UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________
FORM 10-Q
____________________________________
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2011
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number: 000-51398
FEDERAL HOME LOAN BANK OF SAN FRANCISCO
(Exact name of registrant as specified in its charter)
____________________________________
Federally chartered corporation | 94-6000630 | |||
(State or other jurisdiction of incorporation or organization) | (I.R.S. employer identification number) | |||
600 California Street San Francisco, CA | 94108 | |||
(Address of principal executive offices) | (Zip code) |
(415) 616-1000
(Registrant's telephone number, including area code)
____________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing for the past 90 days. x Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | o | Accelerated filer | o | |||
Non-accelerated filer | x (Do not check if a smaller reporting company) | Smaller reporting company | o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Shares Outstanding as of July 29, 2011 | ||
Class B Stock, par value $100 | 112,344,701 |
Federal Home Loan Bank of San Francisco
Form 10-Q
Index
PART I. | ||||
Item 1. | ||||
Item 2. | ||||
Item 3. | ||||
Item 4. | ||||
PART II. | ||||
Item 1. | ||||
Item 1A. | ||||
Item 2. | ||||
Item 3. | ||||
Item 4. | ||||
Item 5. | ||||
Item 6. | ||||
i
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Federal Home Loan Bank of San Francisco
Statements of Condition
(Unaudited)
(In millions-except par value) | June 30, 2011 | December 31, 2010 | |||||
Assets | |||||||
Cash and due from banks | $ | 7,452 | $ | 755 | |||
Federal funds sold | 11,669 | 16,312 | |||||
Trading securities(a) | 3,548 | 2,519 | |||||
Available-for-sale securities(a) | 9,781 | 1,927 | |||||
Held-to-maturity securities (fair values were $26,105 and $32,214, respectively)(b) | 26,224 | 31,824 | |||||
Advances (includes $9,227 and $10,490 at fair value under the fair value option, respectively) | 82,745 | 95,599 | |||||
Mortgage loans held for portfolio, net of allowance for credit losses on mortgage loans of $5 and $3, respectively | 2,097 | 2,381 | |||||
Accrued interest receivable | 169 | 228 | |||||
Premises and equipment, net | 26 | 25 | |||||
Derivative assets | 600 | 718 | |||||
Other assets | 127 | 135 | |||||
Total Assets | $ | 144,438 | $ | 152,423 | |||
Liabilities and Capital | |||||||
Liabilities: | |||||||
Deposits | $ | 146 | $ | 134 | |||
Consolidated obligations, net: | |||||||
Bonds (includes $18,737 and $20,872 at fair value under the fair value option, respectively) | 111,709 | 121,120 | |||||
Discount notes | 20,406 | 19,527 | |||||
Total consolidated obligations, net | 132,115 | 140,647 | |||||
Mandatorily redeemable capital stock | 6,144 | 3,749 | |||||
Accrued interest payable | 411 | 467 | |||||
Affordable Housing Program | 163 | 174 | |||||
Payable to REFCORP | 6 | 37 | |||||
Derivative liabilities | 130 | 163 | |||||
Other liabilities | 304 | 104 | |||||
Total Liabilities | 139,419 | 145,475 | |||||
Commitments and Contingencies (Note 16) | |||||||
Capital: | |||||||
Capital stock—Class B—Putable ($100 par value) issued and outstanding: | |||||||
50 shares and 83 shares, respectively | 5,046 | 8,282 | |||||
Restricted retained earnings | 1,665 | 1,609 | |||||
Accumulated other comprehensive loss: | |||||||
Non-credit-related other-than-temporary impairment loss on available-for-sale securities | (1,524 | ) | — | ||||
Non-credit-related other-than-temporary impairment loss on held-to-maturity securities | (161 | ) | (2,934 | ) | |||
Other | (7 | ) | (9 | ) | |||
Total accumulated other comprehensive loss | (1,692 | ) | (2,943 | ) | |||
Total Capital | 5,019 | 6,948 | |||||
Total Liabilities and Capital | $ | 144,438 | $ | 152,423 |
(a) | At June 30, 2011, and at December 31, 2010, none of these securities were pledged as collateral that may be repledged. |
(b) | Includes $68 at June 30, 2011, and $84 at December 31, 2010, pledged as collateral that may be repledged. |
The accompanying notes are an integral part of these financial statements.
1
Federal Home Loan Bank of San Francisco
Statements of Income
(Unaudited)
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||
(In millions) | 2011 | 2010 | 2011 | 2010 | ||||||||||||
Interest Income: | ||||||||||||||||
Advances | $ | 176 | $ | 285 | $ | 362 | $ | 606 | ||||||||
Prepayment fees on advances, net | 4 | 28 | 10 | 39 | ||||||||||||
Federal funds sold | 6 | 8 | 14 | 13 | ||||||||||||
Trading securities | 7 | 1 | 12 | 1 | ||||||||||||
Available-for-sale securities | 72 | 1 | 73 | 2 | ||||||||||||
Held-to-maturity securities | 166 | 282 | 393 | 570 | ||||||||||||
Mortgage loans held for portfolio | 28 | 39 | 56 | 75 | ||||||||||||
Total Interest Income | 459 | 644 | 920 | 1,306 | ||||||||||||
Interest Expense: | ||||||||||||||||
Consolidated obligations: | ||||||||||||||||
Bonds | 183 | 269 | 374 | 558 | ||||||||||||
Discount notes | 9 | 9 | 20 | 22 | ||||||||||||
Mandatorily redeemable capital stock | 3 | 3 | 6 | 6 | ||||||||||||
Total Interest Expense | 195 | 281 | 400 | 586 | ||||||||||||
Net Interest Income | 264 | 363 | 520 | 720 | ||||||||||||
Provision for credit losses on mortgage loans | 3 | 2 | 3 | 2 | ||||||||||||
Net Interest Income After Mortgage Loan Loss Provision | 261 | 361 | 517 | 718 | ||||||||||||
Other Income/(Loss): | ||||||||||||||||
Net loss on trading securities | — | (1 | ) | (1 | ) | (1 | ) | |||||||||
Total other-than-temporary impairment loss | (116 | ) | (190 | ) | (204 | ) | (382 | ) | ||||||||
Net amount of impairment loss reclassified (from)/to accumulated other comprehensive loss | (47 | ) | 48 | (68 | ) | 180 | ||||||||||
Net other-than-temporary impairment loss | (163 | ) | (142 | ) | (272 | ) | (202 | ) | ||||||||
Net gain/(loss) on advances and consolidated obligation bonds held at fair value | 34 | (21 | ) | (20 | ) | (121 | ) | |||||||||
Net loss on derivatives and hedging activities | (91 | ) | (123 | ) | (71 | ) | (159 | ) | ||||||||
Other | 1 | 2 | 3 | 3 | ||||||||||||
Total Other Income/(Loss) | (219 | ) | (285 | ) | (361 | ) | (480 | ) | ||||||||
Other Expense: | ||||||||||||||||
Compensation and benefits | 15 | 16 | 32 | 33 | ||||||||||||
Other operating expense | 11 | 13 | 21 | 25 | ||||||||||||
Federal Housing Finance Agency | 2 | 3 | 5 | 6 | ||||||||||||
Office of Finance | 1 | 1 | 3 | 3 | ||||||||||||
Other | 1 | 2 | 1 | 4 | ||||||||||||
Total Other Expense | 30 | 35 | 62 | 71 | ||||||||||||
Income Before Assessments | 12 | 41 | 94 | 167 | ||||||||||||
REFCORP | 2 | 9 | 17 | 31 | ||||||||||||
Affordable Housing Program | 1 | 3 | 8 | 14 | ||||||||||||
Total Assessments | 3 | 12 | 25 | 45 | ||||||||||||
Net Income | $ | 9 | $ | 29 | $ | 69 | $ | 122 |
The accompanying notes are an integral part of these financial statements.
2
Federal Home Loan Bank of San Francisco
Statements of Capital Accounts
(Unaudited)
Capital Stock Class B—Putable | Retained Earnings | Accumulated Other Comprehensive | Total Capital | |||||||||||||||||||||||
(In millions) | Shares | Par Value | Restricted | Unrestricted | Total | Income/(Loss) | ||||||||||||||||||||
Balance, December 31, 2009 | 86 | $ | 8,575 | $ | 1,239 | $ | — | $ | 1,239 | $ | (3,584 | ) | $ | 6,230 | ||||||||||||
Issuance of capital stock | — | 42 | 42 | |||||||||||||||||||||||
Repurchase/redemption of capital stock | (3 | ) | (307 | ) | (307 | ) | ||||||||||||||||||||
Capital stock reclassified to mandatorily redeemable capital stock, net | — | (30 | ) | (30 | ) | |||||||||||||||||||||
Comprehensive income/(loss): | ||||||||||||||||||||||||||
Net income | 111 | 11 | 122 | 122 | ||||||||||||||||||||||
Other comprehensive income/(loss): | ||||||||||||||||||||||||||
Net unrealized gain on available-for-sale securities | 4 | 4 | ||||||||||||||||||||||||
Non-credit-related other-than-temporary impairment (OTTI) loss | (379 | ) | (379 | ) | ||||||||||||||||||||||
Reclassification of non-credit-related OTTI loss included in net income | 199 | 199 | ||||||||||||||||||||||||
Accretion of non-credit-related OTTI loss | 428 | 428 | ||||||||||||||||||||||||
Total comprehensive income | 374 | |||||||||||||||||||||||||
Cash dividends paid on capital stock (0.27%) | — | (11 | ) | (11 | ) | (11 | ) | |||||||||||||||||||
Balance, June 30, 2010 | 83 | $ | 8,280 | $ | 1,350 | $ | — | $ | 1,350 | $ | (3,332 | ) | $ | 6,298 | ||||||||||||
Balance, December 31, 2010 | 83 | $ | 8,282 | $ | 1,609 | $ | — | $ | 1,609 | $ | (2,943 | ) | $ | 6,948 | ||||||||||||
Issuance of capital stock | 1 | 100 | 100 | |||||||||||||||||||||||
Repurchase/redemption of capital stock | (7 | ) | (656 | ) | (656 | ) | ||||||||||||||||||||
Capital stock reclassified to mandatorily redeemable capital stock, net | (27 | ) | (2,680 | ) | (2,680 | ) | ||||||||||||||||||||
Comprehensive income: | ||||||||||||||||||||||||||
Net income | 56 | 13 | 69 | 69 | ||||||||||||||||||||||
Other comprehensive income/(loss): | ||||||||||||||||||||||||||
Net unrealized gain on available-for-sale securities | 2 | 2 | ||||||||||||||||||||||||
Non-credit-related OTTI loss on available-for-sale securities: | ||||||||||||||||||||||||||
Non-credit-related OTTI loss transferred from held-to-maturity securities | (2,501 | ) | (2,501 | ) | ||||||||||||||||||||||
Net unrealized gain | 928 | 928 | ||||||||||||||||||||||||
Reclassification of non-credit-related OTTI loss included in net income | 49 | 49 | ||||||||||||||||||||||||
Non-credit-related OTTI loss on held-to-maturity securities: | ||||||||||||||||||||||||||
Non-credit-related OTTI loss | (136 | ) | (136 | ) | ||||||||||||||||||||||
Reclassification of non-credit-related OTTI loss included in net income | 155 | 155 | ||||||||||||||||||||||||
Accretion of non-credit-related OTTI loss | 253 | 253 | ||||||||||||||||||||||||
Non-credit-related OTTI loss transferred to available-for-sale securities | 2,501 | 2,501 | ||||||||||||||||||||||||
Total comprehensive income | 1,320 | |||||||||||||||||||||||||
Cash dividends paid on capital stock (0.30%) | — | (13 | ) | (13 | ) | (13 | ) | |||||||||||||||||||
Balance, June 30, 2011 | 50 | $ | 5,046 | $ | 1,665 | $ | — | $ | 1,665 | $ | (1,692 | ) | $ | 5,019 |
The accompanying notes are an integral part of these financial statements.
3
Federal Home Loan Bank of San Francisco
Statements of Cash Flows
(Unaudited)
For the Six Months Ended June 30, | |||||||
(In millions) | 2011 | 2010 | |||||
Cash Flows from Operating Activities: | |||||||
Net income | $ | 69 | $ | 122 | |||
Adjustments to reconcile net income to net cash provided by operating activities: | |||||||
Depreciation and amortization | (27 | ) | (5 | ) | |||
Provision for credit losses on mortgage loans | 2 | 2 | |||||
Change in net fair value adjustment on trading securities | 1 | 1 | |||||
Change in net fair value adjustment on advances and consolidated obligation bonds held at fair value | 20 | 121 | |||||
Change in net fair value adjustment on derivatives and hedging activities | 28 | 68 | |||||
Net other-than-temporary impairment loss recognized in income | 272 | 202 | |||||
Net change in: | |||||||
Accrued interest receivable | 65 | 141 | |||||
Other assets | 2 | (5 | ) | ||||
Accrued interest payable | (56 | ) | (142 | ) | |||
Other liabilities | (54 | ) | 224 | ||||
Total adjustments | 253 | 607 | |||||
Net cash provided by operating activities | 322 | 729 | |||||
Cash Flows from Investing Activities: | |||||||
Net change in: | |||||||
Federal funds sold | 4,643 | (6,306 | ) | ||||
Loans to other Federal Home Loan Banks | — | (15 | ) | ||||
Premises and equipment | (5 | ) | (4 | ) | |||
Trading securities: | |||||||
Proceeds from maturities of long-term | 3 | 3 | |||||
Purchases of long-term | (1,033 | ) | (1,132 | ) | |||
Held-to-maturity securities: | |||||||
Net decrease/(increase) in short-term | 811 | (940 | ) | ||||
Proceeds from maturities of long-term | 2,912 | 5,109 | |||||
Purchases of long-term | (4,777 | ) | (412 | ) | |||
Advances: | |||||||
Principal collected | 124,285 | 116,246 | |||||
Made to members | (111,495 | ) | (78,626 | ) | |||
Mortgage loans held for portfolio: | |||||||
Principal collected | 284 | 249 | |||||
Net cash provided by investing activities | 15,628 | 34,172 |
4
Federal Home Loan Bank of San Francisco
Statements of Cash Flows (continued)
(Unaudited)
For the Six Months Ended June 30, | |||||||
(In millions) | 2011 | 2010 | |||||
Cash Flows from Financing Activities: | |||||||
Net change in: | |||||||
Deposits | (97 | ) | (107 | ) | |||
Net payments on derivative contracts with financing elements | 4 | 33 | |||||
Net proceeds from consolidated obligations: | |||||||
Bonds issued | 29,751 | 49,510 | |||||
Discount notes issued | 33,643 | 61,780 | |||||
Bonds transferred from another Federal Home Loan Bank | 15 | — | |||||
Payments for consolidated obligations: | |||||||
Bonds matured or retired | (38,950 | ) | (82,107 | ) | |||
Discount notes matured or retired | (32,765 | ) | (64,200 | ) | |||
Proceeds from issuance of capital stock | 100 | 42 | |||||
Payments for repurchase/redemption of mandatorily redeemable capital stock | (285 | ) | (183 | ) | |||
Payments for repurchase of capital stock | (656 | ) | (307 | ) | |||
Cash dividends paid | (13 | ) | (11 | ) | |||
Net cash used in financing activities | (9,253 | ) | (35,550 | ) | |||
Net increase/(decrease) in cash and due from banks | 6,697 | (649 | ) | ||||
Cash and due from banks at beginning of the period | 755 | 8,280 | |||||
Cash and due from banks at end of the period | $ | 7,452 | $ | 7,631 | |||
Supplemental Disclosures: | |||||||
Interest paid | $ | 441 | $ | 655 | |||
Affordable Housing Program payments | 19 | 26 | |||||
REFCORP payments | 48 | 47 | |||||
Transfers of mortgage loans to real estate owned | 3 | 3 | |||||
Transfers of held-to-maturity securities to available-for-sale securities | 7,215 | — |
The accompanying notes are an integral part of these financial statements.
5
Federal Home Loan Bank of San Francisco
Notes to Financial Statements
(Unaudited)
(Dollars in millions except per share amounts)
Note 1 — Summary of Significant Accounting Policies
The information about the Federal Home Loan Bank of San Francisco (Bank) included in these unaudited financial statements reflects all adjustments that, in the opinion of the Bank, are necessary for a fair statement of results for the periods presented. These adjustments are of a normal recurring nature, unless otherwise disclosed. The results of operations in these interim statements are not necessarily indicative of the results to be expected for any subsequent period or for the entire year ending December 31, 2011. These unaudited financial statements should be read in conjunction with the Bank's Annual Report on Form 10-K for the year ended December 31, 2010 (2010 Form 10‑K).
Use of Estimates. The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) requires management to make a number of judgments, estimates, and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, if applicable, and the reported amounts of income, expenses, gains, and losses during the reporting period. The most significant of these estimates include the determination of other-than-temporary impairment (OTTI) of securities and fair value of derivatives, certain advances, certain investment securities, and certain consolidated obligations that are reported at fair value in the Statements of Condition. Actual results could differ significantly from these estimates.
Variable Interest Entities. The Bank's investments in variable interest entities (VIEs) are limited to private-label residential mortgage-backed securities (PLRMBS). The Bank evaluated its investments in VIEs as of June 30, 2011, to determine whether it is a primary beneficiary of any of these investments. The primary beneficiary is required to consolidate a VIE. The Bank determined that consolidation accounting is not required because the Bank is not the primary beneficiary of its VIEs as of June 30, 2011. The Bank does not have the power to significantly affect the economic performance of any of these investments because it does not act as a key decision maker nor does it have the unilateral ability to replace a key decision maker. In addition, the Bank does not design, sponsor, transfer, service, or provide credit or liquidity support in any of its investments in VIEs. The Bank's maximum loss exposure for these investments is limited to the carrying value.
Descriptions of the Bank's significant accounting policies are included in “Item 8. Financial Statements and Supplementary Data – Note 1 – Summary of Significant Accounting Policies” in the Bank's 2010 Form 10-K. Other changes to these policies as of June 30, 2011, are discussed in Note 2 – Recently Issued and Adopted Accounting Guidance.
Note 2 — Recently Issued and Adopted Accounting Guidance
Presentation of Comprehensive Income. On June 16, 2011, the Financial Accounting Standards Board (FASB) issued guidance to increase the prominence of other comprehensive income in financial statements. This guidance requires an entity that reports items of other comprehensive income to present comprehensive income in either a single financial statement or in two consecutive financial statements. In a single continuous statement, an entity is required to present the components of net income and total net income, the components of other comprehensive income and a total for other comprehensive income, as well as a total for comprehensive income. In a two-statement approach, an entity is required to present the components of net income and total net income in its statement of net income. The statement of other comprehensive income should follow immediately and include the components of other comprehensive income as well as totals for both other comprehensive income and comprehensive income. This guidance eliminates the option to present other comprehensive income in the statement of changes in stockholders' equity. This guidance is effective for the Bank for interim and annual periods beginning on January 1, 2012, and should be applied retrospectively for all periods presented. Early adoption is permitted. The adoption of this guidance is expected to be limited to the presentation of the Bank's financial statements and will not have any
6
effect on the Bank's financial condition, results of operations, or cash flows.
Fair Value Measurements and Disclosures. On January 21, 2010, the FASB issued amended guidance for fair value measurements and disclosures. The update requires a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and to describe the reasons for the transfers. Furthermore, this update requires a reporting entity to present separately information about purchases, sales, issuances, and settlements in the reconciliation of fair value measurements using significant unobservable inputs; clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value; and amends guidance on employers' disclosures about postretirement benefit plan assets to require that those disclosures be provided by classes of assets instead of by major categories of assets. The amended guidance became effective for interim and annual reporting periods beginning after December 15, 2009 (January 1, 2010, for the Bank), except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity for Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 (January 1, 2011, for the Bank), and for interim periods within those fiscal years. In the period of initial adoption, entities are not required to provide the amended disclosures for any previous periods presented for comparative purposes. Early adoption is permitted. The Bank adopted this amended guidance as of January 1, 2010, with the exception of the required changes noted above related to the roll forward of activity for Level 3 fair value measurements, which were adopted as of January 1, 2011. The adoption did not result in increased financial statement disclosures and did not have any effect on the Bank's financial condition, results of operations, or cash flows.
On May 12, 2011, the FASB and the International Accounting Standards Board issued substantially converged guidance on fair value measurement and disclosure requirements. This guidance clarifies how fair value accounting should be applied where its use is already required or permitted by other standards within GAAP or International Financial Reporting Standards; these amendments do not require additional fair value measurements. This guidance generally represents clarifications to the application of existing fair value measurement and disclosure requirements, as well as some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This guidance is effective for the Bank for interim and annual periods beginning on January 1, 2012, and should be applied prospectively. Early adoption is not permitted. The adoption of this guidance may result in increased financial statement disclosures, but is not expected to have a material effect on the Bank's financial condition, results of operations, or cash flows.
Reconsideration of Effective Control for Repurchase Agreements. On April 29, 2011, the FASB issued guidance to improve the accounting for repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. The new guidance removes from the assessment of effective control: (i) the criterion requiring the transferor to have the ability to repurchase or redeem financial assets before their maturity on substantially the agreed-upon terms, even in the event of the transferee's default, and (ii) the collateral maintenance implementation guidance related to that criterion. The new guidance is effective for the first interim or annual period beginning on or after December 15, 2011 (January 1, 2012, for the Bank). The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The Bank is currently evaluating the effect of the adoption of this guidance on its financial condition, results of operations, or cash flows.
A Creditor's Determination of Whether a Restructuring Is a Troubled Debt Restructuring. On January 19, 2011, the FASB issued guidance to temporarily defer the effective date of disclosures about troubled debt restructuring required by the amended guidance on disclosures about the credit quality of financing receivables and the allowance for credit losses. The effective date for these new disclosures was to be coordinated with the effective date of the guidance for determining what constitutes a troubled debt restructuring.
On April 5, 2011, the FASB issued guidance that clarifies which loan modifications constitute troubled debt restructurings. It is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss
7
and for presenting previously deferred disclosures related to troubled debt restructurings. The new guidance is effective for interim and annual periods beginning on or after June 15, 2011 (July 1, 2011, for the Bank), and applies retrospectively to troubled debt restructurings occurring on or after the beginning of the fiscal year of adoption. The adoption of this guidance may result in increased financial statement disclosures, but will not have any effect on the Bank's financial condition, results of operations, or cash flows.
Disclosures About the Credit Quality of Financing Receivables and the Allowance for Credit Losses. On July 21, 2010, the FASB issued amended guidance to enhance disclosures about an entity's allowance for credit losses and the credit quality of its financing receivables. The amended guidance requires all public and nonpublic entities with financing receivables, including loans, lease receivables, and other long-term receivables, to provide disclosure of the following: (i) the nature of the credit risk inherent in the financing receivables, (ii) how that risk is analyzed and assessed in arriving at the allowance for credit losses, and (iii) the changes in the allowance for credit losses and reasons for those changes. Both new and existing disclosures must be disaggregated by portfolio segment or class of financing receivable. A portfolio segment is defined as the level at which an entity develops and documents a systematic method for determining its allowance for credit losses. Short-term accounts receivable, receivables measured at fair value or at the lower of cost or fair value, and debt securities are exempt from this amended guidance. The required disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010 (December 31, 2010, for the Bank). The required disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010 (January 1, 2011, for the Bank). The adoption of this amended guidance resulted in increased financial statement disclosures, but did not affect the Bank's financial condition, results of operations, or cash flows.
Note 3 — Trading Securities
The estimated fair value of trading securities as of June 30, 2011, and December 31, 2010, was as follows:
June 30, 2011 | December 31, 2010 | ||||||
Government-sponsored enterprises (GSEs) – Federal Farm Credit Bank (FFCB) bonds | $ | 2,366 | $ | 2,366 | |||
Temporary Liquidity Guarantee Program (TLGP) securities(1) | 1,160 | 128 | |||||
Mortgage-backed securities (MBS): | |||||||
Other U.S. obligations – Ginnie Mae | 19 | 20 | |||||
GSEs – Fannie Mae | 3 | 5 | |||||
Total | $ | 3,548 | $ | 2,519 |
(1) TLGP securities represent corporate debentures of the issuing party that are guaranteed by the Federal Deposit Insurance Corporation (FDIC) and backed by the full faith and credit of the U.S. government.
Redemption Terms. The estimated fair value of non-MBS securities by contractual maturity (based on contractual final principal payment) and of MBS as of June 30, 2011, and December 31, 2010, is shown below. Expected maturities of MBS will differ from contractual maturities because borrowers generally have the right to prepay the underlying obligations without prepayment fees.
8
Year of Contractual Maturity | June 30, 2011 | December 31, 2010 | |||||
Trading securities other than MBS: | |||||||
Due in 1 year or less | $ | 1,492 | $ | — | |||
Due after 1 year through 5 years | 2,034 | 2,494 | |||||
Subtotal | 3,526 | 2,494 | |||||
MBS: | |||||||
Other U.S. obligations – Ginnie Mae | 19 | 20 | |||||
GSEs – Fannie Mae | 3 | 5 | |||||
Total MBS | 22 | 25 | |||||
Total | $ | 3,548 | $ | 2,519 |
Interest Rate Payment Terms. Interest rate payment terms for trading securities at June 30, 2011, and December 31, 2010, are detailed in the following table:
June 30, 2011 | December 31, 2010 | ||||||
Estimated fair value of trading securities other than MBS: | |||||||
Fixed rate | $ | 800 | $ | 128 | |||
Adjustable rate | 2,726 | 2,366 | |||||
Subtotal | 3,526 | 2,494 | |||||
Estimated fair value of trading MBS: | |||||||
Passthrough securities: | |||||||
Adjustable rate | 19 | 20 | |||||
Collateralized mortgage obligations: | |||||||
Fixed rate | 3 | 5 | |||||
Subtotal | 22 | 25 | |||||
Total | $ | 3,548 | $ | 2,519 |
At June 30, 2011, and December 31, 2010, all of the fixed rate trading securities were swapped to an adjustable rate, such as the London Inter-Bank Offered Rate (LIBOR). At June 30, 2011, and December 31, 2010, 78% and 89% of the adjustable rate trading securities were swapped to a different adjustable rate index, such as 1-month or 3-month LIBOR.
The net unrealized loss on trading securities was immaterial and $1 for the three months ended June 30, 2011 and 2010, respectively. The net unrealized loss on trading securities was $1 and $1 for the six months ended June 30, 2011 and 2010, respectively. These amounts represent the changes in the fair value of the securities during the reported periods.
9
Note 4 — Available-for-Sale Securities
Available-for-sale securities as of June 30, 2011, and December 31, 2010, were as follows:
June 30, 2011 | |||||||||||||||||||
Amortized Cost(1) | OTTI Recognized in Accumulated Other Comprehensive Income/(Loss) (AOCI) | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | |||||||||||||||
TLGP securities | $ | 1,926 | $ | — | $ | — | $ | — | $ | 1,926 | |||||||||
PLRMBS: | |||||||||||||||||||
Prime | 1,009 | (185 | ) | 69 | (2 | ) | 891 | ||||||||||||
Alt-A, option ARM | 1,536 | (488 | ) | 62 | (1 | ) | 1,109 | ||||||||||||
Alt-A, other | 6,834 | (1,090 | ) | 118 | (7 | ) | 5,855 | ||||||||||||
Total PLRMBS | 9,379 | (1,763 | ) | 249 | (10 | ) | 7,855 | ||||||||||||
Total | $ | 11,305 | $ | (1,763 | ) | $ | 249 | $ | (10 | ) | $ | 9,781 | |||||||
December 31, 2010 | |||||||||||||||||||
TLGP securities | $ | 1,928 | $ | — | $ | — | $ | (1 | ) | $ | 1,927 |
(1) Amortized cost includes unpaid principal balance and unamortized premiums and discounts, and previous other-than-temporary impairments recognized in earnings (less any cumulative-effect adjustments recognized).
Securities Transferred. PLRMBS classified as held-to-maturity that experienced credit-related OTTI during the first six months of 2011 were reclassified to the Bank's available-for-sale portfolio at their fair values. These transfers allow the Bank the option to divest these securities prior to maturity in response to changes in interest rates, changes in prepayment risk, or other factors, while acknowledging its intent to hold these securities for an indefinite period of time. For additional information on the transferred securities, see Note 6 – Other-Than-Temporary Impairment Analysis.
The following table summarizes the available-for-sale securities with unrealized losses as of June 30, 2011, and December 31, 2010. The unrealized losses are aggregated by major security type and the length of time that individual securities have been in a continuous unrealized loss position. The total unrealized losses in the following table will not agree to the total gross unrealized losses in the table above. The total unrealized losses below include non-credit-related OTTI recognized in AOCI net of subsequent unrealized gains, up to the amount of non-credit-related OTTI in AOCI, related to the other-than-temporarily impaired securities. For OTTI analysis of available-for-sale securities, see Note 6 – Other-Than-Temporary Impairment Analysis.
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June 30, 2011 | |||||||||||||||||||||||
Less Than 12 Months | 12 Months or More | Total | |||||||||||||||||||||
Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | ||||||||||||||||||
TLGP securities | $ | 502 | $ | — | $ | — | $ | — | $ | 502 | $ | — | |||||||||||
PLRMBS: | |||||||||||||||||||||||
Prime | — | — | 817 | 121 | 817 | 121 | |||||||||||||||||
Alt-A, option ARM | — | — | 1,087 | 428 | 1,087 | 428 | |||||||||||||||||
Alt-A, other | 85 | 2 | 5,646 | 981 | 5,731 | 983 | |||||||||||||||||
Total PLRMBS | 85 | 2 | 7,550 | 1,530 | 7,635 | 1,532 | |||||||||||||||||
Total | $ | 587 | $ | 2 | $ | 7,550 | $ | 1,530 | $ | 8,137 | $ | 1,532 | |||||||||||
December 31, 2010 | |||||||||||||||||||||||
TLGP securities | $ | 1,348 | $ | 1 | $ | — | $ | — | $ | 1,348 | $ | 1 |
Redemption Terms. The amortized cost and estimated fair value of non-MBS securities by contractual maturity (based on contractual final principal payment) and of PLRMBS as of June 30, 2011, and December 31, 2010, are shown below. Expected maturities of PLRMBS will differ from contractual maturities because borrowers generally have the right to prepay the underlying obligations without prepayment fees.
June 30, 2011 | December 31, 2010 | ||||||||||||||
Year of Contractual Maturity | Amortized Cost | Estimated Fair Value | Amortized Cost | Estimated Fair Value | |||||||||||
Available-for-sale securities other than PLRMBS: | |||||||||||||||
Due in 1 year or less | $ | 1,620 | $ | 1,620 | $ | — | $ | — | |||||||
Due after 1 year through 5 years | 306 | 306 | 1,928 | 1,927 | |||||||||||
Subtotal | 1,926 | 1,926 | 1,928 | 1,927 | |||||||||||
PLRMBS: | |||||||||||||||
Prime | 1,009 | 891 | — | — | |||||||||||
Alt-A, option ARM | 1,536 | 1,109 | — | — | |||||||||||
Alt-A, other | 6,834 | 5,855 | — | — | |||||||||||
Total PLRMBS | 9,379 | 7,855 | — | — | |||||||||||
Total | $ | 11,305 | $ | 9,781 | $ | 1,928 | $ | 1,927 |
The amortized cost of the TLGP securities, which are classified as available-for-sale, included net premiums of $3 at June 30, 2011, and net premiums of $5 at December 31, 2010. At June 30, 2011, the carrying value of the Bank's PLRMBS classified as available-for-sale included credit-related OTTI of $1,246 (including interest accretion adjustments of $37), non-credit-related OTTI of $1,763, and net unrealized gains of $239.
Interest Rate Payment Terms. Interest rate payment terms for available-for-sale securities at June 30, 2011, and December 31, 2010, are shown in the following table:
11
June 30, 2011 | December 31, 2010 | ||||||
Amortized cost of available-for-sale securities other than PLRMBS: | |||||||
Adjustable rate | $ | 1,926 | $ | 1,928 | |||
Subtotal | 1,926 | 1,928 | |||||
Amortized cost of available-for-sale PLRMBS: | |||||||
Collateralized mortgage obligations: | |||||||
Fixed rate | 4,541 | — | |||||
Adjustable rate | 4,838 | — | |||||
Subtotal | 9,379 | — | |||||
Total | $ | 11,305 | $ | 1,928 |
Certain MBS classified as fixed rate collateralized mortgage obligations have an initial fixed interest rate that subsequently converts to an adjustable interest rate on a specified date as follows:
June 30, 2011 | December 31, 2010 | ||||||
Collateralized mortgage obligations: | |||||||
Converts in 1 year or less | $ | 189 | $ | — | |||
Converts after 1 year through 5 years | 1,373 | — | |||||
Converts after 5 years through 10 years | 406 | — | |||||
Total | $ | 1,968 | $ | — |
The Bank does not own PLRMBS that are backed by mortgage loans purchased by another Federal Home Loan Bank (FHLBank) from either (i) members of the Bank or (ii) members of other FHLBanks.
Note 5 — Held-to-Maturity Securities
The Bank classifies the following securities as held-to-maturity because the Bank has the positive intent and ability to hold these securities to maturity:
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June 30, 2011 | |||||||||||||||||||||||
Amortized Cost(1) | OTTI Recognized in AOCI(1) | Carrying Value(1) | Gross Unrecognized Holding Gains(2) | Gross Unrecognized Holding Losses(2) | Estimated Fair Value | ||||||||||||||||||
Interest-bearing deposits | $ | 6,725 | $ | — | $ | 6,725 | $ | — | $ | — | $ | 6,725 | |||||||||||
Commercial paper | 1,800 | — | 1,800 | — | — | 1,800 | |||||||||||||||||
Housing finance agency bonds | 712 | — | 712 | — | (123 | ) | 589 | ||||||||||||||||
Subtotal | 9,237 | — | 9,237 | — | (123 | ) | 9,114 | ||||||||||||||||
MBS: | |||||||||||||||||||||||
Other U.S. obligations – Ginnie Mae | 232 | — | 232 | 2 | — | 234 | |||||||||||||||||
GSEs: | |||||||||||||||||||||||
Freddie Mac | 3,428 | — | 3,428 | 119 | (2 | ) | 3,545 | ||||||||||||||||
Fannie Mae | 8,388 | — | 8,388 | 289 | (8 | ) | 8,669 | ||||||||||||||||
Subtotal GSEs | 11,816 | — | 11,816 | 408 | (10 | ) | 12,214 | ||||||||||||||||
PLRMBS: | |||||||||||||||||||||||
Prime | 2,607 | (2 | ) | 2,605 | 4 | (193 | ) | 2,416 | |||||||||||||||
Alt-A, option ARM | 49 | — | 49 | — | (15 | ) | 34 | ||||||||||||||||
Alt-A, other | 2,444 | (159 | ) | 2,285 | 66 | (258 | ) | 2,093 | |||||||||||||||
Subtotal PLRMBS | 5,100 | (161 | ) | 4,939 | 70 | (466 | ) | 4,543 | |||||||||||||||
Total MBS | 17,148 | (161 | ) | 16,987 | 480 | (476 | ) | 16,991 | |||||||||||||||
Total | $ | 26,385 | $ | (161 | ) | $ | 26,224 | $ | 480 | $ | (599 | ) | $ | 26,105 |
December 31, 2010 | |||||||||||||||||||||||
Amortized Cost(1) | OTTI Recognized in AOCI(1) | Carrying Value(1) | Gross Unrecognized Holding Gains(2) | Gross Unrecognized Holding Losses(2) | Estimated Fair Value | ||||||||||||||||||
Interest-bearing deposits | $ | 6,834 | $ | — | $ | 6,834 | $ | — | $ | — | $ | 6,834 | |||||||||||
Commercial paper | 2,500 | — | 2,500 | — | — | 2,500 | |||||||||||||||||
Housing finance agency bonds | 743 | — | 743 | — | (119 | ) | 624 | ||||||||||||||||
TLGP securities | 301 | — | 301 | — | — | 301 | |||||||||||||||||
Subtotal | 10,378 | — | 10,378 | — | (119 | ) | 10,259 | ||||||||||||||||
MBS: | |||||||||||||||||||||||
Other U.S. obligations – Ginnie Mae | 33 | — | 33 | — | — | 33 | |||||||||||||||||
GSEs: | |||||||||||||||||||||||
Freddie Mac | 2,326 | — | 2,326 | 92 | (15 | ) | 2,403 | ||||||||||||||||
Fannie Mae | 5,922 | — | 5,922 | 220 | (12 | ) | 6,130 | ||||||||||||||||
Subtotal GSEs | 8,248 | — | 8,248 | 312 | (27 | ) | 8,533 | ||||||||||||||||
PLRMBS: | |||||||||||||||||||||||
Prime | 4,285 | (330 | ) | 3,955 | 153 | (238 | ) | 3,870 | |||||||||||||||
Alt-A, option ARM | 1,751 | (653 | ) | 1,098 | 83 | (10 | ) | 1,171 | |||||||||||||||
Alt-A, other | 10,063 | (1,951 | ) | 8,112 | 694 | (458 | ) | 8,348 | |||||||||||||||
Subtotal PLRMBS | 16,099 | (2,934 | ) | 13,165 | 930 | (706 | ) | 13,389 | |||||||||||||||
Total MBS | 24,380 | (2,934 | ) | 21,446 | 1,242 | (733 | ) | 21,955 | |||||||||||||||
Total | $ | 34,758 | $ | (2,934 | ) | $ | 31,824 | $ | 1,242 | $ | (852 | ) | $ | 32,214 |
(1) Amortized cost includes unpaid principal balance, unamortized premiums and discounts, and previous other-than-temporary impairments recognized in earnings (less any cumulative-effect adjustments recognized). The carrying value of held-to-maturity securities represents amortized cost after adjustment for non-credit-related OTTI recognized in AOCI.
(2) Gross unrecognized holding gains/(losses) represent the difference between estimated fair value and carrying value, while gross unrealized gains/(losses) represent the difference between estimated fair value and amortized cost.
13
Securities Transferred. PLRMBS classified as held-to-maturity that experienced credit-related OTTI during the first six months of 2011 were reclassified to the Bank's available-for-sale portfolio at their fair values. These transfers allow the Bank the option to divest these securities prior to maturity in response to changes in interest rates, changes in prepayment risk, or other factors, while acknowledging its intent to hold these securities for an indefinite period of time. For additional information on the transferred securities, see Note 4 – Available-for-Sale Securities and Note 6 – Other-Than-Temporary Impairment Analysis.
The following tables summarize the held-to-maturity securities with unrealized losses as of June 30, 2011, and December 31, 2010. The unrealized losses are aggregated by major security type and the length of time that individual securities have been in a continuous unrealized loss position. For OTTI analysis of held-to-maturity securities, see Note 6 – Other-Than-Temporary Impairment Analysis.
June 30, 2011 | |||||||||||||||||||||||
Less Than 12 Months | 12 Months or More | Total | |||||||||||||||||||||
Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | ||||||||||||||||||
Interest-bearing deposits | $ | 5,725 | $ | — | $ | — | $ | — | $ | 5,725 | $ | — | |||||||||||
Commercial paper | 650 | — | — | — | 650 | — | |||||||||||||||||
Housing finance agency bonds | — | — | 590 | 123 | 590 | 123 | |||||||||||||||||
Subtotal | 6,375 | — | 590 | 123 | 6,965 | 123 | |||||||||||||||||
MBS: | |||||||||||||||||||||||
Other U.S. obligations – Ginnie Mae | — | — | 4 | — | 4 | — | |||||||||||||||||
GSEs: | |||||||||||||||||||||||
Freddie Mac | 424 | 2 | 24 | — | 448 | 2 | |||||||||||||||||
Fannie Mae | 396 | 5 | 190 | 3 | 586 | 8 | |||||||||||||||||
Subtotal GSEs | 820 | 7 | 214 | 3 | 1,034 | 10 | |||||||||||||||||
PLRMBS(1): | |||||||||||||||||||||||
Prime | 253 | 3 | 1,933 | 192 | 2,186 | 195 | |||||||||||||||||
Alt-A, option ARM | — | — | 34 | 15 | 34 | 15 | |||||||||||||||||
Alt-A, other | — | — | 2,059 | 417 | 2,059 | 417 | |||||||||||||||||
Subtotal PLRMBS | 253 | 3 | 4,026 | 624 | 4,279 | 627 | |||||||||||||||||
Total MBS | 1,073 | 10 | 4,244 | 627 | 5,317 | 637 | |||||||||||||||||
Total | $ | 7,448 | $ | 10 | $ | 4,834 | $ | 750 | $ | 12,282 | $ | 760 |
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December 31, 2010 | |||||||||||||||||||||||
Less Than 12 Months | 12 Months or More | Total | |||||||||||||||||||||
Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | ||||||||||||||||||
Interest-bearing deposits | $ | 4,438 | $ | — | $ | — | $ | — | $ | 4,438 | $ | — | |||||||||||
Commercial paper | 1,500 | — | — | — | 1,500 | — | |||||||||||||||||
Housing finance agency bonds | — | — | 624 | 119 | 624 | 119 | |||||||||||||||||
Subtotal | 5,938 | — | 624 | 119 | 6,562 | 119 | |||||||||||||||||
MBS: | |||||||||||||||||||||||
Other U.S. obligations – Ginnie Mae | 20 | — | 5 | — | 25 | — | |||||||||||||||||
GSEs: | |||||||||||||||||||||||
Freddie Mac | 497 | 15 | 27 | — | 524 | 15 | |||||||||||||||||
Fannie Mae | 623 | 8 | 91 | 4 | 714 | 12 | |||||||||||||||||
Subtotal GSEs | 1,120 | 23 | 118 | 4 | 1,238 | 27 | |||||||||||||||||
PLRMBS(1): | |||||||||||||||||||||||
Prime | 4 | — | 3,339 | 568 | 3,343 | 568 | |||||||||||||||||
Alt-A, option ARM | — | — | 1,150 | 663 | 1,150 | 663 | |||||||||||||||||
Alt-A, other | — | — | 8,307 | 2,409 | 8,307 | 2,409 | |||||||||||||||||
Subtotal PLRMBS | 4 | — | 12,796 | 3,640 | 12,800 | 3,640 | |||||||||||||||||
Total MBS | 1,144 | 23 | 12,919 | 3,644 | 14,063 | 3,667 | |||||||||||||||||
Total | $ | 7,082 | $ | 23 | $ | 13,543 | $ | 3,763 | $ | 20,625 | $ | 3,786 |
(1) Includes securities with gross unrecognized holding losses of $466 and $706 at June 30, 2011, and December 31, 2010, respectively, and securities with non-credit-related OTTI charges of $161 and $2,934 that have been recognized in AOCI at June 30, 2011, and December 31, 2010, respectively.
As indicated in the tables above, as of June 30, 2011, the Bank's investments classified as held-to-maturity had gross unrealized losses totaling $760, primarily relating to PLRMBS. The gross unrealized losses associated with the PLRMBS were primarily due to illiquidity in the MBS market, uncertainty about the future condition of the housing and mortgage markets and the economy, and continued deterioration in the credit performance of loan collateral underlying these securities, which caused these assets to be valued at significant discounts to their acquisition cost.
Redemption Terms. The amortized cost, carrying value, and estimated fair value of non-MBS securities by contractual maturity (based on contractual final principal payment) and of MBS as of June 30, 2011, and December 31, 2010, are shown below. Expected maturities of MBS will differ from contractual maturities because borrowers generally have the right to prepay the underlying obligations without prepayment fees.
15
June 30, 2011 | |||||||||||
Year of Contractual Maturity | Amortized Cost(1) | Carrying Value(1) | Estimated Fair Value | ||||||||
Held-to-maturity securities other than MBS: | |||||||||||
Due in 1 year or less | $ | 8,525 | $ | 8,525 | $ | 8,525 | |||||
Due after 1 year through 5 years | 5 | 5 | 5 | ||||||||
Due after 5 years through 10 years | 24 | 24 | 22 | ||||||||
Due after 10 years | 683 | 683 | 562 | ||||||||
Subtotal | 9,237 | 9,237 | 9,114 | ||||||||
MBS: | |||||||||||
Other U.S. obligations – Ginnie Mae | 232 | 232 | 234 | ||||||||
GSEs: | |||||||||||
Freddie Mac | 3,428 | 3,428 | 3,545 | ||||||||
Fannie Mae | 8,388 | 8,388 | 8,669 | ||||||||
Subtotal GSEs | 11,816 | 11,816 | 12,214 | ||||||||
PLRMBS: | |||||||||||
Prime | 2,607 | 2,605 | 2,416 | ||||||||
Alt-A, option ARM | 49 | 49 | 34 | ||||||||
Alt-A, other | 2,444 | 2,285 | 2,093 | ||||||||
Subtotal PLRMBS | 5,100 | 4,939 | 4,543 | ||||||||
Total MBS | 17,148 | 16,987 | 16,991 | ||||||||
Total | $ | 26,385 | $ | 26,224 | $ | 26,105 |
December 31, 2010 | |||||||||||
Year of Contractual Maturity | Amortized Cost(1) | Carrying Value(1) | Estimated Fair Value | ||||||||
Held-to-maturity securities other than MBS: | |||||||||||
Due in 1 year or less | $ | 9,635 | $ | 9,635 | $ | 9,635 | |||||
Due after 1 year through 5 years | 7 | 7 | 7 | ||||||||
Due after 5 years through 10 years | 26 | 26 | 23 | ||||||||
Due after 10 years | 710 | 710 | 594 | ||||||||
Subtotal | 10,378 | 10,378 | 10,259 | ||||||||
MBS: | |||||||||||
Other U.S. obligations – Ginnie Mae | 33 | 33 | 33 | ||||||||
GSEs: | |||||||||||
Freddie Mac | 2,326 | 2,326 | 2,403 | ||||||||
Fannie Mae | 5,922 | 5,922 | 6,130 | ||||||||
Subtotal GSEs | 8,248 | 8,248 | 8,533 | ||||||||
PLRMBS: | |||||||||||
Prime | 4,285 | 3,955 | 3,870 | ||||||||
Alt-A, option ARM | 1,751 | 1,098 | 1,171 | ||||||||
Alt-A, other | 10,063 | 8,112 | 8,348 | ||||||||
Subtotal PLRMBS | 16,099 | 13,165 | 13,389 | ||||||||
Total MBS | 24,380 | 21,446 | 21,955 | ||||||||
Total | $ | 34,758 | $ | 31,824 | $ | 32,214 |
(1) Amortized cost includes unpaid principal balance, unamortized premiums and discounts, and previous OTTI recognized in earnings (less any cumulative-effect adjustments recognized). The carrying value of held-to-maturity securities represents amortized cost after adjustment for non-credit-related OTTI recognized in AOCI.
16
At June 30, 2011, the carrying value of the Bank's MBS classified as held-to-maturity included net premiums of $31, credit-related OTTI of $29 (including interest accretion adjustments of $7), and non-credit-related OTTI of $161. At December 31, 2010, the carrying value of the Bank's MBS classified as held-to-maturity included net premiums of $8, credit-related OTTI related to credit loss of $995 (including interest accretion adjustments of $36), and non-credit-related OTTI of $2,934.
Interest Rate Payment Terms. Interest rate payment terms for held-to-maturity securities at June 30, 2011, and December 31, 2010, are detailed in the following table:
June 30, 2011 | December 31, 2010 | ||||||
Amortized cost of held-to-maturity securities other than MBS: | |||||||
Fixed rate | $ | 8,525 | $ | 9,635 | |||
Adjustable rate | 712 | 743 | |||||
Subtotal | 9,237 | 10,378 | |||||
Amortized cost of held-to-maturity MBS: | |||||||
Passthrough securities: | |||||||
Fixed rate | 2,112 | 2,461 | |||||
Adjustable rate | 153 | 169 | |||||
Collateralized mortgage obligations: | |||||||
Fixed rate | 9,883 | 11,097 | |||||
Adjustable rate | 5,000 | 10,653 | |||||
Subtotal | 17,148 | 24,380 | |||||
Total | $ | 26,385 | $ | 34,758 |
Certain MBS classified as fixed rate passthrough securities and fixed rate collateralized mortgage obligations have an initial fixed interest rate that subsequently converts to an adjustable interest rate on a specified date as follows:
June 30, 2011 | December 31, 2010 | ||||||
Passthrough securities: | |||||||
Converts in 1 year or less | $ | 157 | $ | 36 | |||
Converts after 1 year through 5 years | 1,113 | 1,484 | |||||
Converts after 5 years through 10 years | 808 | 917 | |||||
Total | $ | 2,078 | $ | 2,437 | |||
Collateralized mortgage obligations: | |||||||
Converts in 1 year or less | $ | 873 | $ | 864 | |||
Converts after 1 year through 5 years | 1,355 | 3,615 | |||||
Converts after 5 years through 10 years | 79 | 561 | |||||
Total | $ | 2,307 | $ | 5,040 |
The Bank does not own MBS that are backed by mortgage loans purchased by another FHLBank from either (i) members of the Bank or (ii) members of other FHLBanks.
Note 6 — Other-Than-Temporary Impairment Analysis
On a quarterly basis, the Bank evaluates its individual available-for-sale and held-to-maturity investment securities in an unrealized loss position for OTTI. As part of this evaluation, the Bank considers whether it intends to sell each debt security and whether it is more likely than not that it will be required to sell the security before its anticipated recovery of the amortized cost basis. If either of these conditions is met, the Bank recognizes an OTTI charge to earnings equal to the entire difference between the security's amortized cost basis and its fair value at the balance
17
sheet date. For securities in an unrealized loss position that meet neither of these conditions, the Bank considers whether it expects to recover the entire amortized cost basis of the security by comparing its best estimate of the present value of the cash flows expected to be collected from the security with the amortized cost basis of the security. If the Bank's best estimate of the present value of the cash flows expected to be collected is less than the amortized cost basis, the difference is considered the credit loss.
PLRMBS. To assess whether it expects to recover the entire amortized cost basis of its PLRMBS, the Bank performed a cash flow analysis for all of its PLRMBS as of June 30, 2011. In performing the cash flow analysis for each security, 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 on an assessment of the individual housing markets. CBSA refers collectively to metropolitan and micropolitan statistical areas as defined by the United States Office of Management and Budget. As currently defined, a CBSA must contain at least one urban area with a population of 10,000 or more people. The Bank's housing price forecast as of June 30, 2011, assumed current-to-trough home price declines ranging from 0% (for those housing markets that are believed to have reached their trough) to 8% over the 3- to 9-month periods beginning April 1, 2011, followed in each case by a 3-month period of flat prices. Thereafter, home prices were projected to recover using one of five different recovery paths that vary by housing market. Under those recovery paths, home prices were projected to increase within a range of 0% to 2.8% in the first year, 0% to 3% in the second year, 1.5% to 4% in the third year, 2% to 5% in the fourth year, 2% to 6% in the fifth and sixth years, and 2.3% to 5.6% in each subsequent year. The month-by-month projections of future loan performance derived from the first model, which reflect projected prepayments, default rates, 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 each securitization structure in accordance with the structure's prescribed cash flow and loss allocation rules. When the credit enhancement for the senior securities in a securitization is derived from the presence of subordinated securities, losses are generally allocated first to the subordinated securities until their principal balance is reduced to zero. The projected cash flows are based on a number of assumptions and expectations, and the results of these models can vary significantly with changes in assumptions and expectations. The scenario of cash flows determined based on the model approach described above reflects a best-estimate scenario and includes a base case current-to-trough housing price forecast and a base case housing price recovery path.
At each quarter end, the Bank compares the present value of the cash flows expected to be collected on its PLRMBS to the amortized cost basis of the securities to determine whether a credit loss exists. For the Bank's variable rate and hybrid PLRMBS, the Bank uses a forward interest rate curve to project the future estimated cash flows. The Bank then uses the effective interest rate for the security prior to impairment for determining the present value of the future estimated cash flows. For all securities, including securities previously identified as other-than-temporarily impaired, the Bank updates its estimate of future estimated cash flows on a quarterly basis.
For all the PLRMBS in its available-for-sale and held-to-maturity portfolios, the Bank does not intend to sell any security and it is not more likely than not that the Bank will be required to sell any security before its anticipated recovery of the remaining amortized cost basis.
For securities determined to be other-than-temporarily impaired as of June 30, 2011 (that is, securities for which the Bank determined that it does not expect to recover the entire amortized cost basis), the following table presents a summary of the significant inputs used in measuring the amount of credit loss recognized in earnings in the second quarter of 2011.
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June 30, 2011 | |||||||||||||||
Significant Inputs for Other-Than-Temporarily Impaired PLRMBS | Current | ||||||||||||||
Prepayment Rates | Default Rates | Loss Severities | Credit Enhancement | ||||||||||||
Year of Securitization | Weighted Average % | Range % | Weighted Average % | Range % | Weighted Average % | Range % | Weighted Average % | Range % | |||||||
Prime | |||||||||||||||
2008 | 10.1 | 8.5-10.7 | 51.7 | 45.7-58.5 | 45.8 | 41.8-51.5 | 29.8 | 29.2-30.5 | |||||||
2006 | 8.7 | 8.7 | 21.8 | 21.8 | 47.3 | 47.3 | 20.7 | 20.7 | |||||||
2005 | 7.7 | 7.7 | 45.9 | 45.9 | 39.1 | 39.1 | 15.0 | 15.0 | |||||||
2004 and earlier | 11.8 | 11.0-12.7 | 17.2 | 10.5-23.3 | 37.3 | 35.7-38.8 | 11.9 | 11.4-12.4 | |||||||
Total Prime | 9.9 | 7.7-12.7 | 45.0 | 10.5-58.5 | 45.2 | 35.7-51.5 | 26.9 | 11.4-30.5 | |||||||
Alt-A, option ARM | |||||||||||||||
2007 | 6.0 | 3.9-7.7 | 79.6 | 73.8-90.0 | 56.7 | 48.3-66.1 | 39.0 | 33.1-46.9 | |||||||
2006 | 6.0 | 4.8-7.4 | 82.1 | 74.6-88.5 | 59.5 | 49.5-68.0 | 36.0 | 31.7-39.6 | |||||||
2005 | 8.6 | 6.3-10.3 | 64.7 | 55.2-77.0 | 46.7 | 40.9-52.9 | 21.4 | 13.0-27.8 | |||||||
Total Alt-A, option ARM | 6.3 | 3.9-10.3 | 78.1 | 55.2-90.0 | 55.8 | 40.9-68.0 | 36.5 | 13.0-46.9 | |||||||
Alt-A, other | |||||||||||||||
2007 | 9.9 | 5.7-15.1 | 54.3 | 28.3-84.5 | 51.1 | 44.2-59.5 | 17.1 | 6.3-44.6 | |||||||
2006 | 10.4 | 4.1-12.1 | 49.6 | 31.7-79.3 | 52.7 | 42.8-58.1 | 20.3 | 6.5-34.7 | |||||||
2005 | 10.8 | 5.3-14.3 | 35.2 | 13.6-73.9 | 48.0 | 32.8-65.3 | 12.9 | 4.8-21.5 | |||||||
2004 and earlier | 12.1 | 11.1-13.2 | 37.6 | 17.4-52.7 | 46.8 | 42.5-51.5 | 17.4 | 8.6-27.1 | |||||||
Total Alt-A, other | 10.5 | 4.1-15.1 | 43.9 | 13.6-84.5 | 49.9 | 32.8-65.3 | 15.8 | 4.8-44.6 | |||||||
Total | 9.6 | 3.9-15.1 | 50.9 | 10.5-90.0 | 50.8 | 32.8-68.0 | 20.8 | 4.8-46.9 |
Credit enhancement is defined as the subordinated tranches and over-collateralization, if any, in a security structure that will generally absorb losses before the Bank will experience a loss on the security, expressed as a percentage of the underlying collateral balance. The calculated averages represent the dollar-weighted averages of all the PLRMBS investments in each category shown. The classification (prime or Alt-A) is based on the model used to run the estimated cash flows for the CUSIP, which may not necessarily be the same as the classification at the time of origination.
The following tables present the Bank's credit- and non-credit-related OTTI on its other-than-temporarily impaired PLRMBS during the three and six months ended June 30, 2011 and 2010:
Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | ||||||||||||||||||||||
Credit- Related OTTI | Non-Credit- Related OTTI | Total OTTI | Credit- Related OTTI | Non-Credit- Related OTTI | Total OTTI | ||||||||||||||||||
Other-than-temporarily impaired PLRMBS backed by loans classified at origination as: | |||||||||||||||||||||||
Prime | $ | 18 | $ | (14 | ) | $ | 4 | $ | 28 | $ | (24 | ) | $ | 4 | |||||||||
Alt-A, option ARM | 64 | (52 | ) | 12 | 56 | 28 | 84 | ||||||||||||||||
Alt-A, other | 81 | 19 | 100 | 58 | 44 | 102 | |||||||||||||||||
Total | $ | 163 | $ | (47 | ) | $ | 116 | $ | 142 | $ | 48 | $ | 190 |
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Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 | ||||||||||||||||||||||
Credit- Related OTTI | Non-Credit- Related OTTI | Total OTTI | Credit- Related OTTI | Non-Credit- Related OTTI | Total OTTI | ||||||||||||||||||
Other-than-temporarily impaired PLRMBS backed by loans classified at origination as: | |||||||||||||||||||||||
Prime | $ | 29 | $ | (16 | ) | $ | 13 | $ | 34 | $ | 29 | $ | 63 | ||||||||||
Alt-A, option ARM | 88 | (70 | ) | 18 | 71 | 14 | 85 | ||||||||||||||||
Alt-A, other | 155 | 18 | 173 | 97 | 137 | 234 | |||||||||||||||||
Total | $ | 272 | $ | (68 | ) | $ | 204 | $ | 202 | $ | 180 | $ | 382 |
For each security classified as held-to-maturity, the estimated non-credit-related OTTI is accreted prospectively, based on the amount and timing of future estimated cash flows, over the remaining life of the security as an increase in the carrying value of the security (with no effect on earnings unless the security is subsequently sold or there are additional decreases in the cash flows expected to be collected). The Bank accreted $253 and $428 from AOCI to increase the carrying value of the respective PLRMBS classified as held-to-maturity for the six months ended June 30, 2011 and 2010, respectively. The Bank does not intend to sell these securities and it is not more likely than not that the Bank will be required to sell these securities before its anticipated recovery of the remaining amortized cost basis.
The following table presents the credit-related OTTI, which is recognized in earnings, for the three and six months ended June 30, 2011 and 2010.
Three Months Ended | Six Months Ended | ||||||||||||||
June 30, 2011 | June 30, 2010 | June 30, 2011 | June 30, 2010 | ||||||||||||
Balance, beginning of the period | $ | 1,061 | $ | 688 | $ | 952 | $ | 628 | |||||||
Charges on securities for which OTTI was not previously recognized | 3 | 2 | 4 | 5 | |||||||||||
Additional charges on securities for which OTTI was previously recognized(1) | 160 | 140 | 268 | 197 | |||||||||||
Increases in cash flows expected to be collected, recognized over the remaining life of the securities | (1 | ) | — | (1 | ) | — | |||||||||
Balance, end of the period | $ | 1,223 | $ | 830 | $ | 1,223 | $ | 830 |
(1) For the three months ended June 30, 2011, “securities for which OTTI was previously recognized” represents all securities that were also other-than-temporarily impaired prior to April 1, 2011. For the three months ended June 30, 2010, “securities for which OTTI was previously recognized” represents all securities that were also previously other-than-temporarily impaired prior to April 1, 2010. For the six months ended June 30, 2011, “securities for which OTTI was previously recognized” represents all securities that were also other-than-temporarily impaired prior to January 1, 2011. For the six months ended June 30, 2010, “securities for which OTTI was previously recognized” represents all securities that were also previously other-than-temporarily impaired prior to January 1, 2010.
Changes in circumstances may cause the Bank to change its intent to hold a certain security to maturity without calling into question its intent to hold other debt securities to maturity in the future. The sale or transfer of a held-to-maturity security because of certain changes in circumstances, such as evidence of significant deterioration in the issuers' creditworthiness, is not considered to be inconsistent with its original classification. In addition, other events that are isolated, nonrecurring, and unusual for the Bank that could not have been reasonably anticipated may cause the Bank to sell or transfer a held-to-maturity security without necessarily calling into question its intent to hold other debt securities to maturity.
As of June 30, 2011, the Bank elected to transfer all its PLRMBS that incurred a credit-related OTTI charge during the second quarter of 2011 from the Bank's held-to-maturity portfolio to its available-for-sale portfolio. The Bank recognized an OTTI credit loss on these held-to-maturity PLRMBS, which the Bank believes is evidence of a significant decline in the issuers' creditworthiness. The decline in the issuers' creditworthiness is the basis for the transfers to its available-for-sale portfolio. These transfers allow the Bank the option to decide to sell these securities prior to maturity in response to changes in interest rates, changes in prepayment risk, or other factors,
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while recognizing the Bank's intent to hold these securities for an indefinite period of time. The Bank has no current plans to sell its other-than-temporarily impaired securities nor is it under any requirement to sell these securities.
The following tables summarize the PLRMBS transferred from the Bank's held-to-maturity portfolio to its available-for-sale portfolio during the three and six months ended June 30, 2011. The amounts shown represent the values when the securities were transferred from the held-to-maturity portfolio to the available-for-sale portfolio.
Three Months Ended June 30, 2011 | |||||||||||||||
Amortized Cost(1) | OTTI Recognized in AOCI(1) | Gross Unrecognized Holding Gains(1) | Estimated Fair Value | ||||||||||||
PLRMBS: | |||||||||||||||
Prime | $ | 390 | $ | (103 | ) | $ | 44 | $ | 331 | ||||||
Alt-A, option ARM | 1,223 | (414 | ) | 63 | 872 | ||||||||||
Alt-A, other | 1,013 | (216 | ) | 61 | 858 | ||||||||||
Total | $ | 2,626 | $ | (733 | ) | $ | 168 | $ | 2,061 |
Six Months Ended June 30, 2011 | |||||||||||||||
Amortized Cost(1) | OTTI Recognized in AOCI(1) | Gross Unrecognized Holding Gains(1) | Estimated Fair Value | ||||||||||||
PLRMBS: | |||||||||||||||
Prime | $ | 1,058 | $ | (294 | ) | $ | 143 | $ | 907 | ||||||
Alt-A, option ARM | 1,575 | (520 | ) | 78 | 1,133 | ||||||||||
Alt-A, other | 7,083 | (1,687 | ) | 636 | 6,032 | ||||||||||
Total | $ | 9,716 | $ | (2,501 | ) | $ | 857 | $ | 8,072 |
(1) Gross unrecognized holding gains/(losses) represent the difference between estimated fair value and carrying value, while gross unrealized gains/(losses) represent the difference between estimated fair value and amortized cost.
The following tables present the Bank's other-than-temporarily impaired PLRMBS that incurred an OTTI charge during the three months ended June 30, 2011 and 2010, by loan collateral type:
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June 30, 2011 | |||||||||||||||||||||||||||
Available-for-Sale Securities | Held-to-Maturity Securities | ||||||||||||||||||||||||||
Unpaid Principal Balance | Amortized Cost | Estimated Fair Value | Unpaid Principal Balance | Amortized Cost | Carrying Value | Estimated Fair Value | |||||||||||||||||||||
Other-than-temporarily impaired PLRMBS backed by loans classified at origination as: | |||||||||||||||||||||||||||
Prime | $ | 875 | $ | 781 | $ | 680 | $ | — | $ | — | $ | — | $ | — | |||||||||||||
Alt-A, option ARM | 1,895 | 1,522 | 1,095 | — | — | — | — | ||||||||||||||||||||
Alt-A, other | 6,594 | 5,972 | 5,112 | — | — | — | — | ||||||||||||||||||||
Total | $ | 9,364 | $ | 8,275 | $ | 6,887 | $ | — | $ | — | $ | — | $ | — | |||||||||||||
June 30, 2010 | |||||||||||||||||||||||||||
Available-for-Sale Securities | Held-to-Maturity Securities | ||||||||||||||||||||||||||
Unpaid Principal Balance | Amortized Cost | Estimated Fair Value | Unpaid Principal Balance | Amortized Cost | Carrying Value | Estimated Fair Value | |||||||||||||||||||||
Other-than-temporarily impaired PLRMBS backed by loans classified at origination as: | |||||||||||||||||||||||||||
Prime | $ | — | $ | — | $ | — | $ | 1,265 | $ | 1,180 | $ | 825 | $ | 950 | |||||||||||||
Alt-A, option ARM | — | — | — | 2,004 | 1,734 | 998 | 1,031 | ||||||||||||||||||||
Alt-A, other | — | — | — | 6,139 | 5,729 | 3,982 | 4,416 | ||||||||||||||||||||
Total | $ | — | $ | — | $ | — | $ | 9,408 | $ | 8,643 | $ | 5,805 | $ | 6,397 |
The following tables present the Bank's other-than-temporarily impaired PLRMBS that incurred an OTTI charge anytime during the life of the securities at June 30, 2011, and December 31, 2010, by loan collateral type:
June 30, 2011 | |||||||||||||||||||||||||||
Available-for-Sale Securities | Held-to-Maturity Securities | ||||||||||||||||||||||||||
Unpaid Principal Balance | Amortized Cost | Estimated Fair Value | Unpaid Principal Balance | Amortized Cost | Carrying Value | Estimated Fair Value | |||||||||||||||||||||
Other-than-temporarily impaired PLRMBS backed by loans classified at origination as: | |||||||||||||||||||||||||||
Prime | $ | 1,141 | $ | 1,009 | $ | 892 | $ | 51 | $ | 50 | $ | 48 | $ | 51 | |||||||||||||
Alt-A, option ARM | 1,943 | 1,536 | 1,110 | — | — | — | — | ||||||||||||||||||||
Alt-A, other | 7,537 | 6,834 | 5,853 | 701 | 679 | 520 | 584 | ||||||||||||||||||||
Total | $ | 10,621 | $ | 9,379 | $ | 7,855 | $ | 752 | $ | 729 | $ | 568 | $ | 635 | |||||||||||||
December 31, 2010 | |||||||||||||||||||||||||||
Available-for-Sale Securities | Held-to-Maturity Securities | ||||||||||||||||||||||||||
Unpaid Principal Balance | Amortized Cost | Estimated Fair Value | Unpaid Principal Balance | Amortized Cost | Carrying Value | Estimated Fair Value | |||||||||||||||||||||
Other-than-temporarily impaired PLRMBS backed by loans classified at origination as: | |||||||||||||||||||||||||||
Prime | $ | — | $ | — | $ | — | $ | 1,263 | $ | 1,159 | $ | 829 | $ | 978 | |||||||||||||
Alt-A, option ARM | — | — | — | 2,047 | 1,723 | 1,070 | 1,154 | ||||||||||||||||||||
Alt-A, other | — | — | — | 7,900 | 7,338 | 5,388 | 6,079 | ||||||||||||||||||||
Total | $ | — | $ | — | $ | — | $ | 11,210 | $ | 10,220 | $ | 7,287 | $ | 8,211 |
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For the Bank's PLRMBS that were not other-than-temporarily impaired as of June 30, 2011, the Bank has experienced net unrealized losses and a decrease in fair value primarily because of illiquidity in the MBS market, uncertainty about the future condition of the housing and mortgage markets and the economy, and continued deterioration in the credit performance of loan collateral underlying these securities, which caused these assets to be valued at significant discounts to their acquisition cost. The Bank does not intend to sell these securities, it is not more likely than not that the Bank will be required to sell these securities before its anticipated recovery of the remaining amortized cost basis, and the Bank expects to recover the entire amortized cost basis of these securities. As a result, the Bank determined that, as of June 30, 2011, the gross unrealized losses on these remaining PLRMBS are temporary. Forty-eight percent of the PLRMBS, based on amortized cost, that were not other-than-temporarily impaired were rated investment grade (7% were rated AAA), and the remaining 52% were rated below investment grade. These securities were included in the securities that the Bank reviewed and analyzed for OTTI as discussed above, and the analyses performed indicated that these securities were not other-than-temporarily impaired. The credit ratings used by the Bank are based on the lowest of Moody's Investors Service (Moody's), Standard & Poor's Ratings Services (Standard & Poor's), or comparable Fitch ratings.
All Other Available-for-Sale and Held-to-Maturity Investments. The Bank determined that, as of June 30, 2011, the immaterial gross unrealized losses on its interest-bearing deposits and commercial paper were temporary because the gross unrealized losses were caused by movements in interest rates and not by the deterioration of the issuers' creditworthiness. The interest-bearing deposits and commercial paper were all with issuers that had credit ratings of at least A at June 30, 2011, and all of the securities matured prior to the date of this report. As a result, the Bank has recovered the entire amortized cost basis of these securities.
As of June 30, 2011, the Bank's investments in housing finance agency bonds, which were issued by the California Housing Finance Agency (CalHFA), had gross unrealized losses totaling $123. These gross unrealized losses were mainly due to an illiquid market and credit concerns regarding the underlying mortgage pool, causing these investments to be valued at a discount to their acquisition cost. In addition, the Bank independently modeled cash flows for the underlying collateral, using assumptions for default rates and loss severity that the Bank deemed reasonable, and concluded that the available credit support within the CalHFA structure more than offset the projected losses on the underlying collateral. The Bank determined that, as of June 30, 2011, all of the gross unrealized losses on these bonds are temporary because the underlying collateral and credit enhancements were sufficient to protect the Bank from losses based on current expectations and because CalHFA had a credit rating of A at June 30, 2011 (based on the lower of Moody's or Standard & Poor's ratings). As a result, the Bank expects to recover the entire amortized cost basis of these securities.
The Bank also invests in corporate debentures issued under the TLGP, which are guaranteed by the FDIC and backed by the full faith and credit of the U.S. government. The Bank expects to recover the entire amortized cost basis of these securities because it determined that the strength of the guarantees and the direct support from the U.S. government are sufficient to protect the Bank from losses based on current expectations. As a result, the Bank determined that as of June 30, 2011, all the gross unrealized losses on its TLGP securities are temporary.
For its agency MBS, the Bank expects to recover the entire amortized cost basis of these securities because it determined that the strength of the issuers' guarantees through direct obligations or support from the U.S. government is sufficient to protect the Bank from losses based on current expectations. As a result, the Bank determined that, as of June 30, 2011, all of the gross unrealized losses on its agency MBS are temporary.
Note 7 — Advances
The Bank offers a wide range of fixed- and adjustable-rate advance products with different maturities, interest rates, payment characteristics, and optionality. Fixed rate advances generally have maturities ranging from one day to 30 years. Adjustable rate advances generally have maturities ranging from less than 30 days to 10 years, where the interest rates reset periodically at a fixed spread to the LIBOR or other specified index.
23
Redemption Terms. The Bank had advances outstanding, excluding overdrawn demand deposit accounts, at interest rates ranging from 0.10% to 8.57% at June 30, 2011, and 0.03% to 8.57% at December 31, 2010, as summarized below.
June 30, 2011 | December 31, 2010 | ||||||||||||
Contractual Maturity | Amount Outstanding | Weighted Average Interest Rate | Amount Outstanding | Weighted Average Interest Rate | |||||||||
Within 1 year | $ | 39,611 | 0.75 | % | $ | 52,051 | 0.97 | % | |||||
After 1 year through 2 years | 15,780 | 1.07 | 11,687 | 1.92 | |||||||||
After 2 years through 3 years | 11,539 | 1.47 | 17,038 | 1.17 | |||||||||
After 3 years through 4 years | 3,604 | 2.41 | 2,310 | 2.81 | |||||||||
After 4 years through 5 years | 5,010 | 2.02 | 5,115 | 2.14 | |||||||||
After 5 years | 6,566 | 1.79 | 6,708 | 1.92 | |||||||||
Total par amount | 82,110 | 1.14 | % | 94,909 | 1.30 | % | |||||||
Valuation adjustments for hedging activities | 303 | 363 | |||||||||||
Valuation adjustments under fair value option | 332 | 327 | |||||||||||
Total | $ | 82,745 | $ | 95,599 |
Many of the Bank's advances are prepayable at the member's option. However, when advances are prepaid, the member is generally charged a prepayment fee intended to make the Bank financially indifferent to the prepayment. In addition, for certain advances with partial prepayment symmetry, the Bank may charge the member a prepayment fee or pay the member a prepayment credit, depending on certain circumstances, such as movements in interest rates, when the advance is prepaid. The Bank had advances with partial prepayment symmetry outstanding totaling $6,948 at June 30, 2011, and $7,335 at December 31, 2010. Some advances may be repaid on pertinent call dates without prepayment fees (callable advances). The Bank had callable advances outstanding totaling $447 at June 30, 2011, and $283 at December 31, 2010.
The Bank's advances at June 30, 2011, and December 31, 2010, included $1,883 and $2,437, respectively, of putable advances. At the Bank's discretion, the Bank may terminate these advances on predetermined exercise dates, and offer, subject to certain conditions, replacement funding at prevailing market rates. The Bank would typically exercise such termination rights when interest rates increase.
The following table summarizes advances at June 30, 2011, and December 31, 2010, by the earlier of the year of contractual maturity or next call date for callable advances and by the earlier of the year of contractual maturity or next put date for putable advances.
Earlier of Contractual Maturity or Next Call Date | Earlier of Contractual Maturity or Next Put Date | ||||||||||||||
June 30, 2011 | December 31, 2010 | June 30, 2011 | December 31, 2010 | ||||||||||||
Within 1 year | $ | 40,058 | $ | 52,328 | $ | 41,146 | $ | 54,145 | |||||||
After 1 year through 2 years | 15,774 | 11,692 | 15,512 | 11,053 | |||||||||||
After 2 years through 3 years | 11,512 | 17,035 | 11,361 | 16,828 | |||||||||||
After 3 years through 4 years | 3,578 | 2,300 | 3,428 | 2,160 | |||||||||||
After 4 years through 5 years | 4,945 | 5,084 | 4,838 | 4,812 | |||||||||||
After 5 years | 6,243 | 6,470 | 5,825 | 5,911 | |||||||||||
Total par amount | $ | 82,110 | $ | 94,909 | $ | 82,110 | $ | 94,909 |
Credit and Concentration Risk. The following tables present the concentration in advances to the top five borrowers and their affiliates at June 30, 2011, and June 30, 2010. The tables also present the interest income from
24
these advances before the impact of interest rate exchange agreements associated with these advances for the three and six months ended June 30, 2011 and 2010.
June 30, 2011 | Three Months Ended June 30, 2011 | Six Months Ended June 30, 2011 | ||||||||||||||||||
Name of Borrower | Advances Outstanding(1) | Percentage of Total Advances Outstanding | Interest Income from Advances(4) | Percentage of Total Interest Income from Advances | Interest Income from Advances(4) | Percentage of Total Interest Income from Advances | ||||||||||||||
JPMorgan Chase & Co.: | ||||||||||||||||||||
JPMorgan Bank & Trust Company, National Association | $ | 23,200 | 28 | % | $ | 30 | 12 | % | $ | 61 | 12 | % | ||||||||
JPMorgan Chase Bank, National Association(2) | 1,567 | 2 | 3 | 1 | 12 | 2 | ||||||||||||||
Subtotal JPMorgan Chase & Co. | 24,767 | 30 | 33 | 13 | 73 | 14 | ||||||||||||||
Citibank, N.A.(3) | 24,010 | 29 | 16 | 7 | 34 | 6 | ||||||||||||||
Bank of America California, N.A. | 5,200 | 6 | 17 | 7 | 42 | 8 | ||||||||||||||
OneWest Bank, FSB | 4,645 | 6 | 28 | 11 | 64 | 12 | ||||||||||||||
Union Bank, N.A. | 4,500 | 6 | 18 | 7 | 33 | 6 | ||||||||||||||
Subtotal | 63,122 | 77 | 112 | 45 | 246 | 46 | ||||||||||||||
Others | 18,988 | 23 | 138 | 55 | 283 | 54 | ||||||||||||||
Total | $ | 82,110 | 100 | % | $ | 250 | 100 | % | $ | 529 | 100 | % |
June 30, 2010 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2010 | ||||||||||||||||||
Name of Borrower | Advances Outstanding(1) | Percentage of Total Advances Outstanding | Interest Income from Advances(4) | Percentage of Total Interest Income from Advances | Interest Income from Advances(4) | Percentage of Total Interest Income from Advances | ||||||||||||||
Citibank, N.A. | $ | 30,003 | 32 | % | $ | 25 | 6 | % | $ | 47 | 5 | % | ||||||||
Bank of America Corporation: | ||||||||||||||||||||
Bank of America California, N.A. | 13,904 | 15 | 34 | 8 | 63 | 6 | ||||||||||||||
Bank of America, NA | 130 | — | — | — | — | — | ||||||||||||||
Subtotal Bank of America Corporation | 14,034 | 15 | 34 | 8 | 63 | 6 | ||||||||||||||
JPMorgan Chase & Co.: | ||||||||||||||||||||
JPMorgan Bank & Trust Company, National Association | 5,000 | 5 | 4 | 1 | 6 | 1 | ||||||||||||||
JPMorgan Chase Bank, National Association(2) | 8,609 | 9 | 89 | 20 | 226 | 24 | ||||||||||||||
Subtotal JPMorgan Chase & Co. | 13,609 | 14 | 93 | 21 | 232 | 25 | ||||||||||||||
OneWest Bank, FSB | 6,074 | 6 | 55 | 12 | 112 | 12 | ||||||||||||||
Wells Fargo Bank, N.A.(2) | 6,387 | 7 | 25 | 6 | 56 | 6 | ||||||||||||||
Subtotal | 70,107 | 74 | 232 | 53 | 510 | 54 | ||||||||||||||
Others | 24,582 | 26 | 209 | 47 | 437 | 46 | ||||||||||||||
Total | $ | 94,689 | 100 | % | $ | 441 | 100 | % | $ | 947 | 100 | % |
(1) Borrower advance amounts and total advance amounts are at par value, and total advance amounts will not agree to carrying value amounts shown in the Statements of Condition. The differences between the par and carrying value amounts primarily relate to unrealized gains or losses associated with hedged advances resulting from valuation adjustments related to hedging activities and the fair value option.
(2) Nonmember institutions.
(3) The Bank reclassified $3,165 of capital stock to mandatorily redeemable capital stock (a liability) on June 28, 2011, as a result of the membership termination of Citibank, N.A., which became ineligible for membership in the Bank when it became a member of another Federal Home Loan Bank in connection with its planned merger with an affiliate outside of the Bank's district.
(4) Interest income amounts exclude the interest effect of interest rate exchange agreements with derivatives counterparties; as a result, the total interest income amounts will not agree to the Statements of Income. The amount of interest income from advances can vary depending on the amount outstanding, terms to maturity, interest rates, and repricing characteristics.
25
The Bank held a security interest in collateral from each of the top five advances borrowers and their affiliates sufficient to support their respective advances outstanding, and the Bank does not expect to incur any credit losses on these advances. As of June 30, 2011, two of the advances borrowers and their affiliates (JPMorgan Chase & Co. and Citibank, N.A.) each owned more than 10% of the Bank's outstanding capital stock, including mandatorily redeemable capital stock.
For information related to the Bank's credit risk on advances and allowance methodology for credit losses, see Note 9 – Allowance for Credit Losses.
Interest Rate Payment Terms. Interest rate payment terms for advances at June 30, 2011, and December 31, 2010, are detailed below:
June 30, 2011 | December 31, 2010 | ||||||
Par amount of advances: | |||||||
Fixed rate: | |||||||
Due within 1 year | $ | 12,350 | $ | 19,800 | |||
Due after 1 year | 20,052 | 24,191 | |||||
Total fixed rate | 32,402 | 43,991 | |||||
Adjustable rate | |||||||
Due within 1 year | 27,261 | 32,251 | |||||
Due after 1 year | 22,447 | 18,667 | |||||
Total adjustable rate | 49,708 | 50,918 | |||||
Total par amount | $ | 82,110 | $ | 94,909 |
At June 30, 2011, and December 31, 2010, 73% and 71% of the fixed rate advances were swapped to an adjustable rate, such as LIBOR, and 3% of the adjustable rate advances at December 31, 2010, were swapped to a different adjustable rate index, such as 1-month or 3-month LIBOR.
Prepayment Fees, Net. The Bank charges borrowers prepayment fees or pays borrowers prepayment credits when the principal on certain advances is paid prior to original maturity. The Bank records prepayment fees net of any associated fair value adjustments related to prepaid advances that were hedged. The net amount of prepayment fees is reflected as interest income in the Statements of Income, as follows:
Three Months Ended | Six Months Ended | ||||||||||||||
June 30, 2011 | June 30, 2010 | June 30, 2011 | June 30, 2010 | ||||||||||||
Prepayment fees received | $ | 22 | $ | 59 | $ | 55 | $ | 78 | |||||||
Fair value adjustments | (18 | ) | (11 | ) | (45 | ) | (19 | ) | |||||||
Other basis adjustments | — | (20 | ) | — | (20 | ) | |||||||||
Net | $ | 4 | $ | 28 | $ | 10 | $ | 39 | |||||||
Advance principal prepaid | $ | 2,620 | $ | 8,146 | $ | 3,295 | $ | 14,551 |
Note 8 — Mortgage Loans Held for Portfolio
Under the Mortgage Partnership Finance® (MPF®) Program, the Bank purchased conventional conforming fixed rate residential mortgage loans directly from its participating members from May 2002 through October 2006. (“Mortgage Partnership Finance” and “MPF” are registered trademarks of the Federal Home Loan Bank of Chicago.) The mortgage loans are held-for-portfolio loans. Participating members originated or purchased the mortgage loans, credit-enhanced them and sold them to the Bank, and generally retained the servicing of the loans.
The following table presents information as of June 30, 2011, and December 31, 2010, on mortgage loans, all of
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which are secured by one- to four-unit residential properties and single-unit second homes.
June 30, 2011 | December 31, 2010 | ||||||
Fixed rate medium-term mortgage loans | $ | 608 | $ | 706 | |||
Fixed rate long-term mortgage loans | 1,509 | 1,694 | |||||
Subtotal | 2,117 | 2,400 | |||||
Net unamortized discounts | (15 | ) | (16 | ) | |||
Mortgage loans held for portfolio | 2,102 | 2,384 | |||||
Less: Allowance for credit losses | (5 | ) | (3 | ) | |||
Total mortgage loans held for portfolio, net | $ | 2,097 | $ | 2,381 |
Medium-term loans have original contractual terms of 15 years or less, and long-term loans have contractual terms of more than 15 years.
The participating member and the Bank share the risk of credit losses on conventional MPF loan products by structuring potential losses on conventional MPF loans into layers with respect to each master commitment. After any primary mortgage insurance, the Bank is obligated to incur the first layer or portion of credit losses not absorbed by the borrower's equity. Under the MPF Program, the participating member's credit enhancement protection consists of the credit enhancement amount, which may be a direct obligation of the participating member or may be a supplemental mortgage insurance policy paid for by the participating member, and may include a contingent performance-based credit enhancement fee payable to the participating member. The participating member is required to pledge collateral to secure any portion of its credit enhancement amount that is a direct obligation.
For taking on the credit enhancement obligation, the Bank pays the participating member or any successor a credit enhancement fee, which is calculated on the remaining unpaid principal balance of the mortgage loans. The Bank records credit enhancement fees as a reduction to interest income. For the three and six months ended June 30, 2011, the Bank reduced net interest income for credit enhancement fees by an immaterial amount and $1, respectively. For the three and six months ended June 30, 2010, the credit enhancement fees were immaterial.
Concentration Risk. The Bank had the following concentration in MPF loans with institutions whose outstanding total of mortgage loans sold to the Bank represented 10% or more of the Bank's total outstanding mortgage loans at June 30, 2011, and December 31, 2010.
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June 30, 2011 | ||||||||||||
Name of Institution | Mortgage Loan Balances Outstanding | Percentage of Total Mortgage Loan Balances Outstanding | Number of Mortgage Loans Outstanding | Percentage of Total Number of Mortgage Loans Outstanding | ||||||||
JPMorgan Chase Bank, National Association | $ | 1,671 | 79 | % | 14,157 | 72 | % | |||||
OneWest Bank, FSB | 276 | 13 | 3,913 | 20 | ||||||||
Subtotal | 1,947 | 92 | 18,070 | 92 | ||||||||
Others | 170 | 8 | 1,569 | 8 | ||||||||
Total | $ | 2,117 | 100 | % | 19,639 | 100 | % | |||||
December 31, 2010 | ||||||||||||
Name of Institution | Mortgage Loan Balances Outstanding | Percentage of Total Mortgage Loan Balances Outstanding | Number of Mortgage Loans Outstanding | Percentage of Total Number of Mortgage Loans Outstanding | ||||||||
JPMorgan Chase Bank, National Association | $ | 1,887 | 79 | % | 15,560 | 72 | % | |||||
OneWest Bank, FSB | 317 | 13 | 4,229 | 20 | ||||||||
Subtotal | 2,204 | 92 | 19,789 | 92 | ||||||||
Others | 196 | 8 | 1,739 | 8 | ||||||||
Total | $ | 2,400 | 100 | % | 21,528 | 100 | % |
For information related to the Bank's credit risk on mortgage loans and allowance methodology for credit losses, see Note 9 – Allowance for Credit Losses.
Note 9 — Allowance for Credit Losses
The Bank has established an allowance methodology for each of its portfolio segments: credit products, mortgage loans held for portfolio, securities purchased under agreements to resell, and Federal funds sold.
Credit Products. Under the Federal Home Loan Bank Act of 1932, as amended (FHLBank Act), the Bank is required to obtain sufficient collateral for credit products to protect the Bank from credit losses. Collateral eligible to secure credit products includes certain investment securities, residential mortgage loans, cash or deposits with the Bank, and other eligible real estate-related assets. The Bank may also accept secured small business, small farm, and small agribusiness loans, and securities representing a whole interest in such secured loans, as collateral from members that are community financial institutions. The Bank evaluates the creditworthiness of its members and nonmember borrowers on an ongoing basis. For more information on security terms, see “Item 8. Financial Statements and Supplementary Data – Note 10 – Allowance for Credit Losses” in the Bank's 2010 Form 10-K.
The Bank classifies as impaired any advance with respect to which the Bank believes it is probable that all principal and interest due will not be collected according to its contractual terms. Impaired advances are valued using the present value of expected future cash flows discounted at the advance's effective interest rate, the advance's observable market price or, if collateral-dependent, the fair value of the advance's underlying collateral. When an advance is classified as impaired, the accrual of interest is discontinued and unpaid accrued interest is reversed. Advances do not return to accrual status until they are brought current with respect to both principal and interest and until the Bank believes future principal payments are no longer in doubt. No advances were classified as impaired during the periods presented.
The Bank manages its credit exposure to credit products through an integrated approach that generally provides for a credit limit to be established for each borrower, includes an ongoing review of each borrower's financial condition, and is coupled with conservative collateral and lending policies to limit risk of loss while taking into account borrowers' needs for a reliable source of funding. At June 30, 2011, and December 31, 2010, none of the Bank's credit products were past due, on nonaccrual status, or considered impaired. There were no troubled debt
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restructurings related to credit products during the six months ended June 30, 2011, and during 2010.
The Bank has policies and procedures in place to manage the credit risk of advances. Based on the collateral pledged as security for advances, the Bank's credit analyses of members' financial condition, and the Bank's credit extension and collateral policies, the Bank expects to collect all amounts due according to the contractual terms of the advances. Therefore, no allowance for losses on advances was deemed necessary by the Bank. The Bank has never experienced any credit losses on advances.
During the first six months of 2011, five member institutions were placed into receivership or liquidation. Four of these institutions had advances outstanding at the time they were placed into receivership or liquidation and one institution did not. The advances outstanding to the four institutions were either repaid prior to June 30, 2011, or assumed by other institutions, and no losses were incurred by the Bank. Bank capital stock held by one of the five institutions totaling $2 was classified as mandatorily redeemable capital stock (a liability). The capital stock of the other four institutions was transferred to other member institutions.
From July 1, 2011, to July 29, 2011, one member institution was placed into receivership. The advances outstanding to this institution were assumed by another member institution and no losses were incurred by the Bank. The Bank capital stock held by this institution was transferred to another member institution.
Mortgage Loans Held for Portfolio. A mortgage loan is considered to be impaired when it is reported 90 days or more past due (nonaccrual) or when it is probable, based on current information and events, that the Bank will be unable to collect all principal and interest amounts due according to the contractual terms of the mortgage loan agreement.
Loans that are on nonaccrual status and that are considered collateral-dependent are measured for impairment based on the fair value of the underlying property less estimated selling costs. Loans are considered collateral-dependent if repayment is expected to be provided solely by the sale of the underlying property, that is, there is no other available and reliable source of repayment. Collateral-dependent loans are impaired if the fair value of the underlying collateral less estimated selling costs is insufficient to recover the unpaid principal balance on the loan. Interest income on impaired loans is recognized in the same manner as nonaccrual loans noted below.
The Bank places a mortgage loan on nonaccrual status when the collection of the contractual principal or interest from the participating institution is reported 90 days or more past due. When a mortgage loan is placed on nonaccrual status, accrued but uncollected interest is reversed against interest income. The Bank records cash payments received on nonaccrual loans first as interest income and then as a reduction of principal as specified in the contractual agreement, unless the collection of the remaining principal amount due is considered doubtful.
The following table presents information on delinquent mortgage loans as of June 30, 2011, and December 31, 2010.
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June 30, 2011 | December 31, 2010 | ||||||
Recorded Investment(1) | Recorded Investment(1) | ||||||
30 – 59 days delinquent | $ | 17 | $ | 27 | |||
60 – 89 days delinquent | 8 | 8 | |||||
90 days or more delinquent | 33 | 29 | |||||
Total past due | 58 | 64 | |||||
Total current loans | 2,054 | 2,330 | |||||
Total mortgage loans | $ | 2,112 | $ | 2,394 | |||
In process of foreclosure, included above(2) | $ | 20 | $ | 18 | |||
Nonaccrual loans | $ | 33 | $ | 30 | |||
Loans past due 90 days or more and still accruing interest | $ | — | $ | — | |||
Serious delinquencies(3) as a percentage of total mortgage loans outstanding | 1.54 | % | 1.23 | % |
(1) The recorded investment in a loan is the unpaid principal balance of the loan, adjusted for accrued interest, net deferred loan fees or costs, unamortized premiums or discounts, and direct write-downs. The recorded investment is not net of any valuation allowance.
(2) Includes loans for which the servicer has reported a decision to foreclose or to pursue a similar alternative, such as deed-in-lieu. Loans in process of foreclosure are included in past due or current loans depending on their delinquency status.
(3) Represents loans that are 90 days or more past due or in the process of foreclosure.
The Bank's average recorded investment in impaired loans totaled $33 and $28 for the second quarter of 2011 and 2010, respectively, and $32 and $26 for the six months ended June 30, 2011 and 2010, respectively. In addition, an insignificant amount of the Bank's MPF loans were classified as troubled debt restructurings at June 30, 2011.
The allowance for credit losses on the mortgage loan portfolio was as follows:
Three Months Ended | Six Months Ended | ||||||||||||||
June 30, 2011 | June 30, 2010 | June 30, 2011 | June 30, 2010 | ||||||||||||
Balance, beginning of the period | $ | 3.2 | $ | 2.0 | $ | 3.3 | $ | 2.0 | |||||||
Chargeoffs – transferred to real estate owned (REO) | (0.3 | ) | (0.3 | ) | (0.7 | ) | (0.7 | ) | |||||||
Provision for credit losses | 2.5 | 1.9 | 2.8 | 2.3 | |||||||||||
Balance, end of the period | $ | 5.4 | $ | 3.6 | $ | 5.4 | $ | 3.6 | |||||||
Ratio of net charge-offs during the period to average loans outstanding during the period | (0.02 | )% | (0.01 | )% | (0.03 | )% | (0.02 | )% | |||||||
Ending balance, individually evaluated for impairment | $ | — | $ | — | |||||||||||
Ending balance, collectively evaluated for impairment | $ | (5.4 | ) | $ | (5.4 | ) | |||||||||
Recorded investment, end of the period(1) | $ | 2,112 | $ | 2,112 | |||||||||||
Individually evaluated for impairment | $ | — | $ | — | |||||||||||
Collectively evaluated for impairment | $ | 2,112 | $ | 2,112 |
(1) Excludes government-guaranteed or government-insured loans.
The Bank calculates its estimated allowance for credit losses on mortgage loans acquired under its two MPF products, Original MPF and MPF Plus, as described below.
Allowance for Credit Losses on Original MPF Loans - The Bank evaluates the allowance for credit losses on Original MPF mortgage loans based on two components. The first component applies to each individual loan that is specifically identified as impaired. The Bank evaluates the exposure on these loans in excess of the first three layers of loss protection (the liquidation value of the real property securing the loan, any primary mortgage insurance, and available credit enhancements) and records a provision for credit losses on the Original MPF loans. The Bank established an allowance for credit losses for this component of the allowance for credit losses on Original MPF
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loans totaling $0.3 as of June 30, 2011, and $0.3 as of December 31, 2010.
The second component applies to loans that are not specifically identified as impaired and is based on the Bank's estimate of probable credit losses on those loans as of the financial statement date. The Bank evaluates the credit loss exposure on a loan pool basis considering various observable data, such as delinquency statistics, past performance, current performance, loan portfolio characteristics, collateral valuations, industry data, and prevailing economic conditions. The availability and collectability of credit enhancements from institutions or from mortgage insurers under the terms of each Master Commitment are also considered. The Bank established an allowance for credit losses for this component of the allowance for credit losses on Original MPF loans totaling $0.1 as of June 30, 2011, and $0.1 as of December 31, 2010.
Allowance for Credit Losses on MPF Plus Loans - The Bank evaluates the allowance for credit losses on MPF Plus loans based on two components. The first component applies to each individual loan that is specifically identified as impaired. The Bank evaluates the exposure on these loans in excess of the first and second layers of loss protection (the liquidation value of the real property securing the loan and any primary mortgage insurance) to determine whether the Bank's potential credit loss exposure is in excess of the accrued performance-based credit enhancement fee and any supplemental mortgage insurance. If it is, the Bank records an allowance for credit losses on MPF Plus loans. The Bank established an allowance for credit losses for this component of the allowance for credit losses on MPF Plus loans totaling $3.9 as of June 30, 2011, and $2.2 as of December 31, 2010.
The second component applies to loans that are not specifically identified as impaired and is based on the Bank's estimate of probable credit losses on those loans as of the financial statement date. The Bank evaluates the credit loss exposure on a loan pool basis and considers various observable data, such as delinquency statistics, past performance, current performance, loan portfolio characteristics, collateral valuations, industry data, and prevailing economic conditions. The availability and collectability of credit enhancements from institutions or from mortgage insurers under the terms of each Master Commitment are also considered. The Bank established an allowance for credit losses for this component of the allowance for credit losses on MPF Plus loans totaling $1.1 as of June 30, 2011, and $0.7 as of December 31, 2010.
Term Securities Purchased Under Agreements to Resell. The Bank did not have any securities purchased under agreements to resell at June 30, 2011, and December 31, 2010.
Term Federal Funds Sold. The Bank invests in Federal funds sold with highly rated counterparties, and these investments are only evaluated for purposes of an allowance for credit losses if the investment is not paid when due. All investments in Federal funds sold as of June 30, 2011, and December 31, 2010, were repaid according to the contractual terms.
Note 10 — Deposits
The Bank maintains demand deposit accounts that are directly related to the extension of credit to members and offers short-term deposit programs to members and qualifying nonmembers. In addition, a member that services mortgage loans may deposit in the Bank funds collected in connection with the mortgage loans, pending disbursement of these funds to the owners of the mortgage loans. The Bank classifies these types of deposits as non-interest-bearing deposits.
Deposits as of June 30, 2011, and December 31, 2010, were as follows:
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June 30, 2011 | December 31, 2010 | ||||||
Interest-bearing deposits: | |||||||
Demand and overnight | $ | 127 | $ | 110 | |||
Term | 11 | 16 | |||||
Other | 6 | 2 | |||||
Total interest-bearing deposits | 144 | 128 | |||||
Non-interest-bearing deposits | 2 | 6 | |||||
Total | $ | 146 | $ | 134 |
Interest Rate Payment Terms. Deposits classified as demand, overnight, and other, pay interest based on a daily interest rate. Term deposits pay interest based on a fixed rate determined at the issuance of the deposit. Interest rate payment terms for deposits at June 30, 2011, and December 31, 2010, are detailed in the following table:
June 30, 2011 | December 31, 2010 | ||||||||||||
Amount Outstanding | Weighted Average Interest Rate | Amount Outstanding | Weighted Average Interest Rate | ||||||||||
Interest-bearing deposits: | |||||||||||||
Fixed rate | $ | 11 | 0.01 | % | $ | 16 | 0.06 | % | |||||
Adjustable rate | 133 | 0.01 | 112 | 0.01 | |||||||||
Total interest-bearing deposits | 144 | 0.01 | 128 | 0.02 | |||||||||
Non-interest-bearing deposits | 2 | — | 6 | — | |||||||||
Total | $ | 146 | 0.01 | % | $ | 134 | 0.02 | % |
The aggregate amount of time deposits with a denomination of $0.1 or more was $11 at June 30, 2011, and $16 at December 31, 2010. These time deposits were scheduled to mature within three months.
Note 11 — Consolidated Obligations
Consolidated obligations, consisting of consolidated obligation bonds and discount notes, are jointly issued by the FHLBanks through the Office of Finance, which serves as the FHLBanks' agent. As provided by the FHLBank Act or by regulations governing the operations of the FHLBanks, all FHLBanks have joint and several liability for all FHLBank consolidated obligations. For a discussion of the joint and several liability regulation, see “Item 8. Financial Statements and Supplementary Data – Note 20 – Commitments and Contingencies” in the Bank's 2010 Form 10-K. In connection with each debt issuance, each FHLBank specifies the type, term, and amount of debt it requests to have issued on its behalf. The Office of Finance tracks the amount of debt issued on behalf of each FHLBank. In addition, the Bank separately tracks and records as a liability its specific portion of the consolidated obligations issued and is the primary obligor for that portion of the consolidated obligations issued. The Federal Housing Finance Agency (Finance Agency), the successor agency to the Federal Housing Finance Board (Finance Board), and the U.S. Secretary of the Treasury have oversight over the issuance of FHLBank debt through the Office of Finance.
Redemption Terms. The following is a summary of the Bank's participation in consolidated obligation bonds at June 30, 2011, and December 31, 2010.
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June 30, 2011 | December 31, 2010 | ||||||||||||
Contractual Maturity | Amount Outstanding | Weighted Average Interest Rate | Amount Outstanding | Weighted Average Interest Rate | |||||||||
Within 1 year | $ | 57,525 | 1.27 | % | $ | 68,636 | 1.53 | % | |||||
After 1 year through 2 years | 17,272 | 1.71 | 18,154 | 0.99 | |||||||||
After 2 years through 3 years | 13,124 | 2.67 | 15,557 | 3.06 | |||||||||
After 3 years through 4 years | 3,511 | 1.97 | 2,228 | 2.69 | |||||||||
After 4 years through 5 years | 7,121 | 2.00 | 5,913 | 1.92 | |||||||||
After 5 years | 11,779 | 3.81 | 9,100 | 3.96 | |||||||||
Index amortizing notes | 4 | 4.61 | 5 | 4.61 | |||||||||
Total par amount | 110,336 | 1.85 | % | 119,593 | 1.87 | % | |||||||
Net unamortized premiums/(discounts) | 85 | 10 | |||||||||||
Valuation adjustments for hedging activities | 1,325 | 1,627 | |||||||||||
Fair value option valuation adjustments | (37 | ) | (110 | ) | |||||||||
Total | $ | 111,709 | $ | 121,120 |
The Bank's participation in consolidated obligation bonds outstanding includes callable bonds of $22,990 at June 30, 2011, and $17,617 at December 31, 2010. Contemporaneous with the issuance of a callable bond for which the Bank is the primary obligor, the Bank routinely enters into an interest rate swap (in which the Bank pays a variable rate and receives a fixed rate) with a call feature that mirrors the call option embedded in the bond (a sold callable swap). The Bank had notional amounts of interest rate exchange agreements hedging callable bonds of $19,910 at June 30, 2011, and $13,853 at December 31, 2010. The combined sold callable swap and callable bond enable the Bank to meet its funding needs at costs not otherwise directly attainable solely through the issuance of non-callable debt, while effectively converting the Bank's net payment to an adjustable rate.
The Bank's participation in consolidated obligation bonds was as follows:
June 30, 2011 | December 31, 2010 | ||||||
Par amount of consolidated obligation bonds: | |||||||
Non-callable | $ | 87,346 | $ | 101,976 | |||
Callable | 22,990 | 17,617 | |||||
Total par amount | $ | 110,336 | $ | 119,593 |
The following is a summary of the Bank's participation in consolidated obligation bonds outstanding at June 30, 2011, and December 31, 2010, by the earlier of the year of contractual maturity or next call date.
Earlier of Contractual Maturity or Next Call Date | June 30, 2011 | December 31, 2010 | |||||
Within 1 year | $ | 78,310 | $ | 81,318 | |||
After 1 year through 2 years | 15,567 | 18,299 | |||||
After 2 years through 3 years | 8,399 | 12,897 | |||||
After 3 years through 4 years | 1,075 | 1,208 | |||||
After 4 years through 5 years | 2,740 | 1,610 | |||||
After 5 years | 4,241 | 4,256 | |||||
Index amortizing notes | 4 | 5 | |||||
Total par amount | $ | 110,336 | $ | 119,593 |
Consolidated obligation discount notes are consolidated obligations issued to raise short-term funds. These notes are issued at less than their face amount and redeemed at par value when they mature. The Bank's participation in consolidated obligation discount notes, all of which are due within one year, was as follows:
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June 30, 2011 | December 31, 2010 | ||||||||||||
Amount Outstanding | Weighted Average Interest Rate | Amount Outstanding | Weighted Average Interest Rate | ||||||||||
Par amount | $ | 20,414 | 0.15 | % | $ | 19,540 | 0.21 | % | |||||
Unamortized discounts | (8 | ) | (13 | ) | |||||||||
Total | $ | 20,406 | $ | 19,527 |
Interest Rate Payment Terms. Interest rate payment terms for consolidated obligations at June 30, 2011, and December 31, 2010, are detailed in the following table. For information on the general terms and types of consolidated obligations outstanding, see “Item 8. Financial Statements and Supplementary Data – Note 12 – Consolidated Obligations” in the Bank's 2010 Form 10-K.
June 30, 2011 | December 31, 2010 | ||||||
Par amount of consolidated obligations: | |||||||
Bonds: | |||||||
Fixed rate | $ | 74,543 | $ | 80,766 | |||
Adjustable rate | 30,146 | 33,300 | |||||
Step-up | 4,798 | 4,843 | |||||
Step-down | 230 | 215 | |||||
Fixed rate that converts to adjustable rate | 495 | 419 | |||||
Adjustable rate that converts to fixed rate | 35 | 35 | |||||
Adjustable rate that converts to step-up | 75 | — | |||||
Range bonds | 10 | 10 | |||||
Index amortizing notes | 4 | 5 | |||||
Total bonds, par | 110,336 | 119,593 | |||||
Discount notes, par | 20,414 | 19,540 | |||||
Total consolidated obligations, par | $ | 130,750 | $ | 139,133 |
At June 30, 2011, and December 31, 2010, 85% and 86% of the fixed rate bonds were swapped to an adjustable rate, such as LIBOR, and 96% and 96% of the adjustable rate bonds were swapped to a different adjustable rate index, such as 1-month or 3-month LIBOR. At June 30, 2011, and December 31, 2010, 77% and 63% of the fixed rate discount notes were swapped to an adjustable rate, such as LIBOR.
Note 12 — Capital
Capital Requirements. Under the Housing and Economic Recovery Act of 2008 (Housing Act), the Director of the Finance Agency is responsible for setting the risk-based capital standards for the FHLBanks. The FHLBank Act and regulations governing the operations of the FHLBanks require that the minimum stock requirement for members must be sufficient to enable the Bank to meet its regulatory requirements for total capital, leverage capital, and risk-based capital. The Bank must maintain (i) total regulatory capital in an amount equal to at least 4% of its total assets, (ii) leverage capital in an amount equal to at least 5% of its total assets, and (iii) permanent capital in an amount at least equal to its regulatory risk-based capital requirement. Regulatory capital and permanent capital are defined as retained earnings and Class B stock, which includes mandatorily redeemable capital stock that is classified as a liability for financial reporting purposes. Regulatory capital and permanent capital do not include AOCI. Leverage capital is defined as the sum of permanent capital, weighted by a 1.5 multiplier, plus non-permanent capital. Non-permanent capital consists of Class A capital stock, which is redeemable upon six months' notice. The Bank's capital plan does not provide for the issuance of Class A capital stock.
The risk-based capital requirements must be met with permanent capital, which must be at least equal to the sum of the Bank's credit risk, market risk, and operations risk capital requirements, all of which are calculated in
34
accordance with the rules and regulations of the Finance Agency. The Finance Agency may require an FHLBank to maintain a greater amount of permanent capital than is required by the risk-based capital requirements as defined.
As of June 30, 2011, and December 31, 2010, the Bank was in compliance with these capital rules and requirements.
The following table shows the Bank's compliance with the Finance Agency's capital requirements at June 30, 2011, and December 31, 2010.
June 30, 2011 | December 31, 2010 | ||||||||||||||
Required | Actual | Required | Actual | ||||||||||||
Risk-based capital | $ | 3,749 | $ | 12,855 | $ | 4,209 | $ | 13,640 | |||||||
Total regulatory capital | $ | 5,778 | $ | 12,855 | $ | 6,097 | $ | 13,640 | |||||||
Total regulatory capital ratio | 4.00 | % | 8.90 | % | 4.00 | % | 8.95 | % | |||||||
Leverage capital | $ | 7,222 | $ | 19,283 | $ | 7,621 | $ | 20,460 | |||||||
Leverage ratio | 5.00 | % | 13.35 | % | 5.00 | % | 13.42 | % |
Mandatorily Redeemable Capital Stock. The Bank had mandatorily redeemable capital stock totaling $6,144 outstanding to 53 institutions at June 30, 2011, and $3,749 outstanding to 50 institutions at December 31, 2010. The change in mandatorily redeemable capital stock for the three and six months ended June 30, 2011 and 2010, was as follows:
Three Months Ended | Six Months Ended | ||||||||||||||
June 30, 2011 | June 30, 2010 | June 30, 2011 | June 30, 2010 | ||||||||||||
Balance at the beginning of the period | $ | 3,102 | $ | 4,858 | $ | 3,749 | $ | 4,843 | |||||||
Reclassified from/(to) capital during the period: | |||||||||||||||
Merger with or acquisition by nonmember institution | 12 | — | 13 | — | |||||||||||
Termination of membership(1) | 3,165 | 12 | 3,167 | 30 | |||||||||||
Acquired by/transferred to members(2) | — | — | (500 | ) | — | ||||||||||
Redemption of mandatorily redeemable capital stock | (3 | ) | — | (26 | ) | (3 | ) | ||||||||
Repurchase of excess mandatorily redeemable capital stock | (132 | ) | (180 | ) | (259 | ) | (180 | ) | |||||||
Balance at the end of the period | $ | 6,144 | $ | 4,690 | $ | 6,144 | $ | 4,690 |
(1) The Bank reclassified $3,165 of capital stock to mandatorily redeemable capital stock (a liability) on June 28, 2011, as a result of the membership termination of Citibank, N.A., which became ineligible for membership in the Bank when it became a member of another Federal Home Loan Bank in connection with its planned merger with an affiliate outside of the Bank's district.
(2) During 2008, JPMorgan Chase Bank, National Association, a nonmember, assumed Washington Mutual Bank's outstanding Bank advances and acquired the associated Bank capital stock. The Bank reclassified the capital stock transferred to JPMorgan Chase Bank, National Association, totaling $3,208, to mandatorily redeemable capital stock (a liability). JPMorgan Bank and Trust Company, National Association, an affiliate of JPMorgan Chase Bank, National Association, became a member of the Bank. During the first quarter of 2011, the Bank allowed the transfer of excess stock totaling $500 from JPMorgan Chase Bank, National Association, to JPMorgan Bank and Trust Company, National Association, to enable JPMorgan Bank and Trust Company, National Association, to satisfy its activity-based stock requirement. The capital stock transferred is no longer classified as mandatorily redeemable capital stock (a liability). However, the capital stock remaining with JPMorgan Chase Bank, National Association, remains classified as mandatorily redeemable capital stock (a liability).
Cash dividends on mandatorily redeemable capital stock in the amount of $3 and $6 were recorded as interest expense for the three and six months ended June 30, 2011. Cash dividends on mandatorily redeemable capital stock in the amount of $3 and $6 were recorded as interest expense for the three and six months ended June 30, 2010.
The Bank's mandatorily redeemable capital stock is discussed more fully in “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital” in the Bank's 2010 Form 10-K.
The following table presents mandatorily redeemable capital stock amounts by contractual redemption period at June 30, 2011, and December 31, 2010.
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Contractual Redemption Period | June 30, 2011 | December 31, 2010 | |||||
Within 1 year | $ | 38 | $ | 58 | |||
After 1 year through 2 years | 48 | 58 | |||||
After 2 years through 3 years | 1,220 | 1,797 | |||||
After 3 years through 4 years | 1,409 | 1,538 | |||||
After 4 years through 5 years | 3,429 | 298 | |||||
Total | $ | 6,144 | $ | 3,749 |
Retained Earnings and Dividend Policy. The Bank's Retained Earnings and Dividend Policy establishes amounts to be retained in restricted retained earnings, which are not made available for dividends in the current dividend period.
Retained Earnings Related to Valuation Adjustments – In accordance with the Retained Earnings and Dividend Policy, the Bank retains in restricted retained earnings any cumulative net gains in earnings (net of applicable assessments) resulting from gains or losses on derivatives and associated hedged items and financial instruments carried at fair value (valuation adjustments). As the cumulative net gains are reversed by periodic net losses and settlements of contractual interest cash flows, the amount of cumulative net gains decreases. The amount of retained earnings required by this provision of the policy is therefore decreased, and that portion of the previously restricted retained earnings becomes unrestricted and may be made available for dividends. Retained earnings restricted in accordance with these provisions totaled $130 at June 30, 2011, and $148 at December 31, 2010. In accordance with this provision, the amount decreased by $18 in the first six months of 2011 as a result of net unrealized losses resulting from valuation adjustments during this period.
Other Retained Earnings – Targeted Buildup – In addition to any cumulative net gains resulting from valuation adjustments, the Bank holds an additional amount in restricted retained earnings intended to protect members' paid-in capital from the effects of an extremely adverse credit event, an extremely adverse operations risk event, an extremely high level of quarterly losses related to the Bank's derivatives and associated hedged items and financial instruments carried at fair value, the risk of an extremely adverse change in the market value of the Bank's capital, and the risk of a significant amount of additional credit-related OTTI on PLRMBS, especially in periods of extremely low net income resulting from an adverse interest rate environment.
The Board of Directors has set the targeted amount of restricted retained earnings at $1,800. The Bank's retained earnings target may be changed at any time. The Board of Directors will periodically review the methodology and analysis to determine whether any adjustments are appropriate. The retained earnings restricted in accordance with this provision of the Retained Earnings and Dividend Policy totaled $1,535 at June 30, 2011, and $1,461 at December 31, 2010.
For more information on these two categories of restricted retained earnings and the Bank's Retained Earnings and Dividend Policy, see “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital” in the Bank's 2010 Form 10-K.
Joint Capital Enhancement Agreement – The 12 FHLBanks entered into a Joint Capital Enhancement Agreement (Agreement), as amended, which is intended to enhance the capital position of each FHLBank by allocating that portion of each FHLBank's earnings historically paid to satisfy its Resolution Funding Corporation (REFCORP) obligation to a separate retained earnings account at that FHLBank.
The Agreement provides that, upon full satisfaction of the REFCORP obligation, each FHLBank will contribute 20% of its net income each quarter to a restricted retained earnings account until the balance of that account equals at least 1% of that FHLBank's average balance of outstanding consolidated obligations for the previous quarter. These restricted retained earnings will not be available to pay dividends.
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The FHLBanks subsequently amended their capital plans or capital plan submissions, as applicable, to implement the provisions of the Agreement, and the Finance Agency approved the capital plan amendments on August 5, 2011. The Bank's amended capital plan will become effective on September 5, 2011.
On August 5, 2011, the Finance Agency certified that the FHLBanks have fully satisfied their REFCORP obligation. In accordance with the Agreement, starting in the third quarter of 2011, each FHLBank is required to allocate 20% of its net income to a separate restricted retained earnings account.
Dividend Payments – Finance Agency rules state that FHLBanks may declare and pay dividends only from previously retained earnings or current net earnings, and may not declare or pay dividends based on projected or anticipated earnings. There is no requirement that the Board of Directors declare and pay any dividend. A decision by the Board of Directors to declare a dividend is a discretionary matter and is subject to the requirements and restrictions of the FHLBank Act and applicable requirements under the regulations governing the operations of the FHLBanks.
The Bank paid dividends (including dividends on mandatorily redeemable capital stock) totaling $10 at an annualized rate of 0.31% in the second quarter of 2011, and $8 at an annualized rate of 0.26% in the second quarter of 2010.
The Bank paid dividends (including dividends on mandatorily redeemable capital stock) totaling $19 at an annualized rate of 0.30% in the first six months of 2011, and $17 at an annualized rate of 0.27% in the first six months of 2010.
On July 28, 2011, the Bank's Board of Directors declared a cash dividend for the second quarter of 2011 at an annualized dividend rate of 0.26%. The Bank recorded the second quarter dividend on July 28, 2011, the day it was declared by the Board of Directors. The Bank expects to pay the second quarter dividend (including dividends on mandatorily redeemable capital stock), which will total $7, on or about August 11, 2011.
The Bank will pay the second quarter 2011 dividend in cash rather than stock to comply with Finance Agency rules, which do not permit the Bank to pay dividends in the form of capital stock if the Bank's excess stock (defined as any stock holdings in excess of a member's minimum capital stock requirement, as established by the Bank's capital plan) exceeds 1% of its total assets. As of June 30, 2011, the Bank's excess capital stock totaled $6,349, or 4.40% of total assets.
The Bank will continue to monitor the condition of its PLRMBS portfolio, the ratio of the estimated market value of the Bank's capital to the par value of the Bank's capital stock, its overall financial performance and retained earnings, developments in the mortgage and credit markets, and other relevant information as the basis for determining the status of dividends in future quarters.
Excess and Surplus Capital Stock. The Bank may repurchase some or all of a member's excess capital stock and any excess mandatorily redeemable capital stock, at the Bank's discretion and subject to certain statutory and regulatory requirements. The Bank must give the member 15 days' written notice; however, the member may waive this notice period. The Bank may also repurchase some or all of a member's excess capital stock at the member's request, at the Bank's discretion and subject to certain statutory and regulatory requirements. A member's excess capital stock is defined as any stock holdings in excess of the member's minimum capital stock requirement, as established by the Bank's capital plan.
The Bank's surplus capital stock repurchase policy provides for the Bank to repurchase excess stock that constitutes surplus stock, at the Bank's discretion and subject to certain statutory and regulatory requirements, if a member has surplus capital stock as of the last business day of the quarter. A member's surplus capital stock is defined as any stock held by a member in excess of 115% of its minimum capital stock requirement, generally excluding stock
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dividends earned and credited for the current year.
On a quarterly basis, the Bank determines whether it will repurchase excess capital stock, including surplus capital stock. Because of a decision to preserve capital in view of the possibility of future OTTI charges on the Bank's PLRMBS portfolio, the Bank did not fully repurchase excess stock created by declining advances balances in 2010 and during the first half of 2011. The Bank opted to maintain its strong regulatory capital position, while repurchasing $445 and $471 in excess capital stock in the first and second quarters of 2011, respectively. The Bank did not repurchase excess stock in the first quarter of 2010 and repurchased excess stock totaling $487 in the second quarter of 2010.
During the second quarter of 2011, the five-year redemption period for $3 in mandatorily redeemable capital stock expired, and the Bank redeemed the stock at its $100 par value on the relevant expiration dates.
On July 28, 2011, the Bank announced that it plans to repurchase up to $500 in excess capital stock on August 15, 2011. The amount of excess capital stock to be repurchased from any shareholder will be based on the shareholder's pro rata ownership share of total capital stock outstanding as of the repurchase date, up to the amount of the shareholder's excess capital stock.
The Bank will continue to monitor the condition of its PLRMBS portfolio, the ratio of the estimated market value of the Bank's capital to the par value of the Bank's capital stock, its overall financial performance and retained earnings, developments in the mortgage and credit markets, and other relevant information as the basis for determining the status of capital stock repurchases in future quarters.
Excess capital stock totaled $6,349 as of June 30, 2011, which included surplus capital stock of $5,986.
For more information on excess and surplus capital stock, see “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital” in the Bank's 2010 Form 10-K.
Concentration. The following table presents the concentration in capital stock held by institutions whose capital stock ownership represented 10% or more of the Bank's outstanding capital stock, including mandatorily redeemable capital stock, as of June 30, 2011, and December 31, 2010.
June 30, 2011 | December 31, 2010 | ||||||||||||
Name of Institution | Capital Stock Outstanding | Percentage of Total Capital Stock Outstanding | Capital Stock Outstanding | Percentage of Total Capital Stock Outstanding | |||||||||
Citigroup Inc.: | |||||||||||||
Citibank, N.A.(1)(2) | $ | 3,165 | 28 | % | $ | 3,445 | 29 | % | |||||
Banamex USA | 2 | — | — | — | |||||||||
Subtotal Citigroup Inc. | 3,167 | 28 | 3,445 | 29 | |||||||||
JPMorgan Chase & Co.: | |||||||||||||
JPMorgan Bank & Trust Company, National Association | 1,470 | 13 | 1,099 | 9 | |||||||||
JPMorgan Chase Bank, National Association(2) | 978 | 9 | 1,566 | 13 | |||||||||
Subtotal JPMorgan Chase & Co. | 2,448 | 22 | 2,665 | 22 | |||||||||
Wells Fargo & Company: | |||||||||||||
Wells Fargo Bank, N.A.(2) | 1,299 | 12 | 1,435 | 12 | |||||||||
Wells Fargo Financial National Bank | 5 | — | 5 | — | |||||||||
Subtotal Wells Fargo & Company | 1,304 | 12 | 1,440 | 12 | |||||||||
Total capital stock ownership over 10% | 6,919 | 62 | 7,550 | 63 | |||||||||
Others | 4,271 | 38 | 4,481 | 37 | |||||||||
Total | $ | 11,190 | 100 | % | $ | 12,031 | 100 | % |
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(1) The Bank reclassified $3,165 of capital stock to mandatorily redeemable capital stock (a liability) on June 28, 2011, as a result of the membership termination of Citibank, N.A., which became ineligible for membership in the Bank when it became a member of another Federal Home Loan Bank in connection with its planned merger with an affiliate outside of the Bank's district.
(2) The capital stock held by these institutions is classified as mandatorily redeemable capital stock.
Note 13 — Segment Information
The Bank uses an analysis of financial performance based on the balances and adjusted net interest income of two operating segments, the advances-related business and the mortgage-related business, as well as other financial information, to review and assess financial performance and to determine the allocation of resources to these two major business segments. For purposes of segment reporting, adjusted net interest income includes interest income and expense associated with economic hedges that are recorded in “Net gain on derivatives and hedging activities” in other income and excludes interest expense that is recorded in “Mandatorily redeemable capital stock.” Other key financial information, such as any OTTI loss on the Bank's available-for-sale and held-to-maturity PLRMBS, other expenses, and assessments, are not included in the segment reporting analysis, but are incorporated into the Bank's overall assessment of financial performance.
For more information on these operating segments, see “Item 8. Financial Statements and Supplementary Data – Note 17 – Segment Information” in the Bank's 2010 Form 10-K.
The following table presents the Bank's adjusted net interest income by operating segment and reconciles total adjusted net interest income to income before assessments for the three and six months ended June 30, 2011 and 2010.
Advances- Related Business | Mortgage- Related Business(1) | Adjusted Net Interest Income | Amortization of Basis Adjustments(2) | Net Interest Expense on Economic Hedges(3) | Interest Expense on Mandatorily Redeemable Capital Stock(4) | Net Interest Income | Other Loss | Other Expense | Income Before Assessments | ||||||||||||||||||||||||||||||
Three months ended: | |||||||||||||||||||||||||||||||||||||||
June 30, 2011 | $ | 88 | $ | 142 | $ | 230 | $ | (27 | ) | $ | (7 | ) | $ | 3 | $ | 261 | $ | (219 | ) | $ | 30 | $ | 12 | ||||||||||||||||
June 30, 2010 | 145 | 154 | 299 | (22 | ) | (43 | ) | 3 | 361 | (285 | ) | 35 | 41 | ||||||||||||||||||||||||||
Six months ended: | |||||||||||||||||||||||||||||||||||||||
June 30, 2011 | 181 | 275 | 456 | (50 | ) | (17 | ) | 6 | 517 | (361 | ) | 62 | 94 | ||||||||||||||||||||||||||
June 30, 2010 | 283 | 292 | 575 | (42 | ) | (107 | ) | 6 | 718 | (480 | ) | 71 | 167 |
(1) Does not include credit-related OTTI charges of $163 and $142 for the three months ended June 30, 2011 and 2010, respectively. Does not include credit-related OTTI charges of $272 and $202 for the six months ended June 30, 2011 and 2010, respectively.
(2) Represents amortization of amounts deferred for adjusted net interest income purposes only in accordance with the Bank's Retained Earnings and Dividend Policy.
(3) The Bank includes interest income and interest expense associated with economic hedges in adjusted net interest income in its analysis of financial performance for its two operating segments. For financial reporting purposes, the Bank does not include these amounts in net interest income in the Statements of Income, but instead records them in other income in “Net gain on derivatives and hedging activities.”
(4) The Bank excludes interest expense on mandatorily redeemable capital stock from adjusted net interest income in its analysis of financial performance for its two operating segments.
The following table presents total assets by operating segment at June 30, 2011, and December 31, 2010.
Advances- Related Business | Mortgage- Related Business | Total Assets | |||||||||
June 30, 2011 | $ | 117,334 | $ | 27,104 | $ | 144,438 | |||||
December 31, 2010 | 128,424 | 23,999 | 152,423 |
Note 14 — Derivatives and Hedging Activities
General. The Bank may enter into interest rate swaps (including callable, putable, and basis swaps); swaptions; and cap, floor, corridor, and collar agreements (collectively, interest rate exchange agreements or derivatives). Most of
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the Bank's interest rate exchange agreements are executed in conjunction with the origination of advances and the issuance of consolidated obligation bonds to create variable rate structures. The interest rate exchange agreements are generally executed at the same time the advances and bonds are transacted and generally have the same maturity dates as the related advances and bonds.
Additional active uses of interest rate exchange agreements include: (i) offsetting interest rate caps, floors, corridors, or collars embedded in adjustable rate advances made to members, (ii) hedging the anticipated issuance of debt, (iii) matching against consolidated obligation discount notes or bonds to create the equivalent of callable fixed rate debt, (iv) reducing the interest rate sensitivity and modifying the repricing gaps of assets and liabilities, and (v) exactly offsetting other derivatives executed with members (with the Bank serving as an intermediary). The Bank's use of interest rate exchange agreements results in one of the following classifications: (i) a fair value hedge of an underlying financial instrument, (ii) a forecasted transaction, (iii) a cash flow hedge of an underlying financial instrument, (iv) an economic hedge for specific asset and liability management purposes, or (v) an intermediary transaction for members.
Interest Rate Swaps – An interest rate swap is an agreement between two entities to exchange cash flows in the future. The agreement sets the dates on which the cash flows will be paid and the manner in which the cash flows will be calculated. One of the simplest forms of an interest rate swap involves the promise by one party to pay cash flows equivalent to the interest on a notional principal amount at a predetermined fixed rate for a given period of time. In return for this promise, the party receives cash flows equivalent to the interest on the same notional principal amount at a variable rate for the same period of time. The variable rate received or paid by the Bank in most interest rate exchange agreements is indexed to LIBOR.
Swaptions – A swaption is an option on a swap that gives the buyer the right to enter into a specified interest rate swap at a certain time in the future. When used as a hedge, a swaption can protect the Bank against future interest rate changes when it is planning to lend or borrow funds in the future. The Bank purchases receiver swaptions. A receiver swaption is the option to receive fixed interest rate payments at a later date.
Interest Rate Caps and Floors – In a cap agreement, a cash flow is generated if the price or interest rate of an underlying variable rises above a certain threshold (or cap) price. In a floor agreement, a cash flow is generated if the price or interest rate of an underlying variable falls below a certain threshold (or floor) price. Caps may be used in conjunction with liabilities and floors may be used in conjunction with assets. Caps and floors are designed as protection against the interest rate on a variable rate asset or liability rising above or falling below a certain level.
Hedging Activities. The Bank documents all relationships between derivative hedging instruments and hedged items, its risk management objectives and strategies for undertaking various hedge transactions, and its method of assessing effectiveness. This process includes linking all derivatives that are designated as fair value or cash flow hedges to: (i) assets and liabilities on the balance sheet, (ii) firm commitments, or (iii) forecasted transactions. The Bank also formally assesses (both at the hedge's inception and at least quarterly on an ongoing basis) whether the derivatives that are used in hedging transactions have been effective in offsetting changes in the fair value or cash flows of hedged items and whether those derivatives may be expected to remain effective in future periods. The Bank typically uses regression analyses or other statistical analyses to assess the effectiveness of its hedges. When it is determined that a derivative has not been or is not expected to be effective as a hedge, the Bank discontinues hedge accounting prospectively.
The Bank discontinues hedge accounting prospectively when: (i) it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item (including hedged items such as firm commitments or forecasted transactions); (ii) the derivative and/or the hedged item expires or is sold, terminated, or exercised; (iii) it is no longer probable that the forecasted transaction will occur in the originally expected period; (iv) a hedged firm commitment no longer meets the definition of a firm commitment; (v) it determines that designating the derivative as a hedging instrument is no longer appropriate; or (vi) it decides to use the derivative to offset changes in the fair value of other derivatives or instruments carried at fair value.
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Intermediation – As an additional service to its members, the Bank enters into offsetting interest rate exchange agreements, acting as an intermediary between exactly offsetting derivatives transactions with members and other counterparties. This intermediation allows members indirect access to the derivatives market. Derivatives in which the Bank is an intermediary may also arise when the Bank enters into derivatives to offset the economic effect of other derivatives that are no longer designated to advances, investments, or consolidated obligations. The offsetting derivatives used in intermediary activities do not receive hedge accounting treatment and are separately marked to market through earnings. The net result of the accounting for these derivatives does not significantly affect the operating results of the Bank. These amounts are recorded in other income and presented as “Net gain on derivatives and hedging activities.”
The notional principal of the interest rate exchange agreements associated with derivatives with members and offsetting derivatives with other counterparties was $950 at June 30, 2011, and $960 at December 31, 2010. The Bank did not have any interest rate exchange agreements outstanding at June 30, 2011, and December 31, 2010, that were used to offset the economic effect of other derivatives that were no longer designated to advances, investments, or consolidated obligations.
Investments – The Bank may invest in U.S. Treasury and agency obligations, MBS rated AAA at the time of acquisition, and the taxable portion of highly rated state or local housing finance agency obligations. The interest rate and prepayment risk associated with these investment securities is managed through a combination of debt issuance and derivatives. The Bank may manage prepayment risk and interest rate risk by funding investment securities with consolidated obligations that have call features or by hedging the prepayment risk with a combination of consolidated obligations and callable swaps or swaptions. The Bank executes callable swaps and purchases swaptions in conjunction with the issuance of certain liabilities to create funding equivalent to fixed rate callable debt. Although these derivatives are economic hedges against prepayment risk and are designated to individual liabilities, they do not receive either fair value or cash flow hedge accounting treatment. The derivatives are marked to market through earnings and provide modest income volatility. Investment securities may be classified as trading, available-for-sale, or held-to-maturity.
The Bank may also manage the risk arising from changing market prices or cash flows of investment securities classified as trading by entering into interest rate exchange agreements (economic hedges) that offset the changes in fair value or cash flows of the securities. The market value changes of both the trading securities and the associated interest rate exchange agreements are included in other income in the Statements of Income.
Advances – The Bank offers a wide array of advance structures to meet members' funding needs. These advances may have maturities up to 30 years with fixed or adjustable rates and may include early termination features or options. The Bank may use derivatives to adjust the repricing and/or options characteristics of advances to more closely match the characteristics of the Bank's funding liabilities. In general, whenever a member executes a fixed rate advance or a variable rate advance with embedded options, the Bank will simultaneously execute an interest rate exchange agreement with terms that offset the terms and embedded options, if any, in the advance. The combination of the advance and the interest rate exchange agreement effectively creates a variable rate asset. This type of hedge is treated as a fair value hedge.
Mortgage Loans – The Bank's investment portfolio includes fixed rate mortgage loans. The prepayment options embedded in mortgage loans can result in extensions or contractions in the expected repayment of these investments, depending on changes in estimated prepayment speeds. The Bank manages the interest rate risk and prepayment risk associated with fixed rate mortgage loans through a combination of debt issuance and derivatives. The Bank uses both callable and non-callable debt to achieve cash flow patterns and market value sensitivities for liabilities similar to those expected on the mortgage loans. Net income could be reduced if the Bank replaces prepaid mortgages with lower-yielding assets and the Bank's higher funding costs are not reduced accordingly.
The Bank executes callable swaps and purchases swaptions in conjunction with the issuance of certain consolidated
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obligations to create funding equivalent to fixed rate callable bonds. Although these derivatives are economic hedges against the prepayment risk of specific loan pools and are referenced to individual liabilities, they do not receive either fair value or cash flow hedge accounting treatment. The derivatives are marked to market through earnings and are presented as “Net gain on derivatives and hedging activities.”
Consolidated Obligations – Although the joint and several liability regulation authorizes the Finance Agency to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor, FHLBanks individually are counterparties to interest rate exchange agreements associated with specific debt issues. The Office of Finance acts as agent of the FHLBanks in the debt issuance process. In connection with each debt issuance, each FHLBank specifies the terms and the amount of debt it requests to have issued on its behalf. The Office of Finance tracks the amount of debt issued on behalf of each FHLBank. In addition, the Bank separately tracks and records as a liability its specific portion of consolidated obligations and is the primary obligor for its specific portion of consolidated obligations issued. Because the Bank knows the amount of consolidated obligations issued on its behalf, it has the ability to structure hedging instruments to match its specific debt. The hedge transactions may be executed upon or after the issuance of consolidated obligations and are accounted for based on the accounting for derivative instruments and hedging activities.
Consolidated obligation bonds are structured to meet the Bank's and/or investors' needs. Common structures include fixed rate bonds with or without call options and adjustable rate bonds with or without embedded options. In general, when bonds with these structures are issued, the Bank will simultaneously execute an interest rate exchange agreement with terms that offset the terms and embedded options, if any, of the consolidated obligation bond. This combination of the consolidated obligation bond and the interest rate exchange agreement effectively creates an adjustable rate bond. The cost of this funding combination is generally lower than the cost that would be available through the issuance of just an adjustable rate bond. These transactions generally receive fair value hedge accounting treatment.
The Bank did not have any consolidated obligations denominated in currencies other than U.S. dollars outstanding during the six months ended June 30, 2011, or the twelve months ended December 31, 2010.
Firm Commitments – A firm commitment for a forward starting advance hedged through the use of an offsetting forward starting interest rate swap is considered a derivative. In this case, the interest rate swap functions as the hedging instrument for both the firm commitment and the subsequent advance. When the commitment is terminated and the advance is made, the current market value associated with the firm commitment is included with the basis of the advance. The basis adjustment is then amortized into interest income over the life of the advance.
Anticipated Debt Issuance – The Bank may enter into interest rate swaps for the anticipated issuances of fixed rate bonds to hedge the cost of funding. These hedges are designated and accounted for as cash flow hedges. The interest rate swap is terminated upon issuance of the fixed rate bond, with the effective portion of the realized gain or loss on the interest rate swap recorded in other comprehensive income. Realized gains and losses reported in AOCI are recognized as earnings in the periods in which earnings are affected by the cash flows of the fixed rate bonds.
Credit Risk – The Bank is subject to credit risk as a result of the risk of nonperformance by counterparties to the derivative agreements. All of the Bank's derivative agreements contain master netting provisions to help mitigate the credit risk exposure to each counterparty. The Bank manages counterparty credit risk through credit analyses and collateral requirements and by following the requirements of the Bank's risk management policies and credit guidelines. Based on the master netting provisions in each agreement, credit analyses, and the collateral requirements in place with each counterparty, the Bank does not expect to incur any credit losses on derivatives agreements.
The notional amount of an interest rate exchange agreement serves as a basis for calculating periodic interest payments or cash flows and is not a measure of the amount of credit risk from that transaction. The Bank had
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notional amounts outstanding of $173,937 and $190,410 at June 30, 2011, and December 31, 2010, respectively. The notional amount does not represent the exposure to credit loss. The amount potentially subject to credit loss is the estimated cost of replacing an interest rate exchange agreement that has a net favorable position if the counterparty defaults; this amount is substantially less than the notional amount.
The following table presents credit risk exposure on derivative instruments, excluding a counterparty's pledged collateral that exceeds the Bank's net position with the counterparty.
June 30, 2011 | December 31, 2010 | ||||||
Total net exposure at fair value(1) | $ | 1,287 | $ | 1,525 | |||
Cash collateral held | 687 | 807 | |||||
Net exposure after cash collateral | 600 | 718 | |||||
Securities collateral held | 562 | 698 | |||||
Net exposure after collateral | $ | 38 | $ | 20 |
(1) Includes net accrued interest receivable of $254 and $253 as of June 30, 2011, and December 31, 2010, respectively.
Certain of the Bank's derivatives agreements contain provisions that link the Bank's credit rating from Moody's and Standard & Poor's to various rights and obligations. In several of the Bank's derivatives agreements, if the Bank's debt rating falls below A, the Bank's counterparty would have the right, but not the obligation, to terminate all of its outstanding derivatives transactions with the Bank. In addition, the amount of collateral that the Bank is required to deliver to a counterparty depends on the Bank's credit rating. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a net derivative liability position at June 30, 2011, was $118, for which the Bank had posted collateral of $70 in the normal course of business. If the credit rating of the Bank's debt had been lowered to one ratings notch below AAA by either Standard & Poor's or Moody's, then the Bank would have been required to deliver up to an additional $31 of collateral (at fair value) to its derivatives counterparties at June 30, 2011.
On April 20, 2011, Standard & Poor's revised its outlook on the FHLBanks' consolidated obligations and on the long-term credit ratings of ten FHLBanks to reflect its revision of the outlook on the long-term sovereign credit rating of the United States to negative from stable. As of June 30, 2011, Standard & Poor's rated the FHLBanks' consolidated obligations AAA/A-1+ with a negative outlook and assigned long-term credit ratings of AAA with a negative outlook to ten FHLBanks, including the Bank; AA+ with a stable outlook to the FHLBank of Chicago; and AA+ with a negative outlook to the FHLBank of Seattle. On July 15, 2011, Standard & Poor's placed the long-term credit ratings of the ten FHLBanks on CreditWatch with negative implications after placing the long-term sovereign credit rating of the United States on CreditWatch negative on July 14, 2011. In the application of Standard & Poor's government-related entities criteria, the ratings of the FHLBank System and the FHLBanks are constrained by the long-term sovereign credit rating of the United States. On August 5, 2011, Standard & Poor's lowered its long-term sovereign credit rating of the United States from AAA to AA+ with a negative outlook and affirmed the A-1+ short-term rating. As a result, on August 8, 2011, Standard & Poor's lowered the long-term issuer credit ratings and related issue ratings with a negative outlook on select government-related entities. Specifically, Standard & Poor's lowered its long-term issuer credit ratings and related issue ratings on the ten FHLBanks and on the senior debt issued by the FHLBank System (FHLBank System consolidated obligations) from AAA to AA+ with a negative outlook and removed the FHLBanks and relevant debt issues from CreditWatch.
As of June 30, 2011, Moody's rated the FHLBanks' consolidated obligations Aaa/P-1 with a stable outlook. On July 13, 2011, Moody's placed the Aaa bond rating of the U. S. government, and consequently the ratings of the GSEs, including the FHLBanks, on review for possible downgrade because of the risk that the statutory debt limit would not be raised in time to prevent a default on U.S. Treasury debt obligations. On August 2, 2011, Moody's confirmed the Aaa bond rating of the U.S. government following the raising of the statutory debt limit and changed the rating outlook to negative. Also on August 2, 2011, Moody's confirmed the Aaa rating for the FHLBanks and announced
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that in conjunction with the revision of the U.S. government outlook to negative, the rating outlook for the FHLBanks was also revised to negative.
The following table summarizes the fair value of derivative instruments without the effect of netting arrangements or collateral as of June 30, 2011, and December 31, 2010. For purposes of this disclosure, the derivatives values include the fair value of derivatives and related accrued interest.
June 30, 2011 | December 31, 2010 | ||||||||||||||||||||||
Notional Amount of Derivatives | Derivative Assets | Derivative Liabilities | Notional Amount of Derivatives | Derivative Assets | Derivative Liabilities | ||||||||||||||||||
Derivatives designated as hedging instruments: | |||||||||||||||||||||||
Interest rate swaps | $ | 72,446 | $ | 1,501 | $ | 304 | $ | 84,131 | $ | 1,816 | $ | 429 | |||||||||||
Total | 72,446 | 1,501 | 304 | 84,131 | 1,816 | 429 | |||||||||||||||||
Derivatives not designated as hedging instruments: | |||||||||||||||||||||||
Interest rate swaps | 100,415 | 433 | 456 | 104,193 | 518 | 535 | |||||||||||||||||
Interest rate caps, floors, corridors, and/or collars | 1,076 | 12 | 18 | 2,086 | 17 | 24 | |||||||||||||||||
Total | 101,491 | 445 | 474 | 106,279 | 535 | 559 | |||||||||||||||||
Total derivatives before netting and collateral adjustments | $ | 173,937 | 1,946 | 778 | $ | 190,410 | 2,351 | 988 | |||||||||||||||
Netting adjustments by counterparty | (659 | ) | (659 | ) | (826 | ) | (826 | ) | |||||||||||||||
Cash collateral and related accrued interest | (687 | ) | 11 | (807 | ) | 1 | |||||||||||||||||
Total collateral and netting adjustments(1) | (1,346 | ) | (648 | ) | (1,633 | ) | (825 | ) | |||||||||||||||
Derivative assets and derivative liabilities as reported on the Statements of Condition | $ | 600 | $ | 130 | $ | 718 | $ | 163 |
(1) Amounts represent the effect of legally enforceable master netting agreements that allow the Bank to settle positive and negative positions and also cash collateral held or placed with the same counterparty.
The following table presents the components of net gain/(loss) on derivatives and hedging activities as presented in the Statements of Income for the three and six months ended June 30, 2011 and 2010.
Three Months Ended | Six Months Ended | ||||||||||||||
June 30, 2011 | June 30, 2010 | June 30, 2011 | June 30, 2010 | ||||||||||||
Gain/(Loss) | Gain/(Loss) | Gain/(Loss) | Gain/(Loss) | ||||||||||||
Derivatives and hedged items in fair value hedging relationships – hedge ineffectiveness by derivative type: | |||||||||||||||
Interest rate swaps | $ | (6 | ) | $ | 1 | $ | (5 | ) | $ | 5 | |||||
Total net gain related to fair value hedge ineffectiveness | (6 | ) | 1 | (5 | ) | 5 | |||||||||
Derivatives not designated as hedging instruments: | |||||||||||||||
Economic hedges: | |||||||||||||||
Interest rate swaps | (78 | ) | (80 | ) | (50 | ) | (54 | ) | |||||||
Interest rate caps, floors, corridors, and/or collars | — | (1 | ) | 1 | (3 | ) | |||||||||
Net interest settlements | (7 | ) | (43 | ) | (17 | ) | (107 | ) | |||||||
Total net gain/(loss) related to derivatives not designated as hedging instruments | (85 | ) | (124 | ) | (66 | ) | (164 | ) | |||||||
Net gain/(loss) on derivatives and hedging activities | $ | (91 | ) | $ | (123 | ) | $ | (71 | ) | $ | (159 | ) |
The following tables present, by type of hedged item, the gains and losses on derivatives and the related hedged
44
items in fair value hedging relationships and the impact of those derivatives on the Bank's net interest income for the three and six months ended June 30, 2011 and 2010.
Three Months Ended | |||||||||||||||||||||||||||||||
June 30, 2011 | June 30, 2010 | ||||||||||||||||||||||||||||||
Hedged Item Type | Gain/ (Loss) on Derivatives | Gain/ (Loss) on Hedged Item | Net Fair Value Hedge Ineffectiveness | Effect of Derivatives on Net Interest Income(1) | Gain/ (Loss) on Derivatives | Gain/ (Loss) on Hedged Item | Net Fair Value Hedge Ineffectiveness | Effect of Derivatives on Net Interest Income(1) | |||||||||||||||||||||||
Advances | $ | (41 | ) | $ | 41 | $ | — | $ | (66 | ) | $ | (2 | ) | $ | 3 | $ | 1 | $ | (143 | ) | |||||||||||
Consolidated obligation bonds | 50 | (56 | ) | (6 | ) | 317 | 31 | (31 | ) | — | 468 | ||||||||||||||||||||
Total | $ | 9 | $ | (15 | ) | $ | (6 | ) | $ | 251 | $ | 29 | $ | (28 | ) | $ | 1 | $ | 325 |
Six Months Ended | |||||||||||||||||||||||||||||||
June 30, 2011 | June 30, 2010 | ||||||||||||||||||||||||||||||
Hedged Item Type | Gain/ (Loss) on Derivatives | Gain/ (Loss) on Hedged Item | Net Fair Value Hedge Ineffectiveness | Effect of Derivatives on Net Interest Income(1) | Gain/ (Loss) on Derivatives | Gain/ (Loss) on Hedged Item | Net Fair Value Hedge Ineffectiveness | Effect of Derivatives on Net Interest Income(1) | |||||||||||||||||||||||
Advances | $ | 41 | $ | (40 | ) | $ | 1 | $ | (150 | ) | $ | 36 | $ | (36 | ) | $ | — | $ | (311 | ) | |||||||||||
Consolidated obligation bonds | (264 | ) | 258 | (6 | ) | 647 | 39 | (34 | ) | 5 | 979 | ||||||||||||||||||||
Total | $ | (223 | ) | $ | 218 | $ | (5 | ) | $ | 497 | $ | 75 | $ | (70 | ) | $ | 5 | $ | 668 |
(1) The net interest on derivatives in fair value hedge relationships is presented in the interest income/expense line item of the respective hedged item.
For the three and six months ended June 30, 2011 and 2010, there were no reclassifications from other comprehensive income/(loss) into earnings as a result of the discontinuance of cash flow hedges because the original forecasted transactions occurred by the end of the originally specified time period or within a two-month period thereafter.
As of June 30, 2011, the amount of unrecognized net losses on derivative instruments accumulated in other comprehensive income/(loss) expected to be reclassified to earnings during the next 12 months was immaterial. The maximum length of time over which the Bank is hedging its exposure to the variability in future cash flows for forecasted transactions, excluding those forecasted transactions related to the payment of variable interest on existing financial instruments, is less than three months.
Note 15 — Fair Values
The following fair value amounts have been determined by the Bank using available market information and the Bank's best judgment of appropriate valuation methods. These estimates are based on pertinent information available to the Bank at June 30, 2011, and December 31, 2010. Although the Bank uses its best judgment in estimating the fair value of these financial instruments, there are inherent limitations in any estimation technique or valuation methodology. For example, because an active secondary market does not exist for a portion of the Bank's financial instruments, in certain cases fair values are not subject to precise quantification or verification and may change as economic and market factors and evaluation of those factors change. Therefore, these fair values are not necessarily indicative of the amounts that would be realized in current market transactions, although they do reflect the Bank's judgment of how a market participant would estimate the fair values. The fair value summary table does not represent an estimate of the overall market value of the Bank as a going concern, which would take into account future business opportunities and the net profitability of total assets and liabilities on a combined basis.
The following table presents the carrying value and the fair value of the Bank's financial instruments at June 30, 2011, and December 31, 2010.
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June 30, 2011 | December 31, 2010 | ||||||||||||||
Carrying Value | Estimated Fair Value | Carrying Value | Estimated Fair Value | ||||||||||||
Assets | |||||||||||||||
Cash and due from banks | $ | 7,452 | $ | 7,452 | $ | 755 | $ | 755 | |||||||
Federal funds sold | 11,669 | 11,669 | 16,312 | 16,312 | |||||||||||
Trading securities | 3,548 | 3,548 | 2,519 | 2,519 | |||||||||||
Available-for-sale securities | 9,781 | 9,781 | 1,927 | 1,927 | |||||||||||
Held-to-maturity securities | 26,224 | 26,105 | 31,824 | 32,214 | |||||||||||
Advances (includes $9,227 and $10,490 at fair value under the fair value option, respectively) | 82,745 | 83,049 | 95,599 | 95,830 | |||||||||||
Mortgage loans held for portfolio, net of allowance for credit losses on mortgage loans | 2,097 | 2,252 | 2,381 | 2,511 | |||||||||||
Accrued interest receivable | 169 | 169 | 228 | 228 | |||||||||||
Derivative assets(1) | 600 | 600 | 718 | 718 | |||||||||||
Liabilities | |||||||||||||||
Deposits | 146 | 146 | 134 | 134 | |||||||||||
Consolidated obligations: | |||||||||||||||
Bonds (includes $18,737 and $20,872 at fair value under the fair value option, respectively) | 111,709 | 111,968 | 121,120 | 121,338 | |||||||||||
Discount notes | 20,406 | 20,410 | 19,527 | 19,528 | |||||||||||
Mandatorily redeemable capital stock | 6,144 | 6,144 | 3,749 | 3,749 | |||||||||||
Accrued interest payable | 411 | 411 | 467 | 467 | |||||||||||
Derivative liabilities(1) | 130 | 130 | 163 | 163 | |||||||||||
Other | |||||||||||||||
Standby letters of credit | 23 | 23 | 26 | 26 |
(1) Amounts include the netting of derivative assets and liabilities by counterparty, including cash collateral, where the Bank has the legal right to do so under its master netting agreement with each counterparty.
Fair Value Methodologies and Techniques and Significant Inputs. The valuation methodologies and techniques and significant inputs used in estimating the fair values of the Bank's financial instruments are discussed below.
Cash and Due from Banks – The estimated fair value approximates the recorded carrying value.
Federal Funds Sold – The estimated fair value of overnight Federal funds sold approximates the recorded carrying value. The estimated fair value of term Federal funds sold has been determined by calculating the present value of expected cash flows for the instruments excluding accrued interest. The discount rates used in these calculations are the replacement rates for comparable instruments with similar terms.
Investment Securities – Commercial Paper and Interest-Bearing Deposits – The estimated fair values of these investments are determined by calculating the present value of expected cash flows, excluding accrued interest, using market-observable inputs as of the last business day of the period or using industry standard analytical models and certain actual and estimated market information. The discount rates used in these calculations are the replacement rates for comparable instruments with similar terms.
Investment Securities – FFCB bonds, TLGP securities, and Housing Finance Agency Bonds and MBS – Under the methodology approved by the MBS Pricing Governance Committee and adopted by the Bank, the Bank requests prices for these securities from four specific third-party vendors, when available. These pricing vendors use methods that generally employ, but are not limited to, benchmark yields, recent trades, dealer estimates, valuation models, benchmarking of like securities, sector groupings, and/or matrix pricing. The Bank establishes a price for each
46
security using a formula that is based on the number of prices received. If four prices are received, the average of the two middle prices is used; if three prices are 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 validation as described below. The computed prices are tested for reasonableness based on differences among pricing vendors 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 the Bank believes may not be appropriate based on all available information (including those limited instances in which only one price is received), are subject to further analysis, including but not limited to a price challenge of pricing vendors, a comparison to the prices for similar securities and/or to non-binding dealer estimates, or use of an internal model that is deemed most appropriate after consideration of all relevant facts and circumstances that a market participant would consider. Such analysis is also applied in those limited instances where no third-party vendor price is available in order to arrive at an estimated fair value. The relative proximity of the vendor prices for each security, as defined by the tolerance thresholds, supports the Bank's conclusion that the final assigned prices are reasonable estimates of fair value. Securities classified as trading are recorded at fair value on a recurring basis.
Advances – Because quoted prices are not available for advances, the fair values are measured using model-based valuation techniques (such as the present value of future cash flows excluding the amount of the accrued interest receivable), creditworthiness of members, advance collateral types, prepayment assumptions, and other factors, such as credit loss assumptions, as necessary.
Because no principal market exists for the sale of advances, the Bank has defined the most advantageous market as a hypothetical market in which an advance sale could occur with a hypothetical financial institution. The Bank's primary inputs for measuring the fair value of advances are market-based consolidated obligation yield curve (CO Curve) inputs obtained from the Office of Finance and provided to the Bank. The Bank prices advances using the CO Curve because it represents the Bank's cost of funds. The CO Curve is then adjusted to reflect the rates on replacement advances with similar terms and collateral. These spread adjustments are not market-observable and are evaluated for significance in the overall fair value measurement and the fair value hierarchy level of the advance. As of June 30, 2011, the spread adjustment to the CO Curve ranged from 3 to 17 basis points for advances carried at fair value. The Bank obtains market-observable inputs from derivatives dealers for complex advances. These inputs may include volatility assumptions, which are market-based expectations of future interest rate volatility implied from current market prices for similar options (swaptions volatilities). The discount rates used in these calculations are the replacement advance rates for advances with similar terms. Pursuant to the Finance Agency's advances regulation, advances with an original term to maturity or repricing period greater than six months generally require a prepayment fee sufficient to make the Bank financially indifferent to the borrower's decision to prepay the advances, and the Bank determined that no adjustment is required to the fair value measurement of advances for prepayment fees.
Mortgage Loans Held for Portfolio – The estimated fair value for mortgage loans represents modeled prices based on observable market prices for agency commitment rates adjusted for differences in coupon and seasoning. Market prices are highly dependent on the underlying prepayment assumptions. Changes in the prepayment speeds often have a material effect on the fair value estimates. These underlying prepayment assumptions are susceptible to material changes in the near term because they are made at a specific point in time.
Loans to Other FHLBanks – Because these are overnight transactions, the estimated fair value approximates the recorded carrying value.
Accrued Interest Receivable and Payable – The estimated fair value approximates the recorded carrying value of accrued interest receivable and accrued interest payable.
Derivative Assets and Liabilities – In general, derivative instruments held by the Bank for risk management activities are traded in over-the-counter markets where quoted market prices are not readily available. These
47
derivatives are interest-rate related. For these derivatives, the Bank measures fair value using internally developed discounted cash flow models that use primarily market-observable inputs, such as the LIBOR swap yield curve, option volatilities adjusted for counterparty credit risk, as necessary, and prepayment assumptions.
The Bank is subject to credit risk in derivatives transactions due to potential nonperformance by the derivatives counterparties. To mitigate this risk, the Bank only executes transactions with highly rated derivatives dealers and major banks (derivatives dealer counterparties) that meet the Bank's eligibility criteria. In addition, the Bank has entered into master netting agreements and bilateral security agreements with all active derivatives dealer counterparties that provide for delivery of collateral at specified levels tied to counterparty credit ratings to limit the Bank's net unsecured credit exposure to these counterparties. Under these policies and agreements, the amount of unsecured credit exposure to an individual derivatives dealer counterparty is limited to the lesser of (i) a percentage of the counterparty's capital or (ii) an absolute dollar credit exposure limit, both according to the counterparty's credit rating, as determined by rating agency long-term credit ratings of the counterparty's debt securities or deposits. All credit exposure from derivatives transactions entered into by the Bank with member counterparties that are not derivatives dealers must be fully secured by eligible collateral. The Bank evaluated the potential for the fair value of the instruments to be affected by counterparty credit risk and determined that no adjustments to the overall fair value measurements were required.
Deposits and Other Borrowings – For deposits and other borrowings, the estimated fair value has been determined by calculating the present value of expected future cash flows from the deposits and other borrowings excluding accrued interest. The discount rates used in these calculations are the cost of deposits and borrowings with similar terms.
Consolidated Obligations – Because quoted prices in active markets are not generally available for identical liabilities, the Bank measures fair values using internally developed models that use primarily market-observable inputs. The Bank's primary inputs for measuring the fair value of consolidated obligation bonds are market-based CO Curve inputs obtained from the Office of Finance and provided to the Bank. The Office of Finance constructs a market observable curve, referred to as the CO Curve, using the Treasury yield curve as a base curve, which may be adjusted by indicative spreads obtained from market observable sources. These market indications are generally derived from pricing indications from dealers, historical pricing relationships, market activity for similar liabilities such as recent GSE trades or secondary market activity. For consolidated obligation bonds with embedded options, the Bank also obtains market-observable quotes and inputs from derivatives dealers. The Bank uses these swaption volatilities as significant inputs for measuring the fair value of consolidated obligations.
Adjustments may be necessary to reflect the Bank's credit quality or the credit quality of the FHLBank System when valuing consolidated obligation bonds measured at fair value. The Bank monitors its own creditworthiness, the creditworthiness of the other 11 FHLBanks, and the FHLBank System to determine whether any adjustments are necessary for creditworthiness in its fair value measurement of consolidated obligation bonds. The credit ratings of the FHLBank System and any changes to the credit ratings are the basis for the Bank to determine whether the fair values of consolidated obligations have been significantly affected during the reporting period by changes in the instrument-specific credit risk.
Mandatorily Redeemable Capital Stock – The estimated fair value of capital stock subject to mandatory redemption is generally at par value as indicated by member contemporaneous purchases and sales at par value. Fair value includes estimated dividends earned at the time of reclassification from capital to liabilities, until such amount is paid, and any subsequently declared stock dividend. The Bank's stock can only be acquired by members at par value and redeemed or repurchased at par value, subject to statutory and regulatory requirements. The Bank's stock is not traded, and no market mechanism exists for the exchange of Bank stock outside the cooperative ownership structure.
Commitments – The estimated fair value of the Bank's commitments to extend credit was immaterial at June 30, 2011, and December 31, 2010. The estimated fair value of standby letters of credit is based on the present value of
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fees currently charged for similar agreements. The value of the Bank's standby letters of credit is recorded in other liabilities.
Subjectivity of Estimates Related to Fair Values of Financial Instruments. Estimates of the fair value of advances with embedded options, mortgage instruments, derivatives with embedded options, and consolidated obligation bonds with embedded options using the methods described below and other methods are highly subjective and require judgments regarding significant matters such as the amount and timing of future cash flows, prepayment speed assumptions, expected interest rate volatility, methods to determine possible distributions of future interest rates used to value options, and the selection of discount rates that appropriately reflect market and credit risks. Changes in these judgments often have a material effect on the fair value estimates. Since these estimates are made as of a specific date, they are susceptible to material near term changes.
Fair Value Hierarchy. The fair value hierarchy is used to prioritize the fair value methodologies and valuation techniques as well as the inputs to the valuation techniques used to measure fair value for assets and liabilities carried at fair value on the Statements of Condition. The inputs are evaluated and an overall level for the fair value measurement is determined. This overall level is an indication of market observability of the fair value measurement for the asset or liability. The fair value hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and lowest priority to unobservable inputs (Level 3 measurements).
The three levels of the fair value hierarchy are as follows:
• | Level 1 – Inputs to the valuation methodology are quoted prices for identical assets or liabilities in active markets. An active market for the asset or liability is a market in which the transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. |
• | Level 2 – Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. |
• | Level 3 – Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Unobservable inputs are supported by little or no market activity or by the Bank's own assumptions. |
A financial instrument's categorization within the valuation hierarchy is based on the lowest level of input that is significant to the fair value measurement.
The following assets and liabilities, including those for which the Bank has elected the fair value option, are carried at fair value on the Statements of Condition as of June 30, 2011:
• | Trading securities |
• | Available-for-sale securities |
• | Certain advances |
• | Derivative assets and liabilities |
• | Certain consolidated obligation bonds |
For instruments carried at fair value, the Bank reviews the fair value hierarchy classifications on a quarterly basis. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets or liabilities. Such reclassifications are reported as transfers in or out at fair value as of the beginning of the quarter in which the changes occur. For the periods presented, the Bank did not have any reclassifications for transfers in or out of the fair value hierarchy levels.
Fair Value on a Recurring Basis. These assets and liabilities are measured at fair value on a recurring basis and are summarized in the following table by fair value hierarchy (as described above).
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June 30, 2011 | |||||||||||||||||||
Fair Value Measurement Using: | Netting | ||||||||||||||||||
Level 1 | Level 2 | Level 3 | Adjustments(1) | Total | |||||||||||||||
Assets: | |||||||||||||||||||
Trading securities: | |||||||||||||||||||
GSEs – FFCB bonds | $ | — | $ | 2,366 | $ | — | $ | — | $ | 2,366 | |||||||||
TLGP securities | — | 1,160 | — | — | 1,160 | ||||||||||||||
MBS: | |||||||||||||||||||
Other U.S. obligations – Ginnie Mae | — | 19 | — | — | 19 | ||||||||||||||
GSEs – Fannie Mae | — | 3 | — | 3 | |||||||||||||||
Total trading securities | — | 3,548 | — | — | 3,548 | ||||||||||||||
Available-for-sale securities: | |||||||||||||||||||
TLGP securities | — | 1,926 | — | — | 1,926 | ||||||||||||||
PLRMBS | — | — | 7,855 | — | 7,855 | ||||||||||||||
Total available-for-sale securities | — | 1,926 | 7,855 | — | 9,781 | ||||||||||||||
Advances(2) | — | 9,591 | — | — | 9,591 | ||||||||||||||
Derivative assets: interest-rate related | — | 1,946 | — | (1,346 | ) | 600 | |||||||||||||
Total assets | $ | — | $ | 17,011 | $ | 7,855 | $ | (1,346 | ) | $ | 23,520 | ||||||||
Liabilities: | |||||||||||||||||||
Consolidated obligation bonds(3) | $ | — | $ | 18,737 | $ | — | $ | — | $ | 18,737 | |||||||||
Derivative liabilities: interest-rate related | — | 778 | — | (648 | ) | 130 | |||||||||||||
Total liabilities | $ | — | $ | 19,515 | $ | — | $ | (648 | ) | $ | 18,867 |
December 31, 2010 | |||||||||||||||||||
Fair Value Measurement Using: | Netting | ||||||||||||||||||
Level 1 | Level 2 | Level 3 | Adjustments(1) | Total | |||||||||||||||
Assets: | |||||||||||||||||||
Trading securities: | |||||||||||||||||||
GSEs – FFCB bonds | $ | — | $ | 2,366 | $ | — | $ | — | $ | 2,366 | |||||||||
TLGP securities | — | 128 | — | — | 128 | ||||||||||||||
MBS: | |||||||||||||||||||
Other U.S. obligations – Ginnie Mae | — | 20 | — | — | 20 | ||||||||||||||
GSEs – Fannie Mae | — | 5 | — | 5 | |||||||||||||||
Total trading securities | — | 2,519 | — | — | 2,519 | ||||||||||||||
Available-for-sale securities (TLGP securities) | — | 1,927 | — | — | 1,927 | ||||||||||||||
Advances(2) | — | 11,297 | — | — | 11,297 | ||||||||||||||
Derivative assets: interest-rate related | — | 2,351 | — | (1,633 | ) | 718 | |||||||||||||
Total assets | $ | — | $ | 18,094 | $ | — | $ | (1,633 | ) | $ | 16,461 | ||||||||
Liabilities: | |||||||||||||||||||
Consolidated obligation bonds(3) | $ | — | $ | 21,384 | $ | — | $ | — | $ | 21,384 | |||||||||
Derivative liabilities: interest-rate related | — | 988 | — | (825 | ) | 163 | |||||||||||||
Total liabilities | $ | — | $ | 22,372 | $ | — | $ | (825 | ) | $ | 21,547 |
(1) | Amounts represent the netting of derivative assets and liabilities by counterparty, including cash collateral, where the Bank has the legal right to do so under its master netting agreement with each counterparty. |
(2) | Includes $9,227 and $10,490 of advances recorded under the fair value option at June 30, 2011, and December 31, 2010, respectively, and $364 and $807 of advances recorded at fair value at June 30, 2011, and December 31, 2010, respectively, where the exposure to overall changes in fair value was economically hedged in accordance with the accounting for derivative instruments and hedging activities. |
(3) | Includes $18,737 and $20,872 of consolidated obligation bonds recorded under the fair value option at June 30, 2011, and December 31, 2010, respectively, and $0 and $512 of consolidated obligation bonds recorded at fair value at June 30, 2011, and December 31, 2010, respectively, where the exposure to overall changes in fair value was economically hedged in accordance with the accounting for derivatives instruments and hedging activities. |
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The following table presents a reconciliation of the Bank's available-for-sale PLRMBS that are measured at fair value on the Statements of Condition using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2011.
Three Months Ended June 30, 2011 | Six Months Ended June 30, 2011 | ||||||
Balance, beginning of period | $ | 6,011 | $ | — | |||
Transfers of held-to-maturity to available-for-sale securities | 1,893 | 7,215 | |||||
Total gain/(loss) realized and unrealized: | |||||||
OTTI credit loss recognized in earnings | (107 | ) | (107 | ) | |||
Unrealized gains in AOCI | 287 | 976 | |||||
Settlements | (229 | ) | (229 | ) | |||
Balance, end of period | $ | 7,855 | $ | 7,855 |
Fair Value on a Nonrecurring Basis. Certain assets are measured at fair value on a nonrecurring basis—that is, the instruments are not measured at fair value on a recurring basis but are subject to fair value adjustment in certain circumstances (for example, when there is evidence of impairment). At June 30, 2011, and December 31, 2010, the Bank measured certain of its held-to-maturity investment securities and REO at fair value on a nonrecurring basis. The following tables present these assets as of June 30, 2011, and December 31, 2010, for which a nonrecurring change in fair value was recorded at June 30, 2011, and December 31, 2010, by level within the fair value hierarchy.
June 30, 2011 | |||||||||||
Fair Value Measurement Using: | |||||||||||
Assets: | Level 1 | Level 2 | Level 3 | ||||||||
REO | $ | — | $ | — | $ | 3 |
December 31, 2010 | |||||||||||
Fair Value Measurement Using: | |||||||||||
Assets: | Level 1 | Level 2 | Level 3 | ||||||||
Held-to-maturity securities – PLRMBS | $ | — | $ | — | $ | 547 | |||||
REO | — | — | 2 |
Based on the current lack of significant market activity for PLRMBS and REO, the nonrecurring fair value measurements for these assets as of June 30, 2011, and December 31, 2010, fell within Level 3 of the fair value hierarchy.
Fair Value Option. The fair value option provides an entity with an irrevocable option to elect fair value as an alternative measurement for selected financial assets, financial liabilities, unrecognized firm commitments, and written loan commitments not previously carried at fair value. It requires an entity to display the fair value of those assets and liabilities for which the entity has chosen to use fair value on the face of the statement of condition. Fair value is used for both the initial and subsequent measurement of the designated assets, liabilities, and commitments, with the changes in fair value recognized in net income. Interest income and interest expense carried on advances and consolidated bonds at fair value are recognized solely on the contractual amount of interest due or unpaid. Any transaction fees or costs are immediately recognized in other non-interest income or other non-interest expense.
The Bank elected the fair value option for certain financial instruments on January 1, 2008, as follows:
• | Adjustable rate credit advances with embedded options |
• | Callable fixed rate credit advances |
• | Putable fixed rate credit advances |
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• | Putable fixed rate credit advances with embedded options |
• | Fixed rate credit advances with partial prepayment symmetry |
• | Callable or non-callable capped floater consolidated obligation bonds |
• | Convertible consolidated obligation bonds |
• | Adjustable or fixed rate range accrual consolidated obligation bonds |
• | Ratchet consolidated obligation bonds |
In addition to the items transitioned to the fair value option on January 1, 2008, the Bank has elected that any new transactions in these categories will be accounted for under the fair value option. In general, transactions for which the Bank has elected the fair value option are in economic hedge relationships. The Bank has also elected the fair value option for the following additional categories for all new transactions entered into starting on January 1, 2008:
• | Adjustable rate credit advances indexed to the following: Prime Rate, U.S. Treasury Bill, Federal funds, Constant Maturity Treasury (CMT), Constant Maturity Swap (CMS), and 12-month Moving Treasury Average of one-year CMT (12MTA) |
• | Adjustable rate consolidated obligation bonds indexed to the following: Prime Rate, U.S. Treasury Bill, Federal funds, CMT, CMS, and 12MTA |
The Bank elected the fair value option for the following financial instruments on October 1, 2009:
• | Step-up callable bonds, which pay interest at increasing fixed rates for specified intervals over the life of the bond and can generally be called at the Bank's option on the step-up dates |
• | Step-down callable bonds, which pay interest at decreasing fixed rates for specified intervals over the life of the bond and can generally be called at the Bank's option on the step-down dates |
The Bank has elected these items for the fair value option to assist in mitigating potential income statement volatility that can arise from economic hedging relationships. The risk associated with using fair value only for the derivative is the Bank's primary reason for electing the fair value option for financial assets and liabilities that do not qualify for hedge accounting or that have not previously met or may be at risk for not meeting the hedge effectiveness requirements.
The following table summarizes the activity related to financial assets and liabilities for which the Bank elected the fair value option during the three and six months ended June 30, 2011 and 2010:
Three Months Ended | |||||||||||||
June 30, 2011 | June 30, 2010 | ||||||||||||
Advances | Consolidated Obligation Bonds | Advances | Consolidated Obligation Bonds | ||||||||||
Balance, beginning of the period | $ | 9,708 | $ | 24,943 | $ | 17,459 | $ | 24,241 | |||||
New transactions elected for fair value option | 1,001 | 2,565 | 127 | 6,574 | |||||||||
Maturities and terminations | (1,588 | ) | (8,838 | ) | (4,781 | ) | (9,709 | ) | |||||
Net gain/(loss) on advances and net (gain)/loss on consolidated obligation bonds held at fair value | 105 | 71 | 35 | 56 | |||||||||
Change in accrued interest | 1 | (4 | ) | (21 | ) | (14 | ) | ||||||
Balance, end of the period | $ | 9,227 | $ | 18,737 | $ | 12,819 | $ | 21,148 |
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Six Months Ended | |||||||||||||
June 30, 2011 | June 30, 2010 | ||||||||||||
Advances | Consolidated Obligation Bonds | Advances | Consolidated Obligation Bonds | ||||||||||
Balance, beginning of the period | $ | 10,490 | $ | 20,872 | $ | 21,616 | $ | 37,022 | |||||
New transactions elected for fair value option | 1,517 | 7,725 | 200 | 14,325 | |||||||||
Maturities and terminations | (2,828 | ) | (9,934 | ) | (8,915 | ) | (30,271 | ) | |||||
Net gain/(loss) on advances and net (gain)/loss on consolidated obligation bonds held at fair value | 54 | 74 | (45 | ) | 76 | ||||||||
Change in accrued interest | (6 | ) | — | (37 | ) | (4 | ) | ||||||
Balance, end of the period | $ | 9,227 | $ | 18,737 | $ | 12,819 | $ | 21,148 |
For advances and consolidated obligations recorded under the fair value option, the estimated impact of changes in credit risk for the three and six months ended June 30, 2011 and 2010, was immaterial.
The following table presents the changes in fair value included in the Statements of Income for each item for which the fair value option has been elected for the three and six months ended June 30, 2011 and 2010:
Three Months Ended | ||||||||||||||||||||||||||
June 30, 2011 | June 30, 2010 | |||||||||||||||||||||||||
Interest Income on Advances | Interest Expense on Consolidated Obligation Bonds | Net Gain/(Loss) on Advances and Consolidated Obligation Bonds Held at Fair Value | Total Changes in Fair Value Included in Current Period Earnings | Interest Income on Advances | Interest Expense on Consolidated Obligation Bonds | Net Gain/(Loss) on Advances and Consolidated Obligation Bonds Held at Fair Value | Total Changes in Fair Value Included in Current Period Earnings | |||||||||||||||||||
Advances | $ | 65 | $ | — | $ | 105 | $ | 170 | $ | 130 | $ | — | $ | 35 | $ | 165 | ||||||||||
Consolidated obligation bonds | — | (34 | ) | (71 | ) | (105 | ) | — | (49 | ) | (56 | ) | (105 | ) | ||||||||||||
Total | $ | 65 | $ | (34 | ) | $ | 34 | $ | 65 | $ | 130 | $ | (49 | ) | $ | (21 | ) | $ | 60 |
Six Months Ended | ||||||||||||||||||||||||||
June 30, 2011 | June 30, 2010 | |||||||||||||||||||||||||
Interest Income on Advances | Interest Expense on Consolidated Obligation Bonds | Net Gain/(Loss) on Advances and Consolidated Obligation Bonds Held at Fair Value | Total Changes in Fair Value Included in Current Period Earnings | Interest Income on Advances | Interest Expense on Consolidated Obligation Bonds | Net Gain/(Loss) on Advances and Consolidated Obligation Bonds Held at Fair Value | Total Changes in Fair Value Included in Current Period Earnings | |||||||||||||||||||
Advances | $ | 135 | $ | — | $ | 54 | $ | 189 | $ | 296 | $ | — | $ | (45 | ) | $ | 251 | |||||||||
Consolidated obligation bonds | — | (68 | ) | (74 | ) | (142 | ) | — | (110 | ) | (76 | ) | (186 | ) | ||||||||||||
Total | $ | 135 | $ | (68 | ) | $ | (20 | ) | $ | 47 | $ | 296 | $ | (110 | ) | $ | (121 | ) | $ | 65 |
The following table presents the difference between the aggregate fair value and aggregate remaining contractual principal balance outstanding of advances and consolidated obligation bonds for which the fair value option has been elected at June 30, 2011, and December 31, 2010:
At June 30, 2011 | At December 31, 2010 | ||||||||||||||||||||||
Principal Balance | Fair Value | Fair Value Over/(Under) Principal Balance | Principal Balance | Fair Value | Fair Value Over/(Under) Principal Balance | ||||||||||||||||||
Advances(1) | $ | 8,895 | $ | 9,227 | $ | 332 | $ | 10,163 | $ | 10,490 | $ | 327 | |||||||||||
Consolidated obligation bonds | 18,774 | 18,737 | (37 | ) | 20,982 | 20,872 | (110 | ) |
(1) At June 30, 2011, and December 31, 2010, none of these advances were 90 days or more past due or had been placed on nonaccrual status.
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Note 16 — Commitments and Contingencies
As provided by the FHLBank Act or regulations governing the operations of the FHLBanks, all FHLBanks have joint and several liability for all FHLBank consolidated obligations, which are backed only by the financial resources of the FHLBanks. The joint and several liability regulation authorizes the Finance Agency to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor. The Bank has never been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank, and as of June 30, 2011, and through the filing date of this report, does not believe that is probable that it will be asked to do so. The par amount of the outstanding consolidated obligations of all 12 FHLBanks was $727,475 at June 30, 2011, and $796,374 at December 31, 2010. The par value of the Bank's participation in consolidated obligations was $130,750 at June 30, 2011, and $139,133 at December 31, 2010. For more information on the joint and several liability regulation, see “Item 8. Financial Statements and Supplementary Data – Note 20 – Commitments and Contingencies” in the Bank's 2010 Form 10-K.
Off-balance sheet commitments as of June 30, 2011, and December 31, 2010, were as follows:
June 30, 2011 | December 31, 2010 | ||||||||||||||||||||||
Expire Within One Year | Expire After One Year | Total | Expire Within One Year | Expire After One Year | Total | ||||||||||||||||||
Standby letters of credit outstanding | $ | 2,079 | $ | 4,052 | $ | 6,131 | $ | 1,554 | $ | 4,481 | $ | 6,035 | |||||||||||
Commitments to fund additional advances | 3 | — | 3 | 304 | — | 304 | |||||||||||||||||
Unsettled consolidated obligation bonds, par(1) | 3,195 | — | 3,195 | 205 | — | 205 | |||||||||||||||||
Interest rate exchange agreements, traded but not yet settled | 3,105 | — | 3,105 | 95 | — | 95 |
(1) At June 30, 2011, and December 31, 2010, $3,105 and $95 were hedged with associated interest rate swaps, respectively.
Advance commitments are generally for periods up to 12 months. Advances funded under advance commitments are fully collateralized at the time of funding (see Note 9 – Allowance for Credit Losses). Based on the Bank's credit analyses of members' financial condition and collateral requirements, no allowance for losses was deemed necessary by the Bank on the advance commitments outstanding as of June 30, 2011, and December 31, 2010. The estimated fair value of advance commitments was immaterial to the balance sheet as of June 30, 2011, and December 31, 2010.
Standby letters of credit are generally issued for a fee on behalf of members to support their obligations to third parties. If the Bank is required to make payment for a beneficiary's drawing under a letter of credit, the amount is charged to the member's demand deposit account with the Bank. The original terms of these standby letters of credit range from 42 days to 10 years, including a final expiration in 2021.
The value of the Bank's obligations related to standby letters of credit is recorded in other liabilities and amounted to $23 at June 30, 2011, and $26 at December 31, 2010. Letters of credit are fully collateralized at the time of issuance. Based on the Bank's credit analyses of members' financial condition and collateral requirements, no allowance for losses was deemed necessary by the Bank on the letters of credit outstanding as of June 30, 2011, and December 31, 2010.
The Bank executes interest rate exchange agreements with major banks and derivatives entities affiliated with broker-dealers that have, or are supported by guarantees from related entities that have, long-term unsecured, unsubordinated debt or deposit ratings from Standard & Poor's, Moody's, and/or Fitch, where the lowest rating is A-/A3 or better. The Bank also executes interest rate exchange agreements with its members. The Bank enters into master agreements with netting provisions with all counterparties and into bilateral security agreements with all active derivatives dealer counterparties. All member counterparty master agreements, excluding those with
54
derivatives dealers, are subject to the terms of the Bank's Advances and Security Agreement with members, and all member counterparties (except for those that are derivatives dealers) must fully collateralize the Bank's net credit exposure. As of June 30, 2011, the Bank had pledged as collateral securities with a carrying value of $68, all of which could be sold or repledged, to counterparties that had market risk exposure to the Bank related to derivatives. As of December 31, 2010, the Bank had pledged as collateral securities with a carrying value of $84, all of which could be sold or repledged, to counterparties that had market risk exposure to the Bank related to derivatives.
The Bank may be subject to various pending legal proceedings that may arise in the normal course of business. After consultation with legal counsel, the Bank does not anticipate that the ultimate liability, if any, arising out of these matters will have a material effect on its financial condition or results of operations.
Other commitments and contingencies are discussed in Note 7 – Advances, Note 8 – Mortgage Loans Held for Portfolio, Note 11 – Consolidated Obligations, Note 12 – Capital, and Note 14 – Derivatives and Hedging Activities.
Note 17 — Transactions with Certain Members, Certain Nonmembers, and Other FHLBanks
Transactions with Certain Members and Certain Nonmembers. The following tables set forth information at the dates and for the periods indicated with respect to transactions with: (i) members and nonmembers holding more than 10% of the outstanding shares of the Bank's capital stock, including mandatorily redeemable capital stock, at each respective period end, (ii) members that had an officer or director serving on the Bank's Board of Directors at any time during the periods indicated, and (iii) affiliates of the foregoing members and nonmembers. All transactions with members, the nonmembers described in the preceding sentence, and their respective affiliates are entered into in the normal course of business.
June 30, 2011 | December 31, 2010 | ||||||
Assets: | |||||||
Cash and due from banks | $ | 1 | $ | — | |||
Investments(1) | 3,022 | 2,568 | |||||
Advances | 51,886 | 57,567 | |||||
Mortgage loans held for portfolio | 1,671 | 1,888 | |||||
Accrued interest receivable | 43 | 80 | |||||
Derivative assets | 660 | 762 | |||||
Total | $ | 57,283 | $ | 62,865 | |||
Liabilities: | |||||||
Deposits | $ | 663 | $ | 760 | |||
Mandatorily redeemable capital stock | 6,144 | 3,001 | |||||
Derivative liabilities | 3 | 4 | |||||
Total | $ | 6,810 | $ | 3,765 | |||
Notional amount of derivatives | $ | 43,775 | $ | 49,695 | |||
Standby letters of credit | 3,694 | 3,764 |
(1) Investments consist of Federal funds sold, available-for-sale securities, and held-to-maturity securities issued by and/or purchased from the members or nonmembers described in this section or their affiliates.
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Three Months Ended | Six Months Ended | ||||||||||||||
June 30, 2011 | June 30, 2010 | June 30, 2011 | June 30, 2010 | ||||||||||||
Interest Income: | |||||||||||||||
Investments(1) | $ | 14 | $ | 24 | $ | 30 | $ | 50 | |||||||
Advances(2) | 47 | 163 | 96 | 333 | |||||||||||
Mortgage loans held for portfolio | 21 | 28 | 43 | 57 | |||||||||||
Total | $ | 82 | $ | 215 | $ | 169 | $ | 440 | |||||||
Interest Expense: | |||||||||||||||
Mandatorily redeemable capital stock | $ | 3 | $ | 2 | $ | 6 | $ | 5 | |||||||
Consolidated obligations(3) | (123 | ) | (168 | ) | (247 | ) | (353 | ) | |||||||
Total | $ | (120 | ) | $ | (166 | ) | $ | (241 | ) | $ | (348 | ) | |||
Other Income/(Loss): | |||||||||||||||
Net gain/(loss) on derivatives and hedging activities | $ | (42 | ) | $ | 11 | $ | (143 | ) | $ | 14 | |||||
Other income | — | 1 | 2 | 2 | |||||||||||
Total | $ | (42 | ) | $ | 12 | $ | (141 | ) | $ | 16 |
(1) Investments consist of Federal funds sold, available-for-sale securities, and held-to-maturity securities issued by and/or purchased from the members or nonmembers described in this section or their affiliates.
(2) Includes the effect of associated derivatives with the members or nonmembers described in this section or their affiliates.
(3) Reflects the effect of associated derivatives with the members or nonmembers described in this section or their affiliates.
Transactions with Other FHLBanks. Transactions with other FHLBanks are identified on the face of the Bank's financial statements.
Note 18 — Subsequent Events
The Bank evaluated events subsequent to June 30, 2011, until the time of the Form 10-Q filing with the Securities and Exchange Commission, and no material subsequent events were identified, other than those discussed below.
On July 28, 2011, the Bank announced that it plans to repurchase up to $500 in excess capital stock on August 15, 2011. The amount of excess capital stock to be repurchased from any shareholder will be based on the shareholder's pro rata ownership share of total capital stock outstanding as of the repurchase date, up to the amount of the shareholder's excess capital stock.
On July 28, 2011, the Bank's Board of Directors declared a cash dividend for the second quarter of 2011 at an annualized dividend rate of 0.26%. The Bank recorded the second quarter dividend on July 28, 2011, the day it was declared by the Board of Directors. The Bank expects to pay the second quarter dividend (including dividends on mandatorily redeemable capital stock), which will total $7, on or about August 11, 2011. The Bank will pay the dividend in cash rather than stock to comply with Finance Agency rules.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Statements contained in this quarterly report on Form 10-Q, including statements describing the objectives, projections, estimates, or predictions of the future of the Federal Home Loan Bank of San Francisco (Bank) or the Federal Home Loan Bank System, are “forward-looking statements.” These statements may use forward-looking terms, such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “likely,” “may,” “probable,” “project,” “should,” “will,” or their negatives or other variations on these terms, and include statements related to, among others, gains and losses on derivatives, plans to pay dividends and repurchase excess capital stock, future other-than-temporary impairment charges, future classification of securities, amendments to the Bank's Capital Plan and Joint Capital Enhancement Agreement, and reform legislation. The Bank cautions that by their nature, forward-looking statements involve risk or uncertainty that could cause actual 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. These risks and uncertainties include, among others, the following:
• | changes in economic and market conditions, including conditions in the mortgage, housing, and capital markets; |
• | the volatility of market prices, rates, and indices; |
• | the timing and volume of market activity; |
• | political events, including legislative, regulatory, judicial, or other developments that affect the Bank, its members, counterparties, or investors in the consolidated obligations of the Federal Home Loan Banks (FHLBanks), such as the impact of any government-sponsored enterprises (GSE) legislative reforms, |
• | changes in the Federal Home Loan Bank Act of 1932 as amended (FHLBank Act), changes in applicable sections of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, or changes in regulations applicable to the FHLBanks; |
• | changes in the Bank's capital structure; |
• | the ability of the Bank to pay dividends or redeem or repurchase capital stock; |
• | membership changes, including changes resulting from mergers or changes in the principal place of business of Bank members; |
• | the soundness of other financial institutions, including Bank members, nonmember borrowers or other counterparties, and the other FHLBanks; |
• | changes in the demand by Bank members for Bank advances; |
• | changes in the value or liquidity of collateral underlying advances to Bank members or nonmember borrowers or collateral pledged by the Bank's derivatives counterparties; |
• | changes in the fair value and economic value of, impairments of, and risks associated with the Bank's investments in mortgage loans and mortgage-backed securities (MBS) or other assets and the related credit enhancement protections; |
• | changes in the Bank's ability or intent to hold MBS and mortgage loans to maturity; |
• | competitive forces, including the availability of other sources of funding for Bank members; |
• | the willingness of the Bank's members to do business with the Bank whether or not the Bank is paying dividends or repurchasing excess capital stock; |
• | changes in investor demand for consolidated obligations and/or the terms of interest rate exchange or similar agreements; |
• | the ability of the Bank to introduce new products and services to meet market demand and to manage successfully the risks associated with new products and services; |
• | the ability of each of the other FHLBanks to repay the principal and interest on consolidated obligations for which it is the primary obligor and with respect to which the Bank has joint and several liability; and |
• | technological changes and enhancements, and the Bank's ability to develop and support technology and information systems sufficient to manage the risks of the Bank's business effectively. |
Readers of this report should not rely solely on the forward-looking statements and should consider all risks and uncertainties addressed throughout this report, as well as those discussed under “Item 1A. Risk Factors” in the Bank's Annual Report on Form 10-K for the year ended December 31, 2010 (2010 Form 10-K).
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This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Bank's interim financial statements and notes and the Bank's 2010 Form 10-K.
On July 30, 2008, the Housing and Economic Recovery Act of 2008 (Housing Act) was enacted. The Housing Act created a new federal agency, the Federal Housing Finance Agency (Finance Agency), which became the new federal regulator of the FHLBanks effective on the date of enactment of the Housing Act. On October 27, 2008, the Federal Housing Finance Board (Finance Board), the federal regulator of the FHLBanks prior to the creation of the Finance Agency, merged into the Finance Agency. Pursuant to the Housing Act, all regulations, orders, determinations, and resolutions that were issued, made, prescribed, or allowed to become effective by the Finance Board will remain in effect until modified, terminated, set aside, or superseded by the Director of the Finance Agency, any court of competent jurisdiction, or operation of law. References throughout this report to regulations of the Finance Agency also include the regulations of the Finance Board where they remain applicable.
Quarterly Overview
U.S. economic conditions continued to affect the Bank's business and results of operations, as well as those of its members, during the second quarter of 2011. The pace of U.S. economic expansion slowed during the period, employment growth stalled, and the housing sector remained weak. As consumer confidence declined, home sales fell. Large supplies of unsold distressed properties continued to overhang many local markets, dampening housing values, and despite low mortgage interest rates, buyers remained discouraged. No upswing in lending by Bank members was evident, although some members reported originating more commercial and industrial loans. Bank members continued to maintain high levels of liquidity, which were adequate to fund most of their lending activities.
Net income for the second quarter of 2011 was $9 million, compared with net income of $29 million for the second quarter of 2010. The decrease in net income for the second quarter of 2011 primarily reflected a decline in net interest income. In addition, the Bank incurred a higher credit-related other-than-temporary impairment (OTTI) charge on private-label residential mortgage-backed securities (PLRMBS) in the second quarter of 2011 relative to the same period in 2010. These negative effects on net income were partially offset by lower net losses associated with derivatives, hedged items, and financial instruments carried at fair value in the second quarter of 2011 compared to the second quarter of 2010.
Net interest income for the second quarter of 2011 was $264 million, down from $363 million for the second quarter of 2010. The decrease in net interest income was due, in part, to lower earnings on invested capital (resulting from the lower interest rate environment), lower advances and MBS balances, and lower advance prepayment fees. In addition, net interest income on economically hedged assets and liabilities was lower in the second quarter of 2011 relative to the year-earlier period. (This income is generally offset by net interest expense on derivative instruments used in economic hedges, reflected in other income). These factors were partially offset by increased spreads on the Bank's portfolio of MBS and mortgage loans.
Other income/(loss) for the second quarter of 2011 was a loss of $219 million, compared to a loss of $285 million for the second quarter of 2010. The loss for the second quarter of 2011 reflected a credit-related OTTI charge of $163 million on certain PLRMBS, compared to a credit-related OTTI charge of $142 million for the second quarter of 2010. The net loss associated with derivatives, hedged items, and financial instruments carried at fair value was $50 million for the second quarter of 2011, compared to a net loss of $102 million for the second quarter of 2010. In addition, net interest expense on derivative instruments used in economic hedges, which was generally offset by net interest income on the economically hedged assets and liabilities, totaled $7 million in the second quarter of 2011, compared to $43 million in the second quarter of 2010.
The $50 million net loss associated with derivatives, hedged items, and financial instruments carried at fair value for the second quarter of 2011 reflected losses, primarily associated with the effects of changes in interest rates and increased swaption volatilities. Net gains and losses on these financial instruments are primarily a matter of timing and will generally reverse through changes in future valuations and settlements of contractual interest cash flows
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over the remaining contractual terms to maturity, or by the exercised call or put dates. As of June 30, 2011, the Bank's retained earnings included a cumulative net gain of $130 million associated with derivatives, hedged items, and financial instruments carried at fair value.
The credit-related OTTI charge of $163 million for the second quarter of 2011 reflected the impact of additional projected losses on loan collateral underlying certain of the Bank's PLRMBS. Each quarter, the Bank updates its OTTI analysis to reflect current and anticipated housing market conditions, observed and anticipated borrower behavior, and updated information on the loans supporting the Bank's PLRMBS. This process includes updating key aspects of the Bank's loss projection models. Projected collateral performance as of the end of the second quarter of 2011 primarily reflected decreases in actual and slower than previously forecasted housing price recovery.
PLRMBS classified as held-to-maturity that experienced OTTI related to credit during the second quarter of 2011 were reclassified to available-for-sale at their fair values as of June 30, 2011. The Bank does not currently intend to sell any of the securities in its available-for-sale portfolio or in its held-to-maturity portfolio. Accumulated other comprehensive loss declined $1.2 billion during the first six months of 2011, from $2.9 billion at December 31, 2010, to $1.7 billion at June 30, 2011, primarily because of two factors. As a result of improvement in the fair value of PLRMBS classified as available-for-sale, accumulated other comprehensive loss was reduced by $928 million. In addition, the Bank accreted $253 million from accumulated other comprehensive loss for PLRMBS classified as held-to-maturity that had experienced OTTI in prior quarters. For PLRMBS classified as held-to-maturity, the amount of the non-credit-related impairment is accreted prospectively, based on the amount and timing of future estimated cash flows, over the remaining life of the security as an increase in the carrying value of the security, with no effect on earnings unless the security is subsequently sold or there are additional decreases in the cash flows expected to be collected.
Additional information about investments and OTTI charges associated with the Bank's PLRMBS is provided in “Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Investments” and in “Item 1. Financial Statements – Note 6 – Other-Than-Temporary Impairment Analysis. Additional information about the Bank's PLRMBS is also provided in “Part II. Item 1. Legal Proceedings.”
On July 28, 2011, the Bank's Board of Directors declared a cash dividend for the second quarter of 2011 at an annualized rate of 0.26%. The Bank recorded the second quarter dividend on July 28, 2011, the day it was declared by the Board of Directors. The Bank expects to pay the dividend (including dividends on mandatorily redeemable capital stock), which will total $7 million, on or about August 11, 2011. The Bank will pay the dividend in cash rather than stock to comply with Finance Agency rules, which do not permit the Bank to pay dividends in the form of capital stock if the Bank's excess capital stock exceeds 1% of its total assets. As of June 30, 2011, the Bank's excess capital stock totaled $6.3 billion, or 4.40% of total assets.
As of June 30, 2011, the Bank was in compliance with all of its regulatory capital requirements. The Bank's total regulatory capital ratio was 8.90%, exceeding the 4.00% requirement. The Bank had $12.9 billion in regulatory capital, exceeding its risk-based capital requirement of $3.7 billion.
In light of the Bank's strong regulatory capital position, the Bank plans to repurchase up to $500 million in excess capital stock on August 15, 2011. The amount of excess capital stock to be repurchased from any shareholder will be based on the shareholder's pro rata ownership share of total capital stock outstanding as of the repurchase date, up to the amount of the shareholder's excess capital stock.
The Bank will continue to monitor the condition of the Bank's PLRMBS portfolio, the ratio of the estimated market value of the Bank's capital to the par value of the Bank's capital stock, its overall financial performance and retained earnings, developments in the mortgage and credit markets, and other relevant information as the basis for determining the status of dividends and excess capital stock repurchases in future quarters.
During the first six months of 2011, total assets decreased $8.0 billion, or 5%, to $144.4 billion at June 30, 2011, from $152.4 billion at December 31, 2010. Total advances declined $12.9 billion, or 13%, to $82.7 billion at June 30, 2011, from $95.6 billion at December 31, 2010. The continued decrease in member advance demand
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reflected general economic conditions and conditions in the mortgage and credit markets. Member liquidity remained high and lending activity remained subdued.
All advances made by the Bank are required to be fully collateralized in accordance with the Bank's credit and collateral requirements. The Bank monitors the creditworthiness of its members on an ongoing basis. In addition, the Bank has a comprehensive process for assigning values to collateral and determining how much it will lend against the collateral pledged. During the second quarter of 2011, the Bank continued to review and adjust its lending parameters based on market conditions. Based on the Bank's risk assessments of housing and mortgage market conditions and of individual members and their collateral, the Bank also continued to adjust collateral terms for individual members during the second quarter of 2011.
One member institution was placed into receivership during the second quarter of 2011. The advances outstanding to this institution were assumed by another institution, and no losses were incurred by the Bank. The Bank capital stock held by this institution was transferred to another member institution.
From July 1, 2011, to July 29, 2011, one member institution was placed into receivership. The advances outstanding to this institution were assumed by another member institution and no losses were incurred by the Bank. The Bank capital stock held by this institution was transferred to another member institution.
The Bank reclassified $3.2 billion of capital stock to mandatorily redeemable capital stock (a liability) on June 28, 2011, as a result of the membership termination of Citibank, N.A., which became ineligible for membership in the Bank when it became a member of another Federal Home Loan Bank in connection with its planned merger with an affiliate outside of the Bank's district, as previously announced. A decrease in advances to any departing member, if not replaced with advances to other members, results in a reduction of the Bank's total assets and net income. The timing and magnitude of the impact of a decrease in the amount of advances related to the departure of Citibank, N.A., as a member will depend on a number of factors, including: the amount and the period over which the advances are prepaid or repaid; the amount and timing of any corresponding decreases in activity-based capital stock; the profitability of the advances; the extent to which consolidated obligations mature as the advances are prepaid or repaid; and the Bank's ability to extinguish consolidated obligations or transfer them to other FHLBanks and the associated costs.
Several issues are contributing to ongoing uncertainty in the housing and mortgage markets, including allegations of widespread failures in the processing of home mortgage foreclosures and increasing investor demands for sellers to repurchase mortgage loans that do not conform to the original representations and warranties. The Bank is monitoring developments in these areas to assess the potential impact on the Bank's PLRMBS and on the creditworthiness or pledged mortgage collateral of any large Bank member or affiliate affected by these issues.
Effective February 28, 2011, the 12 FHLBanks, including the Bank, entered into a Joint Capital Enhancement Agreement (Agreement) intended to enhance the capital position of each FHLBank by allocating that portion of each FHLBank's earnings historically paid to satisfy its Resolution Funding Corporation (REFCORP) obligation to a separate retained earnings account at that FHLBank.
The FHLBanks subsequently amended their capital plans or capital plan submissions, as applicable, to implement the provisions of the Agreement, and the Finance Agency approved the capital plan amendments on August 5, 2011. The amended capital plans, including the Bank's amended capital plan, will become effective on September 5, 2011. On August 5, 2011, the FHLBanks also amended the Agreement to reflect differences between the original Agreement and the capital plan amendments.
On August 5, 2011, the Finance Agency certified that the FHLBanks have fully satisfied their REFCORP obligation. In accordance with the Agreement, starting in the third quarter of 2011, each FHLBank is required to allocate 20% of its net income to a separate restricted retained earnings account until the balance of the account equals at least 1% of that FHLBank's average balance of outstanding consolidated obligations for the previous quarter. These restricted retained earnings will not be available to pay dividends.
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On August 5, 2011, Standard & Poor's Ratings Services (Standard & Poor's) lowered its long-term sovereign credit rating of the United States from AAA to AA+ with a negative outlook and affirmed the A-1+ short-term rating. In Standard & Poor's application of its government-related entities criteria, the ratings of the FHLBank System and the FHLBanks are constrained by the long-term sovereign credit rating of the United States. As a result, on August 8, 2011, Standard & Poor's lowered the long-term issuer credit ratings and related issuer ratings with a negative outlook on select government-related entities. Specifically, Standard & Poor's lowered its long-term issuer credit ratings and related issue ratings on 10 of the 12 FHLBanks and on the senior debt issued by the FHLBank System (FHLBank System consolidated obligations) from AAA to AA+ with a negative outlook (the FHLBank of Chicago and the FHLBank of Seattle had been previously rated AA+) and removed the FHLBanks and relevant debt issues from CreditWatch. The downgrade by Standard &Poor's could result in higher FHLBank funding costs and/or disruptions to capital markets access. In addition, member demand for standby letters of credit issued by the Bank on behalf of members, which may be influenced by the Bank's credit rating, could be weakened by the downgrade of the Bank's credit rating. To the extent that the Bank cannot access funding when needed on acceptable terms to effectively manage its cost of funds or that demand for its products falls, its financial condition and results of operations could be adversely affected. The downgrade by Standard & Poor's also triggers additional collateral posting requirements under most of the Bank's derivatives agreements. For more information about the downgrade, see “Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition.”
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Financial Highlights
The following table presents a summary of certain financial information for the Bank for the periods indicated.
Financial Highlights
(Unaudited)
(Dollars in millions) | June 30, 2011 | March 31, 2011 | December 31, 2010 | September 30, 2010 | June 30, 2010 | ||||||||||||||
Selected Balance Sheet Items at Quarter End | |||||||||||||||||||
Total Assets | $ | 144,438 | $ | 151,444 | $ | 152,423 | $ | 142,695 | $ | 158,198 | |||||||||
Advances | 82,745 | 92,005 | 95,599 | 89,327 | 95,747 | ||||||||||||||
Mortgage Loans Held for Portfolio, Net | 2,097 | 2,205 | 2,381 | 2,623 | 2,788 | ||||||||||||||
Investments(1) | 51,222 | 52,413 | 52,582 | 49,889 | 51,139 | ||||||||||||||
Consolidated Obligations:(2) | |||||||||||||||||||
Bonds | 111,709 | 115,464 | 121,120 | 118,764 | 129,524 | ||||||||||||||
Discount Notes | 20,406 | 22,951 | 19,527 | 11,138 | 15,788 | ||||||||||||||
Mandatorily Redeemable Capital Stock | 6,144 | 3,102 | 3,749 | 3,627 | 4,690 | ||||||||||||||
Capital Stock —Class B —Putable | 5,046 | 8,496 | 8,282 | 8,875 | 8,280 | ||||||||||||||
Restricted Retained Earnings | 1,665 | 1,663 | 1,609 | 1,478 | 1,350 | ||||||||||||||
Accumulated Other Comprehensive Loss | (1,692 | ) | (2,039 | ) | (2,943 | ) | (3,152 | ) | (3,332 | ) | |||||||||
Total Capital | 5,019 | 8,120 | 6,948 | 7,201 | 6,298 | ||||||||||||||
Selected Operating Results for the Quarter | |||||||||||||||||||
Net Interest Income | $ | 264 | $ | 256 | $ | 270 | $ | 306 | $ | 363 | |||||||||
Provision for Credit Losses on Mortgage Loans | 3 | — | — | — | 2 | ||||||||||||||
Other Income/(Loss) | (219 | ) | (142 | ) | (38 | ) | (86 | ) | (285 | ) | |||||||||
Other Expense | 30 | 32 | 41 | 33 | 35 | ||||||||||||||
Assessments | 3 | 22 | 51 | 50 | 12 | ||||||||||||||
Net Income | $ | 9 | $ | 60 | $ | 140 | $ | 137 | $ | 29 | |||||||||
Selected Other Data for the Quarter | |||||||||||||||||||
Net Interest Margin(3) | 0.72 | % | 0.69 | % | 0.72 | % | 0.81 | % | 0.87 | % | |||||||||
Operating Expenses as a Percent of Average Assets | 0.07 | 0.07 | 0.07 | 0.07 | 0.07 | ||||||||||||||
Return on Average Assets | 0.03 | 0.16 | 0.37 | 0.36 | 0.07 | ||||||||||||||
Return on Average Equity | 0.48 | 3.26 | 8.04 | 8.38 | 1.87 | ||||||||||||||
Annualized Dividend Rate(4) | 0.31 | 0.29 | 0.39 | 0.44 | 0.26 | ||||||||||||||
Dividend Payout Ratio(5) | 69.44 | 10.36 | 5.90 | 6.74 | 18.60 | ||||||||||||||
Average Equity to Average Assets Ratio | 5.38 | 4.92 | 4.61 | 4.30 | 3.76 | ||||||||||||||
Selected Other Data at Quarter End | |||||||||||||||||||
Regulatory Capital Ratio(6) | 8.90 | 8.76 | 8.95 | 9.80 | 9.05 | ||||||||||||||
Duration Gap (in months) | 1 | 1 | 1 | 7 | 6 |
(1) | Investments consist of Federal funds sold, trading securities, available-for-sale securities, held-to-maturity securities, securities purchased under agreements to resell, and loans to other Federal Home Loan Banks (FHLBanks). |
(2) | As provided by the FHLBank Act or regulations governing the operations of the FHLBanks, all of the FHLBanks have joint and several liability for FHLBank consolidated obligations, which are backed only by the financial resources of the FHLBanks. The joint and several liability regulation authorizes the Finance Agency to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor. The Bank has never been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank, and as of June 30, 2011, and through the filing date of this report, does not believe that it is probable that it will be asked to do so. The par amount of the outstanding consolidated obligations of all 12 FHLBanks at the dates indicated was as follows: |
Par Amount (In millions) | |||
June 30, 2011 | $ | 727,475 | |
March 31, 2011 | 765,980 | ||
December 31, 2010 | 796,374 | ||
September 30, 2010 | 806,007 | ||
June 30, 2010 | 846,481 |
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(3) | Net interest margin is net interest income (annualized) divided by average interest-earning assets. |
(4) | On July 28, 2011, the Bank's Board of Directors declared a cash dividend for the second quarter of 2011 at an annualized dividend rate of 0.26%. The Bank recorded and will pay the second quarter dividend during the third quarter of 2011. |
(5) | This ratio is calculated as dividends per share divided by net income per share. |
(6) | This ratio is calculated as regulatory capital divided by total assets. Regulatory capital includes mandatorily redeemable capital stock (which is classified as a liability) and excludes accumulated other comprehensive income. |
Results of Operations
The primary source of Bank earnings is net interest income, which is the interest earned on advances, mortgage loans, and investments, less interest paid on consolidated obligations, deposits, and other borrowings. The Average Balance Sheets tables that follow presents the average balances of earning asset categories and the sources that fund those earning assets (liabilities and capital) for the three and six months ended June 30, 2011 and 2010, together with the related interest income and expense. It also presents the average rates on total earning assets and the average costs of total funding sources.
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Second Quarter of 2011 Compared to Second Quarter of 2010
Average Balance Sheets | |||||||||||||||||||||
Three Months Ended | |||||||||||||||||||||
June 30, 2011 | June 30, 2010 | ||||||||||||||||||||
(Dollars in millions) | Average Balance | Interest Income/ Expense | Average Rate | Average Balance | Interest Income/ Expense | Average Rate | |||||||||||||||
Assets | |||||||||||||||||||||
Interest-earning assets: | |||||||||||||||||||||
Federal funds sold | $ | 17,018 | $ | 6 | 0.14 | % | $ | 17,162 | $ | 8 | 0.20 | % | |||||||||
Trading securities: | |||||||||||||||||||||
MBS | 22 | — | 2.85 | 28 | 1 | 3.77 | |||||||||||||||
Other investments | 3,528 | 7 | 0.76 | 396 | — | 0.34 | |||||||||||||||
Available-for-sale securities:(1) | |||||||||||||||||||||
MBS | 6,976 | 71 | 4.02 | — | — | — | |||||||||||||||
Other investments | 1,927 | 1 | 0.27 | 1,933 | 1 | 0.29 | |||||||||||||||
Held-to-maturity securities:(1) | |||||||||||||||||||||
MBS | 18,835 | 161 | 3.43 | 27,966 | 275 | 3.95 | |||||||||||||||
Other investments | 9,372 | 5 | 0.19 | 10,864 | 7 | 0.26 | |||||||||||||||
Mortgage loans held for portfolio, net | 2,155 | 28 | 5.16 | 2,849 | 39 | 5.48 | |||||||||||||||
Advances(2) | 87,506 | 180 | 0.83 | 106,962 | 313 | 1.17 | |||||||||||||||
Loans to other FHLBanks | 3 | — | 0.09 | 4 | — | 0.15 | |||||||||||||||
Total interest-earning assets | 147,342 | 459 | 1.25 | 168,164 | 644 | 1.54 | |||||||||||||||
Other assets(3)(4)(5) | 746 | — | — | 60 | — | — | |||||||||||||||
Total Assets | $ | 148,088 | $ | 459 | 1.24 | % | $ | 168,224 | $ | 644 | 1.54 | % | |||||||||
Liabilities and Capital | |||||||||||||||||||||
Interest-bearing liabilities: | |||||||||||||||||||||
Consolidated obligations: | |||||||||||||||||||||
Bonds(2) | $ | 114,244 | $ | 183 | 0.64 | % | $ | 136,327 | $ | 269 | 0.79 | % | |||||||||
Discount notes | 20,378 | 9 | 0.19 | 17,709 | 9 | 0.21 | |||||||||||||||
Deposits(3) | 904 | — | — | 1,586 | — | 0.06 | |||||||||||||||
Borrowings from other FHLBanks | 2 | — | 0.08 | — | — | — | |||||||||||||||
Mandatorily redeemable capital stock | 3,144 | 3 | 0.33 | 4,771 | 3 | 0.26 | |||||||||||||||
Total interest-bearing liabilities | 138,672 | 195 | 0.56 | 160,393 | 281 | 0.70 | |||||||||||||||
Other liabilities(3)(4) | 1,442 | — | — | 1,511 | — | — | |||||||||||||||
Total Liabilities | 140,114 | 195 | — | 161,904 | 281 | 0.70 | |||||||||||||||
Total Capital | 7,974 | — | — | 6,320 | — | — | |||||||||||||||
Total Liabilities and Capital | $ | 148,088 | $ | 195 | 0.53 | % | $ | 168,224 | $ | 281 | 0.67 | % | |||||||||
Net Interest Income | $ | 264 | $ | 363 | |||||||||||||||||
Net Interest Spread(6) | 0.69 | % | 0.84 | % | |||||||||||||||||
Net Interest Margin(7) | 0.72 | % | 0.87 | % | |||||||||||||||||
Interest-earning Assets/Interest-bearing Liabilities | 106.25 | % | 104.84 | % |
(1) | The average balances of available-for-sale securities and held-to-maturity securities are reflected at amortized cost. As a result, the average rates do not reflect changes in fair value or non-credit-related OTTI charges. |
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(2) | Interest income/expense and average rates include the effect of associated interest rate exchange agreements, as follows: |
Three Months Ended | |||||||||||||||||||||||
June 30, 2011 | June 30, 2010 | ||||||||||||||||||||||
(In millions) | (Amortization)/ Accretion of Hedging Activities | Net Interest Settlements | Total Net Interest Income/(Expense) | (Amortization)/ Accretion of Hedging Activities | Net Interest Settlements | Total Net Interest Income/(Expense) | |||||||||||||||||
Advances | $ | (8 | ) | $ | (66 | ) | $ | (74 | ) | $ | (13 | ) | $ | (143 | ) | $ | (156 | ) | |||||
Consolidated obligation bonds | 22 | 317 | 339 | 25 | 468 | 493 |
(3) | Average balances do not reflect the effect of reclassifications of cash collateral. |
(4) | Includes forward settling transactions and valuation adjustments for certain cash items. |
(5) | Includes non-credit-related OTTI charges on available-for-sale and held-to-maturity securities. |
(6) | Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities. |
(7) | Net interest margin is net interest income (annualized) divided by average interest-earning assets. |
Net interest income in the second quarter of 2011 was $264 million, a 27% decrease from $363 million in the second quarter of 2010. The following table details the changes in interest income and interest expense for the second quarter of 2011 compared to the second quarter of 2010. Changes in both volume and interest rates influence changes in net interest income, net interest spread, and net interest margin.
Change in Net Interest Income: Rate/Volume Analysis Three Months Ended June 30, 2011, Compared to Three Months Ended June 30, 2010 | |||||||||||
Increase/ (Decrease) | Attributable to Changes in(1) | ||||||||||
(In millions) | Average Volume | Average Rate | |||||||||
Interest-earning assets: | |||||||||||
Federal funds sold | $ | (2 | ) | $ | — | $ | (2 | ) | |||
Trading securities: | |||||||||||
MBS | (1 | ) | — | (1 | ) | ||||||
Other investments | 7 | 6 | 1 | ||||||||
Available-for-sale securities: | |||||||||||
MBS | 71 | 71 | — | ||||||||
Other investments | — | — | — | ||||||||
Held-to-maturity securities: | |||||||||||
MBS | (114 | ) | (81 | ) | (33 | ) | |||||
Other investments | (2 | ) | (1 | ) | (1 | ) | |||||
Mortgage loans held for portfolio | (11 | ) | (9 | ) | (2 | ) | |||||
Advances(2) | (133 | ) | (51 | ) | (82 | ) | |||||
Total interest-earning assets | (185 | ) | (65 | ) | (120 | ) | |||||
Interest-bearing liabilities: | |||||||||||
Consolidated obligations: | |||||||||||
Bonds(2) | (86 | ) | (40 | ) | (46 | ) | |||||
Discount notes | — | 1 | (1 | ) | |||||||
Mandatorily redeemable capital stock | — | (1 | ) | 1 | |||||||
Total interest-bearing liabilities | (86 | ) | (40 | ) | (46 | ) | |||||
Net interest income | $ | (99 | ) | $ | (25 | ) | $ | (74 | ) |
(1) | Combined rate/volume variances, a third element of the calculation, are allocated to the rate and volume variances based on their relative sizes. |
(2) | Interest income/expense and average rates include the interest effect of associated interest rate exchange agreements. |
Net interest income included advance prepayment fees of $4 million in the second quarter of 2011 compared to $28 million in the second quarter of 2010 and reflected the impact of cumulative retrospective adjustments for the amortization of net purchase discounts from the acquisition dates of the MBS and mortgage loans, which increased
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interest income by $6 million in the second quarter of 2011 and by $15 million in the second quarter of 2010.
The net interest margin for the second quarter of 2011 was 72 basis points, 15 basis points lower than the net interest margin for the second quarter of 2010, which was 87 basis points. The net interest spread for the second quarter of 2011 was 69 basis points, 15 basis points lower than the net interest spread for the second quarter of 2010, which was 84 basis points. These decreases were primarily due to lower earnings on invested capital (resulting from the lower interest rate environment) and lower advance prepayment fees. In addition, net interest income on economically hedged assets and liabilities was lower in the second quarter of 2011 relative to the year-earlier period. This income is generally offset by net interest expense on derivative instruments used in economic hedges, recognized in “Other Income/(Loss),” which was also lower in the second quarter of 2011. These factors were partially offset by increased spreads on the mortgage portfolio.
Member demand for wholesale funding from the Bank can vary greatly depending on a number of factors, including economic and market conditions, competition from other wholesale funding sources, member deposit inflows and outflows, the activity level of the primary and secondary mortgage markets, and strategic decisions made by individual member institutions. As a result, Bank asset levels and operating results may vary significantly from period to period.
Other Income/(Loss)
The following table presents the components of “Other Income/(Loss)” for the three months ended June 30, 2011 and 2010.
Other Income/(Loss) | |||||||
Three Months Ended | |||||||
(In millions) | June 30, 2011 | June 30, 2010 | |||||
Other Income/(Loss): | |||||||
Net loss on trading securities(1) | $ | — | $ | (1 | ) | ||
Total other-than-temporary impairment loss | (116 | ) | (190 | ) | |||
Net amount of impairment loss reclassified (from)/to accumulated other comprehensive loss | (47 | ) | 48 | ||||
Net other-than-temporary impairment loss | (163 | ) | (142 | ) | |||
Net gain/(loss) on advances and consolidation obligation bonds held at fair value | 34 | (21 | ) | ||||
Net loss on derivatives and hedging activities | (91 | ) | (123 | ) | |||
Other | 1 | 2 | |||||
Total Other Income/(Loss) | $ | (219 | ) | $ | (285 | ) |
(1) The net loss on trading securities that were economically hedged totaled $0.4 million and $(1.2) million for the three months ended June 30, 2011 and 2010, respectively.
Net Other-Than-Temporary Impairment Loss – Each quarter, the Bank updates its OTTI analysis to reflect current and anticipated housing market conditions, observed and anticipated borrower behavior, and updated information on the loans supporting the Bank's PLRMBS. This process includes updating key aspects of the Bank's loss projection models. Projected collateral performance as of the end of the second quarter of 2011 primarily reflected decreases in actual and expected housing prices and an expected slowdown in housing price recovery. The following table presents the net other-than-temporary impairment loss for the three months ended June 30, 2011 and 2010:
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Net Other-Than-Temporary Impairment Loss | |||||||||||||||||||||||
Three Months Ended | |||||||||||||||||||||||
June 30, 2011 | June 30, 2010 | ||||||||||||||||||||||
(In millions) | Credit- Related OTTI | Non-Credit- Related OTTI | Total OTTI | Credit- Related OTTI | Non-Credit- Related OTTI | Total OTTI | |||||||||||||||||
Securities newly impaired during the period | $ | 3 | $ | 53 | $ | 56 | $ | 2 | $ | 175 | $ | 177 | |||||||||||
Securities previously impaired prior to current period(1) | 160 | (100 | ) | 60 | 140 | (127 | ) | 13 | |||||||||||||||
Total | $ | 163 | $ | (47 | ) | $ | 116 | $ | 142 | $ | 48 | $ | 190 |
(1) For the three months ended June 30, 2011, “securities previously impaired prior to current period” represents all securities that were also other-than-temporarily impaired prior to April 1, 2011. For the three months ended June 30, 2010, “securities previously impaired prior to current period” represents all securities that were also other-than-temporarily impaired prior to April 1, 2010.
Additional information about the OTTI charge is provided in “Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Investments” and in “Item 1. Financial Statements – Note 6 – Other-Than-Temporary Impairment Analysis.”
Net Gain/(Loss) on Advances and Consolidated Obligation Bonds Held at Fair Value – The following table presents the net gain/(loss) on advances and consolidated obligation bonds held at fair value, for which the Bank elected the fair value option for the three months ended June 30, 2011 and 2010.
Net Gain/(Loss) on Advances and Consolidated Obligation Bonds Held at Fair Value | |||||||
Three Months Ended | |||||||
(In millions) | June 30, 2011 | June 30, 2010 | |||||
Advances | $ | 105 | $ | 35 | |||
Consolidated obligation bonds | (71 | ) | (56 | ) | |||
Total | $ | 34 | $ | (21 | ) |
In general, transactions elected for the fair value option are in economic hedge relationships. Gains or losses on these transactions are generally offset by losses or gains on derivatives that economically hedge these instruments.
For the second quarter of 2011, the unrealized net fair value gains on advances were primarily driven by the decreased interest rate environment relative to the actual coupon rates on the Bank's advances and by higher swaption volatilities used in pricing fair value option putable advances during the second quarter of 2011. The unrealized net fair value losses on consolidated obligation bonds were primarily driven by the decreased interest rate environment relative to the actual coupon rates on the consolidated obligation bonds.
For the second quarter of 2010, the unrealized net fair value gains on advances were primarily driven by the decreased long-term interest rate environment relative to the actual coupon rates on the Bank's advances. The unrealized net fair value losses on consolidated obligation bonds were primarily driven by the decreased long-term interest rate environment relative to the actual coupon rates on the consolidated obligation bonds.
Net Loss on Derivatives and Hedging Activities – The following table shows the accounting classification of hedges and the categories of hedged items that contributed to the gains and losses on derivatives and hedged items that were recorded in “Net loss on derivatives and hedging activities” in the second quarter of 2011 and 2010.
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Sources of Gains/(Losses) Recorded in Net (Loss)/Gain on Derivatives and Hedging Activities Three Months Ended June 30, 2011, Compared to Three Months Ended June 30, 2010 | |||||||||||||||||||||||||||||||
(In millions) | June 30, 2011 | June 30, 2010 | |||||||||||||||||||||||||||||
Gain/(Loss) | Net Interest Income/ (Expense) on | Total | Gain/(Loss) | Net Interest Income/ (Expense) on | Total | ||||||||||||||||||||||||||
Hedged Item | Fair Value Hedges, Net | Economic Hedges | Economic Hedges | Fair Value Hedges, Net | Economic Hedges | Economic Hedges | |||||||||||||||||||||||||
Advances: | |||||||||||||||||||||||||||||||
Elected for fair value option | $ | — | $ | (98 | ) | $ | (55 | ) | $ | (153 | ) | $ | — | $ | (28 | ) | $ | (112 | ) | $ | (140 | ) | |||||||||
Not elected for fair value option | — | (4 | ) | (9 | ) | (13 | ) | 1 | (9 | ) | (11 | ) | (19 | ) | |||||||||||||||||
Consolidated obligation bonds: | |||||||||||||||||||||||||||||||
Elected for fair value option | — | 53 | 26 | 79 | — | (5 | ) | 43 | 38 | ||||||||||||||||||||||
Not elected for fair value option | (6 | ) | (13 | ) | 46 | 27 | — | 9 | 49 | 58 | |||||||||||||||||||||
Consolidated obligation discount notes: | |||||||||||||||||||||||||||||||
Not elected for fair value option | — | (16 | ) | (11 | ) | (27 | ) | — | (48 | ) | (12 | ) | (60 | ) | |||||||||||||||||
Non-MBS investments: | |||||||||||||||||||||||||||||||
Not elected for fair value option | — | — | (4 | ) | (4 | ) | — | — | — | — | |||||||||||||||||||||
Total | $ | (6 | ) | $ | (78 | ) | $ | (7 | ) | $ | (91 | ) | $ | 1 | $ | (81 | ) | $ | (43 | ) | $ | (123 | ) |
During the second quarter of 2011, net losses on derivatives and hedging activities totaled $91 million compared to net losses of $123 million in the second quarter of 2010. These amounts included net interest expense on derivative instruments used in economic hedges of $7 million in the second quarter of 2011, compared to net interest expense on derivative instruments used in economic hedges of $43 million in the second quarter of 2010. The decrease in net interest expense was primarily due to the impact of lower interest rates throughout the second quarter of 2011 on the adjustable rate leg of the interest rate swaps.
Excluding the $7 million impact from net interest expense on derivative instruments used in economic hedges, net losses for the second quarter of 2011 totaled $84 million as detailed above. The $84 million in net losses were primarily attributable to changes in interest rates and increased swaption volatilities during the second quarter of 2011.
Excluding the $43 million impact from net interest expense on derivative instruments used in economic hedges, net losses for the second quarter of 2010 totaled $80 million as detailed above. The $80 million in net losses were primarily attributable to a decrease in interest rates during the second quarter of 2010.
In general, nearly all of the Bank's derivatives and hedged instruments, as well as certain assets and liabilities that are carried at fair value, are held to the maturity, call, or put date. For these financial instruments, net gains or losses are primarily a matter of timing and will generally reverse through changes in future valuations and settlements of contractual interest cash flows over the remaining contractual terms to maturity, or by the exercised call or put dates. However, the Bank may have instances in which hedging relationships are terminated prior to maturity or prior to the call or put dates. Terminating the hedging relationship may result in a realized gain or loss. In addition, the Bank may have instances in which it may sell trading securities prior to maturity, which may also result in a realized gain or loss.
The ongoing impact of these valuation adjustments on the Bank cannot be predicted, and the Bank's retained earnings in the future may not be sufficient to fully offset the impact of these valuation adjustments. The effects of these valuation adjustments may lead to significant volatility in future earnings, including earnings available for dividends.
Additional information about derivatives and hedging activities is provided in “Item 1. Financial Statements – Note 14 – Derivatives and Hedging Activities.”
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Six Months Ended June 30, 2011, Compared to Six Months Ended June 30, 2010
Average Balance Sheets | |||||||||||||||||||||
Six Months Ended | |||||||||||||||||||||
June 30, 2011 | June 30, 2010 | ||||||||||||||||||||
(Dollars in millions) | Average Balance | Interest Income/ Expense | Average Rate | Average Balance | Interest Income/ Expense | Average Rate | |||||||||||||||
Assets | |||||||||||||||||||||
Interest-earning assets: | |||||||||||||||||||||
Federal funds sold | $ | 16,797 | $ | 14 | 0.17 | % | $ | 15,908 | $ | 13 | 0.17 | % | |||||||||
Trading securities: | |||||||||||||||||||||
MBS | 23 | — | 3.01 | 29 | 1 | 3.92 | |||||||||||||||
Other investments | 3,296 | 12 | 0.71 | 199 | — | 0.34 | |||||||||||||||
Available-for-sale securities:(1) | |||||||||||||||||||||
MBS | 3,547 | 70 | 3.97 | — | — | — | |||||||||||||||
Other investments | 1,928 | 3 | 0.27 | 1,933 | 2 | 0.26 | |||||||||||||||
Held-to-maturity securities:(1) | |||||||||||||||||||||
MBS | 21,662 | 383 | 3.56 | 29,200 | 559 | 3.86 | |||||||||||||||
Other investments | 9,072 | 10 | 0.22 | 10,486 | 11 | 0.23 | |||||||||||||||
Mortgage loans held for portfolio, net | 2,221 | 56 | 5.07 | 2,909 | 75 | 5.16 | |||||||||||||||
Advances(2) | 90,437 | 372 | 0.83 | 115,962 | 645 | 1.12 | |||||||||||||||
Deposits with other FHLBanks | — | — | 0.06 | 1 | — | 0.03 | |||||||||||||||
Loans to other FHLBanks | 2 | — | 0.11 | 8 | — | 0.11 | |||||||||||||||
Total interest-earning assets | 148,985 | 920 | 1.24 | 176,635 | 1,306 | 1.49 | |||||||||||||||
Other assets(3)(4)(5) | 564 | — | — | 81 | — | — | |||||||||||||||
Total Assets | $ | 149,549 | $ | 920 | 1.24 | % | $ | 176,716 | $ | 1,306 | 1.49 | % | |||||||||
Liabilities and Capital | |||||||||||||||||||||
Interest-bearing liabilities: | |||||||||||||||||||||
Consolidated obligations: | |||||||||||||||||||||
Bonds(2) | $ | 115,993 | $ | 374 | 0.65 | % | $ | 142,016 | $ | 558 | 0.79 | % | |||||||||
Discount notes | 19,959 | 20 | 0.20 | 20,415 | 22 | 0.22 | |||||||||||||||
Deposits(3) | 923 | — | 0.02 | 1,652 | — | 0.04 | |||||||||||||||
Borrowings from other FHLBanks | 4 | — | 0.15 | 1 | — | 0.13 | |||||||||||||||
Mandatorily redeemable capital stock | 3,238 | 6 | 0.33 | 4,810 | 6 | 0.27 | |||||||||||||||
Other borrowings | — | — | — | 1 | — | 0.10 | |||||||||||||||
Total interest-bearing liabilities | 140,117 | 400 | 0.58 | 168,895 | 586 | 0.70 | |||||||||||||||
Other liabilities(3)(4) | 1,730 | — | — | 1,505 | — | — | |||||||||||||||
Total Liabilities | 141,847 | 400 | 0.57 | 170,400 | 586 | 0.69 | |||||||||||||||
Total Capital | 7,702 | — | — | 6,316 | — | — | |||||||||||||||
Total Liabilities and Capital | $ | 149,549 | $ | 400 | 0.54 | % | $ | 176,716 | $ | 586 | 0.67 | % | |||||||||
Net Interest Income | $ | 520 | $ | 720 | |||||||||||||||||
Net Interest Spread(6) | 0.66 | % | 0.79 | % | |||||||||||||||||
Net Interest Margin(7) | 0.70 | % | 0.82 | % | |||||||||||||||||
Interest-earning Assets/Interest-bearing Liabilities | 106.33 | % | 104.58 | % |
(1) | The average balances of available-for-sale securities and held-to-maturity securities are reflected at amortized cost. As a result, the average rates do not reflect changes in fair value or non-credit-related OTTI charges. |
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(2) | Interest income/expense and average rates include the effect of associated interest rate exchange agreements, as follows |
Six Months Ended | |||||||||||||||||||||||
June 30, 2011 | June 30, 2010 | ||||||||||||||||||||||
(In millions) | (Amortization)/ Accretion of Hedging Activities | Net Interest Settlements | Total Net Interest Income/(Expense) | (Amortization)/ Accretion of Hedging Activities | Net Interest Settlements | Total Net Interest Income/(Expense) | |||||||||||||||||
Advances | $ | (17 | ) | $ | (150 | ) | $ | (167 | ) | $ | (30 | ) | $ | (311 | ) | $ | (341 | ) | |||||
Consolidated obligation bonds | 44 | 647 | 691 | 49 | 979 | 1,028 |
(3) | Average balances do not reflect the effect of reclassifications of cash collateral. |
(4) | Includes forward settling transactions and valuation adjustments for certain cash items. |
(5) | Includes non-credit-related OTTI charges on available-for-sale and held-to-maturity securities. |
(6) | Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities. |
(7) | Net interest margin is net interest income (annualized) divided by average interest-earning assets. |
Net interest income in the first six months of 2011 was $520 million, a 28% decrease from $720 million in the first six months of 2010. The following table details the changes in interest income and interest expense for the first six months of 2011 compared to the first six months of 2010. Changes in both volume and interest rates influence changes in net interest income, net interest spread, and net interest margin.
Change in Net Interest Income: Rate/Volume Analysis Six Months Ended June 30, 2011, Compared to Six Months Ended June 30, 2010 | |||||||||||
Increase/ (Decrease) | Attributable to Changes in(1) | ||||||||||
(In millions) | Average Volume | Average Rate | |||||||||
Interest-earning assets: | |||||||||||
Federal funds sold | $ | 1 | $ | 1 | $ | — | |||||
Trading securities: | |||||||||||
MBS | (1 | ) | — | (1 | ) | ||||||
Other investments | 12 | 11 | 1 | ||||||||
Available-for-sale securities: | |||||||||||
MBS | 70 | 70 | — | ||||||||
Other investments | 1 | — | 1 | ||||||||
Held-to-maturity securities: | |||||||||||
MBS | (176 | ) | (136 | ) | (40 | ) | |||||
Other investments | (1 | ) | (1 | ) | — | ||||||
Mortgage loans held for portfolio | (19 | ) | (18 | ) | (1 | ) | |||||
Advances(2) | (273 | ) | (125 | ) | (148 | ) | |||||
Total interest-earning assets | (386 | ) | (198 | ) | (188 | ) | |||||
Interest-bearing liabilities: | |||||||||||
Consolidated obligations: | |||||||||||
Bonds(2) | (184 | ) | (93 | ) | (91 | ) | |||||
Discount notes | (2 | ) | (1 | ) | (1 | ) | |||||
Mandatorily redeemable capital stock | — | (2 | ) | 2 | |||||||
Total interest-bearing liabilities | (186 | ) | (96 | ) | (90 | ) | |||||
Net interest income | $ | (200 | ) | $ | (102 | ) | $ | (98 | ) |
(1) | Combined rate/volume variances, a third element of the calculation, are allocated to the rate and volume variances based on their relative sizes. |
(2) | Interest income/expense and average rates include the interest effect of associated interest rate exchange agreements. |
Net interest income included advance prepayment fees of $10 million in the first six months of 2011 compared to $39 million in the first six months of 2010 and reflected the impact of cumulative retrospective adjustments for the
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amortization of net purchase discounts from the acquisition dates of the MBS and mortgage loans, which increased interest income by $6 million in the first six months of 2011 and by $4 million in the first six months of 2010.
The net interest margin was 70 basis points for the first six months of 2011, 12 basis points lower than the net interest margin for the first six months of 2010, which was 82 basis points. The net interest spread was 66 basis points for the first six months of 2011, 13 basis points lower than the net interest spread for the first six months of 2010, which was 79 basis points. These decreases were primarily due to lower earnings on invested capital (resulting from the lower interest rate environment) and lower advance prepayment fees. In addition, net interest income on economically hedged assets and liabilities was lower in the first six months of 2011 relative to the year-earlier period. This income is generally offset by net interest expense on derivative instruments used in economic hedges, recognized in “Other Income/(Loss),” which was also lower in the first six months of 2011. These factors were partially offset by increased spreads on the mortgage portfolio.
Member demand for wholesale funding from the Bank can vary greatly depending on a number of factors, including economic and market conditions, competition from other wholesale funding sources, member deposit inflows and outflows, the activity level of the primary and secondary mortgage markets, and strategic decisions made by individual member institutions. As a result, Bank asset levels and operating results may vary significantly from period to period.
Other Income/(Loss)
The following table presents the components of “Other Income/(Loss)” for the six months ended June 30, 2011 and 2010.
Other Income/(Loss) | |||||||
Six Months Ended | |||||||
(In millions) | June 30, 2011 | June 30, 2010 | |||||
Other Income/(Loss): | |||||||
Net loss on trading securities(1) | $ | (1 | ) | $ | (1 | ) | |
Total other-than-temporary impairment loss | (204 | ) | (382 | ) | |||
Net amount of impairment loss reclassified (from)/to accumulated other comprehensive loss | (68 | ) | 180 | ||||
Net other-than-temporary impairment loss | (272 | ) | (202 | ) | |||
Net loss on advances and consolidation obligation bonds held at fair value | (20 | ) | (121 | ) | |||
Net loss on derivatives and hedging activities | (71 | ) | (159 | ) | |||
Other | 3 | 3 | |||||
Total Other Income/(Loss) | $ | (361 | ) | $ | (480 | ) |
(1) The net loss on trading securities that were economically hedged totaled $0.1 million and $(1.1) million for the six months ended June 30, 2011 and 2010, respectively.
Net Other-Than-Temporary Impairment Loss – Each quarter, the Bank updates its OTTI analysis to reflect current and anticipated housing market conditions, observed and anticipated borrower behavior, and updated information on the loans supporting the Bank's PLRMBS. This process includes updating key aspects of the Bank's loss projection models. Projected collateral performance as of the end of the first six months of 2011 primarily reflected decreases in actual and expected housing prices and an expected slowdown in housing price recovery. The following table presents the net other-than-temporary impairment loss for the six months ended June 30, 2011 and 2010.
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Net Other-Than-Temporary Impairment Loss | |||||||||||||||||||||||
Six Months Ended | |||||||||||||||||||||||
June 30, 2011 | June 30, 2010 | ||||||||||||||||||||||
(In millions) | Credit- Related OTTI | Non-Credit- Related OTTI | Total OTTI | Credit- Related OTTI | Non-Credit- Related OTTI | Total OTTI | |||||||||||||||||
Securities newly impaired during the period | $ | 4 | $ | 129 | $ | 133 | $ | 5 | $ | 289 | $ | 294 | |||||||||||
Securities previously impaired prior to current period(1) | 268 | (197 | ) | 71 | 197 | (109 | ) | 88 | |||||||||||||||
Total | $ | 272 | $ | (68 | ) | $ | 204 | $ | 202 | $ | 180 | $ | 382 |
(1) For the six months ended June 30, 2011, “securities previously impaired prior to current period” represents all securities that were also other-than-temporarily impaired prior to January 1, 2011. For the six months ended June 30, 2010, “securities previously impaired prior to current period” represents all securities that were also other-than-temporarily impaired prior to January 1, 2010.
Additional information about the OTTI charge is provided in “Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Investments” and in “Item 1. Financial Statements – Note 6 – Other-Than-Temporary Impairment Analysis.”
Net Gain/(Loss) on Advances and Consolidated Obligation Bonds Held at Fair Value – The following table presents the net gain/(loss) on advances and consolidated obligation bonds held at fair value, for which the Bank elected the fair value option for the six months ended June 30, 2011 and 2010.
Net Gain/(Loss) on Advances and Consolidated Obligation Bonds Held at Fair Value | |||||||
Six Months Ended | |||||||
(In millions) | June 30, 2011 | June 30, 2010 | |||||
Advances | $ | 54 | $ | (45 | ) | ||
Consolidated obligation bonds | (74 | ) | (76 | ) | |||
Total | $ | (20 | ) | $ | (121 | ) |
For the first six months of 2011, the unrealized net fair value gains on advances were primarily driven by the decreased interest rate environment relative to the actual coupon rates on the Bank's advances during the first six months of 2011. The unrealized net fair value losses on consolidated obligation bonds were primarily driven by the decreased interest rate environment relative to the actual coupon rates on the consolidated obligation bonds.
For the first six months of 2010, the unrealized net fair value losses on advances were primarily driven by the increased short-term interest rate environment relative to the actual coupon rates on the Bank's advances. The unrealized net fair value losses on consolidated obligation bonds were primarily driven by the decreased long-term interest rate environment relative to the actual coupon rates on the consolidated obligation bonds.
Net Gain/(Loss) on Derivatives and Hedging Activities – The following table shows the accounting classification of hedges and the categories of hedged items that contributed to the gains and losses on derivatives and hedged items that were recorded in “Net loss on derivatives and hedging activities” in the first six months of 2011 and 2010.
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Sources of Gains/(Losses) Recorded in Net (Loss)/Gain on Derivatives and Hedging Activities Six Months Ended June 30, 2011, Compared to Six Months Ended June 30, 2010 | |||||||||||||||||||||||||||||||
(In millions) | June 30, 2011 | June 30, 2010 | |||||||||||||||||||||||||||||
Gain/(Loss) | Net Interest Income/ (Expense) on | Gain/(Loss) | Net Interest Income/ (Expense) on | ||||||||||||||||||||||||||||
Hedged Item | Fair Value Hedges, Net | Economic Hedges | Economic Hedges | Total | Fair Value Hedges, Net | Economic Hedges | Economic Hedges | Total | |||||||||||||||||||||||
Advances: | |||||||||||||||||||||||||||||||
Elected for fair value option | $ | — | $ | (34 | ) | $ | (112 | ) | $ | (146 | ) | $ | — | $ | 33 | $ | (258 | ) | $ | (225 | ) | ||||||||||
Not elected for fair value option | 1 | 4 | (17 | ) | (12 | ) | — | (8 | ) | (25 | ) | (33 | ) | ||||||||||||||||||
Consolidated obligation bonds: | |||||||||||||||||||||||||||||||
Elected for fair value option | — | 46 | 51 | 97 | — | 19 | 97 | 116 | |||||||||||||||||||||||
Not elected for fair value option | (6 | ) | (54 | ) | 88 | 28 | 5 | (35 | ) | 113 | 83 | ||||||||||||||||||||
Consolidated obligation discount notes: | |||||||||||||||||||||||||||||||
Not elected for fair value option | — | (11 | ) | (21 | ) | (32 | ) | — | (66 | ) | (34 | ) | (100 | ) | |||||||||||||||||
Non-MBS investments: | |||||||||||||||||||||||||||||||
Not elected for fair value option | — | — | (6 | ) | (6 | ) | — | — | — | — | |||||||||||||||||||||
Total | $ | (5 | ) | $ | (49 | ) | $ | (17 | ) | $ | (71 | ) | $ | 5 | $ | (57 | ) | $ | (107 | ) | $ | (159 | ) |
During the first six months of 2011, net losses on derivatives and hedging activities totaled $71 million compared to net losses of $159 million in the first six months of 2010. These amounts included net interest expense on derivative instruments used in economic hedges of $17 million in the first six months of 2011, compared to net interest expense on derivative instruments used in economic hedges of $107 million in the first six months of 2010. The decrease in net interest expense was primarily due to the impact of lower interest rates throughout the first six months of 2011 on the adjustable leg of the interest rate swaps.
Excluding the $17 million impact from net interest expense on derivative instruments used in economic hedges, net losses for the first six months of 2011 totaled $54 million as detailed above. The $54 million in net losses were primarily attributable to changes in interest rates and decreased swaption volatilities during the first six months of 2011.
Excluding the $107 million impact from net interest expense on derivative instruments used in economic hedges, net losses for the first six months of 2010 totaled $52 million as detailed above. The $52 million in net losses were primarily attributable to a decrease in interest rates during the first six months of 2010.
In general, nearly all of the Bank's derivatives and hedged instruments, as well as certain assets and liabilities that are carried at fair value, are held to the maturity, call, or put date. For these financial instruments, net gains or losses are primarily a matter of timing and will generally reverse through changes in future valuations and settlements of contractual interest cash flows over the remaining contractual terms to maturity, or by the exercised call or put dates. However, the Bank may have instances in which hedging relationships are terminated prior to maturity or prior to the call or put dates. Terminating the hedging relationship may result in a realized gain or loss. In addition, the Bank may have instances in which it may sell trading securities prior to maturity, which may also result in a realized gain or loss.
The ongoing impact of these valuation adjustments on the Bank cannot be predicted, and the Bank's retained earnings in the future may not be sufficient to fully offset the impact of these valuation adjustments. The effects of these valuation adjustments may lead to significant volatility in future earnings, including earnings available for dividends.
Additional information about derivatives and hedging activities is provided in “Item 1. Financial Statements – Note 14 – Derivatives and Hedging Activities.”
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Return on Average Equity
Return on average equity (ROE) was 0.48% (annualized) for the second quarter of 2011, compared to 1.87% (annualized) for the second quarter of 2010. This decline reflected the decrease in net income in the second quarter of 2011 and the increase in average equity, which increased 26%, to $8.0 billion in the second quarter of 2011 from $6.3 billion in the second quarter of 2010.
ROE was 1.81% (annualized) for the first six months of 2011, compared to 3.90% (annualized) for the first six months of 2010. This decline reflected the decrease in net income in the first six months of 2011 and the increase in average equity, which increased 22%, to $7.7 billion in the first six months of 2011 from $6.3 billion in the first six months of 2010.
Dividends and Retained Earnings
By regulations governing the operations of the FHLBanks, dividends may be paid only out of current net earnings or previously retained earnings. As required by the regulations, the Bank has a formal Retained Earnings and Dividend Policy that is reviewed at least annually by the Bank's Board of Directors. The Board of Directors may amend the Retained Earnings and Dividend Policy from time to time. The Bank's Retained Earnings and Dividend Policy establishes amounts to be retained in restricted retained earnings, which are not made available for dividends in the current dividend period. The Bank may be restricted from paying dividends if it is not in compliance with any of its minimum capital requirements or if payment would cause the Bank to fail to meet any of its minimum capital requirements. In addition, the Bank may not pay dividends if any principal or interest due on any consolidated obligation has not been paid in full or is not expected to be paid in full, or, under certain circumstances, if the Bank fails to satisfy certain liquidity requirements under applicable regulations.
The regulatory liquidity requirements state that each FHLBank must: (i) maintain eligible high quality assets (advances with a maturity not exceeding five years, U.S. Treasury securities investments, and deposits in banks or trust companies) in an amount equal to or greater than the deposits received from members, and (ii) hold contingent liquidity in an amount sufficient to meet its liquidity needs for at least five business days without access to the consolidated obligations markets. At June 30, 2011, advances maturing within five years totaled $75.5 billion, significantly in excess of the $0.1 billion of member deposits on that date. At December 31, 2010, advances maturing within five years totaled $88.2 billion, also significantly in excess of the $0.1 billion of member deposits on that date. In addition, as of June 30, 2011, and December 31, 2010, the Bank's estimated total sources of funds obtainable from liquidity investments, repurchase agreement borrowings collateralized by the Bank's marketable securities, and advance repayments would have allowed the Bank to meet its liquidity needs for more than 90 days without access to the consolidated obligations markets.
Retained Earnings Related to Valuation Adjustments – In accordance with the Bank's Retained Earnings and Dividend Policy, the Bank retains in restricted retained earnings any cumulative net gains in earnings (net of applicable assessments) resulting from valuation adjustments.
In general, the Bank's derivatives and hedged instruments, as well as certain assets and liabilities that are carried at fair value, are held to the maturity, call, or put date. For these financial instruments, net gains or losses are primarily a matter of timing and will generally reverse through changes in future valuations and settlements of contractual interest cash flows over the remaining contractual terms to maturity, or by the exercised call or put dates. However, the Bank may have instances in which hedging relationships are terminated prior to maturity or prior to the call or put dates. Terminating the hedging relationship may result in a realized gain or loss. In addition, the Bank may have instances in which it may sell trading securities prior to maturity, which may also result in a realized gain or loss.
As the cumulative net gains are reversed by periodic net losses and settlements of contractual interest cash flows, the amount of the cumulative net gains decreases. The amount of retained earnings required by this provision of the policy is therefore decreased, and that portion of the previously restricted retained earnings becomes unrestricted and may be made available for dividends. In this case, the potential dividend payout in a given period will be substantially the same as it would have been without the effects of valuation adjustments, provided that at the end of
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the period the cumulative net effect since inception remains a net gain. The purpose of the valuation adjustments category of restricted retained earnings is to provide sufficient retained earnings to offset future net losses that result from the reversal of cumulative net gains, so that potential dividend payouts in future periods are not necessarily affected by the reversals of these gains. Although restricting retained earnings in accordance with this provision of the policy may help preserve the Bank's ability to pay dividends, the reversal of cumulative net gains in any given period may result in a net loss if the reversal exceeds net earnings before the impact of valuation adjustments for that period. Also, if the net effect of valuation adjustments since inception results in a cumulative net loss, the Bank's other retained earnings at that time (if any) may not be sufficient to offset the net loss. As a result, the future effects of valuation adjustments may cause the Bank to reduce or temporarily suspend dividend payments.
The retained earnings restricted in accordance with this provision of the Bank's Retained Earnings and Dividend Policy totaled $130 million at June 30, 2011, and $148 million at December 31, 2010.
Other Retained Earnings – Targeted Buildup – In addition to any cumulative net gains resulting from valuation adjustments, the Bank holds an additional amount in restricted retained earnings intended to protect members' paid-in capital from the effects of an extremely adverse credit event, an extremely adverse operations risk event, an extremely high level of quarterly valuation losses related to the Bank's derivatives and associated hedged items and financial instruments carried at fair value, the risk of an extremely adverse change in the market value of the Bank's capital, and the risk of a significant amount of additional credit-related OTTI on PLRMBS, especially in periods of extremely low net income resulting from an adverse interest rate environment.
The Board of Directors has set the targeted amount of restricted retained earnings at $1.8 billion. The Bank's retained earnings target may be changed at any time. The Board of Directors will periodically review the methodology and analysis to determine whether any adjustments are appropriate. The retained earnings restricted in accordance with this provision of the Retained Earnings and Dividend Policy totaled $1.5 billion at June 30, 2011, and $1.5 billion at December 31, 2010.
For more information on these two categories of restricted retained earnings, see “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital” in the Bank's 2010 Form 10-K.
Joint Capital Enhancement Agreement – Effective February 28, 2011, the 12 FHLBanks, including the Bank, entered into a Joint Capital Enhancement Agreement (Agreement) intended to enhance the capital position of each FHLBank by allocating that portion of each FHLBank's earnings historically paid to satisfy its REFCORP obligation to a separate retained earnings account at that FHLBank.
The Agreement provides that, upon full satisfaction of the REFCORP obligation, each FHLBank will contribute 20% of its net income each quarter to a restricted retained earnings account until the balance of that account equals at least 1% of that FHLBank's average balance of outstanding consolidated obligations for the previous quarter. These restricted retained earnings will not be available to pay dividends. For more information on the Agreement, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations - Comparison of 2010 to 2009 - Dividends and Retained Earnings” in the Bank's 2010 Form 10-K.
The FHLBanks subsequently amended their capital plans or capital plan submissions, as applicable, to implement the provisions of the Agreement, and the Finance Agency approved the capital plan amendments on August 5, 2011. The amended capital plans, including the Bank's amended capital plan, will become effective on September 5, 2011. On August 5, 2011, the FHLBanks also amended the Agreement to reflect differences between the original Agreement and the capital plan amendments, including changes to the definition of an automatic termination event, provisions for determining whether an automatic termination event has occurred, and modifications to the provisions regarding the release of restricted retained earnings if the Agreement is terminated. In particular, an FHLBank's obligation to make allocations to the restricted retained earnings account terminates on the automatic termination event declaration date, and restrictions on paying dividends out of the restricted retained earnings account, or otherwise reallocating funds from the restricted retained earnings account, are terminated one year later. For more information on the amendments to the Agreement, see the Bank's Form 8-K filed on August 5, 2011.
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On August 5, 2011, the Finance Agency certified that the FHLBanks have fully satisfied their REFCORP obligation. In accordance with the Agreement, starting in the third quarter of 2011, each FHLBank is required to allocate 20% of its net income to a separate restricted retained earnings account until the balance of the account equals at least 1% of that FHLBank's average balance of outstanding consolidated obligations for the previous quarter. These restricted retained earnings will not be available to pay dividends.
Dividend Payments – Finance Agency rules state that FHLBanks may declare and pay dividends only from previously retained earnings or current net earnings, and may not declare or pay dividends based on projected or anticipated earnings. There is no requirement that the Board of Directors declare and pay any dividend. A decision by the Board of Directors to declare or not declare a dividend is a discretionary matter and is subject to the requirements and restrictions of the FHLBank Act and applicable requirements under the regulations governing the operations of the FHLBanks.
The Bank paid dividends (including dividends on mandatorily redeemable capital stock) totaling $10 million at an annualized rate of 0.31% in the second quarter of 2011, and $8 million at an annualized rate of 0.26% in the second quarter of 2010.
The Bank paid dividends (including dividends on mandatorily redeemable capital stock) totaling $19 million at an annualized rate of 0.30% in the first six months of 2011, and $17 million at an annualized rate of 0.27% in the first six months of 2010.
On July 28, 2011, the Bank's Board of Directors declared a cash dividend for the second quarter of 2011 at an annualized rate of 0.26%. The Bank recorded the second quarter dividend on July 28, 2011, the day it was declared by the Board of Directors. The Bank expects to pay the second quarter dividend (including dividends on mandatorily redeemable capital stock), which will total $7 million, on or about August 11, 2011.
The Bank will pay the second quarter 2011 dividend in cash rather than stock to comply with Finance Agency rules, which do not permit the Bank to pay dividends in the form of capital stock if the Bank's excess stock exceeds 1% of its total assets. As of June 30, 2011, the Bank's excess capital stock totaled $6.3 billion, or 4.40% of total assets.
The Bank will continue to monitor the condition of its PLRMBS portfolio, the ratio of the estimated market value of the Bank's capital to the par value of the Bank's capital stock, its overall financial performance and retained earnings, developments in the mortgage and credit markets, and other relevant information as the basis for determining the status of dividends in future quarters.
For more information on the Bank's Retained Earnings and Dividend Policy, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations – Comparison of 2010 to 2009 – Dividends and Retained Earnings” in the Bank's 2010 Form 10-K.
Financial Condition
Total assets were $144.4 billion at June 30, 2011, a 5% decrease from $152.4 billion at December 31, 2010. Advances decreased by $12.9 billion, or 13%, to $82.7 billion at June 30, 2011, from $95.6 billion at December 31, 2010. Average total assets were $148.1 billion for the second quarter of 2011, a 12% decrease compared to $168.2 billion for the second quarter of 2010. Average total assets were $149.5 billion for the first six months of 2011, a 15% decrease compared to $176.7 billion for the first six months of 2010. Average advances were $87.5 billion for the second quarter of 2011, an 18% decrease from $107.0 billion for the second quarter of 2010. Average advances were $90.4 billion for the first six months of 2011, a 22% decrease from $116.0 billion for the first six months of 2010.
The continued decrease in member advance demand reflected general economic conditions and conditions in the mortgage and credit markets. Member liquidity remained high and lending activity remained subdued.
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Advances outstanding at June 30, 2011, included unrealized gains of $635 million, of which $303 million represented unrealized gains on advances hedged in accordance with the accounting for derivative instruments and hedging activities and $332 million represented unrealized gains on economically hedged advances that are carried at fair value in accordance with the fair value option. Advances outstanding at December 31, 2010, included unrealized gains of $690 million, of which $363 million represented unrealized gains on advances hedged in accordance with the accounting for derivative instruments and hedging activities and $327 million represented unrealized gains on economically hedged advances that are carried at fair value in accordance with the fair value option. The overall decrease in the unrealized gains of the hedged advances and advances carried at fair value from December 31, 2010, to June 30, 2011, was primarily attributable to a decrease in the interest rate environment relative to the actual coupon rates on the Bank's advances.
Total liabilities were $139.4 billion at June 30, 2011, a 4% decrease from $145.5 billion at December 31, 2010, reflecting decreases in consolidated obligations outstanding from $140.6 billion at December 31, 2010, to $132.1 billion at June 30, 2011. The decrease in consolidated obligations outstanding paralleled the decrease in assets during the first six months of 2011. Average total liabilities were $140.1 billion for the second quarter of 2011, a 13% decrease compared to $161.9 billion for the second quarter of 2010. Average total liabilities were $141.8 billion for the first six months of 2011, a 17% decrease compared to $170.4 billion for the first six months of 2010. The decrease in average liabilities reflected decreases in average consolidated obligations, paralleling the decline in average assets. Average consolidated obligations were $134.6 billion in the second quarter of 2011 and $154.0 billion in the second quarter of 2010. Average consolidated obligations were $136.0 billion in the first six months of 2011 and $162.4 billion in the first six months of 2010.
Consolidated obligations outstanding at June 30, 2011, included unrealized losses of $1.3 billion on consolidated obligation bonds hedged in accordance with the accounting for derivative instruments and hedging activities and unrealized gains of $37 million on economically hedged consolidated obligation bonds that are carried at fair value in accordance with the fair value option. Consolidated obligations outstanding at December 31, 2010, included unrealized losses of $1.6 billion on consolidated obligation bonds hedged in accordance with the accounting for derivative instruments and hedging activities and unrealized gains of $110 million on economically hedged consolidated obligation bonds that are carried at fair value in accordance with the fair value option. The overall decrease in the unrealized losses on the hedged consolidated obligation bonds and the consolidated obligation bonds carried at fair value from December 31, 2010, to June 30, 2011, was primarily attributable to a decrease in the interest rate environment.
As provided by the FHLBank Act or regulations governing the operations of the FHLBanks, all FHLBanks have joint and several liability for all FHLBank consolidated obligations. The joint and several liability regulation authorizes the Finance Agency to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor. The Bank has never been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank, and as of June 30, 2011, and through the filing date of this report, does not believe that it is probable that it will be asked to do so. The par amount of the outstanding consolidated obligations of all 12 FHLBanks was $727.5 billion at June 30, 2011, and $796.4 billion at December 31, 2010.
On April 20, 2011, Standard & Poor's revised its outlook on the FHLBanks' consolidated obligations and on the long-term credit ratings of ten FHLBanks to reflect its revision of the outlook on the long-term sovereign credit rating of the United States to negative from stable. As of June 30, 2011, Standard & Poor's rated the FHLBanks' consolidated obligations AAA/A-1+ with a negative outlook and assigned long-term credit ratings of AAA with a negative outlook to ten FHLBanks, including the Bank; AA+ with a stable outlook to the FHLBank of Chicago; and AA+ with a negative outlook to the FHLBank of Seattle. On July 15, 2011, Standard & Poor's placed the long-term credit ratings of the ten FHLBanks on CreditWatch with negative implications after placing the long-term sovereign credit rating of the United States on CreditWatch negative on July 14, 2011. In the application of Standard & Poor's government-related entities criteria, the ratings of the FHLBank System and the FHLBanks are constrained by the long-term sovereign credit rating of the United States. On August 5, 2011, Standard & Poor's lowered its long-term sovereign credit rating of the United States from AAA to AA+ with a negative outlook and affirmed the A-1+ short-term rating. As a result, on August 8, 2011, Standard & Poor's lowered the long-term issuer credit ratings and
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related issue ratings with a negative outlook on select government-related entities. Specifically, Standard & Poor's lowered its long-term issuer credit ratings and related issue ratings on the ten FHLBanks and on the senior debt issued by the FHLBank System (FHLBank System consolidated obligations) from AAA to AA+ with a negative outlook and removed the FHLBanks and relevant debt issues from CreditWatch.
As of June 30, 2011, Moody's Investors Service (Moody's) rated the FHLBanks' consolidated obligations Aaa/P-1 with a stable outlook. On July 13, 2011, Moody's placed the Aaa bond rating of the U.S. government, and consequently the ratings of the GSEs, including the FHLBanks, on review for possible downgrade because of the risk that the statutory debt limit would not be raised in time to prevent a default on U.S. Treasury debt obligations. On August 2, 2011, Moody's confirmed the Aaa bond rating of the U.S. government following the raising of the statutory debt limit and changed the rating outlook to negative. Also on August 2, 2011, Moody's confirmed the Aaa rating for the FHLBanks and announced that in conjunction with the revision of the U.S. government outlook to negative, the rating outlook for the FHLBanks was also revised to negative.
Changes in the long-term credit ratings of individual FHLBanks do not necessarily affect the credit rating of the consolidated obligations issued on behalf of the FHLBanks. Rating agencies may change a rating from time to time because of various factors, including operating results or actions taken, business developments, or changes in their opinion regarding, among other factors, the general outlook for a particular industry or the economy.
The Bank evaluated the publicly disclosed FHLBank regulatory actions and long-term credit ratings of other FHLBanks as of June 30, 2011, and as of each period end presented, and determined that it is unlikely the Bank will be required to repay any principal or interest associated with consolidated obligations for which the Bank is not the primary obligor.
Financial condition is further discussed under “Segment Information.”
Segment Information
The Bank uses an analysis of financial performance based on the balances and adjusted net interest income of two operating segments, the advances-related business and the mortgage-related business, as well as other financial information, to review and assess financial performance and to determine the allocation of resources to these two major business segments. For purposes of segment reporting, adjusted net interest income includes interest income and expense associated with economic hedges that are recorded in “Net loss on derivatives and hedging activities” in other income and excludes interest expense that is recorded in “Mandatorily redeemable capital stock.” Other key financial information, such as any OTTI loss on the Bank's available-for-sale and held-to-maturity PLRMBS, other expenses, and assessments, are not included in the segment reporting analysis, but are incorporated into the Bank's overall assessment of financial performance. For a reconciliation of the Bank's operating segment adjusted net interest income to the Bank's total net interest income, see “Item 1. Financial Statements – Note 13 – Segment Information.”
Advances-Related Business. The advances-related business consists of advances and other credit products, related financing and hedging instruments, liquidity and other non-MBS investments associated with the Bank's role as a liquidity provider, and capital stock.
Assets associated with this segment decreased to $117.3 billion (81% of total assets) at June 30, 2011, from $128.4 billion (84% of total assets) at December 31, 2010, representing a decrease of $11.1 billion, or 9%. The continued decrease in member advance demand reflected general economic conditions and conditions in the mortgage and credit markets. Member liquidity remained high and lending activity remained subdued.
Adjusted net interest income for this segment is derived primarily from the difference, or spread, between the yield on advances and non-MBS investments and the cost of the consolidated obligations funding these assets, including the cash flows from associated interest rate exchange agreements.
Adjusted net interest income for this segment was $88 million in the second quarter of 2011, a decrease of $57
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million, or 39%, compared to $145 million in the second quarter of 2010. In the first six months of 2011, adjusted net interest income for this segment was $181 million, a decrease of $102 million, or 36%, compared to $283 million in the first six months of 2010. These decreases were primarily due to lower earnings on invested capital, resulting from the lower interest rate environment, lower advances balances, and lower advance prepayment fees.
Members and nonmember borrowers prepaid $2.6 billion of advances in the second quarter of 2011 compared to $8.1 billion in the second quarter of 2010. Members and nonmember borrowers prepaid $3.3 billion of advances in the first six months of 2011 compared to $14.6 billion in the first six months of 2010. As a result, interest income was increased by net prepayment fees of $4 million in the second quarter of 2011 and $28 million in the second quarter of 2010. Interest income was increased by net prepayment fees of $10 million in the first six months of 2011 and $39 million in the first six months of 2010.
Adjusted net interest income for this segment represented 38% and 48% of total adjusted net interest income for the second quarter of 2011 and 2010, respectively, and 40% and 49% of total adjusted net interest income for the first six months of 2011 and 2010, respectively.
Advances – The par amount of advances outstanding decreased by $12.8 billion, or 13%, to $82.1 billion at June 30, 2011, from $94.9 billion at December 31, 2010. The decrease was primarily attributable to the $10.9 billion decline in advances outstanding to the Bank's top five borrowers and their affiliates. Advances to the top five borrowers decreased to $63.1 billion at June 30, 2011, from $74.0 billion at December 31, 2010. (See “Item 1. Financial Statements and Supplementary Data – Note 7 – Advances” for further information.) The remaining $1.9 billion decrease in total advances outstanding was attributable to a net decrease in advances to other borrowers of varying asset sizes and charter types. In total, 42 borrowers increased their advances during the first six months of 2011, while 122 borrowers decreased their advances.
The $12.8 billion decrease in advances outstanding reflects a $11.6 billion decrease in fixed rate advances and a $1.5 billion decrease in adjustable rate advances, partially offset by a $0.3 billion increase in daily variable rate advances.
The components of the advances portfolio at June 30, 2011, and December 31, 2010, are presented in the following table.
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Advances Portfolio by Product Type | |||||||||||||
June 30, 2011 | December 31, 2010 | ||||||||||||
(Dollar in millions) | Par Amount | Percentage of Total Par Amount | Par Amount | Percentage of Total Par Amount | |||||||||
Adjustable – London Inter-Bank Offered Rate (LIBOR) | $ | 48,611 | 60 | % | $ | 48,944 | 52 | % | |||||
Adjustable – other indices | 1 | — | 153 | — | |||||||||
Adjustable – LIBOR, with caps and/or floors and PPS(1) | 160 | — | 1,160 | 1 | |||||||||
Subtotal adjustable rate advances | 48,772 | 60 | 50,257 | 53 | |||||||||
Fixed | 23,730 | 29 | 35,373 | 38 | |||||||||
Fixed – amortizing | 371 | — | 395 | — | |||||||||
Fixed – with PPS(1) | 5,771 | 7 | 5,303 | 6 | |||||||||
Fixed – with caps and PPS(1) | 200 | — | 200 | — | |||||||||
Fixed – callable at member's option | 5 | — | 9 | — | |||||||||
Fixed – callable at member's option with PPS(1) | 442 | 1 | 274 | — | |||||||||
Fixed – putable at Bank's option | 1,508 | 2 | 2,039 | 2 | |||||||||
Fixed – putable at Bank's option with PPS(1) | 375 | — | 398 | — | |||||||||
Subtotal fixed rate advances | 32,402 | 39 | 43,991 | 46 | |||||||||
Daily variable rate | 936 | 1 | 661 | 1 | |||||||||
Total par amount | $ | 82,110 | 100 | % | $ | 94,909 | 100 | % |
(1) | Partial prepayment symmetry (PPS) is a product feature under which the Bank may charge the borrower a prepayment fee or pay the borrower a prepayment credit, depending on certain circumstances, such as movements in interest rates, when the advance is prepaid. Any prepayment credit on an advance with PPS would be limited to the lesser of 10% of the par value of the advance or the gain recognized on the termination of the associated interest rate swap, which may also include a similar contractual gain limitation. |
Average advances were $87.5 billion in the second quarter of 2011, an 18% decrease from $107.0 billion in the second quarter of 2010. Average advances were $90.4 billion in the first six months of 2011, a 22% decrease from $116.0 billion in the first six months of 2010. The decline in member advance demand reflected general economic conditions and conditions in the mortgage and credit markets. Member liquidity remained high and lending activity remained subdued.
For a discussion of advances credit risk, see “Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Advances.”
Non-MBS Investments – The Bank's non-MBS investment portfolio consists of financial instruments that are used primarily to facilitate the Bank's role as a cost-effective provider of credit and liquidity to members. These investments are also used as a source of liquidity to meet the Bank's financial obligations on a timely basis, which may supplement or reduce earnings. The Bank's total non-MBS investment portfolio was $26.3 billion as of June 30, 2011, a decrease of $4.8 billion, or 15%, from $31.1 billion as of December 31, 2010. The decline in the non-MBS investment portfolio was primarily due to limited participation by the Bank's investment counterparties in the overnight Federal funds market, which resulted in an increase in cash held at the Federal Reserve Bank of San Francisco.
Cash and Due from Banks – Cash and due from banks increased to $7.5 billion at June 30, 2011, from $0.8 billion at December 31, 2010. The increase in cash and due from banks at June 30, 2011, was caused by limited participation by the Bank's counterparties in the overnight Federal funds market, which resulted in an increase in cash held at the Federal Reserve Bank of San Francisco.
Borrowings – Consistent with the decrease in advances, total liabilities (primarily consolidated obligations) funding the advances-related business decreased $9.2 billion, or 8%, from $121.5 billion at December 31, 2010, to $112.3 billion at June 30, 2011. For further information and discussion of the Bank's joint and several liability for
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FHLBank consolidated obligations, see “Management's Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition and “Item 1. Financial Statements and Supplementary Data – Note 16 – Commitments and Contingencies.”
To meet the specific needs of certain investors, fixed and adjustable rate consolidated obligation bonds may contain embedded call options or other features that result in complex coupon payment terms. When these consolidated obligation bonds are issued on behalf of the Bank, typically the Bank simultaneously enters into interest rate exchange agreements with features that offset the complex features of the bonds and, in effect, convert the bonds to adjustable rate instruments tied to an index, primarily LIBOR. For example, the Bank uses fixed rate callable bonds that are typically offset with interest rate exchange agreements with call features that offset the call options embedded in the callable bonds. This combined financing structure enables the Bank to meet its funding needs at costs not generally attainable solely through the issuance of comparable term non-callable debt.
At June 30, 2011, the notional amount of interest rate exchange agreements associated with the advances-related business totaled $158.6 billion, of which $23.9 billion were hedging advances, $130.8 billion were hedging consolidated obligations, $2.9 billion were economically hedging trading securities, and $1.0 billion were interest rate exchange agreements that the Bank entered into as an intermediary between exactly offsetting derivatives transactions with members and other counterparties. At December 31, 2010, the notional amount of interest rate exchange agreements associated with the advances-related business totaled $173.7 billion, of which $32.7 billion were hedging advances, $137.7 billion were hedging consolidated obligations, $2.3 billion were economically hedging trading securities, and $1.0 billion were interest rate exchange agreements that the Bank entered into as an intermediary between exactly offsetting derivatives transactions with members and other counterparties. The hedges associated with advances and consolidated obligations were primarily used to convert the fixed rate cash flows and non-LIBOR-indexed cash flows of the advances and consolidated obligations to adjustable rate LIBOR-indexed cash flows or to manage the interest rate sensitivity and net repricing gaps of assets, liabilities, and interest rate exchange agreements.
FHLBank System consolidated obligation bonds and discount notes, along with similar debt securities issued by other GSEs such as Fannie Mae and Freddie Mac, are generally referred to as agency debt. The agency debt market is a large sector of the debt capital markets. The costs of debt issued by the FHLBanks and the other GSEs generally rise and fall with increases and decreases in general market interest rates. For more information, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” in the Bank's 2010 Form 10-K.
Since December 16, 2008, the Federal Open Market Committee has not changed the target Federal funds rate. During the first six months of 2011, yields on intermediate-term U.S. Treasury securities declined because of increased demand for U.S. Treasury securities as a result of continued accommodative Federal Reserve policy to address slow economic growth in the U.S. and renewed concerns of European sovereign risks. The following table provides selected market interest rates as of the dates shown.
Selected Market Interest Rates | |||||||||||||||
Market Instrument | June 30, 2011 | December 31, 2010 | June 30, 2010 | December 31, 2009 | |||||||||||
Federal Reserve target rate for overnight Federal funds | 0-0.25 | % | 0-0.25 | % | 0-0.25 | % | 0-0.25 | % | |||||||
3-month Treasury bill | 0.03 | 0.13 | 0.18 | 0.06 | |||||||||||
3-month LIBOR | 0.25 | 0.30 | 0.53 | 0.25 | |||||||||||
2-year Treasury note | 0.46 | 0.60 | 0.61 | 1.14 | |||||||||||
5-year Treasury note | 1.76 | 2.01 | 1.78 | 2.68 |
The following table presents a comparison of the average cost of FHLBank System consolidated obligation bonds relative to 3-month LIBOR and discount notes relative to comparable term LIBOR in the first six months of 2011 and 2010. With respect to discount notes, the Bank experienced slightly higher cost relative to LIBOR in the first
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six months of 2011, compared to a year ago as a result of lower average LIBOR rates in the first six months of 2011 than in the prior year.
Spread to LIBOR of Average Cost of Consolidated Obligations for the Six Months Ended | |||
(In basis points) | June 30, 2011 | June 30, 2010 | |
Consolidated obligation bonds | -16.4 | -15.7 | |
Consolidated obligation discount notes (one month and greater) | -16.9 | -17.7 |
Mortgage-Related Business. The mortgage-related business consists of MBS investments, mortgage loans acquired through the Mortgage Partnership Finance® (MPF®) Program, and the related financing and hedging instruments. (“Mortgage Partnership Finance” and “MPF” are registered trademarks of the FHLBank of Chicago.) Adjusted net interest income for this segment is derived primarily from the difference, or spread, between the yield on the MBS and mortgage loans and the cost of the consolidated obligations funding those assets, including the cash flows from associated interest rate exchange agreements.
At June 30, 2011, assets associated with this segment were $27.1 billion (19% of total assets), an increase of $3.1 billion, or 13%, from $24.0 billion at December 31, 2010 (16% of total assets). The MBS portfolio increased $3.4 billion to $24.9 billion at June 30, 2011, from $21.5 billion at December 31, 2010, primarily due to purchases of agency residential MBS, and mortgage loan balances decreased $0.3 billion to $2.1 billion at June 30, 2011, from $2.4 billion at December 31, 2010. In the second quarter of 2011, average MBS investments were $25.8 billion, a decrease of $2.2 billion compared to $28.0 billion in the second quarter of 2010. In the first six months of 2011, average MBS investments decreased $4.0 billion to $25.2 billion compared to $29.2 billion in the first six months of 2010. Average mortgage loans were $2.2 billion in the second quarter of 2011, a decrease of $0.6 billion from $2.8 billion in the second quarter of 2010. Average mortgage loans decreased $0.7 billion to $2.2 billion in the first six months of 2011 from $2.9 billion in the first six months of 2010.
Adjusted net interest income for this segment was $142 million in the second quarter of 2011, a decrease of $12 million, or 8%, from $154 million in the second quarter of 2010. In the first six months of 2011, adjusted net interest income for this segment was $275 million, a decrease of $17 million, or 6%, from $292 million in the first six months of 2010. These decreases were primarily due to lower average MBS and mortgage loan balances, partially offset by the higher average profit spreads on the mortgage portfolio.
Adjusted net interest income for this segment represented 62% and 52% of total adjusted net interest income for the second quarter of 2011 and 2010, respectively, and 60% and 51% of total adjusted net interest income for the first six months of 2011 and 2010, respectively.
MPF Program – Under the MPF Program, the Bank purchased conventional conforming fixed rate residential mortgage loans directly from eligible members. Participating members originated or purchased the mortgage loans, credit-enhanced them and sold them to the Bank, and generally retained the servicing of the loans. The Bank manages the interest rate risk, prepayment risk, and liquidity risk of each loan in its portfolio. The Bank and the member that sold the loan share in the credit risk of the loan. The Bank has not purchased any new loans since October 2006. For more information regarding credit risk, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – MPF Program” in the Bank's 2010 Form 10-K.
At June 30, 2011, and December 31, 2010, the Bank held conventional conforming fixed rate mortgage loans purchased under one of two MPF products, MPF Plus or Original MPF, which are described in greater detail in “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – MPF Program” in the Bank's 2010 Form 10-K. Mortgage loan balances at June 30, 2011, and December 31, 2010, were as follows:
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Mortgage Loan Balances by MPF Product Type | |||||||
(In millions) | June 30, 2011 | December 31, 2010 | |||||
MPF Plus | $ | 1,946 | $ | 2,203 | |||
Original MPF | 171 | 197 | |||||
Subtotal | 2,117 | 2,400 | |||||
Net unamortized discounts | (15 | ) | (16 | ) | |||
Mortgage loans held for portfolio | 2,102 | 2,384 | |||||
Less: Allowance for credit losses | (5 | ) | (3 | ) | |||
Mortgage loans held for portfolio, net | $ | 2,097 | $ | 2,381 |
The Bank performs periodic reviews of its mortgage loan portfolio to identify probable credit losses in the portfolio and to determine the likelihood of collection of the loans in the portfolio. For more information on how the Bank determines its estimated allowance for credit losses on mortgage loans, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – MPF Program” and “Management's Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates – Allowance for Credit Losses – Mortgage Loans Acquired Under the MPF Program in the Bank's 2010 Form 10-K.”
MBS Investments – The Bank's MBS portfolio was $24.9 billion at June 30, 2011, compared to $21.5 billion, at December 31, 2010. During the first six months of 2011, the Bank's MBS portfolio increased primarily because of purchases of agency residential MBS. For a discussion of the composition of the Bank's MBS portfolio and the Bank's OTTI analysis of that portfolio, see “Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Investments” and “Item 1. Financial Statements and Supplementary Data – Note 6 – Other-Than-Temporary Impairment Analysis.”
Intermediate-term and long-term fixed rate MBS investments are subject to prepayment risk, and long-term adjustable rate MBS investments are subject to interest rate cap risk. The Bank has managed these risks by predominately purchasing intermediate-term fixed rate MBS (rather than long-term fixed rate MBS), funding the fixed rate MBS with a mix of non-callable and callable debt, and using interest rate exchange agreements with interest rate risk characteristics similar to callable debt.
Borrowings – Total consolidated obligations funding the mortgage-related business increased $3.1 billion, or 13%, to $27.1 billion at June 30, 2011, from $24.0 billion at December 31, 2010, paralleling the increase in mortgage portfolio assets. For further information and discussion of the Bank's joint and several liability for FHLBank consolidated obligations, see “Management's Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition” and “Item 1. Financial Statements and Supplementary Data – Note 16 – Commitments and Contingencies.”
At June 30, 2011, the notional amount of interest rate exchange agreements associated with the mortgage-related business totaled $15.3 billion, almost all of which hedged or was associated with consolidated obligations funding the mortgage portfolio.
At December 31, 2010, the notional amount of interest rate exchange agreements associated with the mortgage-related business totaled $16.8 billion, almost all of which hedged or was associated with consolidated obligations funding the mortgage portfolio.
Interest Rate Exchange Agreements
A derivatives transaction or interest rate exchange agreement is a financial contract whose fair value is generally derived from changes in the value of an underlying asset or liability. The Bank uses interest rate swaps; options to enter into interest rate swaps (swaptions); interest rate cap, floor, corridor, and collar agreements; and callable and
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putable interest rate swaps (collectively, interest rate exchange agreements) to manage its exposure to interest rate risks inherent in its normal course of business—lending, investment, and funding activities. For more information on the primary strategies that the Bank employs for using interest rate exchange agreements and the associated market risks, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Market Risk – Interest Rate Exchange Agreements” in the Bank's 2010 Form 10-K. The following table summarizes the Bank's interest rate exchange agreements by type of hedged item, hedging instrument, associated hedging strategy, accounting designation as specified under the accounting for derivative instruments and hedging activities, and notional amount as of June 30, 2011, and December 31, 2010.
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Interest Rate Exchange Agreements | ||||||||||||
(In millions) | Notional Amount | |||||||||||
Hedging Instrument | Hedging Strategy | Accounting Designation | June 30, 2011 | December 31, 2010 | ||||||||
Hedged Item: Advances | ||||||||||||
Pay fixed, receive adjustable interest rate swap | Fixed rate advance converted to a LIBOR adjustable rate | Fair Value Hedge | $ | 13,735 | $ | 21,493 | ||||||
Receive fixed, pay adjustable interest rate swap | LIBOR adjustable rate advance converted to a fixed rate | Economic Hedge(1) | — | 150 | ||||||||
Basis swap | Adjustable rate advance converted to another adjustable rate index to reduce interest rate sensitivity and repricing gaps | Economic Hedge(1) | 1 | 153 | ||||||||
Pay fixed, receive adjustable interest rate swap | Fixed rate advance converted to a LIBOR adjustable rate | Economic Hedge(1) | 1,313 | 913 | ||||||||
Pay fixed, receive adjustable interest rate swap; swap may be callable at the Bank's option or putable at the counterparty's option | Fixed rate advance (with or without an embedded cap) converted to a LIBOR adjustable rate; advance and swap may be callable or putable; matched to advance accounted for under the fair value option | Economic Hedge(1) | 8,728 | 8,844 | ||||||||
Interest rate cap, floor, corridor, and/or collar | Interest rate cap, floor, corridor, and/or collar embedded in an adjustable rate advance; matched to advance accounted for under the fair value option | Economic Hedge(1) | 166 | 1,166 | ||||||||
Subtotal Economic Hedges(1) | 10,208 | 11,226 | ||||||||||
Total | 23,943 | 32,719 | ||||||||||
Hedged Item: Non-Callable Bonds | ||||||||||||
Receive fixed or structured, pay adjustable interest rate swap | Fixed rate or structured rate non-callable bond converted to a LIBOR adjustable rate | Fair Value Hedge | 45,369 | 54,512 | ||||||||
Receive fixed or structured, pay adjustable interest rate swap | Fixed rate or structured rate non-callable bond converted to a LIBOR adjustable rate | Economic Hedge(1) | 5,793 | 6,294 | ||||||||
Receive fixed or structured, pay adjustable interest rate swap | Fixed rate or structured rate non-callable bond converted to a LIBOR adjustable rate; matched to non-callable bond accounted for under the fair value option | Economic Hedge(1) | 460 | 45 | ||||||||
Basis swap | Non-LIBOR adjustable rate non-callable bond converted to a LIBOR adjustable rate to reduce interest rate sensitivity and repricing gaps | Economic Hedge(1) | — | 25 | ||||||||
Basis swap | Non-LIBOR adjustable rate non-callable bond converted to a LIBOR adjustable rate; matched to non-callable bond accounted for under the fair value option | Economic Hedge(1) | 12,896 | 15,340 | ||||||||
Basis swap | Adjustable rate non-callable bond converted to another adjustable rate index to reduce interest rate sensitivity and repricing gaps | Economic Hedge(1) | 15,650 | 16,400 | ||||||||
Basis swap | Fixed rate or adjustable rate non-callable bond previously converted to an adjustable rate index, converted to another adjustable rate to reduce interest rate sensitivity and repricing gaps | Economic Hedge(1) | 21,715 | 27,505 | ||||||||
Pay fixed, receive adjustable interest rate swap | Fixed rate or adjustable rate non-callable bond, which may have been previously converted to LIBOR, converted to fixed rate debt that offsets the interest rate risk of mortgage assets | Economic Hedge(1) | 1,305 | 3,315 | ||||||||
Subtotal Economic Hedges(1) | 57,819 | 68,924 | ||||||||||
Total | 103,188 | 123,436 |
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Interest Rate Exchange Agreements (continued) | ||||||||||||
(In millions) | Notional Amount | |||||||||||
Hedging Instrument | Hedging Strategy | Accounting Designation | June 30, 2011 | December 31, 2010 | ||||||||
Hedged Item: Callable Bonds | ||||||||||||
Receive fixed or structured, pay adjustable interest rate swap with an option to call at the counterparty's option | Fixed or structured rate callable bond converted to a LIBOR adjustable rate; swap is callable | Fair Value Hedge | 13,342 | 8,126 | ||||||||
Receive fixed or structured, pay adjustable interest rate swap with an option to call at the counterparty's option | Fixed or structured rate callable bond converted to a LIBOR adjustable rate; swap is callable | Economic Hedge(1) | 405 | 65 | ||||||||
Receive fixed or structured, pay adjustable interest rate swap with an option to call at the counterparty's option | Fixed or structured rate callable bond converted to a LIBOR adjustable rate; swap is callable; matched to callable bond accounted for under the fair value option | Economic Hedge(1) | 6,163 | 5,662 | ||||||||
Subtotal Economic Hedges(1) | 6,568 | 5,727 | ||||||||||
Total | 19,910 | 13,853 | ||||||||||
Hedged Item: Discount Notes | ||||||||||||
Pay fixed, receive adjustable callable interest rate swap | Discount note, which may have been previously converted to LIBOR, converted to fixed rate callable debt that offsets the prepayment risk of mortgage assets | Economic Hedge(1) | 2,255 | 1,627 | ||||||||
Basis swap or receive fixed, pay adjustable interest rate swap | Discount note converted to one-month LIBOR or other short-term adjustable rate to hedge repricing gaps | Economic Hedge(1) | 20,065 | 15,488 | ||||||||
Pay fixed, receive adjustable non-callable interest rate swap | Discount note, which may have been previously converted to LIBOR, converted to fixed rate non-callable debt that offsets the interest rate risk of mortgage assets | Economic Hedge(1) | 705 | 65 | ||||||||
Total | 23,025 | 17,180 | ||||||||||
Hedged Item: Trading Securities | ||||||||||||
Pay MBS rate, receive adjustable interest rate swap | MBS rate converted to a LIBOR adjustable rate | Economic Hedge(1) | 3 | 4 | ||||||||
Basis swap | Basis swap hedging adjustable rate Federal Farm Credit Bank (FFCB) bonds | Economic Hedge(1) | 2,133 | 2,133 | ||||||||
Pay fixed, receive adjustable interest rate swap | Fixed rate Temporary Liquidity Guarantee Program (TLGP) securities converted to a LIBOR adjustable rate | Economic Hedge(1) | 785 | 125 | ||||||||
Total | 2,921 | 2,262 | ||||||||||
Hedged Item: Intermediary Positions | ||||||||||||
Pay fixed, receive adjustable interest rate swap, and receive fixed, pay adjustable interest rate swap | Interest rate swaps executed with members offset by executing interest rate swaps with derivatives dealer counterparties | Economic Hedge(1) | 40 | 40 | ||||||||
Interest rate cap/floor | Stand-alone interest rate cap and/or floor executed with a member offset by executing an interest rate cap and/or floor with derivatives dealer counterparties | Economic Hedge(1) | 910 | 920 | ||||||||
Total | 950 | 960 | ||||||||||
Total Notional Amount | $ | 173,937 | $ | 190,410 |
(1) | Economic hedges are derivatives that are matched to balance sheet instruments or other derivatives that do not meet the requirements for hedge accounting under the accounting for derivative instruments and hedging activities. |
At June 30, 2011, the total notional amount of interest rate exchange agreements outstanding was $173.9 billion, compared with $190.4 billion at December 31, 2010. The $16.5 billion decrease in the notional amount of derivatives during the first six months of 2011 was primarily due to a net $14.2 billion decrease in interest rate exchange agreements hedging consolidated obligation bonds, and a net $8.8 billion decrease in interest rate
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exchange agreements hedging advances, partially offset by a net $5.8 billion increase in interest rate exchange agreements hedging discount notes and a net $0.7 billion increase in interest rate exchange agreements hedging trading securities. The decrease in interest rate exchange agreements hedging consolidated obligation bonds reflects decreased use of interest rate exchange agreements that effectively converted the repricing frequency from three months to one month, and is consistent with the decline in the amount of bonds outstanding at June 30, 2011, relative to December 31, 2010. The notional amount serves as a basis for calculating periodic interest payments or cash flows received and paid and is not a measure of the amount of credit risk in that transaction.
The following tables categorize the notional amounts and estimated fair values of the Bank’s interest rate exchange agreements, unrealized gains and losses from the related hedged items, and estimated fair value gains and losses from financial instruments carried at fair value by type of accounting treatment and product as of June 30, 2011, and December 31, 2010.
Interest Rate Exchange Agreements Notional Amounts and Estimated Fair Values | |||||||||||||||||||
June 30, 2011 | |||||||||||||||||||
(In millions) | Notional Amount | Fair Value of Derivatives | Unrealized Gain/(Loss) on Hedged Items | Financial Instruments Carried at Fair Value | Difference | ||||||||||||||
Fair value hedges: | |||||||||||||||||||
Advances | $ | 13,735 | $ | (261 | ) | $ | 260 | $ | — | $ | (1 | ) | |||||||
Non-callable bonds | 45,369 | 1,155 | (1,163 | ) | — | (8 | ) | ||||||||||||
Callable bonds | 13,342 | 61 | (10 | ) | — | 51 | |||||||||||||
Subtotal | 72,446 | 955 | (913 | ) | — | 42 | |||||||||||||
Not qualifying for hedge accounting (economic hedges): | |||||||||||||||||||
Advances | 10,208 | (336 | ) | — | 303 | (33 | ) | ||||||||||||
Non-callable bonds | 57,819 | 337 | — | (8 | ) | 329 | |||||||||||||
Callable bonds | 6,568 | (22 | ) | — | 65 | 43 | |||||||||||||
Discount notes | 23,025 | (2 | ) | — | — | (2 | ) | ||||||||||||
MBS – trading | 3 | — | — | — | — | ||||||||||||||
FFCB bonds and TLGP securities | 2,918 | (15 | ) | — | — | (15 | ) | ||||||||||||
Intermediated | 950 | — | — | — | — | ||||||||||||||
Subtotal | 101,491 | (38 | ) | — | 360 | 322 | |||||||||||||
Total excluding accrued interest | 173,937 | 917 | (913 | ) | 360 | 364 | |||||||||||||
Accrued interest | — | 251 | (282 | ) | 9 | (22 | ) | ||||||||||||
Total | $ | 173,937 | $ | 1,168 | $ | (1,195 | ) | $ | 369 | $ | 342 |
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December 31, 2010 | |||||||||||||||||||
(In millions) | Notional Amount | Fair Value of Derivatives | Unrealized Gain/(Loss) on Hedged Items | Financial Instruments Carried at Fair Value | Difference | ||||||||||||||
Fair value hedges: | |||||||||||||||||||
Advances | $ | 21,493 | $ | (314 | ) | $ | 313 | $ | — | $ | (1 | ) | |||||||
Non-callable bonds | 54,512 | 1,422 | (1,432 | ) | — | (10 | ) | ||||||||||||
Callable bonds | 8,126 | 22 | (4 | ) | — | 18 | |||||||||||||
Subtotal | 84,131 | 1,130 | (1,123 | ) | — | 7 | |||||||||||||
Not qualifying for hedge accounting (economic hedges): | |||||||||||||||||||
Advances | 11,226 | (352 | ) | — | 291 | (61 | ) | ||||||||||||
Non-callable bonds | 68,899 | 381 | — | 1 | 382 | ||||||||||||||
Non-callable bonds with embedded derivatives | 25 | — | — | — | — | ||||||||||||||
Callable bonds | 5,727 | (64 | ) | — | 129 | 65 | |||||||||||||
Discount notes | 17,180 | 9 | — | — | 9 | ||||||||||||||
FFCB bonds and TLGP securities | 2,258 | (3 | ) | — | — | (3 | ) | ||||||||||||
MBS – trading | 4 | — | — | — | — | ||||||||||||||
Intermediated | 960 | — | — | — | — | ||||||||||||||
Subtotal | 106,279 | (29 | ) | — | 421 | 392 | |||||||||||||
Total excluding accrued interest | 190,410 | 1,101 | (1,123 | ) | 421 | 399 | |||||||||||||
Accrued interest | — | 262 | (283 | ) | 15 | (6 | ) | ||||||||||||
Total | $ | 190,410 | $ | 1,363 | $ | (1,406 | ) | $ | 436 | $ | 393 |
Because the periodic and cumulative net gains or losses on the Bank’s derivatives, hedged instruments, and certain assets and liabilities that are carried at fair value are primarily a matter of timing, the net gains or losses will generally reverse through changes in future valuations and settlements of contractual interest cash flows over the remaining contractual term to maturity, call date, or put date of the hedged financial instruments, associated interest rate exchange agreements, and financial instruments carried at fair value. However, the Bank may have instances in which the financial instruments or hedging relationships are terminated prior to maturity or prior to the call or put date. Terminating the financial instruments or hedging relationships may result in a realized gain or loss. In addition, the Bank may have instances in which it may sell trading securities prior to maturity, which may also result in a realized gain or loss.
The hedging and fair value option valuation adjustments are primarily driven by changes in overall interest rate spreads and swaption volatilities.
The ongoing impact of these valuation adjustments on the Bank cannot be predicted, and the Bank’s retained earnings in the future may not be sufficient to offset the impact of these valuation adjustments. The effects of these valuation adjustments may lead to significant volatility in future earnings, including earnings available for dividends.
Credit Risk. For a discussion of derivatives credit exposure, see “Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Derivatives Counterparties.”
Concentration Risk. The following table presents the concentration in derivatives with derivatives counterparties whose outstanding notional balances represented 10% or more of the Bank's total notional amount of derivatives outstanding as of June 30, 2011, and December 31, 2010.
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Concentration of Derivatives Counterparties | |||||||||||||||
(Dollars in millions) | June 30, 2011 | December 31, 2010 | |||||||||||||
Derivatives Counterparty | Credit Rating(1) | Notional Amount | Percentage of Total Notional Amount | Notional Amount | Percentage of Total Notional Amount | ||||||||||
Deutsche Bank AG | A | $ | 30,179 | 17 | % | $ | 28,818 | 15 | % | ||||||
BNP Paribas | AA | 29,554 | 17 | 26,321 | 14 | ||||||||||
JPMorgan Chase Bank, National Association | AA | 22,972 | 13 | 24,055 | 12 | ||||||||||
UBS AG | A | 21,076 | 12 | 24,200 | 13 | ||||||||||
Citigroup Inc.: | |||||||||||||||
Citibank, N.A. | A | 15,696 | 9 | 19,172 | 10 | ||||||||||
Citigroup Financial Products | A | 49 | — | 55 | — | ||||||||||
Subtotal Citigroup Inc. | 15,745 | 9 | 19,227 | 10 | |||||||||||
Subtotal | 119,526 | 68 | 122,621 | 64 | |||||||||||
Others | At least A | 54,411 | 32 | 67,789 | 36 | ||||||||||
Total | $ | 173,937 | 100 | % | $ | 190,410 | 100 | % |
(1) | The credit ratings used by the Bank are based on the lowest of Moody's, Standard & Poor's, or comparable Fitch ratings. |
Liquidity and Capital Resources
The Bank's financial strategies are designed to enable the Bank to expand and contract its assets, liabilities, and capital in response to changes in membership composition and member credit needs. The Bank's liquidity and capital resources are designed to support these financial strategies. The Bank's primary source of liquidity is its access to the capital markets through consolidated obligation issuance. The Bank's equity capital resources are governed by its capital plan.
Since the beginning of 2011, the combination of declining FHLBank funding needs and continued investor demand for FHLBank debt has enabled the FHLBanks to issue debt at reasonable costs. During the first six months of 2011, the FHLBanks issued $15 billion in global bonds, $92 billion in callable bonds, and $394 billion in auctioned discount notes.
Liquidity
The Bank strives to maintain the liquidity necessary to meet member credit demands, repay maturing consolidated obligations for which it is the primary obligor, meet other obligations and commitments, and respond to significant changes in membership composition. The Bank monitors its financial position in an effort to ensure that it has ready access to sufficient liquid funds to meet normal transaction requirements, take advantage of appropriate investment opportunities, and cover unforeseen liquidity demands.
The Bank generally manages operational, contingent, and structural liquidity risks using a portfolio of cash and short-term investments—which include commercial paper, interest-bearing deposits, and Federal funds sold to highly rated counterparties—and access to the debt capital markets. In addition, the Bank maintains alternate sources of funds, detailed in its contingent liquidity plan, which also includes an explanation of how sources of funds are allocated under stressed market conditions. The Bank maintains short-term, high-quality money market investments in amounts that may average up to three times the Bank's capital as a primary source of funds to satisfy these requirements and objectives.
The Bank maintains a contingent liquidity plan to meet its obligations and the liquidity needs of members in the event of short-term operational disruptions at the Bank or the Office of Finance or short-term disruptions of the capital markets. In 2009, the Finance Agency established liquidity guidelines that require each FHLBank to maintain sufficient on-balance sheet liquidity in an amount at least equal to its anticipated cash outflows for two different scenarios, both of which assume no capital markets access and no reliance on repurchase agreements or
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the sale of existing held-to-maturity and available-for-sale investments. The two scenarios differ only in the treatment of maturing advances. One scenario assumes that the Bank does not renew any maturing advances and retains sufficient liquidity to meet its obligations for 15 calendar days. The second scenario requires the Bank to renew maturing advances for certain members based on specific criteria established by the Finance Agency. In the renew advances scenario, the Bank must retain sufficient liquidity to meet its obligations for 5 calendar days.
In addition to the Finance Agency's guidelines on contingent liquidity, the Bank's asset-liability management committee has established an operational guideline to maintain at least 90 days of liquidity to enable the Bank to meet its obligations in the event of a longer-term consolidated obligations market disruption. The Bank's operational guideline assumes that mortgage assets can be used as a source of funds with the expectation that those assets can be used as collateral in the repurchase agreement markets. Under this guideline, the Bank maintained at least 90 days of liquidity at all times during the first six months of 2011. On a daily basis, the Bank models its cash commitments and expected cash flows for the next 90 days to determine its projected liquidity position. If a market or operational disruption occurred that prevented the issuance of new consolidated obligation bonds or discount notes through the capital markets, the Bank could meet its obligations by: (i) allowing short-term liquid investments to mature, (ii) using eligible securities as collateral for repurchase agreement borrowings, and (iii) if necessary, allowing advances to mature without renewal. In addition, the Bank may be able to borrow on a short-term unsecured basis from financial institutions (Federal funds purchased) or other FHLBanks (inter-FHLBank borrowings).
The Bank actively monitors and manages structural liquidity risks, which the Bank defines as maturity mismatches greater than 90 days for all sources and uses of funds. Structural liquidity maturity mismatches are identified using maturity gap analysis and valuation sensitivity metrics that quantify the risk associated with the Bank's structural liquidity position.
The following table shows the Bank's principal financial obligations due, estimated sources of funds available to meet those obligations, and the net difference between funds available and funds needed for the 5-business-day and 90-day periods following June 30, 2011, and December 31, 2010. Also shown are additional contingent sources of funds from on-balance sheet collateral available for repurchase agreement borrowings.
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Principal Financial Obligations Due and Funds Available for Selected Periods | |||||||||||||||
As of June 30, 2011 | As of December 31, 2010 | ||||||||||||||
(In millions) | 5 Business Days | 90 Days | 5 Business Days | 90 Days | |||||||||||
Obligations due: | |||||||||||||||
Commitments for new advances | $ | — | $ | 3 | $ | 304 | $ | 304 | |||||||
Commitments to purchase investments | — | 210 | — | — | |||||||||||
Demand deposits | 834 | 834 | 925 | 925 | |||||||||||
Maturing member term deposits | — | 10 | 3 | 16 | |||||||||||
Discount note and bond maturities and expected exercises of bond call options | 3,225 | 37,002 | 2,309 | 21,949 | |||||||||||
Subtotal obligations | 4,059 | 38,059 | 3,541 | 23,194 | |||||||||||
Sources of available funds: | |||||||||||||||
Maturing investments | 4,743 | 20,194 | 11,198 | 25,946 | |||||||||||
Cash at Federal Reserve Bank of San Francisco | 7,451 | 7,451 | 754 | 754 | |||||||||||
Proceeds from scheduled settlements of discount notes and bonds | 1,210 | 3,195 | 30 | 205 | |||||||||||
Maturing advances and scheduled prepayments | 1,193 | 10,825 | 2,061 | 13,857 | |||||||||||
Subtotal sources | 14,597 | 41,665 | 14,043 | 40,762 | |||||||||||
Net funds available | 10,538 | 3,606 | 10,502 | 17,568 | |||||||||||
Additional contingent sources of funds:(1) | |||||||||||||||
Estimated borrowing capacity of securities available for repurchase agreement borrowings: | |||||||||||||||
MBS | — | 20,626 | — | 17,964 | |||||||||||
Marketable money market investments | 6,128 | — | 5,881 | — | |||||||||||
TLGP securities | 2,990 | 2,990 | 2,311 | 2,017 | |||||||||||
FFCB bonds | 2,366 | 2,366 | 2,366 | 2,366 | |||||||||||
Subtotal contingent sources | 11,484 | 25,982 | 10,558 | 22,347 | |||||||||||
Total contingent funds available | $ | 22,022 | $ | 29,588 | $ | 21,060 | $ | 39,915 |
(1) The estimated amount of repurchase agreement borrowings obtainable from authorized securities dealers is subject to market conditions and the ability of securities dealers to obtain financing for the securities and transactions entered into with the Bank. The estimated maximum amount of repurchase agreement borrowings obtainable is based on the current par amount and estimated market value of MBS and other investments (not included in above figures) that are not pledged at the beginning of the period and is subject to estimated collateral discounts taken by securities dealers.
For more information, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources – Liquidity” and “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Liquidity Risk” in the Bank's 2010 Form
10-K.
Regulatory Capital
The FHLBank Act and Finance Agency regulations specify that each FHLBank must meet certain minimum regulatory capital standards. The Bank must maintain: (i) total regulatory capital in an amount equal to at least 4% of its total assets, (ii) leverage capital in an amount equal to at least 5% of its total assets, and (iii) permanent capital in an amount at least equal to its regulatory risk-based capital requirement. Regulatory capital and permanent capital are both defined as total capital stock outstanding, including mandatorily redeemable capital stock, and retained earnings. Regulatory capital and permanent capital do not include accumulated other comprehensive income/(loss). Leverage capital is defined as the sum of permanent capital weighted by a 1.5 multiplier plus non-permanent capital. (Non-permanent capital consists of Class A capital stock, which is redeemable upon six months' notice. The Bank's capital plan does not provide for the issuance of Class A capital stock.) The risk-based capital requirements must be met with permanent capital, which must be at least equal to the sum of the Bank's credit risk, market risk, and operations risk capital requirements, all of which are calculated in accordance with the rules of the Finance Agency.
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The following table shows the Bank's compliance with the Finance Agency's capital requirements at June 30, 2011, and December 31, 2010.
Regulatory Capital Requirements | |||||||||||||||
June 30, 2011 | December 31, 2010 | ||||||||||||||
(Dollars in millions) | Required | Actual | Required | Actual | |||||||||||
Risk-based capital | $ | 3,749 | $ | 12,855 | $ | 4,209 | $ | 13,640 | |||||||
Total regulatory capital | $ | 5,778 | $ | 12,855 | $ | 6,097 | $ | 13,640 | |||||||
Total regulatory capital ratio | 4.00 | % | 8.90 | % | 4.00 | % | 8.95 | % | |||||||
Leverage capital | $ | 7,222 | $ | 19,283 | $ | 7,621 | $ | 20,460 | |||||||
Leverage ratio | 5.00 | % | 13.35 | % | 5.00 | % | 13.42 | % |
In light of the Bank's strong regulatory capital position, the Bank plans to repurchase up to $500 million in excess capital stock on August 15, 2011. The amount of excess capital stock to be repurchased from any shareholder will be based on the shareholder's pro rata ownership share of total capital stock outstanding as of the repurchase date, up to the amount of the shareholder's excess capital stock.
The Bank's capital requirements are more fully discussed in “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital” in the Bank's 2010 Form 10-K.
Risk Management
The Bank has an integrated corporate governance and internal control framework designed to support effective management of the Bank's business activities and the risks inherent in these activities. As part of this framework, the Bank's Board of Directors has adopted a Risk Management Policy and a Member Products Policy, which are reviewed regularly and reapproved at least annually. The Risk Management Policy establishes risk guidelines, limits (if applicable), and standards for credit risk, market risk, liquidity risk, operations risk, concentration risk, and business risk in accordance with Finance Agency regulations, the risk profile established by the Board of Directors, and other applicable guidelines in connection with the Bank's capital plan and overall risk management. For more detailed information, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management” in the Bank's 2010 Form 10‑K.
Advances. The Bank manages the credit risk associated with lending to members by monitoring the creditworthiness of the members and the quality and value of the assets they pledge as collateral. To identify the credit strength of each borrower, other than community development financial institutions (CDFIs), the Bank assigns each member and nonmember borrower an internal credit quality rating from one to ten, with one as the highest rating. These ratings are based on results from the Bank's credit model, which considers financial, regulatory, and other qualitative information, including regulatory examination reports. The internal ratings are reviewed on an ongoing basis using current available information, and are revised, if necessary, to reflect the borrower's current financial position. Advance and collateral terms may be adjusted based on the results of this credit analysis.
The Bank determines the maximum amount and maximum term of the advances it will make to a CDFI based on a separate risk assessment system that considers information from the CDFI's audited annual financial statements, supplemented by additional information deemed relevant by the Bank. Approved terms are designed to meet the needs of the individual member while mitigating the unique credit and collateral risks of CDFIs, which do not file quarterly regulatory financial reports and are not subject to the same inspection and regulation requirements as other types of members.
Pursuant to the Bank's lending agreements with its members, the Bank limits the amount it will lend to a percentage of the market value or unpaid principal balance of pledged collateral, known as the borrowing capacity. The
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borrowing capacity percentage varies according to several factors, including the collateral type, the value assigned to the collateral, the results of the Bank's collateral field review of the member's collateral, the pledging method used for loan collateral (specific identification or blanket lien), data reporting frequency (monthly or quarterly), the member's financial strength and condition, and the concentration of collateral type. Under the terms of the Bank's lending agreements, the aggregate borrowing capacity of a member's pledged eligible collateral must meet or exceed the total amount of the member's outstanding advances, other extensions of credit, and certain other member obligations and liabilities. The Bank monitors each member's aggregate borrowing capacity and collateral requirements on a daily basis by comparing the member's borrowing capacity to its obligations to the Bank.
When a nonmember financial institution acquires some or all of the assets and liabilities of a member, including outstanding advances and Bank capital stock, the Bank may allow the advances to remain outstanding, at its discretion. The nonmember borrower is required to meet all the Bank's credit and collateral requirements, including requirements regarding creditworthiness and collateral borrowing capacity.
The following tables present a summary of the status of the credit outstanding and overall collateral borrowing capacity of the Bank's member and nonmember borrowers as of June 30, 2011, and December 31, 2010.
Member and Nonmember Credit Outstanding and Collateral Borrowing Capacity by Credit Quality Rating | ||||||||||||||||
(Dollars in millions) | ||||||||||||||||
June 30, 2011 | ||||||||||||||||
All Members and Nonmembers | Members and Nonmembers with Credit Outstanding | |||||||||||||||
Collateral Borrowing Capacity(2) | ||||||||||||||||
Member or Nonmember Credit Quality Rating | Number | Number | Credit Outstanding(1) | Total | Used | |||||||||||
1-3 | 103 | 69 | $ | 41,773 | $ | 97,447 | 43 | % | ||||||||
4-6 | 211 | 120 | 44,912 | 76,306 | 59 | |||||||||||
7-10 | 74 | 44 | 1,559 | 4,286 | 36 | |||||||||||
Subtotal | 388 | 233 | 88,244 | 178,039 | 50 | |||||||||||
CDFIs | 2 | 2 | 2 | 12 | 17 | |||||||||||
Total | 390 | 235 | $ | 88,246 | $ | 178,051 | 50 | % | ||||||||
December 31, 2010 | ||||||||||||||||
All Members and Nonmembers | Members and Nonmembers with Credit Outstanding | |||||||||||||||
Collateral Borrowing Capacity(2) | ||||||||||||||||
Member or Nonmember Credit Quality Rating | Number | Number | Credit Outstanding(1) | Total | Used | |||||||||||
1-3 | 87 | 58 | $ | 40,552 | $ | 85,967 | 47 | % | ||||||||
4-6 | 216 | 141 | 58,163 | 107,634 | 54 | |||||||||||
7-10 | 90 | 53 | 2,235 | 5,839 | 38 | |||||||||||
Total | 393 | 252 | $ | 100,950 | $ | 199,440 | 51 | % |
(1) | Includes advances, letters of credit, the market value of swaps, estimated prepayment fees for certain borrowers, and the credit enhancement obligation on MPF loans. |
(2) | Collateral borrowing capacity does not represent any commitment to lend on the part of the Bank. |
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Member and Nonmember Credit Outstanding and Collateral Borrowing Capacity by Unused Borrowing Capacity | ||||||||||
(Dollars in millions) | ||||||||||
June 30, 2011 | ||||||||||
Unused Borrowing Capacity | Number of Members and Nonmembers with Credit Outstanding | Credit Outstanding(1) | Collateral Borrowing Capacity(2) | |||||||
0% – 10% | 8 | $ | 155 | $ | 170 | |||||
11% – 25% | 19 | 29,750 | 33,966 | |||||||
26% – 50% | 42 | 37,671 | 61,570 | |||||||
More than 50% | 166 | 20,670 | 82,345 | |||||||
Total | 235 | $ | 88,246 | $ | 178,051 | |||||
December 31, 2010 | ||||||||||
Unused Borrowing Capacity | Number of Members and Nonmembers with Credit Outstanding(3) | Credit Outstanding(1)(3) | Collateral Borrowing Capacity(2) | |||||||
0% – 10% | 12 | $ | 344 | $ | 358 | |||||
11% – 25% | 28 | 15,624 | 18,190 | |||||||
26% – 50% | 53 | 69,639 | 114,676 | |||||||
More than 50% | 159 | 15,343 | 66,216 | |||||||
Total | 252 | $ | 100,950 | $ | 199,440 |
(1) | Includes advances, letters of credit, the market value of swaps, estimated prepayment fees for certain borrowers, and the credit enhancement obligation on MPF loans. |
(2) | Collateral borrowing capacity does not represent any commitment to lend on the part of the Bank. |
Securities pledged as collateral are assigned borrowing capacities that reflect the securities' pricing volatility and market liquidity risks. Securities are delivered to the Bank's custodian when they are pledged. The Bank prices securities collateral on a daily basis or twice a month, depending on the availability and reliability of external pricing sources. Securities that are normally priced twice a month may be priced more frequently in volatile market conditions. The Bank benchmarks the borrowing capacities for securities collateral to the market on a periodic basis and may review and change the borrowing capacity for any security type at any time. As of June 30, 2011, the borrowing capacities assigned to U.S. Treasury securities and most agency securities ranged from 95% to 99.5% of their market value. The borrowing capacities assigned to private-label MBS, which must be rated AAA or AA when initially pledged, generally ranged from 50% to 85% of their market value, depending on the underlying collateral (residential mortgages, home equity loans, or commercial real estate), the rating and the subordination structure of the respective security.
The following table presents the securities collateral pledged by all members and by nonmembers with credit outstanding at June 30, 2011, and December 31, 2010.
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Composition of Securities Collateral Pledged by Members and by Nonmembers with Credit Outstanding | |||||||||||||||
(In millions) | June 30, 2011 | December 31, 2010 | |||||||||||||
Securities Type with Current Credit Ratings | Current Par | Borrowing Capacity | Current Par | Borrowing Capacity | |||||||||||
U.S. Treasury (bills, notes, bonds) | $ | 447 | $ | 441 | $ | 503 | $ | 497 | |||||||
Agency (notes, subordinate debt, structured notes, indexed amortization notes, and Small Business Administration pools) | 3,239 | 3,228 | 3,799 | 3,769 | |||||||||||
Agency pools and collateralized mortgage obligations | 13,959 | 13,781 | 14,395 | 14,111 | |||||||||||
PLRMBS – publicly registered AAA-rated senior tranches | 109 | 85 | 274 | 203 | |||||||||||
PLRMBS – publicly registered AA-rated senior tranches | 12 | 6 | 24 | 12 | |||||||||||
PLRMBS – publicly registered A-rated senior tranches | 41 | 7 | 87 | 16 | |||||||||||
PLRMBS – publicly registered BBB-rated senior tranches | 76 | 9 | 47 | 7 | |||||||||||
Private-label commercial MBS – publicly registered AAA-rated subordinate tranches | 13 | 11 | 22 | 18 | |||||||||||
Term deposits with the Bank | 10 | 10 | 16 | 16 | |||||||||||
Total | $ | 17,906 | $ | 17,578 | $ | 19,167 | $ | 18,649 |
With respect to loan collateral, most members may choose to pledge loan collateral using a specific identification method or a blanket lien method. Members pledging under the specific identification method must provide a detailed listing of all the loans pledged to the Bank on a monthly or quarterly basis. Under the blanket lien method, a member generally pledges the following loan types, whether or not the individual loans are eligible to receive borrowing capacity: all loans secured by real estate; all loans made for commercial, corporate, or business purposes; and all participations in these loans. Members pledging under the blanket lien method may provide a detailed listing of loans or may use a summary reporting method, which entails a quarterly review by the Bank of certain data regarding the member and its pledged collateral.
The Bank may require certain members to deliver pledged loan collateral to the Bank for one or more reasons, including the following: the member is a de novo institution (chartered within the last three years), the Bank is concerned about the member's creditworthiness, or the Bank is concerned about the maintenance of its collateral or the priority of its security interest. Members required to deliver loan collateral must pledge those loans under the blanket lien method with detailed reporting. The Bank's largest borrowers are required to report detailed data on a monthly basis and may pledge loan collateral using either the specific identification method or the blanket lien method with detailed reporting.
As of June 30, 2011, 62% of the loan collateral pledged to the Bank was pledged by 35 institutions under specific identification, 30% was pledged by 186 institutions under blanket lien with detailed reporting, and 8% was pledged by 100 institutions under blanket lien with summary reporting.
As of June 30, 2011, the Bank's maximum borrowing capacities for loan collateral ranged from 20% to 95% of the unpaid principal balance. For example, the maximum borrowing capacities for collateral pledged under blanket lien with detailed reporting were as follows: 95% for first lien residential mortgage loans, 65% for multifamily mortgage loans, 60% for commercial mortgage loans, 50% for small business, small farm, and small agribusiness loans, and 20% for second lien residential mortgage loans. The highest borrowing capacities are available to members that pledge under blanket lien with detailed reporting because the detailed loan information allows the Bank to assess the value of the collateral more precisely and because additional collateral is pledged under the blanket lien that may not receive borrowing capacity but may be liquidated to repay advances in the event of default. The Bank may review and change the maximum borrowing capacity for any type of loan collateral at any time.
The table below presents the mortgage loan collateral pledged by all members and by nonmembers with credit outstanding at June 30, 2011, and December 31, 2010.
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Composition of Loan Collateral Pledged by Members and by Nonmembers with Credit Outstanding | |||||||||||||||
(In millions) | June 30, 2011 | December 31, 2010 | |||||||||||||
Loan Type | Unpaid Principal Balance | Borrowing Capacity | Unpaid Principal Balance | Borrowing Capacity | |||||||||||
First lien residential mortgage loans | $ | 122,601 | $ | 85,173 | $ | 158,001 | $ | 105,506 | |||||||
Second lien residential mortgage loans and home equity lines of credit | 69,271 | 15,101 | 77,098 | 15,068 | |||||||||||
Multifamily mortgage loans | 35,476 | 22,668 | 33,810 | 20,733 | |||||||||||
Commercial mortgage loans | 48,719 | 29,015 | 51,502 | 27,258 | |||||||||||
Loan participations | 11,251 | 7,807 | 16,717 | 11,600 | |||||||||||
Small business, small farm, and small agribusiness loans | 3,076 | 583 | 3,031 | 478 | |||||||||||
Other | 897 | 126 | 1,015 | 148 | |||||||||||
Total | $ | 291,291 | $ | 160,473 | $ | 341,174 | $ | 180,791 |
The Bank holds a security interest in subprime residential mortgage loans pledged as collateral. Subprime loans are defined as loans with a borrower FICO score of 660 or less at origination, or if the original FICO score is not available, as loans with a current borrower FICO score of 660 or less. At June 30, 2011, and December 31, 2010, the amount of these loans totaled $27 billion and $30 billion, respectively. The Bank reviews and assigns borrowing capacities to subprime mortgage loans as it does for all other types of loan collateral, taking into account the known credit attributes in the pricing of the loans. In addition, members with concentrations in nontraditional and subprime mortgage loans are subject to more frequent analysis to assess the credit quality and value of the loans. All advances, including those made to members pledging subprime mortgage loans, are required to be fully collateralized. The Bank limits the amount of borrowing capacity that may be supported by subprime collateral.
Investments. The Bank has adopted credit policies and exposure limits for investments that promote risk diversification and liquidity. These policies restrict the amounts and terms of the Bank's investments with any given counterparty according to the Bank's own capital position as well as the capital and creditworthiness of the counterparty.
The Bank monitors its investments for substantive changes in relevant market conditions and any declines in fair value. For securities in an unrealized loss position because of factors other than movements in interest rates, such as widening of mortgage asset spreads, the Bank considers whether it expects to recover the entire amortized cost basis of the security by comparing the best estimate of the present value of the cash flows expected to be collected from the security with the amortized cost basis of the security. If the Bank's best estimate of the present value of the cash flows expected to be collected is less than the amortized cost basis, the difference is considered the credit loss.
When the fair value of an individual investment security falls below its amortized cost, the Bank evaluates whether the decline is other than temporary. The Bank recognizes an other-than-temporary impairment when it determines that it will be unable to recover the entire amortized cost basis of the security and the fair value of the investment security is less than its amortized cost. The Bank considers its intent to hold the security and whether it is more likely than not that the Bank will be required to sell the security before its anticipated recovery of the remaining cost basis, and other factors. The Bank generally views changes in the fair value of the securities caused by movements in interest rates to be temporary.
The following tables present the Bank's investment credit exposure at the dates indicated, based on the lowest of the long-term credit ratings provided by Moody's, Standard & Poor's, or comparable Fitch ratings.
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Investment Credit Exposure | |||||||||||||||||||||||||||||||||||||||
(In millions) | |||||||||||||||||||||||||||||||||||||||
June 30, 2011 | |||||||||||||||||||||||||||||||||||||||
Carrying Value | |||||||||||||||||||||||||||||||||||||||
Credit Rating(1) | |||||||||||||||||||||||||||||||||||||||
Investment Type | AAA | AA | A | BBB | BB | B | CCC | CC | C | Total | |||||||||||||||||||||||||||||
Trading securities: | |||||||||||||||||||||||||||||||||||||||
GSEs: | |||||||||||||||||||||||||||||||||||||||
FFCB bonds | $ | 2,366 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 2,366 | |||||||||||||||||||
TLGP securities | 1,160 | — | — | — | — | — | — | — | — | 1,160 | |||||||||||||||||||||||||||||
MBS: | |||||||||||||||||||||||||||||||||||||||
Other U.S. obligations: | |||||||||||||||||||||||||||||||||||||||
Ginnie Mae | 19 | — | — | — | — | — | — | — | — | 19 | |||||||||||||||||||||||||||||
GSEs: | |||||||||||||||||||||||||||||||||||||||
Fannie Mae | 3 | — | — | — | — | — | — | — | — | 3 | |||||||||||||||||||||||||||||
Total trading securities | 3,548 | — | — | — | — | — | — | — | — | 3,548 | |||||||||||||||||||||||||||||
Available-for-sale securities: | |||||||||||||||||||||||||||||||||||||||
TLGP securities(2) | 1,926 | — | — | — | — | — | — | — | — | 1,926 | |||||||||||||||||||||||||||||
PLRMBS: | |||||||||||||||||||||||||||||||||||||||
Prime | — | — | — | — | 83 | 92 | 383 | 199 | 134 | 891 | |||||||||||||||||||||||||||||
Alt-A, option ARM | — | — | — | — | — | 106 | 942 | 61 | — | 1,109 | |||||||||||||||||||||||||||||
Alt-A, other | — | 81 | — | 104 | 30 | 570 | 3,725 | 253 | 1,092 | 5,855 | |||||||||||||||||||||||||||||
Total PLRMBS | — | 81 | — | 104 | 113 | 768 | 5,050 | 513 | 1,226 | 7,855 | |||||||||||||||||||||||||||||
Total available-for-sale securities | 1,926 | 81 | — | 104 | 113 | 768 | 5,050 | 513 | 1,226 | 9,781 | |||||||||||||||||||||||||||||
Held-to-maturity securities: | |||||||||||||||||||||||||||||||||||||||
Interest-bearing deposits | — | 1,875 | 4,850 | — | — | — | — | — | — | 6,725 | |||||||||||||||||||||||||||||
Commercial paper(3) | — | 1,150 | 650 | — | — | — | — | — | — | 1,800 | |||||||||||||||||||||||||||||
Housing finance agency bonds | — | 207 | — | 505 | — | — | — | — | — | 712 | |||||||||||||||||||||||||||||
MBS: | |||||||||||||||||||||||||||||||||||||||
Other U.S. obligations: | |||||||||||||||||||||||||||||||||||||||
Ginnie Mae | 232 | — | — | — | — | — | — | — | — | 232 | |||||||||||||||||||||||||||||
GSEs: | — | ||||||||||||||||||||||||||||||||||||||
Freddie Mac | 3,428 | — | — | — | — | — | — | — | — | 3,428 | |||||||||||||||||||||||||||||
Fannie Mae | 8,388 | — | — | — | — | — | — | — | — | 8,388 | |||||||||||||||||||||||||||||
PLRMBS: | |||||||||||||||||||||||||||||||||||||||
Prime | 319 | 339 | 338 | 781 | 650 | 118 | 60 | — | — | 2,605 | |||||||||||||||||||||||||||||
Alt-A, option ARM | — | — | — | — | — | — | 49 | — | — | 49 | |||||||||||||||||||||||||||||
Alt-A, other | 69 | 66 | 170 | 654 | 434 | 418 | 459 | 15 | — | 2,285 | |||||||||||||||||||||||||||||
Total PLRMBS | 388 | 405 | 508 | 1,435 | 1,084 | 536 | 568 | 15 | — | 4,939 | |||||||||||||||||||||||||||||
Total held-to-maturity securities | 12,436 | 3,637 | 6,008 | 1,940 | 1,084 | 536 | 568 | 15 | — | 26,224 | |||||||||||||||||||||||||||||
Federal funds sold | — | 8,756 | 2,913 | — | — | — | — | — | — | 11,669 | |||||||||||||||||||||||||||||
Total investments | $ | 17,910 | $ | 12,474 | $ | 8,921 | $ | 2,044 | $ | 1,197 | $ | 1,304 | $ | 5,618 | $ | 528 | $ | 1,226 | $ | 51,222 |
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Investment Credit Exposure | |||||||||||||||||||||||||||||||||||||||
(In millions) | |||||||||||||||||||||||||||||||||||||||
December 31, 2010 | |||||||||||||||||||||||||||||||||||||||
Carrying Value | |||||||||||||||||||||||||||||||||||||||
Credit Rating(1) | |||||||||||||||||||||||||||||||||||||||
Investment Type | AAA | AA | A | BBB | BB | B | CCC | CC | C | Total | |||||||||||||||||||||||||||||
Trading securities: | |||||||||||||||||||||||||||||||||||||||
GSEs: | |||||||||||||||||||||||||||||||||||||||
FFCB bonds | $ | 2,366 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 2,366 | |||||||||||||||||||
TLGP securities | 128 | — | — | — | — | — | — | — | — | 128 | |||||||||||||||||||||||||||||
MBS: | |||||||||||||||||||||||||||||||||||||||
Other U.S. obligations: | |||||||||||||||||||||||||||||||||||||||
Ginnie Mae | 20 | — | — | — | — | — | — | — | — | 20 | |||||||||||||||||||||||||||||
GSEs: | |||||||||||||||||||||||||||||||||||||||
Fannie Mae | 5 | — | — | — | — | — | — | — | — | 5 | |||||||||||||||||||||||||||||
Total trading securities | 2,519 | — | — | — | — | — | — | — | — | 2,519 | |||||||||||||||||||||||||||||
Available-for-sale securities: | |||||||||||||||||||||||||||||||||||||||
TLGP securities(2) | 1,927 | — | — | — | — | — | — | — | — | 1,927 | |||||||||||||||||||||||||||||
Total available-for-sale securities | 1,927 | — | — | — | — | — | — | — | — | 1,927 | |||||||||||||||||||||||||||||
Held-to-maturity securities: | |||||||||||||||||||||||||||||||||||||||
Interest-bearing deposits | — | 3,334 | 3,500 | — | — | — | — | — | — | 6,834 | |||||||||||||||||||||||||||||
Commercial paper(3) | — | 1,500 | 1,000 | — | — | — | — | — | — | 2,500 | |||||||||||||||||||||||||||||
Housing finance agency bonds | — | 222 | 521 | — | — | — | — | — | — | 743 | |||||||||||||||||||||||||||||
TLGP securities(2) | 301 | — | — | — | — | — | — | — | — | 301 | |||||||||||||||||||||||||||||
MBS: | |||||||||||||||||||||||||||||||||||||||
Other U.S. obligations: | |||||||||||||||||||||||||||||||||||||||
Ginnie Mae | 33 | — | — | — | — | — | — | — | — | 33 | |||||||||||||||||||||||||||||
GSEs: | |||||||||||||||||||||||||||||||||||||||
Freddie Mac | 2,326 | — | — | — | — | — | — | — | — | 2,326 | |||||||||||||||||||||||||||||
Fannie Mae | 5,922 | — | — | — | — | — | — | — | — | 5,922 | |||||||||||||||||||||||||||||
PLRMBS: | |||||||||||||||||||||||||||||||||||||||
Prime | 1,521 | 709 | 515 | 211 | 92 | 194 | 374 | 267 | 73 | 3,956 | |||||||||||||||||||||||||||||
Alt-A, option ARM | — | — | — | — | 155 | 96 | 775 | 71 | — | 1,097 | |||||||||||||||||||||||||||||
Alt-A, other | 230 | 735 | 583 | 408 | 301 | 1,140 | 3,553 | 282 | 880 | 8,112 | |||||||||||||||||||||||||||||
Total PLRMBS | 1,751 | 1,444 | 1,098 | 619 | 548 | 1,430 | 4,702 | 620 | 953 | 13,165 | |||||||||||||||||||||||||||||
Total held-to-maturity securities | 10,333 | 6,500 | 6,119 | 619 | 548 | 1,430 | 4,702 | 620 | 953 | 31,824 | |||||||||||||||||||||||||||||
Federal funds sold | — | 10,374 | 5,938 | — | — | — | — | — | — | 16,312 | |||||||||||||||||||||||||||||
Total investments | $ | 14,779 | $ | 16,874 | $ | 12,057 | $ | 619 | $ | 548 | $ | 1,430 | $ | 4,702 | $ | 620 | $ | 953 | $ | 52,582 |
(1) | Credit ratings of BB and lower are below investment grade. |
(2) | TLGP securities represent corporate debentures of the issuing party that are guaranteed by the FDIC and backed by the full faith and credit of the U.S. government. |
(3) | The Bank's investment in commercial paper also had a short-term credit rating of A-1/P-1. |
For all the securities in its available-for-sale and held-to-maturity portfolios and for Federal funds sold, the Bank does not intend to sell any security and it is not more likely than not that the Bank will be required to sell any security before its anticipated recovery of the remaining amortized cost basis.
The Bank invests in short-term unsecured Federal funds sold, negotiable certificates of deposit (interest-bearing deposits), and commercial paper with member and nonmember counterparties. The Bank determined that, as of June 30, 2011, all of the gross unrealized losses on its interest-bearing deposits and commercial paper were temporary because the gross unrealized losses were caused by movements in interest rates and not by the
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deterioration of the issuers' creditworthiness; the interest-bearing deposits and commercial paper were all with issuers that had credit ratings of at least A at June 30, 2011; and all of the securities matured prior to the date of this report. As a result, the Bank has recovered the entire amortized cost basis of these securities.
The Bank's investments may also include housing finance agency bonds issued by housing finance agencies located in Arizona, California, and Nevada, the three states that make up the Bank's district, which is the Eleventh District of the FHLBank System. These bonds are mortgage revenue bonds (federally taxable) and are collateralized by pools of first lien residential mortgage loans and credit-enhanced by bond insurance. The bonds held by the Bank are issued by the California Housing Finance Agency (CalHFA) and insured by either Ambac Assurance Corporation (Ambac), MBIA Insurance Corporation (MBIA), or Assured Guaranty Municipal Corporation (formerly Financial Security Assurance Incorporated). At June 30, 2011, all of the bonds were rated at least BBB by Moody's or Standard & Poor's.
At June 30, 2011, the Bank's investments in housing finance agency bonds had gross unrealized losses totaling $123 million. These gross unrealized losses were due to an illiquid market and credit concerns regarding the underlying mortgage pool, causing these investments to be valued at a discount to their acquisition cost. The Bank independently modeled cash flows for the underlying collateral, using assumptions for default rates and loss severity that the Bank deemed reasonable, and concluded that the available credit support within the CalHFA structure more than offset the projected underlying collateral losses. The Bank determined that, as of June 30, 2011, all of the gross unrealized losses on its housing finance agency bonds are temporary because the underlying collateral and credit enhancements were sufficient to protect the Bank from losses based on current expectations and because CalHFA had a credit rating of A at June 30, 2011 (based on the lower of Moody's or Standard & Poor's ratings). As a result, the Bank expects to recover the entire amortized cost basis of these securities.
The Bank also invests in corporate debentures issued under the TLGP, which are guaranteed by the FDIC and backed by the full faith and credit of the U.S. government. The Bank expects to recover the entire amortized cost basis of these securities because it determined that the strength of the guarantees and the direct support from the U.S. government are sufficient to protect the Bank from losses based on current expectations. As a result, the Bank determined that as of June 30, 2011, all the gross unrealized losses on its TLGP securities are temporary.
The Bank's investments also include PLRMBS, all of which were AAA-rated at the time of purchase, and
agency residential MBS, which are backed by Fannie Mae, Freddie Mac, or Ginnie Mae. Some of these PLRMBS were issued by and/or purchased from members, former members, or their affiliates. The Bank does not have investment credit limits and terms for these investments that differ for members and nonmembers. Bank policy limits MBS investments in total to three times the Bank's capital. At June 30, 2011, the Bank's MBS portfolio was 207% of Bank capital (as determined in accordance with regulations governing the operations of the FHLBanks).
The Bank executes all MBS investments without preference to the status of the counterparty or the issuer of the investment as a nonmember, member, or affiliate of a member. When the Bank executes non-MBS investments with members, the Bank may give consideration to their secured credit availability and the Bank's advances price levels.
All of the MBS purchased by the Bank are backed by pools of first lien residential mortgage loans, which may include residential mortgage loans labeled by the issuer as Alt-A. Bank policy prohibits the purchase of MBS backed by pools of mortgage loans labeled by the issuer as subprime or having certain Bank-defined subprime characteristics.
The Bank has not purchased any PLRMBS since 2008, and current Bank policy prohibits the purchase of PLRMBS.
At June 30, 2011, PLRMBS representing 41% of the amortized cost of the Bank's MBS portfolio were labeled Alt-A by the issuer. Alt-A PLRMBS are generally collateralized by mortgage loans that are considered less risky than subprime loans but more risky than prime loans. These loans are generally made to borrowers who have sufficient credit ratings to qualify for a conforming mortgage loan but the loans may not meet all standard guidelines for documentation requirements, property type, or loan-to-value ratios.
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As of June 30, 2011, the Bank's investment in MBS classified as held-to-maturity had gross unrealized losses totaling $637 million, most of which were related to PLRMBS. These gross unrealized losses were primarily due to illiquidity in the MBS market, uncertainty about the future condition of the housing and mortgage markets and the economy, and continued deterioration in the credit performance of loan collateral underlying these securities, causing these assets to be valued at significant discounts to their acquisition cost.
For its agency residential MBS, the Bank expects to recover the entire amortized cost basis of these securities because it determined that the strength of the issuers' guarantees through direct obligations or support from the U.S. government is sufficient to protect the Bank from losses based on current expectations. As a result, the Bank determined that, as of June 30, 2011, all of the gross unrealized losses on its agency residential MBS are temporary.
In 2009, the 12 FHLBanks formed the OTTI Governance Committee (OTTI Committee), which consists of one representative from each FHLBank. The OTTI Committee is responsible for reviewing and approving the key modeling assumptions, inputs, and methodologies to be used by the FHLBanks to generate the cash flow projections used in analyzing credit losses and determining OTTI for all PLRMBS and for certain home equity loan investments, including home equity asset-backed securities. For certain PLRMBS for which underlying collateral data is not available, alternative procedures as provided for by the OTTI Committee are expected to be used to assess these securities for OTTI. Certain private-label MBS backed by multifamily and commercial real estate loans, home equity lines of credit, and manufactured housing loans are outside the scope of the FHLBanks' OTTI Committee and are analyzed for OTTI by each individual FHLBank owning securities backed by such collateral. The Bank does not have any home equity loan investments or any private-label MBS backed by multifamily or commercial real estate loans, home equity lines of credit, or manufactured housing loans.
The Bank's evaluation includes estimating projected cash flows that the Bank is likely to collect based on an assessment of all available information about each security on an individual basis, the structure of the security, and certain assumptions as approved by the FHLBanks' OTTI Committee and approved by the Bank, such as the remaining payment terms for the security, prepayment speeds, default rates, loss severity on the collateral supporting the security based on underlying loan-level borrower and loan characteristics, expected housing price changes, and interest rate assumptions, to determine whether the Bank expects to recover the entire amortized cost basis of the security. In performing a detailed cash flow analysis, the Bank develops its best estimate of the cash flows expected to be collected. If this estimate results in a present value of expected cash flows (discounted at the security's effective yield) that is less than the amortized cost basis of the security, the security is considered to be other-than-temporarily impaired.
To assess whether it expects to recover the entire amortized cost basis of its PLRMBS, the Bank performed a cash flow analysis for all of its PLRMBS as of June 30, 2011. In performing the cash flow analysis for each security, 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 on an assessment of the individual housing markets. CBSA refers collectively to metropolitan and micropolitan statistical areas as defined by the United States Office of Management and Budget. As currently defined, a CBSA must contain at least one urban area with a population of 10,000 or more people. The Bank's housing price forecast as of June 30, 2011, assumed current-to-trough home price declines ranging from 0% (for those housing markets that are believed to have reached their trough) to 8% over the 3- to 9-month periods beginning April 1, 2011, followed in each case by a 3-month period of flat prices. Thereafter, home prices were projected to recover using one of five different recovery paths that vary by housing market. Under those recovery paths, home prices were projected to increase within a range of 0% to 2.8% in the first year, 0% to 3% in the second year, 1.5% to 4% in the third year, 2% to 5% in the fourth year, 2% to 6% in the fifth and sixth years, and 2.3% to 5.6% in each subsequent year. The month-by-month projections of future loan performance derived from the first model, which reflect projected prepayments, default rates, 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 each securitization structure in accordance with the structure's prescribed cash flow and loss allocation rules. When the credit enhancement for the senior securities in a securitization is derived from the presence of subordinated securities,
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losses are generally allocated first to the subordinated securities until their principal balance is reduced to zero. The projected cash flows are based on a number of assumptions and expectations, and the results of these models can vary significantly with changes in assumptions and expectations. The scenario of cash flows determined based on the model approach described above reflects a best-estimate scenario and includes a base case current-to-trough housing price forecast and a base case housing price recovery path.
In addition to evaluating its PLRMBS under a base case (or best estimate) scenario, the Bank performed a cash flow analysis for each of these securities under a more adverse housing price scenario. This more adverse 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 this scenario, current-to-trough home price declines were projected to range from 5% to 13% over the 3- to 9-month periods beginning April 1, 2011, followed in each case by a 3-month period of flat prices. Thereafter, home prices were projected to increase within a range of 0% to 1.9% in the first year, 0% to 2% in the second year, 1% to 2.7% in the third year, 1.3% to 3.4% in the fourth year, 1.3% to 4% in the fifth and sixth years, and 1.5% to 3.8% in each subsequent year.
The following table shows the base case scenario and what the OTTI charges would have been under the more adverse housing price scenario at June 30, 2011:
OTTI Analysis Under Base Case and Adverse Case Scenario | |||||||||||||||||||||||||||||
Housing Price Scenario | |||||||||||||||||||||||||||||
Base Case | Adverse Case | ||||||||||||||||||||||||||||
(Dollars in millions) | Number of Securities | Unpaid Principal Balance | Credit- Related OTTI(1) | Non-Credit- Related OTTI(1) | Number of Securities | Unpaid Principal Balance | Credit- Related OTTI(1) | Non-Credit- Related OTTI(1) | |||||||||||||||||||||
Other-than-temporarily impaired PLRMBS backed by loans classified at origination as: | |||||||||||||||||||||||||||||
Prime | 7 | $ | 875 | $ | 18 | $ | (14 | ) | 13 | $ | 1,218 | $ | 62 | $ | (40 | ) | |||||||||||||
Alt-A, option ARM | 20 | 1,895 | 64 | (52 | ) | 21 | 1,921 | 166 | (146 | ) | |||||||||||||||||||
Alt-A, other | 100 | 6,594 | 81 | 19 | 131 | 8,084 | 263 | (121 | ) | ||||||||||||||||||||
Total | 127 | $ | 9,364 | $ | 163 | $ | (47 | ) | 165 | $ | 11,223 | $ | 491 | $ | (307 | ) |
(1) Amounts are for the three months ended June 30, 2011.
The Bank uses models in projecting the cash flows for all PLRMBS for its analysis of OTTI. The projected cash flows are based on a number of assumptions and expectations, and the results of these models can vary significantly with changes in assumptions and expectations.
For more information on the Bank's OTTI analysis and reviews, see “Item 1. Financial Statements – Note 6 – Other-Than-Temporary Impairment Analysis.”
The following table presents the ratings of the Bank's PLRMBS as of June 30, 2011, by year of securitization and by collateral type at origination.
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Unpaid Principal Balance of PLRMBS by Year of Securitization and Credit Rating | |||||||||||||||||||||||||||||||||||||||
(In millions) | |||||||||||||||||||||||||||||||||||||||
June 30, 2011 | |||||||||||||||||||||||||||||||||||||||
Unpaid Principal Balance | |||||||||||||||||||||||||||||||||||||||
Credit Rating(1) | |||||||||||||||||||||||||||||||||||||||
Collateral Type at Origination and Year of Securitization | AAA | AA | A | BBB | BB | B | CCC | CC | C | Total | |||||||||||||||||||||||||||||
Prime | |||||||||||||||||||||||||||||||||||||||
2008 | $ | — | $ | — | $ | — | $ | 33 | $ | — | $ | 63 | $ | 210 | $ | — | $ | — | $ | 306 | |||||||||||||||||||
2007 | — | — | — | 90 | — | 21 | 242 | 294 | 115 | 762 | |||||||||||||||||||||||||||||
2006 | 74 | 44 | — | — | 188 | 8 | — | 2 | 61 | 377 | |||||||||||||||||||||||||||||
2005 | 60 | — | 11 | — | — | 63 | 59 | — | — | 193 | |||||||||||||||||||||||||||||
2004 and earlier | 185 | 295 | 326 | 656 | 562 | 68 | 18 | — | — | 2,110 | |||||||||||||||||||||||||||||
Total Prime | 319 | 339 | 337 | 779 | 750 | 223 | 529 | 296 | 176 | 3,748 | |||||||||||||||||||||||||||||
Alt-A, option ARM | |||||||||||||||||||||||||||||||||||||||
2007 | — | — | — | — | — | 159 | 1,264 | — | — | 1,423 | |||||||||||||||||||||||||||||
2006 | — | — | — | — | — | — | 247 | — | — | 247 | |||||||||||||||||||||||||||||
2005 | — | — | — | — | — | 22 | 130 | 171 | — | 323 | |||||||||||||||||||||||||||||
Total Alt-A, option ARM | — | — | — | — | — | 181 | 1,641 | 171 | — | 1,993 | |||||||||||||||||||||||||||||
Alt-A, other | |||||||||||||||||||||||||||||||||||||||
2008 | — | — | — | — | — | 215 | — | — | — | 215 | |||||||||||||||||||||||||||||
2007 | — | — | — | — | 172 | 96 | 1,448 | 27 | 827 | 2,570 | |||||||||||||||||||||||||||||
2006 | — | 84 | — | — | — | 28 | 530 | 130 | 469 | 1,241 | |||||||||||||||||||||||||||||
2005 | 11 | — | — | 107 | 56 | 648 | 3,282 | 212 | 248 | 4,564 | |||||||||||||||||||||||||||||
2004 and earlier | 58 | 65 | 172 | 659 | 242 | 167 | 35 | — | — | 1,398 | |||||||||||||||||||||||||||||
Total Alt-A, other | 69 | 149 | 172 | 766 | 470 | 1,154 | 5,295 | 369 | 1,544 | 9,988 | |||||||||||||||||||||||||||||
Total par amount | $ | 388 | $ | 488 | $ | 509 | $ | 1,545 | $ | 1,220 | $ | 1,558 | $ | 7,465 | $ | 836 | $ | 1,720 | $ | 15,729 |
(1) The credit ratings used by the Bank are based on the lowest of Moody's, Standard & Poor's, or comparable Fitch ratings. Credit ratings of BB and lower are below investment grade.
The following table presents the ratings of the Bank's other-than-temporarily impaired PLRMBS at June 30, 2011, by year of securitization and by collateral type at origination.
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Unpaid Principal Balance of Other-Than-Temporarily Impaired PLRMBS by Year of Securitization and Credit Rating | |||||||||||||||||||||||||||||||||||
(In millions) | |||||||||||||||||||||||||||||||||||
June 30, 2011 | |||||||||||||||||||||||||||||||||||
Unpaid Principal Balance | |||||||||||||||||||||||||||||||||||
Credit Rating(1) | |||||||||||||||||||||||||||||||||||
Collateral Type at Origination and Year of Securitization | AA | A | BBB | BB | B | CCC | CC | C | Total | ||||||||||||||||||||||||||
Prime | |||||||||||||||||||||||||||||||||||
2008 | $ | — | $ | — | $ | — | $ | — | $ | 63 | $ | 210 | $ | — | $ | — | $ | 273 | |||||||||||||||||
2007 | — | — | — | — | — | 242 | 294 | 115 | 651 | ||||||||||||||||||||||||||
2006 | — | — | — | 44 | 7 | — | 2 | 61 | 114 | ||||||||||||||||||||||||||
2005 | — | — | — | — | 41 | — | — | — | 41 | ||||||||||||||||||||||||||
2004 and earlier | — | — | — | 95 | — | 18 | — | — | 113 | ||||||||||||||||||||||||||
Total Prime | — | — | — | 139 | 111 | 470 | 296 | 176 | 1,192 | ||||||||||||||||||||||||||
Alt-A, option ARM | |||||||||||||||||||||||||||||||||||
2007 | — | — | — | — | 159 | 1,264 | — | — | 1,423 | ||||||||||||||||||||||||||
2006 | — | — | — | — | — | 247 | — | — | 247 | ||||||||||||||||||||||||||
2005 | — | — | — | — | 22 | 80 | 171 | — | 273 | ||||||||||||||||||||||||||
Total Alt-A, option ARM | — | — | — | — | 181 | 1,591 | 171 | — | 1,943 | ||||||||||||||||||||||||||
Alt-A, other | |||||||||||||||||||||||||||||||||||
2008 | — | — | — | — | 215 | — | — | — | 215 | ||||||||||||||||||||||||||
2007 | — | — | — | — | 96 | 1,448 | 27 | 827 | 2,398 | ||||||||||||||||||||||||||
2006 | 84 | — | — | — | — | 530 | 130 | 469 | 1,213 | ||||||||||||||||||||||||||
2005 | — | — | 43 | — | 512 | 3,080 | 212 | 248 | 4,095 | ||||||||||||||||||||||||||
2004 and earlier | — | 33 | 82 | 55 | 112 | 35 | — | — | 317 | ||||||||||||||||||||||||||
Total Alt-A, other | 84 | 33 | 125 | 55 | 935 | 5,093 | 369 | 1,544 | 8,238 | ||||||||||||||||||||||||||
Total par amount | $ | 84 | $ | 33 | $ | 125 | $ | 194 | $ | 1,227 | $ | 7,154 | $ | 836 | $ | 1,720 | $ | 11,373 |
(1) The credit ratings used by the Bank are based on the lowest of Moody's, Standard & Poor's, or comparable Fitch ratings. Credit ratings of BB and lower are below investment grade.
For the Bank's PLRMBS, the following table shows the amortized cost, estimated fair value, OTTI charges, performance of the underlying collateral based on the classification at the time of origination, and credit enhancement statistics by type of collateral and year of securitization. Credit enhancement is defined as the percentage of subordinated tranches and over-collateralization, if any, in a security structure that will absorb losses before the Bank will experience a loss on the security expressed as a percentage of the underlying collateral balance. The credit enhancement figures include the additional credit enhancement required by the Bank (above the amounts required for an AAA rating by the credit rating agencies) for selected securities starting in late 2004, and for all securities starting in late 2005. The calculated weighted averages represent the dollar-weighted averages of all the PLRMBS in each category shown. The classification (prime or Alt-A) is based on the model used to run the estimated cash flows for the CUSIP, which may not necessarily be the same as the classification at the time of origination.
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PLRMBS Credit Characteristics | ||||||||||||||||||||||||||||||||
(Dollars in millions) | ||||||||||||||||||||||||||||||||
June 30, 2011 | ||||||||||||||||||||||||||||||||
For the Six Months Ended June 30, 2011 | Underlying Collateral Performance and Credit Enhancement Statistics | |||||||||||||||||||||||||||||||
Collateral Type at Origination and Year of Securitization | Amortized Cost | Gross Unrealized Losses | Estimated Fair Value | Credit- Related OTTI | Non- Credit- Related OTTI | Total OTTI | Weighted- Average 60+ Days Collateral Delinquency Rate | Original Weighted Average Credit Support | Current Weighted Average Credit Support | |||||||||||||||||||||||
Prime | ||||||||||||||||||||||||||||||||
2008 | $ | 280 | $ | 19 | $ | 261 | $ | 9 | $ | (8 | ) | $ | 1 | 28.62 | % | 30.00 | % | 29.23 | % | |||||||||||||
2007 | 669 | 112 | 559 | 16 | (16 | ) | — | 20.35 | 22.60 | 15.30 | ||||||||||||||||||||||
2006 | 362 | 4 | 362 | 3 | (2 | ) | 1 | 10.74 | 10.55 | 9.70 | ||||||||||||||||||||||
2005 | 191 | 19 | 172 | — | — | — | 12.90 | 11.21 | 15.16 | |||||||||||||||||||||||
2004 and earlier | 2,114 | 162 | 1,953 | 1 | 10 | 11 | 7.95 | 4.26 | 9.92 | |||||||||||||||||||||||
Total Prime | 3,616 | 316 | 3,307 | 29 | (16 | ) | 13 | 12.69 | 11.08 | 12.84 | ||||||||||||||||||||||
Alt-A, option ARM | ||||||||||||||||||||||||||||||||
2007 | 1,223 | 352 | 870 | 37 | (34 | ) | 3 | 41.57 | 44.14 | 39.04 | ||||||||||||||||||||||
2006 | 187 | 42 | 145 | 14 | (11 | ) | 3 | 48.26 | 44.81 | 35.98 | ||||||||||||||||||||||
2005 | 175 | 49 | 128 | 37 | (25 | ) | 12 | 39.70 | 22.82 | 23.70 | ||||||||||||||||||||||
Total Alt-A, option ARM | 1,585 | 443 | 1,143 | 88 | (70 | ) | 18 | 42.10 | 40.76 | 36.17 | ||||||||||||||||||||||
Alt-A, other | ||||||||||||||||||||||||||||||||
2008 | 215 | 35 | 181 | — | 44 | 44 | 12.45 | 31.80 | 30.45 | |||||||||||||||||||||||
2007 | 2,320 | 363 | 1,976 | 45 | (32 | ) | 13 | 31.25 | 26.85 | 23.07 | ||||||||||||||||||||||
2006 | 1,013 | 100 | 918 | 35 | (23 | ) | 12 | 30.70 | 18.47 | 12.36 | ||||||||||||||||||||||
2005 | 4,324 | 745 | 3,622 | 71 | 21 | 92 | 19.84 | 13.61 | 14.14 | |||||||||||||||||||||||
2004 and earlier | 1,406 | 157 | 1,251 | 4 | 8 | 12 | 12.76 | 7.92 | 16.31 | |||||||||||||||||||||||
Total Alt-A, other | 9,278 | 1,400 | 7,948 | 155 | 18 | 173 | 22.98 | 17.22 | 16.87 | |||||||||||||||||||||||
Total | $ | 14,479 | $ | 2,159 | $ | 12,398 | $ | 272 | $ | (68 | ) | $ | 204 | 22.95 | % | 18.74 | % | 18.35 | % |
The following table presents a summary of the significant inputs used to determine potential OTTI credit losses in the Bank's PLRMBS portfolio for the six months ended June 30, 2011.
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Significant Inputs to OTTI Credit Analysis for All PLRMBS | |||||||||||||||
June 30, 2011 | |||||||||||||||
Significant Inputs | Current | ||||||||||||||
Prepayment Rates | Default Rates | Loss Severities | Credit Enhancement | ||||||||||||
Year of Securitization | Weighted Average % | Range % | Weighted Average % | Range % | Weighted Average % | Range % | Weighted Average % | Range % | |||||||
Prime | |||||||||||||||
2008 | 9.8 | 6.0-10.7 | 50.0 | 24.5-58.5 | 46.1 | 41.8-51.5 | 29.7 | 29.2-30.5 | |||||||
2007 | 8.5 | 8.2-9.8 | 7.0 | 6.9-7.5 | 27.9 | 26.4-28.2 | 10.2 | 7.4-22.4 | |||||||
2006 | 9.2 | 6.8-10.5 | 17.9 | 9.4-35.0 | 42.8 | 36.7-50.4 | 11.9 | 5.6-20.7 | |||||||
2005 | 12.0 | 7.2-13.9 | 11.7 | 0.5-45.9 | 30.1 | 24.3-39.1 | 11.1 | 7.2-15.0 | |||||||
2004 and earlier | 13.2 | 0.4-25.3 | 9.7 | 0.0-33.4 | 29.9 | 18.3-67.3 | 9.6 | 4.8-60.8 | |||||||
Total Prime | 11.9 | 0.4-25.3 | 17.5 | 0.0-58.5 | 34.4 | 18.3-67.3 | 13.3 | 4.8-60.8 | |||||||
Alt-A, option ARM | |||||||||||||||
2007 | 6.0 | 3.9-7.7 | 79.6 | 73.8-90.0 | 56.7 | 48.3-66.1 | 39.0 | 33.1-46.9 | |||||||
2006 | 6.0 | 4.8-7.4 | 82.1 | 74.6-88.5 | 59.5 | 49.5-68.0 | 36.0 | 31.7-39.6 | |||||||
2005 | 8.8 | 6.3-11.5 | 63.8 | 38.4-78.2 | 46.7 | 37.9-54.5 | 23.7 | 13.0-34.8 | |||||||
Total Alt-A, option ARM | 6.5 | 3.9-11.5 | 77.3 | 38.4-90.0 | 55.4 | 37.9-68.0 | 36.2 | 13.0-46.9 | |||||||
Alt-A, other | |||||||||||||||
2007 | 9.8 | 5.8-15.1 | 55.3 | 28.3-84.5 | 50.4 | 33.5-59.5 | 19.0 | 6.3-49.9 | |||||||
2006 | 10.3 | 4.1-13.1 | 50.0 | 31.7-79.3 | 52.6 | 41.7-65.0 | 19.1 | 5.2-34.7 | |||||||
2005 | 10.8 | 5.3-14.3 | 33.2 | 13.6-73.9 | 46.3 | 29.9-65.3 | 14.2 | 4.1-82.2 | |||||||
2004 and earlier | 14.3 | 4.6-20.9 | 20.8 | 0.0-52.7 | 36.8 | 15.5-109.6 | 16.1 | 8.6-74.5 | |||||||
Total Alt-A, other | 11.0 | 4.1-20.9 | 39.5 | 0.0-84.5 | 46.9 | 15.5-109.6 | 16.5 | 4.1-82.2 | |||||||
Total | 10.6 | 0.4-25.3 | 40.0 | 0.0-90.0 | 45.6 | 15.5-109.6 | 18.4 | 4.1-82.2 |
Credit enhancement is defined as the subordinated tranches and over-collateralization, if any, in a security structure that will generally absorb losses before the Bank will experience a loss on the security, expressed as a percentage of the underlying collateral balance. The calculated averages represent the dollar-weighted averages of all the PLRMBS investments in each category shown. The classification (prime or Alt-A) is based on the model used to run the estimated cash flows for the CUSIP, which may not necessarily be the same as the classification at the time of origination.
The following table presents the unpaid principal balance of PLRMBS by collateral type at the time of origination at June 30, 2011, and December 31, 2010.
Unpaid Principal Balance of PLRMBS by Collateral Type at Origination | |||||||||||||||||||||||
June 30, 2011 | December 31, 2010 | ||||||||||||||||||||||
(In millions) | Fixed Rate | Adjustable Rate | Total | Fixed Rate | Adjustable Rate | Total | |||||||||||||||||
PLRMBS: | |||||||||||||||||||||||
Prime | $ | 1,252 | $ | 2,496 | $ | 3,748 | $ | 1,689 | $ | 2,701 | $ | 4,390 | |||||||||||
Alt-A, option ARM | — | 1,993 | 1,993 | — | 2,074 | 2,074 | |||||||||||||||||
Alt-A, other | 5,199 | 4,789 | 9,988 | 5,643 | 4,966 | 10,609 | |||||||||||||||||
Total | $ | 6,451 | $ | 9,278 | $ | 15,729 | $ | 7,332 | $ | 9,741 | $ | 17,073 |
The following table presents credit ratings as of August 8, 2011, on PLRMBS in a loss position at June 30, 2011.
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PLRMBS in a Loss Position at June 30, 2011, and Credit Ratings as of August 8, 2011 | ||||||||||||||||||||||||||||||||||
(Dollars in millions) | ||||||||||||||||||||||||||||||||||
June 30, 2011 | August 8, 2011 | |||||||||||||||||||||||||||||||||
Collateral Type at Origination: | Unpaid Principal Balance | Amortized Cost | Carrying Value | Gross Unrealized Losses | Weighted- Average 60+ Days Collateral Delinquency Rate | % Rated AAA | % Rated AAA | % Rated AA to BBB | % Rated Below Investment Grade | % on Watchlist | ||||||||||||||||||||||||
Prime | $ | 3,438 | $ | 3,316 | $ | 3,193 | $ | 316 | 13.11 | % | 5.23 | % | 5.23 | % | 38.61 | % | 56.16 | % | 0.02 | % | ||||||||||||||
Alt-A, option ARM | 1,923 | 1,564 | 1,136 | 443 | 41.75 | — | — | — | 100.00 | 3.36 | ||||||||||||||||||||||||
Alt-A, other | 9,807 | 9,125 | 7,983 | 1,400 | 22.93 | 0.37 | 0.37 | 10.64 | 88.99 | 0.09 | ||||||||||||||||||||||||
Total | $ | 15,168 | $ | 14,005 | $ | 12,312 | $ | 2,159 | 23.09 | % | 1.42 | % | 1.42 | % | 15.63 | % | 82.95 | % | 0.49 | % |
The following table presents the fair value of the Bank's PLRMBS as a percentage of the unpaid principal balance by collateral type at origination and year of securitization.
Fair Value of PLRMBS as a Percentage of Unpaid Principal Balance by Year of Securitization | ||||||||||||||
Collateral Type at Origination and Year of Securitization | June 30, 2011 | March 31, 2011 | December 31, 2010 | September 30, 2010 | June 30, 2010 | |||||||||
Prime | ||||||||||||||
2008 | 85.62 | % | 85.55 | % | 86.57 | % | 87.24 | % | 84.19 | % | ||||
2007 | 73.30 | 72.06 | 71.04 | 69.65 | 67.93 | |||||||||
2006 | 96.05 | 95.43 | 93.76 | 94.77 | 92.68 | |||||||||
2005 | 89.53 | 86.55 | 86.30 | 87.13 | 85.25 | |||||||||
2004 and earlier | 92.55 | 93.29 | 93.16 | 93.26 | 92.56 | |||||||||
Weighted average of all Prime | 88.26 | 88.31 | 88.15 | 88.51 | 87.43 | |||||||||
Alt-A, option ARM | ||||||||||||||
2007 | 61.19 | 61.93 | 58.88 | 55.74 | 53.35 | |||||||||
2006 | 58.85 | 61.09 | 60.39 | 56.44 | 54.89 | |||||||||
2005 | 39.83 | 41.36 | 41.84 | 40.65 | 40.85 | |||||||||
Weighted average of all Alt-A, option ARM | 57.43 | 58.71 | 56.49 | 53.55 | 51.66 | |||||||||
Alt-A, other | ||||||||||||||
2008 | 83.69 | 80.69 | 79.91 | 79.47 | 75.78 | |||||||||
2007 | 76.84 | 76.88 | 76.39 | 74.15 | 71.65 | |||||||||
2006 | 73.92 | 75.77 | 75.45 | 75.90 | 74.13 | |||||||||
2005 | 79.36 | 80.16 | 77.36 | 76.94 | 74.91 | |||||||||
2004 and earlier | 89.51 | 90.92 | 90.01 | 89.28 | 87.08 | |||||||||
Weighted average of all Alt-A, other | 79.55 | 80.28 | 78.69 | 77.86 | 75.67 | |||||||||
Weighted average of all PLRMBS | 78.82 | % | 79.58 | % | 78.42 | % | 77.86 | % | 76.19 | % |
The following tables summarize rating agency downgrade actions on investments that occurred from July 1, 2011, to August 8, 2011. The credit ratings used by the Bank are based on the lowest of Moody's, Standard & Poor's, or comparable Fitch ratings.
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Investments Downgraded from July 1, 2011, to August 8, 2011 Dollar Amounts as of June 30, 2011 | |||||||||||||||||||||||
To AA | To Below Investment Grade | Total | |||||||||||||||||||||
(In millions) | Carrying Value | Fair Value | Carrying Value | Fair Value | Carrying Value | Fair Value | |||||||||||||||||
Downgrade from AAA: | |||||||||||||||||||||||
GSEs – FFCB bonds | $ | 2,366 | $ | 2,366 | $ | — | $ | — | $ | 2,366 | $ | 2,366 | |||||||||||
TLGP securities | 3,086 | 3,086 | — | — | 3,086 | 3,086 | |||||||||||||||||
MBS: | |||||||||||||||||||||||
Other U.S. obligations – Ginnie Mae | 251 | 253 | — | — | 251 | 253 | |||||||||||||||||
GSEs – Freddie Mac | 3,428 | 3,545 | — | — | 3,428 | 3,545 | |||||||||||||||||
GSEs – Fannie Mae | 8,391 | 8,672 | — | — | 8,391 | 8,672 | |||||||||||||||||
PLRMBS: | |||||||||||||||||||||||
Downgrade from AA | — | — | 42 | 42 | 42 | 42 | |||||||||||||||||
Downgrade from BBB | — | — | 37 | 37 | 37 | 37 | |||||||||||||||||
Downgrade from B | — | — | 65 | 66 | 65 | 66 | |||||||||||||||||
Downgrade from CCC | — | — | 64 | 64 | 64 | 64 | |||||||||||||||||
Total | $ | 17,522 | $ | 17,922 | $ | 208 | $ | 209 | $ | 17,730 | $ | 18,131 |
Investments Downgraded to Below Investment Grade from July 1, 2011, to August 8, 2011 Dollar Amounts as of June 30, 2011 | |||||||||||||||||||||||||||||||||||||||
To BB | To B | To CCC | To CC | Total Below Investment Grade | |||||||||||||||||||||||||||||||||||
(In millions) | Carrying Value | Fair Value | Carrying Value | Fair Value | Carrying Value | Fair Value | Carrying Value | Fair Value | Carrying Value | Fair Value | |||||||||||||||||||||||||||||
PLRMBS: | |||||||||||||||||||||||||||||||||||||||
Downgrade from AA | $ | 42 | $ | 42 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 42 | $ | 42 | |||||||||||||||||||
Downgrade from BBB | — | — | 37 | 37 | — | — | — | — | 37 | 37 | |||||||||||||||||||||||||||||
Downgrade from B | — | — | — | — | 59 | 59 | 6 | 7 | 65 | 66 | |||||||||||||||||||||||||||||
Downgrade from CCC | — | — | — | — | — | — | 64 | 64 | 64 | 64 | |||||||||||||||||||||||||||||
Total | $ | 42 | $ | 42 | $ | 37 | $ | 37 | $ | 59 | $ | 59 | $ | 70 | $ | 71 | $ | 208 | $ | 209 |
On August 5, 2011, Standard & Poor's lowered its long-term U.S. sovereign credit rating from AAA to AA+ with a negative outlook. As a result, on August 8, 2011, Standard & Poor's lowered the long-term issuer credit ratings and related issue ratings of the GSEs from AAA to AA+ with a negative outlook. In Standard & Poor's application of its government-related entities criteria, the ratings of the GSEs, including Fannie Mae, Freddie Mac, and FFCB, are constrained by the long-term sovereign credit rating of the U.S. Although individual agency MBS are not rated, the Bank is including all agency MBS in the table above based on Standard & Poor's action.
The TLGP securities are guaranteed by the FDIC and backed by the full faith and credit of the U.S. government, the agency MBS are guaranteed through the direct obligation of or support from the U.S. government, and the FFCB bonds are issued by a GSE that has implicit support from the U.S. government. The Bank expects to recover all contractual cash flows on these securities because it determined that the strength of the issuers' guarantees and the direct or indirect support from the U.S. government are sufficient to protect the Bank from losses based on current expectations.
The PLRMBS that were downgraded from July 1, 2011, to August 8, 2011, were included in the Bank's OTTI analysis performed as of June 30, 2011, and no additional OTTI charges were required as a result of these
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downgrades.
The Bank believes that, as of June 30, 2011, the gross unrealized losses on the remaining PLRMBS that did not have an OTTI charge are primarily due to illiquidity in the MBS market, uncertainty about the future condition of the housing and mortgage markets and the economy, and continued deterioration in the credit performance of loan collateral underlying these securities, which caused these assets to be valued at significant discounts to their acquisition cost. The Bank does not intend to sell these securities, it is not more likely than not that the Bank will be required to sell these securities before its anticipated recovery of the remaining amortized cost basis, and the Bank expects to recover the entire amortized cost basis of these securities. As a result, the Bank determined that, as of June 30, 2011, all of the gross unrealized losses on these securities are temporary. The Bank will continue to monitor and analyze the performance of these securities to assess the likelihood of the recovery of the entire amortized cost basis of these securities as of each balance sheet date.
The following table summarizes rating agency actions for investments on negative watch as of August 8, 2011. The credit ratings used by the Bank are based on the lowest of Moody's, Standard & Poor's, or comparable Fitch ratings.
Investments on Negative Watch as of August 8, 2011 Dollar Amounts as of June 30, 2011 | |||||||||||||||||||||||||||||||
AAA | BBB | B | Total | ||||||||||||||||||||||||||||
(In millions) | Carrying Value | Fair Value | Carrying Value | Fair Value | Carrying Value | Fair Value | Carrying Value | Fair Value | |||||||||||||||||||||||
Housing finance agency bonds | $ | — | $ | — | $ | 76 | $ | 64 | $ | — | $ | — | $ | 76 | $ | 64 | |||||||||||||||
PLRMBS | 10 | 9 | — | — | 48 | 48 | 58 | 57 | |||||||||||||||||||||||
Total | $ | 10 | $ | 9 | $ | 76 | $ | 64 | $ | 48 | $ | 48 | $ | 134 | $ | 121 |
If conditions in the housing and mortgage markets and general business and economic conditions remain stressed or deteriorate further, the fair value of MBS may decline further and the Bank may experience OTTI of additional PLRMBS in future periods, as well as further impairment of PLRMBS that were identified as other-than-temporarily impaired as of June 30, 2011. Additional future OTTI credit charges could adversely affect the Bank's earnings and retained earnings and its ability to pay dividends and repurchase capital stock. The Bank cannot predict whether it will be required to record additional OTTI charges on its PLRMBS in the future.
Federal and state government authorities, as well as private entities, such as financial institutions and the servicers of residential mortgage loans, have begun or promoted implementation of programs designed to provide homeowners with assistance in avoiding residential mortgage loan foreclosures. These loan modification programs, as well as future legislative, regulatory, or other actions, including amendments to the bankruptcy laws, that result in the modification of outstanding mortgage loans, may adversely affect the value of, and the returns on, these mortgage loans or MBS related to these mortgage loans.
Derivatives Counterparties. The Bank has also adopted credit policies and exposure limits for derivatives credit exposure. All credit exposure from derivatives transactions entered into by the Bank with member counterparties that are not derivatives dealers (including interest rate swaps, caps, floors, corridors, and collars), for which the Bank serves as an intermediary, must be fully secured by eligible collateral, and all such derivatives transactions are subject to both the Bank's Advances and Security Agreement and a master netting agreement.
For all derivatives dealer counterparties, the Bank selects only highly rated derivatives dealers and major banks that meet the Bank's eligibility criteria. In addition, the Bank has entered into master netting agreements and bilateral security agreements with all active derivatives dealer counterparties that provide for delivery of collateral at specified levels tied to counterparty credit ratings to limit the Bank's net unsecured credit exposure to these counterparties.
Under these policies and agreements, the amount of unsecured credit exposure to an individual derivatives dealer
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counterparty is limited to the lesser of: (i) a percentage of the counterparty's capital, or (ii) an absolute dollar credit exposure limit, both according to the counterparty's credit rating, as determined by rating agency long-term credit ratings of the counterparty's debt securities or deposits. The following table presents the Bank's credit exposure to its derivatives counterparties at the dates indicated.
Credit Exposure to Derivatives Counterparties | |||||||||||||||
(In millions) | |||||||||||||||
June 30, 2011 | |||||||||||||||
Counterparty Credit Rating(1) | Notional Balance | Credit Exposure Net of Cash Collateral | Securities Collateral Held | Net Credit Exposure | |||||||||||
AA | $ | 71,959 | $ | 223 | $ | 207 | $ | 16 | |||||||
A | 101,503 | 376 | 354 | 22 | |||||||||||
Subtotal | 173,462 | 599 | 561 | 38 | |||||||||||
Member institutions(2) | 475 | 1 | 1 | — | |||||||||||
Total derivatives | $ | 173,937 | $ | 600 | $ | 562 | $ | 38 | |||||||
December 31, 2010 | |||||||||||||||
Counterparty Credit Rating(1) | Notional Balance | Credit Exposure Net of Cash Collateral | Securities Collateral Held | Net Credit Exposure | |||||||||||
AA | $ | 73,372 | $ | 276 | $ | 268 | $ | 8 | |||||||
A(3) | 116,558 | 441 | 429 | 12 | |||||||||||
Subtotal | 189,930 | 717 | 697 | 20 | |||||||||||
Member institutions(2) | 480 | 1 | 1 | — | |||||||||||
Total derivatives | $ | 190,410 | $ | 718 | $ | 698 | $ | 20 |
(1) | The credit ratings used by the Bank are based on the lowest of Moody's, Standard & Poor's, or comparable Fitch ratings. |
(2) | Collateral held with respect to interest rate exchange agreements with members represents either collateral physically held by or on behalf of the Bank or collateral assigned to the Bank, as evidenced by an Advances and Security Agreement, and held by the members for the benefit of the Bank. These amounts do not include those related to Citibank, N.A., which are included in the A-rated derivatives dealer counterparty amounts above at December 31, 2010. |
(3) | Includes notional amounts of derivatives contracts outstanding totaling $19.2 billion at December 31, 2010, with Citibank, N.A., a former member that is a derivatives dealer counterparty. Effective June 28, 2011, Citibank, N.A., became ineligible for membership in the Bank when it became a member of another Federal Home Loan Bank in connection with its planned merger with an affiliate outside of the Bank's district. |
At June 30, 2011, the Bank had a total of $173.9 billion in notional amounts of derivatives contracts outstanding. Of this total:
• | $173.5 billion represented notional amounts of derivatives contracts outstanding with 17 derivatives dealer counterparties. Eight of these counterparties made up 88% of the total notional amount outstanding with these derivatives dealer counterparties, individually ranging from 5.5% to 17.4% of the total. The remaining counterparties each represented less than 5% of the total. Five of these counterparties, with $66.4 billion of derivatives outstanding at June 30, 2011, were affiliates of members. |
• | $475 million represented notional amounts of derivatives contracts with three member counterparties that are not derivatives dealers. The Bank entered into these derivatives contracts as an intermediary and entered into the same amount of exactly offsetting transactions with derivatives dealer counterparties. The Bank's intermediation in this manner allows members indirect access to the derivatives market. |
Credit exposure net of cash collateral on derivatives contracts at June 30, 2011, was $600 million, which consisted of:
• | $599 million of credit exposure net of cash collateral on open derivatives contracts with ten derivatives dealer counterparties. After consideration of collateral held by the Bank, the amount of net unsecured exposure from these contracts totaled $38 million. |
• | $1 million of credit exposure net of cash collateral on open derivatives contracts, in which the Bank served |
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as an intermediary, with one member counterparty that is not a derivatives dealer, all of which was secured with eligible collateral.
At December 31, 2010, the Bank had a total of $190.4 billion in notional amounts of derivatives contracts outstanding. Of this total:
• | $189.9 billion represented notional amounts of derivatives contracts outstanding with 17 derivatives dealer counterparties. Eight of these counterparties made up 86% of the total notional amount outstanding with these derivatives dealer counterparties, individually ranging from 5% to 15% of the total. The remaining counterparties each represented less than 5% of the total. Six of these counterparties, with $74.3 billion of derivatives outstanding at December 31, 2010, were affiliates of members, and one counterparty, with $19.2 billion outstanding at December 31, 2010, was a member of the Bank. |
• | $480 million represented notional amounts of derivatives contracts with three member counterparties that are not derivatives dealers. The Bank entered into these derivatives contracts as an intermediary and entered into the same amount of exactly offsetting transactions with derivatives dealer counterparties. The Bank's intermediation in this manner allows members indirect access to the derivatives market. |
Credit exposure net of cash collateral on derivatives contracts at December 31, 2010, was $718 million, which consisted of:
• | $717 million of credit exposure net of cash collateral on open derivatives contracts with ten derivatives dealer counterparties. After consideration of collateral held by the Bank, the amount of net unsecured exposure from these contracts totaled $20 million. |
• | $1 million of credit exposure net of cash collateral on open derivatives contracts, in which the Bank served as an intermediary, with one member counterparty that is not a derivatives dealer, all of which was secured with eligible collateral. |
The increase or decrease in the credit exposure net of cash collateral, from one period to the next, may be affected by changes in several variables, such as the size and composition of the portfolio, derivative market values, and accrued interest.
Based on the master netting arrangements, its credit analyses, and the collateral requirements in place with each counterparty, the Bank does not expect to incur any credit losses on its derivatives agreements.
For more information, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – Derivatives Counterparties” in the Bank's 2010 Form 10-K.
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) requires management to make a number of judgments, estimates, and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, if applicable, and the reported amounts of income, expenses, gains, and losses during the reporting period. Changes in these judgments, estimates, and assumptions could potentially affect the Bank's financial position and results of operations significantly. Although the Bank believes these judgments, estimates, and assumptions to be reasonably accurate, actual results may differ.
In the Bank's 2010 Form 10-K, the following accounting policies and estimates were identified as critical because they require the Bank to make subjective or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies and estimates are: estimating the allowance for credit losses on the advances and mortgage loan portfolios; accounting for derivatives; estimating fair values of investments classified as trading and available-for-sale, derivatives and associated hedged items carried at fair value in accordance with the accounting for derivative instruments and associated hedging activities, and financial instruments carried at fair value under the fair value option, and accounting for other-than-temporary impairment for investment securities; and estimating the prepayment speeds on MBS and mortgage loans for the accounting of amortization of premiums
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and accretion of discounts on MBS and mortgage loans.
There have been no significant changes in the judgments and assumptions made during the first six months of 2011 in applying the Bank's critical accounting policies. These policies and the judgments, estimates, and assumptions are described in greater detail in “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” and “Item 8. Financial Statements and Supplementary Data – Note 1 – Summary of Significant Accounting Policies” in the Bank's 2010 Form 10-K and in “Item 1. Financial Statements – Note 15 – Fair Values.”
Recently Issued Accounting Guidance and Interpretations
See “Item 1. Financial Statements – Note 2 – Recently Issued and Adopted Accounting Guidance” for a discussion of recently issued accounting standards and interpretations.
Recent Developments
Dodd-Frank Act. On July 21, 2010, the Dodd-Frank Wall Street and Consumer Protection Act (Dodd-Frank Act) was signed into law. Among its many effects, the Dodd-Frank Act will likely impact the Bank and its operations by (1) creating an inter-agency Financial Stability Oversight Council (Oversight Council) to identify and regulate systemically important financial institutions; (2) regulating the over-the-counter derivatives market; (3) reforming the credit rating agencies; and (4) establishing new requirements, including a risk retention requirement, for MBS. The Bank's business operations, funding costs, rights and obligations, and the manner in which the Bank carries out its housing finance mission are all likely to be affected by the passage of the Dodd-Frank Act and implementing regulations. It is not possible to predict the full impact of the Dodd-Frank Act on the Bank or its members.
Dodd-Frank Act's Impact on the Bank's Derivatives Transactions. The Dodd-Frank Act provides for new statutory and regulatory requirements for derivatives transactions, including those used by the Bank to hedge its interest rate and other risks. As a result of these requirements, certain derivatives transactions will be required to be cleared through a third-party central clearinghouse and traded on regulated exchanges or through new swap execution facilities. The Commodity Futures Trading Commission (CFTC) has issued a final rule regarding the process for determining which types of swaps will be subject to mandatory clearing, but has not yet made any determinations. Based on the effective date of this rule and the time periods set forth in the rule for CFTC determinations regarding mandatory clearing, the Bank does not expect that any of its swaps will be required to be cleared until the last week of 2011, at the earliest, and more likely sometime in 2012.
Cleared swaps will be subject to initial and variation margin requirements established by the clearinghouse and its clearing members. While clearing swaps should reduce counterparty credit risk, the margin requirements for cleared trades could make derivatives transactions more costly and less attractive as risk management tools for the Bank. In addition, mandatory swap clearing will require the Bank to enter into new relationships and will require accompanying documentation with clearing members and additional documentation with its existing swap counterparties.
The Dodd-Frank Act will also change the regulatory requirements for derivatives transactions that are not subject to mandatory clearing requirements (uncleared trades). These trades will be subject to new regulatory requirements, including new mandatory reporting requirements, documentation requirements, and new minimum margin and capital requirements. Under the proposed margin rules for uncleared swaps, the Bank will be required to post both initial margin and variation margin to its swap dealer counterparties, but may be eligible in both instances for modest unsecured thresholds as a “low risk financial end user.” The Bank will also be required to collect both initial margin and variation margin from its swap dealer counterparties, without being able to extend any unsecured thresholds. These margin requirements and any related capital requirements could adversely affect the liquidity and pricing of certain uncleared derivative transactions entered into by the Bank, making uncleared trades more costly and less attractive as risk management tools for the Bank.
The CFTC has issued a proposed rule requiring that collateral posted by swaps customers to a clearinghouse in
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connection with cleared swaps be legally segregated on an individual customer basis. However, the CFTC has also asked for additional comment on other collateral models under which customer collateral would be commingled with all collateral posted by other customers of the Bank's clearing member, which would put the Bank's collateral at risk in the event that another customer and the Bank's clearing member both default. If the CFTC's final rule places the Bank's posted collateral at greater risk of loss in the clearing structure than under the current over-the-counter market structure, the Bank may be adversely affected.
The Dodd-Frank Act will require swap dealers and certain other large users of derivatives to register as "swap dealers" or "major swap participants" with the CFTC and/or the Securities and Exchange Commission (SEC). Based on definitions in the proposed rules jointly issued by the CFTC and SEC, it seems unlikely that the Bank will be required to register as a major swap participant, although this remains a possibility. It also seems unlikely that the Bank will be required to register as a swap dealer in connection with its own hedging activities; however, based on the proposed rules, it is possible that the Bank could be required to register with the CFTC as a swap dealer if it enters into intermediated swaps with its members.
The CFTC and SEC have also issued a joint proposed rule further defining the term “swap” under the Dodd-Frank Act. It is unclear how the final joint rule will treat certain advance products that may contain features that operate in a manner similar to certain derivatives, such as interest rate caps, floors, and options. Although it is unlikely that advances transactions between the Bank and its members will be treated as “swaps,” it is still not completely clear under the proposed rule.
Depending on how the terms “swap” and “swap dealer” are defined in the final regulations, the Bank may reconsider whether to continue to offer certain types of advances products and intermediated derivatives to members if those transactions would require the Bank to register as a swap dealer. Designation as a swap dealer would subject the Bank to significant additional regulation and cost. The full impact of these definitional rules on the Bank and its members is not known at this time.
While certain provisions of the Dodd-Frank Act took effect on July 16, 2011, the CFTC has issued an order temporarily exempting persons or entities with respect to provisions of Title VII of the Dodd-Frank Act that reference "swap dealer," "major swap participant," "eligible contract participant," and "swap." These exemptions will expire on the earlier of: (1) the effective date of the applicable final rule further defining the relevant term; or (2) December 31, 2011. In addition, the provisions of the Dodd-Frank Act that will have the most significant effect on the Bank did not take effect on July 16, 2011, but will take effect no less than 60 days after the CFTC publishes final regulations implementing such provisions. The CFTC is expected to publish the final regulations no later than the end of 2011.
Proposed Rule on Incentive-based Compensation Arrangements. On April 14, 2011, seven federal financial regulators, including the Finance Agency, published a proposed rule that would prohibit “covered financial institutions” from entering into incentive-based compensation arrangements that encourage inappropriate risks.
For the FHLBanks and the Office of Finance, the rule would:
• | prohibit excessive compensation; |
• | prohibit incentive compensation that could lead to material financial loss; |
• | require an annual report; |
• | require policies and procedures; and |
• | require mandatory deferrals of 50% of incentive compensation over three years for executive officers. |
Covered persons under the rule would include senior management responsible for the oversight of firm-wide activities or material business lines and non-executive employees or groups of those employees whose activities may expose the institution to a material loss.
Under the proposed rule, covered financial institutions would be required to comply with three key risk management principles related to the design and governance of incentive-based compensation: balanced design, independent risk management controls, and strong governance.
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The proposed rule identifies four methods to balance compensation design and make it more sensitive to risk: risk adjustment of awards, deferral of payment, longer performance periods, and reduced sensitivity to short-term performance. Larger covered financial institutions, like the Bank, would also be subject to a mandatory 50% deferral of incentive-based compensation for executive officers and board of directors oversight of incentive-based compensation for certain risk-taking employees who are not executive officers. The proposed rule would affect the design of the Bank's compensation policies and practices, including its incentive compensation policies and practices, if adopted as proposed. Comments on the proposed rule were due by May 31, 2011.
Proposed Rule on Credit Risk Retention for Asset-Backed Securities. On March 31, 2011, the Federal banking agencies, the Finance Agency, the U.S. Department of Housing and Urban Development, and the Securities and Exchange Commission jointly issued a notice of proposed rulemaking, which proposes regulations requiring sponsors of asset-backed securities to retain a minimum 5% economic interest in a portion of the credit risk of the assets collateralizing asset-backed securities, unless all the assets securitized satisfy specified qualifications.
The proposed rule specifies criteria for qualified residential mortgage, commercial real estate, auto, and commercial loans that would make them exempt from the risk retention requirement. The criteria for qualified residential mortgages are described in the proposed rulemaking as those underwriting and product features that, based on historical data, are associated with low risk even in periods of housing price declines and high unemployment.
Key issues in the proposed rule include: (1) the appropriate terms for treatment as a qualified residential mortgage; (2) the extent to which Fannie Mae and Freddie Mac securitizations will be exempt from the risk retention rules; and (3) the possibility of creating a category of high quality non-qualified residential mortgage loans that would have a risk retention requirement less than 5%.
If adopted as proposed, the rule could reduce the number of loans originated by the Bank's members, which could reduce member demand for the Bank's products. Comments on this proposed rule were due on August 1, 2011.
Final Conservatorship and Receivership Regulation. On June 20, 2011, the Finance Agency issued a final conservatorship and receivership regulation for the FHLBanks effective July 20, 2011. The final regulation addresses the nature of a conservatorship or receivership and provides greater specificity on their operations, in line with procedures set forth in similar regulatory regimes (for example, the FDIC receivership authorities). The regulation clarifies the relationship among various classes of creditors and equity holders under a conservatorship or receivership and the priorities for contract parties and other claimants in receivership. Under the final regulation:
• | Claims of FHLBank members arising from the members' deposit accounts, service agreements, advances, and other transactions with their FHLBanks are distinct from such members' equity claims as holders of FHLBank stock. The final regulation clarifies that the lowest priority position for equity claims only applies to members' claims in regard to their FHLBank stock; the priority position does not apply to claims arising from other member transactions with an FHLBank; |
• | An FHLBank's claim for repayment/reimbursement in regard to making payment on any consolidated obligations of another FHLBank in conservatorship or receivership following its default in making such payment would be treated as a general creditor claim against the defaulting FHLBank. The Finance Agency noted in the preamble to the final regulation that it could also address such reimbursement in policy statements or discretionary decisions; |
• | With respect to property held by an FHLBank in trust or in custodial arrangements, the Finance Agency confirmed that it expects to follow FDIC and bankruptcy practice and that such property would not be considered part of a receivership estate and would not be available to satisfy general creditor claims. |
Final Investment Regulation. On May 20, 2011, the Finance Agency issued a final investment regulation effective June 20, 2011. The final regulation is narrowly focused and codifies the existing 300% of capital and other existing policy limitations on the FHLBanks' MBS purchases and use of derivatives. The Finance Agency stated in the preamble to the final regulation that it continues to have concerns about FHLBank investments, including investments in MBS, and will likely issue a future rulemaking addressing all aspects of the FHLBanks' investment authority.
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Proposed Rule on Prudential Management Standards. On June 20, 2011, the Finance Agency issued a proposed rule, as required by the Housing and Economic Recovery Act of 2008, to establish prudential standards with respect to ten categories of operation and management of the FHLBanks and the GSEs, including internal controls, interest rate risk exposure, market risk, and others. The Finance Agency has proposed to adopt the standards as guidelines, which generally provide principles and leave to the regulated entities the obligation to organize and manage themselves to ensure that the standards are met, subject to agency oversight. The proposed rule also includes procedural provisions relating to the consequences for failing to meet applicable standards, such as requirements regarding submission of a corrective action plan to the Finance Agency. Comments on the proposal are due on August 19, 2011.
Finance Agency Proposed Rule on FHLBank Liabilities. On April 2, 2011, the Finance Agency issued a final rule that, among other things:
• | reorganizes and re-adopts Finance Board regulations dealing with consolidated obligations, as well as related regulations addressing other authorized FHLBank liabilities and book entry procedures for consolidated obligations; |
• | implements recent statutory amendments that removed authority from the Finance Agency to issue consolidated obligations; |
• | specifies that the FHLBanks issue consolidated obligations that are the joint and several obligations of the FHLBanks as provided for in the statute rather than as joint and several obligations of the FHLBanks as provided for in the current regulation; and |
• | provides that consolidated obligations are issued under Section 11(c) of the FHLBank Act rather than under Section 11(a) of the FHLBank Act. |
The final rule is not expected to have any adverse impact on the FHLBanks' joint and several liability for the principal and interest payments on consolidated obligations.
Off-Balance Sheet Arrangements, Guarantees, and Other Commitments
In accordance with regulations governing the operations of the FHLBanks, each FHLBank, including the Bank, is jointly and severally liable for the FHLBank System's consolidated obligations issued under Section 11(a) of the FHLBank Act, and in accordance with the FHLBank Act, each FHLBank, including the Bank, is jointly and severally liable for consolidated obligations issued under Section 11(c) of the FHLBank Act. The joint and several liability regulation authorizes the Finance Agency to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor.
The Bank's joint and several contingent liability is a guarantee, but is excluded from initial recognition and measurement provisions because the joint and several obligations are mandated by the FHLBank Act or Finance Agency regulation and are not the result of arms-length transactions among the FHLBanks. The Bank has no control over the amount of the guaranty or the determination of how each FHLBank would perform under the joint and several obligations. The valuation of this contingent liability is therefore not recorded on the balance sheet of the Bank. The par amount of the outstanding consolidated obligations of all 12 FHLBanks was $727.5 billion at June 30, 2011, and $796.4 billion at December 31, 2010. The par value of the Bank's participation in consolidated obligations was $130.8 billion at June 30, 2011, and $139.1 billion at December 31, 2010. At June 30, 2011, the Bank had committed to the issuance of $3.2 billion in consolidated obligation bonds, of which $3.1 billion were hedged with associated interest rate swaps. At December 31, 2010, the Bank had committed to the issuance of $205 million in consolidated obligation bonds, of which $95 million were hedged with associated interest rate swaps. For additional information on the Bank's joint and several liability contingent obligation, see “Item 8. Financial Statements and Supplementary Data – Note 20 – Commitments and Contingencies” in the Bank's 2010 Form 10‑K.
In addition, in the ordinary course of business, the Bank engages in financial transactions that, in accordance with U.S. GAAP, are not recorded on the Bank's balance sheet or may be recorded on the Bank's balance sheet in amounts that are different from the full contract or notional amount of the transactions. For example, the Bank routinely enters into commitments to extend advances and issues standby letters of credit. These commitments and standby letters of credit may represent future cash requirements of the Bank, although the standby letters of credit
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usually expire without being drawn upon. Standby letters of credit are subject to the same underwriting and collateral requirements as advances made by the Bank. At June 30, 2011, the Bank had $3 million of advance commitments and $6.1 billion in standby letters of credit outstanding. At December 31, 2010, the Bank had $304 million of advance commitments and $6.0 billion in standby letters of credit outstanding. The estimated fair value of the advance commitments was immaterial to the balance sheet at June 30, 2011, and December 31, 2010. The estimated fair value of the letters of credit was $23 million and $26 million at June 30, 2011, and at December 31, 2010, respectively.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Federal Home Loan Bank of San Francisco's (Bank) market risk management objective is to maintain a relatively low exposure of the value of capital and future earnings (excluding the impact of any cumulative net gains or losses on derivatives and associated hedged items and on financial instruments carried at fair value) to changes in interest rates. This profile reflects the Bank's objective of maintaining a conservative asset-liability mix and its commitment to providing value to its members through products and dividends without subjecting their investments in Bank capital stock to significant interest rate risk.
In May 2008, the Bank's Board of Directors modified the market risk management objective in the Bank's Risk Management Policy to maintaining a relatively low exposure of the net portfolio value of capital and future earnings (excluding the impact of any cumulative net gains or losses on derivatives and associated hedged items and on financial instruments carried at fair value) to changes in interest rates. See “Total Bank Market Risk” below for a discussion of the modification.
Market risk identification and measurement are primarily accomplished through market value of capital sensitivity analyses, net portfolio value of capital sensitivity analyses, and net interest income sensitivity analyses. The Risk Management Policy approved by the Bank's Board of Directors establishes market risk policy limits and market risk measurement standards at the total Bank level as well as at the business segment level. Additional guidelines approved by the Bank's asset-liability management committee (ALCO) apply to the Bank's two business segments, the advances-related business and the mortgage-related business. These guidelines provide limits that are monitored at the segment level and are consistent with the Bank policy limits. Interest rate risk is managed for each business segment on a daily basis, as discussed below in “Segment Market Risk.” At least monthly, compliance with Bank policies and guidelines is presented to the ALCO or the Board of Directors, along with a corrective action plan if applicable.
Total Bank Market Risk
Market Value of Capital Sensitivity and Net Portfolio Value of Capital Sensitivity
The Bank uses market value of capital sensitivity (the interest rate sensitivity of the net fair value of all assets, liabilities, and interest rate exchange agreements) as an important measure of the Bank's exposure to changes in interest rates. As presented below, the Bank continues to measure, monitor, and report on market value of capital sensitivity, but no longer has a policy limit as of May 2008.
In May 2008, the Board of Directors approved a modification to the Bank's Risk Management Policy to use net portfolio value of capital sensitivity as the primary market value metric for measuring the Bank's exposure to changes in interest rate risk and to establish a policy limit on net portfolio value of capital sensitivity. This approach uses valuation methods that estimate the value of mortgage-backed securities (MBS) and mortgage loans in alternative interest rate environments based on valuation spreads that existed at the time the Bank acquired the MBS and mortgage loans (acquisition spreads), rather than valuation spreads implied by the current market prices of MBS and mortgage loans (market spreads). Risk metrics based on spreads existing at the time of acquisition of mortgage assets better reflect the interest rate risk of the Bank because the Bank does not intend to sell its mortgage assets and the use of market spreads calculated from estimates of current market prices (which include large embedded liquidity spreads) would not reflect the actual risks faced by the Bank. Beginning in the third quarter of 2009, in the case of specific PLRMBS for which the Bank expects loss of principal in future periods, the par
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amount of the other-than-temporarily impaired security is reduced by the amount of the projected principal shortfall and the asset price is calculated based on the acquisition spread. This approach directly takes into consideration the impact of projected principal (credit) losses from PLRMBS on the net portfolio value of capital, but eliminates the impact of large liquidity spreads inherent in the prior treatment of other-than-temporarily impaired securities. The Bank continues to monitor both the market value of capital sensitivity and the net portfolio value of capital sensitivity.
The Bank's net portfolio value of capital sensitivity policy limits the potential adverse impact of an instantaneous parallel shift of a plus or minus 100-basis-point change in interest rates from current rates (base case) to no worse than –3% of the estimated net portfolio value of capital. In addition, the policy limits the potential adverse impact of an instantaneous plus or minus 100-basis-point change in interest rates measured from interest rates that are 200 basis points above or below the base case to no worse than –4% of the estimated net portfolio value of capital. In the case where a market risk sensitivity compliance metric cannot be estimated with a parallel shift in interest rates due to low interest rates, the sensitivity metric is not reported. The Bank's measured net portfolio value of capital sensitivity was within the policy limit as of June 30, 2011.
To determine the Bank's estimated risk sensitivities to interest rates for both the market value of capital sensitivity and the net portfolio value of capital sensitivity, the Bank uses a third-party proprietary asset and liability system to calculate estimated net portfolio values under alternative interest rate scenarios. The system analyzes all of the Bank's financial instruments, including derivatives, on a transaction-level basis using sophisticated valuation models with consistent and appropriate behavioral assumptions and current position data. The system also includes a third-party mortgage prepayment model.
At least annually, the Bank reexamines the major assumptions and methodologies used in the model, including interest rate curves, spreads for discounting, and prepayment assumptions. The Bank also compares the prepayment assumptions in the third-party model to other sources, including actual prepayment history.
The Market Value of Capital Sensitivity table below presents the sensitivity of the market value of capital (the market value of all of the Bank's assets, liabilities, and associated interest rate exchange agreements, with mortgage assets valued using market spreads implied by current market prices) to changes in interest rates. The table presents the estimated percentage change in the Bank's market value of capital that would be expected to result from changes in interest rates under different interest rate scenarios, using market spread assumptions.
Market Value of Capital Sensitivity Estimated Percentage Change in Market Value of Bank Capital for Various Changes in Interest Rates | ||||
Interest Rate Scenario(1) | June 30, 2011 | December 31, 2010 | ||
+200 basis-point change above current rates | –3.8 | % | –3.7 | % |
+100 basis-point change above current rates | –1.9 | –2.0 | ||
–100 basis-point change below current rates(2) | +1.9 | +2.4 | ||
–200 basis-point change below current rates(2) | +3.4 | +5.1 |
(1) | Instantaneous change from actual rates at dates indicated. |
(2) | Interest rates for each maturity are limited to non-negative interest rates. |
The Bank's estimates of the sensitivity of the market value of capital to changes in interest rates as of June 30, 2011, show substantially similar sensitivity compared to the estimates as of December 31, 2010. Compared to interest rates as of December 31, 2010, interest rates as of June 30, 2011, were 5 basis points lower for terms of 1 year, 14 basis points lower for terms of 5 years, and 10 basis points lower for terms of 10 years.
As indicated by the table above, the market value of capital sensitivity is adversely affected when rates increase. In general, mortgage assets, including MBS, are expected to remain outstanding for a longer period of time when interest rates increase and prepayment speeds decline as a result of reduced incentives to refinance. Because most of
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the Bank's MBS were purchased when mortgage asset spreads to pricing benchmarks were significantly lower than what is currently required by investors, the adverse spread difference gives rise to an embedded negative impact on the market value of MBS, which directly reduces the estimated market value of Bank capital. If interest rates increase and MBS consequently remain outstanding for a longer period of time, the adverse spread difference will exist for a longer period of time, giving rise to an even larger embedded negative market value impact than exists at current interest rate levels. This creates additional downward pressure on the measured market value of capital. As a result, the Bank's measured market value of capital sensitivity to changes in rates is higher than it would be if it were measured based on the fundamental underlying repricing and option risks (a greater decline in the market value of capital when rates increase and a greater increase in the market value of capital when rates decrease). Based on the liquidity premium investors require for these assets and the Bank's intent and ability to hold the assets to maturity, the Bank determined that the market value of capital sensitivity is not the best indication of risk, and the Bank has therefore developed an alternative way to measure that risk, based on estimates of the sensitivity of the net portfolio value of capital.
The Net Portfolio Value of Capital Sensitivity table below presents the sensitivity of the net portfolio value of capital (the net value of the Bank's assets, liabilities, and hedges, with mortgage assets valued using acquisition valuation spreads) to changes in interest rates. The table presents the estimated percentage change in the Bank's net portfolio value of capital that would be expected to result from changes in interest rates under different interest rate scenarios based on pricing mortgage assets at spreads that existed at the time of purchase rather than current market spreads. The Bank's estimates of the net portfolio value of capital sensitivity to changes in interest rates as of June 30, 2011, show substantially similar sensitivity compared to the estimates as of December 31, 2010.
Net Portfolio Value of Capital Sensitivity Estimated Percentage Change in Net Portfolio Value of Bank Capital for Various Changes in Interest Rates Based on Acquisition Spreads | ||||
Interest Rate Scenario(1) | June 30, 2011 | December 31, 2010 | ||
+200 basis-point change above current rates | –3.4 | % | –2.8 | % |
+100 basis-point change above current rates | –1.5 | –1.2 | ||
–100 basis-point change below current rates(2) | +0.9 | +0.4 | ||
–200 basis-point change below current rates(2) | +0.9 | +0.6 |
(1) | Instantaneous change from actual rates at dates indicated. |
(2) | Interest rates for each maturity are limited to non-negative interest rates. |
On May 27, 2011, the Bank's Board of Directors modified the Bank's Risk Management Policy to provide guidelines for the payment of dividends and the repurchase of excess stock based on the ratio of the Bank's estimated market value of total capital to par value of capital stock. If this ratio at the end of any quarter is: (i) less than 100% but greater than or equal to 90%, any dividend for that quarter would be limited to an annualized rate no greater than the daily average of three-month London Interbank Offered Rate (LIBOR) (subject to certain conditions), and any excess capital stock repurchases during the subsequent quarter would not exceed $500 million (subject to certain conditions); (ii) less than 90% but greater than or equal to 70%, any dividend for that quarter and any excess capital stock repurchases during the subsequent quarter would be subject to the same limitations and conditions as in (i) above, except that any excess capital stock repurchases during the subsequent quarter would not exceed 4% of the Bank's outstanding capital stock as of the repurchase date; and (iii) less than 70%, the Bank would pay no dividend for that quarter, repurchase no excess capital stock during the subsequent quarter (but continue to redeem excess capital stock as provided in the Bank's Capital Plan), limit the acquisition of certain assets, and review the Bank's risk policies. A decision by the Board of Directors to declare or not declare any dividend or repurchase any excess capital stock is a discretionary matter and is subject to the requirements and restrictions of the Federal Home Loan Bank Act and applicable requirements under the regulations governing the operations of the Federal Home Loan Banks. The ratio of the Bank's estimated market value of total capital to par value of capital stock was 100.1% as of June 30, 2011.
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Potential Dividend Yield
The potential dividend yield is a measure used by the Bank to assess financial performance. The potential dividend yield is based on current period economic earnings that exclude the effects of unrealized net gains or losses resulting from the Bank's derivatives and associated hedged items and from financial instruments carried at fair value, which will generally reverse through changes in future valuations and settlements of contractual interest cash flows over the remaining contractual terms to maturity or by the call or put date of the assets and liabilities held at fair value, hedged assets and liabilities, and derivatives. Economic earnings also exclude the interest expense on mandatorily redeemable capital stock.
The Bank limits the sensitivity of projected financial performance through a Board of Directors' policy limit on projected adverse changes in the potential dividend yield. The Bank's potential dividend yield sensitivity policy limits the potential adverse impact of an instantaneous parallel shift of a plus or minus 200-basis-point change in interest rates from current rates (base case) to no worse than –120 basis points from the base case projected potential dividend yield. In the downward shift, the change in interest rates was limited so that interest rates did not go below zero. With the indicated interest rate shifts, the potential dividend yield for the projected period July 2011 through June 2012 would be expected to decrease by 28 basis points, well within the policy limit of –120 basis points.
Duration Gap
Duration gap is the difference between the estimated durations (market value sensitivity) of assets and liabilities (including the impact of interest rate exchange agreements) and reflects the extent to which estimated maturity and repricing cash flows for assets and liabilities are matched. The Bank monitors duration gap analysis at the total Bank level but does not have a policy limit. The Bank's duration gap was one month at June 30, 2011, and one month at December 31, 2010.
Total Bank Duration Gap Analysis | |||||||||||||
June 30, 2011 | December 31, 2010 | ||||||||||||
Amount (In millions) | Duration Gap(1)(2) (In months) | Amount (In millions) | Duration Gap(1)(2) (In months) | ||||||||||
Assets | $ | 144,438 | 7 | $ | 152,423 | 6 | |||||||
Liabilities | 139,419 | 6 | 145,475 | 5 | |||||||||
Net | $ | 5,019 | 1 | $ | 6,948 | 1 |
(1) | Duration gap values include the impact of interest rate exchange agreements. |
(2) | Because of the current low interest rate environment, the duration gap is estimated using an instantaneous, one sided parallel change upward of 100 basis points from base case interest rates. |
The duration gap as of June 30, 2011, was the same as the duration gap as of December 31, 2010. Since duration gap is a measure of market value sensitivity, the impact of the extraordinarily wide mortgage asset spreads on duration gap is the same as described in the analysis in “Market Value of Capital Sensitivity” above. As a result of the liquidity premium investors require for these assets and the Bank's intent and ability to hold its mortgage assets to maturity, the Bank does not believe that market value-based sensitivity risk measures provide a fundamental indication of risk.
Segment Market Risk
The financial performance and interest rate risks of each business segment are managed within prescribed guidelines and policy limits.
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Advances-Related Business
Interest rate risk arises from the advances-related business primarily through the use of member-contributed capital to fund fixed rate investments of targeted amounts and maturities. In general, advances result in very little net interest rate risk for the Bank because most fixed rate advances with original maturities greater than three months and advances with embedded options are hedged contemporaneously with an interest rate swap or option with terms offsetting the advance. The interest rate swap or option generally is maintained as a hedge for the life of the advance. These hedged advances effectively create a pool of variable rate assets, which, in combination with the strategy of raising debt swapped to variable rate liabilities, creates an advances portfolio with low net interest rate risk.
Non-MBS investments used for liquidity management generally have maturities of less than three months or are variable rate investments. These investments effectively match the interest rate risk of the Bank's variable rate funding. To leverage the Bank's capital stock, the Bank also invests in agency or TLGP securities, generally with terms of less than two years. These investments may be variable rate or fixed rate, and the interest rate risk resulting from the fixed rate coupon is hedged with an interest rate swap or fixed rate debt.
The interest rate risk in the advances-related business is primarily associated with the Bank's strategy for investing the members' contributed capital. The Bank's strategy is to generally invest 50% of member capital in short-term investments (maturities of three months or less) and 50% in intermediate-term investments (laddered portfolio of investments with maturities of up to four years). However, this strategy may be altered from time to time depending on market conditions. The strategy to invest 50% of member capital in short-term assets is intended to mitigate the market value of capital risks associated with the potential repurchase or redemption of members' excess capital stock. The strategy to invest 50% of member capital in a laddered portfolio of instruments with short to intermediate maturities is intended to take advantage of the higher earnings available from a generally positively sloped yield curve, when intermediate-term investments generally have higher yields than short-term investments. Excess capital stock primarily results from a decline in a member's advances. Under the Bank's capital plan, capital stock, when repurchased or redeemed, is required to be repurchased or redeemed at its par value of $100 per share, subject to certain regulatory and statutory limits.
The Bank updates the repricing and maturity gaps for actual asset, liability, and derivatives transactions that occur in the advances-related segment each day. The Bank regularly compares the targeted repricing and maturity gaps to the actual repricing and maturity gaps to identify rebalancing needs for the targeted gaps. On a weekly basis, the Bank evaluates the projected impact of expected maturities and scheduled repricings of assets, liabilities, and interest rate exchange agreements on the interest rate risk of the advances-related segment. The analyses are prepared under base case and alternate interest rate scenarios to assess the effect of put options and call options embedded in the advances, related financing, and hedges. These analyses are also used to measure and manage potential reinvestment risk (when the remaining term of advances is shorter than the remaining term of the financing) and potential refinancing risk (when the remaining term of advances is longer than the remaining term of the financing).
Because of the short-term and variable rate nature of the assets, liabilities, and derivatives of the advances-related business, the Bank's interest rate risk guidelines address the amounts of net assets that are expected to mature or reprice in a given period. Net market value sensitivity analyses and net interest income simulations are also used to identify and measure risk and variances to the target interest rate risk exposure in the advances-related segment.
Mortgage-Related Business
The Bank's mortgage assets include MBS, most of which are classified as held-to-maturity or as available-for-sale, with a small amount classified as trading, and mortgage loans held for portfolio purchased under the MPF Program. The Bank is exposed to interest rate risk from the mortgage-related business because the principal cash flows of the mortgage assets and the liabilities that fund them are not exactly matched through time and across all possible interest rate scenarios, given the uncertainty of mortgage prepayments and the existence of interest rate caps on certain adjustable rate MBS.
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The Bank purchases a mix of intermediate-term fixed rate and adjustable rate MBS. Generally, purchases of long-term fixed rate MBS have been relatively small; any MPF loans that have been acquired are medium- or long-term fixed rate mortgage assets. This results in a mortgage portfolio that has a diversified set of interest rate risk attributes.
The estimated market risk of the mortgage-related business is managed both at the time an individual asset is purchased and on a total portfolio level. At the time of purchase (for all significant mortgage asset acquisitions), the Bank analyzes the estimated earnings sensitivity and estimated net market value sensitivity, taking into consideration the estimated prepayment sensitivity of the mortgage assets and anticipated funding and hedging under various interest rate scenarios. The related funding and hedging transactions are executed at or close to the time of purchase of a mortgage asset.
At least monthly, the Bank reviews the estimated market risk of the entire portfolio of mortgage assets and related funding and hedges. Rebalancing strategies to modify the estimated mortgage portfolio market risks are then considered. Periodically, the Bank performs more in-depth analyses, which include the impacts of non-parallel shifts in the yield curve and assessments of unanticipated prepayment behavior. Based on these analyses, the Bank may take actions to rebalance the mortgage portfolio's estimated market risk profile. These rebalancing strategies may include entering into new funding and hedging transactions, forgoing or modifying certain funding or hedging transactions normally executed with new mortgage purchases, or terminating certain funding and hedging transactions for the mortgage asset portfolio.
The Bank manages the estimated interest rate risk associated with mortgage assets, including prepayment risk, through a combination of debt issuance and derivatives. The Bank may obtain funding through callable and non-callable FHLBank System debt and may execute derivatives transactions to achieve principal cash flow patterns and market value sensitivities for the liabilities and derivatives that provide a significant offset to the interest rate and prepayment risks associated with the mortgage assets. Debt issued to finance mortgage assets may be fixed rate debt, callable fixed rate debt, or adjustable rate debt. Derivatives may be used as temporary hedges of anticipated debt issuance or long-term hedges of debt used to finance the mortgage assets. The derivatives used to hedge the interest rate risk of fixed rate mortgage assets generally may be options to enter into interest rate swaps (swaptions) or callable and non-callable pay-fixed interest rate swaps.
In May 2008, the Board of Directors approved a modification to the Bank's Risk Management Policy to use net portfolio value of capital sensitivity as a primary market value metric for measuring the Bank's exposure to interest rate risk and to establish a policy limit on net portfolio value of capital sensitivity. This approach uses valuation methods that estimate the value of MBS and mortgage loans in alternative interest rate environments based on valuation spreads that existed at the time the Bank acquired the MBS and mortgage loans (acquisition spreads), rather than valuation spreads implied by the current market prices of MBS and mortgage loans (market spreads). Risk metrics based on spreads existing at the time of acquisition of mortgage assets better reflect the interest rate risk of the Bank, because the Bank does not intend to sell its mortgage assets, and the use of market spreads calculated from estimates of current market prices (which include large embedded liquidity spreads) would not reflect the actual risks faced by the Bank. Beginning in the third quarter of 2009, in the case of specific PLRMBS for which the Bank expects loss of principal in future periods, the par amount of the other-than-temporarily impaired security is reduced by the amount of the projected principal shortfall and the asset price is calculated based on the acquisition spread. This approach directly takes into consideration the impact of projected principal (credit) losses from PLRMBS on the net portfolio value of capital, but eliminates the impact of large liquidity spreads inherent in the prior treatment of other-than-temporarily impaired securities. The Bank continues to monitor both the market value of capital sensitivity and the net portfolio value of capital sensitivity attributable to the mortgage-related business.
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The following table presents results of the estimated market value of capital sensitivity analysis attributable to the mortgage-related business as of June 30, 2011, and December 31, 2010.
Market Value of Capital Sensitivity Estimated Percentage Change in Market Value of Bank Capital Attributable to the Mortgage-Related Business for Various Changes in Interest Rates | ||||
Interest Rate Scenario(1) | June 30, 2011 | December 31, 2010 | ||
+200 basis-point change | –2.0 | % | –1.9 | % |
+100 basis-point change | –1.1 | –1.2 | ||
–100 basis-point change(2) | +1.0 | +1.7 | ||
–200 basis-point change(2) | +2.1 | +4.1 |
(1) | Instantaneous change from actual rates at dates indicated. |
(2) | Interest rates for each maturity are limited to non-negative interest rates. |
The Bank's estimates of the sensitivity of the market value of capital to changes in interest rates as of June 30, 2011, show substantially similar sensitivity compared to the estimates as of December 31, 2010. Compared to interest rates as of December 31, 2010, interest rates as of June 30, 2011, were 5 basis points lower for terms of 1 year, 14 basis points lower for terms of 5 years, and 10 basis points lower for terms of 10 years.
As indicated by the table above, the market value of capital sensitivity is adversely affected when rates increase. In general, mortgage assets, including MBS, are expected to remain outstanding for a longer period of time when interest rates increase and prepayment speeds decline as a result of reduced incentives to refinance. Because most of the Bank's MBS were purchased when mortgage asset spreads to pricing benchmarks were significantly lower than what is currently required by investors, the adverse spread difference gives rise to an embedded negative impact on the market value of MBS, which directly reduces the estimated market value of Bank capital. If interest rates increase and MBS consequently remain outstanding for a longer period of time, the adverse spread difference will exist for a longer period of time, giving rise to an even larger embedded negative market value impact than exists at current interest rate levels. This creates additional downward pressure on the measured market value of capital. As a result, the Bank's measured market value of capital sensitivity to changes in rates is higher than it would be if it were measured based on the fundamental underlying repricing and option risks (a greater decline in the market value of capital when rates increase and a greater increase in the market value of capital when rates decrease). Based on the liquidity premium investors require for these assets and the Bank's intent and ability to hold the mortgage assets to maturity, the Bank determined that the market value of capital sensitivity is not the best indication of risk, and the Bank has therefore developed an alternative way to measure that risk, based on estimates of the sensitivity of the net portfolio value of capital.
The Bank's interest rate risk policies and guidelines for the mortgage-related business address the net portfolio value of capital sensitivity of the assets, liabilities, and derivatives of the mortgage-related business. The following table presents the estimated percentage change in the value of Bank capital attributable to the mortgage-related business that would be expected to result from changes in interest rates under different interest rate scenarios based on pricing mortgage assets at spreads that existed at the time of purchase rather than current market spreads. The Bank's estimates of the net portfolio value of capital sensitivity to changes in interest rates as of June 30, 2011, show substantially similar sensitivity compared to the estimates as of December 31, 2010.
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Net Portfolio Value of Capital Sensitivity Estimated Percentage Change in Net Portfolio Value of Bank Capital Attributable to the Mortgage-Related Business for Various Changes in Interest Rates Based on Acquisition Spreads | ||||
Interest Rate Scenario(1) | June 30, 2011 | December 31, 2010 | ||
+200 basis-point change above current rates | –1.9 | % | –1.4 | % |
+100 basis-point change above current rates | –0.8 | –0.6 | ||
–100 basis-point change below current rates(2) | +0.1 | –0.1 | ||
–200 basis-point change below current rates(2) | –0.3 | –0.1 |
(1) | Instantaneous change from actual rates at dates indicated. |
(2) | Interest rates for each maturity are limited to non-negative interest rates. |
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The senior management of the Federal Home Loan Bank of San Francisco (Bank) is responsible for establishing and maintaining a system of disclosure controls and procedures designed to ensure that information required to be disclosed by the Bank in the reports filed or submitted under the Securities Exchange Act of 1934 (1934 Act) is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. The Bank's disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Bank in the reports that it files or submits under the 1934 Act is accumulated and communicated to the Bank's management, including its principal executive officer or officers and principal financial officer or officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the Bank's disclosure controls and procedures, the Bank's management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and the Bank's management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of controls and procedures.
Management of the Bank has evaluated the effectiveness of the design and operation of its disclosure controls and procedures with the participation of the president and chief executive officer, executive vice president and chief operating officer, senior vice president and chief financial officer, and senior vice president, controller and operations officer, as of the end of the quarterly period covered by this report. Based on that evaluation, the Bank's president and chief executive officer, executive vice president and chief operating officer, senior vice president and chief financial officer, and senior vice president, controller and operations officer, have concluded that the Bank's disclosure controls and procedures were effective at a reasonable assurance level as of the end of the fiscal quarter covered by this report.
Internal Control Over Financial Reporting
During the three months ended June 30, 2011, there were no changes in the Bank's internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Bank's internal control over financial reporting.
Consolidated Obligations
The Bank's disclosure controls and procedures include controls and procedures for accumulating and communicating information in compliance with the Bank's disclosure and financial reporting requirements relating to the joint and several liability for the consolidated obligations of other Federal Home Loan Banks (FHLBanks). Because the FHLBanks are independently managed and operated, the Bank's management relies on information that is provided or disseminated by the Federal Housing Finance Agency (Finance Agency), the Office of Finance, and
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the other FHLBanks, as well as on published FHLBank credit ratings, in determining whether the joint and several liability regulation is reasonably likely to result in a direct obligation for the Bank or whether it is reasonably possible that the Bank will accrue a direct liability.
The Bank's management also relies on the operation of the joint and several liability regulation, which is located in Section 1270.10 of Title 12 of the Code of Federal Regulations. The joint and several liability regulation requires that each FHLBank file with the Finance Agency a quarterly certification that it will remain capable of making full and timely payment of all of its current obligations, including direct obligations, coming due during the next quarter. In addition, if an FHLBank cannot make such a certification or if it projects that it may be unable to meet its current obligations during the next quarter on a timely basis, it must file a notice with the Finance Agency. Under the joint and several liability regulation, the Finance Agency may order any FHLBank to make principal and interest payments on any consolidated obligations of any other FHLBank, or allocate the outstanding liability of an FHLBank among all remaining FHLBanks on a pro rata basis in proportion to each FHLBank's participation in all consolidated obligations outstanding or on any other basis.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Federal Home Loan Bank of San Francisco (Bank) may be subject to various legal proceedings arising in the normal course of business.
On March 15, 2010, the Bank filed two complaints in the Superior Court of the State of California, County of San Francisco (San Francisco Superior Court), relating to the purchase of private-label residential mortgage-backed securities. The Bank's complaints are actions for rescission and damages and assert claims for and violations of state and federal securities laws, negligent misrepresentation, and rescission of contract. On June 10, 2010, the Bank amended the two complaints to, among other things, add additional defendants. On November 5, 2010, the Bank filed a declaratory relief action against Bank of America Corporation in the San Francisco Superior Court, for a determination that Bank of America Corporation is a successor to the liabilities of defendant Countrywide Financial Corporation.
For a discussion of this litigation, see “Part I. Item 3. Legal Proceedings” in the Bank's Annual Report on Form
10-K for the year ended December 31, 2010.
After consultation with legal counsel, the Bank is not aware of any other legal proceedings that may have a material effect on its financial condition or results of operations or that are otherwise material to the Bank.
ITEM 1A. RISK FACTORS
For a discussion of risk factors, see “Part I. Item 1A. Risk Factors” in the Federal Home Loan Bank of San Francisco's (Bank's) Annual Report on Form 10-K for the year ended December 31, 2010 (2010 Form 10-K). There have been no material changes from the risk factors disclosed in the “Part I. Item 1A. Risk Factors” section of the Bank's 2010 Form 10-K.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. (REMOVED AND RESERVED)
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
4.1 | Capital Plan, as amended and restated effective September 5, 2011, incorporated by reference to Exhibit 99.2 to the Bank's Current Report on Form 8-K filed with the Securities and Exchange Commission on August 5, 2011 (Commission File No. 000-51398) | ||
10.1 | Change in Control Severance Agreement for Dean Schultz, incorporated by reference to Exhibit 99.1 to the Bank's Current Report on Form 8-K filed with the Securities and Exchange Commission on June 7, 2011 (Commission File No. 000-51398) | ||
10.2 | Change in Control Severance Agreement for Lisa B. MacMillen, incorporated by reference to Exhibit 99.2 to the Bank's Current Report on Form 8-K filed with the Securities and Exchange Commission on June 7, 2011 (Commission File No. 000-51398) | ||
10.3 | Corporate Senior Officer Severance Policy, incorporated by reference to Exhibit 99.3 to the Bank's Current Report on Form 8-K filed with the Securities and Exchange Commission on June 7, 2011 (Commission File No. 000-51398) | ||
10.4 | Joint Capital Enhancement Agreement, as amended August 5, 2011, with the other 11 Federal Home Loan Banks, incorporated by reference to Exhibit 99.1 to the Bank's Current Report on Form 8-K filed with the Securities and Exchange Commission on August 5, 2011 (Commission File No. 000-51398) | ||
31.1 | Certification of the President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | ||
31.2 | Certification of the Chief Operating Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | ||
31.3 | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | ||
31.4 | Certification of the Controller and Operations Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | ||
32.1 | Certification of the President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | ||
32.2 | Certification of the Chief Operating Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | ||
32.3 | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | ||
32.4 | Certification of the Controller and Operations Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | ||
99.1 | Computation of Ratio of Earnings to Fixed Charges – Three and Six Months Ended June 30, 2011 | ||
101.1 | Pursuant to Rule 405 of Regulation S-T, the following financial information from the Bank's quarterly report on Form 10-Q for the period ended June 30, 2011, is formatted in XBRL interactive data files: (i) Statements of Condition at June 30, 2011, and December 31, 2010; (ii) Statements of Income for the Three and Six Months Ended June 30, 2011 and 2010; (iii) Statements of Capital Accounts for the Six Months Ended June 30, 2011 and 2010; (iv) Statements of Cash Flows for the Six Months Ended June 30, 2011 and 2010; and (v) Notes to Financial Statements, tagged as blocks of text. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on August 10, 2011.
Federal Home Loan Bank of San Francisco | |
/S/ KENNETH C. MILLER | |
Kenneth C. Miller Senior Vice President and Chief Financial Officer (Principal Financial Officer) | |
/S/ VERA MAYTUM | |
Vera Maytum Senior Vice President, Controller and Operations Officer (Chief Accounting Officer) |
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