | | Sugar Land, TX | | | | | | | | | | | | Duncan W. Stewart | | Texas Citizens Bank, N.A. | | | 70,376 | | Chairman/Chief Executive Officer | | Pasadena, TX | | | | |
There were 125 member institutions in Arkansas that were eligible to vote for member directors, of which 90 institutions cast a total of 709,577 votes. The results of the election for the state of Arkansas were as follows: | | | | | | | | | Member | | Number of Votes | Nominee | | Institution | | Received | Charles G. Morgan, Jr. | | Pine Bluff National Bank | | | 430,610 | | President/Chief Executive Officer | | Pine Bluff, AR | | | | | | | | | | | | Robert H. Adcock | | Centennial Bank | | | 278,967 | | Vice Chairman | | Conway, AR | | | | |
There were 921 member institutions in the Bank’s five-state district that were eligible to vote for the independent directorships, of which 248 institutions cast a total of 5,689,591 votes. Messrs. Conine, Pate and Salazar received 1,980,491 votes, 1,729,565 votes and 1,979,535 votes, respectively. Each nominee received at least 20 percent of the number of votes eligible to be cast in the election to fill the directorship for which they were nominated. Information regarding the Bank’s other directors whose terms of office continued after the election process is provided in Item 10 – Directors, Executive Officers and Corporate Governance. In addition to the directors listed in Item 10, Tyson T. Abston and H. Gary Blankenship (each a member director) and Willard L. Jackson, Jr. (an independent director) continued to serve as directors of the Bank until their terms expired on December 31, 2009. 114
Amendment of Bylaws On March 23, 2010, the Bank’s Board of Directors approved and adopted amendments to the Bank’s bylaws (the “Bylaws”). Certain amendments to the Bank’s Bylaws were required by the regulations of the Finance Agency regarding the eligibility and election of directors. Specifically, Article III of the Bylaws was amended: (i) to provide that the Board of Directors shall determine annually how many of its independent directorships will be designated as public interest directorships, subject to a minimum of two public interest directorships; (ii) to address the procedures that the Bank will use in nominating persons for independent directorships and the election of independent directors; and (iii) to address how and when the Board of Directors will consult with the Bank’s affordable housing Advisory Council concerning independent director nominations. Articles II, III and IV of the Bylaws were also revised to make technical corrections to conform the language of those Articles to the Finance Agency’s regulations. In addition to the amendments required by the Finance Agency’s regulations, as described above, Article III of the Bylaws was revised to specify that the Bank’s directors will be compensated for their time and reimbursed for their expenses in the performance of their duties in accordance with resolutions adopted by the Board of Directors that comply with the rules and regulations of the Finance Agency. Article IV of the Bylaws was revised to add the Strategic Planning Committee as a standing committee of the Board of Directors. Article V of the Bylaws was revised by clarifying the Bank’s officer categories, by confirming that a Bank officer ceases to be an officer upon termination of employment with the Bank and by authorizing the Bank’s President to terminate the employment of any Bank employee except the Director of Internal Audit. In addition to the amendments described above, Articles II, III, IV, V and VII of the Bylaws were revised to make technical corrections. The foregoing description of the amendments to the Bank’s Bylaws is qualified in its entirety by reference to the amended Bylaws, a marked copy (to show changes from the prior version) of which is attached as Exhibit 3.2 to this report and incorporated herein by reference. 115
PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE Directors On July 30, 2008, the President of the United States signed into law the Housing and Economic Recovery Act of 2008 (the “HER Act”). Pursuant to the HER Act, each FHLBank is governed by a board of directors of 13 persons or so many persons as the Director of the Finance Agency may determine. The Bank’s BoardHER Act divides directors of DirectorsFHLBanks into two classes. The first class is comprised of 19 directorships. Eleven“member” directors who are elected by the Bank’s member institutions of each state in the FHLBank’s district to represent that state. The second class is comprised of “independent” directors who are nominated by a FHLBank’s board of directors, after consultation with its affordable housing Advisory Council, and elected by the FHLBank’s members at-large. Pursuant to the HER Act and an implementing Finance Agency regulation, member directors must constitute a majority of the members of the board of directors of each FHLBank and independent directors must constitute at least 40 percent of the members of each board of directors. At least two of the independent directors must be public interest directors with more than four years’ experience representing consumer or community interests in banking services, credit needs, housing, or consumer financial protections. Annually, the Board of Directors of the Bank is required to determine how many of its independent directorships should be designated as public interest directorships, provided that the Bank at all times has at least two public interest directorships. By order of the Finance Agency on June 1, 2009, the Director of the Finance Agency designated that, for 2010, the Bank would have 10 member directors and 7 independent directors. With respect to the director elections that the Bank conducted during calendar year 2009, for terms beginning January 1, 2010, the order designated that two member directors would be elected in Texas, one member director would be elected in Louisiana, one member director would be elected in Arkansas and three independent directors would be elected. Prior law called for each FHLBank to have 14 directors or, for FHLBanks with more than five states in their district, so many as the Finance Board might determine. Of the 14 directors, eight were, under the prior law, “elective” directors arechosen by the members of each state and six were “appointive” directors appointed by the Finance Board. Currently,Board, which in recent years sought, but was not bound by, nominations to fill such directorships submitted by the FHLBanks pursuant to applicable regulations. Under prior law, if the Finance Board increased the number of directors above 14, it also had the authority to increase the number of appointive directors to a number not exceeding 75 percent of the number of elective directors. The term of office of each directorship commencing on or after January 1, 2009 is four years, except as adjusted by the Finance Agency in order to achieve a staggered board of directors (such that approximately one-fourth of the terms expire each year). Of the seven directors that were elected for terms beginning January 1, 2010, five appointive directorships are vacant. Directorsdirectors (C. Kent Conine, Julie A. Cripe, Charles G. Morgan, Jr., James W. Pate, II and Anthony S. Sciortino) will serve four-year terms that will expire on December 31, 2013 and two directors (Robert M. Rigby and John P. Salazar) will serve two-year terms that will expire on December 31, 2011. The HER Act, as clarified by the implementing Finance Agency regulation, did not change the terms of office of then existing FHLBank directors, which directors will remain directors until completion of their current terms of office. Under prior law, directors were elected or appointed to serve three-year terms.
Director terms that commence on January 1 (except in instances where a vacancy is filled, as further discussed below) and end on December 31. Elected directorsDirectors (both member and independent) cannot serve more than three consecutive full terms. There is no limit on the number of terms that an appointed director can serve. ElectedMember (Formerly “Elective”) Directors
Each year the Finance BoardAgency designates the number of electivemember directorships for each state in the Bank’s district. The Finance BoardAgency allocates the electivemember directorships among the states in the Bank’s district as follows: (1) one electivemember directorship is allocated to each state; (2) if the total number of electivemember directorships allocated pursuant to clause (1) is less than eight, the Finance BoardAgency allocates additional electivemember directorships among the states using the method of equal proportions (which is the same equal proportions method used to apportion seats in the House 116
of Representatives among states) until the total allocated for the Bank equals eight; (3) if the number of electivemember directorships allocated to any state pursuant to clauses (1) and (2) is less than the number that was allocated to that state on December 31, 1960, the Finance BoardAgency allocates such additional electivemember directorships to that state until the total allocated to that state equals the number allocated to that state on December 31, 1960; and (4) after consultation with the Bank, the Finance BoardAgency may approve additional discretionary electivemember directorships. TheFor 2009 and 2010, the Finance Board’s annual designation ofAgency designated the Bank’s electivemember directorships for 2006 and 2007 was as follows: Arkansas –— 1; Louisiana –— 2 (the grandfather provision in clause (3) of the preceding sentence guarantees Louisiana two of the electivemember directorships in the Bank’s district); Mississippi –— 1; New Mexico –— 1; and Texas – 6— 5 (the number of electivemember directorships for Texas includes twoone discretionary elective directorships)member directorship). To be eligible to serve as an electeda member director, a candidate must be: (1) a citizen of the United States and (2) an officer or director of a member institution that is located in the represented state and that meets all of the minimum capital requirements established by its federal or state regulator. For purposes of election of directors, a member is deemed to be located in the state in which a member’s principal place of business is located as of December 31 of the calendar year immediately preceding the election year (“Record Date”). A member’s principal place of business is the state in which such member maintains its home office as established in conformity with the laws under which it is organized; provided, however, a member may request in writing to the FHLBank in the district where such member maintains its home office that a state other than the state in which it maintains its home office be designated as its principal place of business. Within 90 calendar days of receipt of such written request, the board of directors of the FHLBank in the district where the member maintains its home office shall designate a state other than the state where the member maintains its home office as the member’s principal place of business, provided all of the following criteria are satisfied: (a) at least 80 percent of such member’s accounting books, records, and ledgers are maintained, located or held in such designated state; (b) a majority of meetings of such member’s board of directors and constituent committees are conducted in such designated state; and (c) a majority of such member’s five highest paid officers have their place of employment located in such designated state. Candidates for electivemember directorships are nominated by members located in the state to be represented by that particular directorship. In certain cases, it is possible forMember directors tomay be elected without a vote such as whenby members if the number of nominees from a state is equal to or less than the number of directorships to be filled from that state. In that case, the Bank shallwill notify the members in the affected voting state in writing (in lieu of providing a ballot) that the directorships are to be filled without an election due to a lack of nominees. 87
For each member directorship that is to be filled in an election, each member institution that is located in the state to be represented by the directorship is entitled to cast one vote for each share of capital stock that the member was required to hold as of the Record Date; provided, however, that the number of votes that any member may cast for any one directorship cannot exceed the average number of shares of capital stock that are required to be held as of the Record Date by all members located in the state to be represented. The effect of limiting the number of shares that a member may vote to the average number of shares required to be held by all members in the member’s state is generally to equalize voting rights among members. Members required to hold the largest number of shares above the average generally have proportionately less voting power, and members required to hold a number of shares closer to or below such average have proportionately greater voting power than would be the case if each member were entitled to cast one vote for each share of stock it was required to hold. A member may not split its votes among multiple nominees for a single directorship, nor, where there are multiple directorships to be filled for a voting state, may it cumulatively vote for a single nominee. Any ballots cast in violation of these restrictions shall beare void. No shareholder meetings are held for the election of directors; the entire election process is conducted by mail. The Bank’s Board of Directors does not solicit proxies, nor are member institutions permitted to solicit or use proxies to cast their votes in an election. NoExcept as set forth in the next sentence, no director, officer, employee, attorney or agent of the Bank may (i) communicate in any manner that a director, officer, employee, attorney or agent of the Bank, directly or indirectly, supportsupports or opposes the nomination or election of a particular individual for an elective directorship. a member directorship or (ii) take any other action to influence the voting with respect to any particular individual. A Bank director, officer, employee, attorney or agent may, acting in his or her personal capacity, support the nomination or election of any individual for a member directorship, provided that no such individual may purport to represent the views of the Bank or its Board of Directors in doing so. 117
In the event of a vacancy in any electivemember directorship, such vacancy is to be filled by an affirmative vote of a majority of the Bank’s remaining directors, regardless of whether such remaining directors constitute a quorum of the Bank’s Board of Directors. A member director so elected shall satisfy the requirements for eligibility whichthat were applicable to his or her predecessor.predecessor and will fill the unexpired term of office of the vacant directorship. On January 15, 2010, the Bank’s Board of Directors appointed Ron G. Wiser to fulfill the unexpired term of a member director representing the state of New Mexico; Mr. Wiser’s term as a member director will expire on December 31, 2010. AppointedIndependent (Formerly “Appointive”) Directors
ToAs noted above, independent directors are nominated by the Bank’s Board of Directors after consultation with its affordable housing Advisory Council. Any individual who seeks to be eligible to serve as an appointedindependent director a person must be: (1) a citizen of the United States and (2)Board of Directors of the Bank may deliver to the Bank, on or before the deadline set by the Bank, an executed independent director application form prescribed by the Finance Agency. Before announcing any independent director nominee, the Bank must deliver to the Finance Agency a residentcopy of the independent director application forms executed by the individuals proposed to be nominated for independent directorships by the Board of Directors of the Bank. If within two weeks of such delivery the Finance Agency provides comments to the Bank on any independent director nominee, the Board of Directors of the Bank must consider the Finance Agency’s comments in determining whether to proceed with those nominees or to reopen the nomination process. If within the two-week period the Finance Agency offers no comment on a nominee, the Bank’s Board of Directors may proceed to nominate such nominee.
The Bank conducts elections for independent directorships in conjunction with elections for member directorships. Independent directors are elected by a plurality of the Bank’s members at-large; in other words, all eligible members in every state in the Bank’s district. Additionally,district vote on the nominees for independent directorships. If the Bank’s Board of Directors nominates only one individual for each independent directorship, then, to be elected, each nominee must receive at least 20 percent of the number of votes eligible to be cast in the election. If any independent directorship is not filled through this initial election process, the Bank must conduct the election process again until a nominee receives at least 20 percent of the votes eligible to be cast in the election. If, however, the Bank’s Board of Directors nominates more persons for the type of independent directorship to be filled (either a public interest directorship or other independent directorship) than there are directorships of that type to be filled in the election, then the Bank will declare elected the nominee receiving the highest number of votes, without regard to whether the nominee received at least 20 percent of the number of votes eligible to be cast in the election. The same determinations and limitations that apply to the number of votes that any member may cast for a member directorship apply equally to the election of independent directors. As with the election process for member directorships, no shareholder meetings are held for the election of independent directors; the entire election process is conducted by mail. The Bank’s Board of Directors does not solicit proxies, nor are member institutions permitted to solicit or use proxies to cast their votes in an appointedelection. Except as set forth in the next sentence, no director, is prohibited from serving asofficer, employee, attorney or agent of the Bank may (i) communicate in any manner that a director, officer, employee, attorney or agent of the Bank, directly or indirectly, supports or opposes the nomination or election of a particular individual for an independent directorship or (ii) take any other action to influence the voting with respect to any particular individual. A Bank director, officer, employee, attorney or agent and the Bank’s Board of Directors and affordable housing Advisory Council (including members of the Advisory Council) may support the candidacy of any FHLBankindividual nominated by the Board of Directors for election to an independent directorship. As determined by the Bank, at least two of the independent directors must be public interest directors with more than four years’ experience representing consumer or as a director or officer of a member of any FHLBank. Lastly, an appointed director is prohibited from holding shares or other financialcommunity interests in banking services, credit needs, housing, or consumer financial protections. The remainder of the independent directors must have demonstrated knowledge of or experience in one or more of the following areas: auditing and accounting; derivatives; financial management; organizational management; project development; risk management practices; or the law. The independent director’s knowledge of or experience in the above areas should be commensurate with that needed to oversee a memberfinancial institution with a size and complexity that is comparable to that of the Bank. By statute,Under prior law, at least two of the appointed directors mustwere required to be representatives from organizations with more than a two-year history of representing consumer or community interests on banking services, credit needs, housing, or financial consumer protections. For 2010, the Bank’s Board of Directors has designated two of its independent directors, C. Kent Conine and James W. Pate, II, as public interest directors. 118
In the event of a vacancy in any appointiveindependent directorship occurring other than by failure of a sole nominee for an independent directorship to receive votes equal to at least 20 percent of all eligible votes, such vacancy is to be filled through appointment by an affirmative vote of a majority of the Bank’s remaining directors, regardless of whether such remaining directors constitute a quorum of the Bank’s Board of Directors. An independent director so elected shall satisfy the requirements for eligibility that were applicable to his or her predecessor and will fill the unexpired term of office of the vacant directorship. If the Board of Directors of the Bank is electing an independent director to fill the unexpired term of office of a vacant directorship, the Bank must deliver to the Finance Agency for its review a copy of the independent director application form of each individual being considered by the Bank’s Board of Directors. To be eligible to serve as an independent director, a person must be: (1) a citizen of the United States and (2) a resident in the Bank’s district. Additionally, an independent director is prohibited from serving as an officer of any FHLBank or as an officer, employee or director of any member of the Bank, or of any recipient of advances from the Bank, except that an independent director may serve as an officer, employee or director of a holding company that controls one or more members of, or recipients of advances from, the Bank if the assets of all such members or recipients of advances constitute less than 35 percent of the assets of the holding company, on a consolidated basis. For these purposes, any officer position, employee position or directorship of the director’s spouse is attributed to the director. An independent director must disclose to the Bank all officer, employee or director positions described above that the director or the director’s spouse holds. Prior to enactment of the HER Act, the Finance Board had the sole responsibility for appointing individuals as appointive directors to the unexpired term. On January 24, 2007, the Finance Board issued an interim final rule establishing procedures for the selectionboards of appointed directors of the FHLBanks. The procedures requirePatricia P. Brister, Mary E. Ceverha and Bobby L. Chain are the board ofonly directors of each FHLBank to submit to the Finance Board (annually,currently serving on or before October 1)a list of nominees who meet the statutory eligibility requirements and are otherwise well-qualified to fill the appointive directorships that will become vacant at the end of that calendar year. The interim final rule required each FHLBank to submit two nominees for each vacant appointive directorship to the Finance Board for its consideration. The nominations must be accompanied by a completed eligibility form, which sets forth the qualifications of each nominee to serve on the board of directors of that FHLBank. The Finance Board intends to use the lists provided by each FHLBank to select individuals to serve as appointed directors on that FHLBank’s board of directors. The Finance Board may decline, in its sole discretion, to appoint any of the individuals on a FHLBank’s initial list of individuals and, if so, may require that FHLBank to submit a supplemental list of nominees for its consideration. As a temporary, one-time provision for filling the appointive directorships that are currently vacant, the rule requires each FHLBank to submit a list of eligible and qualified individuals to the Finance Board on or before March 31, 2007. In accordance with the provisions of the interim final rule, the Bank’s Board of Directors submitted its list of 10 nominees for the Bank’s five currently vacant appointive directorships on March 17, 2007. Under the rule,who were appointed by the Finance Board didand who have not establish a datesubsequently been elected by which it intends or expects to fill the currently vacant appointive directorships.Bank’s members at-large. Their terms as directors will expire on December 31, 2010.
On March 27, 2007, the Finance Board adopted a final rule establishing procedures for the selection of appointed directors to the boards of the FHLBanks. The provisions of the final rule are substantially the same as those contained in the interim final rule with the exception that each FHLBank is required to submit one nominee for each vacant appointive directorship and is allowed, but not required, to submit one additional nominee for each vacant appointive directorship.
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20072010 Directors
The following table sets forth certain information regarding each of the Bank’s directors (ages are as of March 30, 2007)25, 2010): | | | | | | | | | | | | | Director | | Expiration of | | Board | Name | | Age | | Since | | Term as Director | | Committees | Lee R. Gibson, Chairman (Elected) | | 50 | | 2002 | | 2008 | | (a)(b)(c)(d)(e)(f) | Mary E. Ceverha, Vice Chairman (Appointed) | | 62 | | 2004 | | 2007 | | (a)(b)(c)(d)(e)(f) | Tyson T. Abston (Elected) | | 41 | | 2007 | | 2009 | | (a)(e) | Sarah S. Agee (Appointed) | | 61 | | 2004 | | 2007 | | (d)(e) | H. Gary Blankenship (Elected) | | 66 | | 2007 | | 2009 | | (d)(e) | Bobby L. Chain (Appointed) | | 77 | | 2004 | | 2007 | | (b)(c) | James H. Clayton (Elective directorship) | | 55 | | 2005 | | 2007 | | (d)(e)(f) | Howard R. Hackney (Elected) | | 67 | | 2003 | | 2008 | | (a)(b)(f) | Will C. Hubbard (Elected) | | 60 | | 2002 | | 2008 | | (a)(c) | Melvin H. Johnson, Jr. (Elected) | | 65 | | 2006 | | 2008 | | (d)(e) | Charles G. Morgan, Jr. (Elected) | | 45 | | 2004 | | 2009 | | (b)(c) | Anthony S. Sciortino (Elected) | | 59 | | 2003 | | 2009 | | (c)(d)(f) | John B. Stahler (Elected) | | 58 | | 2001 | | 2007 | | (a)(b)(f) | Robert Wertheim (Elected) | | 74 | | 2002 | | 2007 | | (c)(e)(f) |
| | | | | | | | | | | | | | | | | | | | | Director | | Expiration of | | Board | Name | | Age | | Since | | Term as Director | | Committees | Lee R. Gibson, Chairman (Member) | | | 53 | | | | 2002 | | | | 2012 | | | (a)(b)(c)(d)(e)(f)(g) | Mary E. Ceverha, Vice Chairman (Independent) | | | 65 | | | | 2004 | | | | 2010 | | | (a)(b)(c)(d)(e)(f)(g) | Patricia P. Brister (Independent) | | | 63 | | | | 2008 | | | | 2010 | | | (c)(e) | Bobby L. Chain (Independent) | | | 80 | | | | 2004 | | | | 2010 | | | (c)(e)(g) | James H. Clayton (Member) | | | 58 | | | | 2005 | | | | 2010 | | | (d)(f)(g) | C. Kent Conine (Independent) | | | 55 | | | | 2007 | | | | 2013 | | | (e)(f) | Julie A. Cripe (Member) | | | 56 | | | | 2010 | | | | 2013 | | | (a)(f) | Howard R. Hackney (Member) | | | 70 | | | | 2003 | | | | 2012 | | | (b)(d)(g) | Charles G. Morgan, Jr. (Member) | | | 48 | | | | 2004 | | | | 2013 | | | (b)(d)(g) | James W. Pate, II (Independent) | | | 60 | | | | 2007 | | | | 2013 | | | (c)(f) | Joseph F. Quinlan, Jr. (Member) | | | 62 | | | | 2008 | | | | 2012 | | | (a)(d) | Robert M. Rigby (Member) | | | 63 | | | | 2010 | | | | 2011 | | | (a)(e) | John P. Salazar (Independent) | | | 67 | | | | 2010 | | | | 2011 | | | (e)(f) | Margo S. Scholin (Independent) | | | 59 | | | | 2007 | | | | 2012 | | | (b)(d) | Anthony S. Sciortino (Member) | | | 62 | | | | 2003 | | | | 2013 | | | (c)(e)(g) | John B. Stahler (Member) | | | 61 | | | | 2001 | | | | 2010 | | | (a)(b)(g) | Ron G. Wiser (Member) | | | 53 | | | | 2010 | | | | 2010 | | | (a)(b) |
| | | (a) | | Member of Risk Management Committee | | (b) | | Member of Audit Committee | | (c) | | Member of Compensation and Human Resources Committee | | (d) | | Member of Strategic Planning Committee | | (e) | | Member of Government Relations Committee | | (e)(f) | | Member of Affordable Housing and Economic Development Committee | | (f)(g) | | Member of Executive Committee |
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Lee R. Gibson is Chairman of the Board of Directors of the Bank and has served in that capacity since January 1, 2007. Mr. Gibson serves as Senior Executive Vice President and Chief Financial Officer of Southside Bank (a member of the Bank) and its publicly traded holding company, Southside Bancshares, Inc. (Tyler, Texas). He has served as Senior Executive Vice President of Southside Bank since February 2009. From 1990 andto February 2009, he served as Executive Vice President of Southside Bank. Mr. Gibson has served as Senior Executive Vice President of Southside Bancshares, Inc. since February 2010. From 1990 to February 2010, he served as Executive Vice President of Southside Bancshares, Inc. Mr. Gibson has served as Chief Financial Officer of both Southside Bank and Southside Bancshares, Inc. since 2000. Mr. GibsonHe also serves as a director of Southside Bank. Before joining Southside Bank in 1984, Mr. Gibson served as an auditor for Ernst & Young. He currently serves onas chairman of the Council of Federal Home Loan Banks and as president of the Executive Board of the East Texas Area Council of Boy Scouts. He also serves on the boards of directors of the TJC Foundation and the Foundation of the East Texas Boy Scouts. Mr. Gibson also serves asis Chairman of the Executive Committee of the Bank’s Board of Directors. He is a Certified Public Accountant. Mary E. Ceverha is Vice Chairman of the Board of Directors of the Bank and has served in that capacity since December 2005. From January 2005 to December 2005, she served as Acting Vice Chairman of the Board of Directors of the Bank. From 2001 to 2005, Ms. Ceverha served as a director and president of Trinity Commons, Inc. From 2001 to 2004, she also served as a director and president of Trinity Commons Foundation, Inc. Founded by Ms. Ceverha in 2001, these not-for-profit enterprises were organized to coordinate fundraising and other activities relating to the construction of the Trinity River Project in Dallas, Texas. She currently serves as Vice Chair of the foundation’s Government Relations Committee and remains active in itsthe foundation’s fundraising and government relations efforts. Ms. Ceverha also serves on the Council of Federal Home Loan Banks and is a member of the Greater Dallas Planning Council. Further,Previously, she servesserved on the steering committee of the President’s Research Council for the University of Texas Southwestern Medical Center, which raises funds for medical research. Sheresearch, and as a member of the Greater Dallas Planning Council and the Community Advisory Board of the Dallas Heart Disease Prevention Project. Ms. Ceverha is also a former board member and president of Friends of Fair Park, a non-profit citizens group dedicated to the preservation of Fair Park, a national historic landmark in Dallas, Texas. From 1995 to 2004, she served on the Texas State Board of Health. Ms. Ceverha currently serves on the Council of Federal Home Loan Banks. She also serves as Vice Chairman of the Executive Committee of the Bank’s Board of Directors. Tyson T. Abston serves as PresidentPatricia P. Brister is a current board member and Chief Executive Officerimmediate past chairman of Guaranty Bond Bank in Mount Pleasant, Texas. He has served as President of Guaranty Bond Bank, a member of the Bank, since 2002 and as Chief Executive Officer since December 2005. From 1997 to 2002, Mr. Abston served as Executive Vice President of Guaranty Bond Bank. He previously held various positions with Guaranty Bond Bank from 1988 to 1992. From 1993 to 1997, Mr. Abston served as Executive Vice President and Chief Financial Officer of First Heritage Bank. He also
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serves as President of Guaranty Bancshares, Inc., Guaranty Bond Bank’s privately held holding company, and has served in that capacity since June 2004. Mr. Abston currently serves on the boards of directors of the Mount Pleasant Habitat for Humanity and the Mount Pleasant Industrial Foundation.
Sarah S. Agee servedSt. Tammany West. Ms. Brister also currently serves as an elected representative in the Arkansas Housea director of Representatives from 1999Volunteers of America — Greater New Orleans. From June 2006 to 2004. From 2001 to 2004,January 2009, she served on the legislature’s State Agencies and Governmental Affairs Committee. In 2003 and 2004, Ms. Agee served as the committee’s chairman. Since January 1, 2005, Ms. Agee has served as a policy advisorUnited States Ambassador to the governorUnited Nations Commission on the Status of Arkansas andWomen. From 1975 to 2000, Ms. Brister served as his liaison to the state legislature. In addition, she operatesSecretary/Treasurer of Brister-Stephens, Inc., a family farm and cattle-raising operationprivately owned mechanical contracting company in Northwest Arkansas. Ms. AgeeCovington, Louisiana. She previously served onas a Councilwoman for St. Tammany Parish from 2000 to 2007 and is a past chairman of the Prairie Grove School Board and Prairie Grove Police Committee. SheWomen’s Build Habitat for Humanity. Ms. Brister currently serves as Vice Chairman of the Government Relations Committee of the Bank’s Board of Directors.
H. Gary Blankenship is She previously served a three-year term on the founder,Bank’s Board of Directors from January 2002 to December 2004 and was Vice Chairman and Chief Executive Officer of Bank of the West (a memberBank’s Board of the Bank) and its privately held holding company, Greater Southwest Bancshares, Inc. (Irving, Texas). Mr. Blankenship has served as Chairman and Chief Executive Officer of both companies since their inceptionDirectors in 1986. He also serves on the board of directors of Bank of Vernon and as a trustee for the Independent Bankers Association Bond Trust. Mr. Blankenship previously served on the boards of directors of Irving National Bank and National Bancshares, Inc.2004.
Bobby L. Chain is the founder, Chairman and Chief Executive Officer of Chain Electric Company, a multi-state commercial, industrial and utility contractor in Hattiesburg, Mississippi. He has served as Chairman and Chief Executive Officer since 1994. Prior to that, he served as President and Chief Executive Officer from the company’s inception in 1955 until 1994. Mr. Chain currently serves as Vice Chairman of the Compensation and Human Resources Committee of the Bank’s Board of Directors. James H. Clayton serves as Chairman and Chief Executive Officer of Planters Bank and Trust Company in Indianola, Mississippi. Mr. Clayton joined Planters Bank and Trust Company, a member of the Bank, in 1976 and has served as Chairman and Chief Executive Officer since 2003. From 1984 to 2003, he served as a board member, President and Chief Executive Officer. Since 1984, Mr. Clayton has also servesserved as a director of Planters Holding Company.Company, a privately held enterprise. Mr. Clayton is a past president of the Indianola Chamber of Commerce and he currently serves as Vice Chairmanpast chairman of the Mississippi Bankers Association. He previously served on the Government Relations Council of the American Bankers Association (ABA)(“ABA”) and was a member of its BankPac Committee. In February 2005, Mr. Clayton was appointed by the Bank’s Board of Directors to fulfill the unexpired term of an elected director representing Mississippi. He currently serves as Chairman of the Affordable Housing and Economic Development Committee of the Bank’s Board of Directors. 120
C. Kent Conine serves as President of Conine Residential Group, Inc. and has served in that capacity since 1995. Based in Dallas, Texas, Conine Residential Group, Inc. is a privately held company that specializes in single-family home building and subdivision development and the construction, management and development of multifamily apartment communities. Mr. Conine currently serves as the Chairman of the Texas Department of Housing & Community Affairs and is a past president of the National Association of Home Builders. From July 2004 to February 2008, he served on the board of directors of NGP Capital Resources Company (“NGP”), a publicly traded financial services company that invests primarily in small and mid-size private energy companies. NGP is a registered investment company under the Investment Company Act of 1940, as amended. Mr. Conine currently serves as the Vice Chairman of the Affordable Housing and Economic Development Committee of the Bank’s Board of Directors. Julie A. Cripe serves as a board member, President and Chief Executive Officer of OMNIBANK, N.A. in Houston, Texas. Ms. Cripe has served as President since 1999 and as Chief Executive Officer since May 2007. She has served as a director of OMNIBANK, N.A, a member of the Bank, since 1992. From 1999 to May 2007, she also served as Chief Operating Officer of OMNIBANK, N.A. Since August 2007, Ms. Cripe has also served as a Vice President of Bancshares, Inc., OMNIBANK, N.A.’s privately held holding company. Ms. Cripe currently serves as a board member of The Chaplaincy Fund, a support organization for chaplaincy programs at MD Anderson Hospital in Houston, Texas and is the incoming chairman of the American Festival for the Arts. She is the immediate past chairman of the Education Foundation Board of the ABA. Howard R. Hackney is a director of Texas Bank and Trust Company in Longview, Texas (a member of the Bank). From 1995 until his retirement in May 2004, Mr. Hackney served as President of Texas Bank and Trust Company. Since May 2004, he has provided consulting services to Texas Bank and Trust Company. InSince May 2005, Mr. Hackney was appointed to servehas served on the board of directors of Martin Midstream GP LLC, the general partner of Martin Midstream Partners L.P., a publicly traded master limited partnership. He also serves as Vice Chairman of the East Texas Corridor Council and is an adjunct faculty member at LeTourneau University Business School. Mr. Hackney previously served on the boards of directors of the Good Shepherd Medical Center and the Sabine Valley MHMR Foundation. He currently serves as Chairman of the Bank’s Audit Committee. Will C. Hubbard has served as President and Chief Executive Officer of Citizens National Bank of Bossier City, a member of the Bank, since 1990. Mr. Hubbard is a past president of the Louisiana Bankers Association and he currently serves on the board of directors of First National Banker’s Bank (“First National”) in Baton Rouge, Louisiana. First National is also a member of the Bank. Mr. Hubbard currently serves on the boards of directors of the Community Bankers of Louisiana and the Greater Bossier Economic Development Foundation. He also serves as Vice Chairman of the Risk Management Committee of the Bank’s Board of Directors.
Melvin H. Johnson, Jr. has served as a board member, President and Chief Executive Officer of First-Lockhart National Bank (“First-Lockhart”) in Lockhart, Texas since 1997. Mr. Johnson also serves as a director and President of Lockhart Bankshares–Texas, Inc., First-Lockhart’s privately held holding company. Before joining First-Lockhart, a member of the Bank, he served as President and Senior Lending Officer for Citizens State Bank in
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Ganado, Texas from 1994 to 1997. Mr. Johnson is a past president of the South Central Texas Bankers Association and he previously served on the boards of directors of the Independent Bankers Association of Texas and the Lockhart Chamber of Commerce. He currently serves as Vice Chairman of the Affordable Housing and Economic Development Committee of the Bank’s Board of Directors. Mr. Johnson is a Certified Lender – Business Banker.
Charles G. Morgan, Jr. serves as a board member, President and Chief Executive Officer of Pine Bluff National Bank in Pine Bluff, Arkansas. Mr. Morgan joined Pine Bluff National Bank, a member of the Bank, in 1987 and has served as President and Chief Executive Officer since February 2006.2006 and as a director since February 2005. From February 2005 to February 2006, he served as President and Chief Operating Officer and from 1997 to February 2005 he served as Executive Vice President. Since February 2006, Mr. Morgan has also served as President and Chief Operating Officer of Jefferson Bancshares, Inc., Pine Bluff National Bank’s privately held holding company. He currently serves as Chairmanis a current board member and past vice chairman of both the Jefferson Hospital Association and the Jefferson Regional Medical Center. Mr. Morgan is also a board member and past chairman of the Economic Development Alliance of Jefferson County andCounty. Further, he currently serves as Vice Chairmana director of the Jefferson HospitalArkansas Bankers Association. Mr. Morgan also serves on the board of directors of the Jefferson Regional Medical Center. He previously served on the board of directors of the United Way of Southeast Arkansas and is a past chairman of the Greater Pine Bluff Chamber of Commerce. Mr. Morgan currently serves as Chairman of the Strategic Planning Committee of the Bank’s Board of Directors. James W. Pate, II serves as Executive Director of the New Orleans Area Habitat for Humanity and has served in that capacity since 2000. He has worked with affiliates of Habitat for Humanity for over 18 years. Mr. Pate currently serves as Vice Chairman of the Compensation and Human Resources Committee of the Bank’s AuditBoard of Directors. Joseph F. Quinlan, Jr. serves as Chairman of First National Banker’s Bank (a member of the Bank) and as Chairman, President and Chief Executive Officer of its privately held holding company, First National Banker’s Bankshares, Inc. (Baton Rouge, Louisiana) and has served in such capacities since 1984. Since 2000, Mr. Quinlan has also served as Chairman of the Mississippi National Bankers Bank, a member of the Bank. Additionally, he has served as Chairman of the Alabama Banker’s Bank and as Chairman of FNBB Capital Markets, LLC since 2003. Further, Mr. Quinlan has served as a director of the Arkansas Bankers Bank, a member of the Bank, since December 2008 and as its Chairman since February 2009. He currently serves as Vice Chairman of the Risk Management Committee of the Bank’s Board of Directors. 121
Robert M. Rigby serves as Market President of Liberty Bank in North Richland Hills, Texas (a member of the Bank) and has served in that capacity since August 2008. From 1998 to August 2008, he served as a director, President and Chief Executive Officer of Liberty Bank. Since August 2008, he has served as an advisory director for Liberty Bank. Prior to joining Liberty Bank, Mr. Rigby served as a director and Executive Vice President of First National Bank of Weatherford from 1980 to 1998. Mr. Rigby is a current board member and past chairman of the Texas Bankers Association and he currently serves as a member of its Government Relations Council and as chairman of its BancPac Committee. He also serves on the ABA’s BancPac Committee. In addition, Mr. Rigby serves on the board of directors of the Birdville ISD Education Foundation and is an advisory director for the North Texas Special Needs Assistance Partners. Further, he serves as vice chairman of the North Richland Hills Economic Development Advisory Committee. Mr. Rigby previously served on the Weatherford College Board of Trustees and he is a past chairman of the Northeast Tarrant Chamber of Commerce. John P. Salazar is an attorney and director with the law firm of Rodey, Dickason, Sloan, Akin & Robb, P.A. in Albuquerque, New Mexico, where he specializes in real estate-related matters, including land use and development law. He has been with Rodey, Dickason, Sloan, Akin & Robb, P.A. since 1968 and has represented single-family residential and multifamily housing developers and builders. Mr. Salazar currently serves as chairman of the board of directors of the Inter-American Foundation and as a member of the Albuquerque Economic Forum. Mr. Salazar previously served on the board of trustees of the Albuquerque Community Foundation and he is a past board chairman of the Albuquerque Hispano Chamber of Commerce and the Greater Albuquerque Chamber of Commerce. Margo S. Scholin is a partner with Baker Botts L.L.P. in Houston, Texas. As a member of the law firm’s Corporate Section, she specializes in corporate and securities law, including securities law reporting, corporate transactions and governance, corporate finance and the issuance of debt and equity securities. Ms. Scholin has been with Baker Botts L.L.P. since 1983 and has been a partner since 1991. She is a current board member and immediate past chairman of the Houston Area Women’s Center, a non-profit agency serving victims of domestic violence and sexual abuse. Ms. Scholin currently serves as Vice Chairman of the Strategic Planning Committee of the Bank’s Board of Directors. Anthony S. Sciortino has servedserves as a board member,Chairman, President and Chief Executive Officer of State-Investors Bank in Metairie, Louisiana since 1985. HeLouisiana. Mr. Sciortino joined State-Investors Bank, a member of the Bank, in 1975. Mr. Sciortino1975 and has served as Chairman since October 2008 and as a board member, President and Chief Executive Officer since 1985. He currently serves on the board of directors of the Better Business Bureau of Greater New Orleans, and isOrleans. Mr. Sciortino previously served as a board member and treasurer of the New Orleans Area Habitat for Humanity. HeHumanity and he is a past chairman of the Community Bankers of Louisiana. He currently serves as Chairman of the Government Relations Committee of the Bank’s Board of Directors. Mr. Sciortino previously served as a director of the Bank from 1990 to 1996. John B. Stahler has served as a board member, President and Chief Executive Officer of American National Bank in Wichita Falls, Texas since 1979. He joined American National Bank (“ANB”), a member of the Bank, in 1976. Mr. Stahler also serves as a director and President of AmeriBancShares, Inc., ANB’s privately held holding company. He is a past presidentchairman of the Texas Bankers Association and has served on the ABA’s Government Relations Committee and its BankPac Committee. Mr. Stahler previously served on the Wichita Falls 4(A) Board for Economic Development Corporation and is a past chairman of the Wichita Falls Board of Commerce and Industry. He is also a past chairman of the North Texas Area United Way. Mr. Stahler currently serves as Chairman of the Risk Management Committee of the Bank’s Board of Directors. Robert Wertheim has servedRon G. Wiser serves as Chairman and Chief Executive Officer of Charter Companies, Inc. since 1976 and as Chairman of its affiliates (Charter Bank, a member of the Bank, Charter Southwest Commercial, Inc. and Charter Insurance Services, Inc.) since 1986. Mr. Wertheim also served as President of Charter Companies, Inc. from 1976 until 2000 and asdirector, President and Chief Executive Officer of Charter Bank from 1986 to 2001.of the Southwest (a member of the Bank) and as a director of its privately held holding company, New Mexico National Financial, Inc. (Roswell, New Mexico). He alsohas served as President and Chief Executive Officer of CharterBank of the Southwest Commercial, Inc. from 1986 to 1992since 1996 and as its Chief Executive Officer from 1992 until 2000. Previously,since December 2003. Mr. WertheimWiser also served on the Boardas Chief Executive Officer of Governors and Executive CommitteeBank of the MortgageSouthwest from 1996 to November 2000. He has served as a director of both companies since 1996. Mr. Wiser is a current board member and past president of the New Mexico Bankers Association of America and on the Board of Directors of Presbyterian Healthcare Services. Hehe currently serves on the National Advisory BoardCommunity Bankers Council of the Anderson School of Management at the University of New MexicoABA. Mr. Wiser is a Certified Public Accountant and he currently serves as Vice Chairman of the Compensation and Human Resources Committee of the Bank’s Board of Directors. Mr. Wertheim is a Certified Mortgage Banker.Audit Committee.
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Audit Committee Financial Expert The Bank’s Board of Directors has determined that Mr. Gibson qualifies as an “audit committee financial expert” as defined by SEC rules. The Bank is required by SEC rules to disclose whether Mr. Gibson is “independent” and, in making that determination, is required to apply the independence standards of a national securities exchange or an inter-dealer quotation system. For this purpose, the Bank has elected to use the independence standards of the New York Stock Exchange. Under those standards, the Bank’s Board of Directors has determined that presumptively its electedmember directors, including Mr. Gibson, are not independent. However, Mr. Gibson is independent under applicable Finance Board regulations.Agency regulations and under Rule 10A-3 of the Exchange Act related to the independence of audit committee members. For more information regarding director independence, see Item 13 – Certain Relationships and Related Transactions, and Director Independence. Director Qualifications and Attributes As more fully described above, the size of the Bank’s Board of Directors, including the number of member directors and independent directors, is determined by the Finance Agency, subject to a minimum number of directors established by statute. Candidates for member directorships are nominated and elected by members located in the state to be represented by that particular directorship. The Bank’s Board of Directors does not nominate member directors nor can it support or oppose the nomination or election of a particular individual for a member directorship. In the event of a vacancy in any member directorship, such vacancy is to be filled by an affirmative vote of a majority of the Bank’s remaining directors, regardless of whether such remaining directors constitute a quorum of the Bank’s Board of Directors.Independent directors, on the other hand, are nominated by the Bank’s Board of Directors (after consultation with its affordable housing Advisory Council) and are elected by a plurality of the Bank’s members at-large. A vacancy in any independent directorship is similarly filled by an affirmative vote of a majority of the Bank’s remaining directors, regardless of whether such remaining directors constitute a quorum of the Bank’s Board of Directors. Prior to enactment of the HER Act in July 2008, the Finance Board (predecessor to the Finance Agency) had the sole responsibility for appointing individuals as “appointive” directors. Ms. Ceverha, Ms. Brister and Mr. Chain are the only directors currently serving on the Bank’s Board of Directors who were appointed by the Finance Board and who have not subsequently been elected by the Bank’s members at-large. For each of these directorships, the Bank’s Board of Directors was required to submit to the Finance Board for its consideration a list of nominees who met the statutory eligibility requirements and were otherwise well qualified to fill those appointive directorships (these appointive directors are now known as independent directors). In evaluating an independent director candidate (or a candidate to fill a vacancy in any member directorship), the Board of Directors considers factors that are in the best interests of the Bank and its shareholders and which go beyond the statutory eligibility requirements, including the knowledge, experience, integrity and judgment of each candidate; the experience and competencies that the Board desires to have represented; each candidate’s ability to devote sufficient time and effort to his or her duties as a director; geographic representation in the Bank’s five-state district; prior tenure on the Board; the need to have at least two public interest directors from among the Bank’s independent directors; and any core competencies or technical expertise necessary to staff committees of the Board of Directors. In addition, the Board of Directors assesses whether a candidate possesses the integrity, judgment, knowledge, experience, skills and expertise that are likely to enhance the Board’s ability to manage and direct the affairs and business of the Bank including, when applicable, to enhance the ability of committees of the Board to fulfill their duties. Each of the Bank’s member and independent directors brings a unique background and strong set of skills to the Board, giving the Board as a whole competence and experience in a wide variety of areas, including corporate governance and board service, executive management, finance, accounting, human resources, legal, risk management, affordable housing, economic development and government relations. Set forth below are the attributes of each of the Bank’s independent directors (and Mr. Wiser, the only current member director who was appointed by the Board) that the Board of Directors considered important to his or her inclusion on the Board. The Board of Directors does not make any judgments with regard to its member directors who have been elected by the Bank’s members, although the skills and experience of those directors may bear on the Board of Directors’ decisions with regard to the competencies it seeks when nominating candidates for independent directorships or when filling a vacancy in either a member or independent directorship. Ms. Ceverha was reappointed by the Finance Board to serve a three-year term that commenced on January 1, 2008. She has served on the Bank’s Board of Directors since January 1, 2004. Ms. Ceverha brings to the Board extensive 91123
experience in housing, government relations, corporate governance and policy-making. She has held leadership roles in numerous local government agencies and not-for-profits, including serving as vice chairman of the Texas State Board of Health, as a commissioner of the Dallas Housing Authority, and as the founder and past president of an organization that was established for the purpose of coordinating fundraising and other activities relating to the construction of the Trinity River Project in Dallas, Texas. She also provides extensive knowledge of the Texas legislative process to the Board. Ms. Brister was appointed by the Finance Board to serve a three-year term that commenced on January 1, 2008. She previously served a three-year term on the Bank’s Board of Directors from January 2002 through December 2004 and was Vice Chairman of the Bank’s Board of Directors in 2004. Ms. Brister has extensive experience in the areas of affordable housing, economic development, small business, government relations and policy-making. She is a current board member and immediate past chairman of the Habitat for Humanity St. Tammany West and is a past chairman of the Women’s Build Habitat for Humanity. Previously, she served as a Councilwoman for St. Tammany Parish. She also co-owned and managed a small mechanical contracting company for 25 years. Mr. Chain was reappointed by the Finance Board to serve a three-year term that commenced on January 1, 2008. He has served on the Bank’s Board of Directors since January 1, 2004. Mr. Chain brings to the Board broad leadership and policy-making experience both as the founder and head of a multi-state commercial, industrial and utility contractor for 55 years and as the former mayor of Hattiesburg, Mississippi. He previously served on the boards of directors of Deposit Guaranty Holding Company, Deposit Guaranty Bank and Deposit Guaranty Mortgage. Through these various roles, Mr. Chain has developed and provides to the Board expertise in the areas of corporate governance, government relations and compensation. Mr. Conine was elected by the Bank’s members at-large to serve a four-year term that commenced on January 1, 2010. He has served on the Bank’s Board of Directors since April 10, 2007. He brings to the Board extensive knowledge of affordable housing, homebuilding, mortgage finance and government relations. Mr. Conine heads a company that specializes in the development of single-family and multifamily housing. In addition, he currently serves as the Chairman of the Texas Department of Housing and Community Affairs and is a past president of the National Association of Home Builders. Mr. Conine has testified before the U.S. Congress on proposed legislation regarding GSEs and he also recently served on the board of directors of another registered company. Mr. Pate was elected by the Bank’s members at-large to serve a four-year term that commenced on January 1, 2010. He has served on the Bank’s Board of Directors since April 10, 2007. Mr. Pate brings a combination of affordable housing/economic development expertise and legal training to the Board. He serves as Executive Director of the New Orleans Area Habitat for Humanity, the largest developer of low-income housing in New Orleans, and has worked with affiliates of Habitat for Humanity for over 18 years. As a former practicing attorney, Mr. Pate developed expertise in matters involving human resources and compensation. Mr. Salazar was elected by the Bank’s members at-large to serve a two-year term that commenced on January 1, 2010. As an attorney with Rodey, Dickason, Sloan, Akin and Robb, P.A. for over 40 years, he brings extensive legal experience to the Board. Mr. Salazar specializes in real estate related matters, including land use and development law, and has represented single-family residential and multifamily housing developers and builders. Currently, he serves as chairman of the board of directors of the Inter-American Foundation and he has previously served on the boards of several other non-profit organizations that promote economic development, housing availability and/or housing finance. Ms. Scholin was elected by the Bank’s members at-large to serve a four-year term that commenced on January 1, 2009. She has served on the Bank’s Board of Directors since April 10, 2007. As a partner with Baker Botts L.L.P. for almost 20 years, she brings a wealth of legal experience to the Board. Ms. Scholin specializes in corporate and securities law (including securities law reporting) and she has extensive knowledge of regulatory issues. Through her service on other boards and experience representing clients, she has also developed expertise in corporate governance and compliance matters. Mr. Wiser was appointed by the Bank’s Board of Directors to fulfill the unexpired term of a member director representing the state of New Mexico. He brings 29 years of broad-based management and financial experience to the Board. Mr. Wiser has significant board experience and he provides strong accounting skills to the Board. He is a Certified Public Accountant. 124
Executive Officers Set forth below is certain information regarding the Bank’s executive officers (ages are as of March 30, 2007)25, 2010). The executive officers serve at the discretion of, and are elected annually by, the Bank’s Board of Directors. | | | | | | | | | | | | | | | | | | | | | | | Officer | Name | | Age | | Position Held | | Officer Since | | Age | | Position Held | | Since | Terry Smith | | | 50 | | | President and Chief Executive Officer | | | 1986 | | | | 53 | | | President and Chief Executive Officer | | | 1986 | | Michael Sims | | | | 44 | | | Chief Operating Officer, Executive Vice President — Finance and Chief Financial Officer | | | 1998 | | Nancy Parker | | | | 57 | | | Chief Operating Officer and Executive Vice President — Operations | | | 1994 | | Paul Joiner | | | 54 | | | Senior Vice President and Chief Risk Officer | | | 1986 | | | | 57 | | | Senior Vice President and Chief Strategy Officer | | | 1986 | | Karen Krug | | | 48 | | | Senior Vice President, Chief Administrative Officer and Corporate Secretary | | | 2002 | | | Tom Lewis | | | 44 | | | Senior Vice President and Chief Accounting Officer | | | 2003 | | | | 47 | | | Senior Vice President and Chief Accounting Officer | | | 2003 | | Nancy Parker | | | 54 | | | Senior Vice President and Chief Information Officer | | | 1994 | | | Michael Sims | | | 41 | | | Senior Vice President and Chief Financial Officer | | | 1998 | | |
Terry Smith serves as President and Chief Executive Officer of the Bank and has served in such capacity since August 2000. Prior to that, he served as Executive Vice President and Chief Operating Officer of the Bank, responsible for the financial and risk management, credit and collateral, financial services, accounting, and information systems functions. Mr. Smith joined the Bank in January 1986 to coordinate the hedging and asset/liability management functions, and was promoted to Chief Financial Officer in 1988. He served in that capacity until his appointment as Chief Operating Officer in 1991. Mr. Smith currently serves as Vice Chairman of the Board of Directors of the FHLBanks’ Office of FinanceFinance. He is a current member and as Chairmanpast chairman of the Audit Committee of the FHLBanks’ Office of Finance. He also serves on the Council of Federal Home Loan Banks and the Board of Directors of the Pentegra Defined Benefit Plan for Financial Institutions. Mr. Smith currently serves as Chairman ofon the Investment Committee for the Pentegra Defined Benefit Plan for Financial Institutions. Michael Sims serves as Chief Operating Officer, Executive Vice President — Finance and Chief Financial Officer of the Bank. Mr. Sims has served as Chief Operating Officer since January 2010, as Executive Vice President — Finance since April 2009 and as Chief Financial Officer since February 2005. Prior to his appointment as Chief Financial Officer in February 2005, Mr. Sims served as Treasurer of the Bank. From February 2005 to February 2006, he served as both Chief Financial Officer and Treasurer of the Bank. Mr. Sims joined the Bank in 1989 and has served in various financial and asset/liability management positions during his tenure with the institution. Since November 1998, he has had overall responsibility for the Bank’s treasury operations. In February 2005 and August 2008, Mr. Sims’ responsibilities were expanded to include member sales and community investment, respectively. In April 2009, Mr. Sims’ responsibilities were further expanded to include accounting. Mr. Sims served as a Vice President of the Bank from 1998 to 2001 and as a Senior Vice President from 2001 to April 2009. Nancy Parker serves as Chief Operating Officer and Executive Vice President — Operations. Ms. Parker has served as Chief Operating Officer since January 2010 and as Executive Vice President — Operations since April 2009. From January 1999 to April 2009, she served as Chief Information Officer. Ms. Parker oversees information technology, banking operations, human resources, risk management, production support services, security, and property and facilities management. She joined the Bank in February 1987 as a Senior Systems Analyst, and was promoted to Financial Systems Manager in 1991, to Information Technology Director in 1993 and to Chief Information Officer in 1999. Ms. Parker served as a Vice President of the Bank from 1994 to 1996. She was promoted to Senior Vice President in 1996. In February 2005 and August 2008, Ms. Parker’s responsibilities were expanded to include banking operations and human resources, respectively. In April 2009, Ms. Parker’s responsibilities were further expanded to include risk management. Paul Joiner serves as Senior Vice President and Chief RiskStrategy Officer of the Bank and has served in this capacity since June 2007. Mr. Joiner also served in this role from February 2005 to June 2006. As Chief Strategy Officer, Mr. Joiner has responsibility for corporate planning, financial forecasting and research, including market research and analysis. From June 2006 to June 2007, he served as Chief Risk Officer of the Bank. In this role, Mr. Joiner has 125
had responsibility for the Bank’s risk management functions and income forecasting. Prior to being named Chief Risk Officer, Mr. Joiner served as Chief Strategy Officer for the Bank. As Chief Strategy Officer, he had responsibility for corporate planning and research, including market research and analysis. He joined the Bank in August 1983 and served in various marketing, planning and financial positions prior to his appointment as Director of Research and Planning in September 1999, a position he held until his appointment as Chief Strategy Officer in February 2005. Mr. Joiner served as a Vice President of the Bank from 1986 until 1993, when he was promoted to Senior Vice President. Karen Krug serves as Senior Vice President, Chief Administrative Officer and Corporate Secretary and has served in that capacity since August 2002. She has responsibility for corporate administration, including human resources, legal, government relations and corporate communications. In February 2005, Ms. Krug’s responsibilities were expanded to include community investment. She previously held various administrative positions with the Bank from 1983 through 1993. From 1997 to August 2002, Ms. Krug served as Director of Corporate Strategy & Communications and Assistant Corporate Secretary for Campbell-Ewald, a national advertising and communications firm.
Tom Lewis serves as Senior Vice President and Chief Accounting Officer of the Bank. He joined the Bank in January 2003 as Vice President and Controller and was promoted to Senior Vice President in April 2004 and to Chief Accounting Officer in February 2005. From May 2002 through December 2002, Mr. Lewis served as Senior Vice President and Chief Financial Officer for Trademark Property Company (“Trademark”), a privately held commercial real estate developer. Prior to joining Trademark, Mr. Lewis served as Senior Vice President, Chief Financial Officer and Controller for AMRESCO Capital Trust (“AMCT”), a publicly traded real estate investment trust, from February 2000 to May 2002. From the company’s inception in 1998 until February 2000, he served as Vice President and Controller of AMCT. Mr. Lewis is a Certified Public Accountant. Nancy Parker serves as Senior Vice President and Chief Information Officer of the Bank. Ms. Parker has served as Chief Information Officer since January 1999. In addition to information technology, Ms. Parker oversees banking operations, production support services, security, and property and facilities management. She joined the Bank in February 1987 as a Senior Systems Analyst, and was promoted to Financial Systems Manager in 1991 and to
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Information Technology Director in 1993. Ms. Parker served as a Vice President of the Bank from 1994 to 1996. In 1996, she was promoted to Senior Vice President. In February 2005, Ms. Parker’s responsibilities were expanded to include banking operations.
Michael Sims serves as Senior Vice President and Chief Financial Officer of the Bank. Prior to his appointment as Chief Financial Officer in February 2005, Mr. Sims served as Treasurer of the Bank. From February 2005 to February 2006, he served as both Chief Financial Officer and Treasurer of the Bank. Mr. Sims joined the Bank in 1989 and has served in various financial and asset/liability management positions during his tenure with the institution. Since November 1998, he has had overall responsibility for the Bank’s treasury operations. In February 2005, Mr. Sims’ responsibilities were expanded to include member sales. Mr. Sims served as a Vice President of the Bank from 1998 to 2001. In 2001, he was promoted to Senior Vice President.
Relationships There are no family relationships among any of the Bank’s directors or executive officers. Except as described above, none of the Bank’s directors holdholds directorships in any company with a class of securities registered pursuant to Section 12 of the Exchange Act or subject to the requirements of Section 15(d) of such Act or any company registered as an investment company under the Investment Company Act of 1940. There are no arrangements or understandings between any director or executive officer and any other person pursuant to which that director or executive officer was selected. Code of Ethics The Board of Directors has adopted a code of ethics that applies to the Bank’s President and Chief Executive Officer, Chief AccountingFinancial Officer (who serves as the Bank’s principal financial and accounting officer), and Chief FinancialAccounting Officer (collectively, the Bank’s “Senior Financial Officers”). Annually, the Bank’s Senior Financial Officers are required to certify that they have read and complied with the Code of Ethics for Senior Financial Officers. A copy of the Code of Ethics for Senior Financial Officers is filed as an exhibit to this report and is also available on the Bank’s website atwww.fhlb.com by clicking on “About FHLB Dallas”Dallas,” then “Governance” and then “Code of Ethics for Senior Financial Officers.” The Board of Directors has also adopted a Code of Conduct and Ethics for Employees that applies to all employees and directors of the Bank, including the Senior Financial Officers. TheOfficers, and a Code of Conduct and Ethics embodiesand Conflict of Interest Policy for Directors that applies to all directors of the Bank (each individually a “Code of Conduct and Ethics” and together the “Codes of Conduct and Ethics”). The Codes of Conduct and Ethics embody the Bank’s commitment to the highest standards of ethical and professional conduct. The CodeCodes of Conduct and Ethics setsset forth policies on standards for conduct of the Bank’s business, the protection of the rights of the Bank and others, and compliance with laws and regulations applicable to the Bank and its employees and directors. All employees and directors are required to annually certify that they have read and complied with the applicable Code of Conduct and Ethics. A copy of the Code of Conduct and Ethics for Employees is available on the Bank’s website atwww.fhlb.com by clicking on “About FHLB Dallas”Dallas,” then “Governance” and then “Code of Conduct and Ethics.Ethics for Employees.” A copy of the Code of Conduct and Ethics and Conflict of Interest Policy for Directors is available on the Bank’s website by clicking on “About FHLB Dallas,” then “Governance” and then “Code of Conduct and Ethics and Conflict of Interest Policy for Directors.” 126
ITEM 11. EXECUTIVE COMPENSATION COMPENSATION DISCUSSION AND ANALYSIS The Compensation and Human Resources Committee of the Board of Directors (the “Committee”) has responsibility for, among other things, establishing, reviewing and monitoring compliance with the Bank’s compensation philosophy. In support of that philosophy, the Committee is responsible for designingmaking recommendations regarding and implementingmonitoring implementation of compensation and benefit programs that are consistent with our short- and long-term business strategies and objectives. The Committee’s recommendations regarding our compensation philosophy and benefit programs are subject to the approval of our Board of Directors. Compensation Philosophy and Objectives The goal of our compensation program is to attract, retain, and motivate employees and executives with the requisite skills and experience to assistenable the Bank in achievingto achieve its short- and long-term strategic business objectives. We attemptHistorically, we have attempted to accomplish this goal through a mix of base salary, short-term incentive awards and other benefit 93
programs. While we believe that we offer a work environment in which employees can find attractive career challenges and opportunities, we also recognize that those employees have a choice regarding where they pursue their careers and that the compensation we offer may play a significant role in their decision to join or remain with us. As a result, we seek to deliver fair and competitive compensation for our employees, including the named executive officers identified in the Summary Compensation Table on page 105. Our140. For 2009, our named executive officers are:were: Terry Smith, President and Chief Executive Officer; Michael Sims, Chief Operating Officer, Executive Vice President — Finance and Chief Financial Officer; Nancy Parker, Chief Operating Officer and Executive Vice President — Operations; Paul Joiner, Senior Vice President and Chief Strategy Officer; and Tom Lewis, Senior Vice President and Chief Accounting Officer, who serves as our principal financial officer; Nancy Parker, Senior Vice President and Chief Information Officer; Michael Sims, Senior Vice President and Chief Financial Officer; and Paul Joiner, Senior Vice President and Chief Risk Officer. For our named executive officers, we attempt to align and weight total direct and indirect compensation with the prevailing competitive market and provide total compensation that is consistent with the executive’s responsibilities and individual performance and our overall business results. For our executives,Except as described below, for 2009, 2008 and 2007, the Committee and Board of Directors has defined ourthe competitive market for our executives as the other 11 Federal Home Loan Banks (“FHLBanks”(each individually a “FHLBank” and collectively with us, the “FHLBanks” and, together with the Office of Finance, a joint office of the FHLBanks, the “FHLBank System”) and non-depository financial services institutions with approximately $20 billion in assets. Aside from the other FHLBanks, we believe that non-depository financial services institutions with approximately $20 billion in assets present a breadth and level of complexity of operations that are generally comparable to our own. While total direct compensation for some of these institutions includes equity-based and/or long-term incentive compensation, we have purposely limitlimited our comparative analysis for total direct compensation to base salary and short-term incentive pay as we dohave not historically offered long-term incentive compensation and we cannot offer either equity-based or long-term incentives. It The Board of Directors (acting upon a recommendation from the Committee) revised the definition of the competitive market for our President and Chief Executive Officer for 2008 and 2009. The Committee and Board of Directors believe that the most relevant competitive market for Mr. Smith is the other 11 FHLBanks and as a result, for 2008 and 2009, only market data for the other FHLBanks was used in the competitive pay analysis for Mr. Smith. Prior to 2008, the competitive market for Mr. Smith was defined in the same manner as it is for our other executive officers. The Committee and Board of Directors believe that the other 11 FHLBanks represent the most relevant competitive market for Mr. Smith based on the unique nature of our business operations and our desire to retain Mr. Smith’s services given his tenure with us and his extensive knowledge of the FHLBank System. Generally, it has been our overall intent to provide total compensation, including targeted incentive opportunities, for Mr. Smith at or above the median compensation for the FHLBank Presidents taking into consideration base salary and short-term incentive compensation. For our namedother executive officers, it has generally been our overall intent to provide total compensation, including targeted annual incentive opportunities, at or near the competitive market median for comparable positions, exclusive of equity-based and long-term incentive compensation. For this purpose, our targeted annual incentive opportunities are intended to provide awards at or near the market median. With the exception of our tax-qualified defined benefit pension plan, we generally apply this philosophy to each of the direct and indirect components of our compensation program. Because our tax-qualified pension plan has greater value to our longest-tenured employees (including most of our named executive officers), we have elected to 127
provide a benefit under this plan whichthat is at or near the market median for Mr. Smith and above the market median.median for our other executive officers. This element of our compensation program is one of several that constitute an integral part of our retention strategy, which is to reward tenure by linking it to compensation. It also represents an effort on our part to partially offset our inability to provide equity-based compensation to our employees and executives by enhancing what is generally considered by most employees to be a very valuable benefit. Further, to make up for a portion of the lost pension benefit under the tax-qualified plan (due to limitations imposed by the Internal Revenue Code), we have established a supplemental executive retirement plan for our key executives.executive officers. The supplemental plan is a defined contribution plan that we believe (when coupled with our tax-qualified plan) will helphelps us retain our key executives.executive officers. Responsibility for Compensation Decisions The Board of Directors makes all decisions regarding the compensation of Mr. Smith, our President and Chief Executive Officer. His performance is reviewed annually by the Chairman of the Board,and Vice Chairman of the Board and the Chairman and Vice Chairman of the Compensation and Human Resources Committee. Their assessment of Mr. Smith’s performance and recommendations regarding his compensation are then shared with the Committee and the full Board. The Board of Directors is responsible for reviewing and approving and has discretion to modify any of the recommendations regarding Mr. Smith’s compensation that are made jointly by the Chairman of the Board,and Vice Chairman of the Board and the Chairman and Vice Chairman of the Compensation and Human Resources Committee. Mr. Smith annually reviews the performance and has responsibility and authority for setting the base salaries of allour other executive officers, all of the Bank, including our otherwhom are named executive officers. The performance reviews for all of our executive officers are generally conducted in December of each year and salary adjustments, if any, are typically made on January 1 of the following year. While Mr. Smith shares his base salary recommendations (including supporting competitive market pay data and his assessments of each executive’s individual performance) with the Committee and the full Board, approval by the Committee or Board of Directors is not required. The performance reviews for all of our named executive officers are conducted in December of each year and salary adjustments, if any, are typically made on January 1 of the following year. Mr. Smith can make additional base salary adjustments at any time during the year if warranted based on compelling market data, job performance and/or other internal factors, such as a change in job responsibilities. In the absence of a promotion or a change in an officer’s job responsibilities, base salary adjustments on any date other than January 1 are rare.
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The Board of Directors is responsible for approving our annual short-term incentive compensation plan known as the Variable Pay Program. This plan provides all regular, full-time employees, including our named executive officers, with the opportunity to earn an annual incentive award. The Committee is responsible for recommending annually to the Board of Directors the approval of the plan for the next year as it relates to our executive officers and the annual profitability and corporate operating goals that will be applicable under the plan in any givenVariable Pay Program for that year. Acting upon recommendations from the Committee, the Board of Directors is also responsible for approving any proposed revisions to our defined benefit and defined contribution plans, our deferred compensation plans, our Reduction in Workforce Policy and any other benefit plan as the Committee or Board of Directors deems appropriate. Further, the Board of Directors approves all contributions to our supplemental executive retirement plan. Beginning in October 2008, the Federal Housing Finance Agency (“Finance Agency”) requires us to provide a minimum of four weeks’ advance notice of pending actions to be taken by our Board of Directors or President and Chief Executive Officer with respect to any aspect of the compensation of one or more of our named executive officers. As part of the notification process, we are required to provide the proposed compensation actions and any supporting materials, including studies of comparable compensation. We have fully complied with this notification requirement since it was instituted. Use of Compensation Consultants and Surveys Periodically, we will engage an independent compensation consultant to help ensure that the elements of our executive compensation program are both competitive and targeted at or near market-median compensation levels. 128
In 2003 (for compensation to be awarded in 2004),July 2008, we engaged Lawrence Associates to conduct a competitive market pay study for our named executive officers. We recently engaged Lawrence Associates to perform a similar study for compensation to be awardedofficers (other than Mr. Smith) in 2007 (the 2007connection with the determination of their compensation for our named executive officers is discussed below under the heading “2007 Compensation Decisions”).2009. Lawrence Associates utilizes compensation and specific salary survey data provided by the Economic Research Institute (“ERI”), a recognized leader in survey analyses and web-based collection of compensation survey data. The ERI database consists of both proxy statement information and a compilation of compensation data obtained from numerous sources, including subscriber providedsubscriber-provided data and purchased surveys. While the information gathered from proxiesproxy statements can be attributed to specific companies, individual organizations that otherwise participate in the database compilation cannot be specifically identified. Lawrence Associates uses ERI data for organizations with an SIC code of 6100 (“Finance, Insurance, and Real Estate — Nondepository institutions”Non-depository Credit Institutions”). This SIC code is comprised of the following primary sub-categories: 611 — Federal and Federally-sponsored Credit Agencies; 614 — Personal Credit Institutions; 615 — Business Credit Institutions; and 616 — Mortgage Bankers and Brokers. There were approximately 167 institutions in the database for non-depository credit institutions (SIC code 6100) at the time the analysis was conducted. Using regression analysis, the ERI software database enables Lawrence Associates to statistically approximate the competitive market survey data for the requested executive positions at the desired asset size level.non-depository financial services institutions with approximately $20 billion in assets. Each year,For 2009, we also utilizeutilized the results of the 2008 FHLBank Key Position Compensation Survey. This survey, conducted annually by Reimer Consulting, contains executive and non-executive compensation information for various positions across the 12 FHLBanks.
In addition to the two primary sources described above, we also reviewed (in connection with our overall analysis of executive compensation) the results from two commercially availablea custom survey sources (the Watson Wyatt Financial Institution Compensation Benchmark Survey and William Mercer Benchmark Database Surveys for Information Technology, Finance, Legal and Accounting) and two custom surveys prepared specifically for the FHLBanks by McLagan Partners, an affiliate of Aon Consulting, and Riemer Consulting.which contained over 200 financial services organizations. We participatehave participated in all of these surveys. In the years we do not engage an independent consultant (e.g., 2006), we rely exclusively on the published surveys and those prepared specifically for the FHLBanks to benchmark our executive compensation program.this survey since 2007.
The information obtained from these various sources iswas considered by the Committee/Board of Directors or Mr. Smith as appropriate, when making his compensation decisions.decisions for our executive officers. For those positions that do not allow for precise comparisons, we makeMr. Smith made subjective adjustments based on ourhis experience and general knowledge of the competitive market. When making 2009 compensation decisions for Mr. Smith, the Committee and Board of Directors considered the information obtained from the 2008 FHLBank Key Position Compensation Survey and an analysis of this data provided by Lawrence Associates. Elements of Executive Compensation We rely onhave historically relied upon a mix of base salary, short-term incentive compensation, benefits and limited perquisites to attract, retain and motivate our named executive officers. As a cooperative whose stock can only be held by member institutions, we are precluded from offering equity-based compensation to our employees, including our named executive officers. To date,In the past, we have elected not to provide any form of long-term incentive compensation to our named executive officers. The Committee regularly considers the nature of our compensation program, including the various compensation elements that should be part of our overall compensation program for executive officers. In October 2009, the Finance Agency issued Advisory Bulletin 2009-AB-02, “Principles for Executive Compensation at the Federal Home Loan Banks and the Office of Finance” (“AB 2009-02”). In AB 2009-02, the Finance Agency outlines several principles for sound incentive compensation practices to which the FHLBanks should adhere in setting executive compensation policies and practices. Those principles are (i) executive compensation must be reasonable and comparable to that offered to executives in similar positions at other comparable financial institutions, (ii) executive incentive compensation should be consistent with sound risk management and preservation of the par value of a FHLBank’s capital stock, (iii) a significant percentage of an executive’s incentive-based compensation should be tied to longer-term performance and outcome-indicators, (iv) a significant percentage of an executive’s incentive-based compensation should be deferred and made contingent upon performance over several years and (v) the board of directors of each FHLBank should promote accountability and transparency in the process of setting compensation. In response to this guidance, the Committee is considering the framework for a long-term incentive compensation plan for our executive officers and has engaged McLagan Partners to provide insight and analysis. As part of this 95129
evaluation, the Committee is also considering potential modifications to our Variable Pay Program as it relates to our executive officers. However, for 2010, the Variable Pay Program will operate as it did in 2009 for our executive officers. The details of that program are discussed on pages 131 — 134 of this report and the estimated possible payouts under this program for 2010 are presented on page 138 of this report. Base Salary Base salary is the key component of our compensation program. We use the base salary element to provide the foundation of a fair and competitive compensation opportunity for each namedof our executive officer.officers. Base salaries are reviewed annually in December for all of our executive officers. In the case of Mr. Smith, we target his base salary within the top quartile of the base salaries paid to the 12 FHLBank Presidents based upon his tenure in relation to the other Presidents and his leadership roles within the FHLBank System. In the case of our other executive officers, we target base salary compensation at or near the market median base salary practices of our defined competitive market for those officers, although we maintain flexibility to deviate from market-median practices for individual circumstances. In making base salary determinations, we also consider factors such as time in the position, prior related work experience, individual job performance, and the position’s scope of duties and responsibilities within our organizational structure and hierarchy.hierarchy, and how these factors compare to other similar positions within the Federal Home Loan Bank System. The determination of base salaries is generally independent of the decisions regarding other elements of compensation, but some other elements of compensation are dependent upon the determination of base salary, to the extent they are expressed as percentages of base salary. For 2006,In establishing Mr. Smith’s base salary for 2009, the base salariesCommittee and Board of Directors took into consideration his individual job performance, our named executive officers were within plus or minus 14 percent ofoverall corporate operating goal achievement in 2008, his contributions to the identified median market base salariesFHLBank System, and are presented in the Summary Compensation Table on page 105.
In setting the base salaries of our executive officers for 2006, Mr. Smith considered competitive market pay data and each officer’s individual performance.obtained from the 2008 FHLBank Key Position Compensation Survey. The namedresults of this competitive pay analysis showed that Mr. Smith’s base salary remained within the top quartile of the base salaries paid to the 12 FHLBank Presidents. Taking all of these factors into consideration, Mr. Smith was given a standard merit increase for 2009, which was an increase of 5.2 percent from 2008.
The executive officers other than Mr. Smith are each assigned a job grade level with a specific salary range that reflects the internal and external pay levels deemed appropriate for each position based on competitive market data, job duties and responsibilities, and our desire to retain qualified individuals in these job positions. These salary ranges are adjusted annually to reflect the cost of living impact on wage structures in our competitive market. In addition, the assignment of an executive officer to a specific job grade level is reviewed periodically and is subject to change as the relative worth of a given position in our competitive market may change over time, necessitating a move to a higher or lower job grade level. In June 2006,setting the base salaries of our executive officers for 2009, Mr. Smith considered the competitive market pay data from the various sources referred to above and each officer’s individual performance. The competitive market data for 2008 indicated that, with the exception of Mr. Joiner (for whom sufficient comparable FHLBank data was named Chief Risk Officerunavailable given his range of responsibilities for us), the executive officers’ base salaries were within a range of plus or minus: (a) 12 percent of the Bank after having served as Chief Strategy Officer. In connectionmarket median for non-depository financial services institutions with approximately $20 billion in assets and (b) 19 percent of the market median for the FHLBanks. Based on this appointment,data and his subjective assessments of their individual performance and range of duties, Mr. Smith increased the base salaries for Mr. Joiner’sSims, Ms. Parker, Mr. Joiner and Mr. Lewis by 9.1 percent, 9.4 percent, 4.9 percent and 4.6 percent, respectively. In April 2009, Mr. Smith promoted Mr. Sims and Ms. Parker from Senior Vice President to Executive Vice President and expanded the duties and responsibilities of each. In partial recognition of the additional duties and responsibilities associated with these promotions, Mr. Smith increased their base salaries effective June 1, 2009. Mr. Sims’s base salary was increased from $217,500$330,000 to $250,000, effective July 1, 2006. In making this$355,000 (a 7.6 percent increase) and Ms. Parker’s base salary adjustmentwas increased from $320,000 to $345,000 (a 157.8 percent increase), Mr. Smith considered Mr. Joiner’s individual qualifications, the increased responsibilities he would have in this position, and the most recent competitive market data.. Mr. Smith discussed thisthese base salary increaseincreases with the Board of Directors prior to implementation. As part of these discussions, Mr. Smith indicated his intention to make additional promotion-related adjustments to their base salaries effective January 1, 2010. The base salaries for all other named executive officers remained the same throughout 2006.2009. 130
Our BoardThe base salaries of Directors has not established a specific salary rangeour named executive officers for Mr. Smith. While2009, 2008 and 2007 are presented in the Committee and Board of Directors considered competitive market pay data to be a critical factor in determining the appropriateness of his base salary for 2006, consideration was also given to his total cash compensation opportunity (base salary plus short-term incentive pay), tenure and his overall job performance.Summary Compensation Table on page 140. Short-Term Incentive Compensation All of our regular, full-time employees participate in our Variable Pay Program or VPP, under which they have the opportunity to earn an annual cash incentive award. The VPP is designed to encourage and reward achievement of annual performance goals. All VPP awards are calculated as a percentage of an employee’s base salary as of the beginning of the year to which the award payment pertains (or, on a prorated basis, the employee’s base salary as of his or her start date if hired during the year on or before September 15). The VPP provides for substantially the same method of allocation of benefits between management and non-management participants. Potential individual award percentages vary based upon an employee’s job grade level and are higher for those persons serving as senior officers of the Bank. Historically, the VPP has provided for substantially the same method of allocation of benefits between management and non-management participants, except for Mr. Smith and certain members of our sales staff. Award payments under the VPP depend upon the extent to which we achieve a corporate profitability objective and a number of corporate operational goals that are aligned with our long-term strategic business objectives, as well as the extent to which individual employees achieve specific individual goals and whether they achieve satisfactory performance appraisal ratings. The corporate profitability and operational goals are established annually by the Board of Directors, and individual employee goals are established mutually established by management and employees at the beginning of each year. If we do not achieve our minimum profitability objective, then no award payments are made under the VPP even if we have achieved some or all of our corporate operating goals and/or individual employees have achieved some or 96
all of their individual performance goals. Similarly, if we do not achieve some portion of our corporate operating goals, no award payments are made even if we have achieved at least our minimum profitability objective and/or individual employees have achieved some or all of their individual performance goals. For 2006,2009, we used the following formula to calculate annual VPP award payments for all employees:of our named executive officers except Mr. Smith: | | | | | | | | | | | | | | | | | Base Salary
as of 1/1/06 | | X | | Employee’s
Maximum
Potential
Award
Percentage | | X | | Profitability
Achievement
Percentage | | X | | Corporate
Operating
Goal
Achievement
Percentage | | X | | Individual
| as of 1/1/09 | | | | Maximum | | | | Achievement | | | | Operating | | | | Goal
| | | | | Potential | | | | Percentage | | | | Goal | | | | Achievement
| | | | | Award | | | | | | | | Achievement | | | | Percentage | | | | | Percentage | | | | | | | | Percentage | | | | |
For Mr. Smith, 75 percent of his potential VPP award is derived based solely upon the achievement of our corporate profitability and operating objectives, while 25 percent is based solely upon his overall individual performance as subjectively assessed by our Board of Directors, subject to our attainment of our minimum profitability objective. The formula used to calculate Mr. Smith’s 2009 VPP award is set forth below: | | | | | | | | | | | | | | | | | 75% | | X | | Base Salary | | X | | Maximum | | X | | Profitability | | X | | Corporate | | | | | as of 1/1/09 | | | | Potential | | | | Goal | | | | Operating Goal | | | | | | | | | Award | | | | Achievement | | | | Achievement | | | | | | | | | Percentage | | | | Percentage | | | | Percentage | | | | | | | | | | | | | | | | | | | | | | | | | | plus | | | | | | | | | | | | | | | | | | | | | | | | | | 25% | | X | | Base Salary | | X | | Maximum | | X | | Individual | | | | | | | | | as of 1/1/09 | | | | Potential | | | | Performance Goal | | | | | | | | | | | | | Award | | | | Achievement | | | | | | | | | | | | | Percentage | | | | Percentage | | | | |
131
The amount of the VPP award pool that is potentially available for cash incentives in a year depends upon the extent to which our corporate profitability objective is achieved within pre-established minimum and maximum levels. At the minimum level, 50 percent of the award pool is potentially available, and at the maximum level, 100 percent of the award pool is potentially available. Between the minimum and maximum levels, the profitability objective operates on a sliding scale. If we fail to achieve our minimum profitability objective, then no VPP award pool is available. If we exceed the maximum profitability objective, there is no additional increase in the amount of the potential VPP award pool. Our corporate profitability objective is expressed (in basis points) as the excess, if any, of the return on our average capital stock over the average effective federal funds rate for the year. For instance, a minimum profitability objective of 0 basis points would mean that in order to meet that objective we would need to achieve a rate of return on our average capital stock equal to the average effective federal funds rate for the year. In calculating our return on capital stock, net income for the year (excluding the effects of SFAS 133unrealized gains and SFAS 150)losses on derivatives and hedging activities and interest expense on mandatorily redeemable capital stock) is divided by our average outstanding capital stock (excluding the effects of SFAS 150)(including mandatorily redeemable capital stock). In determining the minimum and maximum levels for our profitability objective, the Board of Directors considers factors such as the current interest rate environment, the business outlook, and our desire to generate sufficient economic earnings to meet retained earnings targets and pay dividends at or above the average effective federal fundsour target rate, while at the same time effectively managing our risk in order to maintain the economic value of the Bank. For 2006,2009, our Board of Directors established the minimum and maximum corporate profitability objectives at 1075 basis points and 50125 basis points, respectively, above the average effective federal funds rate. Our profitability for the year, as defined above, was 43326 basis points above the average effective federal funds rate, yielding an achievement rate of 91.25100 percent for our corporate profitability objective. We exceeded our maximum corporate profitability objective for 2009 due in large part to unanticipated gains associated with terminations of interest rate derivative transactions, unanticipated prepayment fees on advances, larger than expected spreads on our purchases of agency mortgage-backed securities, and lower than expected funding costs. Over the previous five years (2004-2008), we have exceeded our maximum corporate profitability objective for every year except 2006 (for 2006, we achieved 91.25 percent of our maximum corporate profitability objective). While our corporate operating objectives vary from year to year, they typically fallhave historically fallen into two broad categories: (a) expanding our traditional business, including new initiatives, and (b) economic and community development. Each corporate operating objective is assigned a specific percentage weightingweight together with a “threshold,” “target” and “stretch” objective. The “threshold” objective is defined as 60% goal achievement and represents a minimum acceptable level of performance for the year. The “target” objective is defined as 80% goal achievement and reflects performance that is consistent with our long-term strategic objectives. The “stretch” objective is defined as 100% goal achievement and reflects outstanding performance that exceeds our long-term strategic objectives. Unlike our profitability objective, the corporate operating objectives do not operate on a sliding scale. For each objective, the percentage achievement can be 0 percent (if the threshold objective is not met), 60 percent (if results are equal to or greater than the threshold objective but less than the target objective), 80 percent (if results are equal to or greater than the target objective but less than the stretch objective) or 100 percent (if results are equal to or greater than the stretch objective). The results for each corporate operating goal are multiplied by the assigned percentage weightingweight to determine their contribution to the overall corporate operating goal achievement percentage. For example, if the target objective is achieved for a goal with a percentage weightingweight of 10 percent, then the contribution of that goal to our overall corporate goal achievement would be 8 percent (10 percent x 80 percent). The sum of the percentages derived from this calculation for each corporate operating objective yields our overall corporate operating goal achievement percentage. Generally, the Board of Directors attempts to set the threshold, target and stretch objectives such that the relative difficulty of achieving each level is consistent from year to year. 97
For 2006,2009, the Board of Directors established eightten separate VPP corporate operating objectives, with specific percentage weightingsweights ranging from 5 percent to 2520 percent. TheAs further set forth in the table below, the objectives relating to our traditional business (excluding new initiatives) comprised 55 percent of our overall corporate goals and included specific measures relating to our members’ usage of the Bank’s credit products.goals. New initiatives and economic and community development objectives comprised 2015 percent and 2530 percent, respectively, of our overall corporate operating goals. In August 2006, the Board of Directors modified two of the eight corporate operating goals, with an aggregate weighting of 30 percent, to take into account the unforeseen effects of Hurricanes Katrina and Rita on our business activity. This action 132
2009 VPP Corporate Operating Objectives (Dollars in millions) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Contribution | | | | | | | | | | | | | | | | | | | | | | | to Overall | | | Percentage | | Objective | | | | | | | Achievement | | | Weight | | Threshold | | | Target | | | Stretch | | | Results | | | Percentage | Expanding the Traditional Business | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 1. Average Total Advances + Letters of Credit | | | 10 | % | | $ | 63,200 | | | $ | 65,000 | | | $ | 66,700 | | | $ | 57,713 | | | | 0 | % | | | | | | | | | | | | | | | | | | | | | | | | | | 2. Average Advances and Letters of Credit to Customers with Assets£ $15 billion | | | 15 | % | | $ | 30,400 | | | $ | 31,300 | | | $ | 32,100 | | | $ | 28,501 | | | | 0 | % | | | | | | | | | | | | | | | | | | | | | | | | | | 3. Average Advances + Letters of Credit to 2009 CFIs | | | 20 | % | | $ | 13,100 | | | $ | 13,400 | | | $ | 13,800 | | | $ | 13,710 | | | | 16 | % | | | | | | | | | | | | | | | | | | | | | | | | | | 4. Total Credit Product Users | | | 10 | % | | | 700 | | | | 725 | | | | 750 | | | | 760 | | | | 10 | % | | | | | | | | | | | | | | | | | | | | | | | | | | New Initiatives | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 1. Interest Rate Derivatives Customers | | | 5 | % | | | 10 | | | | 15 | | | | 20 | | | | 3 | | | | 0 | % | | | | | | | | | | | | | | | | | | | | | | | | | | 2. Advances or Deposit Auction Participants | | | 5 | % | | | 200 | | | | 215 | | | | 235 | | | | 255 | | | | 5 | % | | | | | | | | | | | | | | | | | | | | | | | | | | 3. Average Letters of Credit Outstanding | | | 5 | % | | $ | 4,800 | | | $ | 5,000 | | | $ | 5,200 | | | $ | 4,692 | | | | 0 | % | | | | | | | | | | | | | | | | | | | | | | | | | | Economic and Community Development | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 1. New CIP / EDP Advances Funded + LCs Issued* | | | 10 | % | | $ | 600 | | | $ | 650 | | | $ | 700 | | | $ | 1,174 | | | | 10 | % | | | | | | | | | | | | | | | | | | | | | | | | | | 2. Total CIP / EDP Advances / LC Users* | | | 10 | % | | | 85 | | | | 90 | | | | 100 | | | | 86 | | | | 6 | % | | | | | | | | | | | | | | | | | | | | | | | | | | 3. CIP / EDP Projects Funded / Supported by LCs* | | | 10 | % | | | 275 | | | | 300 | | | | 325 | | | | 367 | | | | 10 | % | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Overall Corporate Operating Goal Achievement Percentage | | | | | | | | | | | | | | | | | | | | | | | 57 | % | | | | | | | | | | | | | | | | | | | | | | | | |
| | | * | | Excluding letters of credit issued on behalf of one particularly active member. |
As shown above, we did not affect the 2006 VPP awards. We failed to achieve the threshold objectivesobjective for twofour of our three “traditional business”ten corporate operating objectives in 2006.2009. These twofour objectives had a combined weighting of 4535 percent. We achieved the threshold, target or stretch objective for each of our other six corporate operating goals such that our overall corporate operating goal achievement rate for 2009 was 57 percent, which was below our target level of 80 percent. We attribute this primarily to a steeper than anticipated decline in member demand for our advances during the year. The reduced demand was due, at least in part, to increases in members’ deposit levels and reduced lending activity due to the economic recession, as well as the availability of federal government programs that provided members with more attractively priced sources of funding and liquidity than were available earlier in the credit crisis. Over the previous five years, our overall corporate operating goal achievement was as follows: 2004 — 76 percent; 2005 — 87 percent; 2006 was— 50 percent; 2007 — 90 percent; and 2008 — 95 percent.
Once the total amount of funds in the VPP award pool has been determined based upon the level of achievement of our corporate profitability and operating objectives, the calculation of individual bonusincentive awards is based upon employeeeach employee’s performance and the maximum award percentage assigned to anthat employee’s job grade level. An employee’s performance is determined based upon his or her appraisal rating and the extent to which the employee achieves his or her individual VPP goals for the year. The maximum award percentages under our VPP are 60 percent of base salary for Mr. Smith and 43.75 percent of base salary for the other named executive officers. The target award percentages for Mr. Smith and the other named executive officers are 4851 percent and 35 percent, respectively. At the threshold level (defined for this purpose as 50 percent profitability achievement, 60 percent corporate operating goal achievement, and 100%100 percent individual goal achievement), the payout percentage for Mr. Smith is 18would be 28.5 percent of base salary, while the payout percentage for the other named executive officers iswould be 13.125 percent of base salary. These award percentages are reviewed and approved annually by the Committee and Board of Directors with the intent that the target award opportunity is at or near the median for our defined competitive market.markets for Mr. Smith and our other executive officers. Except for Mr. Smith, each of our named executive officers has the same set of individual goals for purposes of our VPP. These “joint” senior management goals, which are more tactical in nature than our corporate operating goals, are reviewed and approved annually by Mr. Smith. In 2006,2009, the named executive officers achieved 100 percent of their 2410 joint senior management goals. Mr. Smith assesses the performance of each of our named executive officersMr. Sims, Ms. Parker and Mr. Joiner annually using a performance appraisal form which consists of 44 performance factors (for each factor, an executive 133
can receive 0-3 points). Mr. Sims assesses the performance of Mr. Lewis using this same performance appraisal form, which is then subject to review by Mr. Smith. Executives must receive at least 88 points (out of a total of 132 points) to achieve a “Meets Expectations” performance rating, which is a requirement to receive an annual VPP award. For 2006,2009, each of the named executive officers received at least a “Meets Expectations” performance rating. Mr. Smith’s individual goal achievement for purposes of the VPP is derived from his performance appraisal, which is prepared jointly by the Chairman of the Board,and Vice Chairman of the Board and the Chairman and Vice Chairman of the Compensation and Human Resources Committee. HisFor 2009, his performance iswas assessed based on 317 broad areas comprising 33 specific measuresaccountabilities relating to our strategic objectives and other matters of importance, which arewere approved annually by the Board of Directors (the maximum number of points he can receive for each performance measure ranges from 2-5 points).Directors. Mr. Smith’s individual goal achievement is expressed as a percentage and is calculated by dividing the number of points received on his performance appraisal form by the 78100 total possible points. For 2006,2009, Mr. Smith received 59.5589.4 points on his appraisal form, which resulted in an individual goal achievement percentage of 76.3589.4 percent. The possible VPP payouts to our named executive officers for 20062009 are presented in the Grants of Plan-Based Awards table on page 106,141, while the actual VPP awards earned by these executives for 20062009 are included in the Summary Compensation Table on page 105140 (in the column entitled “Non-Equity Incentive Plan Compensation”) and further set forth. The calculation of the VPP awards earned by our named executive officers in 2009 is shown in the table below. 98
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Corporate | | | | | | | | | | | Maximum | | Profitability | | Operating Goal | | Individual Goal | | | | | Base Salary as of | | Potential Award | | Achievement | | Achievement | | Achievement | | 2006 VPP | | | January 1, 2006 ($) | | Percentage (%) | | Percentage (%) | | Percentage (%) | | Percentage (%) | | Award ($) | Terry Smith | | | 565,000 | | | | 60.00 | | | | 91.25 | | | | 50.00 | | | | 76.35 | | | | 118,090 | | Tom Lewis | | | 217,500 | | | | 43.75 | | | | 91.25 | | | | 50.00 | | | | 100.00 | | | | 43,415 | | Nancy Parker | | | 255,000 | | | | 43.75 | | | | 91.25 | | | | 50.00 | | | | 100.00 | | | | 50,901 | | Mike Sims | | | 265,000 | | | | 43.75 | | | | 91.25 | | | | 50.00 | | | | 100.00 | | | | 52,897 | | Paul Joiner | | | 217,500 | | | | 43.75 | | | | 91.25 | | | | 50.00 | | | | 100.00 | | | | 43,415 | |
For 2006, both our profitability and corporate operating goal achievement were below our targeted levels of 100 percent and 80 percent, respectively. We attribute this to a difficult interest rate environment for both us and our members. Over the past five years, we have achieved our targeted (or maximum) corporate profitability objective. In those years, our overall corporate operating goal achievement was as follows: 2001 – 63 percent; 2002 – 88 percent; 2003 – 66 percent; 2004 – 76 percent; and 2005 – 87 percent. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Corporate | | | | | | | | | | | | | | Award | | | Maximum | | | Profitability | | | Operating Goal | | | Individual Goal | | | | | | | Base Salary as of | | | Component | | | Potential Award | | | Achievement | | | Achievement | | | Achievement | | | 2009 VPP | | | | January 1, 2009 ($) | | | Percentage (%) | | | Percentage (%) | | | Percentage (%) | | | Percentage (%) | | | Percentage (%) | | | Award ($) | | Terry Smith | | | 715,000 | | | | 75.00 | | | | 60.00 | | | | 100.00 | | | | 57.00 | | | | | | | | 183,398 | | | | | 715,000 | | | | 25.00 | | | | 60.00 | | | | | | | | | | | | 89.40 | | | | 95,881 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 279,279 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Michael Sims | | | 330,000 | | | | | | | | 43.75 | | | | 100.00 | | | | 57.00 | | | | 100.00 | | | | 82,294 | | Nancy Parker | | | 320,000 | | | | | | | | 43.75 | | | | 100.00 | | | | 57.00 | | | | 100.00 | | | | 79,800 | | Paul Joiner | | | 267,500 | | | | | | | | 43.75 | | | | 100.00 | | | | 57.00 | | | | 100.00 | | | | 66,708 | | Tom Lewis | | | 264,000 | | | | | | | | 43.75 | | | | 100.00 | | | | 57.00 | | | | 100.00 | | | | 65,835 | |
Under the VPP, discretion cannot be exercised to increase the size of any award. However, discretion can be used (through the performance appraisal process) to reduce or eliminate a VPP award. In addition, wemanagement (or, in the case of Mr. Smith, the Board) can modify or eliminate individual awards within ourtheir sole discretion based on circumstances unique to an individual employee such as misconduct, failure to follow Bank policies, insubordination or other job performance factors. In addition to our VPP, Mr. Smith has a $50,000 annual award pool that he can draw upon to pay discretionary bonuses to employees. In 2006,2009, none of the named executive officers received a discretionary bonus. Defined Benefit Pension Plan All regular employees hired prior to January 1, 2007 who work a minimum of 1,000 hours per year, including our named executive officers, participate in the Pentegra Defined Benefit Plan for Financial Institutions, a tax-qualified multiemployer defined benefit pension plan. The plan also covers any of our regular employees hired on or after January 1, 2007 who work a minimum of 1,000 hours per year, provided that the employee had prior service with a financial services institution that participated in the Pentegra Defined Benefit Plan for Financial Institutions, during which service the employee was covered by such plan. Since this is a qualified defined benefit plan, it is subject to certain compensation and benefit limitations imposed by the Internal Revenue Service. In 2009, the maximum compensation limit was $245,000 and the maximum annual benefit limit was $195,000. The pension benefit earned under the plan is based on the number of years of credited service (up to a maximum of 30 years) and compensation earned over an employee’s three highest consecutive years of earnings. We consider this benefit to be a critical element of our compensation program as it pertains to our executive officers and other key tenured employees. Based on this belief, we have generally targeted this component of our compensation program to provide a pension benefit above the competitive market median. The details of this plan and the accumulated pension benefits for our named executive officers can be found in the Pension Benefits Table and accompanying narrative on pages 106 — 109142-144 of this report. 134
Defined Contribution Savings Plan We offer all regular employees who work a minimum of 1,000 hours per year, including our named executive officers, the opportunity to participate in the Pentegra Defined Contribution Plan for Financial Institutions, a tax-qualified multiemployer defined contribution plan. Since this is a qualified plan, it is subject to the maximum compensation limit set by the Internal Revenue Code, which for 20062009 was $220,000$245,000 per year. In addition, the combined contributions to this plan from both us and the employee are limited by the Internal Revenue Code. For 2006,2009, combined contributions to the plan could not exceed $44,000.$49,000. The plan includes a pre-tax 401(k) option along with an opportunity to make contributions on an after-tax basis. Subject to the limits prescribed by the Internal Revenue Code, employees can contribute up to 25%25 percent of their monthly base salary to the plan on either a pre-tax or after-tax basis. We provide matching funds on the first 3 percent of eligible monthly base salary contributed by employees hired priorwho are eligible to January 1, 2007,participate in the Pentegra Defined Benefit Plan for Financial Institutions, and on the first 5 percent of eligible monthly base salary contributed by employees hired on or after that date.who are not eligible to participate in the Pentegra Defined Benefit Plan for Financial Institutions. In each case, our matching contribution is 100 percent, 150 percent or 200 percent depending upon the employee’s length of service. Employees hired priorwho are eligible to January 1, 2007participate in the Pentegra Defined Benefit Plan for Financial Institutions are fully vested in our matching contributions at the time such funds are deposited in their account. For employees hired on or after January 1, 2007,who do not participate in the Pentegra Defined Benefit Plan for Financial Institutions, there is a 2-6 year step vesting schedule 99
for our matching contributions with the employee becoming fully vested after 6 years. Participants can elect to invest plan contributions in up to 1427 different mutual fund options. Based on their tenure with us, Ms. Parker and Messrs. Smith, Sims and Joiner each of our named executive officers received in 20062009 a 200 percent matching contribution on the first 3 percent of their eligible monthly base salary that they contributed to the plan, subject in all cases to the compensation limit prescribed by the Internal Revenue Code. With less tenure, Mr. Lewis received a 150 percent matching contribution on the first 3 percent of his eligible monthly base salary that he contributed to the plan in 2006. These matching contributions are included in the “All Other Compensation” column of the Summary Compensation Table found on page 105140 and further set forth under the “401(k)/Thrift Plan” column of the related “Components of All Other Compensation”Compensation for 2009” table. We offer the savings plan as a competitive practice and have historically targeted our matching contributions to the plan at or near the market median for comparable companies. Deferred Compensation Program We offer our highly compensated employees, including our named executive officers, the opportunity to voluntarily defer receipt of a portion of their base salary above a specified amount and all or part of their annual VPP award under the terms of our nonqualified deferred compensation program. The program allows participants to save for retirement or other future-dated in-service obligations (e.g., college, home purchase, etc.) in a tax-effective manner, as contributions and earnings on those contributions are not taxable to the participant until received. Under the program, amounts deferred by the participant and our matching contributions can be invested in an array of externally managed mutual funds. We offer the program to higher-level employees in order to allow them to voluntarily defer more compensation than they would otherwise be permitted to defer under our tax-qualified defined contribution savings plan as a result of the limits imposed by the Internal Revenue Code. Further, we offer this program as a competitive practice to help us attract and retain top talent. The matching contributions that we provide in this plan are intended to make the participant whole with respect to the amount of matching funds that he or she would have otherwise been eligible to receive if not for the limits imposed on the qualified plan by the Internal Revenue Code. These matching contributions are included in the “All Other Compensation” column of the Summary Compensation Table found on page 140 and further set forth under the “Nonqualified Deferred Compensation Plan (NQDC Plan)” column of the related “Components of All Other Compensation for 2009” table. Our previous competitive market analyses have indicated that our matching contributions to the qualified savings plan are at or near the market median. Based on our experience and general knowledge of the competitive market, we believe this is also true for the matching contributions that we provide under the deferred compensation program. The provisions of this program are described more fully in the narrative accompanying the Nonqualified Deferred Compensation Tabletable on page 109.pages 144-146. 135
Supplemental Executive Retirement Plan In October 2004, we establishedWe maintain a supplemental executive retirement plan (“SERP”) to servethat serves as an additional incentive for our executive officers to remain with the Bank. The SERP is a nonqualified defined contribution plan and, as such, it does not provide for a specified retirement benefit. Each participant’s benefit under the SERP consists of contributions we make on his or her behalf, plus an allocation of the investment gains or losses on the assets used to fund the plan. Contributions to the SERP are determined solely at the discretion of our Board of Directors and are based upon our desire to provide a reasonable level of supplemental retirement income to our most senior executives. Generally, benefits under the SERP vest when the participant reaches age 62attains the “Rule of 70,” except that some of the amounts contributed on Mr. Smith’s behalf vestvested on January 1, 2010 (when2010. A participant attains the Rule of 70 when the sum of his or her age and years of service with us is at least 70. The provisions of the plan provide for accelerated vesting and payment in the event of a participant’s death or disability if such participant is not otherwise vested at the time of his or her death or disability. Otherwise, vested benefits are not payable to the participant until he will be 53 years old).or she reaches age 62 or, if later, upon retirement, except for some of the amounts contributed on Mr. Smith’s behalf which are payable to him upon his termination of employment for any reason. We maintain the right at any time to amend or terminate the SERP, or remove a participant from the SERP at our discretion, except that no amendment, modification or termination may reduce the then vested account balance of any participant.
It is not our intention to provide a full replacementrestoration of the lost benefit under the tax-qualified defined benefit plan and, as a result, the SERP is expected to be less valuable to our executives than some supplemental executive retirement plans offered by other comparable financial institutions in our defined competitive market.markets. As a percentage of their compensation, we expect the benefits from the plan (for amounts that vest at age 62)upon attaining the Rule of 70) to be greater for Ms. Parker and Messrs. Lewis,Sims, Joiner and SimsLewis than for Mr. Smith. 100
For details regarding the operation of this plan, the contributions we made in 2006,2009, and the current account balances for each of our named executive officers, please refer to the Nonqualified Deferred Compensation Tabletable and accompanying narrative beginning on page 109.144. Other Benefits We offer a number of other benefits to our named executive officers pursuant to benefit programs that are available to all of our regular, full-time employees. These benefits include: medical, dental, vision and prescription drug benefits; a wellness program; paid time off (in the form of vacation and flex leave); short- and long-term disability coverage; life and accidental death and dismemberment insurance; charitable gift matching (limited to $500 per employee per year); health and dependent care flexible spending accounts; healthcare savings accounts; and certain other benefits including, but not limited to, retiree health and life insurance benefits (provided certain eligibility requirements are met). We have a policy under which all regular full-time employees can elect to cash out their accrued and unused vacation leave on an annual basis, subject to certain conditions. Vacation leave cash outs are calculated by multiplying the number of vacation hours cashed out by the employee’s hourly rate. For this purpose, the hourly rate is computed by dividing the employees’ base salary by 2,080 hours. Our employees accrue vacation at different rates depending upon their job grade level and length of service. When an employee has completed 13 or more years of service, he or she is entitled to 200 hours of annual vacation leave, regardless of job grade level. We limit the amount of accrued and unused vacation leave that an employee can carry over to the next calendar year to two times the amount of vacation he or she earns in an annual period. Based on their job grade level and tenure with the Bank, Mr. Lewis currently accrues 160 hours of vacation leave per year while the other named executive officers each accrue 200 hours of vacation leave per year. The vacation payouts made to our named executive officers for 2009 are set forth in the “Components of All Other Compensation”Compensation for 2009” table related to the Summary Compensation Table found on page 105.140. We automatically buy back from all regular full-time employees all accrued and unused flex leave in excess of our maximum annual carryover amount (520 hours) at a rate of 50 cents on the dollar. Flex leave is defined as accrued leave that is available for personal injury or illness, family injury or illness, personal time off (limited to no more than 32 hours per year), and leave covered under the provisions of the Family and Medical Leave Act of 1993. All of our regular full-time employees, including our named executive officers, accrue 80 hours of flex leave per year. 136
Employees (including named executive officers) are not entitled to receive any payments under our flex leave policy if their employment is terminated for any reason prior to the date on which the buy back is processed. The flex leave payouts made to our named executive officers for 2009 are set forth in the “Components of All Other Compensation”Compensation for 2009” table related to the Summary Compensation Table on page 105.140. Based on our general experience and market knowledge, we believe that our vacation and flex leave cash out benefits are above the market median, although we have not conducted a study to confirm this. We do not include, nor do we consider, these items in either our total direct compensation or total compensation analyses for the namedour executive officers. Perquisites and Tax Gross-ups We provide a limited number of perquisites to our named executive officers, which we believe are appropriate in light of the executives’ contributions to us. In 2006,2009, we provided Mr. Smith with the use of a Bank-leased car a Bank-owned personal computer and cost reimbursementswe paid for travel and meal costs associated with his spouse accompanying him to our two out-of-town board meetings.meetings and certain in-town Board functions. In addition, we reimbursed Mr. Smith for the incremental taxes associated with his use of the Bank-leased car. The perquisites for our other named executive officers are limited solely to cost reimbursementspayment of travel and meal costs associated with a spouse accompanying the officer to one or both of our out-of-town board meetings each year.and in-town Board functions. In 2006, Messrs. Lewis and2009, Mr. Joiner each utilized this benefit for onetwo out-of-town board meeting (in each case, the aggregatemeetings and one in-town Board function at a total incremental cost to the Bank totaledof approximately $1,000).$3,300. Historically, we have not attempted to compare these perquisites with those offered by companies in our defined competitive market. 101
Severance BenefitsExecutive Employment Agreements
All of our named executive officers are employed on an at-will basis. NoOn November 20, 2007 (“Effective Date”), we entered into employment agreement or contract of any kind exists between us and anyagreements with each of our named executive officers. However, because we believeThese agreements were authorized and approved by the Committee and Board of Directors and result from the Board’s desire to retain the services of these executive officers for no less than the three-year term of the agreements. We considered this action to be prudent based on our belief that companies should provide reasonable severance benefitsthese individuals are extremely well qualified to perform the duties of their employees, werespective job positions, that they have a Reductionskill sets that are highly sought after in Workforce Policythe financial services industry, and that appliestheir continued employment with us is essential to all employees, including our named executive officers. With certain exceptions,ability to meet our short- and long-term strategic business objectives.
As more fully described in the policy provides severance pay and the continuation of certain employee benefits for any employee in a job position that is eliminated as a result of a merger and/or consolidation, or when warranted by economic conditions, functional reorganization, or technological obsolescence. The severance benefit provided under the policy is based upon an employee’s age, length of service, base salary and job grade level at the time of termination, subject to certain minimum and maximum amounts. In no event may the severance payment paid to any employee under the policy exceed an amount equal to one year’s base salary plus the continuation of certain employee benefits for a one-year period. Any named executive officer or other employee who voluntarily resigns, retires or is discharged for cause is notsection entitled to any benefits under the policy. Please see “Potential Payments Upon Termination or Change in Control” beginning on page 112148, the employment agreements provide for payments in the event that the executive officer’s employment with us is terminated either by the executive for good reason or by us other than for cause, or in the event that either we or the executive officer gives notice of non-renewal of the employment agreement and we relieve the executive officer of his or her duties under the employment agreement prior to the expiration of the term of the agreement. As of each anniversary of the Effective Date, an additional year is automatically added to the unexpired term of the employment agreement unless either we or the executive officer gives a more detailed discussionnotice of our severance benefits as they applynon-renewal. In 2009, neither we nor any of the executive officers gave a notice of non-renewal. Accordingly, an additional year was added to our named executive officers. Based on our market knowledge and general experience, wethe unexpired term of each of the employment agreements. We believe the severance benefit levels for our named executive officersspecified triggering events and the payments resulting from those events are at or below the market median amongsimilar in nature and amount to those commonly found in agreements that are utilized by comparable companies, although weincluding the other FHLBanks that have not conducted a recent studyelected to confirm this.enter into executive employment agreements, and therefore advance our objective of retaining these executive officers. 20072010 Compensation Decisions
The 20072010 base salaries for our named executive officers have been setare presented below (the percentage increase from the salaries in effect at the following amounts:December 31, 2009 is shown parenthetically): | | | | | | | | | | | Terry Smith | | $ | 649,750 | | | $ | 715,000 | | | (No change — see discussion below) | Michael Sims | | | $ | 385,000 | | | (8.45 percent) | Nancy Parker | | | $ | 375,000 | | | (8.70 percent) | Paul Joiner | | | $ | 277,000 | | | (3.55 percent) | Tom Lewis | | $ | 240,000 | | | $ | 268,000 | | | (1.52 Percent) | Nancy Parker | | $ | 275,000 | | | Michael Sims | | $ | 285,000 | | | Paul Joiner | | $ | 250,000 | | |
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In establishingorder to evaluate Mr. Smith’s base salary for 2007 (an increase of 15 percent from 2006),2010, the Committee and Board of Directors tookengaged McLagan Partners in December 2009 to conduct an analysis of Mr. Smith’s total direct compensation, taking into consideration his individual performancethe absence of a long-term incentive compensation component and demonstrated leadership over time,the competitive market pay data includingfor the results12 FHLBank Presidents. Upon completion of McLagan Partners’ analysis and consideration of the study preparedfindings contained therein, the Committee and Board of Directors will make a final decision with regard to Mr. Smith’s base salary for us by2010. The competitive market pay data shows that Mr. Smith’s base salary remains within the top quartile for the FHLBank Presidents, which, as discussed above, is the range the Committee and Board of Directors has established for him. In August 2009, the Board of Directors engaged Lawrence Associates andto conduct a competitive market pay study for our other factors. Theexecutive officers. In setting the base salaries of our executive officers for 2010, Mr. Smith considered the results of this study, andas well as the other surveycompetitive pay data we use showed that while his base salary approximatedprovided by the median for the FHLBanks, it was 20 percent below the median for other comparable financial services institutions. Mr. Smith reviewed similar considerations for each of the other named executive officers.2009 FHLBank Key Position Compensation Survey conducted by Reimer Consulting. The competitive market data indicated that theirthe executive officers’ base salaries (excluding Mr. Joiner, for whom sufficient comparable FHLBank data was unavailable) were within a range of plus or minus 14minus: (a) 21 percent of the market median. As explained above,median for non-depository financial services institutions with approximately $20 billion in assets and (b) 33 percent of the market median for the FHLBanks. Based on this data and in an effort to bring certain executives’ base salaries more in line with comparable FHLBank positions, Mr. Smith had increasedgave Mr. Joiner’sSims and Ms. Parker above standard merit increases for 2010, while Mr. Joiner received a standard merit increase and Mr. Lewis received less than a standard merit increase. In establishing the base salary by 15 percentsalaries for Mr. Sims and Ms. Parker, Mr. Smith also factored in July 2006 and therefore did not increase his base salary on January 1, 2007.the additional adjustments that were contemplated at the time he promoted each of them to Executive Vice President in April 2009.
For purposes of our 20072010 VPP, the Board of Directors has established the Bank’s target (or maximum)minimum corporate profitability objective at 25300 basis points above the average effective federal funds rate and the maximum corporate profitability objective at 400 basis points above the average effective federal funds rate. The Board of Directors has also established 1011 separate VPP corporate operating objectives, each of which havehas a specific percentage weightings ranging fromweight of either 5 percent or 10 percent. For 2010, the operating objectives fall into the following categories: expanding our traditional business; risk management; customer activity and new initiatives; and economic and community development. In order to 20 percent. Theplace additional emphasis on our risk management activities, the Board of Directors (acting uponelected to establish three risk management objectives for 2010, each with a recommendation fromweighting of 10 percent. Adding these corporate operating objectives will result in less weight being given to the Committee) recently modifiedgoals relating to the formula that will be used to calculate Mr. Smith’s future VPP awards. Seventy-five percent of his potential VPP award will be derived based solely upon the achievementexpansion of our corporate profitabilitytraditional business and operating objectives for 2007, while 25 percent will be based solely upon his overall individual performancenew initiatives in the 2010 VPP as subjectively assessed by our Board of Directors, subject to our attainment of our minimum profitability objective, which for 2007 is a return on our average capital stock equalcompared to the average effective federal funds rate. The formula that will be used to calculate Mr. Smith’s 2007 VPP award is as follows:
102
| | | | | | | | | | | | | | | | | 75% | | X | | Base Salary as of 1/1/07 | | X | | Maximum
Potential
Award
Percentage | | X | | Profitability
Goal
Achievement
Percentage | | X | | Corporate
Operating Goal
Achievement
Percentage | | | | | | | | | | | | | | | | | | | | | | | | | | plus | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 25% | | X | | Base Salary as of 1/1/07 | | X | | Maximum
Potential
Award
Percentage | | X | | Individual
Performance Goal
Achievement
Percentage | | | | |
If this formula had been used in 2006, Mr. Smith’s 2006 VPP award would have increased from $118,090 to $180,708. In making this adjustment to Mr. Smith’s VPP award formula, the Committee and Board of Directors considered his total annual cash compensation opportunity (defined as base salary plus short-term incentives) relative to competitive market data. This data indicated that while his total annual cash compensation was near the median for the FHLBanks, it was 35 percent below the national median for comparable financial institutions.2009 VPP.
The following table sets forth an estimate of the possible VPP awards that can be earned by our named executive officers in 2007.2010. The amounts have been calculated using the same assumptions regarding threshold, target and maximum amounts that were used to calculate the possible awards for 2006, and incorporate Mr. Smith’s new VPP award formula.2009. For a discussion of these assumptions, please refer to the Grants of Plan-Based Awards Table and accompanying narrative on pages 105 - 106.page 141. The estimated possible VPP payouts for Mr. Smith could increase depending upon the actions, if any, that the Committee and Board of Directors take with respect to his base salary for 2010. | | | | | | | | | | | | | | | | | | | | | | | | | | | Estimated Possible VPP Payouts for 2007 | | Estimated Possible VPP Payouts for 2010 | | | | Threshold ($) | | Target ($) | | Maximum ($) | | Threshold ($) | | Target ($) | | Maximum ($) | | Terry Smith | | 185,179 | | 331,373 | | 389,850 | | | 203,775 | | 364,650 | | 429,000 | | | | Michael Sims | | | 50,531 | | 134,750 | | 168,438 | | | | Nancy Parker | | | 49,219 | | 131,250 | | 164,063 | | | | Paul Joiner | | | 36,356 | | 96,950 | | 121,188 | | | | Tom Lewis | | 31,500 | | 84,000 | | 105,000 | | | 35,175 | | 93,800 | | 117,250 | | Nancy Parker | | 36,094 | | 96,250 | | 120,313 | | | Michael Sims | | 37,406 | | 99,750 | | 124,688 | | | Paul Joiner | | 32,813 | | 87,500 | | 109,375 | | |
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As discussed on page 131, our VPP has historically provided for substantially the same method of allocation of benefits between management and non-management participants, except for Mr. Smith and certain members of our sales staff. For 2010, we expect the objectives for both management and non-management employees in our Risk and Internal Audit departments, as well as certain members of our sales staff, to differ from those that will apply to all of our other employees, including our executive officers. Among other things, the VPP plans for employees in our Risk and Internal Audit departments are not expected to include a corporate profitability component. Compensation Committee Report The Compensation and Human Resources Committee has reviewed and discussed with management the Compensation Discussion and Analysis found on pages 93 — 103127-139 of this report. Based on our review and discussions, we recommended to the Board of Directors that the Compensation Discussion and Analysis be included in the Bank’s Annual Report on Form 10-K. | | | | | The Compensation and Human Resources Committee Robert Wertheim, Chairman
| | | | | | Bobby L. Chain, Chairman | | | James W. Pate, II, Vice Chairman
| | | Patricia P. Brister | | | Mary E. Ceverha
| | | Lee R. Gibson
Will C. Hubbard
Charles G. Morgan, Jr.
| | | Anthony S. Sciortino 104
SUMMARY COMPENSATION TABLE
The following table sets forth the total compensation for 2006 of our President and Chief Executive Officer, our Senior Vice President and Chief Accounting Officer, who serves as our principal financial officer, and our three other most highly compensated executive officers (collectively, our “named executive officers”). The determination as to which of our executive officers were most highly compensated was made by reference to their total compensation for 2006 reduced by the amount disclosed in the column below entitled “Change in Pension Value and Nonqualified Deferred Compensation Earnings.” As discussed above, we do not provide any form of equity or long-term incentive compensation to our named executive officers.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Change in Pension | | | | | Name and | | | | | | | | | | | | | | | | | | | | | | Non-Equity | | Value and Nonqualified | | | | | Principal | | | | | | | | | | | | | | Stock | | Option | | Incentive Plan | | Deferred Compensation | | All Other | | | Position | | Year | | Salary ($) | | Bonus ($) | | Awards ($) | | Awards ($) | | Compensation ($) (1) | | Earnings ($) (2) | | Compensation ($) (3) | | Total ($) | Terry Smith President/Chief Executive Officer | | | 2006 | | | | 565,000 | | | | — | | | | — | | | | — | | | | 118,090 | | | | 111,000 | | | | 244,192 | | | | 1,038,282 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Tom Lewis SVP/Chief Accounting Officer | | | 2006 | | | | 217,500 | | | | — | | | | — | | | | — | | | | 43,415 | | | | 23,000 | | | | 26,920 | | | | 310,835 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Nancy Parker SVP/Chief Information Officer | | | 2006 | | | | 255,000 | | | | — | | | | — | | | | — | | | | 50,901 | | | | 144,000 | | | | 73,426 | | | | 523,327 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Michael Sims SVP/Chief Financial Officer | | | 2006 | | | | 265,000 | | | | — | | | | — | | | | — | | | | 52,897 | | | | 48,000 | | | | 42,577 | | | | 408,474 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Paul Joiner SVP/Chief Risk Officer | | | 2006 | | | | 233,750 | | | | — | | | | — | | | | — | | | | 43,415 | | | | 164,000 | | | | 50,967 | | | | 492,132 | |
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SUMMARY COMPENSATION TABLE The following table sets forth the total compensation for 2009, 2008 and 2007 of our President and Chief Executive Officer; our Chief Operating Officer, Executive Vice President — Finance and Chief Financial Officer, who has served as our principal financial officer since April 10, 2009; and our three other executive officers (collectively, our “named executive officers”). Prior to April 10, 2009, our Senior Vice President and Chief Accounting Officer served as our principal financial officer. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Change in Pension | | | | | | | | Name and | | | | | | | | | | | | | | | | | | | | | | Non-equity | | | Value and Nonqualified | | | | | | | | Principal | | | | | | | | | | | | | | Stock | | | Option | | | Incentive Plan | | | Deferred Compensation | | | All Other | | | | | Position | | Year | | | Salary ($) | | | Bonus ($) | | | Awards ($) | | | Awards ($) | | | Compensation ($) (1) | | | Earnings ($) (2) | | | Compensation ($) (3) | | | Total ($) | | Terry Smith | | | 2009 | | | | 715,000 | | | | — | | | | — | | | | — | | | | 279,279 | | | | 351,000 | | | | 470,690 | | | | 1,815,969 | | President/Chief Executive Officer | | | 2008 | | | | 680,000 | | | | — | | | | — | | | | — | | | | 376,788 | | | | 195,000 | | | | 391,804 | | | | 1,643,592 | | | | | 2007 | | | | 649,750 | | | | — | | | | — | | | | — | | | | 348,136 | | | | 127,000 | | | | 347,215 | | | | 1,472,101 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Michael Sims | | | 2009 | | | | 344,583 | | | | — | | | | — | | | | — | | | | 82,294 | | | | 214,000 | | | | 96,151 | | | | 737,028 | | Chief Operating Officer/EVP-Finance/ | | | 2008 | | | | 302,500 | | | | — | | | | — | | | | — | | | | 125,727 | | | | 128,000 | | | | 83,615 | | | | 639,842 | | Chief Financial Officer | | | 2007 | | | | 285,000 | | | | — | | | | — | | | | — | | | | 112,219 | | | | 54,000 | | | | 43,697 | | | | 494,916 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Nancy Parker | | | 2009 | | | | 334,583 | | | | — | | | | — | | | | — | | | | 79,800 | | | | 402,000 | | | | 147,062 | | | | 963,445 | | Chief Operating Officer/ | | | 2008 | | | | 292,500 | | | | — | | | | — | | | | — | | | | 121,570 | | | | 161,000 | | | | 143,216 | | | | 718,286 | | EVP-Operations | | | 2007 | | | | 275,000 | | | | 10,000 | (4) | | | — | | | | — | | | | 108,281 | | | | 162,000 | | | | 73,836 | | | | 629,117 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Paul Joiner | | | 2009 | | | | 267,500 | | | | — | | | | — | | | | — | | | | 66,708 | | | | 429,000 | | | | 109,795 | | | | 873,003 | | SVP/Chief Strategy Officer | | | 2008 | | | | 255,000 | | | | — | | | | — | | | | — | | | | 105,984 | | | | 222,000 | | | | 113,032 | | | | 696,016 | | | | | 2007 | | | | 250,000 | | | | — | | | | — | | | | — | | | | 98,438 | | | | 184,000 | | | | 64,033 | | | | 596,471 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Tom Lewis | | | 2009 | | | | 264,000 | | | | — | | | | — | | | | — | | | | 65,835 | | | | 81,000 | | | | 36,743 | | | | 447,578 | | SVP/Chief Accounting Officer | | | 2008 | | | | 252,500 | | | | — | | | | — | | | | — | | | | 104,945 | | | | 48,000 | | | | 59,774 | | | | 465,219 | | | | | 2007 | | | | 240,000 | | | | — | | | | — | | | | — | | | | 94,500 | | | | 28,000 | | | | 19,536 | | | | 382,036 | |
| | | (1) | | Amounts for 2009, 2008 and 2007 represent VPP awards earned for services rendered in those years. These amounts were paid to the named executive officers in February 2010, February 2009 and March 2008, respectively. | | (2) | | Amounts represent VPP awards earned for services rendered in 2006. These amounts were paid to the named executive officers in March 2007. | | (2) | | The amounts reported in this column for 2009, 2008 and 2007 are attributable solely to the change in the actuarial present value of the named executive officers’ accumulated benefit under the Pentegra Defined Benefit Plan for Financial Institutions from December 31, 2005 to December 31, 2006. None of our named executive officers received preferential or above-market earnings on nonqualified deferred compensation during 2006. | | (3) | | The components of this column are provided in the table below. |
Components of All Other Compensation
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Bank | | Bank Contributions to Vested | | | | | | | | | | | | | | | | | | | | | Contributions to | | Defined Contribution Plans | | | | | | | | | | | | | | | | | | | | | Unvested Defined | | 401(k)/ | | Nonqualified | | Payouts | | Payouts | | | | | | | | | | Total | | | | | | | Contribution | | Thrift | | Deferred Compensation | | for Unused | | for Unused | | | | | | Tax | | All Other | Name | | Year | | Plan (SERP) ($) | | Plan ($) | | Plan (NQDC Plan) ($) | | Vacation ($) | | Flex Leave ($) | | Perquisites ($) | | Gross-ups ($) | | Compensation ($) | Terry Smith | | | 2006 | | | | 120,644 | | | | 13,200 | | | | 20,700 | | | | 43,462 | | | | 11,271 | | | | 24,666 | (1) | | | 10,249 | (2) | | | 244,192 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Tom Lewis | | | 2006 | | | | 8,736 | | | | 9,450 | | | | 360 | | | | 8,374 | | | | — | | | | * | | | | — | | | | 26,920 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Nancy Parker | | | 2006 | | | | 29,237 | | | | 13,200 | | | | 2,100 | | | | 23,590 | | | | 5,299 | | | | * | | | | — | | | | 73,426 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Michael Sims | | | 2006 | | | | 10,830 | | | | 13,200 | | | | 2,700 | | | | 15,288 | | | | 559 | | | | * | | | | — | | | | 42,577 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Paul Joiner | | | 2006 | | | | 20,931 | | | | 13,200 | | | | — | | | | 12,019 | | | | 4,817 | | | | * | | | | — | | | | 50,967 | |
| | | (1) | | In 2006, Mr. Smith’s perquisites included the use of a Bank-leased car, a Bank-owned personal computer and spousal travel. | | (2) | | Represents tax reimbursements on income imputed to Mr. Smith for his use of a Bank-leased car. | | * | | Amounts are less than $10,000 or zero. |
GRANTS OF PLAN-BASED AWARDS
The following table sets forth an estimate of the possible VPP awards that could have been earned by our named executive officers for 2006. VPP awards are the only plan-based awards granted to our executive officers. The threshold amounts were computed based upon the assumption that we would achieve our minimum corporate profitability objective (50 percent profitability achievement) and the threshold objective for each of our eight corporate operating goals (60 percent overall corporate goal achievement). The target amounts were computed based upon the assumption that we would achieve our target (or maximum) corporate profitability objective (100 percent profitability achievement) and the target objective for each of our eight corporate operating goals (80 percent overall corporate goal achievement). The maximum amounts were computed based upon the assumption
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that we would achieve our target (or maximum) corporate profitability objective (100 percent profitability achievement) and the stretch objective for each of our eight corporate operating goals (100 percent overall corporate goal achievement). In addition, the threshold, target and maximum amounts presented in the table below were based upon the assumption that Mr. Smith would receive a perfect score on his performance appraisal and that the other named executive officers would achieve 100 percent of their joint senior management goals and receive at least a “Meets Expectations” performance rating from Mr. Smith. Given the number of variables involved in the calculation of our VPP awards, the ultimate payouts (other than the maximum payouts) could vary significantly. For instance, the VPP awards could have been substantially less than the threshold amounts if we achieved our minimum corporate profitability objective but only achieved one or some (but not all) of the threshold objectives relating to our corporate operating goals. Similarly, because our profitability objective operates on a sliding scale between 50 percent and 100 percent achievement and our achievement of each corporate operating goal could be 0 percent, 60 percent, 80 percent or 100 percent, the ultimate VPP awards payable to the named executive officers could vary significantly between the threshold and maximum amounts presented in the table. If we do not achieve our minimum profitability objective, then no award payments are made under the VPP even if we have achieved some or all of our corporate operating goals and/or individual employees have achieved some or all of their individual performance goals. The 2006 VPP awards that were actually earned by our named executive officers are presented in the Non-Equity Incentive Plan Compensation column in the Summary Compensation Table above and are described more fully in the Compensation Discussion and Analysis on pages 93 through 103.
| | | | | | | | | | | | | | | Estimated Possible Payouts Under | | | Non-Equity Incentive Plan Awards for 2006 | | | Threshold | | | | | | Maximum | Name | | ($) | | Target ($) | | ($) | Terry Smith | | | 101,700 | | | | 271,200 | | | | 339,000 | | | Tom Lewis | | | 28,547 | | | | 76,125 | | | | 95,156 | | | Nancy Parker | | | 33,469 | | | | 89,250 | | | | 111,563 | | | Michael Sims | | | 34,781 | | | | 92,750 | | | | 115,938 | | | Paul Joiner | | | 28,547 | | | | 76,125 | | | | 95,156 | |
PENSION BENEFITS
Our named executive officers and all other regular full-time employees hired prior to January 1, 2007 participate in the Pentegra Defined Benefit Plan for Financial Institutions (“Pentegra DB Plan”), a tax-qualified multiemployer defined benefit pension plan. We do not offer any other defined benefit plans (including supplemental executive retirement plans) that provide for specified retirement benefits. The following table shows the present value of the current accrued pension benefit and the number of years of credited service for eachduring those years. None of our named executive officers asreceived preferential or above-market earnings on nonqualified deferred compensation during 2009, 2008 or 2007.
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