UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________
FORM 10-K
____________________________________
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2015
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)
____________________________________
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Class B Stock, par value $100
(Title of class)
____________________________________
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yes x No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes x No
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. x
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
Registrant's capital stock is not publicly traded and is only issued to members of the registrant. Such capital stock is issued and redeemed at par value, $100 per share, subject to certain regulatory and statutory limits. At June 30, 2015, the aggregate par value of the capital stock held by shareholders of the registrant was approximately $2,893 million. At February 29, 2016, the total shares of capital stock outstanding, including mandatorily redeemable capital stock, totaled 28,019,551.
DOCUMENTS INCORPORATED BY REFERENCE: None.
Federal Home Loan Bank of San Francisco
2015 Annual Report on Form 10-K
Table of Contents
| PART I. | ||||
| Item 1. | ||||
| Item 1A. | ||||
| Item 1B. | ||||
| Item 2. | ||||
| Item 3 | ||||
| Item 4 | ||||
| PART II. | ||||
| Item 5. | ||||
| Item 6. | ||||
| Item 7. | ||||
| Item 7A. | ||||
| Item 8. | ||||
| Item 9. | ||||
| Item 9A. | ||||
| Item 9B. | ||||
| PART III. | ||||
| Item 10. | ||||
| Item 11. | ||||
| Item 12. | ||||
| Item 13. | ||||
| Item 14. | ||||
| PART IV. | ||||
| Item 15. | ||||
PART I. FINANCIAL INFORMATION
| ITEM 1. | BUSINESS |
At the Federal Home Loan Bank of San Francisco (Bank), our purpose is to enhance the availability of credit for residential mortgages and economic development by providing a readily available, competitively priced source of funds for housing and community lenders. We are a wholesale bank—we link our customers to the global capital markets and seek to manage our own liquidity so that funds are available when our customers need them. By providing needed liquidity and financial risk management tools, our credit programs enhance competition in the mortgage market and benefit homebuyers and communities.
We are one of 11 regional Federal Home Loan Banks (FHLBanks) that serve the United States as part of the Federal Home Loan Bank System. Each FHLBank operates as a separate federally chartered corporation with its own board of directors, management, and employees. The FHLBanks were organized under the Federal Home Loan Bank Act of 1932, as amended (FHLBank Act), and are government-sponsored enterprises (GSEs). The FHLBanks are not government agencies and do not receive financial support from taxpayers. The U.S. government does not guarantee, directly or indirectly, the debt securities or other obligations of the Bank or the FHLBank System. The FHLBanks are regulated by the Federal Housing Finance Agency (Finance Agency), an independent federal agency.
We have a cooperative ownership structure. To access our products and services, a financial institution must be approved for membership and purchase capital stock in the Bank. The member's capital stock requirement is generally based on its use of Bank products, subject to a minimum asset-based membership requirement that is intended to reflect the value to the member of having ready access to the Bank as a reliable source of competitively priced funds. Bank capital stock is issued, transferred, redeemed, and repurchased at its par value of $100 per share, subject to certain regulatory and statutory limits. It is not publicly traded.
Our members may include federally insured and regulated financial depositories, regulated insurance companies that are engaged in residential housing finance, community development financial institutions (CDFIs) that have been certified by the CDFI Fund of the U.S. Treasury Department, and privately insured, state-chartered credit unions. Financial depositories may include commercial banks, credit unions, industrial loan companies, and savings institutions. CDFIs may include community development loan funds, community development venture capital funds, and privately insured, state-chartered credit unions. All members have a principal place of business located in Arizona, California, or Nevada, the three states that make up the Eleventh District of the FHLBank System. Our members range in size from $5.6 million to over $139 billion in assets.
Our primary business is providing competitively priced, collateralized loans, known as advances, to our members and certain qualifying housing associates. Advances may be fixed or adjustable rate, with terms ranging from one day to 30 years. We accept a wide range of collateral types, some of which cannot be readily pledged elsewhere or readily securitized. Members use their access to advances to support their mortgage loan portfolios, lower their funding costs, facilitate asset-liability management, reduce on-balance sheet liquidity, offer a wider range of mortgage products to their customers, and improve profitability.
As of December 31, 2015, we had advances and capital stock, including mandatorily redeemable capital stock, outstanding to the following types of institutions:
1
| Advances | |||||||||||||
| (Dollars in millions) | Total Number of Institutions | Capital Stock Outstanding | Number of Institutions | Par Value of Advances Outstanding | |||||||||
| Commercial banks | 193 | $ | 1,335 | 103 | $ | 25,333 | |||||||
| Savings institutions | 12 | 154 | 7 | 1,700 | |||||||||
| Credit unions | 119 | 725 | 36 | 5,464 | |||||||||
| Industrial loan companies | 3 | 2 | 3 | 43 | |||||||||
| Insurance companies | 7 | 33 | 2 | 202 | |||||||||
| Community development financial institutions | 6 | 4 | 3 | 90 | |||||||||
| Total member institutions | 340 | 2,253 | 154 | 32,832 | |||||||||
| Housing associates eligible to borrow | 1 | — | — | — | |||||||||
Other nonmember institutions(1) | 9 | 488 | 7 | 18,009 | |||||||||
| Total | 350 | $ | 2,741 | 161 | $ | 50,841 | |||||||
| (1) | Nonmember institutions may be former members or may have acquired the advances and capital stock of a former member. Capital stock held by nonmember shareholders is classified as mandatorily redeemable capital stock, a liability. Nonmember shareholders with advances outstanding are required to meet the Bank's applicable credit, collateral, and capital stock requirements, including requirements regarding creditworthiness and collateral borrowing capacity. Nonmembers (including former members and member successors) are not eligible to borrow new advances from the Bank or renew existing advances as they mature. |
To fund their operations, the FHLBanks issue debt in the form of consolidated obligation bonds and discount notes (jointly referred to as consolidated obligations) through the FHLBanks’ Office of Finance, the fiscal agent for the issuance and servicing of consolidated obligations on behalf of the FHLBanks. Because the FHLBanks’ consolidated obligations are rated Aaa by Moody’s Investors Service (Moody’s) and AA+ by Standard & Poor’s Rating Services (Standard & Poor’s) and because of the FHLBanks' GSE status, the FHLBanks are generally able to raise funds at rates that are typically at a small to moderate spread above U.S. Treasury security yields. Our cooperative ownership structure allows us to pass along the benefit of these low funding rates to our members.
Members also benefit from our affordable housing and economic development programs, which provide grants and below-market-rate loans that support members’ involvement in creating affordable housing and revitalizing communities.
Our Business Model
Our cooperative ownership structure has led us to develop a business model that is different from that of a typical financial services firm. Our business model is based on the premise that we maintain a balance between our objective to promote housing, homeownership, and community and economic development through our activities with members and our objective to provide a return on the private capital provided by our members through their investment in the Bank's capital stock. We achieve this balance by delivering low-cost credit to help our members meet the credit needs of their communities while striving to pay members a reasonable return on their investment in the Bank's capital stock.
As a cooperatively owned wholesale bank, we require our members to purchase capital stock to support their activities with the Bank. We leverage this capital by using our GSE status to borrow funds in the capital markets at rates that are generally at a small to moderate spread above U.S. Treasury security yields. We lend these funds to our members at rates that are competitive with the cost of most wholesale borrowing alternatives available to our largest members.
We may also invest in residential mortgage-backed securities (MBS) up to the regulatory policy limit of three times capital. Our MBS investments include agency-issued MBS that are guaranteed through the direct obligation of or are supported by the U.S. government and private-label residential MBS (PLRMBS) that were AAA-rated at the time of purchase. We also have a portfolio of residential mortgage loans purchased from members. Earnings on these mortgage assets have historically provided us with the financial flexibility to continue providing cost-effective
2
credit and liquidity to our members. While the mortgage assets we hold are intended to increase our earnings, they also modestly increase our interest rate risk.
Additional information about our investments is provided in “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – Investments.”
Our financial strategies are designed to enable us to safely expand and contract our assets, liabilities, and capital as our member base and our members' credit needs change. Our capital increases when members are required to purchase additional capital stock as they increase their advances borrowings, and it contracts when we repurchase excess capital stock from members as their advances decline. As a result of these strategies, we have been able to achieve our mission by meeting member credit needs and maintaining our strong regulatory capital position, while paying dividends (including dividends on mandatorily redeemable capital stock) and repurchasing and redeeming excess capital stock. Throughout 2015, the Bank continued to monitor the condition of its PLRMBS portfolio, the ratio of the Bank’s estimated market value of total capital to par value of 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 payment of dividends and the repurchase of excess capital stock. The Bank paid dividends totaling $434 million and $360 million in 2015 and 2014, respectively, repurchased $2.0 billion and $2.0 billion in excess capital stock in 2015 and 2014, respectively, and redeemed $53 million and $296 million in mandatorily redeemable capital stock during 2015 and 2014, respectively. Total excess capital stock was $0.4 billion and $1.1 billion as of December 31, 2015 and 2014, respectively.
Products and Services
Advances. We offer our members a wide array of fixed and adjustable rate loans, called advances, with maturities ranging from one day to 30 years. Our advance products are designed to help members compete effectively in their markets and meet the credit needs of their communities. For members that choose to retain the mortgage loans they originate as assets (portfolio lenders), advances serve as a funding source for a variety of conforming and nonconforming mortgage loans, including multifamily mortgage loans. As a result, advances support an array of housing market segments, including those focused on low- and moderate-income households. For members that sell or securitize mortgage loans and other assets, advances can provide interim funding.
Our credit products also help members with their asset-liability management. Members can use a wide range of advance types, with different maturities and payment characteristics, to match the characteristics of their assets and reduce their interest rate risk. We offer advances that are callable at the member's option and advances with embedded option features (such as caps and floors), which can reduce the interest rate risk associated with holding fixed rate mortgage loans and adjustable rate mortgage loans with interest rate caps in the member's portfolio.
We offer both standard and customized advance structures. Standard advances include fixed and adjustable rate advance products with different maturities, interest rates, and payment characteristics. 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, with the interest rates resetting periodically at a fixed spread to the London Interbank Offered Rate (LIBOR) or to another specified index. Customized advances may include:
| • | advances with non-standard indices; |
| • | advances with embedded option features (such as interest rate caps, floors, and call and put options); |
| • | amortizing advances; and |
| • | advances with partial prepayment symmetry. (Partial prepayment symmetry is a product feature under which the Bank may charge a prepayment fee or pay a prepayment credit, depending on certain circumstances, such as movements in interest rates, if the advance is prepaid.) |
For each customized advance, we typically execute a derivative to enable us to offset the customized features embedded in the advance.
3
We manage the credit risk of advances and other credit products by setting the credit and collateral terms available to individual members and housing associates based on their creditworthiness and the quality and value of the assets they pledge as collateral. We also have procedures to assess the mortgage loan quality and documentation standards of institutions that pledge mortgage loan collateral. In addition, we have collateral policies and restricted lending procedures in place to help manage our exposure to institutions that experience difficulty in meeting their capital requirements or other standards of creditworthiness. These credit and collateral policies balance our dual goals of meeting the needs of members and housing associates as a reliable source of liquidity and mitigating credit risk by adjusting credit and collateral terms in view of changes in member creditworthiness.
All advances must be fully collateralized. To secure advances, borrowers may pledge one- to four-family first lien residential mortgage loans, multifamily mortgage loans, MBS, U.S. government and agency securities, deposits in the Bank, and certain other real estate-related collateral, such as commercial real estate loans and second lien residential mortgage loans. We may also accept small business, small farm, and small agribusiness loans that are fully secured by collateral (such as real estate, equipment and vehicles, accounts receivable, and inventory) as eligible collateral from members that are community financial institutions. The Housing and Economic Recovery Act of 2008 (Housing Act) added secured loans for community development activities as a type of collateral that we may accept from community financial institutions. The Housing Act defined community financial institutions as depository institutions insured by the Federal Deposit Insurance Corporation with average total assets over the preceding three-year period of $1 billion or less, to be adjusted for inflation annually by the Finance Agency. The average total asset cap for 2015 was $1,123 million.
Pursuant to our lending agreements with our borrowers, including members, housing associates, and nonmember institutions with credit outstanding, we limit extensions of credit to a borrower to a percentage of the market value or unpaid principal balance of the borrower’s pledged collateral, known as the borrowing capacity. The borrowing capacity percentage varies according to several factors, including the charter type of the institution, the collateral type, the value assigned to the collateral, the results of our collateral field review of the borrower’s collateral, the pledging method used for loan collateral (specific identification or blanket lien), the amount of loan data provided (detailed or summary reporting), the data reporting frequency (monthly or quarterly), the borrower’s financial strength and condition, and any institution-specific collateral risks. Under the terms of our lending agreements, the aggregate borrowing capacity of a borrower’s pledged eligible collateral must meet or exceed the total amount of the borrower’s outstanding advances, other extensions of credit, and certain other borrower obligations and liabilities. We monitor each borrower’s aggregate borrowing capacity and collateral requirements on a daily basis, by comparing the institution's borrowing capacity to its obligations to us.
In addition, the total amount of advances made available to each member or housing associate may be limited by the financing availability assigned by the Bank, which is generally expressed as a percentage of the member’s or housing associate’s assets. The amount of financing availability is generally determined by the creditworthiness of the member or housing associate.
Throughout 2015, we regularly reviewed and adjusted our lending parameters in light of changing market conditions, both negative and positive, and periodically adjusted the maximum borrowing capacity of certain collateral types. When necessary, we required additional collateral to fully secure advances.
Based on the collateral pledged as security for advances, our credit analyses of our borrowers' financial condition, and our credit extension and collateral policies, we expect 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 in 2015. We have never experienced any credit losses on advances.
When a borrower prepays an advance prior to its original maturity, we may charge the borrower a prepayment fee, depending on certain circumstances, such as movements in interest rates, at the time the advance is prepaid. For an advance with partial prepayment symmetry, we may charge the borrower a prepayment fee or pay the member a prepayment credit, depending on certain circumstances at the time the advance is prepaid. Our prepayment fee policy is designed to recover at least the net economic costs, if any, associated with the reinvestment of the advance
4
prepayment proceeds or the cost to terminate the funding associated with the prepaid advance, which generally enables us to be financially indifferent to the prepayment of the advance.
Because of the funding alternatives available to our largest borrowers, we establish advances prices that take into account the cost of alternative market choices available to our largest members each day. We offer the same advances prices to all members each day, which means that all members benefit from this pricing strategy. In addition, if further price concessions are negotiated with any member to reflect market conditions on a given day, those price concessions are also made available to all members for the same product with the same terms on the same day.
Standby Letters of Credit. We issue standby letters of credit to support certain obligations of members to third parties. Members may use standby letters of credit issued by the Bank to facilitate residential housing finance and community lending, to achieve liquidity and asset-liability management goals, to secure certain state and local agency deposits, and to provide credit support to certain tax-exempt bonds. Our underwriting and collateral requirements for standby letters of credit are generally the same as our underwriting and collateral requirements for advances, but may differ in cases where member creditworthiness is impaired.
Investments. We invest in high-quality non-MBS investments to facilitate our role as a cost-effective provider of credit and liquidity to members and to enhance the Bank's earnings. We have adopted credit policies and exposure limits for investments that support liquidity and diversification of risk. These policies restrict the amounts and terms of our investments according to our own capital position as well as the capital and creditworthiness of the individual counterparties, with different unsecured credit limit policies for members and nonmembers. When we execute non-MBS investments with members, we may give consideration to their secured credit availability with the Bank and our advances price levels.
We may invest in short-term unsecured Federal funds sold, negotiable certificates of deposit, and commercial paper. We may also invest in short-term secured transactions, such as U.S. Treasury or agency securities resale agreements. Our investments also include bonds issued by the Federal Farm Credit Banks, all of which are rated Aaa by Moody’s and AA+ by Standard & Poor’s. In addition, we may invest in housing finance agency bonds issued by housing finance agencies located in Arizona, California, and Nevada, the three states that make up the Eleventh District of the FHLBank System. These bonds are mortgage revenue bonds (federally taxable), are collateralized by pools of first lien residential mortgage loans, and are credit-enhanced by bond insurance. The bonds we hold are issued by the California Housing Finance Agency.
In addition, our investments include PLRMBS, all of which were AAA-rated at the time of purchase, and agency residential MBS, which are guaranteed through the direct obligation of, or are supported by, the U.S. government. Some of these PLRMBS were issued by and/or purchased from members, former members, or their respective affiliates. We execute 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.
Additional information about our investments and OTTI charges associated with our PLRMBS is provided in “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – Investments” and in “Item 8. Financial Statements and Supplementary Data – Note 7 – Other-Than-Temporary Impairment Analysis.”
Mortgage Loans. Under the Mortgage Partnership Finance® (MPF®) Program, the Bank may purchase conventional conforming fixed rate mortgage loans and mortgage loans insured by the Federal Housing Administration (FHA) or guaranteed by the Department of Veterans Affairs (VA) from members for the Bank’s own portfolio under the MPF Original and MPF Government products. In addition, the Bank may facilitate the purchase of conforming fixed rate mortgage loans from members for concurrent sale to Fannie Mae under the MPF Xtra® product and of jumbo fixed rate mortgage loans for concurrent sale to Redwood Residential Acquisition Corporation, a subsidiary of Redwood Trust, Inc., a real estate investment trust, under the MPF Direct product. (“Mortgage Partnership Finance,” “MPF,” and “MPF Xtra” are registered trademarks of the FHLBank of Chicago.)
5
The Bank has approved ten members as participating financial institutions since renewing its participation in the MPF Program in 2013. We previously purchased conventional conforming fixed rate residential mortgage loans from participating financial institutions from May 2002 to October 2006. The MPF Program allows us to further serve the needs of our members by offering them a competitive alternative secondary market channel for their mortgage originations. The MPF Government product also allows us to offer members a new tool to help low- and moderate-income homeowners and first-time homebuyers.
Affordable Housing Program. Through our Affordable Housing Program (AHP), we provide subsidies to assist in the purchase, construction, or rehabilitation of housing for households earning up to 80% of the median income for the area in which they live. Each year, to fund the AHP, we set aside 10% of the current year's net earnings (income before interest expense related to mandatorily redeemable capital stock and the assessment for the AHP), to be awarded in the following year. Since 1990, we have awarded $942 million in AHP subsidies to support the purchase, development, or rehabilitation of approximately 120,000 affordable homes.
We allocate at least 82% of our annual AHP subsidy to our competitive AHP, under which applications for specific owner-occupied and rental housing projects are submitted by members and are evaluated and scored by the Bank in an annual competitive process. All subsidies for the competitive AHP are funded to affordable housing sponsors or developers through our members in the form of direct subsidies or subsidized advances.
We allocate the remainder of our annual AHP subsidy, up to 18%, to our two homeownership set-aside programs, the Individual Development and Empowerment Account Program and the Workforce Initiative Subsidy for Homeownership Program. Under these programs, members reserve funds from the Bank to be used as matching grants for eligible first-time homebuyers.
Access to Housing and Economic Assistance for Development (AHEAD) Program. AHEAD Program grants, funded annually at the discretion of our Board of Directors, provide early-stage funding for targeted economic development projects and non-AHP-eligible affordable housing initiatives that create or preserve jobs, facilitate improvements to public or private infrastructure, or deliver social services, training or education programs, or other services and programs that benefit lower-income neighborhoods. AHEAD Program applications are submitted by members working with local community groups, and awards are based on project eligibility and evaluation of the applications. In 2015, the Bank awarded $1 million in AHEAD Program grants.
Discounted Credit Programs. We offer members two discounted credit programs available in the form of advances and standby letters of credit. Members may use the Community Investment Program to fund mortgages for low- and moderate-income households, to finance first-time homebuyer programs, to create and maintain affordable housing, and to support other eligible lending activities related to housing for low- and moderate-income families. Members may use the Advances for Community Enterprise (ACE) Program to fund projects and activities that create or retain jobs or provide services or other benefits for low- and moderate-income people and communities. Members may also use ACE Program funds to support eligible community lending and economic development, including small business, community facilities, and public works projects.
Funding Sources
We obtain most of our funds from the sale of the FHLBanks' debt instruments (consolidated obligations), which consist of consolidated obligation bonds and discount notes. The consolidated obligations are issued through the Office of Finance using authorized securities dealers and are backed only by the financial resources of the FHLBanks. 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 regulations provide a general framework for addressing the possibility that an FHLBank may be unable to repay the consolidated obligations for which it is the primary obligor. For more information, see “Item 8. Financial Statements and Supplementary Data – Note 20 – Commitments and Contingencies.” We have never been asked or required to repay
6
the principal or interest on any consolidated obligation on behalf of another FHLBank, and as of December 31, 2015, and through the date of this report, we do not believe that it is probable that we will be asked to do so.
The Bank’s status as a GSE is critical to maintaining its access to the capital markets. Although consolidated obligations are backed only by the financial resources of the FHLBanks and are not guaranteed by the U.S. government, the capital markets have traditionally treated the FHLBanks’ consolidated obligations as comparable to federal agency debt, providing the FHLBanks with access to funding at relatively favorable rates. As of December 31, 2015, Standard & Poor’s rated the FHLBanks’ consolidated obligations AA+, and Moody’s rated them Aaa. As of December 31, 2015, Standard & Poor’s assigned each of the FHLBanks a long-term credit rating of AA+ with a stable outlook, and Moody's assigned each of the FHLBanks a long-term credit rating of Aaa with a stable outlook. 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 or withdraw 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.
Regulations govern the issuance of debt on behalf of the FHLBanks and related activities. All new debt is jointly issued by the FHLBanks through the Office of Finance, which serves as their fiscal agent in accordance with the FHLBank Act and applicable regulations. Pursuant to these regulations, the Office of Finance, often in conjunction with the FHLBanks, has adopted policies and procedures for consolidated obligations that may be issued by the FHLBanks. The policies and procedures relate to the frequency and timing of issuance, issue size, minimum denomination, selling concessions, underwriter qualifications and selection, currency of issuance, interest rate change or conversion features, call or put features, principal amortization features, and selection of clearing organizations and outside counsel. The Office of Finance has responsibility for facilitating and approving the issuance of the consolidated obligations in accordance with these policies and procedures. In addition, the Office of Finance has the authority to redirect, limit, or prohibit the FHLBanks' requests to issue consolidated obligations that are otherwise allowed by its policies and procedures if it determines that its action is consistent with: (i) the regulatory requirement that consolidated obligations be issued efficiently and at the lowest all-in cost over time, consistent with prudent risk management practices, prudent debt parameters, short- and long-term market conditions, and the FHLBanks' status as GSEs; (ii) maintaining reliable access to the short-term and long-term capital markets; and (iii) positioning the issuance of debt to take advantage of current and future capital markets opportunities. The authority of the Office of Finance to redirect, limit, or prohibit the Bank's requests for issuance of consolidated obligations has never adversely affected the Bank's ability to finance its operations. The Office of Finance also services all outstanding FHLBank debt, serves as a source of information for the FHLBanks on developments in the capital markets, and prepares the FHLBanks' quarterly and annual combined financial reports. In addition, it administers the Resolution Funding Corporation and the Financing Corporation, two corporations established by Congress in the 1980s to provide funding for the resolution and disposition of insolvent savings institutions.
Consolidated Obligation Bonds. Consolidated obligations are generally issued with either fixed rate payment terms or adjustable rate payment terms, which use a variety of indices for interest rate resets, including LIBOR. In addition, to meet the specific needs of certain investors, fixed rate and adjustable rate consolidated obligation bonds may contain certain embedded features, which may result in call options and complex coupon payment terms. In general, when such consolidated obligation bonds are issued for which the Bank is the primary obligor, we simultaneously enter into interest rate exchange agreements containing offsetting features to, in effect, convert the terms of the bond to the terms of a simple adjustable rate bond (tied to an index, such as those listed above). Typically, the maturities of these securities range from 6 months to 15 years, but the maturities are not subject to any statutory or regulatory limit. Consolidated obligation bonds may be issued and distributed daily through negotiated or competitively bid transactions with approved underwriters or selling group members.
We receive 100% of the net proceeds of a bond issued through direct negotiation with underwriters of debt when we are the only FHLBank involved in the negotiation. In these cases, the Bank is the sole primary obligor on the consolidated obligation bond. When the Bank and one or more other FHLBanks jointly negotiate the issuance of a
7
bond directly with underwriters, we receive the portion of the proceeds of the bond agreed upon with the other FHLBank(s); in those cases, the Bank is the primary obligor for a pro rata portion of the bond, including all customized features and terms, based on the proceeds received.
We may also request specific amounts of specific consolidated obligation bonds to be offered by the Office of Finance for sale in a competitive auction conducted with the underwriters in a bond selling group. One or more other FHLBanks may also request amounts of those same bonds to be offered for sale for their benefit in the same auction. We may receive zero to 100% of the proceeds of the bonds issued in a competitive auction depending on: (i) the amounts of and costs for the consolidated obligation bonds bid by underwriters; (ii) the maximum costs we or other FHLBanks participating in the same issue, if any, are willing to pay for the bonds; and (iii) guidelines for the allocation of bond proceeds among multiple participating FHLBanks administered by the Office of Finance.
Consolidated Obligation Discount Notes. The FHLBanks also issue consolidated obligation discount notes with maturities ranging from one day to one year, which may be offered daily through a consolidated obligation discount note selling group and through other authorized underwriters. Discount notes are issued at a discount and mature at par.
On a daily basis, we may request specific amounts of discount notes with specific maturity dates to be offered by the Office of Finance at a specific cost for sale to underwriters in the discount note selling group. One or more other FHLBanks may also request amounts of discount notes with the same maturities to be offered for sale for their benefit the same day. The Office of Finance commits to issue discount notes on behalf of the participating FHLBanks when underwriters in the selling group submit orders for the specific discount notes offered for sale. We may receive zero to 100% of the proceeds of the discount notes issued through this sales process depending on: (i) the maximum costs we or other FHLBanks participating in the same discount note issuance, if any, are willing to pay for the discount notes; (ii) the order amounts for the discount notes submitted by underwriters; and (iii) guidelines for the allocation of discount note proceeds among multiple participating FHLBanks administered by the Office of Finance.
Twice weekly, we may also request specific amounts of discount notes with fixed terms to maturity ranging from 4 to 26 weeks to be offered by the Office of Finance for sale in a competitive auction conducted with underwriters in the discount note selling group. One or more other FHLBanks may also request amounts of those same discount notes to be offered for sale for their benefit in the same auction. The discount notes offered for sale in a competitive auction are not subject to a limit on the maximum costs the FHLBanks are willing to pay. We may receive zero to 100% of the proceeds of the discount notes issued in a competitive auction depending on: (i) the amounts of and costs for the discount notes bid by underwriters and (ii) guidelines for the allocation of discount note proceeds among multiple participating FHLBanks administered by the Office of Finance.
Debt Investor Base. The FHLBanks’ consolidated obligations have traditionally had a diversified funding base of domestic and foreign investors. Purchasers of the FHLBanks' consolidated obligations include fund managers, commercial banks, pension funds, insurance companies, foreign central banks, state and local governments, and retail investors. These purchasers are also diversified geographically, with a significant portion of investors historically located in the United States, Europe, and Asia.
Segment Information
We use an analysis of the Bank’s 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 business segments. For purposes of segment reporting, adjusted net interest income includes interest income and expenses associated with economic hedges that are recorded in “Net gain/(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 credit-related OTTI charges on our PLRMBS or other expenses and
8
assessments, is not included in the segment reporting analysis, but is incorporated into our overall assessment of financial performance.
The advances-related business consists of advances and other credit products, related financing and hedging instruments, liquidity and other non-MBS investments associated with our role as a liquidity provider, and capital stock. Adjusted net interest income for this segment is derived primarily from the difference, or spread, between the yield on all assets associated with the business activity in this segment and the cost of funding those activities, including the net settlements from associated interest rate exchange agreements, and from earnings on invested capital.
The mortgage-related business consists of MBS investments, mortgage loans acquired through the MPF Program, the consolidated obligations specifically identified as funding those assets, and the related hedging instruments. 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 net settlements from associated interest rate exchange agreements, less the provision for credit losses on mortgage loans.
Additional information about business segments is provided in “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Segment Information” and in “Item 8. Financial Statements and Supplementary Data – Note 17 – Segment Information.”
Use of Interest Rate Exchange Agreements
We use interest rate exchange agreements, also known as derivatives, as part of our interest rate risk management and funding strategies to reduce identified risks inherent in the ordinary course of business. The types of derivatives we may use include interest rate swaps (including callable, putable, and basis swaps); swaptions; and interest rate cap and floor agreements.
The regulations governing the operations of the FHLBanks and the Bank's Risk Management Policy establish guidelines for our use of derivatives. These regulations and guidelines prohibit trading in derivatives for profit and any other speculative purposes and limit the amount of credit risk allowable from derivatives.
We primarily use derivatives to manage our exposure to changes in interest rates. The goal of our interest rate risk management strategy is not to eliminate interest rate risk, but to manage it within appropriate limits that are consistent with the financial strategies approved by the Board of Directors. One key way we manage interest rate risk is to acquire and maintain a portfolio of assets and liabilities, which, together with their associated derivatives, are conservatively matched with respect to the expected maturities or repricings of the assets and the liabilities. We may also use derivatives to adjust the effective maturity, repricing frequency, or option characteristics of financial instruments (such as advances and consolidated obligations) to achieve risk management objectives.
We measure the Bank’s market risk at the enterprise level, as well as on a portfolio basis, taking into account all financial instruments. The market risk of the derivatives and the hedged items is included in the measurement of our various market risk measures, including duration gap (the difference between the expected weighted average maturities of our assets and liabilities, net of the related derivatives), which was one month at December 31, 2015. This low interest rate risk profile reflects our conservative asset-liability mix, which is supported by integrated use of derivatives in our daily financial management.
Additional information about our interest rate exchange agreements is provided in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Market Risk – Total Bank Market Risk – Interest Rate Exchange Agreements” and in “Item 8. Financial Statements and Supplementary Data – Note 18 – Derivatives and Hedging Activities.”
9
Capital
From its enactment in 1932, the FHLBank Act provided for a subscription-based capital structure for the FHLBanks. The amount of capital stock that each FHLBank issued was determined by a statutory formula establishing how much FHLBank capital stock each member was required to purchase. With the enactment of the Gramm-Leach-Bliley Act of 1999, Congress replaced the statutory subscription-based member capital stock purchase formula with requirements for total capital, leverage capital, and risk-based capital for the FHLBanks and required the FHLBanks to develop new capital plans to replace the previous statutory structure.
We implemented our capital plan on April 1, 2004. The capital plan bases the stock purchase requirement on the level of activity a member has with the Bank, subject to a minimum membership requirement that is intended to reflect the value to the member of having access to the Bank as a funding source. With the approval of the Board of Directors, we may adjust these requirements from time to time within the ranges established in the capital plan. Any changes to our capital plan must be approved by our Board of Directors and the Finance Agency.
Bank capital stock cannot be publicly traded, and under the capital plan, may be issued, transferred, redeemed, and repurchased only at its par value of $100 per share, subject to certain regulatory and statutory limits. Under the capital plan, a member's capital stock will be redeemed by the Bank upon five years' notice from the member, subject to certain conditions. In addition, we have the discretion to repurchase excess capital stock from members.
Competition
Demand for Bank advances is affected by many factors, including the availability and cost of other sources of funding for members, including retail and brokered deposits. We compete with our members' other suppliers of wholesale funding, both secured and unsecured. These suppliers may include securities dealers, commercial banks, and other FHLBanks for members with affiliated institutions that are members of other FHLBanks.
Under the FHLBank Act and regulations governing the operations of the FHLBanks, affiliated institutions in different FHLBank districts may be members of different FHLBanks. Members may have access to alternative funding sources through sales of securities under agreements to resell. Some members, particularly larger members, may have access to many more funding alternatives, including independent access to the national and global credit markets. The availability of alternative funding sources for members can significantly influence the demand for our advances and can vary as a result of many factors, including market conditions, members' creditworthiness, members' strategic objectives, and the availability of collateral.
Our ability to compete successfully for the advances business of our members depends primarily on our advances prices, ability to fund advances through the issuance of consolidated obligations at competitive rates, credit and collateral terms, prepayment terms, product features such as embedded option features, ability to meet members' specific requests on a timely basis, capital stock requirements, retained earnings policy, excess capital stock repurchase policies, and dividends.
In addition, the FHLBanks compete with the U.S. Treasury, Fannie Mae, Freddie Mac, and other GSEs, as well as corporate, sovereign, and supranational entities, for funds raised through the issuance of unsecured debt in the national and global debt markets. Increases in the supply of competing debt products may, in the absence of increases in demand, result in higher debt costs or lower amounts of debt issued at the same cost.
Regulatory Oversight, Audits, and Examinations
The FHLBanks are supervised and regulated by the Finance Agency, an independent agency in the executive branch of the U.S. government. The Finance Agency is also responsible for supervising and regulating Fannie Mae and Freddie Mac. The Finance Agency is supported entirely by assessments from the FHLBanks, Fannie Mae, and Freddie Mac. With respect to the FHLBanks, the Finance Agency is charged with ensuring that the FHLBanks carry
10
out their housing finance mission, remain adequately capitalized and able to raise funds in the capital markets, and operate in a safe and sound manner. The Finance Agency also establishes regulations governing the operations of the FHLBanks.
The Finance Agency has broad supervisory authority over the FHLBanks, including, but not limited to, the power to suspend or remove any entity-affiliated party (including any director, officer, or employee) of an FHLBank who violates certain laws or commits certain other acts; to issue and serve a notice of charges upon an FHLBank or any entity-affiliated party; to obtain a cease and desist order, or a temporary cease and desist order, to stop or prevent any unsafe or unsound practice or violation of law, order, rule, regulation, or condition imposed in writing; to issue civil money penalties against an FHLBank or an entity-affiliated party; to require an FHLBank to take certain actions, or refrain from certain actions, under the prompt corrective action provisions that authorize or require the Finance Agency to take certain supervisory actions, including the appointment of a conservator or receiver for an FHLBank under certain conditions; and to require any one or more of the FHLBanks to repay the primary obligations of another FHLBank on outstanding consolidated obligations.
Pursuant to the Housing Act, the Finance Agency exercises prompt corrective action authority over the FHLBanks. The Capital Classification and Prompt Corrective Action rule establishes the criteria for each of the following capital classifications for the FHLBanks specified in the Housing Act: adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Under the rule, unless the Finance Agency has reclassified an FHLBank based on factors other than its capital levels, an FHLBank is adequately capitalized if it has sufficient total and permanent capital to meet or exceed both its risk-based and minimum capital requirements; is undercapitalized if it fails to meet one or more of its risk-based or minimum capital requirements, but is not significantly undercapitalized; is significantly undercapitalized if its total or permanent capital is less than 75% of what is required to meet any of its requirements, but it is not critically undercapitalized; and is critically undercapitalized if its total capital is equal to or less than 2% of its total assets.
By letter dated December 10, 2015, the Director of the Finance Agency notified the Bank that, based on September 30, 2015, financial information, the Bank met the definition of adequately capitalized under the Finance Agency's Capital Classification and Prompt Corrective Action rule.
The Housing Act and Finance Agency regulations govern capital distributions by an FHLBank, which include cash dividends, capital stock dividends, capital stock repurchases, or any transaction in which the FHLBank purchases or retires any instrument included in its capital. Under the Housing Act and Finance Agency regulations, an FHLBank may not make a capital distribution if after doing so it would not be adequately capitalized or would be reclassified to a lower capital classification, or if such distribution violates any statutory or regulatory restriction, and, in the case of a significantly undercapitalized FHLBank, an FHLBank may not make any capital distribution without approval from the Director of the Finance Agency.
To assess the safety and soundness of the Bank, the Finance Agency conducts an annual on-site examination of the Bank and other periodic reviews of its financial operations. In addition, we are required to submit information on our financial condition and results of operations each month to the Finance Agency.
The Bank’s capital stock is registered with the Securities and Exchange Commission (SEC) under Section 12(g)(1) of the Securities Exchange Act of 1934 (1934 Act) and, as a result, we are required to comply with the disclosure and reporting requirements of the 1934 Act and to file annual, quarterly, and current reports with the SEC, as well as meet other SEC requirements.
Our Board of Directors has an audit committee, and we have an internal audit department. An independent registered public accounting firm audits our annual financial statements. The independent registered public accounting firm conducts these audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).
11
Like other federally chartered corporations, the FHLBanks are subject to general congressional oversight. Each FHLBank must submit annual management reports to Congress, the President, the Office of Management and Budget, and the Comptroller General. These reports include a statement of financial condition, a statement of operations, a statement of cash flows, a statement of internal accounting and administrative control systems, and the report of the independent registered public accounting firm on the financial statements.
The U.S. Commodity Futures Trading Commission (CFTC) has been given regulatory authority over derivatives trading pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, and the FHLBanks are subject to the rules promulgated by the CFTC with respect to their derivatives activities. These rules affect all aspects of the Bank’s derivatives activities by establishing requirements relating to derivatives recordkeeping and reporting, clearing, execution, and margining of uncleared derivative transactions.
The Comptroller General has authority under the FHLBank Act to audit or examine the Finance Agency and the FHLBanks and to determine the extent to which they fairly and effectively fulfill the purposes of the FHLBank Act. Furthermore, the Government Corporations Control Act provides that the Comptroller General may review any audit of the financial statements conducted by an independent registered public accounting firm. If the Comptroller General conducts such a review, then he or she must report the results and provide his or her recommendations to Congress, the Office of Management and Budget, and the relevant FHLBank. The Comptroller General may also conduct his or her own audit of any financial statements of an FHLBank.
The U.S. Treasury, or a permitted designee, is authorized under the combined provisions of the Government Corporations Control Act and the FHLBank Act to prescribe: the form, denomination, maturity, interest rate, and conditions to which FHLBank debt will be subject; the way and time FHLBank debt is issued; and the price for which FHLBank debt will be sold. The U.S. Treasury may purchase FHLBank debt up to an aggregate principal amount of $4.0 billion pursuant to the standards and terms of the FHLBank Act.
All of the FHLBanks' financial institution members are subject to federal or state laws and regulations, and changes to these laws or regulations or to related policies might adversely or favorably affect the business of the FHLBanks.
Available Information
The SEC maintains a website at www.sec.gov that contains all electronically filed or furnished SEC reports, including our annual reports on Form 10-K, our quarterly reports on Form 10-Q, and our current reports on Form 8-K, as well as any amendments. On our website at www.fhlbsf.com, we provide a link to the page on the SEC website that lists all of these reports. These reports may also be read and copied at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. (Further information about the operation of the Public Reference Room may be obtained at 1-800-SEC-0330.) In addition, we provide direct links from our website to our annual report on Form 10-K and our quarterly reports on Form 10-Q on the SEC website as soon as reasonably practicable after electronically filing or furnishing the reports to the SEC. (Note: The website addresses of the SEC and the Bank have been included as inactive textual references only. Information on those websites is not part of this report.)
Employees
We had 263 employees at December 31, 2015. Our employees are not represented by a collective bargaining unit, and we consider our relationship with our employees to be satisfactory.
| ITEM 1A. | RISK FACTORS |
The following discussion summarizes certain of the risks and uncertainties that the Federal Home Loan Bank of San Francisco (Bank) faces. The list is not exhaustive and there may be other risks and uncertainties that are not described below that may also affect our business. Any of these risks or uncertainties, if realized, could negatively
12
affect our financial condition or results of operations or limit our ability to fund advances, pay dividends, or redeem or repurchase capital stock.
Economic weakness could adversely affect the business of many of our members and our business and results of operations.
Our business and results of operations are sensitive to conditions in the housing and mortgage markets, as well as general business and economic conditions. There continue to be challenges to the ongoing economic and housing recovery because of tight credit standards and financial market volatility, which could deter potential home buyers from taking advantage of low mortgage interest rates. If these conditions remain unchanged or deteriorate, the Bank’s business and results of operations could be adversely affected.
If adverse trends reappear in the mortgage lending sector, including declines in housing prices or deterioration in loan performance trends, a reduction could occur in the value of collateral pledged to the Bank to secure member credit and in the fair value of the Bank’s mortgage-backed securities (MBS) investments.
Adverse economic conditions may contribute to deterioration in the credit quality of our MBS and mortgage loan portfolios and could have an adverse impact on our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.
During 2008 and continuing through 2011, the U.S. housing market experienced significant adverse trends, including significant price depreciation in some markets and high mortgage loan delinquency and default rates, which contributed to high delinquency rates on the mortgage loans underlying our private-label residential MBS (PLRMBS) portfolio. Credit-related other-than-temporary impairment (OTTI) charges on certain of our PLRMBS adversely affected our earnings as a result of these conditions. If significant adverse trends in the housing markets reappear, there may be further adverse impacts on the performance of the Bank’s PLRMBS and mortgage loans, which may adversely affect the Bank’s financial condition, results of operations, ability to pay dividends, and ability to redeem or repurchase capital stock. Furthermore, economic deterioration, either in the U.S. as a whole or in specific regions of the country, could result in rising mortgage loan delinquencies and increased risk of credit losses, and adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.
Loan servicing and modification programs or legal actions could adversely affect the value of our MBS and mortgage loans.
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 our MBS and mortgage loans. In addition, legal actions relating to mortgage loan servicing and modifications could adversely affect the members, counterparties, and servicers of the Bank's mortgage collateral and the value of our PLRMBS.
Market uncertainty and volatility may adversely affect our business, profitability, or results of operations.
Adverse conditions in the housing and mortgage markets could result in a decrease in the availability of corporate credit and liquidity within the mortgage industry, causing disruptions in the operations of mortgage originators, including some of our borrowers. We continue to be subject to potential adverse effects on our financial condition, results of operations, ability to pay dividends, and ability to redeem or repurchase capital stock should the economic recovery stall or reverse course.
Weaknesses in the housing and mortgage markets may undermine the need for wholesale funding and have a negative impact on the demand for advances.
13
While the housing and mortgage markets continued to recover in terms of sales and financing activity in 2015, low yields on mortgages, ongoing aversion to risk, emphasis on the origination of government-sponsored enterprise (GSE) conforming products, and a focus on improving credit quality rather than expanding production may result in low levels of residential portfolio lending activity for some members, which could reduce the need for wholesale mortgage funding. A negative trend in the housing and mortgage markets could result in a decline in advance levels and adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.
Changes in or limits on our ability to access the capital markets could adversely affect our financial condition, results of operations, or ability to fund advances, pay dividends, or redeem or repurchase capital stock.
Our primary source of funds is the sale of Federal Home Loan Bank (FHLBank) System consolidated obligations in the capital markets. Our ability to obtain funds through the sale of consolidated obligations depends in part on prevailing conditions in the capital markets, such as investor demand and liquidity in the financial markets. The sale of FHLBank System consolidated obligations can also be influenced by factors other than conditions in the capital markets, including legislative and regulatory developments and government programs and policies that affect the relative attractiveness of FHLBank System consolidated obligations. In addition, the level of dealer participation and support also affect liquidity in the agency debt markets. Based on these factors, we may not be able to obtain funding on acceptable terms. If we cannot access funding on acceptable terms when needed, our ability to support and continue our operations could be adversely affected, which could negatively affect our financial condition, results of operations, or ability to fund advances, pay dividends, or redeem or repurchase capital stock.
Limitations on the payment of dividends and repurchase of excess capital stock may adversely affect the effective operation of the Bank's business model.
Our business model is based on the premise that we maintain a balance between our objective to promote housing, homeownership, and community and economic development through our activities with members and our objective to provide a return on the private capital provided by our members. We achieve this balance by delivering low-cost credit to help our members meet the credit needs of their communities while striving to pay members a reasonable return on their investment in the Bank’s capital stock. Our financial strategies are designed to enable us to safely expand and contract our assets, liabilities, and capital as our member base and our members' credit needs change. Our capital increases when members are required to purchase additional capital stock as they increase their advances, and it contracts when we repurchase excess capital stock from members as their advances decline. As a result of these strategies, we have historically been able to achieve our mission by meeting member credit needs and maintaining our strong regulatory capital position while paying dividends (including dividends on mandatorily redeemable capital stock) and repurchasing and redeeming excess capital stock. Limitations on the payment of dividends and the repurchase of excess capital stock may diminish the effectiveness of our business model and could adversely affect the value of membership from the perspective of a member.
Changes in the credit ratings on FHLBank System consolidated obligations may adversely affect the cost of consolidated obligations.
FHLBank System consolidated obligations are rated Aaa/P-1 with a stable outlook by Moody's Investors Service (Moody's) and AA+/A-1+ with a stable outlook by Standard & Poor's Rating Services (Standard & Poor's). Rating agencies may from time to time change a rating or issue negative reports. Because all of the FHLBanks have joint and several liability for all FHLBank consolidated obligations, negative developments at any FHLBank may affect these credit ratings or result in the issuance of a negative report regardless of our own financial condition and results of operations. In addition, because of the FHLBanks' GSE status, the credit ratings of the FHLBank System and the FHLBanks are generally constrained by the long-term sovereign credit rating of the United States, and any downgrade in that sovereign credit rating may result in a corresponding downgrade to the credit ratings of FHLBank System consolidated obligations. Any adverse rating change or negative report may adversely affect our cost of funds and the FHLBanks' ability to issue consolidated obligations on acceptable terms, which could also adversely
14
affect our financial condition or results of operations or restrict our ability to make advances on acceptable terms, pay dividends, or redeem or repurchase capital stock.
Changes in federal fiscal and monetary policy could adversely affect our business or results of operations.
Our business and results of operations are significantly affected by the fiscal and monetary policies of the federal government and its agencies, including the Federal Reserve Board, which regulates the supply of money and credit in the United States. The Federal Reserve Board's policies directly and indirectly influence the yield on interest-earning assets and the cost of interest-bearing liabilities, which could adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.
Changes in interest rates could adversely affect our financial condition, results of operations, or ability to fund advances on acceptable terms, pay dividends, or redeem or repurchase capital stock.
We realize income primarily from the spread between interest earned on our outstanding advances and investments and interest paid on our consolidated obligations and other liabilities. Although we use various methods and procedures to monitor and manage our exposure to changes in interest rates, we may experience instances when our interest-bearing liabilities will be more sensitive to changes in interest rates than our interest-earning assets, or vice versa. In either case, interest rate movements contrary to our position could negatively affect our financial condition, results of operations, or ability to fund advances on acceptable terms, pay dividends, or redeem or repurchase capital stock. Moreover, the impact of changes in interest rates on mortgage-related assets can be exacerbated by prepayment risks, which are the risk that the assets will be refinanced by the obligor in low interest rate environments and the risk that the assets will remain outstanding longer than expected at below-market yields when interest rates increase.
Our exposure to credit risk could adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.
We assume secured and unsecured credit risk associated with the risk that a borrower or counterparty could default, and we could suffer a loss if we were not able to fully recover amounts owed to us on a timely basis. In addition, we have exposure to credit risk because the market value of an obligation may decline as a result of deterioration in the creditworthiness of the obligor or the credit quality of a security instrument. We have a high concentration of credit risk exposure to financial institutions. Credit losses could have an adverse effect on our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.
We depend on institutional counterparties to provide credit obligations that are critical to our business. Defaults by one or more of these institutional counterparties on their obligations to the Bank could adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.
We face the risk that one or more of our institutional counterparties may fail to fulfill contractual obligations to us. The primary exposures to institutional counterparty risk are with derivative counterparties, mortgage servicers that service the loans we hold as collateral for advances, and third-party providers of supplemental or primary mortgage insurance for mortgage loans purchased under the Mortgage Partnership Finance® (MPF®) Program. A default by a counterparty could result in losses to the Bank if our credit exposure to the counterparty was under-collateralized or our credit obligations to the counterparty were over-collateralized, and could also adversely affect our ability to conduct our operations efficiently and at cost-effective rates, which in turn could adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock. (“Mortgage Partnership Finance” and “MPF” are registered trademarks of the FHLBank of Chicago.)
We rely on derivative transactions to reduce our interest rate risk and funding costs, and changes in our credit ratings or the credit ratings of our derivative counterparties or changes in the legislation or the regulations affecting how derivatives are transacted may adversely affect our ability to enter into derivative transactions on acceptable terms.
15
Our financial strategies are highly dependent on our ability to enter into derivative transactions on acceptable terms to reduce our interest rate risk and funding costs. We currently have a long-term credit rating of Aaa with a stable outlook from Moody's and AA+ with a stable outlook from Standard & Poor's. All of our derivative counterparties or guarantors currently have investment grade long-term credit ratings from Moody's and Standard & Poor's. Rating agencies may from time to time change a rating or issue negative reports, or other factors may raise questions regarding the creditworthiness of a counterparty, which may adversely affect our ability to enter into derivative transactions with acceptable counterparties on satisfactory terms in the quantities necessary to manage our interest rate risk and funding costs effectively. Changes in legislation or regulations affecting how derivatives are transacted may also adversely affect our ability to enter into derivative transactions with acceptable counterparties on satisfactory terms. Any of these changes could negatively affect our financial condition, results of operations, or ability to make advances on acceptable terms, pay dividends, or redeem or repurchase capital stock.
Insufficient collateral protection could adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.
We require that all outstanding advances be fully collateralized. In addition, for mortgage loans that we purchase under the MPF Program, we require that the participating financial institutions fully collateralize the outstanding credit enhancement obligations not covered through the purchase of supplemental mortgage insurance. We evaluate the types of collateral pledged by borrowers and participating financial institutions and assign borrowing capacities to the collateral based on the risks associated with each type of collateral. If we have insufficient collateral before or after an event of payment default by the borrower, or we are unable to liquidate the collateral for the value we assigned to it in the event of a payment default by a borrower, we could experience a credit loss on advances, which could adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.
We may not be able to meet our obligations as they come due or meet the credit and liquidity needs of our members in a timely and cost-effective manner.
We seek to be in a position to meet our members' credit and liquidity needs and pay our obligations without maintaining excessive holdings of low-yielding liquid investments or having to incur unnecessarily high borrowing costs. In addition, we maintain a contingency liquidity plan designed to enable us to meet our obligations and the credit and liquidity needs of members in the event of operational disruptions or short-term disruptions in the capital markets. Our efforts to manage our liquidity position, including our contingency liquidity plan, may not enable us to meet our obligations and the credit and liquidity needs of our members, which could have an adverse effect on our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.
We face competition for advances and access to funding, which could adversely affect our business.
Our primary business is making advances to our members. We compete with other suppliers of wholesale funding, both secured and unsecured, including investment banks, commercial banks, the Federal Reserve Banks, and, in certain circumstances, other FHLBanks. Our members may have access to alternative funding sources, including independent access to the national and global credit markets. These alternative funding sources may offer more favorable terms than we do on our advances, including more flexible credit or collateral standards. In addition, many of our competitors are not subject to the same regulations as the FHLBanks, which may enable those competitors to offer products and terms that we are not able to offer.
The FHLBanks also compete with the U.S. Treasury, Fannie Mae, Freddie Mac, and other GSEs, as well as corporate, sovereign, and supranational entities, for funds raised through the issuance of unsecured debt in the national and global debt markets. Increases in the supply of competing debt products may, in the absence of increases in demand, result in higher debt costs or lower amounts of debt issued at the same cost. Increased competition could adversely affect our ability to access funding, reduce the amount of funding available to us, or
16
increase the cost of funding available to us. Any of these results could adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.
Our efforts to make advances pricing attractive to our members may affect earnings.
A decision to lower advances prices to maintain or gain volume or increase the benefits to borrowing members could result in lower earnings, which could adversely affect the amount of dividends on our capital stock.
We have a high concentration of advances and capital with five institutions and their affiliates, and a loss or change of business activities with any of these institutions could adversely affect our results of operations, financial condition, or ability to pay dividends or redeem or repurchase capital stock.
We have a high concentration of advances and capital with five institutions and their affiliates. Two of the five institutions had increased borrowings from the Bank during 2015, including JPMorgan Chase Bank, National Association (JPMorgan Chase), whose advances and capital stock exceeded 10% of the Bank’s total advances and capital stock, respectively, as of December 31, 2015. The remaining three institutions decreased their borrowings from the Bank during 2015. All of the institutions may prepay or repay advances as they come due. If no other advances or investments are made to replace the prepaid and repaid advances of these institutions, it would result in a significant reduction of our total assets. In addition, because JPMorgan Chase is not a member of the Bank, it is not able to borrow new advances from the Bank or replace outstanding advances as they are repaid or prepaid, so a decrease in advances outstanding to JPMorgan Chase, if they are not replaced with advances to other members or other assets or investments, will result in lower total assets and may result in lower net income for the Bank. The reduction in advances could result in a reduction of capital as the Bank repurchases the resulting excess capital stock, at the Bank’s discretion, or redeems the excess capital stock after the expiration of the relevant five-year redemption period. The reduction in assets and capital could reduce the Bank’s net income.
The timing and magnitude of the impact of a reduction in the amount of advances to these institutions would depend on a number of factors, including:
| • | the amount and period of time 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 amount and profitability of our investments, |
| • | the extent to which consolidated obligations mature as the advances are prepaid or repaid, and |
| • | our ability to extinguish consolidated obligations or transfer them to other FHLBanks and the associated costs of extinguishing or transferring the consolidated obligations. |
The prepayment or repayment of a large amount of advances could also affect our ability to pay dividends or our ability to redeem or repurchase capital stock.
A material and prolonged decline in advances could adversely affect our results of operations, financial condition, or ability to pay dividends or redeem or repurchase capital stock.
If members continue to experience high levels of liquidity, we could experience decreases in members’ use of Bank advances. Also, nonmembers (including former members and member successors) are not eligible to borrow new advances from the Bank or renew existing advances as they mature. Although the Bank’s business model is designed to enable us to safely expand and contract our assets, liabilities, and capital as our members’ credit needs change, a prolonged material decline in advances could affect our results of operations, financial condition, or ability to pay dividends or redeem or repurchase capital stock.
Deteriorating and volatile market conditions increase the risk that our financial models will produce unreliable results.
17
We use market-based information as inputs to our financial models, which we use to inform our operational decisions and to derive estimates for use in our financial reporting processes. While we regularly adjust our models in view of changes in economic conditions and expectations, sudden significant changes in these conditions may increase the risk that our models could produce unreliable results or estimates that vary widely or prove to be inaccurate.
We may become liable for all or a portion of the consolidated obligations for which other FHLBanks are the primary obligors.
As provided by the Federal Home Loan Bank Act of 1932, as amended (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 Federal Housing Finance Agency (Finance Agency) to require any FHLBank to repay all or any portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor, whether or not the other FHLBank has defaulted in the payment of those obligations and even though the FHLBank making the repayment received none of the proceeds from the issuance of the obligations. The likelihood of triggering the Bank's joint and several liability obligation depends on many factors, including the financial condition and financial performance of the other FHLBanks. If we are required by the Finance Agency to repay the principal or interest on consolidated obligations for which another FHLBank is the primary obligor, our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock could be adversely affected.
If the Bank or any other FHLBank has not paid the principal or interest due on all consolidated obligations, we may not be able to pay dividends or redeem or repurchase any shares of our capital stock.
If the principal or interest due on any consolidated obligations has not been paid in full or is not expected to be paid in full, we may not be able to pay dividends on our capital stock or redeem or repurchase any shares of our capital stock. If another FHLBank defaults on its obligation to pay principal or interest on any consolidated obligations, the regulations governing the operations of the FHLBanks provide that the Finance Agency may allocate outstanding principal and interest payments among one or more of the remaining FHLBanks on a pro rata basis or any other basis the Finance Agency may determine. Our ability to pay dividends or redeem or repurchase capital stock could be affected not only by our own financial condition, but also by the financial condition of one or more of the other FHLBanks.
We are affected by federal laws and regulations, which could change or be applied in a manner detrimental to our operations.
The FHLBanks are GSEs, organized under the authority of and governed by the FHLBank Act, and, as such, are also governed by the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 and other federal laws and regulations. Effective July 30, 2008, the Finance Agency, an independent agency in the executive branch of the federal government, became the federal regulator of the FHLBanks, Fannie Mae, and Freddie Mac. From time to time, Congress has amended the FHLBank Act and adopted other legislation in ways that have significantly affected the FHLBanks and the manner in which the FHLBanks carry out their housing finance mission and business operations. New or modified legislation enacted by Congress or regulations or policies of the Finance Agency could have a negative effect on our ability to conduct business or on our cost of doing business. In addition, new or modified legislation or regulations governing our members may affect our ability to conduct business or our cost of doing business with our members.
Changes in statutory or regulatory requirements or policies or in their application could result in changes in, among other things, the FHLBanks' cost of funds, retained earnings and capital requirements, accounting policies, debt issuance, dividend payment limits, form of dividend payments, capital redemption and repurchase limits, permissible business activities, and the size, scope, and nature of the FHLBanks' lending, investment, and mortgage purchase program activities. These changes could negatively affect our financial condition, results of operations,
18
ability to pay dividends, or ability to redeem or repurchase capital stock. In addition, given the Bank's relationship with other FHLBanks, we could be affected by events other than another FHLBank's default on a consolidated obligation. Events that affect other FHLBanks, such as member failures, capital deficiencies, and OTTI charges, could lead the Finance Agency to require or request that an FHLBank provide capital or other assistance to another FHLBank, purchase assets from another FHLBank, or impose other forms of resolution affecting one or more of the other FHLBanks. If the Bank were called upon by the Finance Agency to take any of these steps, it could affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.
We could change our policies, programs, and agreements affecting our members.
We may change our policies, programs, and agreements affecting our members from time to time, including, without limitation, policies, programs, and agreements affecting the availability of and conditions for access to our advances and other credit products, the Affordable Housing Program (AHP), and other programs, products, and services. These changes could cause our members to obtain financing from alternative sources, which could adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock. In addition, changes to our policies, programs, and agreements affecting our members could adversely affect the value of membership from the perspective of a member.
The failure of the FHLBanks to set aside, in the aggregate, at least $100 million annually for the AHP could result in an increase in our AHP contribution, which could adversely affect our results of operations or ability to pay dividends or redeem or repurchase capital stock.
The FHLBank Act requires each FHLBank to establish and fund an AHP. Annually, the FHLBanks are required to set aside, in the aggregate, the greater of $100 million or 10% of their current year's net earnings (income before interest expense related to mandatorily redeemable capital stock and the assessment for the AHP) for their AHPs. If the FHLBanks do not make the minimum $100 million annual AHP contribution in a given year, we could be required to contribute more than 10% of our current year’s net earnings to the AHP. An increase in our AHP contribution could adversely affect our results of operations or ability to pay dividends or redeem or repurchase capital stock.
Our members are governed by federal and state laws and regulations, which could change in a manner detrimental to their ability or motivation to invest in the Bank or to use our products and services.
Most of our members are highly regulated financial institutions, and the regulatory environment affecting members could change in a manner that would negatively affect their ability or motivation to acquire or own our capital stock or use our products and services. Statutory or regulatory changes that make it less attractive to hold our capital stock or use our products and services could negatively affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.
Changes in the status, regulation, and perception of the housing GSEs or in policies and programs relating to the housing GSEs may adversely affect our business activities, future advances balances, the cost of debt issuance, or future dividend payments.
Changes in the status of Fannie Mae and Freddie Mac during the next phases of their conservatorships may result in higher funding costs for the FHLBanks, which could negatively affect our business and financial condition. In addition, negative news articles, industry reports, and other announcements pertaining to GSEs, including Fannie Mae, Freddie Mac, and any of the FHLBanks, could create pressure on all GSE debt pricing, as investors may perceive their debt instruments as bearing increased risk.
As a result of these factors, the FHLBank System may have to pay higher rates on consolidated obligations to make them attractive to investors. If we maintain our current approach to pricing advances, an increase in the cost of issuing consolidated obligations could reduce our net interest spread (the difference between the interest rate received on advances and the interest rate paid on consolidated obligations) and cause our advances to be less
19
profitable. If we increase the price of our advances to avoid a decrease in the net interest spread, the advances may be less attractive to our members, and our outstanding advances balances may decrease. In addition, an increase in the cost of issuing consolidated obligations could reduce our net interest spread on other interest-earning assets. As a result, an increase in the cost of issuing consolidated obligations could negatively affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.
We rely heavily on information systems and other technology. A failure, interruption, or security breach, including events caused by cyber attacks, of our information systems or those of critical vendors and third parties could disrupt the Bank’s business or adversely affect our financial condition, results of operations, or reputation.
We rely heavily on our information systems and other technology to conduct and manage our business, and we rely on vendors and other third parties to perform certain critical services. If we or one of our critical vendors experiences a failure, interruption, or security breach in any information systems or other technology, including events caused by cyber attacks, we may be unable to conduct and manage our business effectively. In addition, such failure or breach could result in significant losses, a loss of personal and confidential information, or reputational damage. In addition, significant initiatives undertaken by the Bank to replace information systems or other technology infrastructures may subject the Bank to a similar risk of failure or interruption in implementing these new systems or technology infrastructures. Although we have implemented a business continuity plan, we may not be able to prevent, timely and adequately address, or mitigate the negative effects of any failure or interruption. Any failure or interruption could adversely affect our member business, member relations, risk management, reputation, or profitability, which could negatively affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.
Restrictions on the redemption, repurchase, or transfer of the Bank's capital stock could result in an illiquid investment for the holder.
Under the Gramm-Leach-Bliley Act of 1999, Finance Agency regulations, and our capital plan, our capital stock must be redeemed upon the expiration of the relevant five-year redemption period, subject to certain conditions. Capital stock may become subject to redemption following a five-year redemption period after a member provides a written redemption notice to the Bank; gives notice of intention to withdraw from membership; attains nonmember status by merger or acquisition, charter termination, or other involuntary membership termination; or after a receiver or other liquidating agent for a member transfers the member's Bank capital stock to a nonmember entity. Only capital stock that is not required to meet a member's membership capital stock requirement or to support a member or nonmember shareholder's outstanding activity with the Bank (excess capital stock) may be redeemed at the end of the redemption period. In addition, we may elect to repurchase some or all of the excess capital stock of a shareholder at any time at our sole discretion.
There is no guarantee, however, that we will be able to redeem capital stock held by a shareholder even at the end of the redemption period or to repurchase excess capital stock. If the redemption or repurchase of the capital stock would cause us to fail to meet our minimum regulatory capital requirements or cause the shareholder to fail to maintain its minimum investment requirement, then the redemption or repurchase is prohibited by Finance Agency regulations and our capital plan. In addition, since our capital stock may only be owned by our members (or, under certain circumstances, former members and certain successor institutions), and our capital plan requires our approval before a member or nonmember shareholder may transfer any of its capital stock to another member or nonmember shareholder, we cannot provide assurance that a member or nonmember shareholder would be allowed to transfer any excess capital stock to another member or nonmember shareholder at any time.
| ITEM 1B. | UNRESOLVED STAFF COMMENTS |
Not applicable.
20
| ITEM 2. | PROPERTIES |
The Federal Home Loan Bank of San Francisco (Bank) maintains its principal offices in leased premises totaling 108,147 square feet of space at 600 California Street in San Francisco, California, and 580 California Street in San Francisco, California. The Bank also leases other offices totaling 9,858 square feet of space at 1155 15th Street NW in Washington, D.C., as well as off-site business continuity facilities located in Rancho Cordova, California. The Bank believes these facilities are adequate for the purposes for which they are currently used and are well maintained.
| ITEM 3. | 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.
In 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 (PLRMBS). The Bank seeks rescission, and asserts claims for and violations of the California Corporate Securities Act and common law rescission of contract.
The current defendants in the first complaint are: J.P. Morgan Securities, Inc. (formerly known as Bear, Stearns & Co. Inc., and referred to as Bear Stearns) involving certificates sold by Bear Stearns to the Bank in an amount paid of approximately $609 million; Credit Suisse Securities (USA) LLC (formerly known as Credit Suisse First Boston LLC, and referred to as Credit Suisse) involving certificates sold by Credit Suisse to the Bank in an amount paid of approximately $1.1 billion; RBS Securities, Inc. (formerly known as Greenwich Capital Markets, Inc., and referred to as Greenwich Capital) involving certificates sold by Greenwich Capital to the Bank in an amount paid of approximately $482 million; Morgan Stanley & Co. Incorporated (Morgan Stanley) involving certificates sold by Morgan Stanley to the Bank in an amount paid of approximately $276 million; UBS Securities, LLC (UBS) involving certificates sold by UBS to the Bank in an amount paid of approximately $1.7 billion; and WaMu Capital Corp. (WaMu) involving certificates sold by WaMu to the Bank in the amount paid of approximately $637 million.
The current defendants in the second complaint are: Credit Suisse involving certificates sold by Credit Suisse to the Bank in an amount paid of approximately $664 million; Deutsche Bank Securities Inc. (Deutsche) involving certificates sold by Deutsche to the Bank in an amount paid of approximately $1.2 billion; Bear Stearns involving certificates that Bear Stearns sold to the Bank in an amount paid of approximately $1.9 billion; Greenwich Capital involving certificates sold by Greenwich Capital to the Bank in an amount paid of approximately $153 million; and UBS involving certificates sold by UBS to the Bank in an amount paid of approximately $770 million.
JPMorgan Chase Bank, National Association, a nonmember borrower of the Bank, is not a defendant in these actions, but is affiliated with the Bear Stearns and WaMu defendants.
The San Francisco Superior Court has scheduled a series of trials for certain claims beginning in 2016.
After consultation with legal counsel, the Bank is not aware of any other legal proceedings that are expected to have a material effect on its financial condition or results of operations or that are otherwise material to the Bank.
| ITEM 4. | MINE SAFETY DISCLOSURES |
Not applicable.
21
PART II. OTHER INFORMATION
| ITEM 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
The Federal Home Loan Bank of San Francisco (Bank) has a cooperative ownership structure. The members and certain nonmembers own all the capital stock of the Bank, the majority of the directors of the Bank are officers or directors of members, and the directors are elected by members (or selected by the Board of Directors to fill mid-term vacancies). There is no established marketplace for the Bank's capital stock. The Bank’s capital stock is not publicly traded. The Bank issues only one class of capital stock, Class B stock, which, under the Bank’s capital plan, may be redeemed at par value, $100 per share, upon five years’ notice from the member to the Bank, subject to certain statutory and regulatory requirements and to the satisfaction of any ongoing capital stock investment requirements applying to the member. At the Bank’s discretion and at any time, the Bank may repurchase shares held by a member in excess of the member’s required capital stock holdings. The information regarding the Bank’s capital requirements is set forth in “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital.” At February 29, 2016, the Bank had 22,618,100 shares of Class B stock held by 336 members and 5,401,451 shares of Class B stock held by 13 nonmembers. Class B stock held by nonmembers is classified as mandatorily redeemable capital stock.
The Bank’s dividend rates declared (annualized) and amounts paid during the respective periods indicated are listed in the table below.
| 2015 | 2014 | ||||||||||||||||||||
| Amount of Cash Dividends | Amount of Cash Dividends | ||||||||||||||||||||
| (Dollars in millions) | Capital Stock – Class B – Putable | Mandatorily Redeemable Capital Stock | Annualized Rate(1) | Capital Stock – Class B – Putable | Mandatorily Redeemable Capital Stock | Annualized Rate(1) | |||||||||||||||
| First quarter | $ | 59 | $ | 15 | 7.11 | % | $ | 58 | $ | 39 | 6.67 | % | |||||||||
Second quarter(2) | 182 | 38 | 22.65 | 59 | 34 | 6.80 | |||||||||||||||
| Third quarter | 72 | 7 | 10.01 | 61 | 26 | 7.35 | |||||||||||||||
| Fourth quarter | 56 | 5 | 8.79 | 62 | 21 | 7.40 | |||||||||||||||
| (1) | Reflects the annualized rate paid on all of the Bank's average capital stock outstanding regardless of its classification for reporting purposes as either capital stock or mandatorily redeemable capital stock (a liability), based on the par value of $100 per share. |
| (2) | In the second quarter of 2015, the amount includes a special dividend at an annualized rate of 14.98%, totaling $145 million, including $120 million in dividends on capital stock and $25 million in dividends on mandatorily redeemable capital stock. |
Additional information regarding the Bank’s dividends is set forth in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations – Comparison of 2015 to 2014 – Dividends and Retained Earnings” and in “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital.”
22
| ITEM 6. | SELECTED FINANCIAL DATA |
The following selected financial data of the Federal Home Loan Bank of San Francisco (Bank) should be read in conjunction with the financial statements and notes thereto and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere herein.
| (Dollars in millions) | 2015 | 2014 | 2013 | 2012 | 2011 | ||||||||||||||
| Selected Balance Sheet Items at Yearend | |||||||||||||||||||
| Total Assets | $ | 85,707 | $ | 75,807 | $ | 85,774 | $ | 86,421 | $ | 113,552 | |||||||||
| Advances | 50,919 | 38,986 | 44,395 | 43,750 | 68,164 | ||||||||||||||
| Mortgage Loans Held for Portfolio, Net | 655 | 708 | 905 | 1,289 | 1,829 | ||||||||||||||
Investments(1) | 32,275 | 31,949 | 35,260 | 40,528 | 39,368 | ||||||||||||||
Consolidated Obligations:(2) | |||||||||||||||||||
| Bonds | 51,835 | 47,045 | 53,207 | 70,310 | 83,350 | ||||||||||||||
| Discount Notes | 27,648 | 21,811 | 24,194 | 5,209 | 19,152 | ||||||||||||||
| Mandatorily Redeemable Capital Stock | 488 | 719 | 2,071 | 4,343 | 5,578 | ||||||||||||||
| Capital Stock —Class B —Putable | 2,253 | 3,278 | 3,460 | 4,160 | 4,795 | ||||||||||||||
| Unrestricted Retained Earnings | 610 | 294 | 317 | 246 | — | ||||||||||||||
| Restricted Retained Earnings | 2,018 | 2,065 | 2,077 | 2,001 | 1,803 | ||||||||||||||
| Accumulated Other Comprehensive Income/(Loss) (AOCI) | 15 | 56 | (145 | ) | (794 | ) | (1,893 | ) | |||||||||||
| Total Capital | 4,896 | 5,693 | 5,709 | 5,613 | 4,705 | ||||||||||||||
| Selected Operating Results for the Year | |||||||||||||||||||
| Net Interest Income | $ | 477 | $ | 539 | $ | 482 | $ | 848 | $ | 1,033 | |||||||||
| Provision for/(Reversal of) Credit Losses on Mortgage Loans | 1 | — | (1 | ) | (1 | ) | 4 | ||||||||||||
| Other Income/(Loss) | 388 | (154 | ) | 5 | (164 | ) | (645 | ) | |||||||||||
| Other Expense | 148 | 144 | 128 | 134 | 126 | ||||||||||||||
| Assessments | 78 | 36 | 52 | 60 | 42 | ||||||||||||||
| Net Income/(Loss) | $ | 638 | $ | 205 | $ | 308 | $ | 491 | $ | 216 | |||||||||
| Selected Other Data for the Year | |||||||||||||||||||
Net Interest Margin(3) | 0.57 | % | 0.64 | % | 0.56 | % | 0.84 | % | 0.74 | % | |||||||||
| Operating Expenses as a Percent of Average Assets | 0.16 | 0.16 | 0.13 | 0.11 | 0.08 | ||||||||||||||
| Return on Average Assets | 0.76 | 0.24 | 0.35 | 0.48 | 0.15 | ||||||||||||||
| Return on Average Equity | 11.68 | 3.58 | 5.36 | 9.44 | 3.43 | ||||||||||||||
| Annualized Dividend Rate | 12.39 | 7.02 | 3.99 | 0.97 | 0.29 | ||||||||||||||
Dividend Payout Ratio(4) | 57.81 | 117.29 | 52.29 | 9.41 | 10.16 | ||||||||||||||
| Average Equity to Average Assets Ratio | 6.52 | 6.75 | 6.55 | 5.09 | 4.49 | ||||||||||||||
| Selected Other Data at Yearend | |||||||||||||||||||
Regulatory Capital Ratio(5) | 6.26 | 8.38 | 9.24 | 12.44 | 10.72 | ||||||||||||||
| Duration Gap (in months) | 1 | — | 1 | (1 | ) | 2 | |||||||||||||
(1) | Investments consist of securities purchased under agreements to resell, Federal funds sold, trading securities, available-for-sale securities, and held-to-maturity securities. |
(2) | As provided by the Federal Home Loan Bank Act of 1932, as amended, 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 Federal Housing Finance Agency (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 December 31, 2015, 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 value of the outstanding consolidated obligations of all FHLBanks at the dates indicated was as follows: |
23
| Yearend | Par Value (In millions) | ||
| 2015 | $ | 905,202 | |
| 2014 | 847,175 | ||
| 2013 | 766,837 | ||
| 2012 | 687,902 | ||
| 2011 | 691,868 | ||
| (3) | Net interest margin is net interest income divided by average interest-earning assets. |
| (4) | This ratio is calculated as dividends per share divided by net income per share. |
| (5) | This ratio is calculated as regulatory capital divided by total assets. Regulatory capital includes retained earnings, Class B capital stock, and mandatorily redeemable capital stock (which is classified as a liability), but excludes AOCI. |
24
| ITEM 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Statements contained in this annual report on Form 10-K, 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 (FHLBank 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 losses, future classification of securities, 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 other statutes or 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, other counterparties, and the other FHLBanks; |
| • | changes in Bank members’ demand 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 derivative 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; |
| • | changes in investor demand for consolidated obligations and/or the terms of interest rate exchange or similar agreements; |
| • | 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; |
| • | designation of the Bank for Federal Reserve Board supervision by the Financial Stability Oversight Council; |
| • | technology 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; and |
| • | changes in the FHLBanks’ long-term credit ratings. |
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.”
25
Overview
Net income for 2015 was $638 million, compared with net income of $205 million for 2014. The $433 million increase in net income for 2015 relative to the prior-year period primarily reflected a $459 million gain (after netting certain legal fees and expenses) relating to settlements with certain defendants in connection with the Bank’s private-label residential mortgage-backed securities (PLRMBS) litigation, partially offset by a decline in net interest income.
Net interest income for 2015 was $477 million, down from $539 million for 2014. The decrease was primarily due to a decline in earnings on MBS, mortgage loans, and invested capital because of lower average balances, partially offset by lower dividends paid on mandatorily redeemable capital stock (which are classified as interest expense).
Other income/(loss) for 2015, excluding the gain from the litigation settlement, was a loss of $71 million, compared with a loss of $154 million for 2014. The change reflected reduced net fair value losses associated with derivatives, hedged items, and financial instruments carried at fair value of $50 million, compared with net fair value losses of $94 million for 2014. The change in net fair value losses was primarily due to the effects of changes in market interest rates, interest rate spreads, interest rate volatility, and other market factors during the period. The change in other income/(loss) also reflected expense on derivative instruments used in economic hedges of $18 million, compared with expense of $64 million for 2014. Income/expense on derivative instruments used in economic hedges is generally offset by interest expense/income on the economically hedged assets and liabilities.
During 2015, total assets increased $9.9 billion, to $85.7 billion at December 31, 2015, from $75.8 billion at December 31, 2014. Advances increased $11.9 billion, or 31%, to $50.9 billion at December 31, 2015, from $39.0 billion at December 31, 2014.
Accumulated other comprehensive income/(loss) decreased by $41 million during 2015, to $15 million at December 31, 2015, from $56 million at December 31, 2014, primarily as a result of a decline in the fair value of PLRMBS classified as available-for-sale (AFS).
Additional information about investments and other-than-temporary impairment (OTTI) losses 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 8. Financial Statements and Supplementary Data – Note 7 – Other-Than-Temporary Impairment Analysis” Additional information about the Bank’s PLRMBS is also provided in “Part I. Item 3. Legal Proceedings.”
On February 18, 2016, the Bank’s Board of Directors declared a cash dividend on the capital stock outstanding during the fourth quarter of 2015 at an annualized rate of 7.99%. The dividend will total $55 million, including $10 million in dividends on mandatorily redeemable capital stock that will be reflected as interest expense in the first quarter of 2016. The Bank recorded the dividend on February 18, 2016, and expects to pay the dividend on or about March 17, 2016.
As of December 31, 2015, the Bank was in compliance with all of its regulatory capital requirements. The Bank’s total regulatory capital ratio was 6.3%, exceeding the 4.0% requirement. The Bank had $5.4 billion in permanent capital, exceeding its risk-based capital requirement of $2.7 billion. Total retained earnings as of December 31, 2015, were $2.6 billion.
The Bank amended its capital plan, effective April 1, 2015, to lower the cap on the membership stock requirement to $15 million from $25 million, lower the activity-based stock requirement to 3.0% from 4.7% for outstanding advances and to 3.0% from 5.0% for mortgage loans purchased and held by the Bank, and change the authorized ranges for the activity-based stock requirement to a range of 2.0% to 5.0% from a range of 4.4% to 5.0% for advances and to a range of 0.0% to 5.0% from a range of 5.0% to 5.7% for mortgage loans purchased and held by the Bank. Effective August 3, 2015, the Bank reduced its activity-based stock requirements within the ranges authorized by the Bank’s capital plan. The activity-based stock requirement for advances was reduced from 3.0% to
26
2.7%, and the activity-based stock requirement for mortgage loans purchased from the member and held by the Bank was reduced from 3.0% to 0.0%.
The Bank plans to repurchase the surplus capital stock of all members and the excess capital stock of all nonmember shareholders on March 18, 2016. Surplus capital stock is defined as any stock holdings in excess of 115% of a member’s minimum capital stock requirement.
The Bank will continue to monitor the condition of its PLRMBS portfolio, the ratio of the Bank’s estimated market value of total capital to par value of 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 payment of dividends and the repurchase of excess capital stock in future quarters.
As previously disclosed, effective August 31, 2015, JPMorgan Bank & Trust Company, National Association (JPMorgan B&T), merged with and into JPMorgan Chase Bank, National Association (JPMorgan Chase). As a result, JPMorgan B&T is no longer a member of the Bank. Upon the merger, $403 million of the Bank’s capital stock held by JPMorgan B&T was transferred to JPMorgan Chase, a nonmember of the Bank, and reclassified as mandatorily redeemable capital stock. In addition, all advances to JPMorgan B&T were transferred to JPMorgan Chase, and, as a result, JPMorgan Chase will be one of the Bank’s largest borrowers and shareholders. Because it is not a member of the Bank, JPMorgan Chase is not able to take out new advances from the Bank or replace outstanding advances as they are repaid or prepaid, so a decrease in advances outstanding to JPMorgan Chase, if they are not replaced with advances to other members or other assets, will result in lower total assets and may result in lower net income for the Bank.
Results of Operations
Comparison of 2015 and 2014
Net Interest Income. The primary source of the Bank’s earnings is net interest income, which is the interest earned on advances, mortgage loans, and investments, less interest paid on consolidated obligations, deposits, mandatorily redeemable capital stock, and other borrowings. The Average Balance Sheets tables that follow present the average balances of interest-earning asset categories and the sources that funded those interest-earning assets (liabilities and capital) for the years ended December 31, 2015 and 2014, together with the related interest income and expense. They also present the average rates on total interest-earning assets and the average costs of total funding sources.
27
| Average Balance Sheets | |||||||||||||||||||||
| 2015 | 2014 | ||||||||||||||||||||
| (Dollars in millions) | Average Balance | Interest Income/ Expense | Average Rate | Average Balance | Interest Income/ Expense | Average Rate | |||||||||||||||
| Assets | |||||||||||||||||||||
| Interest-earning assets: | |||||||||||||||||||||
| Interest-bearing deposits | $ | 719 | $ | — | 0.01 | % | $ | 325 | $ | — | 0.01 | % | |||||||||
| Securities purchased under agreements to resell | 2,513 | 3 | 0.10 | 1,436 | 1 | 0.06 | |||||||||||||||
| Federal funds sold | 6,847 | 9 | 0.13 | 9,602 | 11 | 0.12 | |||||||||||||||
| Trading securities: | |||||||||||||||||||||
| Mortgage-backed securities (MBS) | 10 | — | 1.68 | 12 | — | 1.63 | |||||||||||||||
| Other investments | 2,439 | 5 | 0.21 | 3,432 | 6 | 0.18 | |||||||||||||||
Available-for-sale (AFS) securities:(1) | |||||||||||||||||||||
MBS(2) | 5,809 | 264 | 4.54 | 6,700 | 278 | 4.15 | |||||||||||||||
Held-to-maturity (HTM) securities:(1) | |||||||||||||||||||||
| MBS | 11,783 | 292 | 2.48 | 14,338 | 358 | 2.49 | |||||||||||||||
| Other investments | 297 | 1 | 0.51 | 2,111 | 4 | 0.20 | |||||||||||||||
| Mortgage loans held for portfolio | 675 | 33 | 4.91 | 806 | 42 | 5.16 | |||||||||||||||
Advances(3) | 51,899 | 299 | 0.58 | 45,104 | 305 | 0.68 | |||||||||||||||
| Loans to other FHLBanks | 5 | — | 0.11 | 3 | — | 0.07 | |||||||||||||||
| Total interest-earning assets | 82,996 | 906 | 1.09 | 83,869 | 1,005 | 1.20 | |||||||||||||||
Other assets(4)(5) | 829 | — | — | 929 | — | — | |||||||||||||||
| Total Assets | $ | 83,825 | $ | 906 | 1.08 | % | $ | 84,798 | $ | 1,005 | 1.19 | % | |||||||||
| Liabilities and Capital | |||||||||||||||||||||
| Interest-bearing liabilities: | |||||||||||||||||||||
| Consolidated obligations: | |||||||||||||||||||||
Bonds(3) | $ | 47,481 | $ | 317 | 0.67 | % | $ | 52,805 | $ | 326 | 0.62 | % | |||||||||
| Discount notes | 28,853 | 46 | 0.16 | 23,582 | 20 | 0.09 | |||||||||||||||
| Deposits and other borrowings | 1,122 | 1 | 0.05 | 835 | — | 0.05 | |||||||||||||||
| Mandatorily redeemable capital stock | 421 | 65 | 15.49 | 1,348 | 120 | 8.88 | |||||||||||||||
| Total interest-bearing liabilities | 77,877 | 429 | 0.55 | 78,570 | 466 | 0.59 | |||||||||||||||
Other liabilities(4) | 485 | — | — | 501 | — | — | |||||||||||||||
| Total Liabilities | 78,362 | 429 | 0.55 | 79,071 | 466 | 0.59 | |||||||||||||||
| Total Capital | 5,463 | — | — | 5,727 | — | — | |||||||||||||||
| Total Liabilities and Capital | $ | 83,825 | $ | 429 | 0.51 | % | $ | 84,798 | $ | 466 | 0.55 | % | |||||||||
| Net Interest Income | $ | 477 | $ | 539 | |||||||||||||||||
Net Interest Spread(6) | 0.54 | % | 0.61 | % | |||||||||||||||||
Net Interest Margin(7) | 0.57 | % | 0.64 | % | |||||||||||||||||
| Interest-earning Assets/Interest-bearing Liabilities | 106.57 | % | 106.74 | % | |||||||||||||||||
| (1) | The average balances of AFS securities and HTM securities are reflected at amortized cost. As a result, the average rates do not reflect changes in fair value or non-credit-related OTTI losses. |
| (2) | Interest income on AFS securities includes accretion of yield adjustments on other-than-temporarily impaired PLRMBS (resulting from improvement in expected cash flows) totaling $74 million and $68 million in 2015 and 2014, respectively. |
| (3) | Interest income/expense and average rates include the effect of associated interest rate exchange agreements, as follows: |
28
| 2015 | 2014 | ||||||||||||||||||||||
| (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 | $ | (2 | ) | $ | (106 | ) | $ | (108 | ) | $ | (4 | ) | $ | (128 | ) | $ | (132 | ) | |||||
| Consolidated obligation bonds | 5 | 257 | 262 | 5 | 260 | 265 | |||||||||||||||||
| (4) | Includes forward settling transactions and valuation adjustments for certain cash items. |
| (5) | Includes non-credit-related OTTI losses on AFS and HTM 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 2015 was $477 million, a 12% decrease from $539 million in 2014. The following table details the changes in interest income and interest expense for 2015 compared to 2014. 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 2015 Compared to 2014 | |||||||||||
Increase/ (Decrease) | Attributable to Changes in(1) | ||||||||||
| (In millions) | Average Volume | Average Rate | |||||||||
| Interest-earning assets: | |||||||||||
| Securities purchased under agreements to resell | $ | 2 | $ | 1 | $ | 1 | |||||
| Federal funds sold | (2 | ) | (3 | ) | $ | 1 | |||||
| Trading securities: Other investments | (1 | ) | (2 | ) | 1 | ||||||
| AFS securities: | |||||||||||
| MBS | (14 | ) | (39 | ) | 25 | ||||||
| HTM securities: | |||||||||||
| MBS | (66 | ) | (63 | ) | (3 | ) | |||||
| Other investments | (3 | ) | (6 | ) | 3 | ||||||
| Mortgage loans held for portfolio | (9 | ) | (7 | ) | (2 | ) | |||||
Advances(2) | (6 | ) | 43 | (49 | ) | ||||||
| Total interest-earning assets | (99 | ) | (76 | ) | (23 | ) | |||||
| Interest-bearing liabilities: | |||||||||||
| Consolidated obligations: | |||||||||||
Bonds(2) | (9 | ) | (35 | ) | 26 | ||||||
| Discount notes | 26 | 5 | 21 | ||||||||
| Deposits and other borrowings | 1 | 1 | — | ||||||||
| Mandatorily redeemable capital stock | (55 | ) | (112 | ) | 57 | ||||||
| Total interest-bearing liabilities | (37 | ) | (141 | ) | 104 | ||||||
| Net interest income | $ | (62 | ) | $ | 65 | $ | (127 | ) | |||
| (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. |
The net interest margin was 57 basis points for 2015, 7 basis points lower than the net interest margin for 2014, which was 64 basis points. The net interest spread was 54 basis points for 2015, 7 basis points lower than the net interest spread for 2014, which was 61 basis points. These decreases were primarily due to the decline in earnings on interest-earning assets and a decrease in earnings on invested capital because of lower average capital balances, partially offset by lower dividends on mandatorily redeemable capital stock, which are classified as interest expense. This decrease in interest expense was partially offset by the accretion of yield adjustments on certain other-than-temporarily impaired PLRMBS resulting from improvement in expected cash flows.
29
For securities previously identified as other-than-temporarily impaired, the Bank updates its estimate of future
estimated cash flows on a regular basis. If there is no additional impairment on the security, the yield of the security
is adjusted upward on a prospective basis and accreted into interest income when there is a significant increase in
the expected cash flows. As a result of improvements in the estimated cash flows of securities previously
identified as other-than-temporarily impaired, the accretion of yield adjustments is likely to continue to be a
positive source of net interest income in future periods.
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 years ended December 31, 2015 and 2014.
| Other Income/(Loss) | |||||||
| (In millions) | 2015 | 2014 | |||||
| Other Income/(Loss): | |||||||
| Total OTTI loss | $ | (31 | ) | $ | (14 | ) | |
| Net amount of OTTI loss reclassified to/(from) AOCI | 16 | 10 | |||||
| Net OTTI loss, credit-related | (15 | ) | (4 | ) | |||
Net gain/(loss) on trading securities(1) | (2 | ) | (1 | ) | |||
| Net gain/(loss) on advances and consolidated obligation bonds held under fair value option | (50 | ) | (93 | ) | |||
| Net gain/(loss) on derivatives and hedging activities | (16 | ) | (64 | ) | |||
| Gains on litigation settlements, net | 459 | — | |||||
| Other | 12 | 8 | |||||
| Total Other Income/(Loss) | $ | 388 | $ | (154 | ) | ||
(1) The net gain/(loss) on trading securities that were economically hedged totaled a de minimis amount and $(1) million in 2015 and 2014, respectively.
Net Other-Than-Temporary Impairment Loss, Credit-Related – Each quarter, the Bank updates its OTTI analysis to reflect current housing market conditions, changes in anticipated housing market conditions, observed and anticipated borrower behavior, and updated information on the loans supporting the Bank’s PLRMBS.
Additional information about the OTTI loss is provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Investments” and in “Item 8. Financial Statements and Supplementary Data – Note 7 – Other-Than-Temporary Impairment Analysis.”
Net Gain/(Loss) on Advances and Consolidated Obligation Bonds Held Under Fair Value Option – The following table presents the net gain/(loss) on advances and consolidated obligation bonds held under the fair value option for the years ended December 31, 2015 and 2014.
| Net Gain/(Loss) on Advances and Consolidated Obligation Bonds Held Under Fair Value Option | |||||||
| (In millions) | 2015 | 2014 | |||||
| Advances | $ | (31 | ) | $ | (11 | ) | |
| Consolidated obligation bonds | (19 | ) | (82 | ) | |||
| Total | $ | (50 | ) | $ | (93 | ) | |
30
Under the fair value option, the Bank elected to carry certain assets and liabilities at fair value. 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 the derivatives that economically hedge these instruments.
The unrealized net fair value gains/(losses) on advances and consolidated obligation bonds were primarily driven by the effects of changes in market interest rates, interest rate spreads, interest rate volatility, and other market factors relative to the actual terms on the advances and consolidated obligation bonds during the period.
Additional information about advances and consolidated obligation bonds held under the fair value option is provided in “Item 8. Financial Statements and Supplementary Data – Note 19 – Fair Value.”
Net Gain/(Loss) on Derivatives and Hedging Activities – Under the accounting for derivative instruments and hedging activities, the Bank is required to carry all of its derivative instruments on the balance sheet at fair value. If derivatives meet the hedging criteria, including effectiveness measures, the carrying value of the underlying hedged instruments may also be adjusted to reflect changes in the fair value attributable to the risk being hedged so that some or all of the unrealized gain or loss recognized on the derivative is offset by a corresponding unrealized loss or gain on the underlying hedged instrument. The unrealized gain or loss on the “ineffective” portion of all hedges, which represents the amount by which the change in the fair value of the derivative differs from the change in the fair value of the hedged item or the variability in the cash flows of the forecasted transaction, is recognized in current period earnings. In addition, certain derivatives are associated with assets or liabilities but do not qualify as fair value hedges under the accounting for derivative instruments and hedging activities. These economic hedges are recorded on the balance sheet at fair value with the unrealized gain or loss recorded in earnings without any offsetting unrealized loss or gain from the associated asset or liability.
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 gain/(loss) on derivatives and hedging activities” in 2015 and 2014.
Sources of Gains/(Losses) Recorded in Net Gain/(Loss) on Derivatives and Hedging Activities 2015 Compared to 2014 | |||||||||||||||||||||||||||||||
| (In millions) | 2015 | 2014 | |||||||||||||||||||||||||||||
| Gain/(Loss) | Income/ (Expense) on | Gain/(Loss) | 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 | $ | — | $ | 19 | $ | (73 | ) | $ | (54 | ) | $ | — | $ | 21 | $ | (100 | ) | $ | (79 | ) | |||||||||||
| Not elected for fair value option | (1 | ) | 1 | 1 | 1 | — | 5 | (7 | ) | (2 | ) | ||||||||||||||||||||
| Consolidated obligation bonds: | |||||||||||||||||||||||||||||||
| Elected for fair value option | — | 8 | 49 | 57 | — | 36 | 59 | 95 | |||||||||||||||||||||||
| Not elected for fair value option | (9 | ) | (19 | ) | 35 | 7 | (12 | ) | (24 | ) | 24 | (12 | ) | ||||||||||||||||||
| Consolidated obligation discount notes: | |||||||||||||||||||||||||||||||
| Not elected for fair value option | — | 4 | (30 | ) | (26 | ) | — | (12 | ) | (39 | ) | (51 | ) | ||||||||||||||||||
| MBS: | |||||||||||||||||||||||||||||||
| Not elected for fair value option | — | (3 | ) | — | (3 | ) | — | (15 | ) | — | (15 | ) | |||||||||||||||||||
| Non-MBS investments: | |||||||||||||||||||||||||||||||
| Not elected for fair value option | — | — | — | — | — | 1 | (1 | ) | — | ||||||||||||||||||||||
| Mortgage delivery commitment: | |||||||||||||||||||||||||||||||
| Not elected for fair value option | — | 2 | — | 2 | — | — | — | — | |||||||||||||||||||||||
| Total | $ | (10 | ) | $ | 12 | $ | (18 | ) | $ | (16 | ) | $ | (12 | ) | $ | 12 | $ | (64 | ) | $ | (64 | ) | |||||||||
31
During 2015, net losses on derivatives and hedging activities totaled $16 million compared to net losses of $64 million in 2014. These amounts included expense of $18 million and expense of $64 million resulting from net settlements on derivative instruments used in economic hedges in 2015 and 2014, respectively. Excluding the impact of income or expense from net settlements on derivative instruments used in economic hedges, the net gains or losses on fair value and economic hedges were primarily associated with the effects of changes in market interest rates, interest rate spreads, interest rate volatility, and other market factors during the period.
The ongoing impact of these valuation adjustments on the Bank cannot be predicted and 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 8. Financial Statements and Supplementary Data – Note 18 – Derivatives and Hedging Activities.”
Gains on litigation settlements, net – During 2015, gains relating to settlements with certain defendants in connection with the Bank’s PLRMBS litigation totaled $459 million (after netting certain legal fees and expenses).
Other Expense. Other expenses were $148 million in 2015 compared to $144 million in 2014, reflecting higher compensation and benefits and operating expenses in 2015.
Affordable Housing Program. The FHLBank Act requires each FHLBank to establish and fund an Affordable Housing Program (AHP). Each FHLBank’s AHP provides subsidies to members, which use the funds to assist in the purchase, construction, or rehabilitation of housing for very low-, low-, and moderate-income households. Subsidies may be in the form of direct grants or below-market interest rate advances.
To fund the AHP, the FHLBanks must set aside, in the aggregate, the greater of $100 million or 10% of the current year's net earnings (income before interest expense related to mandatorily redeemable capital stock and the assessment for the AHP). To the extent that the aggregate 10% calculation is less than $100 million, the FHLBank Act requires that each FHLBank contribute such prorated sums as may be required to ensure that the aggregate contribution of the FHLBanks equals $100 million. The proration would be made on the basis of the income of the FHLBanks for the previous year. In the aggregate, the FHLBanks set aside $332 million, $269 million, and $293 million for their AHPs in 2015, 2014, and 2013, respectively, and there was no AHP shortfall in any of those years.
The Bank’s total AHP assessments equaled $78 million in 2015, compared to $36 million in 2014. The increase in the AHP assessments reflected higher earnings in 2015.
Return on Average Equity. Return on average equity (ROE) was 11.68% in 2015, compared to 3.58% in 2014. The increase reflected the increase in net income in 2015 resulting from a $459 million gain (after netting certain legal fees and expenses) relating to settlements with certain defendants in connection with Bank’s PLRMBS litigation in the first quarter of 2015.
Dividends and Retained Earnings. The Bank’s Excess Stock Repurchase, Retained Earnings, and Dividend Framework summarizes the Bank’s capital management principles and objectives, as well as its policies and practices with respect to restricted retained earnings, dividend payments, and the repurchase of excess capital stock.
Under 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’s Excess Stock Repurchase, Retained Earnings, and Dividend Framework is reviewed at least annually by the Bank’s Board of Directors. The Board of Directors may amend the Excess Stock Repurchase, Retained Earnings, and Dividend Framework from time to time. In accordance with the Bank’s Excess Stock Repurchase, Retained Earnings, and Dividend Framework, the Bank retains certain amounts 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
32
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 December 31, 2015, advances maturing within five years totaled $44.2 billion, significantly in excess of the $127 million of member deposits on that date. At December 31, 2014, advances maturing within five years totaled $37.0 billion, also significantly in excess of the $160 million of member deposits on that date. In addition, as of December 31, 2015 and 2014, the Bank held estimated total sources of funds in an amount that would have allowed the Bank to meet its liquidity needs for more than 5 consecutive business days without issuing new consolidated obligations, subject to certain conditions. For more information, see “Management’s Discussion and Analysis of Results of Operations and Financial Condition – Risk Management – Liquidity Risk”.
The Bank’s Risk Management Policy limits the payment of dividends 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 less than 100% but greater than or equal to 70%, any dividend would be limited to an annualized rate no greater than the daily average of the three-month London Interbank Offered Rate (LIBOR) for the applicable quarter (subject to certain conditions), and if this ratio is less than 70%, the Bank would be restricted from paying a dividend. The ratio of the Bank’s estimated market value of total capital to par value of capital stock was 200% as of December 31, 2015. For more information, see “Management’s Discussion and Analysis of Results of Operations and Financial Condition – Risk Management – Market Risk”.
Retained Earnings Related to Valuation Adjustments – In accordance with the Bank’s Excess Stock Repurchase, Retained Earnings, and Dividend Framework, 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 valuation 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 purpose of retaining cumulative net gains in earnings resulting from valuation adjustments as 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 this way may 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.
Retained earnings related to valuation adjustments totaled $10 million and $35 million at December 31, 2015 and 2014, respectively.
Retained Earnings Related to Loss Protection and Capital Compliance – In addition to any cumulative net gains resulting from valuation adjustments, the Bank holds an additional amount in restricted retained earnings intended to protect paid-in capital from the effects of an extremely adverse credit event, an extremely adverse operations risk
33
event, a cumulative net loss related to the Bank’s derivatives and associated hedged items and financial instruments carried at fair value, an extremely adverse change in the market value of the Bank’s capital, a significant amount of additional credit-related OTTI on PLRMBS, or some combination of these effects, especially in periods of extremely low net income resulting from an adverse interest rate environment, and to maintain capital compliance.
On July 31, 2015, the Board of Directors set the required amount of restricted retained earnings for loss protection and capital compliance at $2.0 billion. Restricted retained earnings available to meet this requirement include amounts related to the Bank’s buildup of retained earnings and to the Joint Capital Enhancement Agreement, but exclude retained earnings related to valuation adjustments. Restricted retained earnings for loss protection and capital compliance were $2.0 billion as of December 31, 2015.
This restricted retained earnings requirement may be changed at any time. The Board of Directors periodically reviews the retained earnings methodology and analysis to determine whether any adjustments are appropriate.
Buildup of Retained Earnings – As of March 31, 2012, the Bank reached the $1.8 billion target for the buildup of retained earnings that had previously been set by the Board of Directors. On July 31, 2015, the Board of Directors lowered the requirement to $1.65 billion and transferred $150 million to unrestricted retained earnings.
Joint Capital Enhancement Agreement – In 2011, the FHLBanks entered into a Joint Capital Enhancement Agreement, as amended (JCE Agreement), intended to enhance the capital position of each FHLBank by allocating a portion of each FHLBank’s earnings to a separate retained earnings account at that FHLBank. In accordance with the JCE Agreement, each FHLBank is required to allocate 20% of its net income each quarter 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. Under the JCE Agreement, these restricted retained earnings will not be available to pay dividends.
Retained earnings related to the JCE Agreement totaled $358 million and $230 million at December 31, 2015 and 2014, respectively.
Dividend Payments – Federal Housing Finance Agency (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.
In addition, Finance Agency rules do not permit the Bank to pay dividends in the form of capital stock if its excess
capital stock exceeds 1% of its total assets. Excess capital stock is defined as the aggregate of the capital stock held by each shareholder in excess of its minimum capital stock requirement, as established by the Bank’s capital plan. As of December 31, 2015, the Bank’s excess capital stock totaled $402 million, or 0.47% of total assets.
In 2015, the Bank paid dividends at an annualized rate of 12.39%, totaling $434 million, including $369 million in dividends on capital stock and $65 million in dividends on mandatorily redeemable capital stock. The dividends included four quarterly dividends and a special dividend in the amount of $145 million, including $120 million in dividends on capital stock and $25 million in dividends on mandatorily redeemable capital stock. In 2014, the Bank paid dividends at an annualized rate of 7.02%, totaling $360 million, including $240 million in dividends on capital stock and $120 million in dividends on mandatorily redeemable capital stock.
The Bank paid these dividends in cash. Dividends on capital stock are recognized as dividends on the Statements of Capital Accounts, and dividends on mandatorily redeemable capital stock are recognized as interest expense on the Statements of Income.
34
On February 18, 2016, the Bank’s Board of Directors declared a cash dividend on the capital stock outstanding during the fourth quarter of 2015 at an annualized rate of 7.99% totaling $55 million, including $45 million in dividends on capital stock and $10 million in dividends on mandatorily redeemable capital stock. The Bank recorded the dividend on February 18, 2016. The Bank expects to pay the dividend on or about March 17, 2016. Dividends on mandatorily redeemable capital stock will be recognized as interest expense in the first quarter of 2016.
The Bank will continue to monitor the condition of its PLRMBS portfolio, the ratio of the Bank’s estimated market value of total capital to par value of 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 payment of dividends in future quarters.
Comparison of 2014 to 2013
Net Interest Income. The Average Balance Sheets table that follows presents the average balances of interest-earning asset categories and the sources that funded those interest-earning assets (liabilities and capital) for the years ended December 31, 2014 and 2013, together with the related interest income and expense. It also presents the average rates on total interest-earning assets and the average costs of total funding sources.
35
| Average Balance Sheets | |||||||||||||||||||||
| 2014 | 2013 | ||||||||||||||||||||
| (Dollars in millions) | Average Balance | Interest Income/ Expense | Average Rate | Average Balance | Interest Income/ Expense | Average Rate | |||||||||||||||
| Assets | |||||||||||||||||||||
| Interest-earning assets: | |||||||||||||||||||||
| Interest-bearing deposits | $ | 325 | $ | — | 0.01 | % | $ | 54 | $ | — | 0.04 | % | |||||||||
| Securities purchased under agreements to resell | 1,436 | 1 | 0.06 | 1,315 | 1 | 0.10 | |||||||||||||||
| Federal funds sold | 9,602 | 11 | 0.12 | 10,146 | 15 | 0.15 | |||||||||||||||
| Trading securities: | |||||||||||||||||||||
| Mortgage-backed securities (MBS) | 12 | — | 1.63 | 14 | — | 1.66 | |||||||||||||||
| Other investments | 3,432 | 6 | 0.18 | 3,284 | 7 | 0.21 | |||||||||||||||
Available-for-sale (AFS) securities:(1) | |||||||||||||||||||||
MBS(2) | 6,700 | 278 | 4.15 | 7,692 | 276 | 3.59 | |||||||||||||||
Held-to-maturity (HTM) securities:(1) | |||||||||||||||||||||
| MBS | 14,338 | 358 | 2.49 | 14,818 | 386 | 2.60 | |||||||||||||||
| Other investments | 2,111 | 4 | 0.20 | 2,462 | 6 | 0.22 | |||||||||||||||
| Mortgage loans held for portfolio | 806 | 42 | 5.16 | 1,080 | 50 | 4.63 | |||||||||||||||
Advances(3) | 45,104 | 305 | 0.68 | 45,854 | 345 | 0.75 | |||||||||||||||
| Loans to other FHLBanks | 3 | — | 0.07 | 8 | — | 0.07 | |||||||||||||||
| Total interest-earning assets | 83,869 | 1,005 | 1.20 | 86,727 | 1,086 | 1.25 | |||||||||||||||
Other assets(4)(5) | 929 | — | — | 1,050 | — | — | |||||||||||||||
| Total Assets | $ | 84,798 | $ | 1,005 | 1.19 | % | $ | 87,777 | $ | 1,086 | 1.24 | % | |||||||||
| Liabilities and Capital | |||||||||||||||||||||
| Interest-bearing liabilities: | |||||||||||||||||||||
| Consolidated obligations: | |||||||||||||||||||||
Bonds(3) | $ | 52,805 | $ | 326 | 0.62 | % | $ | 60,913 | $ | 432 | 0.71 | % | |||||||||
| Discount notes | 23,582 | 20 | 0.09 | 16,325 | 17 | 0.10 | |||||||||||||||
| Deposits and other borrowings | 835 | — | 0.05 | 288 | — | 0.13 | |||||||||||||||
| Mandatorily redeemable capital stock | 1,348 | 120 | 8.88 | 3,376 | 155 | 4.59 | |||||||||||||||
| Total interest-bearing liabilities | 78,570 | 466 | 0.59 | 80,902 | 604 | 0.75 | |||||||||||||||
Other liabilities(4) | 501 | — | — | 1,122 | — | — | |||||||||||||||
| Total Liabilities | 79,071 | 466 | 0.59 | 82,024 | 604 | 0.74 | |||||||||||||||
| Total Capital | 5,727 | — | — | 5,753 | — | — | |||||||||||||||
| Total Liabilities and Capital | $ | 84,798 | $ | 466 | 0.55 | % | $ | 87,777 | $ | 604 | 0.69 | % | |||||||||
| Net Interest Income | $ | 539 | $ | 482 | |||||||||||||||||
Net Interest Spread(6) | 0.61 | % | 0.50 | % | |||||||||||||||||
Net Interest Margin(7) | 0.64 | % | 0.56 | % | |||||||||||||||||
| Interest-earning Assets/Interest-bearing Liabilities | 106.74 | % | 107.20 | % | |||||||||||||||||
| (1) | The average balances of AFS securities and HTM securities are reflected at amortized cost. As a result, the average rates do not reflect changes in fair value or non-credit-related OTTI losses. |
| (2) | Interest income on AFS securities includes accretion of yield adjustments on other-than-temporarily impaired PLRMBS (resulting from improvement in expected cash flows) totaling $68 million and $26 million in 2014 and 2013, respectively. |
| (3) | Interest income/expense and average rates include the effect of associated interest rate exchange agreements, as follows: |
36
| 2014 | 2013 | ||||||||||||||||||||||
| (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 | $ | (4 | ) | $ | (128 | ) | $ | (132 | ) | $ | (7 | ) | $ | (126 | ) | $ | (133 | ) | |||||
| Consolidated obligation bonds | 5 | 260 | 265 | 47 | 366 | 413 | |||||||||||||||||
| (4) | Includes forward settling transactions and valuation adjustments for certain cash items. |
| (5) | Includes non-credit-related OTTI losses on AFS and HTM 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 divided by average interest-earning assets. |
Net interest income in 2014 was $539 million, a 12% increase from $482 million in 2013. The following table details the changes in interest income and interest expense for 2014 compared to 2013. 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 2014 Compared to 2013 | |||||||||||
Increase/ (Decrease) | Attributable to Changes in(1) | ||||||||||
| (In millions) | Average Volume | Average Rate | |||||||||
| Interest-earning assets: | |||||||||||
| Federal funds sold | (4 | ) | (1 | ) | (3 | ) | |||||
| Trading securities: Other investments | (1 | ) | — | (1 | ) | ||||||
| AFS securities: | |||||||||||
| MBS | 2 | (38 | ) | 40 | |||||||
| HTM securities: | |||||||||||
| MBS | (28 | ) | (12 | ) | (16 | ) | |||||
| Other investments | (2 | ) | (1 | ) | (1 | ) | |||||
| Mortgage loans held for portfolio | (8 | ) | (13 | ) | 5 | ||||||
Advances(2) | (40 | ) | (6 | ) | (34 | ) | |||||
| Total interest-earning assets | (81 | ) | (71 | ) | (10 | ) | |||||
| Interest-bearing liabilities: | |||||||||||
| Consolidated obligations: | |||||||||||
Bonds(2) | (106 | ) | (54 | ) | (52 | ) | |||||
| Discount notes | 3 | 6 | (3 | ) | |||||||
| Mandatorily redeemable capital stock | (35 | ) | (127 | ) | 92 | ||||||
| Total interest-bearing liabilities | (138 | ) | (175 | ) | 37 | ||||||
| Net interest income | $ | 57 | $ | 104 | $ | (47 | ) | ||||
| (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. |
The net interest margin was 64 basis points for 2014, 8 basis points higher than the net interest margin for 2013, which was 56 basis points. The net interest spread was 61 basis points for 2014, 11 basis points higher than the net interest spread for 2013, which was 50 basis points. These increases were primarily due to improved spreads on interest-earning assets, including the accretion of yield adjustments on certain other-than-temporarily impaired PLRMBS resulting from improvement in expected cash flows, partially offset by a decrease in earnings on invested capital because of lower average capital balances and the lower interest rate environment.
For securities previously identified as other-than-temporarily impaired, the Bank updates its estimate of future estimated cash flows on a regular basis. If there is no additional impairment on the security, the yield of the security
37
is adjusted upward on a prospective basis and accreted into interest income when there is a significant increase in the expected cash flows. If there continue to be improvements in the estimated cash flows of securities previously identified as other-than-temporarily impaired, the accretion of yield adjustments is likely to continue to be a positive source of net interest income in future periods.
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 years ended December 31, 2014 and 2013.
| Other Income/(Loss) | |||||||
| (In millions) | 2014 | 2013 | |||||
| Other Income/(Loss): | |||||||
Net gain/(loss) on trading securities(1) | $ | (1 | ) | $ | 2 | ||
| Total OTTI loss | (14 | ) | (14 | ) | |||
| Net amount of OTTI loss reclassified to/(from) AOCI | 10 | 7 | |||||
| Net OTTI loss, credit-related | (4 | ) | (7 | ) | |||
| Net gain/(loss) on advances and consolidated obligation bonds held under fair value option | (93 | ) | (23 | ) | |||
| Net gain/(loss) on derivatives and hedging activities | (64 | ) | 26 | ||||
| Other | 8 | 7 | |||||
| Total Other Income/(Loss) | $ | (154 | ) | $ | 5 | ||
| (1) | The net gain/(loss) on trading securities that were economically hedged totaled $(1) million and $2 million in 2014 and 2013, respectively. |
Net Other-Than-Temporary Impairment Loss, Credit-Related – Each quarter, the Bank updates its OTTI analysis to reflect current housing market conditions, changes in anticipated housing market conditions, observed and anticipated borrower behavior, and updated information on the loans supporting the Bank’s PLRMBS.
Additional information about the OTTI loss is provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Investments” and in “Item 8. Financial Statements and Supplementary Data – Note 7 – Other-Than-Temporary Impairment Analysis.”
Net Gain/(Loss) on Advances and Consolidated Obligation Bonds Held Under Fair Value Option – The following table presents the net gain/(loss) on advances and consolidated obligation bonds held under the fair value option for the years ended December 31, 2014 and 2013.
| Net Gain/(Loss) on Advances and Consolidated Obligation Bonds Held Under Fair Value Option | |||||||
| (In millions) | 2014 | 2013 | |||||
| Advances | $ | (11 | ) | $ | (169 | ) | |
| Consolidated obligation bonds | (82 | ) | 146 | ||||
| Total | $ | (93 | ) | $ | (23 | ) | |
38
Under the fair value option, the Bank elected to carry certain assets and liabilities at fair value. 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 the derivatives that economically hedge these instruments.
The unrealized net fair value gains/(losses) on advances and consolidated obligation bonds were primarily driven by the effects of changes in market interest rates, interest rate spreads, interest rate volatility, and other market factors relative to the actual terms on the advances and consolidated obligation bonds during the period.
Additional information about advances and consolidated obligation bonds held under the fair value option is provided in “Item 8. Financial Statements and Supplementary Data – Note 19 – Fair Value.”
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 gain/(loss) on derivatives and hedging activities” in 2014 and 2013.
Sources of Gains/(Losses) Recorded in Net Gain/(Loss) on Derivatives and Hedging Activities 2014 Compared to 2013 | |||||||||||||||||||||||||||||||
| (In millions) | 2014 | 2013 | |||||||||||||||||||||||||||||
| Gain/(Loss) | Income/ (Expense) on | Gain/(Loss) | 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 | $ | — | $ | 21 | $ | (100 | ) | $ | (79 | ) | $ | — | $ | 156 | $ | (114 | ) | $ | 42 | ||||||||||||
| Not elected for fair value option | — | 5 | (7 | ) | (2 | ) | 3 | 17 | (16 | ) | 4 | ||||||||||||||||||||
| Consolidated obligation bonds: | |||||||||||||||||||||||||||||||
| Elected for fair value option | — | 36 | 59 | 95 | — | (100 | ) | 66 | (34 | ) | |||||||||||||||||||||
| Not elected for fair value option | (12 | ) | (24 | ) | 24 | (12 | ) | (5 | ) | (113 | ) | 120 | 2 | ||||||||||||||||||
| Consolidated obligation discount notes: | |||||||||||||||||||||||||||||||
| Not elected for fair value option | — | (12 | ) | (39 | ) | (51 | ) | — | 34 | (21 | ) | 13 | |||||||||||||||||||
| MBS: | |||||||||||||||||||||||||||||||
| Not elected for fair value option | — | (15 | ) | — | (15 | ) | — | — | — | — | |||||||||||||||||||||
| Non-MBS investments: | |||||||||||||||||||||||||||||||
| Not elected for fair value option | — | 1 | (1 | ) | — | — | — | (1 | ) | (1 | ) | ||||||||||||||||||||
| Total | $ | (12 | ) | $ | 12 | $ | (64 | ) | $ | (64 | ) | $ | (2 | ) | $ | (6 | ) | $ | 34 | $ | 26 | ||||||||||
During 2014, net losses on derivatives and hedging activities totaled $64 million compared to net gains of $26 million in 2013. These amounts included expense of $64 million and income of $34 million resulting from net settlements on derivative instruments used in economic hedges in 2014 and 2013, respectively. Excluding the impact of income or expense from net settlements on derivative instruments used in economic hedges, the net gains or losses on fair value and economic hedges were primarily associated with the effects of changes in market interest rates, interest rate spreads, interest rate volatility, and other market factors during the period.
The ongoing impact of these valuation adjustments on the Bank cannot be predicted and 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 8. Financial Statements and Supplementary Data – Note 18 – Derivatives and Hedging Activities.”
39
Other Expense. Other expenses were $144 million in 2014 compared to $128 million in 2013, primarily reflecting higher operating expenses in 2014.
Return on Average Equity. Return on average equity (ROE) was 3.58% in 2014, compared to 5.36% in 2013. The decrease reflected the decrease in net income in 2014.
Dividends and Retained Earnings. In 2014, the Bank paid dividends at an annualized rate of 7.02%, totaling $360 million, including $240 million in dividends on capital stock and $120 million in dividends on mandatorily redeemable capital stock. In 2013, the Bank paid dividends at an annualized rate of 3.99%, totaling $316 million, including $161 million in dividends on capital stock and $155 million in dividends on mandatorily redeemable capital stock.
The Bank paid these dividends in cash. Dividends on capital stock are recognized as dividends on the Statements of Capital Accounts, and dividends on mandatorily redeemable capital stock are recognized as interest expense on the Statements of Income.
Retained earnings related to the JCE Agreement totaled $230 million and $189 million at December 31, 2014 and 2013, respectively.
For more information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations – Comparison of 2015 to 2014 – Dividends and Retained Earnings.”
Financial Condition
Total assets were $85.7 billion at December 31, 2015, compared to $75.8 billion at December 31, 2014. Advances increased by $11.9 billion, or 31%, to $50.9 billion at December 31, 2015, from $39.0 billion at December 31, 2014. MBS decreased by $3.6 billion, or 18%, to $16.0 billion at December 31, 2015, from $19.6 billion at December 31, 2014. Average total assets were $83.8 billion for 2015, a 1% decrease compared to $84.8 billion for 2014. Average advances were $51.9 billion for 2015, a 15% increase from $45.1 billion for 2014. Average MBS were $17.6 billion for 2015, a 17% decrease from $21.1 billion for 2014.
Advances outstanding at December 31, 2015, included unrealized gains of $78 million, of which $40 million represented unrealized gains on advances hedged in accordance with the accounting for derivative instruments and hedging activities and $38 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, 2014, included unrealized gains of $156 million, of which $67 million represented unrealized gains on advances hedged in accordance with the accounting for derivative instruments and hedging activities and $89 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 on the hedged advances and advances carried at fair value from December 31, 2014, to December 31, 2015, was primarily attributable to the effects of changes in market interest rates, interest rate spreads, interest rate volatility, and other market factors relative to the terms on the Bank’s advances during the period.
Total liabilities were $80.8 billion at December 31, 2015, an increase of $10.7 billion from $70.1 billion at December 31, 2014, reflecting an increase in consolidated obligations outstanding from $68.9 billion at December 31, 2014, to $79.5 billion at December 31, 2015, partially offset by a decrease in mandatorily redeemable capital stock from $0.7 billion at December 31, 2014, to $0.5 billion at December 31, 2015. The decrease in mandatorily redeemable capital stock was primarily attributable to the Bank’s repurchase of excess capital stock during 2015. Average total liabilities were $78.4 billion for 2015, a 1% decrease compared to $79.1 billion for 2014. Average consolidated obligations were $76.3 billion for 2015 and $76.4 billion for 2014. Average mandatorily redeemable capital stock was $0.4 billion for 2015, and $1.3 billion for 2014.
40
Consolidated obligations outstanding at December 31, 2015, included unrealized losses of $142 million on consolidated obligation bonds hedged in accordance with the accounting for derivative instruments and hedging activities and unrealized gains of $17 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, 2014, included unrealized losses of $308 million on consolidated obligation bonds hedged in accordance with the accounting for derivative instruments and hedging activities and unrealized gains of $31 million on economically hedged consolidated obligation bonds that are carried at fair value in accordance with the fair value option. The decrease in the unrealized losses on the hedged consolidated obligation bonds and the decrease in the unrealized gains on the consolidated obligation bonds carried at fair value from December 31, 2014, to December 31, 2015, were primarily attributable to the effects of changes in market interest rates, interest rate spreads, interest rate volatility, and other market factors relative to the actual terms on the Bank's consolidated obligation bonds during the period.
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 December 31, 2015, 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 value of the outstanding consolidated obligations of the FHLBanks was $905.2 billion at December 31, 2015, and $847.2 billion at December 31, 2014.
On October 2, 2015, Standard & Poor’s Rating Services (Standard & Poor’s) affirmed the long-term issuer credit ratings on all of the FHLBanks at AA+. The outlook for all ratings remained stable.
On December 21, 2015, Moody’s Investors Service (Moody’s) affirmed the Aaa long-term ratings of the FHLBank System. The outlook for all ratings remained stable.
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 or withdraw 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 the other FHLBanks as of December 31, 2015, and as of each period end presented, and does not believe, as of the date of this report, that it is probable that the Bank will be required to repay any principal or interest associated with consolidated obligations for which the Bank is not the primary obligor.
The Bank’s 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 income and expense associated with net settlements from economic hedges that are recorded in “Net gain/(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 credit-related OTTI losses on the Bank’s PLRMBS, other expenses, and assessments, is not included in the segment reporting analysis, but is incorporated into the Bank’s overall assessment of financial performance. For a reconciliation of the Bank’s operating segment adjusted
41
net interest income to the Bank’s total net interest income, see “Item 8. Financial Statements and Supplementary Data – Note 17 – Segment Information.”
Advances-Related Business. The advances-related business consists of advances and other credit products, related financing and hedging instruments, and liquidity and other non-MBS investments associated with the Bank’s role as a liquidity provider, and capital. Assets associated with this segment increased $13.6 billion, or 25%, to $69.0 billion (81% of total assets) at December 31, 2015, from $55.4 billion (73% of total assets) at December 31, 2014.
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 net settlements from associated interest rate exchange agreements, and from earnings on capital.
Adjusted net interest income for this segment was $155 million in 2015, a decrease of $11 million, or 7%, compared with $166 million in 2014. The decrease was primarily due to a decline in spreads on advances-related assets and a decline in earnings on invested capital because of lower average capital balances, partially offset by an increase in earnings because of higher advances balances.
Adjusted net interest income for this segment was $166 million in 2014, a decrease of $9 million, or 5%, compared
with $175 million in 2013. The decrease was primarily due to a decline in earnings on invested capital because of
lower average capital balances and the lower interest rate environment, as well as lower earnings on non-MBS
investments, partially offset by improved spreads on advances-related assets.
Adjusted net interest income for this segment represented 31%, 29% and 28% of total adjusted net interest income for 2015, 2014, and 2013, respectively.
Members and nonmember borrowers prepaid $2.2 billion of advances in 2015 compared to $1.7 billion in 2014. Interest income was increased by net prepayment fees of $8 million in 2015 and $6 million in 2014.
Advances – The par value of advances outstanding increased by $12.0 billion, or 31%, to $50.8 billion at December 31, 2015, from $38.8 billion at December 31, 2014. Average advances outstanding were $51.9 billion in 2015, a 15% increase from $45.1 billion in 2014.
The increase in advances outstanding was primarily attributable to a $10.3 billion net increase in advances outstanding to the Bank’s top five borrowers and their affiliates, including JPMorgan Chase, whose advances and capital stock exceeded 10% of the Bank’s total advances and capital stock, respectively, as of December 31, 2015. (See “Item 8. Financial Statements and Supplementary Data – Note 8 – Advances– Credit and Concentration Risk” and “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital – Concentration” for further information.) Advances to the top five borrowers increased to $31.7 billion at December 31, 2015, from $21.4 billion at December 31, 2014. Two of the top five borrowers increased their borrowings from the Bank during 2015, while the remaining three borrowers decreased their borrowings from the Bank. The increase was also attributable to a $1.7 billion increase in total advances outstanding to the Bank’s other borrowers of varying asset sizes and charter types. (See “Item 8. Financial Statements and Supplementary Data – Note 8 – Advances” for further information.)
The $12.0 billion increase in advances outstanding primarily reflected a $13.9 billion increase in adjustable rate advances and a $3.4 billion increase in variable rate advances, partially offset by a $5.3 billion decrease in fixed rate advances.
The components of the advances portfolio at December 31, 2015 and 2014, are presented in the following table.
42
| Advances Portfolio by Product Type | |||||||||||||
| 2015 | 2014 | ||||||||||||
| (Dollar in millions) | Par Value | Percentage of Total Par Value | Par Value | Percentage of Total Par Value | |||||||||
| Adjustable – LIBOR | $ | 5,912 | 12 | % | $ | 7,068 | 19 | % | |||||
| Adjustable – LIBOR, callable at borrower’s option | 15,150 | 30 | — | — | |||||||||
| Adjustable – LIBOR, with caps and/or floors | 50 | — | 56 | — | |||||||||
Adjustable – LIBOR, with caps and/or floors and PPS(1) | 30 | — | 100 | — | |||||||||
| Adjustable – Other Indices | 2 | — | — | — | |||||||||
| Subtotal adjustable rate advances | 21,144 | 42 | 7,224 | 19 | |||||||||
| Fixed | 18,674 | 37 | 22,626 | 58 | |||||||||
| Fixed – amortizing | 231 | — | 242 | 1 | |||||||||
Fixed – with PPS(1) | 2,859 | 5 | 3,991 | 10 | |||||||||
Fixed – with caps and PPS(1) | 275 | 1 | 425 | 1 | |||||||||
| Fixed – callable at borrower’s option | 4 | — | 4 | — | |||||||||
Fixed – callable at borrower’s option with PPS(1) | 271 | 1 | 324 | 1 | |||||||||
| Fixed – putable at Bank’s option | 65 | — | 65 | — | |||||||||
Fixed – putable at Bank’s option with PPS(1) | 75 | — | 75 | — | |||||||||
| Subtotal fixed rate advances | 22,454 | 44 | 27,752 | 71 | |||||||||
| Daily variable rate | 7,243 | 14 | 3,854 | 10 | |||||||||
| Total par value | $ | 50,841 | 100 | % | $ | 38,830 | 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. |
For a discussion of advances credit risk, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – 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 and to support the operations of the Bank. The Bank’s total non-MBS investment portfolio was $16.3 billion and $12.3 billion as of December 31, 2015 and 2014, respectively. The increase in the total size of the non-MBS investment portfolio reflects higher balances of short-term securities purchased under agreements to resell, partially offset by lower balances of Federal funds sold and agency debentures.
Cash and Due from Banks – Cash and due from banks was $1.6 billion at December 31, 2015, a $2.3 billion decrease compared to December 31, 2014. Cash and due from banks is largely composed of cash held at the Federal Reserve Bank of San Francisco and can increase or decrease depending on the availability of other investment opportunities.
Borrowings – Total liabilities (primarily consolidated obligations) funding the advances-related business increased to $64.1 billion at December 31, 2015, from $49.7 billion at December 31, 2014. 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 8. Financial Statements and Supplementary Data – Note 20 – Commitments and Contingencies.”
43
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 December 31, 2015, the notional amount of interest rate exchange agreements associated with the advances-related business totaled $72.6 billion, of which $17.4 billion were hedging advances, $54.6 billion were hedging consolidated obligations, $0.5 billion were economically hedging trading securities, and $0.1 billion were offsetting derivatives. At December 31, 2014, the notional amount of interest rate exchange agreements associated with the advances-related business totaled $55.2 billion, of which $17.8 billion were hedging advances, $35.0 billion were hedging consolidated obligations, and $2.4 billion were economically hedging trading securities. 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 costs of debt issued by the FHLBanks and the other GSEs generally rise and fall with increases and decreases in general market interest rates.
On December 16, 2015, the Federal Open Market Committee (FOMC) changed the target Federal funds rate for the first time since 2008. The new target range for the Federal funds rate was set to 0.25% to 0.50% in response to a continued moderate increase in economic activity and improvement in labor market conditions. As of December 31, 2015, rates on 3-month U.S. Treasury bills, 3-month LIBOR, and 2-year and 5-year U.S. Treasury notes increased compared with December 31, 2014.
| Selected Market Interest Rates | ||||||||
| Market Instrument | December 31, 2015 | December 31, 2014 | ||||||
| Federal Reserve target range for overnight Federal funds | 0.25-0.50 | % | 0-0.25 | % | ||||
| 3-month Treasury bill | 0.16 | 0.03 | ||||||
| 3-month LIBOR | 0.61 | 0.26 | ||||||
| 2-year Treasury note | 1.05 | 0.67 | ||||||
| 5-year Treasury note | 1.76 | 1.65 | ||||||
The following table presents a comparison of the average issuance cost of FHLBank System consolidated obligation bonds and discount notes converted to LIBOR-indexed liabilities through interest rate swaps in 2015 and 2014. The average issuance cost of consolidated obligation bonds relative to LIBOR was slightly more expensive in 2015 compared to 2014, while the average cost of consolidated obligation discount notes improved over the same period.
Spread to LIBOR of Average Cost of Consolidated Obligations for the Twelve Months Ended | |||
| (In basis points) | December 31, 2015 | December 31, 2014 | |
| Consolidated obligation bonds | –11.8 | –12.4 | |
| Consolidated obligation discount notes (one month and greater) | –15.8 | –14.7 | |
44
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. 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 net settlements from associated interest rate exchange agreements.
At December 31, 2015, assets associated with this segment were $16.7 billion (19% of total assets), a decrease of $3.7 billion from $20.4 billion at December 31, 2014 (27% of total assets).
Adjusted net interest income for this segment was $351 million in 2015, a decrease of $59 million, or 14%, from $410 million in 2014. The decrease was primarily due to lower average unpaid principal balances of MBS and mortgage loans and reduced spreads on mortgage-related assets, partially offset by the net accretion, which includes yield adjustments on certain other-than-temporarily impaired PLRMBS resulting from improvement in expected cash flows.
Adjusted net interest income for this segment represented 69%, 71%, and 72% of total adjusted net interest income for 2015, 2014, and 2013, respectively.
MBS Investments – The Bank’s MBS portfolio was $16.0 billion at December 31, 2015, compared with $19.6 billion at December 31, 2014. During 2015, the Bank’s MBS portfolio decreased primarily because of principal repayments totaling $3.7 billion. In 2015, average MBS investments were $17.6 billion, a decrease of $3.5 billion from $21.1 billion in 2014. 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 8. Financial Statements and Supplementary Data – Note 7 – Other-Than-Temporary Impairment Analysis.”
Intermediate-term and long-term fixed rate MBS investments are subject to prepayment risk, and intermediate-term and long-term adjustable rate MBS investments are also subject to interest rate cap risk. The Bank has managed these risks predominately by 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. The Bank has purchased interest rate caps to hedge some of the interest rate cap risk associated with the long-term adjustable rate MBS investments.
MPF Program – Under the MPF Program, the Bank may purchase from members, for its own portfolio, conventional conforming fixed rate mortgage loans under the MPF Original product and mortgage loans insured by the Federal Housing Administration (FHA) or guaranteed by the Department of Veterans Affairs (VA) under the MPF Government product. In addition, the Bank may facilitate the purchase of conforming fixed rate mortgage loans from members for concurrent sale to Fannie Mae under the MPF Xtra product and of jumbo fixed rate mortgage loans for concurrent sale to Redwood Residential Acquisition Corporation, a subsidiary of Redwood Trust, Inc., a real estate investment trust, under the MPF Direct product. As of December 31, 2015, the Bank had approved ten members as participating financial institutions since renewing its participation in the MPF Program in 2013.
From May 2002 through October 2006, the Bank purchased conventional conforming fixed rate mortgage loans from its participating financial institutions under the MPF Original and MPF Plus products. 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.
As of December 31, 2015, all mortgage loans purchased by the Bank under the MPF Program were qualifying conventional conforming fixed rate, first lien mortgage loans with fully amortizing loan terms of up to 30 years. A conventional loan is one that is not insured by the federal government or any of its agencies. Conforming loan size, which is established annually as required by Finance Agency regulations, may not exceed the loan limits set by the
45
Finance Agency each year. All MPF loans are secured by owner-occupied, one- to four-unit residential properties or single-unit second homes.
The MPF Servicing Guide establishes the MPF Program requirements for loan servicing and servicer eligibility. At the time the Bank purchases loans under the MPF Program, the member selling the loans makes representations that all mortgage loans it delivers to the Bank have the characteristics of an investment quality mortgage. An investment quality mortgage is a loan that is made to a borrower from whom repayment of the debt can be expected, is adequately secured by real property, and was originated and is being serviced in accordance with the MPF Origination Guide and MPF Servicing Guide or an approved waiver.
The FHLBank of Chicago, which developed the MPF Program, establishes the minimum eligibility standards for members to participate in the program, the structure of the MPF products, and the standard eligibility criteria for the loans; establishes pricing and manages the delivery mechanism for the loans; publishes and maintains the MPF Origination Guide and the MPF Servicing Guide; and provides operational support for the program. In addition, the FHLBank of Chicago acts as master servicer and as master custodian for the MPF loans held by the Bank and is compensated for these services through fees paid by the Bank. The FHLBank of Chicago is obligated to provide operational support to the Bank for all loans purchased until those loans are fully repaid.
Mortgage loan balances decreased to $655 million at December 31, 2015, from $708 million at December 31, 2014, a decrease of $53 million. Average mortgage loans were $675 million in 2015, a decrease of $131 million from $806 million in 2014.
At December 31, 2015, and 2014, the Bank held conventional conforming fixed rate mortgage loans purchased under one of two MPF products, MPF Plus or MPF Original, which are described in greater detail in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – MPF Program.” The Bank purchased $131 million in eligible loans under the MPF Original product during 2015. Mortgage loan balances at December 31, 2015 and 2014, were as follows:
| Mortgage Loan Balances by MPF Product Type | |||||||
| (In millions) | 2015 | 2014 | |||||
| MPF Plus | $ | 486 | $ | 653 | |||
| MPF Original | 167 | 60 | |||||
| Subtotal | 653 | 713 | |||||
| Unamortized premiums | 10 | 6 | |||||
| Unamortized discounts | (8 | ) | (10 | ) | |||
| Mortgage loans held for portfolio | 655 | 709 | |||||
| Less: Allowance for credit losses | — | (1 | ) | ||||
| Mortgage loans held for portfolio, net | $ | 655 | $ | 708 | |||
The following table presents the balances of loans wholly owned by the Bank and loans with allocated participation interests that were outstanding as of December 31, 2015 and 2014. Only the FHLBank of Chicago owned participation interests in any of the Bank’s MPF loans.
46
| Balances Outstanding on Mortgage Loans | |||||||
| (Dollars in millions) | 2015 | 2014 | |||||
| Outstanding amounts wholly owned by the Bank | $ | 472 | $ | 462 | |||
| Outstanding amounts with participation interests by FHLBank: | |||||||
| San Francisco | 181 | 251 | |||||
| Chicago | 116 | 156 | |||||
| Total | $ | 769 | $ | 869 | |||
| Number of loans outstanding: | |||||||
| Number of outstanding loans wholly owned by the Bank | 3,624 | 4,111 | |||||
| Number of outstanding loans participated | 4,104 | 5,013 | |||||
| Total number of loans outstanding | 7,728 | 9,124 | |||||
Under the Bank’s agreement with the FHLBank of Chicago, the credit risk is shared pro rata between the two FHLBanks according to: (i) their respective ownership of the loans in each master commitment for MPF Plus and (ii) their respective participation shares of the first loss account for the master commitment for MPF Original.
The Bank is responsible for credit oversight of the participating financial institution, which consists of monitoring the financial condition of the participating financial institution on a quarterly basis and holding collateral to secure the participating financial institution’s outstanding credit enhancement obligations. Monitoring of the participating financial institution’s financial condition includes an evaluation of its capital, assets, management, earnings, and liquidity.
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 the Bank’s mortgage loan portfolio, see “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.”
The Bank manages the interest rate risk and prepayment risk of the mortgage loans by funding these assets with callable and non-callable debt, by entering into certain interest rate swaps, and by limiting the size of the fixed rate mortgage loan portfolio.
Borrowings – Total consolidated obligations funding the mortgage-related business decreased $3.7 billion to $16.7 billion at December 31, 2015, from $20.4 billion at December 31, 2014, paralleling the decrease 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 8. Financial Statements and Supplementary Data – Note 20 – Commitments and Contingencies.”
The notional amount of interest rate exchange agreements associated with the mortgage-related business totaled $7.2 billion at December 31, 2015, of which $5.0 billion were hedging or were associated with consolidated obligations funding the mortgage portfolio and $2.2 billion were associated with MBS. The notional amount of interest rate exchange agreements associated with the mortgage-related business totaled $7.1 billion at December 31, 2014, of which $4.9 billion were hedging or were associated with consolidated obligations funding the mortgage portfolio and $2.2 billion were associated with MBS.
47
Liquidity and Capital Resources
The Bank’s financial strategies are designed to enable the Bank to expand and contract its assets, liabilities, and capital as membership composition and member credit needs change. The Bank’s liquidity and capital resources are designed to support its financial strategies. The Bank’s primary source of liquidity is its access to the debt capital markets through consolidated obligation issuance, which is described in “Item 1. Business – Funding Sources.” The Bank’s status as a GSE is critical to maintaining its access to the capital markets. Although consolidated obligations are backed only by the financial resources of the FHLBanks and are not guaranteed by the U.S. government, the capital markets have traditionally treated the FHLBanks’ consolidated obligations as comparable to federal agency debt, providing the FHLBanks with access to funding at relatively favorable rates. The maintenance of the Bank’s capital resources are governed by its capital plan.
Liquidity
The Bank strives to maintain the liquidity necessary to repay maturing consolidated obligations for which it is the primary obligor, meet other obligations and commitments, and meet expected and unexpected member credit demands. The Bank monitors its financial position in order to maintain ready access to sufficient liquid funds to meet normal transaction requirements, take advantage of appropriate investment opportunities, and cover unforeseen liquidity demands.
The Bank’s ability to expand as member credit needs increase is based, in part, on the capital stock requirements for advances. A member is required to maintain sufficient capital stock to support its advances activity and loan sale activity with the Bank. Unless a member already has sufficient excess capital stock, it must increase its capital stock investment in the Bank as its balance of outstanding advances increases and as it sells mortgage loans to the Bank. The activity-based capital stock requirement is currently 2.7% for outstanding advances and 0.0% for mortgage loans purchased and held by the Bank, while the Bank’s minimum regulatory capital-to-assets ratio requirement is currently 4.0%. Because the Bank’s capital plan does not provide for the issuance of Class A stock (non-permanent capital that is redeemable upon six months’ notice), regulatory capital for the Bank is composed of retained earnings and Class B stock, including mandatorily redeemable capital stock (which is classified as a liability for financial reporting purposes), and excludes AOCI.
The Bank is also able to contract its balance sheet as borrowers’ credit needs decrease. As changing borrower credit
needs result in reduced advances, borrowers will have capital stock in excess of the amount required by the Bank’s
capital plan. The Bank’s capital plan allows the Bank to repurchase a borrower’s excess capital stock, at the Bank’s
discretion. On May 29, 2015, the Bank reinstated its practice of repurchasing the surplus capital stock of all members and the excess capital stock of all nonmember shareholders on a regular quarterly basis, at the Bank’s discretion and subject to certain statutory and regulatory requirements and to the Bank’s Risk Management Policy and capital plan limitations. Surplus capital stock is defined as any stock holdings in excess of 115% of a member’s minimum stock requirement.
The Bank may also allow its consolidated obligations to mature without replacement or repurchase and retire outstanding consolidated obligations, allowing its balance sheet to contract.
The Bank amended its capital plan, effective April 1, 2015, to lower the cap on the membership stock requirement to $15 million from $25 million, lower the activity-based stock requirement to 3.0% from 4.7% for outstanding advances and to 3.0% from 5.0% for mortgage loans purchased and held by the Bank, and change the authorized ranges for the activity-based stock requirement to a range of 2.0% to 5.0% from a range of 4.4% to 5.0% for advances and to a range of 0.0% to 5.0% from a range of 5.0% to 5.7% for mortgage loans purchased and held by the Bank. Effective August 3, 2015, the Bank reduced its activity-based stock requirements within the ranges authorized by the Bank’s capital plan. The activity-based stock requirement for advances was reduced from 3.0% to 2.7%, and the activity-based stock requirement for mortgage loans purchased from the member and held by the Bank was reduced from 3.0% to 0.0%.
48
The Bank maintained its strong regulatory capital position while repurchasing $2.0 billion and $2.0 billion in excess capital stock during 2014 and 2015, respectively, and redeeming $296 million and $53 million in mandatorily redeemable capital stock in 2014 and 2015, respectively. Total excess capital stock was $0.4 billion as of December 31, 2015, compared to $1.1 billion as of December 31, 2014.
The Bank is not able to predict future trends in member credit needs since they are driven by complex interactions among a number of factors, including members’ mortgage loan growth, other asset portfolio growth, deposit growth, and the attractiveness of advances compared to other wholesale borrowing alternatives. The Bank regularly monitors current trends and anticipates future debt issuance needs with the objective of being prepared to fund its members’ credit needs and appropriate investment opportunities.
Short-term liquidity management practices are described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Liquidity Risk.” The Bank manages its liquidity needs to enable it to meet all of its contractual obligations on a timely basis, to support its members’ daily liquidity needs, and to pay operating expenditures as they come due. The Bank maintains contingency liquidity plans 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. For further information and discussion of the Bank’s guarantees and other commitments, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Off-Balance Sheet Arrangements and Aggregate Contractual Obligations.” 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 8. Financial Statements and Supplementary Data – Note 20 – Commitments and Contingencies.”
Capital
The Bank may repurchase some or all of a shareholder’s excess capital stock, including any excess mandatorily redeemable capital stock, at the Bank’s discretion, subject to certain statutory and regulatory requirements. The Bank must give the shareholder 15 days’ written notice; however, the shareholder may waive this notice period. The Bank may also repurchase all of a member's excess capital stock at a member’s request, at the Bank’s discretion, subject to certain statutory and regulatory requirements. Excess capital stock is defined as any capital stock holdings in excess of a shareholder's minimum capital stock requirement, as established by the Bank’s capital plan.
A member may schedule redemption of its excess capital stock following a five-year redemption period, subject to certain conditions, by providing a written redemption notice to the Bank. Capital stock may also become subject to redemption following a five-year redemption period after a member gives notice of intention to withdraw from membership or attains nonmember status by merger or acquisition, charter termination, or other involuntary membership termination, or after a receiver or other liquidating agent for a member transfers the member’s Bank capital stock to a nonmember entity. Capital stock required to meet a withdrawing member’s membership capital stock requirement may only be redeemed at the end of the five-year redemption period, subject to statutory and regulatory limits and other conditions.
On a quarterly basis, the Bank determines whether it will repurchase excess capital stock. The Bank maintained its strong regulatory capital position while repurchasing $2.0 billion and $2.0 billion in excess capital stock during 2015 and 2014, respectively.
On May 29, 2015, the Bank's Excess Stock Repurchase, Retained Earnings, and Dividend Framework was revised to reinstate the Bank’s practice of repurchasing the surplus capital stock of all members and the excess capital stock of all nonmember shareholders on a regular quarterly basis, at the Bank’s discretion and subject to certain statutory and regulatory requirements and to the Bank’s Risk Management Policy and capital plan limitations. Surplus capital stock is defined as any stock holdings in excess of 115% of a member’s minimum stock requirement, and excess capital stock is defined as any stock holdings in excess of a shareholder’s minimum stock requirement. In addition, at the Bank’s discretion, all of the excess stock held by a member may be repurchased upon request of the member, subject to the requirements and limitations mentioned above. In accordance with the revised Excess Stock
49
Repurchase, Retained Earnings, and Dividend Framework, each quarter Bank management evaluates and determines the amount of capital stock to be repurchased in that quarter, if any, giving consideration to certain capital metrics and capital management objectives and strategies, and subject to the requirements and limitations listed above. At least 15 calendar days before any repurchase, the Bank will notify shareholders of its intention to repurchase capital stock and of the scheduled repurchase date. On the scheduled repurchase date, the Bank will calculate the amount of stock to be repurchased to ensure that each member and former nonmember shareholder will continue to meet its minimum stock requirement after the repurchase.
In accordance with its practice, the Bank plans to repurchase the surplus capital stock of all members and the excess capital stock of all nonmember shareholders on March 18, 2016.
The Bank is required to redeem any mandatorily redeemable capital stock that is in excess of a former member’s minimum stock requirement on or after the expiration of the five-year redemption date. During 2015 and 2014, the Bank redeemed $53 million and $296 million, respectively, in mandatorily redeemable capital stock, for which the five-year redemption period had expired, at its $100 par value. The stock was redeemed on the scheduled redemption dates or, for stock that was not excess stock on its scheduled redemption date because of outstanding activity with the Bank, on the first available repurchase date after the stock was no longer required to support outstanding activity with the Bank.
The Bank will continue to monitor the condition of its PLRMBS portfolio, the ratio of the Bank’s estimated market value of total capital to par value of 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 repurchase of excess capital stock in future quarters.
Excess capital stock totaled $0.4 billion as of December 31, 2015, and $1.1 billion as of December 31, 2014.
Provisions of the Bank’s capital plan are more fully discussed in “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital.”
Regulatory Capital Requirements
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 that is greater than or equal to its risk-based capital requirement. Because the Bank issues only Class B stock, regulatory capital and permanent capital for the Bank are both composed of retained earnings and Class B stock, including mandatorily redeemable capital stock (which 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. The risk-based capital requirement is 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 and regulations of the Finance Agency.
The following table shows the Bank’s compliance with the Finance Agency’s capital requirements at December 31, 2015 and 2014. The Bank’s risk-based capital requirement decreased to $2.7 billion at December 31, 2015, from $3.2 billion at December 31, 2014.
50
| Regulatory Capital Requirements | |||||||||||||||
| 2015 | 2014 | ||||||||||||||
| (Dollars in millions) | Required | Actual | Required | Actual | |||||||||||
| Risk-based capital | $ | 2,684 | $ | 5,369 | $ | 3,231 | $ | 6,356 | |||||||
| Total regulatory capital | $ | 3,428 | $ | 5,369 | $ | 3,032 | $ | 6,356 | |||||||
| Total regulatory capital ratio | 4.00 | % | 6.26 | % | 4.00 | % | 8.38 | % | |||||||
| Leverage capital | $ | 4,285 | $ | 8,054 | $ | 3,790 | $ | 9,534 | |||||||
| Leverage ratio | 5.00 | % | 9.40 | % | 5.00 | % | 12.58 | % | |||||||
The Bank’s total regulatory capital ratio decreased to 6.26% at December 31, 2015, from 8.38% at December 31, 2014, primarily because of the decrease in regulatory capital resulting from the Bank’s excess capital stock repurchase activity. The Bank repurchased $2.0 billion in excess capital stock in 2015.
As a result of recent changes in the Bank’s capital plan, both capital stock and retained earnings are required to support regulatory capital compliance.
The Bank’s capital requirements are more fully discussed in “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital.”
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 Governance Policy that outlines the key roles and responsibilities of the Board of Directors and management and sets forth how the Bank is organized to achieve its risk management objectives, including the implementation of the Bank’s strategic objectives, risk management strategies, corporate governance, and standards of conduct. The policy also establishes the Bank’s risk governance organizational structure and identifies the general roles and responsibilities of the Board of Directors and management in establishing risk management policies, procedures, and guidelines; in overseeing the enterprise risk profile; and in implementing enterprise risk management processes and business strategies. The policy establishes an independent risk oversight function to identify, assess, measure, monitor, and report on the enterprise risk profile and risk management capabilities of the Bank.
The Bank’s risk management framework includes a risk appetite statement, the risk policies, and related procedures and guidelines established by the Board of Directors and management to address and manage risk. These include both enterprise-wide risk policies and related procedures and guidelines.
The Risk Management Policy establishes risk limits, guidelines, and standards for credit risk, market risk, liquidity risk, operations 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 overall risk management. The Member Products Policy, which applies to products offered to members and housing associates (nonmember mortgagees approved under Title II of the National Housing Act, to which the Bank is permitted to make advances under the FHLBank Act), addresses the credit risk of secured credit by establishing credit underwriting criteria, appropriate collateralization levels, and collateral valuation methodologies. The Bank also establishes polices for capital management and compliance risk management.
Business Risk
Business risk is defined as the possibility of an adverse impact on the Bank’s ability to fulfill its mission and to meet ongoing business and profitability objectives resulting from external factors that may occur in both the short
51
and long term. Such factors may include, but are not limited to, continued financial services industry consolidation; changes in the membership base and in member demand for Bank products; the concentration of borrowing among members; the introduction of new competing products and services; increased inter-FHLBank and non-FHLBank competition; and significant adverse changes to the effectiveness and competitiveness of the Bank’s products, services, or business model associated with regulatory and legislative changes.
The identification of business risks is an integral part of the Bank’s annual planning process, and the Bank’s strategic plan identifies initiatives and plans to address these risks.
Operations Risk
Operations risk is defined as the risk of loss to the Bank resulting from inadequate or failed internal processes, resources, and systems and from external events. The Bank’s operations risk is controlled through a system of internal controls designed to minimize the risk of operational losses. Also, the Bank has established and annually tests its business continuity plan under various business disruption scenarios involving offsite recovery and the testing of the Bank’s operations and information systems. In addition, an ongoing internal audit function audits significant risk areas to evaluate the Bank’s internal controls.
Concentration Risk
Concentration risk for the Bank is defined as the exposure to loss arising from a disproportionately large number of financial transactions with a limited number of individual customers or counterparties.
Advances. The following tables present the concentration in advances and the interest income (before the impact of interest rate exchange agreements associated with advances) from the advances to the Bank’s top five borrowers and their affiliates at December 31, 2015 and 2014.
| Concentration of Advances and Interest Income from Advances Top Five Borrowers and Their Affiliates | ||||||||||||||
| (Dollars in millions) | ||||||||||||||
| December 31, 2015 | ||||||||||||||
| Name of Borrower | Advances Outstanding | Percentage of Total Advances Outstanding | Interest Income from Advances(1) | Percentage of Total Interest Income from Advances | ||||||||||
JPMorgan Chase Bank, National Association(2)(3) | $ | 14,813 | 29 | % | $ | 65 | 16 | % | ||||||
| Bank of the West | 6,791 | 13 | 27 | 7 | ||||||||||
| First Republic Bank | 4,000 | 8 | 75 | 19 | ||||||||||
CIT Bank, National Association(4) | 3,113 | 6 | 19 | 5 | ||||||||||
| Citigroup Inc | ||||||||||||||
Citibank, N.A.(2) | 3,000 | 6 | 5 | 1 | ||||||||||
| Banamex USA | — | — | — | — | ||||||||||
| Subtotal Citigroup Inc | 3,000 | 6 | 5 | 1 | ||||||||||
| Subtotal | 31,717 | 62 | 191 | 48 | ||||||||||
| Others | 19,124 | 38 | 207 | 52 | ||||||||||
| Total par value | $ | 50,841 | 100 | % | $ | 398 | 100 | % | ||||||
52
| December 31, 2014 | |||||||||||||
| Name of Borrower | Advances Outstanding | Percentage of Total Advances Outstanding | Interest Income from Advances(1) | Percentage of Total Interest Income from Advances | |||||||||
| Bank of the West | $ | 5,484 | 14 | % | $ | 29 | 7 | % | |||||
| First Republic Bank | 5,275 | 13 | 86 | 20 | |||||||||
| JPMorgan Chase & Co.: | |||||||||||||
JPMorgan Bank & Trust Company, National Association(3) | 3,000 | 8 | 54 | 13 | |||||||||
JPMorgan Chase Bank, National Association(2) | 819 | 2 | 7 | 2 | |||||||||
| Subtotal JPMorgan Chase & Co. | 3,819 | 10 | 61 | 15 | |||||||||
| Bank of America California, N.A. | 3,500 | 9 | 18 | 4 | |||||||||
OneWest Bank, N.A.(4) | 3,364 | 9 | 28 | 6 | |||||||||
| Subtotal | 21,442 | 55 | 222 | 52 | |||||||||
| Others | 17,388 | 45 | 209 | 48 | |||||||||
| Total par value | $ | 38,830 | 100 | % | $ | 431 | 100 | % | |||||
| (1) | Interest income amounts exclude the interest effect of interest rate exchange agreements with derivative 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. |
| (2) | Nonmember institution. |
| (3) | Effective August 31, 2015, JPMorgan Bank & Trust Company, National Association (JPMorgan B&T), merged with and into JPMorgan Chase Bank, National Association (JPMorgan Chase). As a result, JPMorgan B&T is no longer a member of the Bank. Upon the merger, all of the Bank capital stock held by JPMorgan B&T was transferred to JPMorgan Chase, a nonmember of the Bank, and reclassified as mandatorily redeemable capital stock, and all advances to JPMorgan B&T were transferred to JPMorgan Chase. |
| (4) | Effective August 3, 2015, CIT Bank merged with and into OneWest Bank, which was renamed CIT Bank, National Association. |
Because of this concentration in advances, the Bank may perform more frequent credit and collateral reviews for some of these institutions, including more frequent analysis of detailed data on pledged loan collateral to assess the credit quality and risk-based valuation of the loans. The Bank also analyzes the implications for its financial management and profitability if it were to lose the advances business of one or more of these institutions or if the advances outstanding to one or more of these institutions were not replaced when repaid.
If these institutions were to prepay the advances (subject to the Bank’s limitations on the amount of advances prepayments from a single borrower in a day or a month) or repay the advances as they came due and no other advances were made to replace them, the Bank’s assets would decrease significantly and income could be adversely affected. In addition, because JPMorgan Chase is not a member of the Bank, it is not able to borrow new advances from the Bank or replace outstanding advances as they are repaid or prepaid, so a decrease in advances outstanding to JPMorgan Chase, if they are not replaced with advances to other members or other assets, will result in lower total assets and may result in lower net income for the Bank. The loss of a significant amount of advances could have a material adverse impact on the Bank’s financial performance and dividend rate. The timing and magnitude of the impact would depend on a number of factors, including: (i) the amount of advances prepaid or repaid and the period over which the advances were prepaid or repaid, (ii) the amount and timing of any decreases in capital, (iii) the profitability of the advances, (iv) the size and profitability of the Bank’s investments, (v) the extent to which debt matured as the advances were prepaid or repaid, and (vi) the ability of the Bank to extinguish debt or transfer it to other FHLBanks and the costs to extinguish or transfer the debt. As discussed in “Item 1. Business – Our Business Model,” the Bank’s financial strategies are designed to enable it to expand and contract its assets, liabilities, and capital in view of changes in membership composition and member credit needs while striving to pay members a reasonable return on their investment in the Bank’s capital stock. Under the Bank’s capital plan, the Bank may repurchase all of a shareholder’s excess capital stock, including any excess mandatorily redeemable capital stock, at the Bank’s discretion, subject to certain statutory and regulatory requirements.
MPF Program. 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 December 31, 2015 and 2014.
53
| Concentration of Mortgage Loans | ||||||||||||
| (Dollars in millions) | ||||||||||||
| December 31, 2015 | ||||||||||||
| 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) | $ | 432 | 66 | % | 5,095 | 66 | % | |||||
| Wilshire Bank | 65 | 10 | 174 | 2 | ||||||||
| Subtotal | 497 | 76 | 5,269 | 68 | ||||||||
| Others | 156 | 24 | 2,459 | 32 | ||||||||
| Total | $ | 653 | 100 | % | 7,728 | 100 | % | |||||
| December 31, 2014 | ||||||||||||
| 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) | $ | 570 | 80 | % | 6,269 | 69 | % | |||||
OneWest Bank, N.A.(2) | 84 | 12 | 2,124 | 23 | ||||||||
| Subtotal | 654 | 92 | 8,393 | 92 | ||||||||
| Others | 59 | 8 | 731 | 8 | ||||||||
| Total | $ | 713 | 100 | % | 9,124 | 100 | % | |||||
| (1) | Nonmember institution. |
(2) Effective August 3, 2015, CIT Bank merged with and into OneWest Bank, which was renamed CIT Bank, National Association.
Members that sell mortgage loans to the Bank through the MPF Program make representations and warranties that the loans comply with the MPF underwriting guidelines. In the event a mortgage loan does not comply with the MPF underwriting guidelines, the Bank’s agreement with the participating financial institution provides that the institution is required to repurchase the loan as a result of the breach of the institution’s representations and warranties. The Bank may, at its discretion, choose to retain the loan if the Bank determines that the noncompliance can be cured or mitigated through additional contract assurances from the institution or any successor. In addition, all participating financial institutions have retained the servicing on the mortgage loans purchased by the Bank, and the servicing obligation of any former participating financial institution is held by the successor or another Bank-approved financial institution. The FHLBank of Chicago (the MPF Provider and master servicer) has contracted with Wells Fargo Bank, N.A., to monitor the servicing performed by all participating financial institutions and successors, including JPMorgan Chase, Wilshire Bank, and CIT Bank, National Association. The Bank obtains a Type II Statement on Standards for Attestation Engagements (SSAE) No. 16 service auditor's report to confirm the effectiveness of the MPF Provider's controls over the services it provides to the Bank, including its monitoring of the participating financial institutions’ servicing. The FHLBank of Chicago outsourced a portion of its infrastructure controls to a third party, and as a result, the Bank receives an additional report addressing the effectiveness of controls performed by the third party. The Bank has the right to transfer the servicing at any time, without paying the participating financial institution or any successor a servicing termination fee, in the event a participating financial institution or any successor does not meet the MPF servicing requirements. The Bank may also transfer servicing without cause subject to a servicing transfer fee payable to the participating financial institution or any successor.
Investments. The following table presents the portfolio concentration in the Bank’s investment portfolios at December 31, 2015 and 2014, with U.S. government corporation and GSE issuers and other issuers (at the time of purchase), whose aggregate carrying values represented 10% or more of the Bank’s capital (including mandatorily redeemable capital stock). The amounts include securities issued by the issuer’s holding company, along with its affiliated companies. The Bank’s investment portfolio includes securities classified as trading, AFS, and HTM, and other assets such as securities purchased under agreements to resell and Federal funds sold.
54
| Investments: Portfolio Concentration | |||||||||||||||
| 2015 | 2014 | ||||||||||||||
| (In millions) | Carrying Value | Estimated Fair Value | Carrying Value | Estimated Fair Value | |||||||||||
| Non-MBS: | |||||||||||||||
| Housing finance agency bonds: | |||||||||||||||
| California Housing Finance Agency (CalHFA) bonds | $ | 275 | $ | 242 | $ | 328 | $ | 283 | |||||||
| GSEs: | |||||||||||||||
| Federal Farm Credit Bank (FFCB) bonds | 1,424 | 1,424 | 3,513 | 3,513 | |||||||||||
| Total non-MBS | 1,699 | 1,666 | 3,841 | 3,796 | |||||||||||
| MBS: | |||||||||||||||
| Other U.S. obligations: | |||||||||||||||
| Ginnie Mae | 1,236 | 1,237 | 1,524 | 1,537 | |||||||||||
| GSEs: | |||||||||||||||
| Freddie Mac | 3,677 | 3,696 | 4,517 | 4,566 | |||||||||||
| Fannie Mae | 4,136 | 4,194 | 5,313 | 5,428 | |||||||||||
| Total GSEs | 7,813 | 7,890 | 9,830 | 9,994 | |||||||||||
| PLRMBS: | |||||||||||||||
| Bank of America Corporation | 677 | 673 | 824 | 820 | |||||||||||
| Bear Stearns Companies Inc. | 592 | 590 | 667 | 666 | |||||||||||
| Countrywide Financial Corporation | 1,050 | 1,048 | 1,283 | 1,282 | |||||||||||
| IndyMac Bank, F.S.B. | 961 | 971 | 1,121 | 1,134 | |||||||||||
| Lehman Brothers Inc. | 1,127 | 1,122 | 1,376 | 1,370 | |||||||||||
| UBS AG | 634 | 630 | 741 | 736 | |||||||||||
Other(1) | 1,860 | 1,841 | 2,239 | 2,217 | |||||||||||
| Total PLRMBS | 6,901 | 6,875 | 8,251 | 8,225 | |||||||||||
| Total MBS | 15,950 | 16,002 | 19,605 | 19,756 | |||||||||||
| Total securities | 17,649 | 17,668 | 23,446 | 23,552 | |||||||||||
Securities purchased under agreements to resell: | |||||||||||||||
| Federal Reserve Bank of New York | 9,000 | 9,000 | — | — | |||||||||||
| Nomura Securities International, Inc. | 1,000 | 1,000 | 1,000 | 1,000 | |||||||||||
| Total Securities purchased under agreements to resell | 10,000 | 10,000 | 1,000 | 1,000 | |||||||||||
| Federal funds sold: | |||||||||||||||
| Australia & New Zealand Bank Group | 934 | 934 | — | — | |||||||||||
| The Bank of New York Mellon | 924 | 924 | — | — | |||||||||||
| Bank of Nova Scotia | 622 | 622 | 744 | 744 | |||||||||||
| Bank of Tokyo-Mitsubishi UFJ | — | — | 744 | 744 | |||||||||||
| Nordea Bank Finland | 934 | 934 | 1,116 | 1,116 | |||||||||||
| Rabobank Nederland | 622 | 622 | 744 | 744 | |||||||||||
| Royal Bank of Canada | — | — | 744 | 744 | |||||||||||
| Toronto Dominion Bank | — | — | 868 | 868 | |||||||||||
Other Federal funds sold(1) | 590 | 590 | 2,543 | 2,543 | |||||||||||
| Total Federal funds sold | 4,626 | 4,626 | 7,503 | 7,503 | |||||||||||
| Total investments | $ | 32,275 | $ | 32,294 | $ | 31,949 | $ | 32,055 | |||||||
| (1) | Includes issuers of securities that have a carrying value that is less than 10% of total Bank capital (including mandatorily redeemable capital stock). |
55
Many of the Bank’s members and their affiliates are extensively involved in residential mortgage finance. Accordingly, members or their affiliates may be involved in the sale of MBS to the Bank or in the origination or securitization of the mortgage loans backing the MBS purchased by the Bank.
Capital Stock. 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 December 31, 2015 or 2014.
Concentration of Capital Stock Including Mandatorily Redeemable Capital Stock | |||||||||||||
| (Dollars in millions) | 2015 | 2014 | |||||||||||
| Name of Institution | Capital Stock Outstanding | Percentage of Total Capital Stock Outstanding | Capital Stock Outstanding | Percentage of Total Capital Stock Outstanding | |||||||||
| JPMorgan Chase & Co.: | |||||||||||||
| JPMorgan Bank & Trust Company, National Association | $ | — | — | % | $ | 268 | 7 | % | |||||
JPMorgan Chase Bank, National Association(1)(2) | 400 | 15 | 68 | 2 | |||||||||
| Subtotal JPMorgan Chase & Co. | 400 | 15 | 336 | 9 | |||||||||
| Citigroup Inc.: | |||||||||||||
Citibank, N.A.(1) | 81 | 3 | 577 | 14 | |||||||||
| Banamex USA | 4 | — | 2 | — | |||||||||
| Subtotal Citigroup Inc. | 85 | 3 | 579 | 14 | |||||||||
| Subtotal | 485 | 18 | 915 | 23 | |||||||||
| Others | 2,256 | 82 | 3,082 | 77 | |||||||||
| Total | $ | 2,741 | 100 | % | $ | 3,997 | 100 | % | |||||
| (1) | The capital stock held by these nonmember institutions is classified as mandatorily redeemable capital stock. |
| (2) | The Bank reclassified $403 million of capital stock to mandatorily redeemable capital stock (a liability) on September 1, 2015, as a result of the merger of JPMorgan B&T with and into JPMorgan Chase, a nonmember of the Bank. |
Derivative Counterparties. The following table presents the concentration in derivatives with derivative counterparties whose outstanding notional balances represented 10% or more of the Bank’s total notional amount of derivatives outstanding as of December 31, 2015 and 2014.
56
| Concentration of Derivative Counterparties | ||||||||||||||||||
| (Dollars in millions) | 2015 | 2014 | ||||||||||||||||
| Derivative Counterparty | Credit Rating(1) | Notional Amount | Percentage of Total Notional Amount | Credit Rating(1) | Notional Amount | Percentage of Total Notional Amount | ||||||||||||
| Uncleared | ||||||||||||||||||
| JPMorgan Chase Bank, National Association | A | $ | 4,858 | 6 | % | A | $ | 7,439 | 12 | % | ||||||||
| Morgan Stanley Capital Services | BBB | 2,876 | 4 | BBB | 6,957 | 11 | ||||||||||||
| Subtotal | 7,734 | 10 | 14,396 | 23 | ||||||||||||||
| Others | At least BBB | 15,187 | 19 | At least BBB | 22,982 | 37 | ||||||||||||
| Subtotal uncleared | 22,921 | 29 | 37,378 | 60 | ||||||||||||||
| Cleared | ||||||||||||||||||
LCH Clearnet(2) | ||||||||||||||||||
| Credit Suisse Securities (USA) LLC | A | 46,086 | 58 | A | 14,290 | 23 | ||||||||||||
| Deutsche Bank Securities Inc. | BBB | 8,722 | 11 | A | 10,629 | 17 | ||||||||||||
| Subtotal | 54,808 | 69 | 24,919 | 40 | ||||||||||||||
| Morgan Stanley & Co. LLC | A | 2,055 | 2 | — | — | — | ||||||||||||
| Subtotal cleared | 56,863 | 71 | 24,919 | 40 | ||||||||||||||
Total(3) | $ | 79,784 | 100 | % | $ | 62,297 | 100 | % | ||||||||||
| (1) | The credit ratings used by the Bank are based on the lower of Moody's or Standard & Poor's ratings. |
| (2) | London Clearing House (LCH) Clearnet is the Bank’s counterparty for all of its cleared swaps. Credit Suisse Securities (USA) LLC, Deutsche Bank Securities Incorporated, and Morgan Stanley & Co. LLC are the Bank’s clearing agents for purposes of clearing swaps with LCH Clearnet. LCH Clearnet’s parent, LCH Clearnet Group, Ltd., is rated A+ by Standard &Poor’s. |
| (3) | Total notional amount at December 31, 2015, does not include $5 million of mortgage delivery commitments with members. |
Liquidity Risk
Liquidity risk is defined as the risk that the Bank will be unable to meet its obligations as they come due or meet the credit needs of its members and eligible nonmember borrowers in a timely and cost-effective manner. The Bank is required to maintain liquidity for operating needs and for contingency purposes in accordance with Finance Agency regulations and guidelines and with the Bank's own Risk Management Policy. The Bank strives to maintain the liquidity necessary to repay maturing consolidated obligations for which it is the primary obligor, meet other obligations and commitments, and meet expected and unexpected member credit demands. The Bank monitors its financial position in order to maintain 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 may include commercial paper, certificates of deposit, securities purchased under agreements to resell, 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 may be allocated under stressed market conditions, such as short-term operational disruptions at the Bank or the Office of Finance or short-term disruptions in the debt capital markets. The Bank maintains short-term, high-quality money market investments and government and agency securities 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 has a regulatory contingent liquidity requirement to maintain at least 5 business days of liquidity to enable it to meet its obligations without issuance of new consolidated obligations. In addition, the Finance Agency has established liquidity guidelines that require each FHLBank to maintain sufficient on-balance sheet liquidity in
57
an amount at least equal to its anticipated cash outflows for two different scenarios, both of which assume no new consolidated obligation issuance and no reliance on repurchase agreements and permit the sale of certain existing investments as determined by the Finance Agency. The two scenarios differ only in the treatment of maturing advances. One scenario assumes that the Bank does not renew any maturing advances. For this scenario, the Bank must have 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. For this scenario, the Bank must have sufficient liquidity to meet its obligations for 5 calendar days.
In addition to the regulatory contingent liquidity requirement and the Finance Agency’s guidelines on contingent liquidity, the Bank models its cash commitments and expected cash flows on a daily basis to determine its projected liquidity position. If a market or operational disruption occurred that prevented the issuance of new consolidated obligations, 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 other financial institutions (Federal funds purchased) or other FHLBanks (inter-FHLBank borrowings).
The Bank actively monitors and manages the structural liquidity risks, which the Bank defines as maturity mismatches greater than 90 days for sources and uses of funds, of the advances business segment. 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 period following December 31, 2015 and 2014.
| Principal Financial Obligations Due and Funds Available for Selected Period | |||||||
| As of December 31, 2015 | As of December 31, 2014 | ||||||
| (In millions) | 5 Business Days | 5 Business Days | |||||
| Obligations due: | |||||||
| Commitments to purchase investments | $ | 250 | $ | — | |||
| Demand deposits | 1,107 | 845 | |||||
| Discount note and bond maturities and expected exercises of bond call options | 3,165 | 2,420 | |||||
| Subtotal obligations due | 4,522 | 3,265 | |||||
| Sources of available funds: | |||||||
| Maturing investments | 15,807 | 8,155 | |||||
| Available cash | 1,634 | 3,919 | |||||
| Proceeds from scheduled settlements of discount notes and bonds | 300 | 3 | |||||
| Maturing advances and scheduled prepayments | 6,943 | 4,837 | |||||
| Subtotal sources of available funds | 24,684 | 16,914 | |||||
| Net funds available | $ | 20,162 | $ | 13,649 | |||
In addition, Section 11(i) of the FHLBank Act authorizes the U.S. Treasury to purchase certain obligations issued by the FHLBanks aggregating not more than $4.0 billion under certain conditions. There were no such purchases by the U.S. Treasury during the two-year period ended December 31, 2015.
Credit Risk
Credit risk is defined as the risk that the market value, or estimated fair value if market value is not available, of an obligation will decline as a result of deterioration in the creditworthiness of the obligor. The Bank further refines the
58
definition of credit risk as the risk that a secured or unsecured borrower is unable to meet its financial obligations and the Bank is inadequately protected by the liquidation value of collateral, if any, which could result in a credit loss to the Bank.
Advances. The Bank manages the credit risk of advances and other credit products by setting the credit and collateral terms available to individual members and housing associates based on their creditworthiness and on the quality and value of the assets they pledge as collateral. The Bank also has procedures to assess the mortgage loan quality and documentation standards of institutions that pledge mortgage loan collateral. In addition, the Bank has collateral policies and restricted lending procedures in place to help manage its exposure to institutions that experience difficulty in meeting their capital requirements or other standards of creditworthiness. These credit and collateral policies balance the Bank’s dual goals of meeting the needs of members and housing associates as a reliable source of liquidity and mitigating credit risk by adjusting credit and collateral terms in view of deterioration in creditworthiness. The Bank has never experienced a credit loss on an advance.
The Bank determines the maximum amount and maximum term of the advances it will make to a member or housing associate based on the institution’s creditworthiness and eligible collateral pledged in accordance with the Bank’s credit and collateral policies and regulatory requirements. The Bank may review and change the maximum amount and maximum term at any time. The maximum amount a member or housing associate may borrow is also limited by the amount and type of collateral pledged because all advances must be fully collateralized.
To identify the credit strength of each borrower and potential borrower, other than insurance companies, community development financial institutions (CDFIs), and housing associates, the Bank assigns each member and each nonmember borrower an internal credit quality rating from one to ten, with one as the highest credit quality 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 institution’s current financial position. Credit 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 an insurance company based on an ongoing risk assessment that considers the member's financial and regulatory standing and other qualitative information deemed relevant by the Bank. This evaluation results in the assignment of an internal credit quality rating from one to ten, with one as the highest credit quality rating. Approved terms are designed to meet the needs of the individual member while mitigating the unique credit and collateral risks associated with insurance companies, including risks related to the resolution process for insurance companies, which is significantly different from the resolution processes established for the Bank’s insured depository members.
The Bank determines the maximum amount and maximum term of the advances it will make to a CDFI based on an ongoing risk assessment 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 the Bank’s insured depository members.
The Bank determines the maximum amount and maximum term of the advances it will make to a housing associate based on an ongoing risk assessment that considers the housing associate’s financial and regulatory standing and other qualitative information deemed relevant by the Bank. Approved terms are designed to meet the needs of the individual housing associate while mitigating the unique credit and collateral risks of housing associates, which do not file quarterly regulatory financial reports and are not subject to the same inspection and regulation requirements as the Bank’s insured depository members.
The Bank underwrites and actively monitors the financial condition and performance of all borrowers to determine and periodically assess creditworthiness. The Bank uses, to the extent available, financial information provided by the borrower, quarterly financial reports filed by borrowers with their primary regulators, regulatory examination
59
reports and known regulatory enforcement actions, and public information. In determining creditworthiness, the Bank considers available examination findings, performance trends and forward-looking information, the borrower's business model, changes in risk profile, capital adequacy, asset quality, profitability, interest rate risk, supervisory history, the results of periodic collateral field reviews conducted by the Bank, the risk profile of the collateral, and the amount of eligible collateral on the borrower's balance sheet.
In accordance with the FHLBank Act, borrowers may pledge the following eligible assets to secure advances: one- to four-family first lien residential mortgage loans; multifamily mortgage loans; MBS; securities issued, insured, or guaranteed by the U.S. government or any of its agencies, including without limitation MBS backed by Fannie Mae, Freddie Mac, or Ginnie Mae; cash or deposits in the Bank; and certain other real estate-related collateral, such as commercial real estate loans and second lien residential mortgage loans or home equity loans. The Bank may also accept small business, small farm, and small agribusiness loans that are fully secured by collateral (such as real estate, equipment and vehicles, accounts receivable, and inventory) from members that are community financial institutions. The Housing and Economic Recovery Act of 2008 (Housing Act) added secured loans for community development activities as collateral that the Bank may accept from community financial institutions. The Housing Act defined community financial institutions as depository institutions insured by the Federal Deposit Insurance Corporation with average total assets over the preceding three-year period of $1 billion or less, to be adjusted for inflation annually by the Finance Agency. The average total asset cap for 2015 was $1,123 million.
Under the Bank’s written lending agreements with its borrowers, its credit and collateral policies, and applicable statutory and regulatory provisions, the Bank has the right to take a variety of actions to address credit and collateral concerns, including calling for the borrower to pledge additional or substitute collateral (including ineligible collateral) at any time that advances are outstanding to the borrower, and requiring the delivery of all pledged collateral. In addition, if a borrower fails to repay any advance or is otherwise in default on its obligations to the Bank, the Bank may foreclose on and liquidate the borrower’s collateral and apply the proceeds toward repayment of the borrower’s obligations to the Bank. The Bank’s collateral policies are designed to address changes in the value of collateral and the risks and costs relating to foreclosure and liquidation of collateral, and the Bank periodically adjusts the amount it is willing to lend against various types of collateral to reflect these factors. Market conditions, the volume and condition of the borrower’s collateral at the time of liquidation, and other factors could affect the amount of proceeds the Bank is able to realize from liquidating a borrower’s collateral. In addition, the Bank could sell collateral over an extended period of time, rather than liquidating it immediately, and the Bank would have the right to receive principal and interest payments made on the collateral it continued to hold and apply those proceeds toward repayment of the borrower’s obligations to the Bank.
The Bank perfects its security interest in securities collateral by taking delivery of all securities at the time they are pledged. The Bank perfects its security interest in loan collateral by filing a UCC-1 financing statement for each borrower that pledges loans. The Bank may also require delivery of loan collateral under certain conditions (for example, from a newly formed institution or when a borrower's creditworthiness deteriorates below a certain level). In addition, the FHLBank Act provides that any security interest granted to the Bank by any member or member affiliate has priority over the claims and rights of any other party, including any receiver, conservator, trustee, or similar entity that has the rights of a lien creditor, unless these claims and rights would be entitled to priority under otherwise applicable law or are held by bona fide purchasers for value or by parties that have actual perfected security interests.
Pursuant to the Bank’s lending agreements with its borrowers, the Bank limits extensions of credit to individual borrowers to a percentage of the market value or unpaid principal balance of the borrower’s pledged collateral, known as the borrowing capacity. The borrowing capacity percentage varies according to several factors, including the charter type of the institution, the collateral type, the value assigned to the collateral, the results of the Bank’s collateral field review of the borrower’s collateral, the pledging method used for loan collateral (specific identification or blanket lien), the amount of loan data provided (detailed or summary reporting), the data reporting frequency (monthly or quarterly), the borrower’s financial strength and condition, and any institution-specific collateral risks. Under the terms of the Bank’s lending agreements, the aggregate borrowing capacity of a borrower’s pledged eligible collateral must meet or exceed the total amount of the borrower’s outstanding advances,
60
other extensions of credit, and certain other borrower obligations and liabilities. The Bank monitors each borrower’s aggregate borrowing capacity and collateral requirements on a daily basis by comparing the institution’s borrowing capacity to its obligations to the Bank.
In addition, the total amount of advances made available to each member or housing associate may be limited by the financing availability assigned by the Bank, which is generally expressed as a percentage of the member’s or housing associate’s assets. The amount of financing availability is generally determined by the creditworthiness of the member or housing associate.
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 the Bank’s applicable credit, collateral, and capital stock 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 December 31, 2015 and 2014. During 2015, the Bank’s internal credit ratings stayed the same or improved for the majority of members and nonmember borrowers.
Member and Nonmember Credit Outstanding and Collateral Borrowing Capacity by Credit Quality Rating | ||||||||||||||||
| (Dollars in millions) | ||||||||||||||||
| December 31, 2015 | ||||||||||||||||
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 | 273 | 158 | $ | 59,898 | $ | 180,851 | 33 | % | ||||||||
| 4-6 | 61 | 26 | 3,138 | 14,287 | 22 | |||||||||||
| 7-10 | 6 | 4 | 32 | 89 | 36 | |||||||||||
| Subtotal | 340 | 188 | 63,068 | 195,227 | 32 | |||||||||||
| CDFIs | 7 | 3 | 90 | 96 | 94 | |||||||||||
| Total | 347 | 191 | $ | 63,158 | $ | 195,323 | 32 | % | ||||||||
| December 31, 2014 | ||||||||||||||||
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 | 254 | 157 | $ | 38,375 | $ | 166,407 | 23 | % | ||||||||
| 4-6 | 85 | 38 | 5,746 | 19,753 | 29 | |||||||||||
| 7-10 | 10 | 4 | 46 | 71 | 65 | |||||||||||
| Subtotal | 349 | 199 | 44,167 | 186,231 | 24 | |||||||||||
| CDFIs | 5 | 3 | 77 | 92 | 84 | |||||||||||
| Total | 354 | 202 | $ | 44,244 | $ | 186,323 | 24 | % | ||||||||
| (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. |
61
Member and Nonmember Credit Outstanding and Collateral Borrowing Capacity by Unused Borrowing Capacity | ||||||||||
| (Dollars in millions) | ||||||||||
| December 31, 2015 | ||||||||||
| Unused Borrowing Capacity | Number of Members and Nonmembers with Credit Outstanding | Credit Outstanding(1) | Collateral Borrowing Capacity(2) | |||||||
| 0% – 10% | 7 | $ | 3,200 | $ | 3,407 | |||||
| 11% – 25% | 5 | 1,054 | 1,289 | |||||||
| 26% – 50% | 21 | 29,265 | 46,966 | |||||||
| More than 50% | 158 | 29,639 | 143,661 | |||||||
| Total | 191 | $ | 63,158 | $ | 195,323 | |||||
| December 31, 2014 | ||||||||||
| Unused Borrowing Capacity | Number of Members and Nonmembers with Credit Outstanding | Credit Outstanding(1) | Collateral Borrowing Capacity(2) | |||||||
| 0% – 10% | 10 | $ | 3,178 | $ | 3,331 | |||||
| 11% – 25% | 7 | 181 | 226 | |||||||
| 26% – 50% | 18 | 11,693 | 21,584 | |||||||
| More than 50% | 167 | 29,192 | 161,182 | |||||||
| Total | 202 | $ | 44,244 | $ | 186,323 | |||||
| (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. |
Based on the collateral pledged as security for advances, the Bank’s credit analyses of borrowers’ 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 credit losses on advances is deemed necessary by the Bank. The Bank has never experienced any credit losses on advances.
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 December 31, 2015, the borrowing capacities assigned to U.S. Treasury and agency securities ranged from 55% to 98% 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 55% to 80% of their market value, depending on the underlying collateral (residential mortgage loans, home equity loans, or commercial real estate loans), the rating, and the subordination structure of the respective securities.
The following table presents the securities collateral pledged by all members and by nonmembers with credit outstanding at December 31, 2015 and 2014.
62
| Composition of Securities Collateral Pledged by Members and by Nonmembers with Credit Outstanding | |||||||||||||||
| (In millions) | 2015 | 2014 | |||||||||||||
| Securities Type with Current Credit Ratings | Current Par | Borrowing Capacity | Current Par | Borrowing Capacity | |||||||||||
| U.S. Treasury (bills, notes, bonds) | $ | 1,538 | $ | 1,489 | $ | 461 | $ | 472 | |||||||
| Agency (notes, subordinated debt, structured notes, indexed amortization notes, and Small Business Administration pools) | 3,567 | 3,478 | 3,541 | 3,474 | |||||||||||
| Agency pools and collateralized mortgage obligations | 6,765 | 6,516 | 8,696 | 8,379 | |||||||||||
| PLRMBS – publicly registered investment-grade-rated senior tranches | 1 | 1 | 2 | 1 | |||||||||||
| Total | $ | 11,871 | $ | 11,484 | $ | 12,700 | $ | 12,326 | |||||||
With respect to loan collateral, most borrowers may choose to pledge loan collateral by specific identification or under a blanket lien. Insurance companies, CDFIs, and housing associates are required to pledge loan collateral by specific identification with monthly reporting. All other borrowers pledging by specific identification must provide a detailed listing of all the loans pledged to the Bank on a monthly or quarterly basis. With a blanket lien, a borrower 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. Borrowers pledging under a blanket lien may provide a detailed listing of loans or may use a summary reporting method.
The Bank may require certain borrowers to deliver pledged loan collateral to the Bank for one or more reasons, including the following: the borrower is a de novo institution (chartered within the last three years), an insurance company, a CDFI, or a housing associate; the Bank is concerned about the borrower’s creditworthiness; or the Bank is concerned about the maintenance of its collateral or the priority of its security interest. With the exception of insurance companies, CDFIs, and housing associates, borrowers required to deliver loan collateral must pledge those loans under a blanket lien with detailed reporting.
As of December 31, 2015, of the loan collateral pledged to the Bank, 34% was pledged by 30 institutions by specific identification, 45% was pledged by 133 institutions under a blanket lien with detailed reporting, and 21% was pledged by 124 institutions under a blanket lien with summary reporting.
The Bank monitors each borrower’s borrowing capacity and collateral requirements on a daily basis. The borrowing capacities for loan collateral reflect the assigned value of the collateral and a margin for the costs and risks of liquidation. The Bank reviews the margins for loan collateral regularly and may adjust them at any time as market conditions change.
The Bank assigns a value to loan collateral using one of two methods. For mortgage loans that are reported to the Bank with detailed information on the individual loans, the Bank uses third-party pricing vendors to price all the loans on a quarterly basis. The third-party vendors use proprietary analytical tools to calculate the value of each loan. The vendors model the future performance of each individual loan and generate the monthly cash flows given the current loan characteristics and applying specific market assumptions. The value of each loan is determined based on the present value of those cash flows after being discounted by the current market yields commonly used by buyers of these types of loans. The current market yields are derived by the third-party pricing vendors from prevailing conditions in the secondary market. For mortgage loans pledged under a blanket lien with summary reporting, the Bank establishes a standard market value for each collateral type based on quarterly pricing results.
For each borrower that pledges loan collateral, the Bank conducts loan collateral field reviews once every six months or every one, two, or three years, depending on the risk profile of the borrower and the types of collateral pledged by the borrower. During the borrower's collateral field review, the Bank examines a statistical sample of the
63
borrower's pledged loans to validate loan ownership, confirm the existence of the critical legal documents, identify documentation and servicing deficiencies, and verify eligibility. Based on any loan defects identified in the pool of sample loans, the Bank determines the applicable non-credit secondary market discounts. The Bank also sends the sample loans to a third-party pricing vendor for valuation of the financial and credit-related attributes of the loans. The Bank adjusts the borrower's borrowing capacity for each collateral type in its pledged portfolio based on the pricing of the field review sample loans and the non-credit secondary market discounts identified in the field review.
As of December 31, 2015, the Bank’s maximum borrowing capacities as a percentage of the assigned market value of mortgage loan collateral pledged under a blanket lien with detailed reporting were as follows: 92% for first lien residential mortgage loans, 91% for multifamily mortgage loans, 88% for commercial mortgage loans, and 82% for second lien residential mortgage loans. The maximum borrowing capacity for small business, small agribusiness, and small farm loans was 50% of the unpaid principal balance, although most of these loans are pledged under blanket lien with summary reporting, with a maximum borrowing capacity of 25%. The highest borrowing capacities are available to borrowers that pledge under a 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 December 31, 2015 and 2014.
| Composition of Loan Collateral Pledged by Members and by Nonmembers with Credit Outstanding | |||||||||||||||
| (In millions) | 2015 | 2014 | |||||||||||||
| Loan Type | Unpaid Principal Balance | Borrowing Capacity | Unpaid Principal Balance | Borrowing Capacity | |||||||||||
| First lien residential mortgage loans | $ | 116,745 | $ | 100,667 | $ | 106,467 | $ | 90,942 | |||||||
| Second lien residential mortgage loans and home equity lines of credit | 25,543 | 14,328 | 29,133 | 14,997 | |||||||||||
| Multifamily mortgage loans | 22,716 | 18,971 | 20,820 | 17,366 | |||||||||||
| Commercial mortgage loans | 59,347 | 43,405 | 54,707 | 39,144 | |||||||||||
Loan participations(1) | 7,155 | 5,710 | 13,141 | 10,698 | |||||||||||
| Small business, small farm, and small agribusiness loans | 3,063 | 756 | 3,123 | 776 | |||||||||||
| Other | 3 | 2 | 106 | 74 | |||||||||||
| Total | $ | 234,572 | $ | 183,839 | $ | 227,497 | $ | 173,997 | |||||||
| (1) | The unpaid principal balance for loan participations is 100% of the outstanding loan amount. The borrowing capacity for loan participations is based on the participated amount pledged to the Bank. |
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 December 31, 2015 and 2014, the unpaid principal balance of these loans totaled $13 billion and $14 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. All advances, including those made to borrowers 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.
MPF Program. Under the MPF Program, the Bank may purchase from members, for its own portfolio, conventional conforming fixed rate mortgage loans under the MPF Original product and FHA-insured or VA-guaranteed mortgage loans under the MPF Government product. In addition, the Bank may facilitate the purchase of
64
conforming fixed rate mortgage loans from members for concurrent sale to Fannie Mae under the MPF Xtra product and of jumbo fixed rate mortgage loans for concurrent sale to Redwood Residential Acquisition Corporation, a subsidiary of Redwood Trust, Inc., a real estate investment trust, under the MPF Direct product. As of December 31, 2015, the Bank had approved ten members as participating financial institutions since renewing its participation in the MPF Program in 2013.
From May 2002 through October 2006, the Bank purchased conventional conforming fixed rate mortgage loans from its participating financial institutions members under the MPF Original and MPF Plus products. 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 and any participating financial institution share in the credit risk of the loans sold by that institution as specified in a master agreement. Loans purchased under the MPF Program generally have a credit risk exposure at the time of purchase equivalent to assets rated AA, taking into consideration the credit risk sharing structure mandated by the Finance Agency’s acquired member assets (AMA) regulation. The MPF Program structures potential credit losses on conventional MPF loans into layers with respect to each pool of loans purchased by the Bank under a single master commitment, as follows:
| 1. | The first layer of protection against loss is the liquidation value of the real property securing the loan. |
| 2. | The next layer of protection comes from the primary mortgage insurance that is required for loans with an initial loan-to-value ratio greater than 80%, if still in place. |
| 3. | Losses that exceed the liquidation value of the real property and any primary mortgage insurance, up to an agreed-upon amount called the first loss account for each master commitment, are incurred by the Bank. |
| 4. | Losses in excess of the first loss account for each master commitment, up to an agreed-upon amount called the “credit enhancement amount,” are covered by the participating financial institution's credit enhancement obligation at the time losses are incurred. |
| 5. | Losses in excess of the first loss account and the participating financial institution's remaining credit enhancement for the master commitment, if any, are incurred by the Bank. |
The first loss account provided by the Bank is a memorandum account, a record-keeping mechanism the Bank uses to track the amount of potential expected losses for which it is liable on each master commitment (before the participating financial institution's credit enhancement is used to cover losses).
The credit enhancement amount for each master commitment, together with any primary mortgage insurance coverage, is sized to limit the Bank’s credit losses in excess of the first loss account to those that would be expected on an equivalent investment with a long-term credit rating of AA at the time of purchase, as determined by the MPF Program methodology. As required by the AMA regulation, a nationally recognized statistical rating organization (NRSRO) confirms that the MPF Program methodology would provide an analysis of each master commitment that was “comparable to a methodology that the NRSRO would use in determining credit enhancement levels when conducting a rating review of the asset or pool of assets in a securitization transaction.” By requiring credit enhancement in the amount determined by the MPF Program methodology, the Bank expects to have the same probability of incurring credit losses in excess of the first loss account and the participating financial institution's credit enhancement obligation on mortgage loans purchased under any master commitment as an investor would have of incurring credit losses on an equivalent investment with a long-term credit rating of AA.
Before delivering loans for purchase under the MPF Program, each participating financial institution submits data on the individual loans to the FHLBank of Chicago, which calculates the loan level credit enhancement needed. The rating agency model used considers many characteristics, such as loan-to-value ratio, property type, loan purpose, borrower credit scores, level of loan documentation, and loan term, to determine the loan level credit enhancement. The resulting credit enhancement amount for each loan purchased is accumulated under a master commitment to establish a pool level credit enhancement amount for the master commitment.
65
The Bank’s mortgage loan portfolio currently consists of mortgage loans purchased under two MPF products: MPF Original and MPF Plus, which differ from each other in the way the amount of the first loss account is determined, the options available for covering the participating financial institution's credit enhancement obligation, and the fee structure for the credit enhancement fees.
Under MPF Original, the first loss account accumulates over the life of the master commitment. Each month, the outstanding aggregate principal balance of the loans at monthend is multiplied by an agreed-upon percentage (typically 4 basis points per annum), and that amount is added to the first loss account. As credit and special hazard losses are realized that are not covered by the liquidation value of the real property or primary mortgage insurance, they are first charged to the Bank, with a corresponding reduction of the first loss account for that master commitment up to the amount accumulated in the first loss account at that time. Over time, the first loss account may cover the expected credit losses on a master commitment, although losses that are greater than expected or that occur early in the life of the master commitment could exceed the amount accumulated in the first loss account. In that case, the excess losses would be charged next to the member's credit enhancement to the extent available. For each master commitment, the Bank considers the credit performance, credit enhancement levels, and the NRSRO rating equivalent in the determination of its risk-based capital requirements, and the credit performance, collateral protection, and availability of credit enhancement in the evaluation of appropriate loan loss allowances.
The aggregate first loss account for all participating financial institutions for MPF Original totaled $1 million for the years ended December 31, 2015, 2014, and 2013.
The participating financial institution’s credit enhancement obligation under MPF Original must be collateralized by the participating financial institution in the same way that advances from the Bank are collateralized, as described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – Advances.” For taking on the credit enhancement obligation, the Bank pays the participating financial institution a monthly credit enhancement fee, typically 10 basis points per annum, calculated on the unpaid principal balance of the loans in the master commitment. The Bank charges this amount to interest income, effectively reducing the overall yield earned on the loans purchased by the Bank. The Bank reduced net interest income for credit enhancement fees totaling $0.1 million in 2015, $0.1 million in 2014, and $0.1 million in 2013 for MPF Original loans.
Under MPF Plus, the first loss account is equal to a specified percentage of the scheduled principal balance of loans in the pool as of the sale date of each loan. The percentage of the first loss account was negotiated for each master commitment. The participating financial institution provides credit enhancement for loans sold to the Bank under MPF Plus by maintaining a supplemental mortgage insurance (SMI) policy that equals its credit enhancement obligation. The amount of required credit enhancement is recalculated annually. Because the MPF Plus product provides that the requirement may only be reduced (and not increased), the SMI coverage could be reduced as a result of the annual recalculation of the required credit enhancement.
Typically, the amount of the first loss account is equal to the deductible on the SMI policy. However, the SMI policy does not cover special hazard losses or credit losses on loans with a loan-to-value ratio below a certain percentage (usually 50%). As a result, credit losses on loans not covered by the SMI policy and special hazard losses may reduce the amount of the first loss account without reducing the deductible on the SMI policy. If the deductible on the SMI policy has not been met and the pool incurs credit losses that exceed the amount of the first loss account, those losses will be allocated to the Bank until the SMI policy deductible has been met. Once the deductible has been met, the SMI policy will cover credit losses on loans covered by the policy up to the maximum loss coverage provided by the policy. If the SMI provider's claims-paying ability rating falls below a specified level, the participating financial institution has six months to either replace the SMI policy or assume the credit enhancement obligation and fully collateralize the obligation; otherwise the Bank may choose not to pay the participating financial institution its performance-based credit enhancement fee. Finally, the Bank will absorb credit losses that exceed the maximum loss coverage of the SMI policy (or the substitute credit enhancement provided by the participating financial institution), all credit losses on loans not covered by the policy, and all special hazard losses, if any.
66
Three of the six master commitments (totaling $0.5 billion) continue to rely on SMI coverage for a portion of their credit enhancement obligation, which is provided by two SMI companies and totals $11.6 million. The claims-paying ability ratings of these two SMI companies are below the AA rating required for the program; both are rated BB+. The participating financial institutions associated with the relevant master commitments have chosen to forego their performance-based credit enhancement fees rather than assume the credit enhancement obligation. The largest of the commitments (totaling $0.4 billion) did not achieve AA credit equivalency solely because the SMI company was rated BB+.
At December 31, 2015, the deductibles under the SMI policies totaled approximately 32% of the participating financial institutions’ credit enhancement obligation on MPF Plus loans. At December 31, 2014, the deductibles under the SMI policies totaled approximately 28% of the participating financial institutions’ credit enhancement obligation on MPF Plus loans. None of the SMI was provided by participating financial institutions or their affiliates at December 31, 2015 and 2014.
The first loss account for MPF Plus for the years ended December 31, 2015, 2014, and 2013 was as follows:
| First Loss Account for MPF Plus | |||||||||||
| (In millions) | 2015 | 2014 | 2013 | ||||||||
| Balance, beginning of the period | $ | 10 | $ | 10 | $ | 11 | |||||
| Losses incurred in excess of liquidation value of the real property securing the loan and primary mortgage insurance | (1 | ) | — | (1 | ) | ||||||
| Balance, end of the period | $ | 9 | $ | 10 | $ | 10 | |||||
Under MPF Plus, the Bank pays the participating financial institution a credit enhancement fee that is divided into a fixed credit enhancement fee and a performance-based credit enhancement fee. The fixed credit enhancement fee is paid each month beginning with the month after each loan delivery. The performance-based credit enhancement fee accrues monthly beginning with the month after each loan delivery and is paid to the member beginning 12 months later. Performance-based credit enhancement fees payable to the member are reduced by an amount equal to loan losses, up to the full amount of the first loss account established for each master commitment. If losses up to the full amount of the first loss account, net of previously withheld performance-based credit enhancement fees, exceed the credit enhancement fee payable in any period, the excess will be carried forward and applied against future performance-based credit enhancement fees. Because loans in the MPF Plus program have experienced a high rate of voluntary prepayments, causing the current balance of each respective master commitment to be significantly reduced since purchase, it is possible that the remaining loans will not generate enough performance-based credit enhancement fees over the remaining life of each master commitment to enable the Bank to collect performance-based credit enhancement fees equal to the full amount of the first loss account established for each MPF Plus master commitment. The amount of performance-based credit enhancement fees expected to be accrued in the future is uncertain and highly dependent on the future rate of principal prepayments of the underlying mortgage loans. The Bank reduced net interest income for credit enhancement fees totaling $0.3 million in 2015, $0.4 million in 2014, and $0.6 million in 2013 for MPF Plus loans. The Bank’s liability for performance-based credit enhancement fees for MPF Plus was $0.1 million and $0.1 million at December 31, 2015 and 2014, respectively.
The Bank provides for a loss allowance, net of the credit enhancement, for any impaired loans and for the estimates of other probable losses, and the Bank has policies and procedures in place to monitor the credit risk. The Bank bases the allowance for credit losses for the Bank’s mortgage loan portfolio on its estimate of probable credit losses in the portfolio as of the Statements of Condition date.
Effective January 1, 2015, the Bank implemented the accounting requirements of regulatory Advisory Bulletin 2012-02. As a result, for any mortgage loans that are more than 180 days past due and that have any outstanding balance in excess of the fair value of the property, less cost to sell, this excess is charged off as a loss by the end of
67
the month in which the applicable time period elapses. Likewise, when a borrower is in bankruptcy, loans are written down to the fair value of the collateral, less cost to sell, in general within 60 days of receipt of the notification of filing from the bankruptcy court, unless it can be clearly demonstrated and documented that repayment is likely to occur. As a result of these charge-offs during 2015, the corresponding Allowance for Credit Losses on MPF Loans, which had previously provided for most of these expected losses, was reduced accordingly.
Mortgage Loans Evaluated at the Individual Master Commitment Level – The credit risk analysis of all conventional MPF loans is performed at the individual master commitment level to determine the credit enhancements available to recover losses on MPF loans under each individual master commitment.
Individually Evaluated Mortgage Loans – Certain conventional mortgage loans, primarily impaired mortgage loans that are considered collateral-dependent, may be specifically identified for purposes of calculating the allowance for credit losses. The estimated credit losses on impaired collateral-dependent loans may be separately determined because sufficient information exists to make a reasonable estimate of the inherent loss on those loans on an individual loan basis. The Bank estimates the fair value of collateral using real estate broker price opinions or automated valuation models based on property characteristics as well as recent market sales and current listings. The resulting incurred loss, if any, is equal to the difference between the carrying value of the loan and the estimated fair value of the collateral less estimated selling costs.
Collectively Evaluated Mortgage Loans – The credit risk analysis of conventional loans collectively evaluated for impairment considers loan pool-specific attribute data, applies estimated loss severities, and considers the associated credit enhancements to determine the Bank's best estimate of probable incurred losses. The analysis includes estimating projected cash flows that the Bank is likely to collect based on an assessment of all available information, including prepayment speeds, default rates, and loss severity of the mortgage loans based on underlying loan-level borrower and loan characteristics; expected housing price changes; and interest rate assumptions. In performing a detailed cash flow analysis, the Bank develops its best estimate of the cash flows expected to be collected using a third-party model to project prepayments, default rates, and loss severities based on borrower characteristics and the particular attributes of the mortgage loans, in conjunction with assumptions related primarily to future changes in housing prices and interest rates. The assumptions used as inputs to the model, including the forecast of future housing price changes, are consistent with assumptions used for the Bank's evaluation of its PLRMBS for OTTI.
The Bank performs periodic reviews of its mortgage loan portfolio to identify the probable credit losses in the portfolio and to determine the likelihood of collection of the loans in the portfolio. The overall allowance is determined by an analysis that includes consideration of observable data such as delinquency statistics, past performance, current performance, loan portfolio characteristics, collateral valuations, industry data, collectability of credit enhancements from members or from mortgage insurers, and prevailing economic conditions, taking into account the credit enhancement provided by the member under the terms of each master commitment. The allowance for credit losses on the mortgage loan portfolio for the years ended December 31, 2015, 2014, and 2013, was as follows:
| Allowance for Credit Losses on Mortgage Loan Portfolio | |||||||||||
| (Dollars in millions) | 2015 | 2014 | 2013 | ||||||||
| Balance, beginning of the period | $ | 1 | $ | 2 | $ | 3 | |||||
| (Charge-offs)/recoveries | (2 | ) | (1 | ) | — | ||||||
| Provision for/(reversal of) credit losses | 1 | — | (1 | ) | |||||||
| Balance, end of the period | $ | — | $ | 1 | $ | 2 | |||||
| Ratio of net charge-offs during the period to average loans outstanding during the period | (0.24 | )% | (0.05 | )% | (0.07 | )% | |||||
68
The decline in the estimated allowance for credit losses during 2015 is primarily due to higher charge-offs resulting from the Bank’s implementation of the charge-off provisions of Advisory Bulletin 2012-02. (See “Item 8. Financial Statements and Supplementary Data – Note 2 – Recently Issued and Adopted Accounting Guidance” for further information.)
The allowance for credit losses and recorded investment by impairment methodology for individually and collectively evaluated impaired loans are as follows:
| (In millions) | 2015 | 2014 | |||||
| Allowance for credit losses, end of the period: | |||||||
| Individually evaluated for impairment | $ | — | $ | 1 | |||
| Total allowance for credit losses | $ | — | $ | 1 | |||
| Recorded investment, end of the period: | |||||||
| Individually evaluated for impairment | $ | 14 | $ | 20 | |||
| Collectively evaluated for impairment | 644 | 692 | |||||
| Total recorded investment | $ | 658 | $ | 712 | |||
The recorded investment, unpaid principal balance, and related allowance of impaired loans individually evaluated for impairment are as follows:
| 2015 | 2014 | ||||||||||||||||||||||
| (In millions) | Recorded Investment | Unpaid Principal Balance | Related Allowance | Recorded Investment | Unpaid Principal Balance | Related Allowance | |||||||||||||||||
| With no related allowance | $ | 13 | $ | 13 | $ | — | $ | 14 | $ | 14 | $ | — | |||||||||||
| With an allowance | 1 | 1 | — | 6 | 6 | 1 | |||||||||||||||||
| Total | $ | 14 | $ | 14 | $ | — | $ | 20 | $ | 20 | $ | 1 | |||||||||||
The average recorded investment on impaired loans individually evaluated for impairment is as follows:
| (In millions) | 2015 | 2014 | |||||
| With no related allowance | $ | 15 | $ | 17 | |||
| With an allowance | 1 | 7 | |||||
| Total | $ | 16 | $ | 24 | |||
For the three MPF Plus master commitments that still rely on SMI for a portion of their credit enhancement obligation, the external ratings of the SMI providers have declined since the loans were purchased. Because the relevant participating financial institutions have elected not to assume the credit enhancement obligations as their own, the Bank has discontinued paying the associated performance-based credit enhancement fees, in accordance with the terms of the applicable agreements. Formerly, upon a realized loss, the Bank would have withheld credit enhancement fees up to the amount of the SMI deductible to offset the loss. Because these fees are no longer owed to the participating financial institutions, they cannot be withheld to offset a loss. Instead, the Bank is accounting for the performance-based credit enhancement fees as income and has now begun to directly recognize the potential loan losses in the related loan loss allowance account.
For more information on how the Bank determines its estimated allowance for credit losses on mortgage loans, see “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” and “Item 8. Financial Statements and Supplementary Data – Note 10 – Allowance for Credit Losses.”
69
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.
The following table presents information on delinquent mortgage loans as of December 31, 2015 and 2014.
| Mortgage Loan Delinquencies | |||||||
| 2015 | 2014 | ||||||
| (Dollars in millions) | Recorded Investment(1) | Recorded Investment(1) | |||||
| 30 – 59 days delinquent | $ | 10 | $ | 12 | |||
| 60 – 89 days delinquent | 5 | 5 | |||||
| 90 days or more delinquent | 18 | 22 | |||||
| Total past due | 33 | 39 | |||||
| Total current loans | 625 | 673 | |||||
| Total mortgage loans | $ | 658 | $ | 712 | |||
In process of foreclosure, included above(2) | $ | 7 | $ | 11 | |||
| Nonaccrual loans | $ | 18 | $ | 22 | |||
| Loans past due 90 days or more and still accruing interest | $ | — | $ | — | |||
Serious delinquencies as a percentage of total mortgage loans outstanding(3) | 2.76 | % | 3.12 | % | |||
| (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 as a percentage of the recorded investment of total mortgage loans outstanding. |
For 2015, 2014, and 2013, the interest on nonaccrual loans that was contractually due and recognized in income was as follows:
| Interest on Nonaccrual Loans | |||||||||||
| (In millions) | 2015 | 2014 | 2013 | ||||||||
| Interest contractually due on nonaccrual loans during the period | $ | 1 | $ | 1 | $ | 1 | |||||
| Interest recognized in income for nonaccrual loans during the period | — | — | — | ||||||||
| Shortfall | $ | 1 | $ | 1 | $ | 1 | |||||
Delinquencies amounted to 5.05% of the total loans in the Bank’s portfolio as of December 31, 2015, and 5.54% of the total loans in the Bank’s portfolio as of December 31, 2014. The decline in the delinquency percentage was due to the purchase of new loans in 2015 as well as declining delinquencies during 2015. The weighted average age of the Bank’s MPF portfolio was 126 months as of December 31, 2015, and 135 months as of December 31, 2014.
Troubled Debt Restructurings – Troubled debt restructuring (TDR) is considered to have occurred when a concession is granted to the debtor for economic or legal reasons related to the debtor's financial difficulties and that concession would not have been considered otherwise. An MPF loan considered a TDR is individually evaluated for impairment when determining its related allowance for credit losses. Credit loss is measured by factoring in expected cash flow shortfalls incurred as of the reporting date as well as the economic loss attributable to delaying the original contractual principal and interest due dates, if applicable.
70
The Bank’s TDRs of MPF loans primarily involve modifying the borrower's monthly payment for a period of up to 36 months to reflect a housing expense ratio that is no more than 31% of the borrower's qualifying monthly income. The outstanding principal balance is re-amortized to reflect a principal and interest payment for a term not to exceed 40 years from the original note date and a housing expense ratio not to exceed 31%. This would result in a balloon payment at the original maturity date of the loan because the maturity date and number of remaining monthly payments are not adjusted. If the 31% ratio is still not achieved through re-amortization, the interest rate is reduced in 0.125% increments below the original note rate, to a floor rate of 3%, resulting in reduced principal and interest payments, for the temporary payment modification period of up to 36 months, until the 31% housing expense ratio is met.
The recorded investment of the Bank’s nonperforming MPF loans classified as TDRs totaled $3.3 million as of December 31, 2015, and $2.3 million as of December 31, 2014.
At December 31, 2015, the Bank’s other assets included $2.0 million of REO resulting from the foreclosure of 21 mortgage loans held by the Bank. At December 31, 2014, the Bank’s other assets included $2.5 million of REO resulting from the foreclosure of 23 mortgage loans held by the Bank.
Investments. The Bank has adopted credit policies and exposure limits for investments that promote risk limitation, diversification, and liquidity. These policies determine eligible counterparties and 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 OTTI 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 (Fitch) ratings.
71
| Investment Credit Exposure | |||||||||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||||||
| December 31, 2015 | |||||||||||||||||||||||||||
| Carrying Value | |||||||||||||||||||||||||||
Credit Rating(1) | |||||||||||||||||||||||||||
| Investment Type | AAA | AA | A | BBB | Below Investment Grade | Unrated | Total | ||||||||||||||||||||
| Non-MBS | |||||||||||||||||||||||||||
| Housing finance agency bonds: | |||||||||||||||||||||||||||
| CalHFA bonds | $ | — | $ | — | $ | 275 | $ | — | $ | — | $ | — | $ | 275 | |||||||||||||
| GSEs: | |||||||||||||||||||||||||||
| FFCB bonds | — | 1,424 | — | — | — | — | 1,424 | ||||||||||||||||||||
| Total non-MBS | — | 1,424 | 275 | — | — | — | 1,699 | ||||||||||||||||||||
| MBS: | |||||||||||||||||||||||||||
| Other U.S. obligations: | |||||||||||||||||||||||||||
| Ginnie Mae | — | 1,236 | — | — | — | — | 1,236 | ||||||||||||||||||||
| GSEs: | |||||||||||||||||||||||||||
| Freddie Mac | — | 3,677 | — | — | — | — | 3,677 | ||||||||||||||||||||
Fannie Mae(2) | — | 4,112 | 15 | — | 9 | — | 4,136 | ||||||||||||||||||||
| Total GSEs | — | 7,789 | 15 | — | 9 | — | 7,813 | ||||||||||||||||||||
| PLRMBS: | |||||||||||||||||||||||||||
| Prime | — | — | 2 | 368 | 1,044 | 2 | 1,416 | ||||||||||||||||||||
| Alt-A, option ARM | — | — | — | — | 980 | — | 980 | ||||||||||||||||||||
| Alt-A, other | 8 | 10 | 44 | 151 | 4,288 | 4 | 4,505 | ||||||||||||||||||||
| Total PLRMBS | 8 | 10 | 46 | 519 | 6,312 | 6 | 6,901 | ||||||||||||||||||||
| Total MBS | 8 | 9,035 | 61 | 519 | 6,321 | 6 | 15,950 | ||||||||||||||||||||
| Total securities | 8 | 10,459 | 336 | 519 | 6,321 | 6 | 17,649 | ||||||||||||||||||||
| Securities purchased under agreements to resell | — | 10,000 | — | — | — | — | 10,000 | ||||||||||||||||||||
| Federal funds sold | — | 2,992 | 1,588 | 46 | — | — | 4,626 | ||||||||||||||||||||
| Total investments | $ | 8 | $ | 23,451 | $ | 1,924 | $ | 565 | $ | 6,321 | $ | 6 | $ | 32,275 | |||||||||||||
72
| (In millions) | |||||||||||||||||||||||||||
| December 31, 2014 | |||||||||||||||||||||||||||
| Carrying Value | |||||||||||||||||||||||||||
Credit Rating(1) | |||||||||||||||||||||||||||
| Investment Type | AAA | AA | A | BBB | Below Investment Grade | Unrated | Total | ||||||||||||||||||||
| Non-MBS | |||||||||||||||||||||||||||
| Housing finance agency bonds: | |||||||||||||||||||||||||||
| CalHFA bonds | $ | — | $ | — | $ | 303 | $ | 25 | $ | — | $ | — | $ | 328 | |||||||||||||
| GSEs: | |||||||||||||||||||||||||||
| FFCB bonds | — | 3,513 | — | — | — | — | 3,513 | ||||||||||||||||||||
| Total non-MBS | — | 3,513 | 303 | 25 | — | — | 3,841 | ||||||||||||||||||||
| MBS: | |||||||||||||||||||||||||||
| Other U.S. obligations: | |||||||||||||||||||||||||||
| Ginnie Mae | — | 1,524 | — | — | — | — | 1,524 | ||||||||||||||||||||
| GSEs: | |||||||||||||||||||||||||||
| Freddie Mac | — | 4,517 | — | — | — | — | 4,517 | ||||||||||||||||||||
Fannie Mae(2) | — | 5,282 | 19 | — | 12 | — | 5,313 | ||||||||||||||||||||
| Total GSEs | — | 9,799 | 19 | — | 12 | — | 9,830 | ||||||||||||||||||||
| PLRMBS: | |||||||||||||||||||||||||||
| Prime | — | — | 3 | 384 | 1,336 | 2 | 1,725 | ||||||||||||||||||||
| Alt-A, option ARM | — | — | — | — | 1,079 | — | 1,079 | ||||||||||||||||||||
| Alt-A, other | 10 | 1 | 76 | 187 | 5,171 | 2 | 5,447 | ||||||||||||||||||||
| Total PLRMBS | 10 | 1 | 79 | 571 | 7,586 | 4 | 8,251 | ||||||||||||||||||||
| Total MBS | 10 | 11,324 | 98 | 571 | 7,598 | 4 | 19,605 | ||||||||||||||||||||
| Total securities | 10 | 14,837 | 401 | 596 | 7,598 | 4 | 23,446 | ||||||||||||||||||||
| Securities purchased under agreements to resell | — | 1,000 | — | — | — | — | 1,000 | ||||||||||||||||||||
Federal funds sold(3) | — | 3,528 | 3,929 | 46 | — | — | 7,503 | ||||||||||||||||||||
| Total investments | $ | 10 | $ | 19,365 | $ | 4,330 | $ | 642 | $ | 7,598 | $ | 4 | $ | 31,949 | |||||||||||||
| (1) | Credit ratings of BB and lower are below investment grade. |
| (2) | The Bank has one security guaranteed by Fannie Mae but rated BB by Moody's because of extraordinary expenses incurred during bankruptcy of the security's sponsor. |
| (3) | Includes $300 million at December 31, 2014, in Federal funds sold to a member counterparty determined by the Bank to have an internal credit rating equivalent to an AA+ rating. |
For all securities in its AFS and HTM portfolios, for Federal funds sold, and for securities purchased under agreements to resell, 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, securities purchased under agreements to resell, and negotiable certificates of deposit with member and nonmember counterparties, all of which are highly rated.
Bank policies set forth the capital and creditworthiness requirements for member and nonmember counterparties for unsecured credit. All Federal funds counterparties (members and nonmembers) must be federally insured financial institutions or domestic branches of foreign commercial banks. In addition, for any unsecured credit line, a member counterparty must have at least $100 million in Tier 1 capital (as defined by the applicable regulatory agency) or tangible capital and a nonmember must have at least $250 million in Tier 1 capital (as defined by the applicable regulatory agency) or tangible capital. The general unsecured credit policy limits are as follows:
73
| Unsecured Credit Policy Limits | ||||||||||
Unsecured Credit Limit Amount (Lower of Percentage of Bank Capital or Percentage of Counterparty Capital) | ||||||||||
Long-Term Credit Rating(1) | Maximum Percentage Limit for Outstanding Term(2) | Maximum Percentage Limit for Total Outstanding | Maximum Investment Term (Months) | |||||||
| Member counterparty | AAA | 15 | % | 30 | % | 3 | ||||
| AA | 14 | 28 | 3 | |||||||
| A | 9 | 18 | 3 | |||||||
| BBB | — | 6 | Overnight | |||||||
| Nonmember counterparty | AAA | 15 | 20 | 3 | ||||||
| AA | 14 | 18 | 3 | |||||||
| A | 9 | 12 | 3 | |||||||
| (1) | Long-term credit ratings are based on the lowest of Moody’s, Standard & Poor's, or comparable Fitch ratings. The Bank also uses other similar standards, such as the Bank’s internal credit quality rating, to determine maximum limits to members and nonmembers. If a member is not rated by an NRSRO, the Bank will determine the applicable credit rating by using the Bank’s credit quality rating and may provide overnight unsecured credit to that member. |
(2) Term limit applies to unsecured extensions of credit excluding Federal funds transactions with a maturity of one day or less and Federal funds subject to a continuing contract.
The Bank’s unsecured investment credit limits and terms for member counterparties may be less restrictive than for nonmember counterparties because the Bank has access to more information about members to assist in evaluating the member counterparty credit risk.
The Bank actively monitors its credit exposures and the credit quality of its counterparties, including an assessment of each counterparty’s financial performance, capital adequacy, likelihood of parental or sovereign support, and the current market perceptions of the counterparties. The Bank may also consider general macroeconomic and market conditions and political stability when establishing limits on unsecured investments with U.S. branches and agency offices of foreign commercial banks. As a result of deteriorating financial condition or concerns about adverse economic or market developments, the Bank may reduce limits or terms on unsecured investments or suspend a counterparty.
Finance Agency regulations limit the amount of unsecured credit that an individual FHLBank may extend to a single counterparty. This limit is calculated with reference to a percentage of either the FHLBank’s or the counterparty’s capital and to the counterparty’s overall credit rating. Under these regulations, the lesser of the FHLBank’s total regulatory capital or the counterparty’s Tier 1 capital is multiplied by a percentage specified in the regulation. The percentages used to determine the maximum amount of term extensions of unsecured credit range from 1% to 15%, depending on the counterparty’s overall credit rating. Term extensions of unsecured credit include on-balance sheet transactions, off-balance sheet commitments, and derivative transactions, but exclude overnight Federal funds sales, even if subject to a continuing contract. (See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Derivative Counterparties” for additional information related to derivatives exposure.)
Finance Agency regulations also permit the FHLBanks to extend additional unsecured credit to the same single counterparty for overnight sales of Federal funds, even if subject to a continuing contract. However, an FHLBank’s total unsecured credit to a single counterparty (total term plus additional overnight Federal funds unsecured credit) may not exceed twice the regulatory limit for term exposures (2% to 30% of the lesser of the FHLBank’s total capital or the counterparty’s Tier 1 capital, based on the counterparty’s overall credit rating). In addition, the FHLBanks are prohibited by Finance Agency regulation from investing in financial instruments issued by non-U.S. entities other than those issued by U.S. branches and agency offices of foreign commercial banks.
Under Finance Agency regulations, the total amount of unsecured credit that an FHLBank may extend to a group of affiliated counterparties for term extensions of unsecured credit and overnight Federal funds sales, combined, may
74
not exceed 30% of the FHLBank’s total capital. These limits on affiliated counterparty groups are in addition to the limits on extensions of unsecured credit applicable to any single counterparty within the affiliated group.
As of December 31, 2015, the Bank’s unsecured investment credit exposure to U.S. branches and agency offices of foreign commercial banks was limited to Federal funds sold, which represented 72% of the Bank’s total unsecured investment credit exposure in Federal funds sold.
The following table presents the credit ratings of the unsecured investment credit exposures presented by the domicile of the counterparty or the domicile of the counterparty’s parent for U.S. branches and agency offices of foreign commercial banks, based on the lowest of the credit ratings provided by Moody’s, Standard & Poor’s, or comparable Fitch ratings. This table does not reflect the foreign sovereign government’s credit rating. At December 31, 2015, 65% of the carrying value of unsecured investments held by the Bank were rated AA.
| Ratings of Unsecured Investment Credit Exposure by Domicile of Counterparty | |||||||||||||||
| (In millions) | |||||||||||||||
| December 31, 2015 | |||||||||||||||
Carrying Value(1) | |||||||||||||||
Credit Rating(2) | |||||||||||||||
| Domicile of Counterparty | AA | A | BBB | Total | |||||||||||
| Domestic | $ | 924 | $ | — | $ | 46 | $ | 970 | |||||||
| U.S. subsidiaries of foreign commercial banks | — | 344 | — | 344 | |||||||||||
| Total domestic and U.S. subsidiaries of foreign commercial banks | 924 | 344 | 46 | 1,314 | |||||||||||
| U.S. branches and agency offices of foreign commercial banks: | |||||||||||||||
| Australia | 1,134 | — | — | 1,134 | |||||||||||
| Canada | — | 622 | — | 622 | |||||||||||
| Finland | 934 | — | — | 934 | |||||||||||
| Netherlands | — | 622 | — | 622 | |||||||||||
| Total U.S. branches and agency offices of foreign commercial banks | 2,068 | 1,244 | — | 3,312 | |||||||||||
| Total unsecured credit exposure | $ | 2,992 | $ | 1,588 | $ | 46 | $ | 4,626 | |||||||
| (1) | Excludes unsecured investment credit exposure to U.S. government agencies and instrumentalities, government-sponsored enterprises, and supranational entities and does not include related accrued interest as of December 31, 2015. |
| (2) | Does not reflect changes in ratings, outlook, or watch status occurring after December 31, 2015. These ratings represent the lowest rating available for each unsecured investment owned by the Bank, based on the ratings provided by Moody’s, Standard & Poor’s, or comparable Fitch ratings. The Bank’s internal rating may differ from this rating. |
The following table presents the contractual maturity of the Bank’s unsecured investment credit exposure by the domicile of the counterparty or the domicile of the counterparty’s parent for U.S. branches and agency offices of foreign commercial banks.
75
| Contractual Maturity of Unsecured Investment Credit Exposure by Domicile of Counterparty | |||||||||||
| (In millions) | |||||||||||
| December 31, 2015 | |||||||||||
Carrying Value(1) | |||||||||||
| Domicile of Counterparty | Overnight | Due 2 Days Through 30 Days | Total | ||||||||
| Domestic | $ | 970 | $ | — | $ | 970 | |||||
| U.S. subsidiaries of foreign commercial banks | 344 | — | 344 | ||||||||
| Total domestic and U.S. subsidiaries of foreign commercial banks | 1,314 | — | 1,314 | ||||||||
| U.S. branches and agency offices of foreign commercial banks: | |||||||||||
| Australia | 408 | 726 | 1,134 | ||||||||
| Canada | 156 | 466 | 622 | ||||||||
| Finland | 208 | 726 | 934 | ||||||||
| Netherlands | 156 | 466 | 622 | ||||||||
| Total U.S. branches and agency offices of foreign commercial banks | 928 | 2,384 | 3,312 | ||||||||
| Total unsecured credit exposure | $ | 2,242 | $ | 2,384 | $ | 4,626 | |||||
| (1) | Excludes unsecured investment credit exposure to U.S. government agencies and instrumentalities, government-sponsored enterprises, and supranational entities and does not include related accrued interest as of December 31, 2015. |
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. These bonds are mortgage revenue bonds (federally taxable), are collateralized by pools of first lien residential mortgage loans, and are 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), National Public Financial Guarantee (formerly MBIA Insurance Corporation), or Assured Guaranty Municipal Corporation (formerly Financial Security Assurance Incorporated). At December 31, 2015, all of the bonds were rated at least A by Moody’s or Standard & Poor’s.
For the Bank’s investments in housing finance agency bonds, which were issued by CalHFA, the gross unrealized losses were mainly due to an illiquid market, credit concerns regarding the underlying mortgage collateral, and credit concerns regarding the monoline insurance providers, 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 a market participant would deem 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 December 31, 2015, all of the gross unrealized losses on the CalHFA bonds are temporary because the underlying collateral and credit enhancements were sufficient to protect the Bank from losses. As a result, the Bank expects to recover the entire amortized cost basis of these securities. If conditions in the housing and mortgage markets and general business and economic conditions deteriorate, the fair value of the CalHFA bonds may decline further and the Bank may experience OTTI in future periods.
The Bank’s MBS investments 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 the PLRMBS were issued by and/or purchased from members, former members, or their affiliates. The Bank has investment credit limits and terms for these investments that do not differ for members and nonmembers. Regulatory policy limits total MBS investments to three times the Bank’s capital at the time of purchase. At December 31, 2015, the Bank’s MBS portfolio was 297% of Bank capital (as determined in accordance with regulations governing the operations of the FHLBanks). The Bank has not purchased any PLRMBS since the first quarter of 2008.
76
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.
At December 31, 2015, PLRMBS representing 34% of the amortized cost of the Bank’s MBS portfolio were labeled Alt-A by the issuer. These 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 with credit scores that are high enough to qualify for a prime mortgage loan, but the loans may not meet standard underwriting guidelines for documentation requirements, property type, or loan-to-value ratios.
As of December 31, 2015, the Bank’s investment in MBS had gross unrealized losses totaling $268 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 market expectations of the credit performance of loan collateral underlying these securities, causing these assets to be valued at discounts to their acquisition cost.
For its agency MBS, the Bank expects to recover the entire amortized cost basis of these securities because the Bank 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. As a result, the Bank determined that, as of December 31, 2015, all of the gross unrealized losses on its agency MBS are temporary.
In 2009, the 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. 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 of its PLRMBS for OTTI 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 approved by the FHLBanks' OTTI Committee and by the Bank. These assumptions may include 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. 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 have incurred a credit-related OTTI.
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 December 31, 2015, using two third-party models. The first model projects prepayments, default rates, and loss severities on the underlying collateral based on borrower characteristics and the particular attributes of the loans underlying the Bank’s securities, in conjunction with assumptions related primarily to future changes in housing prices and interest rates. 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 regional housing markets. CBSA refers collectively to metropolitan and micropolitan statistical areas as defined by the U.S. 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 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
77
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 housing price forecast that reflects the expectations for near- and long-term housing price behavior.
The FHLBanks’ OTTI Committee developed a short-term housing price forecast with projected changes ranging from a decrease of 3.0% to an increase of 8.0% over the 12-month period beginning October 1, 2015. For the vast majority of markets, the projected short-term housing price changes range from an increase of 2.0% to an increase of 5.0%. Thereafter, a unique path is projected for each geographic area based on an internally developed framework derived from historical data.
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 primarily based on a short-term housing price forecast that was five percentage points below the base case forecast, followed by a recovery path with annual rates of housing price growth that were 33.0% lower than the base case.
The following table shows the base case scenario and what the credit-related OTTI loss would have been under the more adverse housing price scenario at December 31, 2015:
| OTTI Analysis Under Base Case and Adverse Case Scenarios | |||||||||||||||||||||
| Housing Price Scenario | |||||||||||||||||||||
| Base Case | Adverse Case | ||||||||||||||||||||
| (Dollars in millions) | Number of Securities | Unpaid Principal Balance | Credit- Related OTTI(1) | Number of Securities | Unpaid Principal Balance | Credit- Related OTTI(1) | |||||||||||||||
| Other-than-temporarily impaired PLRMBS backed by loans classified at origination as: | |||||||||||||||||||||
| Prime | 2 | $ | 80 | $ | (1 | ) | 2 | $ | 80 | $ | (1 | ) | |||||||||
| Alt-A, option ARM | 1 | 12 | — | 2 | 120 | — | |||||||||||||||
| Alt-A, other | 12 | 364 | (2 | ) | 21 | 741 | (5 | ) | |||||||||||||
| Total | 15 | $ | 456 | $ | (3 | ) | 25 | $ | 941 | $ | (6 | ) | |||||||||
| (1) | Amounts are for the three months ended December 31, 2015. |
For more information on the Bank’s OTTI analysis and reviews, see “Item 8. Financial Statements and Supplementary Data – Note 7 – Other-Than-Temporary Impairment Analysis.”
The following table presents the ratings of the Bank’s PLRMBS as of December 31, 2015, by collateral type at origination and by year of securitization.
78
| Unpaid Principal Balance of PLRMBS by Year of Securitization and Credit Rating | |||||||||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||||||
| December 31, 2015 | |||||||||||||||||||||||||||
| Unpaid Principal Balance | |||||||||||||||||||||||||||
Credit Rating(1) | |||||||||||||||||||||||||||
| Collateral Type at Origination and Year of Securitization | AAA | AA | A | BBB | Below Investment Grade | Unrated | Total | ||||||||||||||||||||
| Prime | |||||||||||||||||||||||||||
| 2008 | $ | — | $ | — | $ | — | $ | — | $ | 160 | $ | — | $ | 160 | |||||||||||||
| 2007 | — | — | — | — | 394 | — | 394 | ||||||||||||||||||||
| 2006 | — | — | — | — | 54 | — | 54 | ||||||||||||||||||||
| 2005 | — | — | — | 21 | 51 | — | 72 | ||||||||||||||||||||
| 2004 and earlier | — | — | 2 | 345 | 466 | 2 | 815 | ||||||||||||||||||||
| Total Prime | — | — | 2 | 366 | 1,125 | 2 | 1,495 | ||||||||||||||||||||
| Alt-A, option ARM | |||||||||||||||||||||||||||
| 2007 | — | — | — | — | 920 | — | 920 | ||||||||||||||||||||
| 2006 | — | — | — | — | 163 | — | 163 | ||||||||||||||||||||
| 2005 | — | — | — | — | 187 | — | 187 | ||||||||||||||||||||
| Total Alt-A, option ARM | — | — | — | — | 1,270 | — | 1,270 | ||||||||||||||||||||
| Alt-A, other | |||||||||||||||||||||||||||
| 2008 | — | — | — | — | 113 | — | 113 | ||||||||||||||||||||
| 2007 | — | — | — | — | 1,417 | — | 1,417 | ||||||||||||||||||||
| 2006 | — | — | 12 | — | 577 | — | 589 | ||||||||||||||||||||
| 2005 | — | 8 | 2 | — | 2,322 | — | 2,332 | ||||||||||||||||||||
| 2004 and earlier | 8 | 2 | 30 | 151 | 473 | 3 | 667 | ||||||||||||||||||||
| Total Alt-A, other | 8 | 10 | 44 | 151 | 4,902 | 3 | 5,118 | ||||||||||||||||||||
| Total par value | $ | 8 | $ | 10 | $ | 46 | $ | 517 | $ | 7,297 | $ | 5 | �� | $ | 7,883 | ||||||||||||
| (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 December 31, 2015, by collateral type at origination and by year of securitization.
79
Unpaid Principal Balance of Other-Than-Temporarily Impaired PLRMBS by Year of Securitization and Credit Rating | ||||||||||||||||||
| (In millions) | ||||||||||||||||||
| December 31, 2015 | ||||||||||||||||||
| Unpaid Principal Balance | ||||||||||||||||||
Credit Rating(1) | ||||||||||||||||||
| Collateral Type at Origination and Year of Securitization | AA | A | BBB | Below Investment Grade | Total | |||||||||||||
| Prime | ||||||||||||||||||
| 2008 | $ | — | $ | — | $ | — | $ | 147 | $ | 147 | ||||||||
| 2007 | — | — | — | 340 | 340 | |||||||||||||
| 2006 | — | — | — | 24 | 24 | |||||||||||||
| 2005 | — | — | — | 22 | 22 | |||||||||||||
| 2004 and earlier | — | — | — | 58 | 58 | |||||||||||||
| Total Prime | — | — | — | 591 | 591 | |||||||||||||
| Alt-A, option ARM | ||||||||||||||||||
| 2007 | — | — | — | 920 | 920 | |||||||||||||
| 2006 | — | — | — | 163 | 163 | |||||||||||||
| 2005 | — | — | — | 186 | 186 | |||||||||||||
| Total Alt-A, option ARM | — | — | — | 1,269 | 1,269 | |||||||||||||
| Alt-A, other | ||||||||||||||||||
| 2008 | — | — | — | 113 | 113 | |||||||||||||
| 2007 | — | — | — | 1,366 | 1,366 | |||||||||||||
| 2006 | — | 12 | — | 577 | 589 | |||||||||||||
| 2005 | — | — | — | 2,315 | 2,315 | |||||||||||||
| 2004 and earlier | 1 | 2 | 20 | 229 | 252 | |||||||||||||
| Total Alt-A, other | 1 | 14 | 20 | 4,600 | 4,635 | |||||||||||||
| Total par value | $ | 1 | $ | 14 | $ | 20 | $ | 6,460 | $ | 6,495 | ||||||||
| (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, credit- and non-credit-related OTTI, 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 security, which may not necessarily be the same as the classification at the time of origination.
80
| PLRMBS Credit Characteristics | ||||||||||||||||||||||||||||||||
| (Dollars in millions) | ||||||||||||||||||||||||||||||||
| December 31, 2015 | ||||||||||||||||||||||||||||||||
Underlying Collateral Performance and Credit Enhancement Statistics | ||||||||||||||||||||||||||||||||
| Collateral Type at Origination and Year of Securitization | Amortized Cost | Gross Unrealized Losses(2) | Estimated Fair Value | Total OTTI(1) | Non- Credit- Related OTTI(1) | Credit- Related OTTI(1) | Weighted Average 60+ Days Collateral Delinquency Rate | Original Weighted Average Credit Support | Current Weighted Average Credit Support | |||||||||||||||||||||||
| Prime | ||||||||||||||||||||||||||||||||
| 2008 | $ | 138 | $ | — | $ | 147 | $ | — | $ | — | $ | — | 12.48 | % | 30.00 | % | 13.07 | % | ||||||||||||||
| 2007 | 325 | (6 | ) | 327 | (5 | ) | — | (5 | ) | 12.58 | 22.47 | 3.11 | ||||||||||||||||||||
| 2006 | 47 | — | 49 | (1 | ) | — | (1 | ) | 14.78 | 12.75 | 3.87 | |||||||||||||||||||||
| 2005 | 70 | (2 | ) | 70 | — | — | — | 10.19 | 11.86 | 15.10 | ||||||||||||||||||||||
| 2004 and earlier | 814 | (20 | ) | 796 | — | — | — | 6.74 | 4.44 | 12.57 | ||||||||||||||||||||||
| Total Prime | 1,394 | (28 | ) | 1,389 | (6 | ) | — | (6 | ) | 9.35 | 12.59 | 9.94 | ||||||||||||||||||||
| Alt-A, option ARM | ||||||||||||||||||||||||||||||||
| 2007 | 754 | (29 | ) | 745 | — | — | — | 23.61 | 44.18 | 15.24 | ||||||||||||||||||||||
| 2006 | 118 | (8 | ) | 125 | (1 | ) | — | (1 | ) | 22.65 | 44.90 | 6.61 | ||||||||||||||||||||
| 2005 | 84 | (3 | ) | 110 | (1 | ) | 1 | — | 18.44 | 22.74 | 4.85 | |||||||||||||||||||||
| Total Alt-A, option ARM | 956 | (40 | ) | 980 | (2 | ) | 1 | (1 | ) | 22.72 | 41.12 | 12.60 | ||||||||||||||||||||
| Alt-A, other | ||||||||||||||||||||||||||||||||
| 2008 | 110 | (10 | ) | 100 | — | — | — | 8.80 | 31.80 | 23.41 | ||||||||||||||||||||||
| 2007 | 1,230 | (53 | ) | 1,213 | (12 | ) | 8 | (4 | ) | 18.05 | 27.12 | 11.01 | ||||||||||||||||||||
| 2006 | 443 | (1 | ) | 496 | (3 | ) | 2 | (1 | ) | 18.60 | 18.42 | 1.42 | ||||||||||||||||||||
| 2005 | 2,076 | (83 | ) | 2,044 | (8 | ) | 5 | (3 | ) | 14.78 | 14.25 | 5.36 | ||||||||||||||||||||
| 2004 and earlier | 663 | (18 | ) | 653 | — | — | — | 10.97 | 8.13 | 17.47 | ||||||||||||||||||||||
| Total Alt-A, other | 4,522 | (165 | ) | 4,506 | (23 | ) | 15 | (8 | ) | 15.50 | 17.88 | 8.45 | ||||||||||||||||||||
| Total | $ | 6,872 | $ | (233 | ) | $ | 6,875 | $ | (31 | ) | $ | 16 | $ | (15 | ) | 15.50 | % | 20.62 | % | 9.40 | % | |||||||||||
| (1) | Amounts are for the twelve months ended December 31, 2015. |
(2) Represents total gross unrealized losses, including non-credit-related other-than-temporary impairment recognized in AOCI. The unpaid principal
balance of Prime, Alt-A, option ARM, and Alt-A, other in a gross unrealized loss position was $893 million, $550 million, and $2.6 billion, respectively, at December 31, 2015, and the amortized cost of Prime, Alt-A, option ARM, and Alt-A, other in a gross unrealized loss position was $895 million, $474 million, and $2.4 billion, respectively, at December 31, 2015.
The following table presents a summary of the significant inputs used to determine potential OTTI credit losses in the Bank’s PLRMBS portfolio at December 31, 2015.
81
| Significant Inputs to OTTI Credit Analysis for All PLRMBS | |||||||
| December 31, 2015 | |||||||
| Significant Inputs | Current | ||||||
| Prepayment Rates | Default Rates | Loss Severities | Credit Enhancement | ||||
| Year of Securitization | Weighted Average % | Weighted Average % | Weighted Average % | Weighted Average % | |||
| Prime | |||||||
| 2008 | 12.7 | 11.5 | 26.1 | 17.4 | |||
| 2007 | 9.5 | 4.7 | 21.4 | 9.7 | |||
| 2006 | 10.8 | 9.0 | 25.4 | 11.3 | |||
| 2005 | 15.7 | 5.6 | 24.8 | 12.6 | |||
| 2004 and earlier | 16.9 | 4.0 | 21.0 | 11.9 | |||
| Total Prime | 15.2 | 6.1 | 22.5 | 13.1 | |||
| Alt-A, option ARM | |||||||
| 2007 | 6.5 | 32.9 | 38.5 | 15.2 | |||
| 2006 | 5.9 | 35.5 | 38.7 | 6.6 | |||
| 2005 | 7.1 | 22.9 | 34.8 | 4.9 | |||
| Total Alt-A, option ARM | 6.5 | 31.8 | 38.0 | 12.6 | |||
| Alt-A, other | |||||||
| 2007 | 11.0 | 24.0 | 36.0 | 6.3 | |||
| 2006 | 10.7 | 22.1 | 38.8 | 8.4 | |||
| 2005 | 13.3 | 15.3 | 35.8 | 5.6 | |||
| 2004 and earlier | 14.5 | 11.3 | 31.1 | 17.7 | |||
| Total Alt-A, other | 12.4 | 18.1 | 35.7 | 7.9 | |||
| Total | 11.9 | 18.6 | 34.2 | 9.4 | |||
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 security, which may not necessarily be the same as the classification at the time of origination.
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.
82
| Fair Value of PLRMBS as a Percentage of Unpaid Principal Balance by Year of Securitization | ||||||||||||||
| Collateral Type at Origination and Year of Securitization | December 31, 2015 | September 30, 2015 | June 30, 2015 | March 31, 2015 | December 31, 2014 | |||||||||
| Prime | ||||||||||||||
| 2008 | 92.09 | % | 93.00 | % | 93.09 | % | 93.52 | % | 92.36 | % | ||||
| 2007 | 82.96 | 83.03 | 83.73 | 83.70 | 83.38 | |||||||||
| 2006 | 91.36 | 92.03 | 92.65 | 92.10 | 91.51 | |||||||||
| 2005 | 97.28 | 97.61 | 96.90 | 97.64 | 97.78 | |||||||||
| 2004 and earlier | 97.70 | 97.74 | 98.18 | 98.25 | 98.24 | |||||||||
| Weighted average of all Prime | 92.96 | 93.21 | 93.68 | 93.85 | 93.70 | |||||||||
| Alt-A, option ARM | ||||||||||||||
| 2007 | 80.96 | 81.13 | 82.19 | 81.63 | 80.82 | |||||||||
| 2006 | 76.70 | 77.49 | 78.54 | 79.33 | 79.83 | |||||||||
| 2005 | 58.93 | 59.24 | 60.14 | 58.98 | 56.16 | |||||||||
| Weighted average of all Alt-A, option ARM | 77.17 | 77.37 | 78.30 | 77.73 | 76.72 | |||||||||
| Alt-A, other | ||||||||||||||
| 2008 | 88.74 | 88.74 | 89.64 | 92.47 | 96.33 | |||||||||
| 2007 | 85.54 | 85.94 | 86.12 | 87.12 | 86.85 | |||||||||
| 2006 | 84.18 | 84.23 | 84.75 | 84.85 | 84.45 | |||||||||
| 2005 | 87.65 | 88.09 | 88.35 | 88.24 | 88.29 | |||||||||
| 2004 and earlier | 97.87 | 97.98 | 98.34 | 98.52 | 98.31 | |||||||||
| Weighted average of all Alt-A, other | 88.02 | 88.36 | 88.67 | 88.99 | 88.95 | |||||||||
| Weighted average of all PLRMBS | 87.21 | % | 87.54 | % | 88.02 | % | 88.21 | % | 88.03 | % | ||||
The Bank determined that, as of December 31, 2015, the gross unrealized losses on the PLRMBS that have not had an OTTI loss are primarily due to illiquidity in the PLRMBS market, uncertainty about the future condition of the housing and mortgage markets and the economy, and market expectations of the credit performance of loan collateral underlying these securities, which caused these assets to be valued at 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 December 31, 2015, 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.
If conditions in the housing and mortgage markets and general business and economic conditions deteriorate, 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 December 31, 2015. Additional future credit-related OTTI losses 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 credit-related OTTI losses on its PLRMBS in the future.
Derivative Counterparties. The Bank has also adopted credit policies and exposure limits for uncleared derivatives credit exposure. Over-the-counter derivatives may be either entered into directly with a counterparty (uncleared derivatives) or executed either with an executing dealer or on a swap execution facility and then cleared through a futures commission merchant (clearing agent) with a derivatives clearing organization (cleared derivatives).
Uncleared Derivatives. The Bank selects only highly rated derivative dealers and major banks (derivative dealer counterparties) that meet the Bank’s eligibility criteria to act as counterparties for its uncleared derivative activities. In addition, the Bank has entered into master netting agreements and bilateral credit support agreements with all
83
active derivative dealer counterparties that provide for delivery of collateral at specified levels 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 derivative dealer counterparty is either (i) limited to an absolute dollar credit exposure according to the counterparty’s long-term debt or deposit credit rating, as determined by the rating agencies, or (ii) set at zero (subject to a minimum transfer amount). All credit exposure from derivative transactions entered into by the Bank with member counterparties that are not derivative dealers (including interest rate swaps, caps, and floors), for which the Bank serves as an intermediary, must be fully secured by eligible collateral, and all such derivative transactions are subject to both the Bank’s Advances and Security Agreement and a master netting agreement.
The Bank is subject to the risk of potential nonperformance by the counterparties to derivative agreements. Unless the collateral delivery threshold is set at zero, the amount of net unsecured credit exposure that is permissible with respect to each counterparty depends on the credit rating of that counterparty. A counterparty generally must deliver collateral to the Bank if the total market value of the Bank’s exposure to that counterparty rises above a specific trigger point. Currently, all of the Bank’s active uncleared derivative counterparties have a zero threshold. As a result of these risk mitigation initiatives, the Bank does not anticipate any credit losses on its uncleared derivative transactions with counterparties as of December 31, 2015.
Cleared Derivatives. The Bank is subject to nonperformance by the derivatives clearing organizations (clearinghouses) and clearing agents. The requirement that the Bank post initial and variation margin through the clearing agent, to the clearinghouse, exposes the Bank to institutional credit risk in the event that the clearing agent or the clearinghouse fails to meet its obligations. However, the use of cleared derivatives mitigates the Bank’s overall credit risk exposure because a central counterparty is substituted for individual counterparties and variation margin is posted daily for changes in the value of cleared derivatives through a clearing agent. The Bank does not anticipate any credit losses on its cleared derivatives as of December 31, 2015.
The following table presents the Bank’s credit exposure to its derivative dealer counterparties at the dates indicated.
| Credit Exposure to Derivative Dealer Counterparties | |||||||||||||||||||
| (In millions) | |||||||||||||||||||
| December 31, 2015 | |||||||||||||||||||
Counterparty Credit Rating(1) | Notional Amount | Net Fair Value of Derivatives Before Collateral | Cash Collateral Pledged to/ (from) Counterparty | Non-cash Collateral Pledged to/ (from) Counterparty | Net Credit Exposure to Counterparties | ||||||||||||||
| Asset positions with credit exposure: | |||||||||||||||||||
| Uncleared derivatives | |||||||||||||||||||
| A | $ | 4,858 | $ | 89 | $ | (84 | ) | $ | — | $ | 5 | ||||||||
Cleared derivatives(2) | 8,722 | 47 | (39 | ) | — | 8 | |||||||||||||
| Liability positions with credit exposure: | |||||||||||||||||||
| Uncleared derivatives | |||||||||||||||||||
| AA | 777 | (1 | ) | 1 | — | — | |||||||||||||
| A | 3,951 | (12 | ) | 13 | — | 1 | |||||||||||||
| BBB | 25 | (1 | ) | 1 | — | — | |||||||||||||
Cleared derivatives(2) | 48,141 | (7 | ) | 26 | — | 19 | |||||||||||||
| Total derivative positions with credit exposure to nonmember counterparties | 66,474 | 115 | (82 | ) | — | 33 | |||||||||||||
Member institutions(3) | 5 | — | — | — | — | ||||||||||||||
| Total | 66,479 | $ | 115 | $ | (82 | ) | $ | — | $ | 33 | |||||||||
| Derivative positions without credit exposure | 13,310 | ||||||||||||||||||
| Total notional | $ | 79,789 | |||||||||||||||||
84
| December 31, 2014 | |||||||||||||||||||
Counterparty Credit Rating(1) | Notional Amount | Net Fair Value of Derivatives Before Collateral | Cash Collateral Pledged to/ (from) Counterparty | Non-cash Collateral Pledged to/ (from) Counterparty | Net Credit Exposure to Counterparties | ||||||||||||||
| Asset positions with credit exposure: | |||||||||||||||||||
| Uncleared derivatives | |||||||||||||||||||
| AA | $ | 148 | $ | 1 | $ | — | $ | — | $ | 1 | |||||||||
| A | 7,439 | 166 | (164 | ) | — | 2 | |||||||||||||
Cleared derivatives(2) | 10,629 | 79 | (65 | ) | — | 14 | |||||||||||||
| Liability positions with credit exposure: | |||||||||||||||||||
| Uncleared derivatives | |||||||||||||||||||
| A | 50 | — | — | — | — | ||||||||||||||
Cleared derivatives(2) | 14,290 | (10 | ) | 27 | — | 17 | |||||||||||||
| Total derivative positions with credit exposure to nonmember counterparties | 32,556 | $ | 236 | $ | (202 | ) | $ | — | $ | 34 | |||||||||
| Derivative positions without credit exposure | 29,741 | ||||||||||||||||||
| Total notional | $ | 62,297 | |||||||||||||||||
| (1) | The credit ratings used by the Bank are based on the lower of Moody's or Standard & Poor's ratings. |
| (2) | Represents derivative transactions cleared with LCH Clearnet, the Bank’s clearinghouse, which is not rated. LCH Clearnet’s parent, LCH Clearnet Group, Ltd., is rated A+ by Standard & Poor’s. |
| (3) | Member institutions include mortgage delivery commitments with members. |
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, market values of derivatives, 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 derivative agreements.
Market Risk
Market risk is defined as the risk to the Bank's market value and 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) as a result of movements in market interest rates, interest rate spreads, interest rate volatility, and other market factors (market rate factors). 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 market risk.
The Bank’s Risk Management Policy includes a market risk management objective aimed at maintaining a relatively low adverse 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 market rate factors. See “Total Bank Market Risk” below.
Market risk identification and measurement are primarily accomplished through market value of capital sensitivity analyses, net portfolio value of capital sensitivity analyses, and projected earnings and adjusted return on capital 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 Enterprise Risk Committee 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’s policy limits. Market risk is managed for each business segment on a daily basis, as discussed below in “Segment Market Risk.” Compliance with Bank policies
85
and guidelines is reviewed by the Bank’s Board of Directors on a regular basis, 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 explained below, the Bank measures, monitors, and reports on market value of capital sensitivity but does not have a policy limit for this measure.
Since 2008, the Bank has used net portfolio value of capital sensitivity as the primary market value metric for measuring the Bank’s exposure to changes in interest rates and has established 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 market 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 may 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 private-label residential mortgage-backed securities (PLRMBS) for which the Bank expects loss of principal in future periods, the par value 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’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 –4.0% 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 –6.0% 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 because of prevailing low interest rates, the sensitivity metric is not reported. The Bank’s measured net portfolio value of capital sensitivity was within the policy limits as of December 31, 2015.
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 mortgage prepayment assumptions. The Bank also compares the mortgage prepayment assumptions in the third-party model to other sources, including actual mortgage prepayment history.
The 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
86
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) | December 31, 2015 | December 31, 2014 | ||
| +200 basis-point change above current rates | –5.0 | % | –2.7 | % |
| +100 basis-point change above current rates | –2.3 | –1.2 | ||
–100 basis-point change below current rates(2) | +2.8 | +2.6 | ||
–200 basis-point change below current rates(2) | +9.0 | +6.4 | ||
| (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 December 31, 2015, show greater adverse sensitivity in rising rate scenarios and greater favorable sensitivity in declining rate scenarios compared to the estimates as of December 31, 2014. The factors contributing to the change in sensitivity in the rising rate scenarios are the impact of higher volatility, the increase in the Bank’s assets-to-capital leverage, and impacts associated with enhancements to models incorporating additional data for modified loans. The higher volatility affects the sensitivity for interest rate caps in the Bank’s floating-rate MBS portfolio. In 2015, the Bank repurchased additional excess capital stock, which reduced the Bank’s capital stock outstanding and further increased sensitivity, which is presented as a percentage of capital. The change in sensitivity in the declining rate scenarios is primarily related to the current low interest rate environment, in which interest rates in declining rate scenarios cannot decrease to the same extent as interest rates in rising rate scenarios can increase. As of December 31, 2015, interest rates could decrease more in a declining rate scenario relative to the measurements as of December 31, 2014. LIBOR interest rates as of December 31, 2015, were 42 basis points higher for the 1-year term, 5 basis points lower for the 5-year term, and 11 basis points lower for the 10-year term.
The 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 at current market spreads. The Bank’s estimates of the sensitivity of the net portfolio value of capital to changes in interest rates as of December 31, 2015, show greater adverse sensitivity in rising rate scenarios and greater favorable sensitivity in declining rate scenarios compared to the estimates as of December 31, 2014. The factors contributing to the change in sensitivity in the rising rate scenarios are the impact of higher volatility, the increase in the Bank’s assets-to-capital leverage, and impacts associated with enhancements to models incorporating additional data for modified loans. The higher volatility affects the sensitivity for interest rate caps in the Bank’s floating-rate MBS portfolio. In 2015, the Bank repurchased additional excess capital stock, which reduced the Bank’s capital stock outstanding and further increased sensitivity, which is presented as a percentage of capital. The change in sensitivity in the declining rate scenarios is primarily related to the current low interest rate environment, in which interest rates in declining rate scenarios cannot decrease to the same extent as interest rates in rising rate scenarios can increase. As of December 31, 2015, interest rates could decrease more in a declining rate scenario relative to the measurements as of December 31, 2014. LIBOR interest rates as of December 31, 2015, were 42 basis points higher for the 1-year term, 5 basis points lower for the 5-year term, and 11 basis points lower for the 10-year term.
87
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) | December 31, 2015 | December 31, 2014 | ||
| +200 basis-point change above current rates | –4.5 | % | –2.7 | % |
| +100 basis-point change above current rates | –2.0 | –1.1 | ||
–100 basis-point change below current rates(2) | +1.8 | +1.9 | ||
–200 basis-point change below current rates(2) | +6.2 | +4.3 | ||
| (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 Risk Management Policy provides guidelines for the payment of dividends and the repurchase of excess capital 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 would be limited to an annualized rate no greater than the daily average of the three-month LIBOR for the applicable quarter (subject to certain conditions), and any excess capital stock repurchases would not exceed $500 million (subject to certain conditions); (ii) less than 90% but greater than or equal to 70%, any dividend and any excess capital stock repurchases would be subject to the same limitations and conditions as in (i) above, except that any excess capital stock repurchases would not exceed 4% of the Bank's outstanding capital stock as of the repurchase date; and (iii) less than 70%, the Bank would not pay a dividend, not repurchase excess capital stock (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 FHLBank Act and applicable requirements under the regulations governing the operations of the FHLBanks. The ratio of the Bank's estimated market value of total capital to par value of capital stock was 200% as of December 31, 2015.
Adjusted Return on Capital – The adjusted return on capital is a measure used by the Bank to assess financial performance. The adjusted return on capital 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 under the fair value option, hedged assets and liabilities, and derivatives. Economic earnings also exclude the interest expense on mandatorily redeemable capital stock and the 20% of net income allocated to the Bank’s restricted retained earnings account in accordance with the FHLBanks’ JCE Agreement. Economic earnings exclude these amounts in order to more accurately reflect the amount of earnings that may be available to be paid as dividends to shareholders.
The Bank limits the sensitivity of projected financial performance through a Board of Directors policy limit on projected adverse changes in the adjusted return on capital. The Bank’s adjusted return on capital 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 adjusted return on capital. In both the upward and downward shift scenarios, the adjusted return on capital for the projected 12-month horizon is not expected to deteriorate relative to the base case environment.
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 and does not have a policy limit. The Bank’s duration gap was one month at December 31, 2015, and less than one month at December 31, 2014.
88
| Total Bank Duration Gap Analysis | |||||||||||||
| December 31, 2015 | December 31, 2014 | ||||||||||||
Amount (In millions) | Duration Gap(1)(2) (In months) | Amount (In millions) | Duration Gap(1)(2) (In months) | ||||||||||
| Assets | $ | 85,707 | 7 | $ | 75,807 | 10 | |||||||
| Liabilities | 80,811 | 6 | 70,114 | 10 | |||||||||
| Net | $ | 4,896 | 1 | $ | 5,693 | — | |||||||
| (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. |
Since duration gap is a measure of market value sensitivity, the impact of large embedded mortgage liquidity spreads on duration gap is the same as described in the analysis in “Total Bank Market Risk – Market Value of Capital Sensitivity and Net Portfolio 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.
Advances-Related Business – Interest rate risk arises from the advances-related business primarily through the use of shareholder-contributed capital and retained earnings 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 all advances with embedded options are simultaneously hedged 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.
Money market investments used for liquidity management generally have maturities of one month or less. In addition, the Bank invests in non-MBS agency securities, generally with terms of less than three 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 capital (capital stock, including mandatorily redeemable capital stock, and retained earnings). The Bank’s strategy is generally to invest 50% of capital in short-term investments (maturities of three months or less) and 50% in intermediate-term investments (a 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 capital in short-term assets is intended to mitigate the market value of capital risks associated with the potential repurchase or redemption of excess capital stock. Excess capital stock usually results from a decline in a borrower’s outstanding advances or by a membership termination. 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 strategy to invest 50% of capital in a laddered portfolio of investments 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.
The Bank updates the repricing and maturity gaps for actual asset, liability, and derivative 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
89
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 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 (HTM) or available-for-sale (AFS), 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 impact of mortgage prepayments and the existence of interest rate caps on certain adjustable rate MBS.
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 limited. 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 asset is purchased and on an ongoing basis for the total portfolio. 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 mortgage prepayment sensitivity of the mortgage assets and anticipated funding and hedging activities 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 profile of the entire portfolio of mortgage assets and related funding and hedging transactions. The Bank then considers rebalancing strategies to modify the estimated mortgage portfolio market risk profile. Periodically, the Bank performs more in-depth analyses, which include an analysis of the impacts of non-parallel shifts in the yield curve and assessments of the impacts of unanticipated mortgage prepayment behavior. Based on these analyses, the Bank may take actions to rebalance the mortgage portfolio’s 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 mortgage 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 derivative 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 mortgage 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 callable and non-callable pay-fixed interest rate swaps. Derivatives may also be used to offset the interest rate cap risk embedded in adjustable rate MBS.
As discussed above in “Total Bank Market Risk – Market Value of Capital Sensitivity and Net Portfolio Value of Capital Sensitivity,” the Bank uses net portfolio value of capital sensitivity as a primary market value metric for measuring the Bank’s exposure to interest rates. The Bank’s interest rate risk policies and guidelines for the
90
mortgage-related business address the net portfolio value of capital sensitivity of the assets, liabilities, and derivatives of the mortgage-related business. In addition, the Bank continues to use 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. The Bank measures, monitors, and reports on both the net portfolio value of capital sensitivity and the market value of capital sensitivity attributable to the mortgage-related business.
The following table presents results of the estimated market value of capital sensitivity analysis attributable to the mortgage-related business as of December 31, 2015 and 2014.
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) | December 31, 2015 | December 31, 2014 | ||
| +200 basis-point change | –3.0 | % | –1.6 | % |
| +100 basis-point change | –1.4 | –0.7 | ||
–100 basis-point change(2) | +2.0 | +2.0 | ||
–200 basis-point change(2) | +4.8 | +5.0 | ||
| (1) | Instantaneous change from actual rates at dates indicated. |
(2) | Interest rates for each maturity are limited to non-negative interest rates. |
For the mortgage-related business, the Bank’s estimates of the sensitivity of the market value of capital to changes in interest rates as of December 31, 2015, show greater adverse sensitivity in rising rate scenarios and are comparable in declining rate scenarios as compared to the estimates as of December 31, 2014. The factors
contributing to the change in sensitivity in the rising rate scenarios are the impact of higher volatility and impacts
associated with enhancements to models incorporating additional data for modified loans. The higher volatility
affects the sensitivities for interest rate caps in the Bank's floating-rate MBS portfolio. LIBOR interest rates as of December 31, 2015, were 42 basis points higher for the 1-year term, 5 basis points lower for the 5-year term, and 11 basis points lower for the 10-year term. Because interest rates in the declining rate scenarios are limited to non-negative interest rates and the current interest rate environment is so low, the interest rates in the declining rate scenarios cannot decrease to the same extent that the interest rates in the rising rate scenarios can increase.
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 results of the estimated net portfolio value of capital sensitivity analysis attributable to the mortgage-related business as of December 31, 2015 and 2014. The 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 December 31, 2015, show greater adverse sensitivity in rising rate scenarios and are comparable in declining rate scenarios as compared to the estimates as of December 31, 2014. The factors contributing to the change in sensitivity in the rising rate scenarios are the impact of higher volatility and impacts associated with enhancements to models incorporating additional data for modified loans. The higher volatility affects the sensitivities for interest rate caps in the Bank's floating-rate MBS portfolio. LIBOR interest rates as of December 31, 2015, were 42 basis points higher for the 1-year term, 5 basis points lower for the 5-year term, and 11 basis points lower for the 10-year term. Because interest rates in the declining rate scenarios are limited to non-negative interest rates and the current interest rate environment is so low, the interest rates in the declining rate scenarios cannot decrease to the same extent that the interest rates in the rising rate scenarios can increase.
91
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) | December 31, 2015 | December 31, 2014 | ||
| +200 basis-point change above current rates | –2.8 | % | –1.7 | % |
| +100 basis-point change above current rates | –1.2 | –0.7 | ||
–100 basis-point change below current rates(2) | +1.2 | +1.3 | ||
–200 basis-point change below current rates(2) | +2.6 | +3.1 | ||
| (1) | Instantaneous change from actual rates at dates indicated. |
(2) | Interest rates for each maturity are limited to non-negative interest rates. |
Interest Rate Exchange Agreements
A derivative 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; interest rate cap and floor agreements; and callable and putable interest rate swaps (collectively, interest rate exchange agreements) to manage its exposure to interest rate risks inherent in its ordinary course of business, including its lending, investment, and funding activities.
The Bank uses interest rate exchange agreements to implement the following hedging strategies for addressing market risk:
| • | To convert fixed rate advances to LIBOR-indexed adjustable rate structures, which reduces the Bank’s exposure to fixed interest rates. |
| • | To convert non-LIBOR-indexed advances to LIBOR-indexed adjustable rate structures, which reduces the Bank’s exposure to basis risk from non-LIBOR interest rates. |
| • | To convert fixed rate consolidated obligations to LIBOR-indexed adjustable rate structures, which reduces the Bank’s exposure to fixed interest rates. (A combined structure of the callable derivative and callable debt instrument is usually lower in cost than a comparable LIBOR-indexed adjustable rate debt instrument, allowing the Bank to reduce its funding costs.) |
| • | To convert non-LIBOR-indexed consolidated obligations to LIBOR-indexed adjustable rate structures, which reduces the Bank’s exposure to basis risk from non-LIBOR interest rates. |
| • | To reduce the interest rate sensitivity and modify the repricing frequency of assets and liabilities. |
| • | To obtain an option to enter into an interest rate swap to receive a fixed rate, which provides an option to reduce the Bank’s exposure to fixed interest rates on consolidated obligations. |
| • | To obtain callable fixed rate equivalent funding by entering into a callable pay-fixed interest rate swap in connection with the issuance of a short-term discount note. The callable fixed rate equivalent funding is used to reduce the Bank’s exposure to prepayment of mortgage assets. |
| • | To offset an embedded option in an advance. |
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 December 31, 2015 and 2014.
92
| Interest Rate Exchange Agreements | ||||||||||||
| (In millions) | Notional Amount | |||||||||||
| Hedging Instrument | Hedging Strategy | Accounting Designation | December 31, 2015 | December 31, 2014 | ||||||||
| Hedged Item: Advances | ||||||||||||
| Pay fixed, receive adjustable interest rate swap | Fixed rate advance converted to a LIBOR adjustable rate | Fair Value Hedge | $ | 10,758 | $ | 9,883 | ||||||
| Basis swap | Adjustable rate advance converted to another adjustable rate index to reduce interest rate sensitivity and repricing gaps | Economic Hedge(1) | 1 | — | ||||||||
| Received fixed, pay adjustable interest rate swap | LIBOR adjustable rate advance converted to a fixed rate | Economic Hedge(1) | 672 | 200 | ||||||||
| Pay fixed, receive adjustable interest rate swap | Fixed rate advance converted to a LIBOR adjustable rate | Economic Hedge(1) | 2,365 | 2,716 | ||||||||
| 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) | 3,557 | 4,892 | ||||||||
| Interest rate cap or floor | Interest rate cap or floor embedded in an adjustable rate advance; matched to advance accounted for under the fair value option | Economic Hedge(1) | 80 | 156 | ||||||||
Subtotal Economic Hedges(1) | 6,675 | 7,964 | ||||||||||
| Total | 17,433 | 17,847 | ||||||||||
| 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 | 15,857 | 15,885 | ||||||||
| 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) | 2,034 | 6,340 | ||||||||
| 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) | 1,915 | 1,425 | ||||||||
| 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) | 100 | 1,175 | ||||||||
| 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) | 14,986 | 1,400 | ||||||||
| 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) | 170 | 255 | ||||||||
Subtotal Economic Hedges(1) | 19,205 | 10,595 | ||||||||||
| Total | 35,062 | 26,480 | ||||||||||
93
| Interest Rate Exchange Agreements (continued) | ||||||||||||
| (In millions) | Notional Amount | |||||||||||
| Hedging Instrument | Hedging Strategy | Accounting Designation | December 31, 2015 | December 31, 2014 | ||||||||
| 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 | 495 | 2,250 | ||||||||
| 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) | 2,070 | 3,175 | ||||||||
| 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) | 2,270 | 4,148 | ||||||||
Subtotal Economic Hedges(1) | 4,340 | 7,323 | ||||||||||
| Total | 4,835 | 9,573 | ||||||||||
| 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) | 1,355 | 1,670 | ||||||||
| 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) | 17,572 | 1,899 | ||||||||
| 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) | 720 | 315 | ||||||||
| Total | 19,647 | 3,884 | ||||||||||
| Hedged Item: Trading Securities | ||||||||||||
| Basis swap | Basis swap hedging adjustable rate Federal Farm Credit Bank (FFCB) bonds | Economic Hedge(1) | 525 | 2,363 | ||||||||
| Interest rate cap | Stand-alone interest rate cap used to offset cap risk embedded in floating rate MBS | Economic Hedge(1) | 2,150 | 2,150 | ||||||||
| Total | 2,675 | 4,513 | ||||||||||
| Hedged Item: Intermediary Positions and Offsetting Derivatives | ||||||||||||
| Pay fixed, receive adjustable interest rate swap and receive fixed, pay adjustable interest rate swap | Interest rate swap used to offset the economic effect of interest rate swap that is no longer designated to advances, investments, or consolidated obligations | Economic Hedge(1) | 132 | — | ||||||||
| Total | 132 | — | ||||||||||
| Stand-Alone Derivatives | ||||||||||||
| Mortgage delivery commitments | To offset the fair value risk associated with fixed rate mortgage purchase commitments. | N/A | 5 | — | ||||||||
| Total | 5 | — | ||||||||||
| Total Notional Amount | $ | 79,789 | $ | 62,297 | ||||||||
| (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. |
Although the Bank uses interest rate exchange agreements to achieve the specific financial objectives described above, certain transactions do not qualify for hedge accounting (economic hedges). An economic hedge introduces the potential for earnings variability caused by changes in the fair value of the derivatives that are recorded in the Bank’s income but are not offset by corresponding changes in the value of the economically hedged assets and
94
liabilities. Finance Agency regulations and the Bank’s Risk Management Policy prohibit the speculative use of interest rate exchange agreements, and the Bank does not trade derivatives for profit.
It is the Bank’s policy to use interest rate exchange agreements only to reduce the market risk exposures inherent in the otherwise unhedged asset and funding positions of the Bank and to achieve other financial objectives of the Bank, such as obtaining low-cost funding for advances and mortgage assets. The primary objective of the financial management practices of the Bank is to preserve and enhance the long-term economic performance and risk management of the Bank. In accordance with the accounting for derivative instruments and hedging activities, reported net income and other comprehensive income will likely exhibit period-to-period volatility, which may be significant.
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 December 31, 2015 and 2014.
Interest Rate Exchange Agreements Notional Amounts and Estimated Fair Values | |||||||||||||||||||
| December 31, 2015 | |||||||||||||||||||
| (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 | $ | 10,758 | $ | (40 | ) | $ | 39 | $ | — | $ | (1 | ) | |||||||
| Non-callable bonds | 15,857 | 140 | (140 | ) | — | — | |||||||||||||
| Callable bonds | 495 | 2 | 1 | — | 3 | ||||||||||||||
| Subtotal | 27,110 | 102 | (100 | ) | — | 2 | |||||||||||||
| Not qualifying for hedge accounting (economic hedges): | |||||||||||||||||||
| Advances | 6,675 | (38 | ) | — | 31 | (7 | ) | ||||||||||||
| Non-callable bonds | 19,205 | 16 | — | (2 | ) | 14 | |||||||||||||
| Callable bonds | 4,340 | (14 | ) | — | 25 | 11 | |||||||||||||
| Discount notes | 19,647 | 6 | — | — | 6 | ||||||||||||||
| FFCB bonds | 525 | — | — | — | — | ||||||||||||||
| MBS | 2,150 | 6 | — | — | 6 | ||||||||||||||
| Mortgage delivery commitments | 5 | — | — | — | — | ||||||||||||||
| Offsetting derivatives | 132 | — | — | — | — | ||||||||||||||
| Subtotal | 52,679 | (24 | ) | — | 54 | 30 | |||||||||||||
| Total excluding accrued interest | 79,789 | 78 | (100 | ) | 54 | 32 | |||||||||||||
| Accrued interest | — | 35 | (28 | ) | 2 | 9 | |||||||||||||
| Total | $ | 79,789 | $ | 113 | $ | (128 | ) | $ | 56 | $ | 41 | ||||||||
95
| December 31, 2014 | |||||||||||||||||||
| (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 | $ | 9,883 | $ | (62 | ) | $ | 62 | $ | — | $ | — | ||||||||
| Non-callable bonds | 15,885 | 307 | (309 | ) | — | (2 | ) | ||||||||||||
| Callable bonds | 2,250 | 4 | 9 | — | 13 | ||||||||||||||
| Subtotal | 28,018 | 249 | (238 | ) | — | 11 | |||||||||||||
| Not qualifying for hedge accounting (economic hedges): | |||||||||||||||||||
| Advances | 7,964 | (69 | ) | — | 76 | 7 | |||||||||||||
| Non-callable bonds | 10,595 | 43 | — | (12 | ) | 31 | |||||||||||||
| Callable bonds | 7,323 | (31 | ) | — | 54 | 23 | |||||||||||||
| Discount notes | 3,884 | 1 | — | — | 1 | ||||||||||||||
| FFCB bonds | 2,363 | — | — | — | — | ||||||||||||||
| MBS | 2,150 | 9 | — | — | 9 | ||||||||||||||
| Subtotal | 34,279 | (47 | ) | — | 118 | 71 | |||||||||||||
| Total excluding accrued interest | 62,297 | 202 | (238 | ) | 118 | 82 | |||||||||||||
| Accrued interest | — | 20 | (38 | ) | 2 | (16 | ) | ||||||||||||
| Total | $ | 62,297 | $ | 222 | $ | (276 | ) | $ | 120 | $ | 66 | ||||||||
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.
The Bank has identified the following accounting policies and estimates 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 AFS, 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 and accretion of discounts on MBS and mortgage loans. These policies and the judgments, estimates, and assumptions are also described in “Item 8. Financial Statements and Supplementary Data – Note 1 – Summary of Significant Accounting Policies.”
Allowance for Credit Losses
The Bank has developed and documented a methodology for determining an allowance for credit losses, where applicable, for:
| • | advances, letters of credit, and other extensions of credit, collectively referred to as “credit products,” |
| • | MPF loans held for portfolio, |
| • | term securities purchased under agreements to resell, and |
| • | term Federal funds sold. |
96
The allowance for credit losses for credit products and mortgage loans acquired under the MPF Program represents the Bank’s estimate of the probable credit losses inherent in these two portfolios. Determining the amount of the allowance for credit losses is considered a critical accounting estimate because the Bank’s evaluation of the adequacy of the provision is inherently subjective and requires significant estimates, including the amounts and timing of estimated future cash flows, estimated losses based on historical loss experience, and consideration of current economic trends, all of which are subject to change. The Bank’s assumptions and judgments in estimating its allowance for credit losses are based on information available as of the date of the financial statements. Actual results could differ from these estimates.
Credit Products. In determining the allowance for credit losses on credit products, the Bank evaluates its exposure to credit loss taking into consideration: (i) the Bank's judgment as to the creditworthiness of the borrowers to which the Bank lends funds, and (ii) review and valuation of the collateral pledged by borrowers.
The Bank has policies and procedures in place to manage its credit risk on credit products. These include:
| • | Monitoring the creditworthiness and financial condition of the borrowers. |
| • | Assessing the quality and value of collateral pledged by borrowers to secure advances. |
| • | Establishing borrowing capacities based on collateral value and type for each borrower, including assessment of margin requirements based on factors such as the cost to liquidate and inherent risk exposure based on collateral type. |
| • | Evaluating historical loss experience. |
The Bank is required by the FHLBank Act and Finance Agency regulations to obtain sufficient collateral on credit products and to accept only certain collateral for credit products, such as one- to four-family first lien residential mortgage loans, multifamily mortgage loans, MBS, U.S. government and agency securities, deposits in the Bank, and certain other real estate-related collateral, such as commercial real estate loans and second lien residential mortgage loans. The Bank may also accept small business, small farm, and small agribusiness loans that are fully secured by collateral (such as real estate, equipment and vehicles, accounts receivable, and inventory) as eligible collateral from members that are community financial institutions. The Housing Act added secured loans for community development activities as a type of collateral that the Bank may accept from community financial institutions.
At December 31, 2015, the Bank had $50.9 billion of advances outstanding and collateral pledged with an estimated borrowing capacity of $195.3 billion. At December 31, 2014, the Bank had $39.0 billion of advances outstanding and collateral pledged with an estimated borrowing capacity of $186.3 billion.
Based on the collateral pledged as security for advances, the Bank’s credit analyses of borrowers’ financial condition, and the Bank’s credit extension and collateral policies as of December 31, 2015, the Bank expects to collect all amounts due according to the contractual terms. Therefore, no allowance for losses on credit products was deemed necessary by the Bank. The Bank has never experienced a credit loss on any of its credit products.
Significant changes to any of the factors described above could materially affect the Bank’s allowance for losses on credit products. For example, the Bank’s current assumptions about the financial strength of any borrower may change because of various circumstances, such as new information becoming available regarding the borrower’s financial strength or changes in the national or regional economy. New information may cause the Bank to: place a borrower on credit watch, require the borrower to pledge additional collateral, require the borrower to deliver collateral, adjust the borrowing capacity of the borrower's collateral, require prepayment of the credit products, or provide for losses on the credit products.
Mortgage Loans Acquired Under the MPF Program. In determining the allowance for credit losses on mortgage loans, the Bank evaluates its exposure to credit loss taking into consideration: (i) the Bank’s judgment as to the eligibility of participating financial institutions to continue to service and credit-enhance the loans sold to the Bank,
97
(ii) evaluation of credit exposure on purchased loans, (iii) valuation of available credit enhancements, and (iv) estimation of loss exposure and historical loss experience.
The Bank has policies and procedures in place to manage its credit risk. These include:
| • | Monitoring the creditworthiness and financial condition of the institutions that sold the mortgage loans to the Bank or their successors (both considered to be participating financial institutions) and their ability to meet servicing obligations. |
| • | Determining required credit enhancements to be provided by participating financial institutions and assessing the availability of other credit enhancements. |
| • | Estimating loss exposure and historical loss experience to establish an adequate level of allowance for credit losses. |
The Bank maintains an allowance for credit losses, net of credit enhancements, on mortgage loans acquired under the MPF Program at levels that it believes to be adequate to absorb estimated losses identified and inherent in the total mortgage portfolio. Setting the level of allowance for credit losses requires significant judgment and regular evaluation by the Bank. Many factors, including delinquency statistics, past performance, current performance, loan portfolio characteristics, collateral valuations, industry data, collectability of credit enhancements from institutions or from mortgage insurers, and prevailing economic conditions, are important in estimating mortgage loan losses, taking into account the available credit enhancement. The use of different estimates or assumptions as well as changes in external factors could produce materially different allowance levels.
The Bank calculates its estimated allowance for credit losses for MPF Original and MPF Plus loans as described below.
The Bank has a process in place for monitoring and identifying loans that are deemed impaired. The Bank also uses a credit model to estimate credit losses. A loan is considered 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.
Allowance for Credit Losses on MPF Loans – The Bank evaluates the allowance for credit losses on 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 by considering the first layer of loss protection (the liquidation value of the real property securing the loan) and the availability and collectability of credit enhancements under the terms of each master commitment, and then records a provision for credit losses. For this component, the Bank established a de minimis allowance for credit losses for MPF Original loans as of December 31, 2015 and 2014. For MPF Plus loans, the Bank established an allowance for credit losses totaling a de minimis amount as of December 31, 2015, and $1 million as of December 31, 2014.
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 Bank also considers the availability and collectability of credit enhancements from participating financial institutions or from mortgage insurers under the terms of each master commitment. For this component, the Bank established an allowance for credit losses for MPF Original loans totaling de minimis amounts as of December 31, 2015 and 2014, and for MPF Plus loans totaling de minimis amounts as of December 31, 2015 and 2014.
Significant changes in any of the factors described above could materially affect the Bank’s allowance for credit losses on mortgage loans. In addition, as the Bank’s mortgage loan portfolio ages and becomes sufficiently seasoned and additional loss history is obtained, the Bank may have to adjust its methods of estimating its allowance for credit losses and make additional provisions for credit losses in the future.
98
Term Securities Purchased Under Agreements to Resell. Securities purchased under agreements to resell are considered collateralized financing arrangements and effectively represent short-term loans to counterparties that are considered by the Bank to be of investment quality, which are classified as assets in the Statements of Condition. Securities purchased under agreements to resell are held in safekeeping in the name of the Bank by third-party custodians approved by the Bank. In accordance with the terms of these loans, if the market value of the underlying securities decreases below the market value required as collateral, the counterparty must place an equivalent amount of additional securities as collateral or remit an equivalent amount of cash. If an agreement to resell is deemed to be impaired, the difference between the fair value of the collateral and the amortized cost of the agreement is charged to earnings. The Bank did not have any term securities purchased under agreements to resell at December 31, 2015 and 2014.
Term Federal Funds Sold. The Bank invests in Federal funds sold with counterparties that are considered by the Bank to be of investment quality, and these investments are 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 December 31, 2015 and 2014, were repaid or are expected to be repaid according to the contractual terms.
Accounting for Derivatives
Accounting for derivatives includes the following assumptions and estimates by the Bank: (i) assessing whether the hedging relationship qualifies for hedge accounting, (ii) assessing whether an embedded derivative should be bifurcated, (iii) calculating the estimated effectiveness of the hedging relationship, (iv) evaluating exposure associated with counterparty credit risk, and (v) estimating the fair value of the derivatives (which is discussed in “Fair Values” below). The Bank’s assumptions and judgments include subjective calculations and estimates based on information available as of the date of the financial statements and could be materially different based on different assumptions, calculations, and estimates.
For additional discussion of the Bank’s accounting for derivatives, see “Item 8. Financial Statements and Supplementary Data – Note 1 – Summary of Significant Accounting Policies” and “Note 18 – Derivatives and Hedging Activities.”
Assessment of Effectiveness. Highly effective hedging relationships that use interest rate swaps as the hedging instrument and that meet certain criteria under the accounting for derivative instruments and hedging activities may qualify for the “short-cut” method of assessing effectiveness. The short-cut method allows the Bank to make the assumption of no ineffectiveness, which means that the change in fair value of the hedged item can be assumed to be equal to the change in fair value of the derivative. No further evaluation of effectiveness is performed for these hedging relationships unless a critical term is changed. Included in these hedging relationships may be hedged items for which the settlement of the hedged item occurs within the shortest period of time possible for the type of instrument based on market settlement conventions. The Bank defines market settlement conventions to be 5 business days or less for advances and 30 calendar days, using a next business day convention, for consolidated obligations. The Bank designates the hedged item in a qualifying hedging relationship as of its trade date. Although the hedged item will not be recognized in the financial statements until the settlement date, in certain circumstances when the fair value of the hedging instrument is zero on the trade date, the Bank believes that it meets a condition that allows the use of the short-cut method. The Bank then records the changes in fair value of the derivative and the hedged item beginning on the trade date.
For a hedging relationship that does not qualify for the short-cut method, the Bank measures its effectiveness using the “long-haul” method, in which the change in fair value of the hedged item must be measured separately from the change in fair value of the derivative. The Bank designs effectiveness testing criteria based on its knowledge of the hedged item and hedging instrument that were employed to create the hedging relationship. The Bank uses regression analyses or other statistical analyses to evaluate effectiveness results, which must fall within established tolerances. Effectiveness testing is performed at inception and on at least a quarterly basis for both prospective considerations and retrospective evaluations.
99
Hedge Discontinuance. When a hedging relationship fails the effectiveness test, the Bank immediately discontinues hedge accounting for that relationship. In addition, the Bank discontinues hedge accounting when it is no longer probable that a forecasted transaction will occur in the original expected time period and when a hedged firm commitment no longer meets the required criteria of a firm commitment. The Bank treats modifications of hedged items (such as a reduction in par value, change in maturity date, or change in strike rates) as a termination of a hedge relationship.
Accounting for Hedge Ineffectiveness. The Bank quantifies and records in other income the ineffective portion of its hedging relationships. Ineffectiveness for fair value hedging relationships is calculated as the difference between the change in fair value of the hedging instrument and the change in fair value of the hedged item. Ineffectiveness for anticipatory hedge relationships is recorded when the change in the forecasted fair value of the hedging instrument exceeds the change in the fair value of the anticipated hedged item.
Credit Risk for Counterparties. The Bank is subject to credit risk as a result of nonperformance by counterparties to the derivative agreements. All uncleared derivatives with counterparties that are members of the Bank and that are not derivative dealers, in which the Bank serves as an intermediary, are fully secured by eligible collateral and are subject to both the Bank's Advances and Security Agreement and a master netting agreement. For all derivative dealer counterparties, the Bank selects only highly rated derivative dealers and major banks that meet the Bank's eligibility requirements. In addition, the Bank enters into master netting agreements and bilateral security agreements with all active derivative dealer and major bank counterparties that provide for delivery of collateral at specified levels tied to counterparty credit rating to limit the Bank’s net unsecured credit exposure to these counterparties. The Bank makes judgments on each counterparty’s creditworthiness and estimates of collateral values in analyzing its credit risk for nonperformance by counterparties. In addition, the Bank is subject to nonperformance by the clearinghouse(s) and clearing agents. The requirement that the Bank post initial and variation margin through the clearing agent to the clearinghouse exposes the Bank to institutional credit risk in the event that the clearing agent or the clearinghouse fails to meet its obligations. However, the use of cleared derivatives mitigates the Bank’s overall credit risk exposure because a central counterparty is substituted for individual counterparties and variation margin is posted daily for changes in the value of cleared derivatives through a clearing agent. See additional discussion of credit exposure to derivatives counterparties in “ Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – Derivative Counterparties.”
Fair Values
Fair Value Measurements. Fair value measurement guidance defines fair value, establishes a framework for measuring fair value under U.S. GAAP, and stipulates disclosures about fair value measurements. This guidance applies whenever other accounting pronouncements require or permit assets or liabilities to be measured at fair value. The Bank uses fair value measurements to record fair value adjustments for certain assets and liabilities and to determine fair value disclosures.
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is a market-based measurement, and the price used to measure fair value is an exit price considered from the perspective of the market participant that holds the asset or owes the liability.
This guidance establishes a three-level fair value hierarchy that prioritizes the inputs into the valuation technique used to measure fair value. 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. |
100
| • | 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 use of fair value to measure the Bank's financial instruments is fundamental to the Bank's financial statements and is a critical accounting estimate because a significant portion of the Bank's assets and liabilities are carried at fair value.
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 December 31, 2015:
| • | Trading securities |
| • | AFS securities |
| • | Certain advances |
| • | Derivative assets and liabilities |
| • | Certain consolidated obligation bonds |
| • | Certain other assets |
In general, these items carried at fair value are categorized within Level 2 of the fair value hierarchy and are valued primarily using inputs that are observable in the marketplace or can be substantially derived from observable market data.
Certain assets and liabilities are measured at fair value on a nonrecurring basis, that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustment in certain circumstances (for example, when there is evidence of impairment). At December 31, 2015, the Bank measured its REO and certain impaired mortgage loans held for portfolio on a nonrecurring basis at Level 3 of the fair value hierarchy.
The Bank monitors and evaluates the inputs into its fair value measurements to ensure that the asset or liability is properly categorized in the fair value hierarchy based on the lowest level of input that is significant to the fair value measurement. Because items classified as Level 3 are generally based on unobservable inputs, the process to determine the fair value of such items is generally more subjective and involves a higher degree of judgment and assumptions by the Bank.
The Bank employs internal control processes to validate the fair value of its financial instruments. These control processes are designed to ensure that the fair value measurements used for financial reporting are based on observable inputs wherever possible. In the event that observable market-based inputs are not available, the control processes are designed to ensure that the valuation approach used is appropriate and consistently applied and that the assumptions and judgments made are reasonable. The Bank’s control processes provide for segregation of duties and oversight of the fair value methodologies and valuations by the Bank. Valuation models are regularly reviewed by the Bank and are subject to an independent model validation process. Any changes to the valuation methodology or the models are also reviewed to confirm that the changes are appropriate.
The assumptions and judgments applied by the Bank may have a significant effect on its estimates of fair value, and the use of different assumptions as well as changes in market conditions could have a material effect on the Bank’s results of operations or financial condition. See “Item 8. Financial Statements and Supplementary Data – Note 19 – Fair Value” for further information regarding the fair value measurement guidance (including the classification within the fair value hierarchy) and the summary of valuation methodologies and primary inputs used to measure fair value for all the Bank’s assets and liabilities carried at fair value.
101
The Bank continues to refine its valuation methodologies as markets and products develop and the pricing for certain products becomes more or less transparent. While the Bank believes that its valuation methodologies are appropriate and consistent with those of other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a materially different estimate of fair value as of the reporting date. These fair values may not represent the actual values of the financial instruments that could have been realized as of yearend or that will be realized in the future. 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.
Other-Than-Temporary Impairment for Investment Securities. A security is considered impaired when its fair value is less than its amortized cost basis. For impaired debt securities, an entity is required to assess whether: (i) it has the intent to sell the debt security; (ii) it is more likely than not that it will be required to sell the debt security before its anticipated recovery of the remaining amortized cost basis of the security; or (iii) it does not expect to recover the entire amortized cost basis of the impaired debt security. If any of these conditions is met, an OTTI on the security must be recognized.
With respect to any debt security, a credit loss is defined as the amount by which the amortized cost basis exceeds the present value of the cash flows expected to be collected. If a credit loss exists but the entity does not intend to sell the debt security and it is not more likely than not that the entity will be required to sell the debt security before the anticipated recovery of its remaining amortized cost basis (the amortized cost basis less any current-period credit loss), the carrying value of the debt security is adjusted to its fair value. However, instead of recognizing the entire difference between the amortized cost basis and fair value in earnings, only the amount of the impairment representing the credit loss is recognized in earnings, while the amount of non-credit-related impairment is recognized in AOCI. The total OTTI is presented in the Statements of Income with an offset for the amount of the total OTTI that is recognized in AOCI. This presentation provides additional information about the amounts that the entity does not expect to collect related to a debt security. The credit loss on a debt security is limited to the amount of that security's unrealized losses.
For subsequent accounting of other-than-temporarily impaired securities, if the present value of cash flows expected to be collected is less than the amortized cost basis, the Bank records an additional OTTI. The amount of total OTTI for a security that was previously impaired is calculated as the difference between its amortized cost less the amount of OTTI recognized in AOCI prior to the determination of OTTI and its fair value. For an other-than-temporarily impaired security that was previously impaired and has subsequently incurred an additional OTTI related to credit loss (limited to that security's unrealized losses), this additional credit-related OTTI, up to the amount in AOCI, would be reclassified out of non-credit-related OTTI in AOCI and charged to earnings. Any credit loss in excess of the related AOCI is charged to earnings.
Subsequent related increases and decreases (if not an OTTI) in the fair value of AFS securities will be netted against the non-credit component of OTTI previously recognized in AOCI.
For securities classified as HTM, the OTTI recognized in AOCI is accreted to the carrying value of each security on a prospective basis, based on the amount and timing of future estimated cash flows (with no effect on earnings unless the security is subsequently sold or there are additional decreases in cash flows expected to be collected). For securities classified as AFS, the Bank does not accrete the OTTI recognized in AOCI to the carrying value because the subsequent measurement basis for these securities is fair value.
For securities previously identified as other-than-temporarily impaired, the Bank recognizes accretion or amortization of OTTI credit charges along with the net interest income associated with the securities’ effective yield in net interest income in the Statement of Income. The total accretion or amortization associated with OTTI credit charges was $82 million, $66 million, and $20 million for the years ended December 31, 2015, 2014, and 2013, respectively. The Bank updates its estimate of future expected cash flows for previously other-than-temporarily impaired securities on a regular basis. If there is no additional impairment on the security, the yield of the security is
102
adjusted upward on a prospective basis when there is a significant increase in the expected cash flows. This accretion, included in the total accretion or amortization amounts above, totaled $74 million, $68 million, and $26 million for the years ended December 31, 2015, 2014, and 2013, respectively.
As of December 31, 2015, on a cumulative basis, the Bank had recognized $1.4 billion in credit-related OTTI in its Statements of Income. Each reporting period, these losses were based on the Bank’s then-current best estimates of lifetime losses on each security determined to be other-than-temporarily impaired. As housing prices, mortgage credit conditions, and other key inputs into the Bank’s OTTI assumptions and estimates have improved, the Bank has seen significant increases in expected cash flows on previously other-than-temporarily-impaired securities. Based on the Bank’s current assumptions and estimates, the Bank’s estimate of lifetime losses on its other-than-temporarily-impaired securities as of December 31, 2015, is $715 million. As a result of the increases in expected cash flows and resulting decreases in estimated lifetime losses, the number of securities for which the yield has been adjusted on a prospective basis has increased. As the Bank’s estimates and assumptions are updated each reporting period, the amount of improvement or decrement in expected cash flows will change each period. In addition, the number of securities with a significant improvement in cash flows and the prospective accretion of the increase in expected cash flows will vary each period. The Bank currently estimates that it will accrete approximately $610 million of additional interest income associated with the reduction in OTTI losses over the life of the securities. This estimate of accretion of additional interest income is a forward-looking statement, and actual results may differ materially from the Bank’s current estimation.
The Bank closely monitors the performance of its investment securities classified as AFS or HTM on at least a quarterly basis to evaluate its exposure to the risk of loss on these investments in order to determine whether a loss is other-than-temporary.
Each FHLBank is responsible for making its own determination of impairment and of the reasonableness of the assumptions, inputs, and methodologies used and for performing the required present value calculations using appropriate historical cost bases and yields. FHLBanks that hold the same private-label MBS are required to consult with one another to ensure that any decision that a commonly held private-label MBS is other-than-temporarily impaired, including the determination of fair value and the credit loss component of the unrealized loss, is consistent among those FHLBanks.
In performing the cash flow analysis for each security, the Bank uses two third-party models. The first model projects prepayments, default rates, and loss severities on the underlying collateral based on borrower characteristics and the particular attributes of the loans underlying the Bank's securities, in conjunction with assumptions related primarily to future changes in housing prices and interest rates. Another significant input to the first model is the forecast of future housing price changes for the relevant states and CBSAs, which are based on an assessment of the regional housing markets. CBSA refers collectively to metropolitan and micropolitan statistical areas as defined by the U.S. 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 FHLBanks’ OTTI Committee developed a short-term housing price forecast with projected changes ranging from a decrease of 3.0% to an increase of 8.0% over the 12-month period beginning October 1, 2015. For the vast majority of markets, the projected short-term housing price changes range from an increase of 2.0% to an increase of 5.0%. Thereafter, a unique path is projected for each geographic area based on an internally developed framework derived from historical data.
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
103
reflects a best-estimate scenario and includes a base case housing price forecast that reflects the expectations for near- and long-term housing price behavior.
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 the effective interest rate derived from a variable rate index (for example, the one-month LIBOR) plus the contractual spread, plus or minus a fixed spread adjustment when there is an existing discount or premium on the security. As the implied forward rates of the index change over time, the effective interest rates derived from that index will also change over time. 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 the years ended December 31, 2015, 2014, and 2013, the Bank recorded a credit-related OTTI charge of $15 million, $4 million, and $7 million, respectively.
Because there is a risk that the Bank may record additional material OTTI charges in future periods, the Bank's earnings and retained earnings and its ability to pay dividends and repurchase excess capital stock could be adversely affected in future periods.
Additional information about 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 – Credit Risk – Investments” and in “Item 8. Financial Statements and Supplementary Data – Note 7 – Other-Than-Temporary Impairment Analysis.”
Amortization of Premiums and Accretion of Discounts on MBS and Purchased Mortgage Loans
When the Bank purchases MBS and mortgage loans, it does not necessarily pay the seller the par value of the MBS or the exact amount of the unpaid principal balance of the mortgage loans. If the Bank pays more than the par value or the unpaid principal balance, purchasing the asset at a premium, the premium reduces the yield the Bank recognizes on the asset below the coupon rate. Conversely, if the Bank pays less than the par value or the unpaid principal balance, purchasing the asset at a discount, the discount increases the yield above the coupon rate.
The Bank amortizes premiums and accretes discounts from the acquisition dates of the MBS and mortgage loans. The Bank applies the level-yield method on a retrospective basis over the estimated life of the MBS and purchased mortgage loans for which prepayments reasonably can be expected and estimated. This method requires a retrospective adjustment of the effective yield each time the Bank changes the estimated life as if the new estimate had been known since the original acquisition date of the securities. Use of the retrospective method may increase volatility of reported earnings during periods of changing interest rates, and the use of different estimates or assumptions as well as changes in external factors could produce significantly different results.
Recently Issued Accounting Guidance and Interpretations
See “Item 8. Financial Statements and Supplementary Data – Note 2 – Recently Issued and Adopted Accounting Guidance” for a discussion of recently issued accounting standards and interpretations.
Recent Developments
Finance Agency’s Final Rule on FHLBank Membership. On January 20, 2016, the Finance Agency issued a final rule, effective on February 19, 2016, that, among other things:
| • | defines the “principal place of business” of an institution eligible for FHLBank membership to be the state in which it maintains its home office and from which the institution conducts business operations; |
104
| • | defines “insurance company” as an entity that holds an insurance license or charter under the laws of a state and whose primary business is the underwriting of insurance for persons or entities that are not its affiliates; |
| • | defines “captive” as an entity that holds an insurance license or charter under the laws of a state, but that does not meet the definition of “insurance company” set forth in the rule or fall within any other category of institution that may be eligible for membership; and |
| • | makes captive insurance companies ineligible for FHLBank membership. |
Captive insurance company members that were admitted as FHLBank members prior to September 12, 2014 (the date the Finance Agency proposed this rule) shall have their memberships terminated no later than February 19, 2021. There are restrictions on the level and maturity of advances that FHLBanks can make to these members during this “wind down” period. Captive insurance company members that were admitted as FHLBank members after September 12, 2014, shall have their memberships terminated no later than February 19, 2017, and the respective FHLBanks shall not make or renew any advances to these captives.
The Bank does not expect the rule to have a material impact on its financial condition or results of operations.
Finance Agency Final Rule on Responsibilities of Boards of Directors, Corporate Practices and Corporate Governance Matters. On November 19, 2015, the Finance Agency issued a final rule effective on December 21, 2015, that requires each FHLBank to, among other things:
| • | operate an enterprise-wide risk management program and assign its chief risk officer certain enumerated responsibilities; |
| • | maintain a compliance program headed by a compliance officer who reports directly to the chief executive officer and must regularly report to the board of directors (or a board committee); |
| • | maintain board committees specifically responsible for risk management, audit, compensation, and corporate governance; and |
| • | designate in its bylaws a body of law to follow for its corporate governance and indemnification practices and procedures, choosing from the law of the jurisdiction in which the FHLBank maintains its principal office, the Delaware General Corporation Law, or the Revised Model Business Corporation Act. |
In addition, the rule provides that the Finance Agency has the authority to review a regulated entity’s indemnification policies, procedures, and practices to ensure that they are conducted in a safe and sound manner and that they are consistent with the body of law adopted by the board of directors of the FHLBank.
The Bank does not expect this rule to materially affect its financial condition or results of operations.
Finance Agency Proposed Rule on Acquired Member Assets. On December 17, 2015, the Finance Agency published a proposed rule that would amend the current Acquired Member Assets (AMA) rule, which governs an FHLBank’s ability to purchase and hold certain types of mortgage loans from its members. The proposed rule would allow an FHLBank to use its own model instead of a NRSRO ratings model to determine the credit rating for AMA loan assets and loan pools. The proposed rule would also eliminate the use of pool level insurance, such as supplemental mortgage insurance, as part of the required credit risk-sharing structure for AMA products; however, the FHLBanks are not currently acquiring AMA loans using this structure.
The Bank does not expect this rule to materially affect its financial condition or results of operations. Comments on the proposed rule are due by April 15, 2016.
Amendment of FHLBank Act to Make Privately Insured Credit Unions Eligible for FHLBank Membership.
On December 4, 2015, the Fixing America’s Surface Transportation Act (FAST Act) was signed into law. The FAST Act amends the FHLBank Act to make privately insured credit unions eligible for FHLBank membership, provided they satisfy certain initial and ongoing eligibility and reporting requirements.
105
Joint Final Rules on Margin and Capital Requirements for Covered Swap Entities. On November 30, 2015, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Farm Credit Administration, and the Finance Agency (“Prudential Regulators”) published their joint final rules to establish minimum margin and capital requirements for swap entities (registered swap dealers, major swap participants, security-based swap dealers, and major security-based swap participants) that are subject to the jurisdiction of one of the Prudential Regulators.
The final rules will be phased in, beginning December 1, 2016, and, when they take effect, will subject non-cleared swaps and non-cleared security-based swaps between swap entities covered by the rules and financial end users that have “material swaps exposure” (an average daily aggregate notional exposure of $8 billion or more in non-cleared swaps) to a mandatory two-way initial margin requirement, subject to a $50 million delivery threshold. The amount of the initial margin requirement will be calculated by the swap entity using either a standardized schedule set forth in the rules or an internal margin model conforming to the requirements of the rules. The final margin rules specify the types of collateral that may be posted or collected as initial margin and haircuts for certain collateral asset classes. Initial margin collected by a covered swap entity must be segregated with an independent, third-party custodian and generally may not be rehypothecated.
The final margin rules also require variation margin to be exchanged daily for non-cleared swaps and non-cleared security-based swaps between covered swap entities and all financial end users and impose limits on the types of eligible collateral.
The new variation margin requirement will become effective for the Bank on March 1, 2017; it is not expected to have a material impact on the Bank’s costs.
The new initial margin requirement is expected to become effective for the Bank on September 1, 2020. Although the Bank is not a swap dealer, major swap participant, or other covered swap entity under the final margin rules, the Bank is a financial end user and will likely be subject to the initial margin requirements of the final rules when those requirements become effective (assuming that the Bank’s daily aggregate notional amount of outstanding swaps with all counterparties for June, July, and August of the previous year exceeds $8 billion). The Bank anticipates that the initial margin requirements will increase its cost of engaging in non-cleared swaps.
Off-Balance Sheet Arrangements and Aggregate Contractual 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 determined that it was not necessary to recognize a liability for the fair value of the Bank's joint and
several liability for all consolidated obligations. The joint and several obligations are mandated by the FHLBank
Act or regulations governing the operations of the FHLBanks and are not the result of arms-length transactions
among the FHLBanks. The FHLBanks have no control over the amount of the guarantee or the determination of
how each FHLBank would perform under the joint and several obligations. Because the FHLBanks are subject to
the authority of the Finance Agency as it relates to decisions involving the allocation of the joint and several
liability for the FHLBanks' consolidated obligations, the FHLBanks' joint and several obligations are excluded from
the initial recognition and measurement provisions. Accordingly, the Bank has not recognized a liability for its joint
and several obligations related to other FHLBanks' participations in the consolidated obligations. The par value of the outstanding consolidated obligations of the FHLBanks was $905.2 billion at December 31, 2015, and $847.2 billion at December 31, 2014. The par value of the Bank’s participation in consolidated obligations was $79.4
106
billion at December 31, 2015, and $68.5 billion at December 31, 2014. The Bank had committed to the issuance of $410 million and $3 million in consolidated obligations at December 31, 2015, and December 31, 2014, respectively.
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 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 December 31, 2015, the Bank had $10 million in advance commitments and $12.3 billion in standby letters of credit outstanding. At December 31, 2014, the Bank had $126 million in advance commitments and $5.4 billion in standby letters of credit outstanding.
For additional information, see “Item 8. Financial Statements and Supplementary Data – Note 20 – Commitments and Contingencies.”
Contractual Obligations
The following table summarizes the Bank’s contractual obligations as of December 31, 2015, except for obligations associated with short-term discount notes. Additional information with respect to the Bank’s consolidated obligations is presented in “Item 8. Financial Statements and Supplementary Data – Note 12 – Consolidated Obligations” and “Note 20 – Commitments and Contingencies.”
In addition, “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital” includes a discussion of the Bank’s mandatorily redeemable capital stock, and “Item 8. Financial Statements and Supplementary Data – Note 16 – Employee Retirement Plans and Incentive Compensation Plans” includes a discussion of the Bank’s pension and retirement expenses and commitments.
The Bank enters into derivative financial instruments, which create contractual obligations, as part of the Bank’s interest rate risk management. “Item 8. Financial Statements and Supplementary Data – Note 18 – Derivatives and Hedging Activities” includes additional information regarding derivative financial instruments.
| Contractual Obligations | |||||||||||||||||||
| (In millions) | |||||||||||||||||||
| December 31, 2015 | |||||||||||||||||||
| Payments Due By Period | |||||||||||||||||||
| Contractual Obligations | < 1 Year | 1 to < 3 Years | 3 to < 5 Years | ≥ 5 Years | Total | ||||||||||||||
| Long-term debt | $ | 29,114 | $ | 16,426 | $ | 3,170 | $ | 2,982 | $ | 51,692 | |||||||||
| Mandatorily redeemable capital stock | 82 | 1 | 381 | 24 | 488 | ||||||||||||||
| Operating leases | 4 | 8 | 5 | — | 17 | ||||||||||||||
| Pension and post-retirement contributions | 8 | 5 | 2 | 17 | 32 | ||||||||||||||
| Commitments to fund/purchase mortgage loans | 5 | — | — | — | 5 | ||||||||||||||
| Total contractual obligations | $ | 29,213 | $ | 16,440 | $ | 3,558 | $ | 3,023 | $ | 52,234 | |||||||||
| ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
See “Item 7. Management’s Discussion and Analysis of Results of Operations and Financial Condition – Risk Management – Market Risk.”
107
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Financial Statements and Supplementary Data
| Financial Statements: | ||||
| Supplementary Data: | ||||
108
Management's Report on Internal Control Over Financial Reporting
The management of the Federal Home Loan Bank of San Francisco (Bank) is responsible for establishing and maintaining adequate internal control over the Bank's financial reporting. The Bank’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. There are inherent limitations in the ability of internal control over financial reporting to provide absolute assurance of achieving financial reporting objectives. These inherent limitations include the possibility of human error and the circumvention or overriding of controls. Accordingly, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. These inherent limitations are known features of the financial reporting process, however, and it is possible to design into the process safeguards to reduce, although not eliminate, this risk.
Management assessed the effectiveness of the Bank's internal control over financial reporting as of December 31, 2015. This assessment was based on criteria for effective internal control over financial reporting described in Internal Control – Integrated Framework (2013), issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management concludes that, as of December 31, 2015, the Bank maintained effective internal control over financial reporting. The effectiveness of the Bank's internal control over financial reporting as of December 31, 2015, has been audited by PricewaterhouseCoopers LLP, the Bank's independent registered public accounting firm, as stated in its report appearing on the following page, which expressed an unqualified opinion on the effectiveness of the Bank's internal control over financial reporting as of December 31, 2015.
109
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of the Federal Home Loan Bank of San Francisco:
In our opinion, the accompanying statements of condition and the related statements of income, comprehensive income, capital accounts, and cash flows present fairly, in all material respects, the financial position of the Federal Home Loan Bank of San Francisco (the “FHLBank”) at December 31, 2015 and 2014, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the FHLBank maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The FHLBank's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express opinions on these financial statements and on the FHLBank's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
San Francisco, California
March 11, 2016
110
Federal Home Loan Bank of San Francisco
Statements of Condition
| (In millions-except par value) | December 31, 2015 | December 31, 2014 | |||||
| Assets: | |||||||
| Cash and due from banks | $ | 1,637 | $ | 3,920 | |||
| Securities purchased under agreements to resell | 10,000 | 1,000 | |||||
| Federal funds sold | 4,626 | 7,503 | |||||
Trading securities(a) | 1,433 | 3,524 | |||||
Available-for-sale (AFS) securities(a) | 5,414 | 6,371 | |||||
Held-to-maturity (HTM) securities (fair values were $10,821 and $13,657, respectively)(b) | 10,802 | 13,551 | |||||
| Advances (includes $3,677 and $5,137 at fair value under the fair value option, respectively) | 50,919 | 38,986 | |||||
| Mortgage loans held for portfolio, net of allowance for credit losses of $0 and $1, respectively | 655 | 708 | |||||
| Accrued interest receivable | 56 | 67 | |||||
| Premises, software, and equipment, net | 32 | 28 | |||||
| Derivative assets, net | 44 | 59 | |||||
| Other assets | 89 | 90 | |||||
| Total Assets | $ | 85,707 | $ | 75,807 | |||
| Liabilities: | |||||||
| Deposits | $ | 127 | $ | 160 | |||
| Consolidated obligations: | |||||||
| Bonds (includes $4,233 and $6,717 at fair value under the fair value option, respectively) | 51,835 | 47,045 | |||||
| Discount notes | 27,648 | 21,811 | |||||
| Total consolidated obligations | 79,483 | 68,856 | |||||
| Mandatorily redeemable capital stock | 488 | 719 | |||||
| Accrued interest payable | 80 | 95 | |||||
| Affordable Housing Program (AHP) payable | 172 | 147 | |||||
| Derivative liabilities, net | 6 | 20 | |||||
| Other liabilities | 455 | 117 | |||||
| Total Liabilities | 80,811 | 70,114 | |||||
| Commitments and Contingencies (Note 20) | |||||||
| Capital: | |||||||
| Capital stock—Class B—Putable ($100 par value) issued and outstanding: | |||||||
| 23 shares and 33 shares, respectively | 2,253 | 3,278 | |||||
| Unrestricted retained earnings | 610 | 294 | |||||
| Restricted retained earnings | 2,018 | 2,065 | |||||
| Total Retained Earnings | 2,628 | 2,359 | |||||
| Accumulated other comprehensive income/(loss) (AOCI) | 15 | 56 | |||||
| Total Capital | 4,896 | 5,693 | |||||
| Total Liabilities and Capital | $ | 85,707 | $ | 75,807 | |||
| (a) | At December 31, 2015, and 2014, none of these securities were pledged as collateral that may be repledged. |
| (b) | At December 31, 2015, none of these securities were pledged as collateral that may be repledged. At December 31, 2014, a de minimis amount of these securities were pledged as collateral that may be repledged. |
The accompanying notes are an integral part of these financial statements.
111
Federal Home Loan Bank of San Francisco
Statements of Income
| For the Years Ended December 31, | |||||||||||
| (In millions) | 2015 | 2014 | 2013 | ||||||||
| Interest Income: | |||||||||||
| Advances | $ | 291 | $ | 299 | $ | 340 | |||||
| Prepayment fees on advances, net | 8 | 6 | 5 | ||||||||
| Securities purchased under agreements to resell | 3 | 1 | 1 | ||||||||
| Federal funds sold | 9 | 11 | 15 | ||||||||
| Trading securities | 5 | 6 | 7 | ||||||||
| AFS securities | 264 | 278 | 276 | ||||||||
| HTM securities | 293 | 362 | 392 | ||||||||
| Mortgage loans held for portfolio | 33 | 42 | 50 | ||||||||
| Total Interest Income | 906 | 1,005 | 1,086 | ||||||||
| Interest Expense: | |||||||||||
| Consolidated obligations: | |||||||||||
| Bonds | 317 | 326 | 432 | ||||||||
| Discount notes | 46 | 20 | 17 | ||||||||
| Deposits | 1 | — | — | ||||||||
| Mandatorily redeemable capital stock | 65 | 120 | 155 | ||||||||
| Total Interest Expense | 429 | 466 | 604 | ||||||||
| Net Interest Income | 477 | 539 | 482 | ||||||||
| Provision for/(reversal of) credit losses on mortgage loans | 1 | — | (1 | ) | |||||||
| Net Interest Income After Mortgage Loan Loss Provision | 476 | 539 | 483 | ||||||||
| Other Income/(Loss): | |||||||||||
| Total other-than-temporary impairment (OTTI) loss | (31 | ) | (14 | ) | (14 | ) | |||||
| Net amount of OTTI loss reclassified to/(from) AOCI | 16 | 10 | 7 | ||||||||
| Net OTTI loss, credit-related | (15 | ) | (4 | ) | (7 | ) | |||||
| Net gain/(loss) on trading securities | (2 | ) | (1 | ) | 2 | ||||||
| Net gain/(loss) on advances and consolidated obligation bonds held under fair value option | (50 | ) | (93 | ) | (23 | ) | |||||
| Net gain/(loss) on derivatives and hedging activities | (16 | ) | (64 | ) | 26 | ||||||
| Gains on litigation settlements, net | 459 | — | — | ||||||||
| Other | 12 | 8 | 7 | ||||||||
| Total Other Income/(Loss) | 388 | (154 | ) | 5 | |||||||
| Other Expense: | |||||||||||
| Compensation and benefits | 67 | 63 | 63 | ||||||||
| Other operating expense | 71 | 69 | 53 | ||||||||
| Federal Housing Finance Agency | 6 | 7 | 7 | ||||||||
| Office of Finance | 4 | 5 | 5 | ||||||||
| Total Other Expense | 148 | 144 | 128 | ||||||||
| Income/(Loss) Before Assessment | 716 | 241 | 360 | ||||||||
| AHP Assessment | 78 | 36 | 52 | ||||||||
| Net Income/(Loss) | $ | 638 | $ | 205 | $ | 308 | |||||
The accompanying notes are an integral part of these financial statements.
112
Federal Home Loan Bank of San Francisco
Statements of Comprehensive Income
| For the Years Ended December 31, | |||||||||||
| (In millions) | 2015 | 2014 | 2013 | ||||||||
| Net Income/(Loss) | $ | 638 | $ | 205 | $ | 308 | |||||
| Other Comprehensive Income/(Loss): | |||||||||||
| Net change in pension and postretirement benefits | (2 | ) | (5 | ) | 5 | ||||||
| Net non-credit-related OTTI gain/(loss) on AFS securities: | |||||||||||
| Non-credit-related OTTI loss transferred from HTM securities | (1 | ) | — | (4 | ) | ||||||
| Net change in fair value of other-than-temporarily impaired securities | (29 | ) | 209 | 644 | |||||||
| Net amount of OTTI loss reclassified to/(from) other income/(loss) | (15 | ) | (10 | ) | (3 | ) | |||||
| Total net non-credit-related OTTI gain/(loss) on AFS securities | (45 | ) | 199 | 637 | |||||||
| Net non-credit-related OTTI gain/(loss) on HTM securities: | |||||||||||
| Net amount of OTTI loss reclassified to/(from) other income/(loss) | (1 | ) | — | (4 | ) | ||||||
| Accretion of non-credit-related OTTI loss | 6 | 7 | 7 | ||||||||
| Non-credit-related OTTI loss transferred to AFS securities | 1 | — | 4 | ||||||||
| Total net non-credit-related OTTI gain/(loss) on HTM securities | 6 | 7 | 7 | ||||||||
| Total other comprehensive income/(loss) | (41 | ) | 201 | 649 | |||||||
| Total Comprehensive Income/(Loss) | $ | 597 | $ | 406 | $ | 957 | |||||
The accompanying notes are an integral part of these financial statements.
113
Federal Home Loan Bank of San Francisco
Statements of Capital Accounts
Capital Stock Class B—Putable | Retained Earnings | Total Capital | ||||||||||||||||||||||||
| (In millions) | Shares | Par Value | Restricted | Unrestricted | Total | AOCI | ||||||||||||||||||||
| Balance, December 31, 2012 | 42 | $ | 4,160 | $ | 2,001 | $ | 246 | $ | 2,247 | $ | (794 | ) | $ | 5,613 | ||||||||||||
| Issuance of capital stock | 5 | 530 | 530 | |||||||||||||||||||||||
| Repurchase of capital stock | (12 | ) | (1,226 | ) | (1,226 | ) | ||||||||||||||||||||
| Capital stock reclassified from/(to) mandatorily redeemable capital stock, net | — | (4 | ) | (4 | ) | |||||||||||||||||||||
| Comprehensive income/(loss) | 76 | 232 | 308 | 649 | 957 | |||||||||||||||||||||
| Cash dividends paid on capital stock (3.99%) | (161 | ) | (161 | ) | (161 | ) | ||||||||||||||||||||
| Balance, December 31, 2013 | 35 | $ | 3,460 | $ | 2,077 | $ | 317 | $ | 2,394 | $ | (145 | ) | $ | 5,709 | ||||||||||||
| Issuance of capital stock | 8 | 762 | 762 | |||||||||||||||||||||||
| Repurchase of capital stock | (10 | ) | (941 | ) | (941 | ) | ||||||||||||||||||||
| Capital stock reclassified from/(to) mandatorily redeemable capital stock, net | — | (3 | ) | (3 | ) | |||||||||||||||||||||
| Comprehensive income/(loss) | (12 | ) | 217 | 205 | 201 | 406 | ||||||||||||||||||||
| Cash dividends paid on capital stock (7.02%) | (240 | ) | (240 | ) | (240 | ) | ||||||||||||||||||||
| Balance, December 31, 2014 | 33 | $ | 3,278 | $ | 2,065 | $ | 294 | $ | 2,359 | $ | 56 | $ | 5,693 | |||||||||||||
| Issuance of capital stock | 8 | 829 | 829 | |||||||||||||||||||||||
| Repurchase of capital stock | (14 | ) | (1,439 | ) | (1,439 | ) | ||||||||||||||||||||
| Capital stock reclassified from/(to) mandatorily redeemable capital stock, net | (4 | ) | (415 | ) | (415 | ) | ||||||||||||||||||||
| Comprehensive income/(loss) | 103 | 535 | 638 | (41 | ) | 597 | ||||||||||||||||||||
| Transfers from restricted retained earnings | (150 | ) | 150 | — | — | |||||||||||||||||||||
| Cash dividends paid on capital stock (12.39%) | (369 | ) | (369 | ) | (369 | ) | ||||||||||||||||||||
| Balance, December 31, 2015 | 23 | $ | 2,253 | $ | 2,018 | $ | 610 | $ | 2,628 | $ | 15 | $ | 4,896 | |||||||||||||
The accompanying notes are an integral part of these financial statements.
114
Federal Home Loan Bank of San Francisco
Statements of Cash Flows
| For the Years Ended December 31, | |||||||||||
| (In millions) | 2015 | 2014 | 2013 | ||||||||
| Cash Flows from Operating Activities: | |||||||||||
| Net Income /(Loss) | $ | 638 | $ | 205 | $ | 308 | |||||
| Adjustments to reconcile net income/(loss) to net cash provided by operating activities: | |||||||||||
| Depreciation and amortization | (80 | ) | (90 | ) | (68 | ) | |||||
| Provision for/(reversal of) credit losses on mortgage loans | 1 | — | (1 | ) | |||||||
| Change in net fair value of trading securities | 2 | 1 | (2 | ) | |||||||
| Change in net fair value adjustment on advances and consolidated obligation bonds held under the fair value option | 50 | 93 | 23 | ||||||||
| Change in net derivatives and hedging activities | (33 | ) | (64 | ) | 7 | ||||||
| Net OTTI loss, credit-related | 15 | 4 | 7 | ||||||||
| Net change in: | |||||||||||
| Accrued interest receivable | 16 | 18 | 21 | ||||||||
| Other assets | (9 | ) | (4 | ) | (8 | ) | |||||
| Accrued interest payable | (20 | ) | 1 | (85 | ) | ||||||
| Other liabilities | 109 | 1 | 18 | ||||||||
| Total adjustments | 51 | (40 | ) | (88 | ) | ||||||
| Net cash provided by/(used in) operating activities | 689 | 165 | 220 | ||||||||
| Cash Flows from Investing Activities: | |||||||||||
| Net change in: | |||||||||||
| Interest-bearing deposits | (404 | ) | (352 | ) | (128 | ) | |||||
| Securities purchased under agreements to resell | (9,000 | ) | (1,000 | ) | 1,500 | ||||||
| Federal funds sold | 2,877 | (5 | ) | 3,359 | |||||||
| Premises, software, and equipment | (12 | ) | (12 | ) | (8 | ) | |||||
| Trading securities: | |||||||||||
| Proceeds from maturities of long-term | 2,339 | 582 | 236 | ||||||||
| Purchases of long-term | — | (899 | ) | (525 | ) | ||||||
| AFS securities: | |||||||||||
| Proceeds from maturities of long-term | 996 | 938 | 1,283 | ||||||||
| HTM securities: | |||||||||||
| Net (increase)/decrease in short-term | — | 1,660 | 79 | ||||||||
| Proceeds from maturities of long-term | 2,746 | 2,504 | 3,927 | ||||||||
| Purchases of long-term | — | (207 | ) | (4,193 | ) | ||||||
| Advances: | |||||||||||
| Principal collected | 1,057,469 | 780,733 | 529,782 | ||||||||
| Made to members | (1,069,480 | ) | (775,375 | ) | (530,789 | ) | |||||
| Mortgage loans held for portfolio: | |||||||||||
| Principal collected | 184 | 200 | 379 | ||||||||
| Purchases | (131 | ) | (4 | ) | — | ||||||
| Proceeds from sales of foreclosed assets | 4 | 3 | 4 | ||||||||
| Net cash provided by/(used in) investing activities | (12,412 | ) | 8,766 | 4,906 | |||||||
115
Federal Home Loan Bank of San Francisco
Statements of Cash Flows (continued)
| For the Years Ended December 31, | |||||||||||
| (In millions) | 2015 | 2014 | 2013 | ||||||||
| Cash Flows from Financing Activities: | |||||||||||
| Net change in: | |||||||||||
| Deposits | 262 | 254 | 273 | ||||||||
| Net (payments)/proceeds on derivative contracts with financing elements | 17 | 14 | 66 | ||||||||
| Net proceeds from issuance of consolidated obligations: | |||||||||||
| Bonds | 38,935 | 31,415 | 29,195 | ||||||||
| Discount notes | 106,536 | 104,611 | 107,252 | ||||||||
| Bonds transferred from another Federal Home Loan Bank | — | — | 122 | ||||||||
| Payments for matured and retired consolidated obligations: | |||||||||||
| Bonds | (33,968 | ) | (37,446 | ) | (45,827 | ) | |||||
| Discount notes | (100,717 | ) | (106,991 | ) | (88,272 | ) | |||||
| Proceeds from issuance of capital stock | 829 | 762 | 530 | ||||||||
| Payments for repurchase/redemption of mandatorily redeemable capital stock | (646 | ) | (1,355 | ) | (2,276 | ) | |||||
| Payments for repurchase of capital stock | (1,439 | ) | (941 | ) | (1,226 | ) | |||||
| Cash dividends paid | (369 | ) | (240 | ) | (161 | ) | |||||
| Net cash provided by/(used in) financing activities | 9,440 | (9,917 | ) | (324 | ) | ||||||
| Net increase/(decrease) in cash and due from banks | (2,283 | ) | (986 | ) | 4,802 | ||||||
| Cash and due from banks at beginning of the period | 3,920 | 4,906 | 104 | ||||||||
| Cash and due from banks at end of the period | $ | 1,637 | $ | 3,920 | $ | 4,906 | |||||
| Supplemental Disclosures: | |||||||||||
| Interest paid | $ | 412 | $ | 457 | $ | 520 | |||||
| AHP payments | 53 | 40 | 45 | ||||||||
| Supplemental Disclosures of Noncash Investing Activities: | |||||||||||
| Transfers of mortgage loans to real estate owned | 2 | 3 | 4 | ||||||||
| Transfers of other-than-temporarily impaired HTM securities to AFS securities | 15 | — | 72 | ||||||||
The accompanying notes are an integral part of these financial statements.
116
(Dollars in millions except per share amounts)
Background Information
The Federal Home Loan Bank of San Francisco (Bank), a federally chartered corporation exempt from ordinary federal, state, and local taxation except real property taxes, is one of 11 District Federal Home Loan Banks (FHLBanks). The FHLBanks are government-sponsored enterprises (GSEs) that serve the public by enhancing the availability of credit for residential mortgages and targeted community development by providing a readily available, competitively priced source of funds to their member institutions. Each FHLBank is operated as a separate entity with its own management, employees, and board of directors. The Bank does not have any special purpose entities or any other type of off-balance sheet conduits. The Bank has a cooperative ownership structure. Regulated financial depositories and insurance companies engaged in residential housing finance, with principal places of business located in Arizona, California, and Nevada, are eligible to apply for membership. In addition, authorized community development financial institutions are eligible to be members of the Bank. All members are required to purchase capital stock in the Bank. State and local housing authorities that meet certain statutory criteria may also borrow from the Bank. While eligible to borrow, these housing authorities are not members of the Bank, and, as such, are not required to hold capital stock. To access the Bank's products and services, a financial institution must be approved for membership and purchase capital stock in the Bank. The member's capital stock requirement is generally based on its use of Bank products, subject to a minimum asset-based membership requirement that is intended to reflect the value to the member of having ready access to the Bank as a reliable source of competitively priced funds. Bank capital stock is issued, transferred, redeemed, and repurchased at its par value of $100 per share, subject to certain regulatory and statutory limits. It is not publicly traded. All shareholders may receive dividends on their capital stock, to the extent declared by the Bank's Board of Directors.
The Bank conducts business with members in the ordinary course of business. See Note 21 – Transactions with Certain Members, Certain Nonmembers, and Other FHLBanks for more information.
The Federal Housing Finance Agency (Finance Agency), an independent federal agency in the executive branch of the United States government, supervises and regulates the FHLBanks and the FHLBanks' Office of Finance.
The Office of Finance is a joint office of the FHLBanks that facilitates the issuance and servicing of the debt instruments (consolidated obligations) of the FHLBanks and prepares the combined quarterly and annual financial reports of the FHLBanks.
The primary source of funds for the FHLBanks is the proceeds from the sale to the public of the FHLBanks' consolidated obligations through the Office of Finance using authorized securities dealers. As provided by the Federal Home Loan Bank Act of 1932, as amended (FHLBank Act), or regulations governing the operations of the FHLBanks, all the FHLBanks have joint and several liability for all FHLBank consolidated obligations. Other funds are provided by deposits, other borrowings, and the issuance of capital stock to members. The Bank primarily uses these funds to provide advances to members.
Note 1 — Summary of Significant Accounting Policies
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 may affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of income, expenses, gains, and losses during the reporting period. The most significant of these estimates include 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 (OTTI) for investment
117
securities; and estimating the prepayment speeds on mortgage-backed securities (MBS) and mortgage loans for the accounting of amortization of premiums and accretion of discounts on MBS and mortgage loans. Actual results could differ significantly from these estimates.
Estimated Fair Values. Many of the Bank's financial instruments lack an available liquid trading market as characterized by frequent exchange transactions between a willing buyer and willing seller. Therefore, the Bank uses financial models employing significant assumptions and present value calculations for the purpose of determining estimated fair values. Thus, the fair values may not represent the actual values of the financial instruments that could have been realized as of yearend or that will be realized in the future.
Fair values for certain financial instruments are based on quoted prices, market rates, or replacement rates for similar financial instruments as of the last business day of the year. The estimated fair values of the Bank's financial instruments and related assumptions are detailed in Note 19 – Fair Value.
Securities Purchased under Agreements to Resell. These investments provide short-term liquidity and are carried at cost. The Bank treats securities purchased under agreements to resell as collateralized financing arrangements because they effectively represent short-term loans to counterparties that are considered by the Bank to be of investment quality, which are classified as assets in the Statements of Condition. Securities purchased under agreements to resell are held in safekeeping in the name of the Bank by third-party custodians approved by the Bank. In accordance with the terms of these loans, if the market value of the underlying securities decreases below the market value required as collateral, the counterparty must place an equivalent amount of additional securities as collateral or remit an equivalent amount of cash.
Federal Funds Sold. These investments provide short-term liquidity and are carried at cost. The Bank invests in Federal funds sold with counterparties that are considered by the Bank to be of investment quality.
Investment Securities. The Bank classifies investments as trading, available-for-sale (AFS), or held-to-maturity (HTM) at the date of acquisition. Purchases and sales of securities are recorded on a trade date basis.
The Bank classifies certain investments as trading. These securities are held for liquidity purposes and carried at fair value with changes in the fair value of these investments recorded in other income. The Bank does not participate in speculative trading practices and holds these investments indefinitely as the Bank periodically evaluates its liquidity needs.
The Bank classifies certain securities as AFS and carries these securities at their fair value. Unrealized gains and losses on these securities are recognized in accumulated other comprehensive income (AOCI).
HTM securities are carried at cost, adjusted for periodic principal repayments; amortization of premiums and accretion of discounts; and previous OTTI recognized in net income and AOCI. The Bank classifies these investments as HTM securities because the Bank has the positive intent and ability to hold these securities until maturity.
Certain 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. Thus, the sale or transfer of an HTM security because of certain changes in circumstances, such as evidence of significant deterioration in the issuer's creditworthiness or changes in regulatory requirements, is not considered to be inconsistent with its original classification. 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 an HTM security without necessarily calling into question its intent to hold other debt securities to maturity. In addition, sales of debt securities that meet either of the following two conditions may be considered as maturities for purposes of the classification of securities: (i) the sale occurs near enough to its maturity date (or call date if exercise of the call is probable) that interest rate risk is substantially eliminated as a pricing factor and changes in market interest rates
118
would not have a significant effect on the security's fair value, or (ii) the sale occurs after the Bank has already collected a substantial portion (at least 85%) of the principal outstanding at acquisition because of prepayments on the debt security or scheduled payments on a debt security payable in equal installments (both principal and interest) over its term.
The Bank calculates the amortization of purchase premiums and accretion of purchase discounts on investments using the level-yield method on a retrospective basis over the estimated life of the securities. This method requires a retrospective adjustment of the effective yield each time the Bank changes the estimated life as if the new estimate had been known since the original acquisition date of the securities. The Bank uses nationally recognized, market-based, third-party prepayment models to project estimated lives.
On a quarterly basis, the Bank evaluates its individual AFS and HTM investment securities in an unrealized loss position for OTTI. A security is considered impaired when its fair value is less than its amortized cost basis. For impaired debt securities, an entity is required to assess whether: (i) it has the intent to sell the debt security; (ii) it is more likely than not that it will be required to sell the debt security before its anticipated recovery of the remaining amortized cost basis of the security; or (iii) it does not expect to recover the entire amortized cost basis of the impaired debt security. If any of these conditions is met, an OTTI on the security must be recognized.
With respect to any debt security, a credit loss is defined as the amount by which the amortized cost basis exceeds the present value of the cash flows expected to be collected. If a credit loss exists but the entity does not intend to sell the debt security and it is not more likely than not that the entity will be required to sell the debt security before the anticipated recovery of its remaining amortized cost basis (the amortized cost basis less any current-period credit loss), the carrying value of the debt security is adjusted to its fair value. However, instead of recognizing the entire difference between the amortized cost basis and fair value in earnings, only the amount of the impairment representing the credit loss is recognized in earnings, while the amount of non-credit-related impairment is recognized in AOCI. The total OTTI is presented in the Statements of Income with an offset for the amount of the total OTTI that is recognized in AOCI. This presentation provides additional information about the amounts that the entity does not expect to collect related to a debt security. The credit loss on a debt security is limited to the amount of that security's unrealized losses.
For subsequent accounting of other-than-temporarily impaired securities, if the present value of cash flows expected to be collected is less than the amortized cost basis, the Bank records an additional OTTI. The amount of total OTTI for a security that was previously impaired is calculated as the difference between its amortized cost less the amount of OTTI recognized in AOCI prior to the determination of OTTI and its fair value. For an other-than-temporarily impaired security that was previously impaired and has subsequently incurred an additional OTTI related to credit loss (limited to that security's unrealized losses), this additional credit-related OTTI, up to the amount in AOCI, would be reclassified out of non-credit-related OTTI in AOCI and charged to earnings. Any credit loss in excess of the related AOCI is charged to earnings.
Subsequent related increases and decreases (if not an OTTI) in the fair value of AFS securities will be netted against the non-credit component of OTTI previously recognized in AOCI.
For securities classified as HTM, the OTTI recognized in AOCI is accreted to the carrying value of each security on a prospective basis, based on the amount and timing of future estimated cash flows (with no effect on earnings unless the security is subsequently sold or there are additional decreases in cash flows expected to be collected). For securities classified as AFS, the Bank does not accrete the OTTI recognized in AOCI to the carrying value because the subsequent measurement basis for these securities is fair value.
For securities previously identified as other-than-temporarily impaired, the Bank updates its estimate of future estimated cash flows on a regular basis. If there is no additional impairment on the security, the yield of the security is adjusted upward on a prospective basis when there is a significant increase in the expected cash flows. This accretion is included in net interest income in the Statements of Income.
119
Financial Instruments Meeting Netting Requirements. The Bank presents certain financial instruments, including derivative instruments and securities purchased under agreements to resell, on a net basis when they have a legal right of offset and all other requirements for netting are met (collectively referred to as the netting requirements). The Bank has elected to offset its derivative asset and liability positions, as well as cash collateral received or pledged, when the netting requirements are met. The Bank did not have any offsetting liabilities related to its securities purchased under agreements to resell for the periods presented.
The net exposure for these financial instruments can change on a daily basis; therefore, there may be a delay between the time this exposure change is identified and additional collateral is requested, and the time this collateral is received or pledged. Likewise, there may be a delay for excess collateral to be returned. For derivative instruments that meet the netting requirements, any excess cash collateral received or pledged is recognized as a derivative liability or derivative asset. Additional information regarding these agreements is provided in Note 18 – Derivatives and Hedging Activities. Based on the fair value of the related collateral held, the securities purchased under agreements to resell were fully collateralized for the periods presented.
Variable Interest Entities. The Bank’s investments in variable interest entities (VIEs) are limited to private-label residential mortgage-backed securities (PLRMBS). On an ongoing basis, the Bank performs a quarterly evaluation
to determine whether it is the primary beneficiary in any VIE. The Bank evaluated its investments in VIEs as of December 31, 2015, 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 these VIEs for the periods presented. 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.
Advances. The Bank reports advances (loans to members, former members or their successors, or housing associates) either at amortized cost or at fair value when the fair value option is elected. Advances carried at amortized cost are reported net of premiums, discounts (including discounts related to the Affordable Housing Program), and hedging adjustments. The Bank amortizes premiums and accretes discounts and recognizes hedging adjustments resulting from the discontinuation of a hedging relationship to interest income using a level-yield methodology. Interest on advances is credited to income as earned. For advances carried at fair value, the Bank recognizes contractual interest in interest income.
Advance Modifications. In cases in which the Bank funds an advance concurrent with or within a short period of time before or after the prepayment of a previous advance to the same member, the Bank evaluates whether the subsequent advance meets the accounting criteria to qualify as a modification of an existing advance or whether it constitutes a new advance. The Bank compares the present value of the cash flows on the subsequent advance to the present value of the cash flows remaining on the previous advance. If there is at least a 10% difference in the present value of the cash flows or if the Bank concludes that the difference between the advances is more than minor based on a qualitative assessment of the modifications made to the previous advance's contractual terms, then the subsequent advance is accounted for as a new advance. In all other instances, the subsequent advance is accounted for as a modification.
Prepayment Fees. When a borrower prepays certain advances prior to the original maturity, the Bank may charge the borrower a prepayment fee. For certain advances with partial prepayment symmetry, 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.
For prepaid advances that are hedged and meet the hedge accounting requirements, the Bank terminates the hedging relationship upon prepayment and records the associated fair value gains and losses, adjusted for the prepayment
120
fees, in interest income. If a new advance represents a modification of an original hedged advance, the fair value gains or losses on the advance and the prepayment fees are included in the carrying amount of the modified advance, and gains or losses and prepayment fees are amortized in interest income over the life of the modified advance using the level-yield method. If the modified advance is also hedged and the hedge meets the hedge accounting requirements, the modified advance is marked to fair value after the modification, and subsequent fair value changes are recorded in other income. If the prepayment represents an extinguishment of the original hedged advance, the prepayment fee and any fair value gain or loss are immediately recognized in interest income.
For prepaid advances that are not hedged or that are hedged but do not meet the hedge accounting requirements, the Bank records prepayment fees in interest income unless the Bank determines that the new advance represents a modification of the original advance. If the new advance represents a modification of the original advance, the prepayment fee on the original advance is deferred, recorded in the basis of the modified advance, and amortized over the life of the modified advance using the level-yield method. This amortization is recorded in interest income.
Mortgage Loans Held in Portfolio. Under the Mortgage Partnership Finance® (MPF®) Program, the Bank may purchase conventional conforming fixed rate residential mortgage loans and mortgage loans insured by the Federal Housing Administration (FHA) or guaranteed by the Department of Veterans Affairs (VA) from its participating members. (“Mortgage Partnership Finance” and “MPF” are registered trademarks of the FHLBank of Chicago.) Participating members originate or purchase the mortgage loans, credit-enhance them and sell them to the Bank, and generally retain 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 participating financial institution (either the original participating member that sold the loans to the Bank or a successor to that member) share in the credit risk of the loans, with the Bank assuming the first loss obligation limited by the first loss account, and the participating financial institution assuming credit losses in excess of the first loss account, up to the amount of the credit enhancement obligation specified in the master agreement. The amount of the credit enhancement is calculated so that any Bank credit losses (excluding special hazard losses) in excess of the first loss account are limited to those that would be expected from an equivalent investment with a long-term credit rating of AA. In addition, the Bank may facilitate the purchase of conforming fixed rate mortgage loans from members for concurrent sale to Fannie Mae under the MPF Xtra® product and of jumbo fixed rate mortgage loans for concurrent sale to Redwood Residential Acquisition Corporation, a subsidiary of Redwood Trust, Inc., a real estate investment trust, under the MPF Direct product. (“MPF Xtra” is a registered trademark of the FHLBank of Chicago.)
For taking on the credit enhancement obligation, the Bank pays the participating financial institution a credit enhancement fee, which is calculated on the remaining unpaid principal balance of the mortgage loans. Depending on the specific MPF product, all or a portion of the credit enhancement fee is paid monthly beginning with the month after each delivery of loans. The MPF Plus product also provides for a performance-based credit enhancement fee, which accrues monthly, beginning with the month after each delivery of loans, and is paid to the participating financial institution beginning 12 months later. The performance-based credit enhancement fee will be reduced by an amount equivalent to loan losses up to the amount of the first loss account established for each master commitment. The participating financial institutions obtain supplemental mortgage insurance (SMI) to cover their credit enhancement obligations under this product. If the SMI provider's claims-paying ability rating falls below a specified level, the participating financial institution has six months to either replace the SMI policy or assume the credit enhancement obligation and fully collateralize the obligation; otherwise the Bank may choose not to pay the participating financial institution its performance-based credit enhancement fee.
The Bank classifies mortgage loans as held for investment and, accordingly, reports them at their principal amount outstanding net of unamortized premiums, discounts, and unrealized gains and losses from loans initially classified as mortgage loan commitments. The Bank defers and amortizes these amounts as interest income using the level-yield method on a retrospective basis over the estimated life of the related mortgage loan. Actual prepayment experience and estimates of future principal prepayments are used in calculating the estimated life of the mortgage loans. The Bank aggregates the mortgage loans by similar characteristics (type, maturity, note rate, and acquisition date) in determining prepayment estimates. A retrospective adjustment is required each time the Bank changes the
121
estimated amounts as if the new estimate had been known since the original acquisition date of the assets. The Bank uses nationally recognized, market-based, third-party prepayment models to project estimated lives.
The Bank records credit enhancement fees as a reduction to interest income.
Allowance for Credit Losses. An allowance for credit losses is a valuation allowance separately established for each identified portfolio segment, if it is probable that impairment has occurred in the Bank's portfolio as of the Statements of Condition date and the amount of loss can be reasonably estimated. To the extent necessary, an allowance for credit losses for off-balance sheet credit exposures is recorded as a liability.
Portfolio Segments. 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. The Bank has developed and documented a systematic methodology for determining an allowance for credit losses for each applicable portfolio segment.
See Note 10 – Allowance for Credit Losses for more information.
Impairment Methodology on Mortgage Loans. A mortgage loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement.
Loans that are on non-accrual 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 interest income on non-accrual loans noted below.
The Bank places a mortgage loan on nonaccrual status when the collection of the contractual principal or interest from the participating financial 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. If the collection of the remaining principal amount due is considered doubtful, then cash payments received would be applied first solely to principal until the remaining principal amount due is expected to be collected and then as a recovery of any charge-off, if applicable, followed by recording interest income. A loan on non-accrual status may be restored to accrual when (1) none of its contractual principal and interest is due and unpaid, and the Bank expects repayment of the remaining contractual interest and principal, or (2) it otherwise becomes well secured and in the process of collection. For any mortgage loans that are more than 180 days past due and that have any outstanding balance in excess of the fair value of the property, less cost to sell, this excess is charged off as a loss by the end of the month in which the applicable time period elapses. Likewise, when a borrower is in bankruptcy, loans are written down to the fair value of the collateral, less cost to sell, in general within 60 days of receipt of the notification of filing from the bankruptcy court, unless it can be clearly demonstrated and documented that repayment is likely to occur.
Real Estate Owned. Real estate owned (REO) includes assets that have been received in satisfaction of debt through foreclosures. REO is initially recorded at fair value less estimated selling costs and is subsequently carried at the lower of that amount or current fair value less estimated selling costs. The Bank recognizes a charge-off to the allowance for credit losses if the fair value of the REO less estimated selling costs is less than the recorded investment in the loan at the date of transfer from loans to REO. Any subsequent realized gains, realized or unrealized losses, and carrying costs are included in other non-interest expense in the Statements of Income. REO is recorded in “Other assets” in the Statements of Condition. At December 31, 2015, the Bank’s other assets included
122
$2 of REO resulting from foreclosure of 21 mortgage loans held by the Bank. At December 31, 2014, the Bank’s other assets included $2 of REO resulting from foreclosure of 23 mortgage loans held by the Bank.
Other Fees. Letter of credit fees are recorded as other income over the term of the letter of credit.
Derivatives. All derivatives are recognized on the Statements of Condition at their fair value. The Bank has elected to report derivative assets and derivative liabilities net of cash collateral, including initial and variation margin, and accrued interest received from or pledged to futures commission merchants (clearing agents) or counterparties. The fair values of derivatives are netted by clearing agent or counterparty when the netting requirements have been met. If these netted amounts are positive, they are classified as an asset, and if negative, they are classified as a liability. Cash flows associated with derivatives are reflected as cash flows from operating activities in the Statements of Cash Flows unless the derivative meets the criteria to be a financing derivative.
Each derivative is designated as one of the following:
| (1) | a qualifying hedge of the change in fair value of (i) a recognized asset or liability or (ii) an unrecognized firm commitment (a fair value hedge); |
| (2) | a qualifying hedge of (i) a forecasted transaction or (ii) the variability of cash flows that are to be received or paid in connection with a recognized asset or liability (a cash flow hedge); |
| (3) | a non-qualifying hedge of an asset or liability for asset-liability management purposes or of certain advances and consolidated obligation bonds for which the Bank elected the fair value option (an economic hedge); or |
| (4) | a non-qualifying hedge of another derivative (an intermediation hedge) that is offered as a product to members or used to offset other derivatives with nonmember counterparties. |
If hedging relationships meet certain criteria, including but not limited to formal documentation of the hedging relationship and an expectation to be hedge effective, they are eligible for hedge accounting, and the offsetting changes in fair value of the hedged items attributable to the hedged risk may be recorded in earnings. The application of hedge accounting generally requires the Bank to evaluate the effectiveness of the hedging relationships at inception and on an ongoing basis and to calculate the changes in fair value of the derivatives and the related hedged items independently. This is known as the “long-haul” method of hedge accounting. Transactions that meet certain criteria qualify for the “short-cut” method of hedge accounting, in which an assumption can be made that the change in the fair value of a hedged item, because of changes in the benchmark rate, exactly offsets the change in the value of the related derivative. Under the shortcut method, the entire change in fair value of the interest rate swap is considered to be effective at achieving offsetting changes in fair values or cash flows of the hedged asset or liability.
Derivatives are typically executed at the same time as the hedged item, and the Bank designates the hedged item in a qualifying hedge relationship as of the trade date. In many hedging relationships, the Bank may designate the hedging relationship upon its commitment to disburse an advance or trade a consolidated obligation in which settlement occurs within the shortest period of time possible for the type of instrument based on market settlement conventions. The Bank records the changes in the fair value of the derivatives and the hedged item beginning on the trade date.
Changes in the fair value of a derivative that qualifies as a fair value hedge and is designated as a fair value hedge, along with changes in the fair value of the hedged asset or liability (hedged item) that are attributable to the hedged risk (including changes that reflect losses or gains on firm commitments), are recorded in other income as “Net gain/(loss) on derivatives and hedging activities.”
Changes in the fair value of a derivative that qualifies as a cash flow hedge and is designated as a cash flow hedge, to the extent that the hedge is effective, are recorded in AOCI, a component of capital, until earnings are affected by the variability of the cash flows of the hedged transaction (until the periodic recognition of interest on a variable rate asset or liability is recorded in earnings).
123
For both fair value and cash flow hedges, any hedge ineffectiveness (which represents the amount by which the change in the fair value of the derivative differs from the change in the fair value of the hedged item or the variability in the cash flows of the forecasted transaction) is recorded in other income as “Net gain/(loss) on derivatives and hedging activities.”
Changes in the fair value of a derivative designated as an economic hedge or an intermediation hedge are recorded in current period earnings with no fair value adjustment to an asset or liability. An economic hedge is defined as a derivative hedging certain advances and consolidated obligation bonds for which the Bank elected the fair value option, or hedging specific or non-specific underlying assets, liabilities, or firm commitments, that does not qualify or was not designated for fair value or cash flow hedge accounting, but is an acceptable hedging strategy under the Bank's risk management program. These economic hedging strategies also comply with Finance Agency regulatory requirements prohibiting speculative hedge transactions. An economic hedge introduces the potential for earnings variability caused by the changes in fair value of the derivatives that are recorded in the Bank's income but are not offset by corresponding changes in the value of the economically hedged assets, liabilities, or firm commitments. The derivatives used in intermediary activities do not qualify for 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. Changes in the fair value of these non-qualifying hedges are recorded in other income as “Net gain/(loss) on derivatives and hedging activities.” In addition, the net settlements associated with these non-qualifying hedges are recorded in other income as “Net gain/(loss) on derivatives and hedging activities.” Cash flows associated with these stand-alone derivatives are reflected as cash flows from operating activities in the Statements of Cash Flows unless the derivative meets the criteria to be designated as a financing derivative.
The net settlements of interest receivables and payables on derivatives designated as fair value or cash flow hedges are recognized as adjustments to the interest income or interest expense of the designated underlying hedged item. The net settlements of interest receivables and payables on intermediated derivatives for members and other economic hedges are recognized in other income as “Net gain/(loss) on derivatives and hedging activities.”
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.
When hedge accounting is discontinued, the Bank either terminates the derivative or continues to carry the derivative on the Statements of Condition at its fair value, ceases to adjust the hedged asset or liability for changes in fair value, and amortizes the cumulative basis adjustment on the hedged item into earnings over the remaining life of the hedged item using a level-yield methodology.
When hedge accounting is discontinued because the Bank determines that the derivative no longer qualifies as an effective cash flow hedge of an existing hedged item, the Bank continues to carry the derivative on the Statements of Condition at its fair value and reclassifies the AOCI adjustment into earnings when earnings are affected by the existing hedged item (the original forecasted transaction).
Under limited circumstances, when the Bank discontinues cash flow hedge accounting because it is no longer probable that the forecasted transaction will occur by the end of the originally specified time period, or within the following two months, but it is probable the transaction will still occur in the future, the gain or loss on the derivative remains in AOCI and is recognized in earnings when the forecasted transaction affects earnings. However, if it is probable that a forecasted transaction will not occur by the end of the originally specified time
124
period or within the following two months, the gains and losses that were recorded in AOCI are recognized immediately in earnings.
When hedge accounting is discontinued because the hedged item no longer meets the definition of a firm commitment, the Bank continues to carry the derivative on the Statements of Condition at its fair value, removing from the Statements of Condition any asset or liability that was recorded to recognize the firm commitment and recording it as a gain or loss in current period earnings.
The Bank may be the primary obligor on consolidated obligations and may make advances in which derivative instruments are embedded. Upon execution of these transactions, the Bank assesses whether the economic characteristics of the embedded derivative are clearly and closely related to the economic characteristics of the remaining component of the advance or debt (the host contract) and whether a separate, non-embedded instrument with the same terms as the embedded instrument would meet the definition of a derivative instrument. When it is determined that: (i) the embedded derivative has economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, and (ii) a separate, stand-alone instrument with the same terms would qualify as a derivative instrument, the embedded derivative is separated from the host contract, carried at fair value, and designated as a stand-alone derivative instrument equivalent to an economic hedge. However, the entire contract is carried on the Statements of Condition at fair value and no portion of the contract is designated as a hedging instrument if the entire contract (the host contract and the embedded derivative) is to be measured at fair value, with changes in fair value reported in current period earnings (such as an investment security classified as trading, as well as hybrid financial instruments that are eligible for the fair value option), or if the Bank cannot reliably identify and measure the embedded derivative for purposes of separating the derivative from its host contract.
Premises, Software, and Equipment. The Bank records premises, software, and equipment at cost less accumulated depreciation and amortization. The Bank's accumulated depreciation and amortization related to premises, software, and equipment totaled $52 and $67 at December 31, 2015 and 2014, respectively. Improvements and major renewals are capitalized; ordinary maintenance and repairs are expensed as incurred. Depreciation is computed on the straight-line method over the estimated useful lives of assets ranging from 3 to 10 years, and leasehold improvements are amortized on the straight-line method over the estimated useful life of the improvement or the remaining term of the lease, whichever is shorter. Depreciation and amortization expense was $8 for 2015, $9 for 2014, and $9 for 2013. The Bank includes gains and losses on disposal of premises, software, and equipment in other income. The net realized gain on disposal of premises, software, and equipment, primarily related to the 1999 sale of the Bank's building, was $1, $1, and $1 in 2015, 2014, and 2013, respectively.
The cost of computer software developed or obtained for internal use is capitalized and depreciated over future periods. At December 31, 2015 and 2014, the Bank had $18 and $20 in unamortized computer software costs respectively. Depreciation of computer software costs charged to expense was $6, $7, and $7 in 2015, 2014, and 2013, respectively.
Consolidated Obligations. Consolidated obligations are recorded at amortized cost unless the Bank has elected the fair value option, in which case the consolidated obligations are carried at fair value.
Concessions on Consolidated Obligations. Concessions are paid to dealers in connection with the issuance of consolidated obligations for which the Bank is the primary obligor. The amount of the concession is allocated to the Bank by the Office of Finance based on the percentage of the debt issued for which the Bank is the primary obligor. Concessions paid on consolidated obligations designated under the fair value option are expensed as incurred. Concessions paid on consolidated obligations not designated under the fair value option are deferred and amortized to expense using the level-yield method over the remaining contractual life or on a retrospective basis over the estimated life of the consolidated obligations. Unamortized concessions were $9 and $12 at December 31, 2015 and 2014, respectively, and are included in “Other assets.” Amortization of concessions is included in consolidated obligation interest expense and totaled $7, $6, and $7, in 2015, 2014, and 2013, respectively.
125
Discounts and Premiums on Consolidated Obligations. The discounts on consolidated obligation discount notes for which the Bank is the primary obligor are amortized to expense using the level-yield method over the term to maturity. The discounts and premiums on consolidated obligation bonds for which the Bank is the primary obligor are amortized to expense using the level-yield method over the remaining contractual life or on a retrospective basis over the estimated life of the consolidated obligation bonds.
Mandatorily Redeemable Capital Stock. The Bank reclassifies the capital stock subject to redemption from capital to a liability after a member provides the Bank with a written notice of redemption; gives notice of intention to withdraw from membership; or attains nonmember status by merger or acquisition, charter termination, or other involuntary membership termination; or after a receiver or other liquidating agent for a member transfers the member's Bank capital stock to a nonmember entity, resulting in the member's shares then meeting the definition of a mandatorily redeemable financial instrument. Shares meeting this definition are reclassified to a liability at fair value. Dividends declared on shares classified as a liability are accrued at the expected dividend rate and reflected as interest expense in the Statements of Income. The repayment of these mandatorily redeemable financial instruments (by repurchase or redemption of the shares) is reflected as a financing cash outflow in the Statements of Cash Flows once settled. See Note 15 – Capital for more information.
If a member cancels its written notice of redemption or notice of withdrawal or if the Bank allows the transfer of mandatorily redeemable capital stock to a member, the Bank reclassifies mandatorily redeemable capital stock from a liability to capital. After the reclassification, dividends on the capital stock are no longer classified as interest expense.
Finance Agency Expenses. The FHLBanks fund a portion of the costs of operating the Finance Agency, and each FHLBank is assessed a proportionate share of those costs. The Finance Agency allocates its expenses and working capital fund among the FHLBanks based on the ratio between each FHLBank's minimum required regulatory capital and the aggregate minimum required regulatory capital of all the FHLBanks.
Office of Finance Expenses. Each FHLBank is assessed a proportionate share of the cost of operating the Office of Finance, which facilitates the issuance and servicing of consolidated obligations. The Office of Finance allocates its operating and capital expenditures among the FHLBanks as follows: (1) two-thirds of the assessment is based on each FHLBank's share of total consolidated obligations outstanding, and (2) one-third of the assessment is based on an equal pro rata allocation.
Affordable Housing Program. As more fully discussed in Note 13 – Affordable Housing Program, the FHLBank Act requires each FHLBank to establish and fund an Affordable Housing Program (AHP). The Bank charges the required funding for the AHP to earnings and establishes a liability. The AHP funds provide subsidies to members to assist in the purchase, construction, or rehabilitation of housing for very low-, low-, and moderate-income households. Subsidies may be in the form of direct grants or below-market interest rate advances.
Gains on Litigation Settlements, Net. Litigation settlement gains, net of related legal expenses, are recorded in Other Income/(Loss) in “Gains on litigation settlements, net” in the Statements of Income. A litigation settlement gain is considered realized and recorded when the Bank receives cash or assets that are readily convertible to known amounts of cash or claims to cash. In addition, a litigation settlement gain is considered realizable and recorded when the Bank enters into a signed agreement that is not subject to appeal, where the counterparty has the ability to pay, and the amount to be received can be reasonably estimated. Prior to being realized or realizable, the Bank considers potential litigation settlement gains to be gain contingencies, and therefore they are not recorded in the Statements of Income. The related legal expenses are contingent-based fees and are only incurred and recorded upon a litigation settlement gain.
126
Note 2 — Recently Issued and Adopted Accounting Guidance
Recognition of Lease Assets and Lease Liabilities. On February 25, 2016, the Financial Accounting Standards Board (FASB) issued guidance that requires recognition of lease assets and lease liabilities on the Statements of Condition and disclosure of key information about leasing arrangements. In particular, this guidance requires a lessee of operating or finance leases to recognize on the Statements of Condition a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. However, for leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election not to recognize lease
assets and lease liabilities. Under previous GAAP, a lessee was not required to recognize lease assets and lease liabilities arising from operating leases on the Statements of Condition. While this guidance does not fundamentally change lessor accounting, some changes have been made to align that guidance with the lessee guidance and other areas within GAAP.
The guidance becomes effective for the Bank for the interim and annual periods beginning on January 1, 2019, and early application is permitted. The guidance requires lessors and lessees to recognize and measure leases at the beginning of the earliest period presented in the financial statements using a modified retrospective approach. The Bank is in the process of evaluating this guidance, and its effect on the Bank’s financial condition, results of operations, and cash flows has not yet been determined.
Recognition and Measurement of Financial Assets and Financial Liabilities. On January 5, 2016, the FASB issued amended guidance on certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. This guidance includes, but is not limited to, the following:
| • | Requires equity investments (with certain exceptions) to be measured at fair value with changes in fair value recognized in net income; |
| • | Requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; |
| • | Requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or in the accompanying notes to the financial statements; |
| • | Eliminates the requirement for public entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. |
The guidance becomes effective for the Bank for the interim and annual periods beginning on January 1, 2018, and early adoption is only permitted for certain provisions. The amendments, in general, should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the period of adoption. The Bank is in the process of evaluating this guidance, and its effect on the Bank’s financial condition, results of operations, and cash flows has not yet been determined.
Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement. On April 15, 2015, the FASB issued amendments to clarify a customer’s accounting for fees paid in a cloud computing arrangement. The amendments provide guidance to customers on determining whether a cloud computing arrangement includes a software license that should be accounted for as internal-use software. If the arrangement does not contain a software license, it would be accounted for as a service contract. This guidance became effective for the Bank for the interim and annual periods beginning after December 15, 2015, and was adopted prospectively. The adoption of this guidance did not have an impact on the Bank’s financial condition, results of operations, or cash flows.
Simplifying the Presentation of Debt Issuance Costs. On April 7, 2015, the FASB issued guidance to simplify the presentation of debt issuance costs. This guidance requires that debt issuance costs related to a recognized debt liability be presented on the Statements of Condition as a direct deduction from the carrying amount of that debt liability, consistent with the presentation of debt discounts. The adoption of this guidance will result in a
127
reclassification of unamortized debt issuance costs from other assets to consolidated obligations on the Bank’s Statements of Condition. This guidance became effective for the Bank for the interim and annual periods beginning after December 15, 2015, and was adopted retrospectively. Upon adoption of this guidance on January 1, 2016, the retrospective impact to the Bank’s Statements of Condition was a decrease of $9 and $12 to other assets and to consolidated obligations as of December 31, 2015, and December 31, 2014, respectively. The adoption of this guidance did not have an impact on the Bank’s results of operations or cash flows.
Amendments to the Consolidation Guidance. On February 18, 2015, the FASB issued guidance intended to enhance consolidation guidance for legal entities such as limited partnerships, limited liability corporations, and securitization structures (collateralized debt obligations, collateralized loan obligations, and mortgage-backed security transactions). The new guidance primarily focuses on the following:
| • | Placing more emphasis on risk of loss when determining a controlling financial interest. A reporting organization may no longer have to consolidate a legal entity in certain circumstances based solely on its fee arrangement, when certain criteria are met. |
| • | Reducing the frequency of the application of related-party guidance when determining a controlling financial interest in a VIE. |
| • | Potentially changing consolidation conclusions for public and private companies in several industries that typically make use of limited partnerships or VIEs. |
This guidance became effective for the Bank for interim and annual periods beginning after December 15, 2015. The adoption of this guidance did not affect the Bank’s financial condition, results of operations, or cash flows.
Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. On August 27, 2014, the FASB issued guidance about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. This guidance requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year after the date the financial statements are issued or within one year after the financial statements are available to be issued, when applicable. Substantial doubt exists if it is probable that the entity will be unable to meet its obligations for the assessed period. This guidance becomes effective for the Bank for the interim and annual periods ending after December 15, 2016, and early application is permitted. This guidance is not expected to affect the Bank’s financial condition, results of operations, or cash flows.
Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure. On August 8, 2014, the FASB issued amended guidance relating to the classification and measurement of certain government-guaranteed mortgage loans upon foreclosure. The amendments in this guidance require that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if certain conditions are met. This guidance became effective for the Bank for the interim and annual periods beginning on January 1, 2015, and was adopted prospectively. The adoption of this guidance did not affect the Bank’s financial condition, results of operations, or cash flows.
Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. On June 12, 2014, the FASB issued amended guidance for repurchase-to-maturity transactions and repurchase agreements executed as repurchase financings. Specifically, this guidance requires entities to account for (1) repurchase-to-maturity transactions as secured borrowings rather than as sales with forward repurchase agreements; and (2) repurchase agreements executed contemporaneously with the initial transfer of the underlying financial asset with the same counterparty as separate transactions only. In addition, this guidance requires a transferor to disclose additional information about certain transactions, including those in which it retains substantially all of the exposure to the economic returns of the underlying transferred asset over the transaction’s term. This guidance became effective for the Bank for the interim and annual periods beginning on January 1, 2015. The changes in accounting for transactions outstanding on the effective date are required to be presented on a cumulative-effect basis. The adoption of this guidance did not affect the Bank’s financial condition, results of operations, or cash flows.
128
Revenue from Contracts with Customers. On May 28, 2014, the FASB issued its guidance on revenue from contracts with customers. This guidance outlines a comprehensive model for recognizing revenue arising from contracts with customers and supersedes most current revenue recognition guidance. In addition, this guidance amends the existing requirements for the recognition of a gain or loss on the transfer of non-financial assets that are not in a contract with a customer. This guidance applies to all contracts with customers except those that are within the scope of certain other standards, such as financial instruments, certain guarantees, insurance contracts, and lease contracts.
The guidance provides entities with the option of using either of the following adoption methods: a full retrospective method, applied retrospectively to each prior reporting period presented; or a modified retrospective method, with the cumulative effect of retrospectively applying this guidance recognized at the date of initial application. The Bank is in the process of evaluating this guidance and its effect on the Bank’s financial condition, results of operations, and cash flows, but it is not expected to be material.
On August 12, 2015, the FASB issued an amendment to defer the effective date of the guidance issued in May 2014 by one year. The guidance is effective for the Bank for interim and annual periods beginning after December 15, 2017. Early application is permitted only as of the interim and annual reporting periods beginning after December 15, 2016.
Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. On January 17, 2014, the FASB issued guidance clarifying when consumer mortgage loans collateralized by real estate should be reclassified to REO. Specifically, these collateralized mortgage loans should be reclassified to REO when either the creditor obtains legal title to the residential real estate property upon completion of a foreclosure or the borrower conveys all interest in the residential real estate property to the creditor to satisfy the loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. The guidance became effective for interim and annual periods beginning on January 1, 2015, and was adopted prospectively. The adoption of this guidance did not affect the Bank’s financial condition, results of operations, or cash flows.
Regulatory Guidance
Framework for Adversely Classifying Loans, Other Real Estate Owned, and Other Assets and Listing Assets for Special Mention. On April 9, 2012, the Finance Agency issued Advisory Bulletin 2012-02, Framework for Adversely Classifying Loans, Other Real Estate Owned, and Other Assets and Listing Assets for Special Mention (AB 2012-02). The guidance establishes a standard and uniform methodology for classifying loans, other real estate owned, and certain other assets (excluding investment securities) and prescribes the timing of asset charge-offs based on these classifications. The guidance is generally consistent with the Uniform Retail Credit Classification and Account Management Policy issued by the federal banking regulators in June 2000. The Bank implemented the asset classification provisions as of January 1, 2014, and this adoption did not have any impact on the Bank’s financial condition, results of operations, or cash flows. The charge-off provisions were implemented on January 1, 2015, and resulted in a $1 charge-off to the Bank’s allowance for credit losses on the mortgage loan portfolio. The adoption of these charge-off provisions did not have a material effect on the Bank’s financial condition, results of operations, or cash flows.
Note 3 — Cash and Due from Banks
Cash on hand, cash items in the process of collection, and amounts due from correspondent banks and the Federal Reserve Bank are included in Cash and due from banks on the Statements of Condition.
Cash and due from banks includes certain compensating balances, where the Bank maintains collected cash balances with commercial banks in consideration for certain services. There are no legal restrictions under these agreements on the withdrawal of these funds. The average collected cash balances were approximately $41 for 2015 and $2 for 2014.
129
Note 4 — Trading Securities
The estimated fair value of trading securities as of December 31, 2015 and 2014, was as follows:
| 2015 | 2014 | ||||||
| Government-Sponsored Enterprises (GSEs) – Federal Farm Credit Bank (FFCB) bonds | $ | 1,424 | $ | 3,513 | |||
| MBS – Other U.S. obligations – Ginnie Mae | 9 | 11 | |||||
| Total | $ | 1,433 | $ | 3,524 | |||
The net unrealized gain/(loss) on trading securities was $(2), $(1), and $2 for the years ended December 31, 2015, 2014, and 2013, respectively. These amounts represent the changes in the fair value of the securities during the reported periods.
Note 5 — Available-for-Sale Securities
Available-for-sale (AFS) securities by major security type as of December 31, 2015 and 2014, were as follows:
| December 31, 2015 | |||||||||||||||||||
Amortized Cost(1) | OTTI Recognized in AOCI | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | |||||||||||||||
| PLRMBS: | |||||||||||||||||||
| Prime | $ | 489 | $ | (1 | ) | $ | 23 | $ | — | $ | 511 | ||||||||
| Alt-A, option ARM | 956 | (37 | ) | 64 | (3 | ) | 980 | ||||||||||||
| Alt-A, other | 3,926 | (127 | ) | 135 | (11 | ) | 3,923 | ||||||||||||
| Total | $ | 5,371 | $ | (165 | ) | $ | 222 | $ | (14 | ) | $ | 5,414 | |||||||
| December 31, 2014 | |||||||||||||||||||
Amortized Cost(1) | OTTI Recognized in AOCI | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | |||||||||||||||
| PLRMBS: | |||||||||||||||||||
| Prime | $ | 565 | $ | (4 | ) | $ | 31 | $ | — | $ | 592 | ||||||||
| Alt-A, option ARM | 1,031 | (43 | ) | 77 | — | 1,065 | |||||||||||||
| Alt-A, other | 4,687 | (145 | ) | 174 | (2 | ) | 4,714 | ||||||||||||
| Total | $ | 6,283 | $ | (192 | ) | $ | 282 | $ | (2 | ) | $ | 6,371 | |||||||
| (1) | Amortized cost includes unpaid principal balance, unamortized premiums and discounts, and previous OTTI recognized in earnings. |
Expected maturities of PLRMBS will differ from contractual maturities because borrowers generally have the right to prepay the underlying obligations without prepayment fees.
At December 31, 2015, the amortized cost of the Bank’s PLRMBS classified as AFS included credit-related OTTI of $1,023. At December 31, 2014, the amortized cost of the Bank’s PLRMBS classified as AFS included credit-related OTTI of $1,173.
The following table summarizes the AFS securities with unrealized losses as of December 31, 2015 and 2014. 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. Total unrealized losses in the following table will not agree to total gross unrealized losses in the table above. The unrealized losses in the following table also include non-credit-related
130
OTTI losses recognized in AOCI. For OTTI analysis of AFS securities, see Note 7 – Other-Than-Temporary Impairment Analysis.
| December 31, 2015 | |||||||||||||||||||||||
| Less Than 12 Months | 12 Months or More | Total | |||||||||||||||||||||
Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | ||||||||||||||||||
| PLRMBS: | |||||||||||||||||||||||
| Prime | $ | — | $ | — | $ | 25 | $ | 1 | $ | 25 | $ | 1 | |||||||||||
| Alt-A, option ARM | — | — | 435 | 40 | 435 | 40 | |||||||||||||||||
| Alt-A, other | 168 | 2 | 1,521 | 136 | 1,689 | 138 | |||||||||||||||||
| Total | $ | 168 | $ | 2 | $ | 1,981 | $ | 177 | $ | 2,149 | $ | 179 | |||||||||||
| December 31, 2014 | |||||||||||||||||||||||
| Less Than 12 Months | 12 Months or More | Total | |||||||||||||||||||||
Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | ||||||||||||||||||
| PLRMBS: | |||||||||||||||||||||||
| Prime | $ | 71 | $ | 3 | $ | 36 | $ | 1 | $ | 107 | $ | 4 | |||||||||||
| Alt-A, option ARM | — | — | 580 | 43 | 580 | 43 | |||||||||||||||||
| Alt-A, other | 403 | 12 | 1,682 | 135 | 2,085 | 147 | |||||||||||||||||
| Total | $ | 474 | $ | 15 | $ | 2,298 | $ | 179 | $ | 2,772 | $ | 194 | |||||||||||
As indicated in the tables above, as of December 31, 2015, the Bank’s investments classified as AFS had unrealized losses related to PLRMBS, which were primarily due to illiquidity in the PLRMBS market, uncertainty about the future condition of the housing and mortgage markets and the economy, and market expectations of the credit performance of loan collateral underlying these securities, which caused these assets to be valued at discounts to their acquisition cost.
Interest Rate Payment Terms. Interest rate payment terms for AFS securities at December 31, 2015 and 2014, are shown in the following table:
| 2015 | 2014 | ||||||
| Amortized cost of AFS PLRMBS: | |||||||
| Collateralized mortgage obligations: | |||||||
| Fixed rate | $ | 1,540 | $ | 1,917 | |||
| Adjustable rate | 3,831 | 4,366 | |||||
| Total | $ | 5,371 | $ | 6,283 | |||
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:
| 2015 | 2014 | ||||||
| Collateralized mortgage obligations: | |||||||
| Converts in 1 year or less | $ | 102 | $ | 71 | |||
| Converts after 1 year through 5 years | 99 | 226 | |||||
| Total | $ | 201 | $ | 297 | |||
See Note 7 – Other-Than-Temporary Impairment Analysis for information on the transfers of securities between the AFS portfolio and the HTM portfolio.
131
Note 6 — Held-to-Maturity Securities
The Bank classifies the following securities as HTM because the Bank has the positive intent and ability to hold these securities to maturity:
| December 31, 2015 | |||||||||||||||||||||||
Amortized Cost(1) | OTTI Recognized in AOCI(1) | Carrying Value(1) | Gross Unrecognized Holding Gains | Gross Unrecognized Holding Losses | Estimated Fair Value | ||||||||||||||||||
| Housing finance agency bonds: | |||||||||||||||||||||||
| California Housing Finance Agency (CalHFA) bonds | $ | 275 | $ | — | $ | 275 | $ | — | $ | (33 | ) | $ | 242 | ||||||||||
| MBS: | |||||||||||||||||||||||
| Other U.S. obligations – Ginnie Mae | 1,227 | — | 1,227 | 4 | (3 | ) | 1,228 | ||||||||||||||||
| GSEs: | |||||||||||||||||||||||
| Freddie Mac | 3,677 | — | 3,677 | 39 | (20 | ) | 3,696 | ||||||||||||||||
| Fannie Mae | 4,136 | — | 4,136 | 70 | (12 | ) | 4,194 | ||||||||||||||||
| Subtotal GSEs | 7,813 | — | 7,813 | 109 | (32 | ) | 7,890 | ||||||||||||||||
| PLRMBS: | |||||||||||||||||||||||
| Prime | 905 | — | 905 | — | (27 | ) | 878 | ||||||||||||||||
| Alt-A, option ARM | — | — | — | — | — | — | |||||||||||||||||
| Alt-A, other | 596 | (14 | ) | 582 | 14 | (13 | ) | 583 | |||||||||||||||
| Subtotal PLRMBS | 1,501 | (14 | ) | 1,487 | 14 | (40 | ) | 1,461 | |||||||||||||||
| Total MBS | 10,541 | (14 | ) | 10,527 | 127 | (75 | ) | 10,579 | |||||||||||||||
| Total | $ | 10,816 | $ | (14 | ) | $ | 10,802 | $ | 127 | $ | (108 | ) | $ | 10,821 | |||||||||
| December 31, 2014 | |||||||||||||||||||||||
Amortized Cost(1) | OTTI Recognized in AOCI(1) | Carrying Value(1) | Gross Unrecognized Holding Gains | Gross Unrecognized Holding Losses | Estimated Fair Value | ||||||||||||||||||
| Housing finance agency bonds: | |||||||||||||||||||||||
| California Housing Finance Agency (CalHFA) bonds | $ | 328 | $ | — | $ | 328 | $ | — | $ | (45 | ) | $ | 283 | ||||||||||
| MBS: | |||||||||||||||||||||||
| Other U.S. obligations – Ginnie Mae | 1,513 | — | 1,513 | 15 | (2 | ) | 1,526 | ||||||||||||||||
| GSEs: | |||||||||||||||||||||||
| Freddie Mac | 4,517 | — | 4,517 | 61 | (12 | ) | 4,566 | ||||||||||||||||
| Fannie Mae | 5,313 | — | 5,313 | 121 | (6 | ) | 5,428 | ||||||||||||||||
| Subtotal GSEs | 9,830 | — | 9,830 | 182 | (18 | ) | 9,994 | ||||||||||||||||
| PLRMBS: | |||||||||||||||||||||||
| Prime | 1,133 | — | 1,133 | 1 | (27 | ) | 1,107 | ||||||||||||||||
| Alt-A, option ARM | 14 | — | 14 | — | (1 | ) | 13 | ||||||||||||||||
| Alt-A, other | 753 | (20 | ) | 733 | 19 | (18 | ) | 734 | |||||||||||||||
| Subtotal PLRMBS | 1,900 | (20 | ) | 1,880 | 20 | (46 | ) | 1,854 | |||||||||||||||
| Total MBS | 13,243 | (20 | ) | 13,223 | 217 | (66 | ) | 13,374 | |||||||||||||||
| Total | $ | 13,571 | $ | (20 | ) | $ | 13,551 | $ | 217 | $ | (111 | ) | $ | 13,657 | |||||||||
| (1) | Amortized cost includes unpaid principal balance, unamortized premiums and discounts, and previous OTTI recognized in earnings. The carrying value of HTM securities represents amortized cost after adjustment for non-credit-related OTTI recognized in AOCI. |
132
At December 31, 2015, the amortized cost of the Bank’s MBS classified as HTM included premiums of $39, discounts of $42, and credit-related OTTI of $8. At December 31, 2014, the amortized cost of the Bank’s MBS classified as HTM included premiums of $51, discounts of $55, and credit-related OTTI of $7.
The following tables summarize the HTM securities with unrealized losses as of December 31, 2015 and 2014. 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. Total unrealized losses in the following table will not agree to the total gross unrecognized holding losses in the table above. The unrealized losses in the following table also include non-credit-related OTTI losses recognized in AOCI. For OTTI analysis of HTM securities, see Note 7 – Other-Than-Temporary Impairment Analysis.
| December 31, 2015 | |||||||||||||||||||||||
| Less Than 12 Months | 12 Months or More | Total | |||||||||||||||||||||
Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | ||||||||||||||||||
| Housing finance agency bonds: | |||||||||||||||||||||||
| CalHFA bonds | $ | — | $ | — | $ | 240 | $ | 33 | $ | 240 | $ | 33 | |||||||||||
| MBS: | |||||||||||||||||||||||
| Other U.S. obligations – Ginnie Mae | 799 | 3 | 2 | — | 801 | 3 | |||||||||||||||||
| GSEs: | |||||||||||||||||||||||
| Freddie Mac | 1,736 | 20 | 20 | — | 1,756 | 20 | |||||||||||||||||
| Fannie Mae | 1,095 | 9 | 154 | 3 | 1,249 | 12 | |||||||||||||||||
| Subtotal GSEs | 2,831 | 29 | 174 | 3 | 3,005 | 32 | |||||||||||||||||
| PLRMBS: | |||||||||||||||||||||||
| Prime | 165 | 1 | 676 | 26 | 841 | 27 | |||||||||||||||||
| Alt-A, option ARM | — | — | — | — | — | — | |||||||||||||||||
| Alt-A, other | 10 | — | 573 | 27 | 583 | 27 | |||||||||||||||||
| Subtotal PLRMBS | 175 | 1 | 1,249 | 53 | 1,424 | 54 | |||||||||||||||||
| Total MBS | 3,805 | 33 | 1,425 | 56 | 5,230 | 89 | |||||||||||||||||
| Total | $ | 3,805 | $ | 33 | $ | 1,665 | $ | 89 | $ | 5,470 | $ | 122 | |||||||||||
| December 31, 2014 | |||||||||||||||||||||||
| Less Than 12 Months | 12 Months or More | Total | |||||||||||||||||||||
Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | ||||||||||||||||||
| Housing finance agency bonds: | |||||||||||||||||||||||
| CalHFA bonds | $ | — | $ | — | $ | 283 | $ | 45 | $ | 283 | $ | 45 | |||||||||||
| MBS: | |||||||||||||||||||||||
| Other U.S. obligations – Ginnie Mae | 131 | — | 94 | 2 | 225 | 2 | |||||||||||||||||
| GSEs: | |||||||||||||||||||||||
| Freddie Mac | 622 | 1 | 1,044 | 11 | 1,666 | 12 | |||||||||||||||||
| Fannie Mae | 286 | 1 | 562 | 5 | 848 | 6 | |||||||||||||||||
| Subtotal GSEs | 908 | 2 | 1,606 | 16 | 2,514 | 18 | |||||||||||||||||
| PLRMBS: | |||||||||||||||||||||||
| Prime | 264 | 2 | 682 | 25 | 946 | 27 | |||||||||||||||||
| Alt-A, option ARM | — | — | 13 | 1 | 13 | 1 | |||||||||||||||||
| Alt-A, other | 30 | — | 685 | 38 | 715 | 38 | |||||||||||||||||
| Subtotal PLRMBS | 294 | 2 | 1,380 | 64 | 1,674 | 66 | |||||||||||||||||
| Total MBS | 1,333 | 4 | 3,080 | 82 | 4,413 | 86 | |||||||||||||||||
| Total | $ | 1,333 | $ | 4 | $ | 3,363 | $ | 127 | $ | 4,696 | $ | 131 | |||||||||||
133
As indicated in the tables above, the Bank’s investments classified as HTM had unrealized losses primarily related to CalHFA bonds and MBS. The unrealized losses associated with the CalHFA bonds were mainly due to an illiquid market, credit concerns regarding the underlying mortgage collateral, and credit concerns regarding the monoline insurance providers, causing these investments to be valued at a discount to their acquisition cost. For its agency MBS, the Bank expects to recover the entire amortized cost basis of these securities because the Bank 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. The unrealized losses associated with the PLRMBS were primarily due to illiquidity in the PLRMBS market, uncertainty about the future condition of the housing and mortgage markets and the economy, and market expectations of the credit performance of the loan collateral underlying these securities, which caused these assets to be valued at 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 December 31, 2015 and 2014, 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.
| December 31, 2015 | |||||||||||
| Year of Contractual Maturity | Amortized Cost(1) | Carrying Value(1) | Estimated Fair Value | ||||||||
| HTM securities other than MBS: | |||||||||||
| Due after 5 years through 10 years | $ | 60 | $ | 60 | $ | 56 | |||||
| Due after 10 years | 215 | 215 | 186 | ||||||||
| Subtotal | 275 | 275 | 242 | ||||||||
| MBS | 10,541 | 10,527 | 10,579 | ||||||||
| Total | $ | 10,816 | $ | 10,802 | $ | 10,821 | |||||
| December 31, 2014 | |||||||||||
| Year of Contractual Maturity | Amortized Cost(1) | Carrying Value(1) | Estimated Fair Value | ||||||||
| HTM securities other than MBS: | |||||||||||
| Due after 5 years through 10 years | $ | 78 | $ | 78 | $ | 70 | |||||
| Due after 10 years | 250 | 250 | 213 | ||||||||
| Subtotal | 328 | 328 | 283 | ||||||||
| MBS | 13,243 | 13,223 | 13,374 | ||||||||
| Total | $ | 13,571 | $ | 13,551 | $ | 13,657 | |||||
| (1) | Amortized cost includes unpaid principal balance, unamortized premiums and discounts, and previous OTTI recognized in earnings. The carrying value of HTM securities represents amortized cost after adjustment for non-credit-related OTTI recognized in AOCI. |
Interest Rate Payment Terms. Interest rate payment terms for HTM securities at December 31, 2015 and 2014, are detailed in the following table:
134
| 2015 | 2014 | ||||||
| Amortized cost of HTM securities other than MBS: | |||||||
| Adjustable rate | $ | 275 | $ | 328 | |||
| Subtotal | 275 | 328 | |||||
| Amortized cost of HTM MBS: | |||||||
| Passthrough securities: | |||||||
| Fixed rate | 146 | 285 | |||||
| Adjustable rate | 416 | 415 | |||||
| Collateralized mortgage obligations: | |||||||
| Fixed rate | 7,224 | 9,249 | |||||
| Adjustable rate | 2,755 | 3,294 | |||||
| Subtotal | 10,541 | 13,243 | |||||
| Total | $ | 10,816 | $ | 13,571 | |||
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:
| 2015 | 2014 | ||||||
| Passthrough securities: | |||||||
| Converts in 1 year or less | $ | 22 | $ | 79 | |||
| Converts after 1 year through 5 years | 119 | 140 | |||||
| Converts after 5 years through 10 years | — | 59 | |||||
| Total | $ | 141 | $ | 278 | |||
| Collateralized mortgage obligations: | |||||||
| Converts in 1 year or less | $ | 7 | $ | 73 | |||
| Converts after 1 year through 5 years | 13 | 26 | |||||
| Total | $ | 20 | $ | 99 | |||
See Note 7 – Other-Than-Temporary Impairment Analysis for information on the transfers of securities between the AFS portfolio and the HTM portfolio.
Note 7 — Other-Than-Temporary Impairment Analysis
On a quarterly basis, the Bank evaluates its individual AFS and HTM investment securities in an unrealized loss position for OTTI.
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 December 31, 2015, using two third-party models. The first model projects prepayments, default rates, and loss severities on the underlying loan collateral based on borrower characteristics and the particular attributes of the loans underlying the Bank’s securities, in conjunction with assumptions related primarily to future changes in housing prices and interest rates. 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 regional housing markets. CBSA refers collectively to metropolitan and micropolitan statistical areas as defined by the U.S. 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 OTTI Governance Committee of the Federal Home Loan Banks (FHLBanks) developed a short-term housing price forecast with projected changes ranging from a decrease of 3.0% to an increase of 8.0% over the 12-month period beginning October 1, 2015. For the vast majority of markets, the projected short-term housing price changes
135
range from an increase of 2.0% to an increase of 5.0%. Thereafter, a unique path is projected for each geographic area based on an internally developed framework derived from historical data.
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 housing price forecast that reflects the expectations for near- and long-term housing price behavior.
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 the effective interest rate derived from a variable rate index (for example, the one-month London Interbank Offered Rate (LIBOR)) plus the contractual spread, plus or minus a fixed spread adjustment when there is an existing discount or premium on the security. As the implied forward rates of the index change over time, the effective interest rates derived from that index will also change over time. 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 the PLRMBS in its AFS and HTM 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 December 31, 2015 (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 during the year ended December 31, 2015, and the related current credit enhancement for the Bank.
136
| December 31, 2015 | |||||||
| Significant Inputs for Other-Than-Temporarily Impaired PLRMBS | Current | ||||||
| Prepayment Rates | Default Rates | Loss Severities | Credit Enhancement | ||||
| Year of Securitization | Weighted Average % (1) | Weighted Average % (1) | Weighted Average % (1) | Weighted Average % (1) | |||
| Prime | |||||||
| 2007 | 13.2 | 3.7 | 20.8 | 19.2 | |||
| 2006 | 13.1 | 18.1 | 32.5 | — | |||
| Total Prime | 13.2 | 3.8 | 20.9 | 19.0 | |||
| Alt-A, option ARM | |||||||
| 2006 | 5.7 | 39.9 | 39.2 | 6.1 | |||
| 2005 | 7.4 | 11.1 | 32.5 | 29.4 | |||
| Total Alt-A, option ARM | 5.9 | 35.9 | 38.2 | 9.3 | |||
| Alt-A, other | |||||||
| 2007 | 11.3 | 24.7 | 34.8 | 10.3 | |||
| 2006 | 10.2 | 26.5 | 38.7 | 19.6 | |||
| 2005 | 13.3 | 14.9 | 36.9 | 5.8 | |||
| 2004 and earlier | 17.3 | 7.1 | 30.7 | 13.3 | |||
| Total Alt-A, other | 12.2 | 20.0 | 36.4 | 10.8 | |||
| Total | 11.7 | 21.0 | 36.3 | 10.8 | |||
(1) Weighted average percentage is based on unpaid principal balance.
Credit enhancement is defined as the percentage of subordinated tranches, excess spread, and over-collateralization, if any, in a security structure that will generally absorb losses before the Bank will experience a loss on the security. The calculated averages represent the dollar-weighted averages of all the PLRMBS investments in each category shown. The classification (Prime; Alt-A, option ARM; and Alt-A, other) 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 credit-related OTTI, which is recognized in earnings, for the years ended December 31, 2015, 2014, and 2013.
| 2015 | 2014 | 2013 | |||||||||
| Balance, beginning of the period | $ | 1,314 | $ | 1,378 | $ | 1,397 | |||||
Additional charges on securities for which OTTI was previously recognized(1) | 15 | 4 | 7 | ||||||||
Accretion of yield adjustments resulting from improvement of expected cash flows that are recognized over the remaining life of the securities(2) | (74 | ) | (68 | ) | (26 | ) | |||||
| Balance, end of the period | $ | 1,255 | $ | 1,314 | $ | 1,378 | |||||
| (1) | For the year ended December 31, 2015, “securities for which OTTI was previously recognized” represents all securities that were also other-than-temporarily impaired prior to January 1, 2015. For the year ended December 31, 2014, “securities for which OTTI was previously recognized” represents all securities that were also other-than-temporarily impaired prior to January 1, 2014. For the year ended December 31, 2013, “securities for which OTTI was previously recognized” represents all securities that were also other-than-temporarily impaired prior to January 1, 2013. |
(2) The total accretion or amortization associated with other-than-temporarily impaired PLRMBS (amount recognized in interest income) totaled $82, $66, and $20 for the years ended December 31, 2015, 2014, and 2013, respectively.
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 an HTM 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, or unusual for the Bank that could not have been reasonably anticipated may cause the
137
Bank to sell or transfer an HTM security without necessarily calling into question its intent to hold other debt securities to maturity.
Beginning in the first quarter of 2011, the Bank elected to transfer any PLRMBS that incurred a credit-related OTTI charge during the applicable period from the Bank’s HTM portfolio to its AFS portfolio at their fair values. The Bank recognized an OTTI credit loss on these HTM 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 the AFS portfolio. These transfers allow the Bank the option to sell these securities prior to maturity in view of changes in interest rates, changes in prepayment risk, or other factors, while recognizing the Bank’s intent to hold these securities for an indefinite period of time. The Bank does not intend to sell its other-than-temporarily impaired securities 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 following table summarizes the PLRMBS transferred from the Bank’s HTM portfolio to its AFS portfolio during the year ended December 31, 2015. The amounts shown represent the values when the securities were transferred from the HTM portfolio to the AFS portfolio. The Bank did not transfer any PLRMBS from its HTM portfolio to its AFS portfolio during the year ended December 31, 2014.
| 2015 | |||||||||||||||
Amortized Cost | OTTI Recognized in AOCI | Gross Unrecognized Holding Gains (Losses) | Estimated Fair Value | ||||||||||||
| Other-than-temporarily impaired PLRMBS backed by loans classified at origination as: | |||||||||||||||
| Prime | $ | 4 | $ | — | $ | — | $ | 4 | |||||||
| Alt-A, option ARM | 12 | (1 | ) | — | 11 | ||||||||||
| Total | $ | 16 | $ | (1 | ) | $ | — | $ | 15 | ||||||
The following tables present the Bank’s AFS and HTM PLRMBS that incurred OTTI losses anytime during the life of the securities at December 31, 2015 and 2014, by loan collateral type:
| December 31, 2015 | |||||||||||||||||||||||||||
| 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 | $ | 591 | $ | 489 | $ | 511 | $ | — | $ | — | $ | — | $ | — | |||||||||||||
| Alt-A, option ARM | 1,269 | 956 | 980 | — | — | — | — | ||||||||||||||||||||
| Alt-A, other | 4,524 | 3,926 | 3,923 | 111 | 107 | 93 | 107 | ||||||||||||||||||||
| Total | $ | 6,384 | $ | 5,371 | $ | 5,414 | $ | 111 | $ | 107 | $ | 93 | $ | 107 | |||||||||||||
138
| December 31, 2014 | |||||||||||||||||||||||||||
| 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 | $ | 682 | $ | 565 | $ | 592 | $ | — | $ | — | $ | — | $ | — | |||||||||||||
| Alt-A, option ARM | 1,391 | 1,031 | 1,065 | — | — | — | — | ||||||||||||||||||||
| Alt-A, other | 5,374 | 4,687 | 4,714 | 132 | 128 | 108 | 127 | ||||||||||||||||||||
| Total | $ | 7,447 | $ | 6,283 | $ | 6,371 | $ | 132 | $ | 128 | $ | 108 | $ | 127 | |||||||||||||
For the Bank’s PLRMBS that were not other-than-temporarily impaired as of December 31, 2015, the Bank has experienced net unrealized losses primarily because of illiquidity in the PLRMBS market, uncertainty about the future condition of the housing and mortgage markets and the economy, and market expectations of the credit performance of loan collateral underlying these securities, which caused these assets to be valued at 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 December 31, 2015, all of the gross unrealized losses on these PLRMBS are temporary. 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.
All Other Available-for-Sale and Held-to-Maturity Investments. For the Bank’s investments in housing finance agency bonds, which were issued by CalHFA, the gross unrealized losses were mainly due to an illiquid market, credit concerns regarding the underlying mortgage collateral, and credit concerns regarding the monoline insurance providers, 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 a market participant would deem 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 December 31, 2015, all of the gross unrealized losses on the bonds are temporary because the underlying collateral and credit enhancements were sufficient to protect the Bank from losses. As a result, the Bank expects to recover the entire amortized cost basis of these securities.
For its agency MBS, the Bank expects to recover the entire amortized cost basis of these securities because the Bank 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. As a result, the Bank determined that, as of December 31, 2015, all of the gross unrealized losses on its agency MBS are temporary.
Note 8 — Advances
The Bank offers a wide range of fixed and adjustable rate advance products with different maturities, interest rates, payment characteristics, and option features. 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, with the interest rates resetting periodically at a fixed spread to LIBOR or to another specified index.
Redemption Terms. The Bank had advances outstanding, excluding overdrawn demand deposit accounts, at interest rates ranging from 0.25% to 8.57% at December 31, 2015, and 0.14% to 8.57% at December 31, 2014, as summarized below.
139
| 2015 | 2014 | ||||||||||||
| Contractual Maturity | Amount Outstanding | Weighted Average Interest Rate | Amount Outstanding | Weighted Average Interest Rate | |||||||||
| Within 1 year | $ | 24,807 | 0.59 | % | $ | 21,328 | 0.63 | % | |||||
| After 1 year through 2 years | 4,252 | 1.19 | 7,597 | 1.07 | |||||||||
| After 2 years through 3 years | 6,208 | 1.19 | 3,235 | 1.39 | |||||||||
| After 3 years through 4 years | 6,877 | 0.89 | 3,216 | 1.65 | |||||||||
| After 4 years through 5 years | 2,022 | 1.11 | 1,655 | 1.82 | |||||||||
| After 5 years | 6,675 | 1.11 | 1,799 | 2.81 | |||||||||
| Total par value | 50,841 | 0.84 | % | 38,830 | 1.02 | % | |||||||
| Valuation adjustments for hedging activities | 40 | 67 | |||||||||||
| Valuation adjustments under fair value option | 38 | 89 | |||||||||||
| Total | $ | 50,919 | $ | 38,986 | |||||||||
Many of the Bank’s advances are prepayable at the borrower’s option. However, when advances are prepaid, the borrower 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 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. The Bank had advances with partial prepayment symmetry outstanding totaling $3,510 at December 31, 2015, and $4,915 at December 31, 2014. Some advances may be repaid on pertinent call dates without prepayment fees (callable advances). The Bank had callable advances outstanding totaling $15,425 at December 31, 2015, and $328 at December 31, 2014.
The Bank’s advances at December 31, 2015 and 2014, included $140 of putable advances. At the Bank’s discretion, the Bank may terminate these advances on predetermined exercise dates and offer replacement funding at prevailing market rates, subject to certain conditions. The Bank would typically exercise such termination rights when interest rates increase.
The following table summarizes advances at December 31, 2015 and 2014, 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 | ||||||||||||||
| 2015 | 2014 | 2015 | 2014 | ||||||||||||
| Within 1 year | $ | 25,983 | $ | 21,460 | $ | 24,947 | $ | 21,468 | |||||||
| After 1 year through 2 years | 6,124 | 7,693 | 4,152 | 7,597 | |||||||||||
| After 2 years through 3 years | 8,432 | 3,258 | 6,168 | 3,135 | |||||||||||
| After 3 years through 4 years | 3,173 | 3,291 | 6,877 | 3,176 | |||||||||||
| After 4 years through 5 years | 5,706 | 1,646 | 2,022 | 1,655 | |||||||||||
| After 5 years | 1,423 | 1,482 | 6,675 | 1,799 | |||||||||||
| Total par value | $ | 50,841 | $ | 38,830 | $ | 50,841 | $ | 38,830 | |||||||
Credit and Concentration Risk. The following tables present the concentration in advances to the top five borrowers and their affiliates at December 31, 2015 and 2014. The tables also present the interest income from
these advances before the impact of interest rate exchange agreements associated with these advances for the years ended December 31, 2015 and 2014.
140
| December 31, 2015 | ||||||||||||||
| Name of Borrower | Advances Outstanding | Percentage of Total Advances Outstanding | Interest Income from Advances(1) | Percentage of Total Interest Income from Advances | ||||||||||
JPMorgan Chase Bank, National Association(2)(3) | $ | 14,813 | 29 | % | $ | 65 | 16 | % | ||||||
| Bank of the West | 6,791 | 13 | 27 | 7 | ||||||||||
| First Republic Bank | 4,000 | 8 | 75 | 19 | ||||||||||
CIT Bank, National Association(4) | 3,113 | 6 | 19 | 5 | ||||||||||
| Citigroup Inc | ||||||||||||||
Citibank, N.A.(2) | 3,000 | 6 | 5 | 1 | ||||||||||
| Banamex USA | — | — | — | — | ||||||||||
| Subtotal Citigroup Inc | 3,000 | 6 | 5 | 1 | ||||||||||
| Subtotal | 31,717 | 62 | 191 | 48 | ||||||||||
| Others | 19,124 | 38 | 207 | 52 | ||||||||||
| Total par value | $ | 50,841 | 100 | % | $ | 398 | 100 | % | ||||||
| December 31, 2014 | |||||||||||||
| Name of Borrower | Advances Outstanding | Percentage of Total Advances Outstanding | Interest Income from Advances(1) | Percentage of Total Interest Income from Advances | |||||||||
| Bank of the West | $ | 5,484 | 14 | % | $ | 29 | 7 | % | |||||
| First Republic Bank | 5,275 | 13 | 86 | 20 | |||||||||
| JPMorgan Chase & Co.: | |||||||||||||
JPMorgan Bank & Trust Company, National Association(3) | 3,000 | 8 | 54 | 13 | |||||||||
JPMorgan Chase Bank, National Association(2) | 819 | 2 | 7 | 2 | |||||||||
| Subtotal JPMorgan Chase & Co. | 3,819 | 10 | 61 | 15 | |||||||||
| Bank of America California, N.A. | 3,500 | 9 | 18 | 4 | |||||||||
OneWest Bank, N.A.(4) | 3,364 | 9 | 28 | 6 | |||||||||
| Subtotal | 21,442 | 55 | 222 | 52 | |||||||||
| Others | 17,388 | 45 | 209 | 48 | |||||||||
| Total par value | $ | 38,830 | 100 | % | $ | 431 | 100 | % | |||||
| (1) | Interest income amounts exclude the interest effect of interest rate exchange agreements with derivative 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. |
| (2) | Nonmember institution. |
| (3) | Effective August 31, 2015, JPMorgan Bank & Trust Company, National Association (JPMorgan B&T), merged with and into JPMorgan Chase Bank, National Association (JPMorgan Chase). As a result, JPMorgan B&T is no longer a member of the Bank. Upon the merger, all of the Bank capital stock held by JPMorgan B&T was transferred to JPMorgan Chase, a nonmember of the Bank, and reclassified as mandatorily redeemable capital stock, and all advances to JPMorgan B&T were transferred to JPMorgan Chase. |
| (4) | Effective August 3, 2015, CIT Bank merged with and into OneWest Bank, which was renamed CIT Bank, National Association. |
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.
For information related to the Bank’s credit risk on advances and allowance methodology for credit losses, see Note 10 – Allowance for Credit Losses.
141
Interest Rate Payment Terms. Interest rate payment terms for advances at December 31, 2015 and 2014, are detailed below:
| 2015 | 2014 | ||||||
| Par value of advances: | |||||||
| Fixed rate: | |||||||
| Due within 1 year | $ | 13,073 | $ | 15,422 | |||
| Due after 1 year | 9,381 | 12,330 | |||||
| Total fixed rate | 22,454 | 27,752 | |||||
| Adjustable rate: | |||||||
| Due within 1 year | 11,734 | 5,906 | |||||
| Due after 1 year | 16,653 | 5,172 | |||||
| Total adjustable rate | 28,387 | 11,078 | |||||
| Total par value | $ | 50,841 | $ | 38,830 | |||
The Bank may use derivatives to adjust the repricing and options characteristics of advances to more closely match the characteristics of the Bank’s funding liabilities. In general, whenever a member executes a fixed or 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 in the advance. The combination of the advance and the interest rate exchange agreement effectively creates a variable rate asset. This type of hedge relationship receives fair value option accounting treatment. In addition, for certain advances for which the Bank has elected the fair value option, the Bank will simultaneously execute an interest rate exchange agreement with terms that economically offset the terms of the advance. However, this type of hedge is treated as an economic hedge because these combinations generally do not meet the requirements for fair value hedge accounting treatment. For more information, see Note 18 – Derivatives and Hedging Activities and Note 19 – Fair Value.
The Bank did not have any advances with embedded features that met the requirements to separate the embedded feature from the host contract and designate the embedded feature as a stand-alone derivative at December 31, 2015 or 2014. The Bank has generally elected to account for certain advances with embedded features under the fair value option, and these advances are carried at fair value on the Statements of Condition. For more information, see Note 19 – Fair Value.
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 for the years ended December 31, 2015, 2014, and 2013,
as follows:
| 2015 | 2014 | 2013 | |||||||||
| Prepayment fees received | $ | 28 | $ | 16 | $ | 14 | |||||
| Fair value adjustments | (20 | ) | (10 | ) | (9 | ) | |||||
| Net | $ | 8 | $ | 6 | $ | 5 | |||||
| Advance principal prepaid | $ | 2,229 | $ | 1,650 | $ | 365 | |||||
Note 9 — Mortgage Loans Held for Portfolio
Under the Mortgage Partnership Finance® (MPF®) Program, the Bank may purchase from members, for its own portfolio, conventional conforming fixed rate mortgage loans under the MPF Original product and FHA-insured or VA-guaranteed mortgage loans under the MPF Government product. In addition, the Bank may facilitate the purchase of conforming fixed rate mortgage loans from members for concurrent sale to Fannie Mae under the MPF Xtra® product and of jumbo fixed rate mortgage loans for concurrent sale to Redwood Residential Acquisition
142
Corporation, a subsidiary of Redwood Trust, Inc., a real estate investment trust, under the MPF Direct product. As of December 31, 2015, the Bank had approved ten members as participating financial institutions since renewing its participation in the MPF Program in 2013.
From May 2002 through October 2006, the Bank purchased conventional conforming fixed rate mortgage loans from its participating financial institutions under the MPF Original and MPF Plus products. 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 December 31, 2015 and 2014, on mortgage loans, all of which are secured by one- to four-unit residential properties and single-unit second homes.
| 2015 | 2014 | ||||||
| Fixed rate medium-term mortgage loans | $ | 100 | $ | 160 | |||
| Fixed rate long-term mortgage loans | 553 | 553 | |||||
| Subtotal | 653 | 713 | |||||
| Unamortized premiums | 10 | 6 | |||||
| Unamortized discounts | (8 | ) | (10 | ) | |||
| Mortgage loans held for portfolio | 655 | 709 | |||||
| Less: Allowance for credit losses | — | (1 | ) | ||||
| Total mortgage loans held for portfolio, net | $ | 655 | $ | 708 | |||
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 financial institution 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 liquidation value of the real property securing the loan. Under the MPF Program, the participating financial institution’s credit enhancement protection consists of the credit enhancement amount, which may be a direct obligation of the participating financial institution or may be a supplemental mortgage insurance policy paid for by the participating financial institution, and may include a contingent performance-based credit enhancement fee payable to the participating financial institution. The participating financial institution 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 financial institution 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. The Bank reduced net interest income for credit enhancement fees totaling a de minimis amount in 2015, $1 in 2014, and $1 in 2013.
For information related to the Bank’s credit risk on mortgage loans and allowance methodology for credit losses, see Note 10 – Allowance for Credit Losses.
Note 10 — Allowance for Credit Losses
An allowance for credit losses is a valuation allowance separately established for each identified portfolio segment, if it is probable that impairment has occurred in the Bank's portfolio as of the Statements of Condition date and the amount of loss can be reasonably estimated. To the extent necessary, an allowance for credit losses for off-balance sheet credit exposures is recorded as a liability.
143
Portfolio Segments. 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. The Bank has developed and documented a systematic methodology for determining an allowance for credit losses for each of the following portfolio segments:
| • | advances, letters of credit, and other extensions of credit, collectively referred to as “credit products,” |
| • | MPF loans held for portfolio, |
| • | term securities purchased under agreements to resell, and |
| • | term Federal funds sold. |
Classes of Financing Receivables. Classes of financing receivables generally are a disaggregation of a portfolio segment to the extent needed to understand the exposure to credit risk arising from these financing receivables. The Bank determined that no further disaggregation of the portfolio segments identified above is needed because the credit risk arising from these financing receivables is assessed and measured by the Bank at the portfolio segment level.
Credit Products. The Bank lends to member financial institutions that have a principal place of business in Arizona, California, or Nevada. Under the 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 capital stock of the Bank owned by each borrowing member is pledged as additional collateral for the member's indebtedness to the Bank. 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 Housing and Economic Recovery Act of 2008 (Housing Act) added secured loans for community development activities as collateral that the Bank may accept from community financial institutions. In addition, the Bank has advances outstanding to former members and member successors, which are also subject to these security terms.
The Bank requires each borrowing member to execute a written Advances and Security Agreement, which describes the lending relationship between the Bank and the borrower. At December 31, 2015 and 2014, the Bank had a perfected security interest in collateral pledged by each borrowing member, or by the member's affiliate on behalf of the member, and by each nonmember borrower, with an estimated value in excess of the outstanding credit products for that borrower. Based on the financial condition of the borrower, the Bank may either (i) allow the borrower or the pledging affiliate to retain physical possession of loan collateral pledged to the Bank, provided that the borrower or the pledging affiliate agrees to hold the collateral for the benefit of the Bank, or (ii) require the borrower or the pledging affiliate to deliver physical possession of loan collateral to the Bank or its custodial agent. All securities collateral is required to be delivered to the Bank's custodial agent. All loan collateral pledged to the Bank is subject to a UCC-1 financing statement.
Section 10(e) of the FHLBank Act affords any security interest granted to the Bank by a member or any affiliate of the member or any nonmember borrower priority over claims or rights of any other party, except claims or rights that (i) would be entitled to priority under otherwise applicable law and (ii) are held by bona fide purchasers for value or secured parties with perfected security interests.
The Bank classifies as impaired any advance with respect to which 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 future principal payments are no longer in doubt. No advances were classified as impaired during the periods presented.
The Bank manages its credit exposure related 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
144
financial condition, and is coupled with conservative collateral and lending policies to limit the risk of loss while taking into account borrowers’ needs for a reliable funding source. At December 31, 2015 and 2014, none of the Bank’s credit products were past due, on nonaccrual status, or considered impaired. There were no troubled debt restructurings related to credit products during 2015 and 2014.
Based on the collateral pledged as security for advances, the Bank’s credit analyses of borrowers’ financial condition, and the Bank’s credit extension and collateral policies as of December 31, 2015, the Bank expects to collect all amounts due according to the contractual terms. Therefore, no allowance for losses on credit products was deemed necessary by the Bank. The Bank has never experienced any credit losses on its credit products.
No member institutions were placed into receivership during 2015 or from January 1, 2016, to February 29, 2016.
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, if it is considered likely that the borrower will default and there is no credit enhancement to offset losses under the master commitment, or the collectability or availability of credit enhancement is deemed to be uncertain. 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 interest income on nonaccrual loans, as noted below.
The Bank places a mortgage loan on nonaccrual status when the collection of the contractual principal or interest from the participating financial institution is reported 90 days or more past due or when the loan is in foreclosure. 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 December 31, 2015 and 2014.
| 2015 | 2014 | ||||||
Recorded Investment(1) | Recorded Investment(1) | ||||||
| 30 – 59 days delinquent | $ | 10 | $ | 12 | |||
| 60 – 89 days delinquent | 5 | 5 | |||||
| 90 days or more delinquent | 18 | 22 | |||||
| Total past due | 33 | 39 | |||||
| Total current loans | 625 | 673 | |||||
| Total mortgage loans | $ | 658 | $ | 712 | |||
In process of foreclosure, included above(2) | $ | 7 | $ | 11 | |||
| Nonaccrual loans | $ | 18 | $ | 22 | |||
| Loans past due 90 days or more and still accruing interest | $ | — | $ | — | |||
Serious delinquencies as a percentage of total mortgage loans outstanding(3) | 2.76 | % | 3.12 | % | |||
| (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. |
145
| (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 as a percentage of the recorded investment of total mortgage loans outstanding. |
Mortgage Loans Evaluated at the Individual Master Commitment Level – The credit risk analysis of all
conventional MPF loans is performed at the individual master commitment level to determine the credit
enhancements available to recover losses on MPF loans under each individual master commitment.
Individually Evaluated Mortgage Loans – Certain conventional mortgage loans, primarily impaired mortgage loans
that are considered collateral-dependent, may be specifically identified for purposes of calculating the allowance for
credit losses. The estimated credit losses on impaired collateral-dependent loans may be separately determined
because sufficient information exists to make a reasonable estimate of the inherent loss on those loans on an
individual loan basis. The Bank estimates the fair value of collateral using real estate broker price opinions or
automated valuation models (AVMs) based on property characteristics as well as recent market sales and current
listings. The resulting incurred loss, if any, is equal to the difference between the carrying value of the loan and the
estimated fair value of the collateral less estimated selling costs.
Collectively Evaluated Mortgage Loans – The credit risk analysis of conventional loans collectively evaluated for
impairment considers loan pool-specific attribute data, applies estimated loss severities, and considers the
associated credit enhancements to determine the Bank's best estimate of probable incurred losses. The analysis
includes estimating projected cash flows that the Bank is likely to collect based on an assessment of all available
information, including prepayment speeds, default rates, and loss severity for the mortgage loans based on
underlying loan-level borrower and loan characteristics; expected housing price changes; and interest rate assumptions. In performing a detailed cash flow analysis, the Bank develops its best estimate of the cash flows
expected to be collected using a third-party model to project prepayments, default rates, and loss severities based on
borrower characteristics and the particular attributes of the mortgage loans, in conjunction with assumptions related
primarily to future changes in housing prices and interest rates. The assumptions used as inputs to the model,
including the forecast of future housing price changes, are consistent with assumptions used for the Bank's
evaluation of its PLRMBS for OTTI.
The allowance for credit losses on the mortgage loan portfolio was as follows:
| 2015 | 2014 | 2013 | |||||||||
| Balance, beginning of the period | $ | 1 | $ | 2 | $ | 3 | |||||
| (Charge-offs) /recoveries | (2 | ) | (1 | ) | — | ||||||
| Provision for/(reversal of) credit losses | 1 | — | (1 | ) | |||||||
| Balance, end of the period | $ | — | $ | 1 | $ | 2 | |||||
The allowance for credit losses and recorded investment by impairment methodology for individually and collectively evaluated impaired loans are as follows:
| 2015 | 2014 | ||||||
| Allowance for credit losses, end of period: | |||||||
| Individually evaluated for impairment | $ | — | $ | 1 | |||
| Total allowance for credit losses | $ | — | $ | 1 | |||
| Recorded investment, end of period: | |||||||
| Individually evaluated for impairment | $ | 14 | $ | 20 | |||
| Collectively evaluated for impairment | 644 | 692 | |||||
| Total recorded investment | $ | 658 | $ | 712 | |||
146
The recorded investment, unpaid principal balance, and related allowance of impaired loans individually evaluated for impairment are as follows:
| 2015 | 2014 | ||||||||||||||||||||||
| Recorded Investment | Unpaid Principal Balance | Related Allowance | Recorded Investment | Unpaid Principal Balance | Related Allowance | ||||||||||||||||||
| With no related allowance | $ | 13 | $ | 13 | $ | — | $ | 14 | $ | 14 | $ | — | |||||||||||
| With an allowance | 1 | 1 | — | 6 | 6 | 1 | |||||||||||||||||
| Total | $ | 14 | $ | 14 | $ | — | $ | 20 | $ | 20 | $ | 1 | |||||||||||
The average recorded investment on impaired loans individually evaluated for impairment is as follows:
| 2015 | 2014 | |||||||
| With no related allowance | $ | 15 | $ | 17 | ||||
| With an allowance | 1 | 7 | ||||||
| Total | $ | 16 | $ | 24 | ||||
The Bank and any participating financial institution share in the credit risk of the loans sold by that institution as specified in a master agreement. Loans purchased under the MPF Program generally have a credit risk exposure at the time of purchase equivalent to assets rated AA, taking into consideration the credit risk sharing structure mandated by the Finance Agency’s acquired member assets (AMA) regulation. The MPF Program structures potential credit losses on conventional MPF loans into layers with respect to each pool of loans purchased by the Bank under a single master commitment, as follows:
| 1. | The first layer of protection against loss is the liquidation value of the real property securing the loan. |
| 2. | The next layer of protection comes from the primary mortgage insurance that is required for loans with a loan-to-value ratio greater than 80%, if still in place. |
| 3. | Losses that exceed the liquidation value of the real property and any primary mortgage insurance, up to an agreed-upon amount called the first loss account for each master commitment, are incurred by the Bank. |
| 4. | Losses in excess of the first loss account for each master commitment, up to an agreed-upon amount called the credit enhancement amount, are covered by the participating financial institution’s credit enhancement obligation at the time losses are incurred. |
| 5. | Losses in excess of the first loss account and the participating financial institution’s remaining credit enhancement for the master commitment, if any, are incurred by the Bank. |
The Bank calculates its estimated allowance for credit losses on mortgage loans acquired under the MPF Original and MPF Plus products as described below. Effective January 1, 2015, the Bank implemented the accounting requirements of regulatory Advisory Bulletin 2012-02. As a result, for any mortgage loans that are more than 180 days past due and that have any outstanding balance in excess of the fair value of the property, less cost to sell, this excess is charged off as a loss by the end of the month in which the applicable time period elapses. Likewise, when a borrower is in bankruptcy, loans are written down to the fair value of the collateral, less cost to sell, in general within 60 days of receipt of the notification of filing from the bankruptcy court, unless it can be clearly demonstrated and documented that repayment is likely to occur. As a result of these charge-offs during 2015, corresponding Allowance for Credit Losses on MPF Loans, which had previously provided for most of these expected losses, was reduced accordingly.
Allowance for Credit Losses on MPF Loans – The Bank evaluates the allowance for credit losses on 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 by considering the first layer of loss protection (the liquidation value of the real property securing the loan) and the availability and collectability of credit enhancements under the terms of each master commitment and records a provision for credit losses. For this component, the Bank established a de minimis allowance for credit losses for MPF Original loans as of
147
December 31, 2015 and 2014. For MPF Plus loans, the Bank established an allowance for credit losses totaling a de minimis amount as of December 31, 2015, and $1 as of December 31, 2014.
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 Bank also considers the availability and collectability of credit enhancements from participating financial institutions or from mortgage insurers under the terms of each master commitment. For this component, the Bank established an allowance for credit losses for MPF Original loans totaling de minimis amounts as of December 31, 2015 and 2014, and for MPF Plus loans totaling de minimis amounts as of December 31, 2015 and 2014.
Troubled Debt Restructurings – Troubled debt restructuring (TDR) is considered to have occurred when a concession is granted to the debtor for economic or legal reasons related to the debtor’s financial difficulties and that concession would not have been considered otherwise. An MPF loan considered a TDR is individually evaluated for impairment when determining its related allowance for credit losses. Credit loss is measured by factoring in expected cash flow shortfalls incurred as of the reporting date as well as the economic loss attributable to delaying the original contractual principal and interest due dates, if applicable.
The Bank’s TDRs of MPF loans primarily involve modifying the borrower’s monthly payment for a period of up to 36 months to reflect a housing expense ratio that is no more than 31% of the borrower’s qualifying monthly income. The outstanding principal balance is re-amortized to reflect a principal and interest payment for a term not to exceed 40 years from the original note date and a housing expense ratio not to exceed 31%. This would result in a balloon payment at the original maturity date of the loan because the maturity date and number of remaining monthly payments are not adjusted. If the 31% ratio is still not achieved through re-amortization, the interest rate is reduced in 0.125% increments below the original note rate, to a floor rate of 3.00%, resulting in reduced principal and interest payments, for the temporary payment modification period of up to 36 months, until the 31% housing expense ratio is met. The recorded investment of the Bank's nonperforming MPF loans classified as TDRs totaled $3 as of December 31, 2015, and $2 as of December 31, 2014.
Term Securities Purchased Under Agreements to Resell. Securities purchased under agreements to resell are considered collateralized financing arrangements and effectively represent short-term loans to counterparties that are considered by the Bank to be of investment quality, which are classified as assets in the Statements of Condition. Securities purchased under agreements to resell are held in safekeeping in the name of the Bank by third-party custodians approved by the Bank. In accordance with the terms of these loans, if the market value of the underlying securities decreases below the market value required as collateral, the counterparty must place an equivalent amount of additional securities as collateral or remit an equivalent amount of cash. If an agreement to resell is deemed to be impaired, the difference between the fair value of the collateral and the amortized cost of the agreement is charged to earnings. The Bank did not have any term securities purchased under agreements to resell at December 31, 2015 and 2014.
Term Federal Funds Sold. The Bank invests in Federal funds sold with counterparties that are considered by the Bank to be of investment quality, and these investments are evaluated for purposes of an allowance for credit losses only if the investment is not paid when due. All investments in Federal funds sold as of December 31, 2015 and 2014, were repaid or are expected to be repaid according to the contractual terms.
Note 11 — 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
148
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 December 31, 2015 and 2014, were as follows:
| 2015 | 2014 | ||||||
| Interest-bearing deposits: | |||||||
| Demand and overnight | $ | 124 | $ | 159 | |||
| Total interest-bearing deposits | 124 | 159 | |||||
| Non-interest-bearing deposits | 3 | 1 | |||||
| Total | $ | 127 | $ | 160 | |||
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 December 31, 2015 and 2014, are detailed in the following table:
| 2015 | 2014 | ||||||||||||
Amount Outstanding | Weighted Average Interest Rate | Amount Outstanding | Weighted Average Interest Rate | ||||||||||
| Interest-bearing deposits – Adjustable rate | $ | 124 | 0.01 | % | $ | 159 | 0.01 | % | |||||
| Non-interest-bearing deposits | 3 | 1 | |||||||||||
| Total | $ | 127 | $ | 160 | |||||||||
Note 12 — 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 Note 20 – Commitments and Contingencies. In connection with each issuance of consolidated obligations, 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 Finance Agency and the U.S. Secretary of the Treasury have oversight over the issuance of FHLBank debt through the Office of Finance.
Consolidated obligation bonds are issued primarily to raise intermediate- and long-term funds for the FHLBanks. The maturity of consolidated obligation bonds generally ranges from 6 months to 15 years, but the maturity is not subject to any statutory or regulatory limits. Consolidated obligation discount notes are primarily used to raise short-term funds. These notes are issued at less than their face amount and redeemed at par value when they mature.
The par value of the outstanding consolidated obligations of the FHLBanks was $905,202 at December 31, 2015, and $847,175 at December 31, 2014. Regulations require the FHLBanks to maintain, for the benefit of investors in consolidated obligations, in the aggregate, unpledged qualifying assets in an amount equal to the consolidated obligations outstanding. Qualifying assets are defined as cash; secured advances; assets with an assessment or credit rating at least equivalent to the current assessment or credit rating of the consolidated obligations; obligations, participations, mortgages, or other securities of or issued by the United States or an agency of the United States; and such securities as fiduciary and trust funds may invest in under the laws of the state in which the FHLBank is located. Any assets subject to a lien or pledge for the benefit of holders of any issue of consolidated obligations are treated as if they were free from lien or pledge for the purposes of compliance with these regulations. At
149
December 31, 2015, the Bank had qualifying assets totaling $85,542, and the Bank's participation in consolidated obligations outstanding was $79,483.
General Terms. Consolidated obligations are generally issued with either fixed rate payment terms or adjustable rate payment terms, which use a variety of indices for interest rate resets, including LIBOR, the Federal funds effective rate, and others. In addition, to meet the specific needs of certain investors, fixed rate and adjustable rate consolidated obligation bonds may contain certain embedded features, such as call options and complex coupon payment terms. In general, when such consolidated obligation bonds are issued for which the Bank is the primary obligor, the Bank simultaneously enters into interest rate exchange agreements containing offsetting features to, in effect, convert the terms of the bond to the terms of a simple adjustable rate bond indexed to LIBOR.
In addition to having fixed rate or simple adjustable rate coupon payment terms, consolidated obligations may include:
| • | Callable bonds, which the Bank may call in whole or in part at its option on predetermined call dates according to the terms of the bond offerings; |
| • | 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 according to the terms of the bond offerings; |
| • | 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 according to the terms of the bond offerings; |
| • | Conversion callable bonds, which have coupon rates that convert from fixed to adjustable or from adjustable to fixed on predetermined dates and can generally be called at the Bank’s option on predetermined call dates according to the terms of the bond offerings. |
Redemption Terms. The following is a summary of the Bank’s participation in consolidated obligation bonds at December 31, 2015 and 2014.
| 2015 | 2014 | ||||||||||||
| Contractual Maturity | Amount Outstanding | Weighted Average Interest Rate | Amount Outstanding | Weighted Average Interest Rate | |||||||||
| Within 1 year | $ | 29,114 | 1.03 | % | $ | 21,044 | 0.36 | % | |||||
| After 1 year through 2 years | 11,264 | 0.91 | 9,871 | 2.43 | |||||||||
| After 2 years through 3 years | 5,162 | 1.28 | 4,518 | 1.70 | |||||||||
| After 3 years through 4 years | 1,430 | 1.44 | 2,336 | 1.49 | |||||||||
| After 4 years through 5 years | 1,740 | 1.67 | 3,103 | 1.71 | |||||||||
| After 5 years | 2,982 | 2.43 | 5,851 | 2.13 | |||||||||
| Total par value | 51,692 | 1.14 | % | 46,723 | 1.29 | % | |||||||
| Unamortized premiums | 27 | 58 | |||||||||||
| Unamortized discounts | (9 | ) | (13 | ) | |||||||||
| Valuation adjustments for hedging activities | 142 | 308 | |||||||||||
| Fair value option valuation adjustments | (17 | ) | (31 | ) | |||||||||
| Total | $ | 51,835 | $ | 47,045 | |||||||||
The Bank’s participation in consolidated obligation bonds outstanding includes callable bonds of $8,005 at December 31, 2015, and $14,158 at December 31, 2014. When a callable bond for which the Bank is the primary obligor is issued, the Bank may simultaneously enter 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 $4,835 at December 31, 2015, and $9,573 at December 31, 2014. The combined sold callable swaps and callable bonds
150
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 at December 31, 2015 and 2014, was as follows:
| 2015 | 2014 | ||||||
| Par value of consolidated obligation bonds: | |||||||
| Non-callable | $ | 43,687 | $ | 32,565 | |||
| Callable | 8,005 | 14,158 | |||||
| Total par value | $ | 51,692 | $ | 46,723 | |||
The following is a summary of the Bank’s participation in consolidated obligation bonds outstanding at December 31, 2015 and 2014, by the earlier of the year of contractual maturity or next call date.
Earlier of Contractual Maturity or Next Call Date | 2015 | 2014 | |||||
| Within 1 year | $ | 36,469 | $ | 33,558 | |||
| After 1 year through 2 years | 10,914 | 9,156 | |||||
| After 2 years through 3 years | 3,282 | 2,043 | |||||
| After 3 years through 4 years | 455 | 1,010 | |||||
| After 4 years through 5 years | 395 | 385 | |||||
| After 5 years | 177 | 571 | |||||
| Total par value | $ | 51,692 | $ | 46,723 | |||
Consolidated obligation discount notes are consolidated obligations issued to raise short-term funds. These notes are issued at less than their face value 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:
| 2015 | 2014 | ||||||||||||
Amount Outstanding | Weighted Average Interest Rate (1) | Amount Outstanding | Weighted Average Interest Rate (1) | ||||||||||
| Par value | $ | 27,663 | 0.25 | % | $ | 21,815 | 0.09 | % | |||||
| Unamortized discounts | (15 | ) | (4 | ) | |||||||||
| Total | $ | 27,648 | $ | 21,811 | |||||||||
(1) Represents yield to maturity excluding concession fees.
Interest Rate Payment Terms. Interest rate payment terms for consolidated obligations at December 31, 2015 and 2014, are detailed in the following table.
151
| 2015 | 2014 | ||||||
| Par value of consolidated obligations: | |||||||
| Bonds: | |||||||
| Fixed rate | $ | 28,942 | $ | 39,324 | |||
| Adjustable rate | 20,815 | 3,678 | |||||
| Step-up | 1,110 | 2,654 | |||||
| Step-down | 550 | 500 | |||||
| Fixed rate that converts to adjustable rate | 175 | 467 | |||||
| Range bonds | 100 | 100 | |||||
| Total bonds, par value | 51,692 | 46,723 | |||||
| Discount notes, par value | 27,663 | 21,815 | |||||
| Total consolidated obligations, par value | $ | 79,355 | $ | 68,538 | |||
Consolidated obligation bonds may be structured to meet the Bank's or the 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 are issued, the Bank simultaneously executes 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 an adjustable rate bond alone. These transactions generally receive fair value hedge accounting treatment. In addition, when certain consolidated obligation bonds for which the Bank has elected the fair value option are issued, the Bank simultaneously executes an interest rate exchange agreement with terms that economically offset the terms of the consolidated obligation bond. However, this type of hedge is treated as an economic hedge because these combinations generally do not meet the requirements for fair value hedge accounting treatment. For more information, see Note 18 – Derivatives and Hedging Activities and Note 19 – Fair Value.
The Bank did not have any bonds with embedded features that met the requirements to separate the embedded feature from the host contract and designate the embedded feature as a stand-alone derivative at December 31, 2015 or 2014. The Bank has generally elected to account for certain bonds with embedded features under the fair value option, and these bonds are carried at fair value on the Statements of Condition. For more information, see Note 19 – Fair Value.
Note 13 — Affordable Housing Program
The FHLBank Act requires each FHLBank to establish an Affordable Housing Program (AHP). Each FHLBank provides subsidies to members, which use the funds to assist in the purchase, construction, or rehabilitation of housing for very low-, low-, and moderate-income households. Subsidies may be in the form of direct grants or below-market interest rate advances. Annually, the FHLBanks must set aside for their AHPs, in the aggregate, the greater of $100 or 10% of the current year's net earnings (income before interest expense related to mandatorily redeemable capital stock and the assessment for AHP).
The Bank accrues its AHP assessment monthly based on its net earnings. If the Bank experienced a net loss during a quarter but still had net earnings for the year, the Bank's obligation to the AHP would be calculated based on the Bank's year-to-date net earnings. If the Bank had net earnings in subsequent quarters, it would be required to contribute additional amounts to meet its calculated annual obligation. If the Bank experienced a net loss for a full year, the amount of the AHP liability would be equal to zero, since each FHLBank's required annual AHP contribution is limited to its annual net earnings. However, if the result of the aggregate 10% calculation is less than $100 for the FHLBanks combined, then the FHLBank Act requires that each FHLBank contribute such prorated sums as may be required to ensure that the aggregate contribution of the FHLBanks equals $100. The proration would be made on the basis of an FHLBank's income in relation to the income of all the FHLBanks for the previous
152
year. There was no AHP shortfall, as described above, in 2015, 2014, or 2013. If an FHLBank finds that its required AHP assessments are contributing to the financial instability of that FHLBank, it may apply to the Finance Agency for a temporary suspension of its contributions. The Bank did not make such an application in 2015, 2014, or 2013.
The Bank's total AHP assessments equaled $78, $36, and $52 during 2015, 2014, and 2013, respectively. These amounts were charged to earnings each year and recognized as a liability. As subsidies are disbursed, the AHP liability is reduced. The AHP liability was as follows:
| 2015 | 2014 | 2013 | |||||||||
| Balance, beginning of the period | $ | 147 | $ | 151 | $ | 144 | |||||
| AHP assessments | 78 | 36 | 52 | ||||||||
| AHP grant payments | (53 | ) | (40 | ) | (45 | ) | |||||
| Balance, end of the period | $ | 172 | $ | 147 | $ | 151 | |||||
All subsidies were distributed in the form of direct grants in 2015, 2014, and 2013.
Note 14 — Accumulated Other Comprehensive Income/(Loss)
The following table summarizes the changes in AOCI for the years ended December 31, 2015, 2014, and 2013:
153
| Net Non-Credit-Related OTTI Loss on AFS Securities | Net Non-Credit-Related OTTI Loss on HTM Securities | Pension and Postretirement Benefits | Total AOCI | ||||||||||||
| Balance, December 31, 2012 | $ | (748 | ) | $ | (34 | ) | $ | (12 | ) | $ | (794 | ) | |||
| Other comprehensive income/(loss) before reclassifications: | |||||||||||||||
| Net change in pension and postretirement benefits | 5 | 5 | |||||||||||||
| Non-credit-related OTTI loss | — | (4 | ) | (4 | ) | ||||||||||
| Non-credit-related OTTI loss transferred | (4 | ) | 4 | — | |||||||||||
| Net change in fair value | 644 | 644 | |||||||||||||
| Accretion of non-credit-related OTTI loss | 7 | 7 | |||||||||||||
| Reclassification from other comprehensive income/(loss) to net income/(loss): | |||||||||||||||
| Non-credit-related OTTI to credit-related OTTI | (3 | ) | — | (3 | ) | ||||||||||
| Net current period other comprehensive income/(loss) | 637 | 7 | 5 | 649 | |||||||||||
| Balance, December 31, 2013 | (111 | ) | (27 | ) | (7 | ) | (145 | ) | |||||||
| Other comprehensive income/(loss) before reclassifications: | |||||||||||||||
| Net change in pension and postretirement benefits | (5 | ) | (5 | ) | |||||||||||
| Non-credit-related OTTI loss | (10 | ) | — | (10 | ) | ||||||||||
| Net change in fair value | 209 | 209 | |||||||||||||
| Accretion of non-credit-related OTTI loss | 7 | 7 | |||||||||||||
| Net current period other comprehensive income/(loss) | 199 | 7 | (5 | ) | 201 | ||||||||||
| Balance, December 31, 2014 | 88 | (20 | ) | (12 | ) | 56 | |||||||||
| Other comprehensive income/(loss) before reclassifications: | |||||||||||||||
| Net change in pension and postretirement benefits | (2 | ) | (2 | ) | |||||||||||
| Non-credit-related OTTI loss | (18 | ) | (1 | ) | (19 | ) | |||||||||
| Non-credit-related OTTI loss transferred | (1 | ) | 1 | — | |||||||||||
| Net change in fair value | (29 | ) | (29 | ) | |||||||||||
| Accretion of non-credit-related OTTI loss | 6 | 6 | |||||||||||||
| Reclassification from other comprehensive income/(loss) to net income/(loss): | |||||||||||||||
| Non-credit-related OTTI to credit-related OTTI | 3 | — | 3 | ||||||||||||
| Net current period other comprehensive income/(loss) | (45 | ) | 6 | (2 | ) | (41 | ) | ||||||||
| Balance, December 31, 2015 | $ | 43 | $ | (14 | ) | $ | (14 | ) | $ | 15 | |||||
Note 15 — Capital
Capital Requirements. The Bank issues only one class of capital stock, Class B stock, with a par value of one hundred dollars per share, which may be redeemed (subject to certain conditions) upon five years' notice by the member to the Bank. In addition, at its discretion, under certain conditions, the Bank may repurchase excess capital stock at any time. (See “Excess Capital Stock” below for more information.) The capital stock may be issued, redeemed, and repurchased only at its stated par value, subject to certain statutory and regulatory requirements. The Bank may only redeem or repurchase capital stock from a shareholder if, following the redemption or repurchase, the shareholder will continue to meet its minimum capital stock requirement and the Bank will continue to meet its regulatory requirements for total capital, leverage capital, and risk-based capital.
154
Under the 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 Bank’s minimum capital stock requirement for shareholders 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 that is greater than or equal to its risk-based capital requirement. Because the Bank issues only Class B stock, regulatory capital and permanent capital for the Bank are both composed of retained earnings and Class B stock, including mandatorily redeemable capital stock (which 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.
The risk-based capital requirement is 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 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 requirement as defined.
As of December 31, 2015 and 2014, the Bank was in compliance with these capital rules and requirements as shown in the following table.
| 2015 | 2014 | ||||||||||||||
| Required | Actual | Required | Actual | ||||||||||||
| Risk-based capital | $ | 2,684 | $ | 5,369 | $ | 3,231 | $ | 6,356 | |||||||
| Total regulatory capital | $ | 3,428 | $ | 5,369 | $ | 3,032 | $ | 6,356 | |||||||
| Total regulatory capital ratio | 4.00 | % | 6.26 | % | 4.00 | % | 8.38 | % | |||||||
| Leverage capital | $ | 4,285 | $ | 8,054 | $ | 3,790 | $ | 9,534 | |||||||
| Leverage ratio | 5.00 | % | 9.40 | % | 5.00 | % | 12.58 | % | |||||||
The Bank's capital plan requires each member to own capital stock in an amount equal to the greater of its membership capital stock requirement or its activity-based capital stock requirement. The Bank may adjust these requirements from time to time within limits established in the capital plan. Any changes to the capital plan must be approved by the Bank's Board of Directors and the Finance Agency.
The Bank amended its capital plan, effective April 1, 2015, to lower the cap on the membership stock requirement to $15 from $25, lower the activity-based stock requirement to 3.0% from 4.7% for outstanding advances and to 3.0% from 5.0% for mortgage loans purchased and held by the Bank, and change the authorized ranges for the activity-based stock requirement to a range of 2.0% to 5.0% from a range of 4.4% to 5.0% for advances and to a range of 0.0% to 5.0% from a range of 5.0% to 5.7% for mortgage loans purchased and held by the Bank. Effective August 3, 2015, the Bank reduced its activity-based stock requirements within the ranges authorized by the Bank’s capital plan. The activity-based stock requirement for advances was reduced from 3.0% to 2.7%, and the activity-based stock requirement for mortgage loans purchased from the member and held by the Bank was reduced from 3.0% to 0.0%.
A member's membership capital stock requirement is 1.0% of its membership asset value. The membership capital stock requirement for a member is capped at $15. The Bank may adjust the membership capital stock requirement for all members within a range of 0.5% to 1.5% of a member's membership asset value and may adjust the cap for all members within an authorized range of $10 to $50. A member's membership asset value is determined by multiplying the amount of the member's membership assets by the applicable membership asset factors. Membership assets are generally defined as assets (other than Bank capital stock) of a type that could qualify as collateral to secure a member's indebtedness to the Bank under applicable law, whether or not the assets are pledged to the Bank or accepted by the Bank as eligible collateral. The membership asset factors were initially based on the typical borrowing capacity percentages generally assigned by the Bank to the same types of assets when pledged to
155
the Bank (although the factors may differ from the actual borrowing capacities, if any, assigned to particular assets pledged by a specific member at any point in time).
A member's activity-based capital stock requirement is the sum of 2.7% of the member's outstanding advances plus 0.0% of any portion of any mortgage loan purchased and held by the Bank. The Bank may adjust the activity-based capital stock requirement for all members within a range of 2.0% to 5.0% of the member's outstanding advances and a range of 0.0% to 5.0% of any portion of any mortgage loan purchased and held by the Bank.
Any member may withdraw from membership and, subject to certain statutory and regulatory restrictions, have its capital stock redeemed after giving the required notice. Members that withdraw from membership may not reapply for membership for five years, in accordance with Finance Agency rules.
Mandatorily Redeemable Capital Stock. The Bank reclassifies the capital stock subject to redemption from capital to a liability after a member provides the Bank with a written notice of redemption; gives notice of intention to withdraw from membership; or attains nonmember status by merger or acquisition, charter termination, or other involuntary membership termination; or after a receiver or other liquidating agent for a member transfers the member's Bank capital stock to a nonmember entity, resulting in the member's shares then meeting the definition of a mandatorily redeemable financial instrument. Shares meeting this definition are reclassified to a liability at fair value. Dividends declared on shares classified as a liability are accrued at the expected dividend rate and reflected as interest expense in the Statements of Income. The repayment of these mandatorily redeemable financial instruments (by repurchase or redemption of the shares) is reflected as a financing cash outflow in the Statements of Cash Flows once settled.
The Bank has a cooperative ownership structure under which members, former members, and certain other nonmembers own the Bank's capital stock. Former members and certain other nonmembers are required to maintain their investment in the Bank's capital stock until their outstanding transactions are paid off or until their capital stock is redeemed following the relevant five-year redemption period for capital stock or is repurchased by the Bank, in accordance with the Bank's capital requirements. Capital stock cannot be issued, repurchased, redeemed, or transferred except between the Bank and its members (or their affiliates and successors) at the capital stock's par value of one hundred dollars per share. If a member cancels its written notice of redemption or notice of withdrawal or if the Bank allows the transfer of mandatorily redeemable capital stock to a member, the Bank reclassifies mandatorily redeemable capital stock from a liability to capital. After the reclassification, dividends on the capital stock are no longer classified as interest expense.
The Bank will not redeem or repurchase capital stock required to meet the minimum capital stock requirement until five years after the member's membership is terminated or after the Bank receives notice of the member's withdrawal, and the Bank will redeem or repurchase only the amounts that are in excess of the capital stock required to support activity (advances and mortgage loans) that may remain outstanding after the five-year redemption period has expired. The Bank will not redeem or repurchase activity-based capital stock as long as the activity remains outstanding, even after the expiration of the five-year redemption period. In both cases, the Bank will only redeem or repurchase capital stock if certain statutory and regulatory conditions are met. In accordance with the Bank's current practice, if activity-based capital stock becomes excess capital stock because an activity no longer remains outstanding, the Bank may repurchase the excess activity-based capital stock at its discretion, subject to certain statutory and regulatory conditions, on a scheduled quarterly basis.
The Bank had mandatorily redeemable capital stock totaling $488 outstanding to 9 institutions at December 31, 2015, and $719 outstanding to 32 institutions at December 31, 2014. The change in mandatorily redeemable capital stock for the years ended December 31, 2015, 2014, and 2013 was as follows:
156
| 2015 | 2014 | 2013 | |||||||||
| Balance at the beginning of the period | $ | 719 | $ | 2,071 | $ | 4,343 | |||||
Reclassified from/(to) capital during the period(1) | 415 | 3 | 4 | ||||||||
| Redemption of mandatorily redeemable capital stock | (53 | ) | (296 | ) | (502 | ) | |||||
| Repurchase of excess mandatorily redeemable capital stock | (593 | ) | (1,059 | ) | (1,774 | ) | |||||
| Balance at the end of the period | $ | 488 | $ | 719 | $ | 2,071 | |||||
| (1) | The Bank reclassified $403 of capital stock to mandatorily redeemable capital stock (a liability) on September 1, 2015, as a result of the merger of JPMorgan B&T with and into JPMorgan Chase, a nonmember of the Bank. |
Cash dividends on mandatorily redeemable capital stock were recorded as interest expense in the amount of $65, $120, and $155 for the years ended December 31, 2015, 2014, and 2013, respectively.
The following table presents mandatorily redeemable capital stock amounts by contractual redemption period at December 31, 2015 and 2014.
| Contractual Redemption Period | 2015 | 2014 | |||||
| Within 1 year | $ | 82 | $ | 51 | |||
| After 1 year through 2 years | 1 | 582 | |||||
| After 2 years through 3 years | — | 9 | |||||
| After 3 years through 4 years | — | 1 | |||||
| After 4 years through 5 years | 381 | 2 | |||||
Past contractual redemption date because of remaining activity(1) | 24 | 74 | |||||
| Total | $ | 488 | $ | 719 | |||
| (1) | Represents mandatorily redeemable capital stock that is past the end of the contractual redemption period because of outstanding activity. |
A member may cancel its notice of redemption or notice of withdrawal from membership by providing written notice to the Bank prior to the end of the relevant five-year redemption period or the membership termination date. If the Bank receives the notice of cancellation within 30 months following the notice of redemption or notice of withdrawal, the member is charged a fee equal to fifty cents multiplied by the number of shares of capital stock affected. If the Bank receives the notice of cancellation more than 30 months following the notice of redemption or notice of withdrawal (or if the Bank does not redeem the member's capital stock because following the redemption the member would fail to meet its minimum capital stock requirement), the member is charged a fee equal to one dollar multiplied by the number of shares of capital stock affected. In certain cases the Board of Directors may waive a cancellation fee for bona fide business purposes.
The Bank's capital stock is considered putable by the shareholder. There are significant statutory and regulatory restrictions on the Bank's obligation or ability to redeem outstanding capital stock, which include the following:
| • | The Bank may not redeem any capital stock if, following the redemption, the Bank would fail to meet its minimum capital requirements for total capital, leverage capital, and risk-based capital. All of the Bank's capital stock immediately becomes nonredeemable if the Bank fails to meet its minimum capital requirements. |
| • | The Bank may not be able to redeem any capital stock if either its Board of Directors or the Finance Agency determines that it has incurred or is likely to incur losses resulting in or expected to result in a charge against capital that would have any of the following effects: cause the Bank not to comply with its regulatory capital requirements, result in negative retained earnings, or otherwise create an unsafe and unsound condition at the Bank. |
157
| • | In addition to being able to prohibit capital stock redemptions, the Bank's Board of Directors has a right to call for additional capital stock purchases by its members, as a condition of continuing membership, as needed for the Bank to satisfy its statutory and regulatory capital requirements. |
| • | If, during the period between receipt of a capital stock redemption notice and the actual redemption (a period that could last indefinitely), the Bank becomes insolvent and is either liquidated or merged with another FHLBank, the redemption value of the capital stock will be established either through the liquidation or the merger process. If the Bank is liquidated, after satisfaction of the Bank's obligations to creditors and to the extent funds are then available, each shareholder will be entitled to receive the par value of its capital stock as well as any retained earnings in an amount proportional to the shareholder's share of the total shares of capital stock, subject to any limitations that may be imposed by the Finance Agency. In the event of a merger or consolidation, the Board of Directors will determine the rights and preferences of the Bank's shareholders, subject to any terms and conditions imposed by the Finance Agency. |
| • | The Bank may not redeem any capital stock if the principal or interest due on any consolidated obligations issued by the Office of Finance has not been paid in full. |
| • | The Bank may not redeem any capital stock if the Bank fails to provide the Finance Agency with the quarterly certification required by Finance Agency rules prior to declaring or paying dividends for a quarter. |
| • | The Bank may not redeem any capital stock if the Bank is unable to provide the required quarterly certification, projects that it will fail to comply with statutory or regulatory liquidity requirements or will be unable to fully meet all of its obligations on a timely basis, actually fails to satisfy these requirements or obligations, or negotiates to enter or enters into an agreement with another FHLBank to obtain financial assistance to meet its current obligations. |
Mandatorily redeemable capital stock is considered capital for determining the Bank's compliance with its regulatory capital requirements. Based on Finance Agency interpretation, the classification of certain shares of the Bank's capital stock as mandatorily redeemable does not affect the definition of total capital for purposes of: determining the Bank's compliance with its regulatory capital requirements, calculating its mortgage-backed securities investment authority (300% of total capital), calculating its unsecured credit exposure to other GSEs (limited to 100% of total capital), or calculating its unsecured credit limits to other counterparties (various percentages of total capital depending on the rating of the counterparty).
Excess Stock Repurchase, Retained Earnings, and Dividend Framework. By Finance Agency regulation, dividends may be paid only out of current net earnings or previously retained earnings. As required by the Finance Agency, the Bank’s Excess Stock Repurchase, Retained Earnings, and Dividend Framework is reviewed at least annually by the Bank's Board of Directors. It summarizes the Bank’s capital management principles and objectives, as well as its policies and practices, with respect to retained earnings, dividend payments, and the repurchase of excess capital stock. The Board of Directors may amend the Excess Stock Repurchase, Retained Earnings, and Dividend Framework from time to time.
The Bank may be restricted from paying dividends if the Bank 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 obligations 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 Finance Agency regulations.
The Bank’s Risk Management Policy limits the payment of dividends if the ratio of the Bank’s estimated market value of total capital to par value of capital stock falls below certain levels. If this ratio at the end of any quarter is less than 100% but greater than or equal to 70%, any dividend would be limited to an annualized rate no greater than the daily average of the three-month LIBOR for the applicable quarter (subject to certain conditions), and if this ratio is less than 70%, the Bank would be restricted from paying a dividend. The ratio of the Bank’s estimated market value of total capital to par value of capital stock was 200% as of December 31, 2015.
158
In addition, the Bank monitors the condition of its PLRMBS portfolio, the ratio of the Bank’s estimated market value of total capital to par value of 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 payment of dividends and the repurchase of excess capital stock each quarter.
Retained Earnings Related to Valuation Adjustments – In accordance with the Bank’s Excess Stock Repurchase, Retained Earnings, and Dividend Framework, 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).
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 valuation 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 purpose of retaining cumulative net gains in earnings resulting from valuation adjustments as 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 this way may preserve the Bank's ability to pay dividends, the reversal of the 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.
Retained Earnings Related to Loss Protection and Capital Compliance – In addition to any cumulative net gains resulting from valuation adjustments, the Bank holds an additional amount in restricted retained earnings intended to protect paid-in capital from the effects of an extremely adverse credit event, an extremely adverse operations risk event, a cumulative net loss related to the Bank's derivatives and associated hedged items and financial instruments carried at fair value, an extremely adverse change in the market value of the Bank's capital, a significant amount of additional credit-related OTTI on PLRMBS, or some combination of these effects, especially in periods of extremely low net income resulting from an adverse interest rate environment, and to maintain capital compliance.
On July 31, 2015, the Board of Directors set the required amount of restricted retained earnings for loss protection and capital compliance at $2,000. Restricted retained earnings available to meet this requirement include amounts related to the Bank’s buildup of retained earnings and to the Joint Capital Enhancement Agreement, but exclude retained earnings related to valuations adjustments. Restricted retained earnings for loss protection and capital compliance were $2,008 as of December 31, 2015.
The Bank’s retained earnings requirement may be changed at any time. The Board of Directors periodically reviews the retained earnings methodology and analysis to determine whether any adjustments are appropriate.
Buildup – As of March 31, 2012, the Bank reached the $1,800 target for the buildup of retained earnings that had previously been set by the Board of Directors. On July 31, 2015, the Board of Directors lowered the requirement to $1,650 and transferred $150 to unrestricted retained earnings.
Joint Capital Enhancement Agreement – The FHLBanks’ Joint Capital Enhancement Agreement, as amended (JCE Agreement), is intended to enhance the capital position of each FHLBank. In accordance with the JCE Agreement, each FHLBank is required to allocate 20% of its net income each quarter 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
159
consolidated obligations for the previous quarter. Under the JCE Agreement, these restricted retained earnings will not be available to pay dividends.
Retained earnings related to the JCE Agreement totaled $358 and $230 at December 31, 2015 and 2014, respectively.
The following table summarizes the activity related to retained earnings for the years ended December 31, 2015 and 2014:
| Restricted Retained Earnings Related to: | ||||||||||||||||||
| Unrestricted Retained Earnings | Valuation Adjustments | Buildup | Joint Capital Enhancement Agreement | Total Restricted Retained Earnings | Total Retained Earnings | |||||||||||||
| Balance, December 31, 2013 | $ | 317 | $ | 88 | $ | 1,800 | $ | 189 | $ | 2,077 | $ | 2,394 | ||||||
| Net income | 217 | (53 | ) | — | 41 | (12 | ) | 205 | ||||||||||
| Cash dividends on capital stock | (240 | ) | — | — | — | — | (240 | ) | ||||||||||
| Balance, December 31, 2014 | $ | 294 | $ | 35 | $ | 1,800 | $ | 230 | $ | 2,065 | $ | 2,359 | ||||||
| Net income | 535 | (25 | ) | — | 128 | 103 | 638 | |||||||||||
| Cash dividends on capital stock | (369 | ) | — | — | — | — | (369 | ) | ||||||||||
| Transfers from restricted retained earnings | 150 | — | (150 | ) | — | (150 | ) | — | ||||||||||
| Balance, December 31, 2015 | $ | 610 | $ | 10 | $ | 1,650 | $ | 358 | $ | 2,018 | $ | 2,628 | ||||||
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.
In addition, Finance Agency rules do not permit the Bank to pay dividends in the form of capital stock if its excess
capital stock exceeds 1% of its total assets. Excess capital stock is defined as the aggregate of the capital stock held by each shareholder in excess of its minimum capital stock requirement, as established by the Bank’s capital plan. As of December 31, 2015, the Bank’s excess capital stock totaled $402, or 0.47% of total assets.
The Bank paid dividends at an annualized rate of 12.39%, totaling $434, including $369 in dividends on capital stock and $65 in dividends on mandatorily redeemable capital stock. The dividends included four quarterly dividends and a special dividend in the amount of $145, including $120 on capital stock and $25 in dividends on mandatorily redeemable capital stock. The Bank paid dividends at an annualized rate of 7.02%, totaling $360, including $240 in dividends on capital stock and $120 in dividends on mandatorily redeemable capital stock in 2014.
For the periods referenced above, the Bank paid dividends in cash. Dividends on capital stock are recognized as dividends on the Statements of Capital Accounts, and dividends on mandatorily redeemable capital stock are recognized as interest expense on the Statements of Income.
On February 18, 2016, the Bank’s Board of Directors declared a cash dividend on the capital stock outstanding during the fourth quarter of 2015 at an annualized rate of 7.99%, totaling $55, including $45 in dividends on capital stock and $10 in dividends on mandatorily redeemable capital stock. The Bank recorded the dividend on February 18, 2016. The Bank expects to pay the dividend on or about March 17, 2016. Dividends on mandatorily redeemable capital stock will be recognized as interest expense in the first quarter of 2016.
160
Excess Capital Stock – The Bank may repurchase some or all of a shareholder’s excess capital stock, including any excess mandatorily redeemable capital stock, at the Bank’s discretion, subject to certain statutory and regulatory requirements. The Bank must give the shareholder 15 days’ written notice; however, the shareholder may waive this notice period. The Bank may also repurchase all of a member’s excess capital stock at a member’s request, at the Bank’s discretion, subject to certain statutory and regulatory requirements. A shareholder’s excess capital stock is defined as any capital stock holdings in excess of the shareholder’s minimum capital stock requirement, as established by the Bank’s capital plan. The Bank repurchased $2,032 and $2,000 in excess capital stock during 2015 and 2014, respectively.
The Bank is required to redeem any mandatorily redeemable capital stock that is in excess of a former member’s minimum stock requirement on or after the expiration of the five-year redemption date. During 2015 and 2014, the Bank redeemed $53 and $296, respectively, in mandatorily redeemable capital stock, for which the five-year redemption period had expired, at its $100 par value. The stock was redeemed on the scheduled redemption dates or, for stock that was not excess stock on its scheduled redemption date because of outstanding activity with the Bank, on the first available repurchase date after the stock was no longer required to support outstanding activity with the Bank.
On May 29, 2015, the Bank’s Excess Stock Repurchase, Retained Earnings, and Dividend Framework was revised to reinstate the Bank’s practice of repurchasing the surplus capital stock of all members and the excess capital stock of all nonmember shareholders on a regular quarterly basis, at the Bank’s discretion and subject to certain statutory and regulatory requirements and to the Bank’s Risk Management Policy and capital plan limitations. Surplus capital stock is defined as any stock holdings in excess of 115% of a member’s minimum stock requirement. In addition, at the Bank’s discretion, all of the excess stock held by a member may be repurchased upon request of a member, subject to the requirements and limitations mentioned above. In accordance with the revised Excess Stock Repurchase, Retained Earnings, and Dividend Framework, each quarter Bank management evaluates and determines the amount of capital stock to be repurchased in that quarter, if any, giving consideration to certain capital metrics and capital management objectives and strategies, and subject to the requirements and limitations mentioned above. At least 15 calendar days before any repurchase, the Bank will notify shareholders of its intention to repurchase capital stock and of the scheduled repurchase date. On the scheduled repurchase date, the Bank will calculate the amount of stock to be repurchased to ensure that each member and nonmember shareholder will continue to meet its minimum stock requirement after the repurchase.
On February 19, 2016, the Bank announced that it plans to repurchase the surplus capital stock of all members and the excess capital stock of all nonmember shareholders on March 18, 2016.
Excess capital stock totaled $402 as of December 31, 2015, and $1,118 as of December 31, 2014.
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 December 31, 2015 or 2014.
161
| 2015 | 2014 | ||||||||||||
| Name of Institution | Capital Stock Outstanding | Percentage of Total Capital Stock Outstanding | Capital Stock Outstanding | Percentage of Total Capital Stock Outstanding | |||||||||
| JPMorgan Chase & Co.: | |||||||||||||
| JPMorgan Bank & Trust Company, National Association | $ | — | — | % | $ | 268 | 7 | % | |||||
JPMorgan Chase Bank, National Association(1)(2) | 400 | 15 | 68 | 2 | |||||||||
| Subtotal JPMorgan Chase & Co. | 400 | 15 | % | 336 | 9 | ||||||||
| Citigroup Inc.: | |||||||||||||
Citibank, N.A.(1) | 81 | 3 | 577 | 14 | |||||||||
| Banamex USA | 4 | — | 2 | — | |||||||||
| Subtotal Citigroup Inc. | 85 | 3 | 579 | 14 | |||||||||
| Subtotal | 485 | 18 | 915 | 23 | |||||||||
| Others | 2,256 | 82 | 3,082 | 77 | |||||||||
| Total | $ | 2,741 | 100 | % | $ | 3,997 | 100 | % | |||||
| (1) | The capital stock held by these nonmember institutions is classified as mandatorily redeemable capital stock. |
| (2) | The Bank reclassified $403 of capital stock to mandatorily redeemable capital stock (a liability) on September 1, 2015, as a result of the merger of JPMorgan B&T with and into JPMorgan Chase, a nonmember of the Bank. |
Note 16 — Employee Retirement Plans and Incentive Compensation Plans
Defined Benefit Plans
Qualified Defined Benefit Plan. The Bank provides retirement benefits through a Bank-sponsored Cash Balance Plan, a qualified defined benefit plan. The Cash Balance Plan is provided to all employees who have completed six months of Bank service. Under the plan, each eligible Bank employee accrues benefits annually equal to 6% of the employee's annual compensation, plus 6% interest on the benefits accrued to the employee through the prior yearend. The Cash Balance Plan is funded through a qualified trust established by the Bank.
Non-Qualified Defined Benefit Plans. The Bank sponsors the following non-qualified defined benefit retirement plans:
| • | Benefit Equalization Plan, a non-qualified retirement plan restoring benefits offered under the Cash Balance Plan that are limited by laws governing the plan. See below for further discussion of the defined contribution portion of the Benefit Equalization Plan. |
| • | Supplemental Executive Retirement Plan (SERP), a non-qualified unfunded retirement benefit plan available to the Bank's eligible senior officers, which generally provides a service-linked supplemental cash balance annual contribution credit to SERP participants and an annual interest credit of 6% on the benefits accrued to the SERP participants through the prior yearend. |
| • | Deferred Compensation Plan, a non-qualified retirement plan available to all eligible Bank officers, which provides make-up pension benefits that would have been earned under the Cash Balance Plan had the compensation not been deferred. The make-up benefits vest according to the corresponding provisions of the Cash Balance Plan. See below for further discussion of the defined contribution portion of the Deferred Compensation Plan. |
Postretirement Health Benefit Plan. The Bank provides a postretirement health benefit plan to employees hired before January 1, 2003. The Bank's costs are capped at 1998 health care premium amounts. As a result, changes in health care cost trend rates will have no effect on the Bank's accumulated postretirement benefit obligation or service and interest costs.
162
The following table summarizes the changes in the benefit obligations, plan assets, and funded status of the defined benefit Cash Balance Plan, non-qualified defined benefit plans, and postretirement health benefit plan for the years ended December 31, 2015 and 2014.
| 2015 | 2014 | ||||||||||||||||||||||
Cash Balance Plan | Non-Qualified Defined Benefit Plans | Post-retirement Health Benefit Plan | Cash Balance Plan | Non-Qualified Defined Benefit Plans | Post-retirement Health Benefit Plan | ||||||||||||||||||
| Change in benefit obligation | |||||||||||||||||||||||
| Benefit obligation, beginning of the period | $ | 43 | $ | 23 | $ | 2 | $ | 37 | $ | 21 | $ | 2 | |||||||||||
| Service cost | 3 | 1 | — | 2 | 1 | — | |||||||||||||||||
| Interest cost | 2 | 1 | — | 2 | 1 | — | |||||||||||||||||
| Actuarial (gain)/loss | (1 | ) | (1 | ) | — | 3 | — | — | |||||||||||||||
| Benefits paid | (1 | ) | — | — | (1 | ) | — | — | |||||||||||||||
| Benefit obligation, end of the period | 46 | 24 | 2 | 43 | 23 | 2 | |||||||||||||||||
| Change in plan assets | |||||||||||||||||||||||
| Fair value of plan assets, beginning of the period | 41 | — | — | 38 | — | — | |||||||||||||||||
| Actual return on plan assets | (1 | ) | — | — | 2 | — | — | ||||||||||||||||
| Employer contributions | 4 | — | — | 2 | — | — | |||||||||||||||||
| Benefits paid | (1 | ) | — | — | (1 | ) | — | — | |||||||||||||||
| Fair value of plan assets, end of the period | 43 | — | — | 41 | — | — | |||||||||||||||||
| Funded status at the end of the period | $ | (3 | ) | $ | (24 | ) | $ | (2 | ) | $ | (2 | ) | $ | (23 | ) | $ | (2 | ) | |||||
Amounts recognized in the Statements of Condition at December 31, 2015 and 2014, consist of:
| 2015 | 2014 | ||||||||||||||||||||||
Cash Balance Plan | Non-Qualified Defined Benefit Plans | Post-retirement Health Benefit Plan | Cash Balance Plan | Non-Qualified Defined Benefit Plans | Post-retirement Health Benefit Plan | ||||||||||||||||||
| Other liabilities | $ | (3 | ) | $ | (24 | ) | $ | (2 | ) | $ | (2 | ) | $ | (23 | ) | $ | (2 | ) | |||||
Amounts recognized in AOCI at December 31, 2015 and 2014, consist of:
| 2015 | 2014 | ||||||||||||||||||||||
Cash Balance Plan | Non-Qualified Defined Benefit Plans | Post-retirement Health Benefit Plan | Cash Balance Plan | Non-Qualified Defined Benefit Plans | Post-retirement Health Benefit Plan | ||||||||||||||||||
| Net loss/(gain) | $ | 12 | $ | 3 | $ | (1 | ) | $ | 9 | $ | 4 | $ | (2 | ) | |||||||||
| Prior service cost | — | — | — | — | 1 | — | |||||||||||||||||
| AOCI | $ | 12 | $ | 3 | $ | (1 | ) | $ | 9 | $ | 5 | $ | (2 | ) | |||||||||
The following table presents information for pension plans with benefit obligations in excess of plan assets at December 31, 2015 and 2014.
163
| 2015 | 2014 | ||||||||||||||||||||||
| Cash Balance Plan | Non-Qualified Defined Benefit Plans | Post-retirement Health Benefit Plan | Cash Balance Plan | Non-Qualified Defined Benefit Plans | Post-retirement Health Benefit Plan | ||||||||||||||||||
| Projected benefit obligation | $ | 46 | $ | 24 | $ | 2 | $ | 43 | $ | 23 | $ | 2 | |||||||||||
| Accumulated benefit obligation | 44 | 24 | 2 | 41 | 22 | 2 | |||||||||||||||||
| Fair value of plan assets | 43 | — | — | 41 | — | — | |||||||||||||||||
Components of the net periodic benefit costs and other amounts recognized in other comprehensive income for the years ended December 31, 2015, 2014, and 2013, were as follows:
| 2015 | 2014 | 2013 | |||||||||||||||||||||||||||||||||
| Cash Balance Plan | Non-Qualified Defined Benefit Plans | Post-retirement Health Benefit Plan | Cash Balance Plan | Non-Qualified Defined Benefit Plans | Post-retirement Health Benefit Plan | Cash Balance Plan | Non-Qualified Defined Benefit Plans | Post-retirement Health Benefit Plan | |||||||||||||||||||||||||||
| Net periodic benefit cost/(income) | |||||||||||||||||||||||||||||||||||
| Service cost | $ | 3 | $ | 1 | $ | — | $ | 2 | $ | 1 | $ | — | $ | 3 | $ | 2 | $ | — | |||||||||||||||||
| Interest cost | 2 | 1 | — | 2 | 1 | — | 1 | 1 | — | ||||||||||||||||||||||||||
| Expected return on plan assets | (3 | ) | — | — | (3 | ) | — | — | (3 | ) | — | — | |||||||||||||||||||||||
| Amortization of net loss/(gain) | — | 1 | (1 | ) | — | — | — | 1 | — | — | |||||||||||||||||||||||||
| Net periodic benefit cost | 2 | 3 | (1 | ) | 1 | 2 | — | 2 | 3 | — | |||||||||||||||||||||||||
| Other changes in plan assets and benefit obligations recognized in other comprehensive income | |||||||||||||||||||||||||||||||||||
| Net loss/(gain) | 3 | (1 | ) | — | 4 | 1 | — | (5 | ) | — | (1 | ) | |||||||||||||||||||||||
| Prior service cost | — | — | — | — | — | — | — | 1 | — | ||||||||||||||||||||||||||
| Amortization of net loss/(gain) | — | (1 | ) | 1 | — | — | — | — | — | — | |||||||||||||||||||||||||
| Total recognized in other comprehensive income | 3 | (2 | ) | 1 | 4 | 1 | — | (5 | ) | 1 | (1 | ) | |||||||||||||||||||||||
| Total recognized in net periodic benefit cost and other comprehensive income | $ | 5 | $ | 1 | $ | — | $ | 5 | $ | 3 | $ | — | $ | (3 | ) | $ | 4 | $ | (1 | ) | |||||||||||||||
The amounts in AOCI expected to be recognized as components of net periodic benefit cost in 2016 are as follows:
Cash Balance Plan | Non-Qualified Defined Benefit Plans | Post-retirement Health Benefit Plan | |||||||||
| Estimated net gain/(loss) | $ | 1 | $ | — | $ | — | |||||
Weighted average assumptions used to determine the benefit obligations at December 31, 2015 and 2014, for the Cash Balance Plan, non-qualified defined benefit plans, and postretirement health benefit plan were as follows:
164
| 2015 | 2014 | ||||||||||||||||
| Cash Balance Plan | Non-Qualified Defined Benefit Plans | Post- retirement Health Benefit Plan | Cash Balance Plan | Non-Qualified Defined Benefit Plans | Post-retirement Health Benefit Plan | ||||||||||||
| Discount rate | 3.75 | % | 3.75 | % | 4.00 | % | 3.50 | % | 3.50 | % | 3.75 | % | |||||
| Rate of salary increase | 3.00% through 2016 4.00% thereafter | 3.00% through 2016 4.00% thereafter | — | 3.00% through 2015 4.00% thereafter | 3.00% through 2015 4.00% thereafter | — | |||||||||||
Weighted average assumptions used to determine the net periodic benefit costs for the years ended December 31, 2015, 2014, and 2013, for the Cash Balance Plan, non-qualified defined benefit plans, and postretirement health benefit plan were as follows:
| 2015 | 2014 | 2013 | ||||||||||||||||||||||||
| Cash Balance Plan | Non-Qualified Defined Benefit Plans | Post-retirement Health Benefit Plan | Cash Balance Plan | Non-Qualified Defined Benefit Plans | Post-retirement Health Benefit Plan | Cash Balance Plan | Non-Qualified Defined Benefit Plans | Post-retirement Health Benefit Plan | ||||||||||||||||||
| Discount rate | 3.50 | % | 3.50 | % | 3.75 | % | 4.25 | % | 4.25 | % | 4.75 | % | 3.25 | % | 3.25 | % | 3.75 | % | ||||||||
| Rate of salary increase | 3.00% through 2015 4.00% thereafter | 3.00% through 2015 4.00% thereafter | — | 3.00% through 2015 4.00% thereafter | 3.00% through 2015 4.00% thereafter | — | 3.00% through 2015 4.00% thereafter | 3.00% through 2015 4.00% thereafter | — | |||||||||||||||||
| Expected return on plan assets | 8.00 | % | — | — | 8.00 | % | — | — | 8.00 | % | — | — | ||||||||||||||
The Bank uses a discount rate to determine the present value of its future benefit obligations. The discount rate was determined based on the Citigroup Pension Discount Curve at the measurement date. The Citigroup Pension Discount Curve is a yield curve that reflects the market-observed yields for high-quality fixed income securities for each maturity. The projected benefit payments for each year from the plan are discounted using the spot rates on the yield curve to derive a single equivalent discount rate. The discount rate is reset annually on the measurement date.
The expected return on plan assets was determined based on: (i) the historical returns for each asset class, (ii) the expected future long-term returns for these asset classes, and (iii) the plan's target asset allocation.
The table below presents the fair values of the Cash Balance Plan's assets as of December 31, 2015 and 2014, by asset category. See Note 19 – Fair Value for further information regarding the three levels of fair value measurement.
| 2015 | 2014 | ||||||||||||||||||||||||||||||
| Fair Value Measurement Using: | Fair Value Measurement Using: | ||||||||||||||||||||||||||||||
| Asset Category | Level 1 | Level 2 | Level 3 | Total | Level 1 | Level 2 | Level 3 | Total | |||||||||||||||||||||||
| Cash and cash equivalents | $ | 2 | $ | — | $ | — | $ | 2 | $ | 1 | $ | — | $ | — | $ | 1 | |||||||||||||||
| Equity mutual funds | 24 | — | — | 24 | 25 | — | — | 25 | |||||||||||||||||||||||
| Fixed income mutual funds | 14 | — | — | 14 | 13 | — | — | 13 | |||||||||||||||||||||||
| Real estate mutual funds | 2 | — | — | 2 | 1 | — | — | 1 | |||||||||||||||||||||||
| Other mutual funds | 1 | — | — | 1 | 1 | — | — | 1 | |||||||||||||||||||||||
| Total | $ | 43 | $ | — | $ | — | $ | 43 | $ | 41 | $ | — | $ | — | $ | 41 | |||||||||||||||
165
The Cash Balance Plan is administered by the Bank's Retirement Committee, which establishes the plan's Statement of Investment Policy and Objectives. The Retirement Committee has adopted a strategic asset allocation based on a stable distribution of assets among major asset classes. These asset classes include domestic large-, mid-, and small-capitalization equity investments; international equity investments; real return investments; and fixed income investments. The Retirement Committee has set the Cash Balance Plan's target allocation percentages for a mix of 60% equity, 10% real return, and 30% fixed income. The Retirement Committee reviews the performance of the Cash Balance Plan on a regular basis.
The Cash Balance Plan's weighted average asset allocation at December 31, 2015 and 2014, by asset category was as follows:
| Asset Category | 2015 | 2014 | |||
| Cash and cash equivalents | 6 | % | 4 | % | |
| Equity mutual funds | 56 | 61 | |||
| Fixed income mutual funds | 32 | 31 | |||
| Real estate mutual funds | 4 | 2 | |||
| Other mutual funds | 2 | 2 | |||
| Total | 100 | % | 100 | % | |
The Bank contributed $4 in 2015 and expects to contribute $2 in 2016 to the Cash Balance Plan. The Bank contributed a de minimis amount in 2015 and expects to contribute $6 in 2016 to the non-qualified defined benefit plans and postretirement health benefit plan.
The following are the estimated future benefit payments, which reflect expected future service, as appropriate:
| Year | Cash Balance Plan | Non-Qualified Defined Benefit Plans | Postretirement Health Benefit Plan | ||||||||
| 2016 | $ | 4 | $ | 6 | $ | — | |||||
| 2017 | 3 | 1 | — | ||||||||
| 2018 | 3 | 4 | — | ||||||||
| 2019 | 4 | 1 | — | ||||||||
| 2020 | 4 | 1 | — | ||||||||
| 2021 – 2025 | 22 | 16 | 1 | ||||||||
Defined Contribution Plans
Retirement Savings Plan. The Bank sponsors a qualified defined contribution retirement 401(k) savings plan, the Federal Home Loan Bank of San Francisco Savings Plan (Savings Plan). Contributions to the Savings Plan consist of elective participant contributions of up to 20% of each participant's base compensation and a Bank matching contribution of up to 6% of each participant's base compensation. The Bank contributed approximately $2, $2, and $2 during the years ended December 31, 2015, 2014, and 2013, respectively.
Benefit Equalization Plan. The Bank sponsors a non-qualified retirement plan restoring benefits offered under the Savings Plan that have been limited by laws governing the plan. Contributions made during the years ended December 31, 2015, 2014, and 2013, were de minimis.
Deferred Compensation Plan. The Bank maintains a deferred compensation plan that is available to all eligible Bank officers. The defined contribution portion of the plan is comprised of two components: (i) officer or director deferral of current compensation, and (ii) make-up matching contributions for officers that would have been made
166
by the Bank under the Savings Plan had the compensation not been deferred. The make-up benefits under the Deferred Compensation Plan vest according to the corresponding provisions of the Savings Plan. The Deferred Compensation Plan liability consists of the accumulated compensation deferrals and accrued earnings on the deferrals, as well as the make-up matching contributions and any accrued earnings on the contributions. The Bank's obligation for this plan at December 31, 2015, 2014, and 2013, was $35, $33, and $30, respectively.
Incentive Compensation Plans
The Bank provides incentive compensation plans for many of its employees, including senior officers. Other liabilities include $12 and $12 for incentive compensation at December 31, 2015 and 2014, respectively.
Note 17 — 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 income and expense associated with net settlements from economic hedges that are recorded in “Net gain/(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 credit-related OTTI losses on the Bank’s PLRMBS, other expenses, and assessments, is not included in the segment reporting analysis, but is incorporated into the Bank’s overall assessment of financial performance.
The advances-related business consists of advances and other credit products, related financing and hedging
instruments, other non-MBS investments associated with the Bank's role as a liquidity provider, and capital.
Adjusted net interest income for this segment is derived primarily from the difference, or spread, between the yield
on all assets associated with the business activities in this segment and the cost of funding those activities, including
the net settlements from associated interest rate exchange agreements, and from earnings on invested capital.
The mortgage-related business consists of MBS investments, mortgage loans acquired through the MPF Program,
the consolidated obligations specifically identified as funding those assets, and related hedging instruments.
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 net settlements from associated interest rate exchange agreements, less the provision for credit losses on mortgage loans.
The following table presents the Bank’s adjusted net interest income by operating segment and reconciles total adjusted net interest income to income before the AHP assessment for the years ended December 31, 2015, 2014, and 2013.
Advances- Related Business | Mortgage- Related Business(1) | Adjusted Net Interest Income | Amortization of Basis Adjustments(2) | Income/(Expense) on Economic Hedges(3) | Interest Expense on Mandatorily Redeemable Capital Stock(4) | Net Interest Income After Mortgage Loan Loss Provision | Other Income/ (Loss) | Other Expense | Income Before AHP Assessment | ||||||||||||||||||||||||||||||
| 2015 | $ | 155 | $ | 351 | $ | 506 | $ | (17 | ) | $ | (18 | ) | $ | 65 | $ | 476 | $ | 388 | $ | 148 | $ | 716 | |||||||||||||||||
| 2014 | 166 | 410 | 576 | (19 | ) | (64 | ) | 120 | 539 | (154 | ) | 144 | 241 | ||||||||||||||||||||||||||
| 2013 | 175 | 449 | 624 | (48 | ) | 34 | 155 | 483 | 5 | 128 | 360 | ||||||||||||||||||||||||||||
| (1) | The mortgage-related business includes total accretion or amortization associated with other-than-temporarily impaired PLRMBS, which are recognized in interest income, and totaled $82, $66, and $20 for the years ended December 31, 2015, 2014, and 2013. The mortgage-related business does not include credit-related OTTI losses of $15, $4, and $7 for the years ended December 31, 2015, 2014, and 2013, respectively. |
167
| (2) | Represents amortization of amounts deferred for adjusted net interest income purposes only, in accordance with the Bank’s Excess Stock Repurchase, Retained Earnings, and Dividend Framework. |
| (3) | The Bank includes income and expense associated with net settlements from 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/(loss) 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 December 31, 2015, 2014, and 2013.
Advances- Related Business | Mortgage- Related Business | Total Assets | |||||||||
| 2015 | $ | 69,051 | $ | 16,656 | $ | 85,707 | |||||
| 2014 | 55,424 | 20,383 | 75,807 | ||||||||
| 2013 | 62,297 | 23,477 | 85,774 | ||||||||
Note 18 — Derivatives and Hedging Activities
General. The Bank may enter into interest rate swaps (including callable, putable, and basis swaps); and cap and floor agreements (collectively, interest rate exchange agreements or derivatives). Most of 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. The Bank transacts most of its derivatives with large banks and major broker-dealers. Some of these banks and broker-dealers or their affiliates buy, sell, and distribute consolidated obligations. Over-the-counter derivatives may be either uncleared or cleared. In an uncleared derivative transaction, the Bank’s counterparty is the executing bank or broker-dealer. In a cleared derivative transaction, the Bank may execute the transaction either directly with the executing bank or broker-dealer or on a swap execution facility, but in either case, the Bank’s counterparty is a derivatives clearing organization or clearinghouse once the derivative transaction has been accepted for clearing. The Bank is not a derivative dealer and does not trade derivatives for short-term profit.
Additional uses of interest rate exchange agreements include: (i) offsetting embedded features in assets and liabilities, (ii) hedging anticipated issuance of debt, (iii) matching against consolidated obligation discount notes or bonds to create the equivalent of callable or non-callable fixed rate debt, (iv) modifying the repricing frequency of assets and liabilities, (v) matching against certain advances and consolidated obligations for which the Bank elected the fair value option, and (vi) exactly offsetting other derivatives that may be executed with members (with the Bank serving as an intermediary) or cleared at a derivatives clearing organization. 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) an economic hedge of assets or liabilities, or (iii) 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.
Interest Rate Caps and Floors – In a cap agreement, additional cash flow is generated if the price or interest rate of an underlying variable rate rises above a certain threshold (or cap) price. In a floor agreement, additional cash flow is generated if the price or interest rate of an underlying variable rate falls below a certain threshold (or floor) price. Caps and floors may be used in conjunction with assets or liabilities. In general, 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.
168
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 hedge effectiveness. This process includes linking all derivatives that are designated as fair value hedges to: (i) assets and liabilities on the balance sheet, (ii) firm commitments, or (iii) forecasted transactions. The Bank also formally assesses (both at hedge inception and on an ongoing basis) whether the hedging derivatives have been effective in offsetting changes in the fair value of hedged items attributable to the hedged risk and whether those derivatives may be expected to remain effective hedges 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 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.
Intermediation and Offsetting Derivatives – As an additional service to its members, the Bank has in the past entered into offsetting interest rate exchange agreements, acting as an intermediary between offsetting derivative transactions with members and other counterparties. This intermediation allows members indirect access to the derivatives market. The Bank also enters into derivatives to offset the economic effect of other derivatives that are no longer designated to advances, investments, or consolidated obligations. Neither type of offsetting derivatives receives hedge accounting treatment and both 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.
The notional principal of the interest rate exchange agreements associated with derivatives with members or offsetting derivatives with other counterparties was $132 at December 31, 2015. The Bank had no interest rate exchange agreements with members or offsetting derivatives with other counterparties at December 31, 2014.
Investments – The Bank may invest in U.S. Treasury and agency obligations, agency MBS, and the taxable portion of highly rated state or local housing finance agency obligations. In the past, the Bank has also invested in PLRMBS rated AAA at the time of acquisition. 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. The Bank may execute callable swaps in conjunction with the issuance of certain liabilities to create funding that is economically 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. Investment securities may be classified as trading, AFS, or HTM.
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 advances 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 options characteristics of advances to more closely match the characteristics of the Bank’s funding liabilities. In general, whenever a member executes a fixed or variable rate advance with embedded options, the Bank will simultaneously execute an interest rate exchange
169
agreement with terms that offset the terms and embedded options in the advance. The combination of the advance and the interest rate exchange agreement effectively creates a variable rate asset.
In addition, for certain advances for which the Bank has elected the fair value option, the Bank will simultaneously execute an interest rate exchange agreement with terms that economically offset the terms of the advance.
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 in conjunction with the issuance of certain consolidated obligations to create funding that is economically 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.
Consolidated Obligations – Consolidated obligation bonds may be structured to meet the Bank’s or the 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 are issued, the Bank simultaneously executes 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 an adjustable rate bond alone. These transactions generally receive fair value hedge accounting treatment.
In addition, when certain consolidated obligation bonds for which the Bank has elected the fair value option are issued, the Bank simultaneously executes an interest rate exchange agreement with terms that economically offset the terms of the consolidated obligation bond. However, this type of hedge is treated as an economic hedge because these combinations generally do not meet the requirements for fair value hedge accounting treatment.
The Bank did not have any consolidated obligations denominated in currencies other than U.S. dollars outstanding during 2015, 2014, or 2013.
Credit Risk – The Bank is subject to credit risk as a result of the risk of potential nonperformance by counterparties to the derivative agreements. All of the Bank’s agreements governing uncleared derivative transactions 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 and Finance Agency regulations. The Bank also requires credit support agreements with collateral delivery thresholds on all uncleared derivatives. Currently, all of the Bank’s active uncleared derivative counterparties have a zero threshold. In addition, collateral related to derivative transactions with member institutions includes collateral pledged to the Bank, as evidenced by the Advances and Security Agreement, which may be held by the member institution for the benefit of the Bank.
For cleared derivatives, the clearinghouse is the Bank’s counterparty. The requirement that the Bank post initial and variation margin through the clearing agent, to the clearinghouse, exposes the Bank to institutional credit risk in the event that the clearing agent or the clearinghouse fails to meet its obligations. The use of cleared derivatives, however, mitigates the Bank’s overall credit risk exposure because a central counterparty is substituted for individual counterparties and variation margin is posted daily for changes in the value of cleared derivatives through a clearing agent. The Bank has analyzed the enforceability of offsetting rights applicable to its cleared derivative transactions
170
and determined that the exercise of those offsetting rights by a non-defaulting party under these transactions should be upheld under applicable bankruptcy law and Commodity Futures Trading Commission rules in the event of a clearinghouse or clearing agent insolvency and under applicable clearinghouse rules upon a non-insolvency-based event of default of the clearinghouse or clearing agent. Based on this analysis, the Bank presents a net derivative receivable or payable for all of its transactions through a particular clearing agent with a particular clearinghouse.
Based on the Bank’s credit analyses and the collateral requirements, the Bank does not expect to incur any credit losses on its derivative transactions.
The notional amount of an interest rate exchange agreement serves as a factor in determining periodic interest payments or cash flows received and paid. However, the notional amount of derivatives represents neither the actual amounts exchanged nor the overall exposure of the Bank to credit risk and market risk. The risks of derivatives can be measured meaningfully on a portfolio basis by taking into account the counterparties, the types of derivatives, the items being hedged, and any offsets between the derivatives and the items being hedged.
The Bank’s agreements for uncleared derivative transactions contain provisions that link the Bank’s credit rating from Moody’s and Standard & Poor’s to various rights and obligations. Certain of these derivative agreements provide that, if the Bank’s long-term debt rating falls below a specified rating (ranging from A3/A- to Baa3/BBB-), the Bank’s counterparty would have the right, but not the obligation, to terminate all of its outstanding derivative transactions with the Bank; the Bank’s agreements with its clearing agents for cleared derivative transactions have similar provisions with respect to the debt rating of FHLBank System consolidated bonds. If this occurs, the Bank may choose to enter into replacement hedges, either by transferring the existing transactions to another counterparty or entering into new replacement transactions, based on prevailing market rates. In addition, under some of its credit support agreements for uncleared derivative transactions, 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 uncleared derivative instruments with credit-risk-related contingent features that were in a net derivative liability position (before cash collateral and related accrued interest) at December 31, 2015, was $35, for which the Bank had posted collateral with a fair value of $31 in the ordinary course of business. If the Bank’s credit rating at December 31, 2015, had been lowered from its current rating to the next lower rating, that would have triggered additional collateral to be delivered, and the Bank would have been required to deliver up to a total of $2 of additional collateral (at fair value) to its derivative counterparties at December 31, 2015.
The following table summarizes the fair value of derivative instruments including the effect of netting adjustments and cash collateral as of December 31, 2015 and 2014. For purposes of this disclosure, the derivative values include the fair value of derivatives and related accrued interest.
171
| 2015 | 2014 | ||||||||||||||||||||||
Notional Amount of Derivatives | Derivative Assets | Derivative Liabilities | Notional Amount of Derivatives | Derivative Assets | Derivative Liabilities | ||||||||||||||||||
| Derivatives designated as hedging instruments: | |||||||||||||||||||||||
| Interest rate swaps | $ | 27,110 | $ | 192 | $ | 71 | $ | 28,018 | $ | 374 | $ | 103 | |||||||||||
| Total | 27,110 | 192 | 71 | 28,018 | 374 | 103 | |||||||||||||||||
| Derivatives not designated as hedging instruments: | |||||||||||||||||||||||
| Interest rate swaps | 50,444 | 58 | 71 | 31,973 | 72 | 129 | |||||||||||||||||
| Interest rate caps and floors | 2,230 | 6 | 1 | 2,306 | 9 | 1 | |||||||||||||||||
| Mortgage delivery commitments | 5 | — | — | — | — | — | |||||||||||||||||
| Total | 52,679 | 64 | 72 | 34,279 | 81 | 130 | |||||||||||||||||
| Total derivatives before netting and collateral adjustments | $ | 79,789 | 256 | 143 | $ | 62,297 | 455 | 233 | |||||||||||||||
Netting adjustments and cash collateral(1) | (212 | ) | (137 | ) | (396 | ) | (213 | ) | |||||||||||||||
| Total derivative assets and total derivative liabilities | $ | 44 | $ | 6 | $ | 59 | $ | 20 | |||||||||||||||
| (1) | Amounts include the netting of derivative assets and liabilities by counterparty, including cash collateral and related accrued interest, where the netting requirements have been met. Cash collateral posted and related accrued interest was $57 and $65 at December 31, 2015, and 2014, respectively. Cash collateral received and related accrued interest was $132 and $248 at December 31, 2015, and 2014, respectively. |
The following table presents the components of net gain/(loss) on derivatives and hedging activities as presented in the Statements of Income for the years ended December 31, 2015, 2014, and 2013.
| 2015 | 2014 | 2013 | |||||||||
| Gain/(Loss) | Gain/(Loss) | Gain/(Loss) | |||||||||
| Derivatives designated as hedging instruments: | |||||||||||
| Interest rate swaps | $ | (10 | ) | $ | (12 | ) | $ | (2 | ) | ||
| Total net gain/(loss) related to fair value hedge ineffectiveness | (10 | ) | (12 | ) | (2 | ) | |||||
| Derivatives not designated as hedging instruments: | |||||||||||
| Economic hedges: | |||||||||||
| Interest rate swaps | 13 | 26 | (8 | ) | |||||||
| Interest rate caps and floors | (3 | ) | (14 | ) | 2 | ||||||
| Net settlements | (18 | ) | (64 | ) | 34 | ||||||
| Mortgage delivery commitments | 2 | — | — | ||||||||
| Total net gain/(loss) related to derivatives not designated as hedging instruments | (6 | ) | (52 | ) | 28 | ||||||
| Net gain/(loss) on derivatives and hedging activities | $ | (16 | ) | $ | (64 | ) | $ | 26 | |||
The following table presents, by type of hedged item, the gains and losses on derivatives and the related hedged items in fair value hedging relationships and the impact of those derivatives on the Bank’s net interest income for the years ended December 31, 2015, 2014, and 2013.
172
| 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) | |||||||||||
| Year ended December 31, 2015: | |||||||||||||||
| Advances | $ | 19 | $ | (20 | ) | $ | (1 | ) | $ | (106 | ) | ||||
| Consolidated obligation bonds | (170 | ) | 161 | (9 | ) | 257 | |||||||||
| Total | $ | (151 | ) | $ | 141 | $ | (10 | ) | $ | 151 | |||||
| Year ended December 31, 2014: | |||||||||||||||
| Advances | $ | 23 | $ | (23 | ) | $ | — | $ | (128 | ) | |||||
| Consolidated obligation bonds | (189 | ) | 177 | (12 | ) | 260 | |||||||||
| Total | $ | (166 | ) | $ | 154 | $ | (12 | ) | $ | 132 | |||||
| Year ended December 31, 2013: | |||||||||||||||
| Advances | $ | 178 | $ | (175 | ) | $ | 3 | $ | (126 | ) | |||||
| Consolidated obligation bonds | (373 | ) | 368 | (5 | ) | 366 | |||||||||
| Total | $ | (195 | ) | $ | 193 | $ | (2 | ) | $ | 240 | |||||
| (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. |
The Bank may present derivative instruments, related cash collateral received or pledged, and associated accrued interest by clearing agent or by counterparty when the netting requirements have been met.
The following table presents separately the fair value of derivative assets and derivative liabilities that have met the netting requirements, including the related collateral received from or pledged to counterparties as of December 31, 2015 and 2014.
| 2015 | 2014 | ||||||||||||||
Derivative Assets | Derivative Liabilities | Derivative Assets | Derivative Liabilities | ||||||||||||
| Derivative instruments meeting netting requirements | |||||||||||||||
| Gross recognized amount | |||||||||||||||
| Uncleared derivatives | $ | 166 | $ | 93 | $ | 352 | $ | 199 | |||||||
| Cleared derivatives | 90 | 50 | 103 | 34 | |||||||||||
| Total gross recognized amount | 256 | 143 | 455 | 233 | |||||||||||
| Gross amounts of netting adjustments and cash collateral | |||||||||||||||
| Uncleared derivatives | (149 | ) | (87 | ) | (324 | ) | (179 | ) | |||||||
| Cleared derivatives | (63 | ) | (50 | ) | (72 | ) | (34 | ) | |||||||
| Total gross amount of netting adjustments and cash collateral | (212 | ) | (137 | ) | (396 | ) | (213 | ) | |||||||
| Total derivative assets and total derivative liabilities | |||||||||||||||
| Uncleared derivatives | 17 | 6 | 28 | 20 | |||||||||||
| Cleared derivatives | 27 | — | 31 | — | |||||||||||
| Total derivative assets and derivative liabilities presented in the Statements of Condition | 44 | 6 | 59 | 20 | |||||||||||
| Non-cash collateral received or pledged not offset | |||||||||||||||
| Can be sold or repledged - Uncleared derivatives | 11 | — | 25 | — | |||||||||||
| Net unsecured amount | |||||||||||||||
| Uncleared derivatives | 6 | 6 | 3 | 20 | |||||||||||
| Cleared derivatives | 27 | — | 31 | — | |||||||||||
| Total net unsecured amount | $ | 33 | $ | 6 | $ | 34 | $ | 20 | |||||||
173
Note 19 — Fair Value
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 December 31, 2015 and 2014. 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 cannot be precisely quantified or verified and may change as economic and market factors and evaluation of those factors change. The Bank continues to refine its valuation methodologies as markets and products develop and the pricing for certain products becomes more or less transparent. While the Bank believes that its valuation methodologies are appropriate and consistent with those of other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a materially different estimate of fair value as of the reporting date. Therefore, the 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 as to 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.
The following tables present the carrying value, the estimated fair value, and the fair value hierarchy level of the Bank’s financial instruments at December 31, 2015 and 2014.
| December 31, 2015 | |||||||||||||||||||||||
Carrying Value | Estimated Fair Value | Level 1 | Level 2 | Level 3 | Netting Adjustments(1) | ||||||||||||||||||
| Assets | |||||||||||||||||||||||
| Cash and due from banks | $ | 1,637 | $ | 1,637 | $ | 1,637 | $ | — | $ | — | $ | — | |||||||||||
| Securities purchased under agreements to resell | 10,000 | 10,000 | — | 10,000 | — | — | |||||||||||||||||
| Federal funds sold | 4,626 | 4,626 | — | 4,626 | — | — | |||||||||||||||||
| Trading securities | 1,433 | 1,433 | — | 1,433 | — | — | |||||||||||||||||
| AFS securities | 5,414 | 5,414 | — | — | 5,414 | — | |||||||||||||||||
| HTM securities | 10,802 | 10,821 | — | 9,118 | 1,703 | — | |||||||||||||||||
| Advances | 50,919 | 50,844 | — | 50,844 | — | — | |||||||||||||||||
| Mortgage loans held for portfolio, net of allowance for credit losses on mortgage loans | 655 | 694 | — | 694 | — | — | |||||||||||||||||
| Accrued interest receivable | 56 | 56 | — | 56 | — | — | |||||||||||||||||
Derivative assets, net(1) | 44 | 44 | — | 256 | — | (212 | ) | ||||||||||||||||
Other assets(2) | 10 | 10 | 10 | — | — | — | |||||||||||||||||
| Liabilities | |||||||||||||||||||||||
| Deposits | 127 | 127 | — | 127 | — | — | |||||||||||||||||
| Consolidated obligations: | |||||||||||||||||||||||
| Bonds | 51,835 | 51,773 | — | 51,773 | — | — | |||||||||||||||||
| Discount notes | 27,648 | 27,640 | — | 27,640 | — | — | |||||||||||||||||
| Total consolidated obligations | 79,483 | 79,413 | — | 79,413 | — | — | |||||||||||||||||
| Mandatorily redeemable capital stock | 488 | 488 | 488 | — | — | — | |||||||||||||||||
| Accrued interest payable | 80 | 80 | — | 80 | — | — | |||||||||||||||||
Derivative liabilities, net(1) | 6 | 6 | — | 143 | — | (137 | ) | ||||||||||||||||
| Other | |||||||||||||||||||||||
| Standby letters of credit | 18 | 18 | — | 18 | — | — | |||||||||||||||||
Commitments to issue consolidated obligation bonds(3) | — | 1 | — | 1 | — | — | |||||||||||||||||
174
| December 31, 2014 | |||||||||||||||||||||||
Carrying Value | Estimated Fair Value | Level 1 | Level 2 | Level 3 | Netting Adjustments(1) | ||||||||||||||||||
| Assets | |||||||||||||||||||||||
| Cash and due from banks | $ | 3,920 | $ | 3,920 | $ | 3,920 | $ | — | $ | — | $ | — | |||||||||||
| Securities purchased under agreements to resell | 1,000 | 1,000 | — | 1,000 | — | — | |||||||||||||||||
| Federal funds sold | 7,503 | 7,503 | — | 7,503 | — | — | |||||||||||||||||
| Trading securities | 3,524 | 3,524 | — | 3,524 | — | — | |||||||||||||||||
| AFS securities | 6,371 | 6,371 | — | — | 6,371 | — | |||||||||||||||||
| HTM securities | 13,551 | 13,657 | — | 11,521 | 2,136 | — | |||||||||||||||||
| Advances | 38,986 | 39,060 | — | 39,060 | — | — | |||||||||||||||||
| Mortgage loans held for portfolio, net of allowance for credit losses on mortgage loans | 708 | 769 | — | 769 | — | — | |||||||||||||||||
| Accrued interest receivable | 67 | 67 | — | 67 | — | — | |||||||||||||||||
Derivative assets, net(1) | 59 | 59 | — | 455 | — | (396 | ) | ||||||||||||||||
Other assets(2) | 11 | 11 | 11 | — | — | — | |||||||||||||||||
| Liabilities | |||||||||||||||||||||||
| Deposits | 160 | 160 | — | 160 | — | — | |||||||||||||||||
| Consolidated obligations: | |||||||||||||||||||||||
| Bonds | 47,045 | 47,021 | — | 47,021 | — | — | |||||||||||||||||
| Discount notes | 21,811 | 21,811 | — | 21,811 | — | — | |||||||||||||||||
| Total consolidated obligations | 68,856 | 68,832 | — | 68,832 | — | — | |||||||||||||||||
| Mandatorily redeemable capital stock | 719 | 719 | 719 | — | — | — | |||||||||||||||||
| Accrued interest payable | 95 | 95 | — | 95 | — | — | |||||||||||||||||
Derivative liabilities, net(1) | 20 | 20 | — | 233 | — | (213 | ) | ||||||||||||||||
| Other | |||||||||||||||||||||||
| Standby letters of credit | 12 | 12 | — | 12 | — | — | |||||||||||||||||
Commitments to fund advances(3) | — | 2 | — | 2 | — | — | |||||||||||||||||
| (1) | Amounts include the netting of derivative assets and liabilities by counterparty, including cash collateral and related accrued interest, where the netting requirements have been met. |
| (2) | Represents publicly traded mutual funds held in a grantor trust. |
| (3) | Estimated fair values of these commitments are presented as a net gain or (loss). For more information regarding these commitments, see Note 20 – Commitments and Contingencies. |
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 the lowest priority to unobservable inputs (Level 3 measurements). An entity must disclose the level within the fair value hierarchy in which the measurements are classified for all financial assets and liabilities measured on a recurring or non-recurring basis.
The application of the fair value hierarchy to the Bank’s financial assets and financial liabilities that are carried at fair value either on a recurring or non-recurring basis is as follows:
| • | Level 1 – Quoted prices (unadjusted) for identical assets or liabilities in an active market that the reporting entity can access on the measurement date. |
| • | Level 2 – Inputs other than quoted prices within Level 1 that are observable inputs for the asset or liability, either directly or indirectly. If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the asset or liability. Level 2 inputs include the following: (1) quoted prices for similar assets or liabilities in active markets; (2) quoted prices for identical or similar |
175
assets or liabilities in markets that are not active; (3) inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates and yield curves that are observable at commonly quoted intervals, and implied volatilities); and (4) inputs that are derived principally from or corroborated by observable market data by correlation or other means.
| • | Level 3 – Unobservable inputs for the asset or liability. |
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 December 31, 2015:
| • | Trading securities |
| • | AFS securities |
| • | Certain advances |
| • | Derivative assets and liabilities |
| • | Certain consolidated obligation bonds |
| • | Certain other assets |
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 inputs may result in a reclassification of certain assets or liabilities. Such reclassifications are reported as transfers in or out 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.
Summary of Valuation Methodologies and Primary Inputs.
Cash and Due from Banks – The estimated fair value equals the carrying value.
Federal Funds Sold and Securities Purchased Under Agreements to Resell – The estimated fair value of overnight Federal funds sold and securities purchased under agreements to resell approximates the carrying value. The estimated fair value of term Federal funds sold and term securities purchased under agreements to resell has been determined by calculating the present value of expected cash flows for the instruments and reducing the amount for accrued interest receivable. The discount rates used in these calculations are the replacement rates for comparable instruments with similar terms.
Investment Securities – Certificates of Deposit – The estimated fair values of these investments are determined by calculating the present value of expected cash flows and reducing the amount for accrued interest receivable, 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 – MBS – To value its MBS, the Bank obtains prices from four designated third-party pricing vendors when available. The pricing vendors use various proprietary models to price these securities. The inputs to those models are derived from various sources including, but not limited to: benchmark yields, reported trades, dealer estimates, issuer spreads, prices on benchmark securities, bids, offers, and other market-related data. Since many securities do not trade on a daily basis, the pricing vendors use available information as applicable, such as benchmark yield curves, benchmarking of like securities, sector groupings, and matrix pricing, to determine the prices for individual securities. Each pricing vendor has an established challenge process in place for all security valuations, which facilitates resolution of price discrepancies identified by the Bank.
At least annually, the Bank conducts reviews of the four pricing vendors to update and confirm its understanding of the vendors’ pricing processes, methodologies, and control procedures.
176
The Bank’s valuation technique for estimating the fair values of its MBS first requires the establishment of a median vendor price for each security. If four vendor prices are received, the average of the middle two prices is the median price; if three prices are received, the middle price is the median price; if two prices are received, the average of the two prices is the median price; and if one price is received, it is the median price (and also the default fair value) subject to additional validation. All vendor prices that are within a specified tolerance threshold of the median price are included in the cluster of vendor prices that are averaged to establish a default fair value. All vendor prices that are outside the threshold (outliers) are subject to further analysis including, but not limited to, comparison to prices provided by an additional third-party valuation service, prices for similar securities and/or dealer estimates, or use of internal model prices, which are deemed to be reflective 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 or only one third-party vendor price is available in order to arrive at an estimated fair value. If an outlier (or some other price identified in the analysis) is determined to be a better estimate of fair value, then the outlier (or the other price, as appropriate) is used as the fair value rather than the default fair value. If, instead, the analysis confirms that an outlier is (or outliers are) not representative of fair value and the default fair value is the best estimate, then the default fair value is used as the fair value.
If all vendor prices received for a security are outside the tolerance threshold level of the median price, then there is no default fair value, and the fair value is determined by an evaluation of all outlier prices (or the other prices, as appropriate) as described above.
As of December 31, 2015, four vendor prices were received for most of the Bank’s MBS, and the fair value estimates for most of those securities were determined by averaging the four vendor prices. Based on the Bank’s reviews of the pricing methods employed by the third-party pricing vendors and the relative lack of dispersion among the vendor prices (or, in those instances in which there were outliers or significant yield variances, the Bank’s additional analyses), the Bank believes that its fair value estimates are reasonable and that the fair value measurements are classified appropriately in the fair value hierarchy. Based on limited market liquidity for PLRMBS, the fair value measurements for these securities were classified as Level 3 within the fair value hierarchy.
As an additional step, the Bank reviewed the fair value estimates of its PLRMBS as of December 31, 2015, for reasonableness using a market-implied yield test. The Bank calculated a market-implied yield for each of its PLRMBS using the estimated fair value derived from the process described above and the security’s projected cash flows from the Bank’s OTTI process and compared the market-implied yield to the yields for comparable securities according to dealers and other third-party sources to the extent comparable market yield data was available. This analysis did not indicate that any adjustments to the fair value estimates were necessary.
Investment Securities – FFCB Bonds and CalHFA Bonds – The Bank estimates the fair values of these securities using the methodology described above for Investment Securities – MBS.
Advances – Because quoted prices are not available for advances, the fair values are measured using model-based valuation techniques (such as calculating the present value of future cash flows and reducing the amount for accrued interest receivable).
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. 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. The Bank obtains market-observable inputs 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 (swaption volatility and volatility skew). The discount rates used in these calculations are the replacement advance rates for advances with similar terms. Pursuant to the Finance Agency’s advances
177
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. The Bank determined that no adjustment is required to the fair value measurement of advances for prepayment fees. In addition, the Bank did not adjust its fair value measurement of advances for creditworthiness primarily because advances were fully collateralized.
Mortgage Loans Held for Portfolio – The estimated fair value for seasoned mortgage loans represents modeled prices based on observable market prices for seasoned agency mortgage-backed passthrough securities adjusted for differences in coupon, average loan rate, credit, and cash flow remittance between the Bank’s mortgage loans and the referenced instruments, while the estimated fair value for newly originated mortgage loans represents modeled prices based on MPF commitment rates. 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 carrying value of accrued interest receivable and accrued interest payable.
Other Assets – The estimated fair value of grantor trust assets is based on quoted market prices.
Derivative Assets and Liabilities – In general, derivative instruments transacted and held by the Bank for risk management activities are traded in over-the-counter markets where quoted market prices are not readily available. These derivatives are interest rate-related. For these derivatives, the Bank measures fair value using internally developed discounted cash flow models that use market-observable inputs, such as the overnight index swap (OIS) curve and volatility assumptions, which are market-based expectations of future interest rate volatility implied from current market prices for similar options (swaption volatility and volatility skew), adjusted for counterparty credit risk, as necessary.
The Bank is subject to credit risk because of the risk of potential nonperformance by its derivative counterparties. To mitigate this risk, the Bank executes uncleared derivative transactions only with highly rated derivative dealers and major banks (derivative dealer counterparties) that meet the Bank’s eligibility criteria. In addition, the Bank has entered into master netting agreements and bilateral credit support agreements with all active derivative dealer counterparties that provide for delivery of collateral at specified levels 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 derivative dealer counterparty is either (i) limited to an absolute dollar credit exposure limit according to the counterparty’s long-term debt or deposit credit rating, as determined by rating agencies or (ii) set at zero (subject to a minimum transfer amount). The Bank clears its cleared derivative transactions only through clearing agents that meet the Bank’s eligibility requirements, and the Bank’s credit exposure to the clearinghouse is secured by variation margin received from the clearinghouse. All credit exposure from derivative transactions entered into by the Bank with member counterparties that are not derivative 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.
The fair values of the derivative assets and liabilities include accrued interest receivable/payable and cash collateral remitted to/received from counterparties. The estimated fair values of the accrued interest receivable/payable and cash collateral approximate their carrying values because of their short-term nature. The fair values of derivatives that met the netting requirements are presented on a net basis. If these netted amounts are positive, they are classified as an asset and, if negative, they are classified as a liability.
178
Deposits – The fair value of deposits is generally equal to the carrying value of the deposits because the deposits are primarily overnight deposits or due on demand. The Bank determines the fair values of term deposits by calculating the present value of expected future cash flows from the deposits and reducing the amount for accrued interest payable. The discount rates used in these calculations are the cost of deposits 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 input for measuring the fair value of consolidated obligation bonds is a market-based CO Curve obtained from the Office of Finance. The Office of Finance constructs the CO Curve using the Treasury yield curve as a base curve, which is adjusted by indicative consolidated obligation spreads obtained from market-observable sources. These market indications are generally derived from pricing indications from dealers, historical pricing relationships, and market activity for similar liabilities, such as recent GSE issuances or secondary market activity. For consolidated obligation bonds with embedded options, the Bank also obtains market-observable inputs, such as volatility assumptions, which are market-based expectations of future interest rate volatility implied from current market prices for similar options (swaption volatility and volatility skew).
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 and the creditworthiness of the other 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 contemporaneous purchases, redemptions, and repurchases 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 capital stock dividend. The Bank’s capital 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 capital stock is not traded, and no market mechanism exists for the exchange of Bank capital stock outside the cooperative ownership structure.
Commitments – The estimated fair value of standby letters of credit is based on the present value of fees currently charged for similar agreements and is recorded in other liabilities. The estimated fair value of off-balance sheet fixed rate commitments to fund advances and commitments to issue consolidated obligations takes into account the difference between current and committed interest rates.
Subjectivity of Estimates Related to Fair Values of Financial Instruments. Estimates of the fair value of financial assets and liabilities using the methodologies described above are 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.
Fair Value Measurements. The tables below present the fair value of assets and liabilities, which are recorded on a recurring or nonrecurring basis at December 31, 2015 and 2014, by level within the fair value hierarchy.
179
| December 31, 2015 | |||||||||||||||||||
| Fair Value Measurement Using: | Netting | ||||||||||||||||||
| Level 1 | Level 2 | Level 3 | Adjustments(1) | Total | |||||||||||||||
| Recurring fair value measurements – Assets: | |||||||||||||||||||
| Trading securities: | |||||||||||||||||||
| GSEs – FFCB bonds | $ | — | $ | 1,424 | $ | — | $ | — | $ | 1,424 | |||||||||
| MBS: | |||||||||||||||||||
| Other U.S. obligations – Ginnie Mae | — | 9 | — | — | 9 | ||||||||||||||
| Total trading securities | — | 1,433 | — | — | 1,433 | ||||||||||||||
| AFS securities: | |||||||||||||||||||
| PLRMBS | — | — | 5,414 | — | 5,414 | ||||||||||||||
| Total AFS securities | — | — | 5,414 | — | 5,414 | ||||||||||||||
Advances(2) | — | 3,677 | — | — | 3,677 | ||||||||||||||
| Derivative assets, net: interest rate-related | — | 256 | — | (212 | ) | 44 | |||||||||||||
| Other assets | 10 | — | — | — | 10 | ||||||||||||||
| Total recurring fair value measurements – Assets | $ | 10 | $ | 5,366 | $ | 5,414 | $ | (212 | ) | $ | 10,578 | ||||||||
| Recurring fair value measurements – Liabilities: | |||||||||||||||||||
Consolidated obligation bonds(3) | $ | — | $ | 4,233 | $ | — | $ | — | $ | 4,233 | |||||||||
| Derivative liabilities, net: interest rate-related | — | 143 | — | (137 | ) | 6 | |||||||||||||
| Total recurring fair value measurements – Liabilities | $ | — | $ | 4,376 | $ | — | $ | (137 | ) | $ | 4,239 | ||||||||
Nonrecurring fair value measurements – Assets:(4) | |||||||||||||||||||
| REO | $ | — | $ | — | $ | 1 | $ | 1 | |||||||||||
| Impaired mortgage loans held for portfolio | — | — | 5 | 5 | |||||||||||||||
| Total nonrecurring fair value measurements – Assets | $ | — | $ | — | $ | 6 | $ | 6 | |||||||||||
| December 31, 2014 | |||||||||||||||||||
| Fair Value Measurement Using: | Netting | ||||||||||||||||||
| Level 1 | Level 2 | Level 3 | Adjustments(1) | Total | |||||||||||||||
| Recurring fair value measurements – Assets: | |||||||||||||||||||
| Trading securities: | |||||||||||||||||||
| GSEs – FFCB bonds | $ | — | $ | 3,513 | $ | — | $ | — | $ | 3,513 | |||||||||
| MBS: | |||||||||||||||||||
| Other U.S. obligations – Ginnie Mae | — | 11 | — | — | 11 | ||||||||||||||
| Total trading securities | — | 3,524 | — | — | 3,524 | ||||||||||||||
| AFS securities: | |||||||||||||||||||
| PLRMBS | — | — | 6,371 | — | 6,371 | ||||||||||||||
| Total AFS securities | — | — | 6,371 | — | 6,371 | ||||||||||||||
Advances(2) | — | 5,137 | — | — | 5,137 | ||||||||||||||
| Derivative assets, net: interest rate-related | — | 455 | — | (396 | ) | 59 | |||||||||||||
| Other assets | 11 | — | — | — | 11 | ||||||||||||||
| Total recurring fair value measurements – Assets | $ | 11 | $ | 9,116 | $ | 6,371 | $ | (396 | ) | $ | 15,102 | ||||||||
| Recurring fair value measurements – Liabilities: | |||||||||||||||||||
Consolidated obligation bonds(3) | $ | — | $ | 6,717 | $ | — | $ | — | $ | 6,717 | |||||||||
| Derivative liabilities, net: interest rate-related | — | 233 | — | (213 | ) | 20 | |||||||||||||
| Total recurring fair value measurements – Liabilities | $ | — | $ | 6,950 | $ | — | $ | (213 | ) | $ | 6,737 | ||||||||
| Nonrecurring fair value measurements – Assets: | |||||||||||||||||||
| REO | $ | — | $ | — | $ | 1 | $ | 1 | |||||||||||
| (1) | Amounts represent the netting of derivative assets and liabilities by counterparty, including cash collateral, where the netting requirements have been met. |
180
| (2) | Represents advances recorded under the fair value option at December 31, 2015 and 2014. |
| (3) | Represents consolidated obligation bonds recorded under the fair value option at December 31, 2015 and 2014. |
| (4) | The fair value information presented is as of the date the fair value adjustment was recorded during the year ended December 31, 2015. |
The following table presents a reconciliation of the Bank’s AFS PLRMBS that are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2015, 2014, and 2013.
| 2015 | 2014 | 2013 | |||||||||
| Balance, beginning of the period | $ | 6,371 | $ | 7,047 | $ | 7,604 | |||||
| Total gain/(loss) realized and unrealized included in: | |||||||||||
| Interest income | 83 | 66 | 21 | ||||||||
| Net OTTI loss, credit-related | (15 | ) | (4 | ) | (7 | ) | |||||
| Unrealized gain/(loss) of other-than-temporarily impaired securities included in AOCI | (29 | ) | 209 | 644 | |||||||
| Net amount of OTTI loss reclassified to/(from) other income/(loss) | (15 | ) | (10 | ) | (3 | ) | |||||
| Settlements | (996 | ) | (937 | ) | (1,284 | ) | |||||
| Transfers of HTM securities to AFS securities | 15 | — | 72 | ||||||||
| Balance, end of the period | $ | 5,414 | $ | 6,371 | $ | 7,047 | |||||
| Total amount of gain/(loss) for the period included in earnings attributable to the change in unrealized gains/losses relating to assets and liabilities still held at the end of the period | $ | 68 | $ | 62 | $ | 15 | |||||
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 Statements 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 on advances and consolidated bonds carried at fair value are recognized solely on the contractual amount of interest due or unpaid. Any transaction fees or costs are immediately recognized in non-interest income or non-interest expense.
The Bank elected the fair value option for certain financial instruments as follows:
| • | Adjustable rate advances with embedded options (excluding call and put options) |
| • | Callable fixed rate advances |
| • | Putable fixed rate advances |
| • | Putable fixed rate advances with embedded options |
| • | Fixed rate 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 |
| • | Adjustable rate advances indexed to non-LIBOR indices such as the Prime Rate, U.S. Treasury bill, and Federal funds effective rate |
| • | Adjustable rate consolidated obligation bonds indexed to non-LIBOR indices such as the Prime Rate, U.S. Treasury bill, and Federal funds effective rate |
| • | 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 |
181
The Bank has elected the fair value option for certain financial instruments to assist in mitigating potential earnings volatility that can arise from economic hedging relationships in which the carrying value of the hedged item is not adjusted for changes in fair value. The potential earnings volatility 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 years ended December 31, 2015, 2014, and 2013:
| 2015 | 2014 | 2013 | |||||||||||||||||||||
| Advances | Consolidated Obligation Bonds | Advances | Consolidated Obligation Bonds | Advances | Consolidated Obligation Bonds | ||||||||||||||||||
| Balance, beginning of the period | $ | 5,137 | $ | 6,717 | $ | 7,069 | $ | 10,115 | $ | 7,390 | $ | 27,884 | |||||||||||
| New transactions elected for fair value option | 1,018 | 2,585 | 783 | 3,607 | 837 | 3,547 | |||||||||||||||||
| Maturities and terminations | (2,442 | ) | (5,083 | ) | (2,700 | ) | (7,088 | ) | (988 | ) | (21,165 | ) | |||||||||||
| Net gain/(loss) on advances and net (gain)/loss on consolidated obligation bonds held under fair value option | (31 | ) | 19 | (11 | ) | 82 | (169 | ) | (146 | ) | |||||||||||||
| Change in accrued interest | (5 | ) | (5 | ) | (4 | ) | 1 | (1 | ) | (5 | ) | ||||||||||||
| Balance, end of the period | $ | 3,677 | $ | 4,233 | $ | 5,137 | $ | 6,717 | $ | 7,069 | $ | 10,115 | |||||||||||
For instruments for which the fair value option has been elected, the related contractual interest income and contractual interest expense are recorded as part of net interest income on the Statements of Income. The remaining changes in fair value for instruments for which the fair value option has been elected are recorded as net gains/ (losses) on financial instruments held under the fair value option in the Statements of Income. The change in fair value does not include changes in instrument-specific credit risk. For advances and consolidated obligations recorded under the fair value option, the Bank determined that no adjustments to the fair values of these instruments for instrument-specific credit risk were necessary for the years ended December 31, 2015, 2014, and 2013.
The following table presents the difference between the aggregate remaining contractual principal balance outstanding and aggregate fair value of advances and consolidated obligation bonds for which the Bank elected the fair value option at December 31, 2015 and 2014:
| 2015 | 2014 | ||||||||||||||||||||||
| Principal Balance | Fair Value | Fair Value Over/(Under) Principal Balance | Principal Balance | Fair Value | Fair Value Over/(Under) Principal Balance | ||||||||||||||||||
Advances(1) | $ | 3,639 | $ | 3,677 | $ | 38 | $ | 5,048 | $ | 5,137 | $ | 89 | |||||||||||
| Consolidated obligation bonds | 4,250 | 4,233 | (17 | ) | 6,748 | 6,717 | (31 | ) | |||||||||||||||
| (1) | At December 31, 2015 and 2014, none of these advances were 90 days or more past due or had been placed on nonaccrual status. |
Note 20 — 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 regulations provide a general framework for addressing the possibility that an FHLBank may be unable to repay the consolidated obligations for which it 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
182
FHLBank, and as of December 31, 2015, and through the filing date of this report, does not believe that it is probable that it will be asked to do so.
The Bank determined that it was not necessary to recognize a liability for the fair value of the Bank's joint and several liability for all consolidated obligations. The joint and several obligations are mandated by the FHLBank Act or regulations governing the operations of the FHLBanks and are not the result of arms-length transactions among the FHLBanks. The FHLBanks have no control over the amount of the guarantee or the determination of how each FHLBank would perform under the joint and several obligations. Because the FHLBanks are subject to the authority of the Finance Agency as it relates to decisions involving the allocation of the joint and several liability for the FHLBanks' consolidated obligations, the FHLBanks' joint and several obligations are excluded from the initial recognition and measurement provisions. Accordingly, the Bank has not recognized a liability for its joint and several obligation related to other FHLBanks' participations in the consolidated obligations. The par value of the outstanding consolidated obligations of the FHLBanks was $905,202 at December 31, 2015, and $847,175 at December 31, 2014. The par value of the Bank’s participation in consolidated obligations was $79,355 at December 31, 2015, and $68,538 at December 31, 2014.
The joint and several liability regulation provides a general framework for addressing the possibility that an FHLBank may be unable to repay its participation in the consolidated obligations for which it is the primary obligor. In accordance with this regulation, the president of each FHLBank is required to provide a quarterly certification that, among other things, the FHLBank will remain capable of making full and timely payment of all its current obligations, including direct obligations.
In addition, the regulation requires that an FHLBank must provide written notice to the Finance Agency if at any time the FHLBank is unable to provide the quarterly certification; projects that it will be unable to fully meet all of its current obligations, including direct obligations, on a timely basis during the quarter; or negotiates or enters into an agreement with another FHLBank for financial assistance to meet its obligations. If an FHLBank gives any one of these notices (other than in a case of a temporary interruption in the FHLBank's debt servicing operations resulting from an external event such as a natural disaster or a power failure), it must promptly file a consolidated obligations payment plan for Finance Agency approval specifying the measures the FHLBank will undertake to make full and timely payments of all its current obligations.
Notwithstanding any other provisions in the regulation, the regulation provides that the Finance Agency in its discretion may at any time order any FHLBank to make any principal or interest payment due on any consolidated obligation. To the extent an FHLBank makes any payment on any consolidated obligation on behalf of another FHLBank, the paying FHLBank is entitled to reimbursement from the FHLBank that is the primary obligor, which will have a corresponding obligation to reimburse the FHLBank for the payment and associated costs, including interest.
The regulation also provides that the Finance Agency may allocate the outstanding liability of an FHLBank for consolidated obligations among the other FHLBanks on a pro rata basis in proportion to each FHLBank's participation in all consolidated obligations outstanding. The Finance Agency reserves the right to allocate the outstanding liabilities for the consolidated obligations among the FHLBanks in any other manner it may determine to ensure that the FHLBanks operate in a safe and sound manner.
Off-balance sheet commitments as of December 31, 2015 and 2014, were as follows:
183
| 2015 | 2014 | ||||||||||||||||||||||
Expire Within One Year | Expire After One Year | Total | Expire Within One Year | Expire After One Year | Total | ||||||||||||||||||
| Standby letters of credit outstanding | $ | 9,072 | $ | 3,237 | $ | 12,309 | $ | 2,699 | $ | 2,711 | $ | 5,410 | |||||||||||
Commitments to fund additional advances(1) | 5 | 5 | 10 | 121 | 5 | 126 | |||||||||||||||||
| Commitments to issue consolidated obligation discount notes, par | 300 | — | 300 | 3 | — | 3 | |||||||||||||||||
Commitments to issue consolidated obligation bonds, par(2) | 110 | — | 110 | — | — | — | |||||||||||||||||
| Commitments to purchase mortgage loans | 5 | — | 5 | — | — | — | |||||||||||||||||
| (1) | At December 31, 2015, none of the commitments to fund additional advances were hedged with associated interest rate swaps. At December 31, 2014, $100 of the commitments to fund additional advances were hedged with associated interest rate swaps. |
| (2) | At December 31, 2015, all of the unsettled consolidated obligation bonds were hedged with associated interest rate swaps. |
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 a payment for a beneficiary’s drawing under a letter of credit, the amount is immediately due and payable by the member to the Bank and is charged to the member’s demand deposit account with the Bank. The original terms of these standby letters of credit range from 33 days to 15 years, including a final expiration in 2030. The Bank monitors the creditworthiness of members that have standby letters of credit. The value of the Bank’s obligations related to standby letters of credit is recorded in other liabilities and amounted to $18 at December 31, 2015, and $12 at December 31, 2014. 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, the Bank deemed it unnecessary to record any additional liability on the letters of credit outstanding as of December 31, 2015 and 2014.
Commitments to fund advances totaled $10 at December 31, 2015, and $126 at December 31, 2014. Advances funded under advance commitments are fully collateralized at the time of funding (see Note 10 – Allowance for Credit Losses). Based on the Bank’s credit analyses of members’ financial condition and collateral requirements, the Bank deemed it unnecessary to record any additional liability on the advance commitments outstanding as of December 31, 2015 and 2014.
The Bank may enter into commitments that unconditionally obligate it to purchase mortgage loans from its members. Commitments are generally for periods not exceeding 45 days. Delivery commitments are recorded at fair value as derivative assets or derivative liabilities in the Statements of Condition.
The Bank executes over-the-counter uncleared interest rate exchange agreements with major banks and derivative entities affiliated with broker-dealers and with the Bank’s members. The Bank enters into master agreements with netting provisions and into bilateral credit support agreements with all active derivative dealer counterparties. All member counterparty master agreements, excluding those with derivative 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 derivative dealers) must fully collateralize the Bank’s net credit exposure. For cleared derivatives, the clearinghouse is the Bank’s counterparty, and the Bank has clearing agreements with clearing agents that provide for delivery of initial margin to, and exchange of variation margin with, the clearinghouse. See Note 18 – Derivatives and Hedging Activities for additional information about the Bank’s pledged collateral and other credit-risk-related contingent features.
The Bank charged operating expenses for net rental and related costs of approximately $5, $5, and $5 for the years ended December 31, 2015, 2014, and 2013, respectively. Future minimum rentals at December 31, 2015, were as follows:
184
| Year | Future Minimum Rentals | ||
| 2016 | $ | 4 | |
| 2017 | 4 | ||
| 2018 | 4 | ||
| 2019 | 3 | ||
| 2020 | 2 | ||
| Total | $ | 17 | |
Lease agreements for Bank premises generally provide for increases in the basic rentals resulting from increases in property taxes and maintenance expenses. Such increases are not expected to have a material effect on the Bank's financial condition or results of operations.
The Bank may be subject to various pending legal proceedings that may arise in the ordinary 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 1 – Summary of Significant Accounting Policies, Note 8 – Advances, Note 9 – Mortgage Loans Held for Portfolio, Note 12 – Consolidated Obligations, Note 13 – Affordable Housing Program, Note 15 – Capital, Note 16 – Employee Retirement Plans and Incentive Compensation Plans, and Note 18 – Derivatives and Hedging Activities.
Note 21 — Transactions with Certain Members, Certain Nonmembers, and Other FHLBanks
Transactions with Members and Nonmembers. The Bank has a cooperative ownership structure under which current member institutions, certain former members, and certain other nonmembers own the capital stock of the Bank. Former members and nonmembers that have outstanding transactions with the Bank are required to maintain their investment in the Bank's capital stock until their outstanding transactions mature or are paid off or until their capital stock is redeemed following the five-year redemption period for capital stock or is repurchased by the Bank, in accordance with the Bank's capital requirements. (For further information on concentration risk, see Note 15 – Capital and Note 8 – Advances).
Under the FHLBank Act and Finance Agency regulations, each member eligible to vote is entitled to cast by ballot one vote for each share of stock that it was required to hold as of the record date, which is December 31, of the year prior to each election, subject to the limitation that no member may cast more votes than the average number of shares of the Bank’s stock that are required to be held by all members located in such member's state. As of and for the three-year period ending December 31, 2015, no shareholder owned more than 10% of the total voting interests in the Bank because of this statutory limit on members' voting rights.
All advances are made to members, and all mortgage loans held for portfolio were purchased from members. The Bank also maintains deposit accounts for members, certain former members, and certain other nonmembers primarily to facilitate settlement activities that are directly related to advances and mortgage loan purchases. All transactions with members and their affiliates are entered into in the ordinary course of business.
The Bank may invest in Federal funds sold, interest-bearing deposits, commercial paper, and MBS and executes derivative transactions with members or their affiliates. The Bank purchases MBS through securities brokers or dealers and 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 a member, the Bank may give consideration to the member’s secured credit and the Bank's advances pricing. As an additional service to its members, the Bank has in the past entered into offsetting interest rate exchange agreements,
185
acting as an intermediary between exactly offsetting derivative transactions with members and other counterparties. These transactions were executed at market rates.
The FHLBank Act requires the Bank to establish an AHP. The Bank provides subsidies to members, which use the funds to assist in the purchase, construction, or rehabilitation of housing for very low-, low-, and moderate-income households. Subsidies may be in the form of direct grants or below-market interest rate advances. Only Bank members, along with their nonmember AHP project sponsors, may submit AHP applications. All AHP subsidies are made in the ordinary course of business.
The FHLBank Act also requires the Bank to establish a Community Investment Program (CIP) and authorizes the Bank to offer additional CICA programs. Under these programs, the Bank provides subsidies in the form of grants and below-market interest rate advances to members or standby letters of credit for members for community lending and economic development projects. Only Bank members may submit applications for CICA subsidies. All CICA subsidies are made in the ordinary course of business.
In instances where the member has an officer or director serving on the Bank’s Board of Directors, all of the aforementioned transactions with the member are subject to the same eligibility and credit criteria, as well as the same conditions, as comparable transactions with all other members, in accordance with regulations governing the operations of the FHLBanks. The following table shows transactions with members that have an officer or director serving on the Bank’s Board of Directors.
| December 31, 2015 | December 31, 2014 | ||||||
| Assets: | |||||||
| Advances | $ | 3,297 | $ | 2,080 | |||
| Mortgage loans held for portfolio | 24 | 32 | |||||
| Accrued interest receivable | 5 | 6 | |||||
| Liabilities: | |||||||
| Deposits | $ | 4 | $ | 3 | |||
| Capital: | |||||||
| Capital Stock | $ | 119 | $ | 162 | |||
| For the Years Ended December 31, | |||||||||||
| 2015 | 2014 | 2013 | |||||||||
| Interest Income: | |||||||||||
| Advances | $ | 35 | $ | 42 | $ | 65 | |||||
| Mortgage loans held for portfolio | 1 | 2 | 3 | ||||||||
Transactions with Other FHLBanks. The Bank may occasionally enter into transactions with other FHLBanks. These transactions are summarized below.
Overnight Funds. The Bank may borrow or lend unsecured overnight funds from or to other FHLBanks. All such transactions are at current market rates. Interest income and interest expense related to these transactions with other FHLBanks are included in other interest income and interest expense from other borrowings in the Statements of Income. Transactions with other FHLBanks, if any, are identified in the Bank’s financial statements.
MPF Mortgage Loans. The Bank pays a transaction services fee to the FHLBank of Chicago for its participation in the MPF program. This fee is assessed monthly and is based on the amount of mortgage loans in which the Bank invested and which remain outstanding on its Statements of Condition. For the years ended December 31, 2015, 2014, and 2013, the Bank recorded a de minimis amount in MPF transaction services fee expense to the FHLBank of Chicago, which was recorded in the Statements of Income as other expense
186
Consolidated Obligations. The Bank may, from time to time, transfer to or assume from another FHLBank the outstanding primary liability for FHLBank consolidated obligations. During the years ended December 31, 2015 and 2014, the Bank did not transfer any debt to other FHLBanks or assume any debt from other FHLBanks.
Transactions with the Office of Finance. The Bank’s proportionate share of the cost of operating the Office of Finance is identified in the Statements of Income.
Note 22 — Other
The table below discloses the categories included in other operating expense for the years ended December 31, 2015, 2014, and 2013.
| 2015 | 2014 | 2013 | |||||||||
| Professional and contract services | $ | 50 | $ | 48 | $ | 33 | |||||
| Travel | 2 | 2 | 2 | ||||||||
| Occupancy | 5 | 5 | 5 | ||||||||
| Equipment | 10 | 10 | 9 | ||||||||
| Other | 4 | 4 | 4 | ||||||||
| Total | $ | 71 | $ | 69 | $ | 53 | |||||
Note 23 — Subsequent Events
There were no material subsequent events identified, subsequent to December 31, 2015, until the time of the Form 10-K filing with the Securities and Exchange Commission.
187
Supplementary Financial Data (Unaudited)
Supplementary financial data for each full quarter in the years ended December 31, 2015 and 2014, are included in the following tables (dollars in millions except per share amounts).
| Three Months Ended | |||||||||||||||
| December 31, 2015 | September 30, 2015 | June 30, 2015 | March 31, 2015 | ||||||||||||
| Interest income | $ | 221 | $ | 222 | $ | 236 | $ | 227 | |||||||
| Interest expense | 101 | 103 | 128 | 97 | |||||||||||
| Net interest income | 120 | 119 | 108 | 130 | |||||||||||
| Provision for/(reversal of) credit losses on mortgage loans | 1 | — | — | — | |||||||||||
| Other income/(loss) | (9 | ) | (33 | ) | (2 | ) | 432 | ||||||||
| Other expense | 46 | 34 | 34 | 34 | |||||||||||
| Assessments | 7 | 6 | 11 | 54 | |||||||||||
| Net income/(loss) | $ | 57 | $ | 46 | $ | 61 | $ | 474 | |||||||
Dividends declared per share(1) | $ | 2.22 | $ | 2.50 | $ | 5.58 | $ | 1.79 | |||||||
Annualized dividend rate(1) | 8.79 | % | 10.01 | % | 22.65 | % | 7.11 | % | |||||||
| (1) | In the second quarter of 2015, the amount of dividends declared per share includes a special dividend of $3.69 at an annualized dividend rate of 14.98%. |
| Three Months Ended | |||||||||||||||
| December 31, 2014 | September 30, 2014 | June 30, 2014 | March 31, 2014 | ||||||||||||
| Interest income | $ | 237 | $ | 247 | $ | 260 | $ | 261 | |||||||
| Interest expense | 104 | 114 | 122 | 126 | |||||||||||
| Net interest income | 133 | 133 | 138 | 135 | |||||||||||
| Provision for/(reversal of) credit losses on mortgage loans | — | (1 | ) | — | 1 | ||||||||||
| Other income/(loss) | (40 | ) | (12 | ) | (54 | ) | (48 | ) | |||||||
| Other expense | 41 | 34 | 37 | 32 | |||||||||||
| Assessments | 7 | 12 | 8 | 9 | |||||||||||
| Net income/(loss) | 45 | $ | 76 | $ | 39 | $ | 45 | ||||||||
| Dividends declared per share | $ | 1.87 | $ | 1.83 | $ | 1.68 | $ | 1.68 | |||||||
| Annualized dividend rate | 7.40 | % | 7.35 | % | 6.80 | % | 6.67 | % | |||||||
188
Investments
Supplementary financial data on the carrying values of the Bank’s investments as of December 31, 2015, 2014, and 2013, are included in the tables below.
| (In millions) | 2015 | 2014 | 2013 | ||||||||
| Trading securities: | |||||||||||
| U.S. government corporations and GSEs – FFCB bonds | $ | 1,424 | $ | 3,513 | $ | 3,194 | |||||
| MBS: | |||||||||||
| Other U.S. obligations – Ginnie Mae | 9 | 11 | 14 | ||||||||
| Total trading securities | 1,433 | 3,524 | 3,208 | ||||||||
| AFS securities: | |||||||||||
| MBS: | |||||||||||
| PLRMBS | 5,414 | 6,371 | 7,047 | ||||||||
| Total AFS securities | 5,414 | 6,371 | 7,047 | ||||||||
| HTM securities: | |||||||||||
| Certificates of deposits | — | — | 1,660 | ||||||||
| States and political subdivisions: | |||||||||||
| Housing finance agency bonds – CalHFA bonds | 275 | 328 | 416 | ||||||||
| U.S. government corporations and GSEs: | |||||||||||
| MBS: | |||||||||||
| Other U.S. obligations – Ginnie Mae | 1,227 | 1,513 | 1,575 | ||||||||
| GSEs: | |||||||||||
| Freddie Mac | 3,677 | 4,517 | 5,250 | ||||||||
| Fannie Mae | 4,136 | 5,313 | 6,331 | ||||||||
| PLRMBS | 1,487 | 1,880 | 2,275 | ||||||||
| Total HTM securities | 10,802 | 13,551 | 17,507 | ||||||||
| Total securities | 17,649 | 23,446 | 27,762 | ||||||||
| Securities purchased under agreements to resell | 10,000 | 1,000 | — | ||||||||
| Federal funds sold | 4,626 | 7,503 | 7,498 | ||||||||
| Total investments | $ | 32,275 | $ | 31,949 | $ | 35,260 | |||||
189
As of December 31, 2015, the Bank’s investments had the following maturity (based on contractual final principal payment) and yield characteristics.
| (Dollars in millions) | Within One Year | After One Year But Within Five Years | After Five Years But Within Ten Years | After Ten Years | Carrying Value | ||||||||||||||
| Trading securities: | |||||||||||||||||||
| U.S. government corporations and GSEs – FFCB bonds | $ | 275 | $ | 1,149 | $ | — | $ | — | $ | 1,424 | |||||||||
| MBS: | |||||||||||||||||||
| Other U.S. obligations – Ginnie Mae | — | — | 7 | 2 | 9 | ||||||||||||||
| Total trading securities | 275 | 1,149 | 7 | 2 | 1,433 | ||||||||||||||
| Yield on trading securities | 0.30 | % | 0.43 | % | 1.79 | % | 1.81 | % | 0.41 | % | |||||||||
| AFS securities: | |||||||||||||||||||
| MBS: | |||||||||||||||||||
| PLRMBS | — | — | — | 5,414 | 5,414 | ||||||||||||||
| Total AFS securities | — | — | — | 5,414 | 5,414 | ||||||||||||||
| Yield on AFS securities | — | % | — | % | — | % | 5.29 | % | 5.29 | % | |||||||||
| HTM securities: | |||||||||||||||||||
| States and political subdivisions: | |||||||||||||||||||
| Housing finance agency bonds – CalHFA bonds | — | — | 60 | 215 | 275 | ||||||||||||||
| U.S. government corporations and GSEs: | |||||||||||||||||||
| MBS: | |||||||||||||||||||
| Other U.S. obligations – Ginnie Mae | — | — | 1 | 1,226 | 1,227 | ||||||||||||||
| GSEs: | |||||||||||||||||||
| Freddie Mac | — | 3 | 6 | 3,668 | 3,677 | ||||||||||||||
| Fannie Mae | — | 9 | 35 | 4,092 | 4,136 | ||||||||||||||
| PLRMBS | — | — | — | 1,487 | 1,487 | ||||||||||||||
| Total HTM securities | — | 12 | 102 | 10,688 | 10,802 | ||||||||||||||
Yield on HTM securities (1) | 5.18 | % | 4.71 | % | 2.06 | % | 2.43 | % | 2.43 | % | |||||||||
| Total securities | 275 | 1,161 | 109 | 16,104 | 17,649 | ||||||||||||||
| Yield on total securities | 0.30 | % | 0.47 | % | 2.05 | % | 3.39 | % | 3.14 | % | |||||||||
| Securities purchased under agreements to resell | 10,000 | — | — | — | 10,000 | ||||||||||||||
| Federal funds sold | 4,626 | — | — | — | 4,626 | ||||||||||||||
| Total investments | $ | 14,901 | $ | 1,161 | $ | 109 | $ | 16,104 | $ | 32,275 | |||||||||
(1) Yield on HTM securities maturing within one year represents yield on de minimis amounts of HTM securities in this category.
190
Mortgage Loan Data
The unpaid principal balances of delinquent mortgage loans for the past five years were as follows:
| (Dollars in millions) | 2015 | 2014 | 2013 | 2012 | 2011 | ||||||||||||||
| 30 - 59 days delinquent | $ | 10 | $ | 12 | $ | 14 | $ | 18 | $ | 24 | |||||||||
| 60 - 89 days delinquent | 5 | 5 | 7 | 7 | 9 | ||||||||||||||
| 90 days or more delinquent | 18 | 22 | 27 | 32 | 31 | ||||||||||||||
| Total past due | 33 | 39 | 48 | 57 | 64 | ||||||||||||||
| Total current loans | 620 | 674 | 865 | 1,239 | 1,777 | ||||||||||||||
| Total mortgage loans | $ | 653 | $ | 713 | $ | 913 | $ | 1,296 | $ | 1,841 | |||||||||
In process of foreclosure, included above(1) | $ | 7 | $ | 11 | $ | 15 | $ | 19 | $ | 20 | |||||||||
| Nonaccrual loans | $ | 18 | $ | 22 | $ | 27 | $ | 32 | $ | 31 | |||||||||
| Loans past due 90 days or more and still accruing interest | $ | — | $ | — | $ | — | $ | — | $ | — | |||||||||
| Delinquencies as a percentage of total mortgage loans outstanding | 5.05 | % | 5.47 | % | 5.26 | % | 4.40 | % | 3.48 | % | |||||||||
Serious delinquencies as a percentage of total mortgage loans outstanding(2) | 2.79 | % | 3.13 | % | 3.00 | % | 2.46 | % | 1.70 | % | |||||||||
| (1) | 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. |
| (2) | Represents loans that are 90 days or more past due or in the process of foreclosure. |
The allowance for credit losses on the mortgage loan portfolio was as follows:
| (Dollars in millions) | 2015 | 2014 | 2013 | 2012 | 2011 | ||||||||||||||
| Balance, beginning of the period | $ | 1 | $ | 2 | $ | 3 | $ | 6 | $ | 3 | |||||||||
| (Charge-offs)/recoveries | (2 | ) | (1 | ) | — | (2 | ) | (1 | ) | ||||||||||
| Provision for/(recovery of) credit losses | 1 | — | (1 | ) | (1 | ) | 4 | ||||||||||||
| Balance, end of the period | $ | — | $ | 1 | $ | 2 | $ | 3 | $ | 6 | |||||||||
| Ratio of net charge-offs during the period to average loans outstanding during the period | (0.24 | )% | (0.05 | )% | (0.07 | )% | (0.08 | )% | (0.07 | )% | |||||||||
For the past five years, the interest on nonaccrual loans that was contractually due and recognized in income was as follows:
| Interest on Nonaccrual Loans | |||||||||||||||||||
| (In millions) | 2015 | 2014 | 2013 | 2012 | 2011 | ||||||||||||||
| Interest contractually due on nonaccrual loans during the period | $ | 1 | $ | 1 | $ | 1 | $ | 2 | $ | 2 | |||||||||
| Interest recognized in income for nonaccrual loans during the period | — | — | — | — | — | ||||||||||||||
| Shortfall | $ | 1 | $ | 1 | $ | 1 | $ | 2 | $ | 2 | |||||||||
191
Geographic Concentration of Mortgage Loans(1)
| December 31, 2015 | December 31, 2014 | ||||
| California | 47.19 | % | 36.09 | % | |
| New York | 6.56 | 7.77 | |||
| Illinois | 6.30 | 7.78 | |||
| Massachusetts | 3.92 | 4.68 | |||
| New Jersey | 3.55 | 4.28 | |||
All others(2) | 32.48 | 39.40 | |||
| Total | 100.00 | % | 100.00 | % | |
| (1) | Percentages calculated based on the unpaid principal balance at the end of each period. |
| (2) | None of the remaining states represented more than 3.10% and 3.74% of the portfolio at December 31, 2015 and 2014, respectively. |
Short-Term Borrowings
Borrowings with original maturities of one year or less are classified as short-term. The following is a summary of short-term borrowings for the years ended December 31, 2015, 2014, and 2013:
| Consolidated Obligation Discount Notes | Consolidated Obligation Bonds With Original Maturities of One Year or Less | ||||||||||||||||||||||
| (Dollars in millions) | 2015 | 2014 | 2013 | 2015 | 2014 | 2013 | |||||||||||||||||
| Outstanding at end of the period | $ | 27,648 | $ | 21,811 | $ | 24,194 | $ | 18,273 | $ | 11,700 | $ | 14,700 | |||||||||||
| Weighted average rate at end of the period | 0.25 | % | 0.09 | % | 0.10 | % | 0.25 | % | 0.13 | % | 0.14 | % | |||||||||||
| Daily average outstanding for the period | $ | 28,853 | $ | 23,582 | $ | 16,325 | $ | 11,085 | $ | 16,841 | $ | 11,697 | |||||||||||
| Weighted average rate for the period | 0.16 | % | 0.09 | % | 0.10 | % | 0.17 | % | 0.13 | % | 0.15 | % | |||||||||||
| Highest outstanding at any monthend | $ | 33,859 | $ | 25,640 | $ | 24,194 | $ | 18,273 | $ | 22,345 | $ | 14,980 | |||||||||||
| ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
None.
| ITEM 9A. | 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.
192
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, and senior vice president and chief financial officer as of the end of the period covered by this report. Based on that evaluation, the Bank’s president and chief executive officer, executive vice president and chief operating officer, and senior vice president and chief financial officer have concluded that the Bank’s disclosure controls and procedures were effective at a reasonable assurance level as of the end of the period covered by this report.
Internal Control Over Financial Reporting
Internal control over financial reporting is defined in Rule 13a-15(f) promulgated under the 1934 Act as a process designed by, or under the supervision of, the Bank's principal executive and principal financial officers and effected by the Bank's Board of Directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) and includes those policies and procedures that:
| • | pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of assets of the Bank; |
| • | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that receipts and expenditures of the Bank are being made only in accordance with authorizations of management and directors of the Bank; and |
| • | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. |
During the three months ended December 31, 2015, 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. For management’s assessment of the Bank’s internal control over financial reporting, refer to “Item 8. Financial Statements and Supplementary Data – Management’s Report on 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 the 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 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. 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.
193
| ITEM 9B. | OTHER INFORMATION |
None.
PART III.
| ITEM 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE |
The Board of Directors (Board) of the Federal Home Loan Bank of San Francisco (Bank) is composed of member directors and nonmember independent directors. Each year the Federal Housing Finance Agency (Finance Agency) designates the total number of director positions for the Bank. Member director positions are allocated to each of the three states in the Bank's district. The allocation is based on the number of shares of capital stock required to be held by the members in each of the three states as of December 31 of the preceding calendar year (the record date), with at least one member director position allocated to each state and at least three member director positions allocated to California. Of the eight member director positions designated by the Finance Agency for 2015, one was allocated to Arizona, six were allocated to California, and one was allocated to Nevada. The nonmember independent director positions on the Board must be at least two-fifths of the number of member director positions and at least two of them must be public interest director positions. The Finance Agency designated six nonmember independent director positions for 2015, two of which were public interest director positions.
The Bank holds elections each year for the director positions with terms ending at yearend, with new terms beginning the following January 1. For member director positions, members located in the relevant states as of the record date are eligible to participate in the election for the state in which they are located. For nonmember independent director positions, all members located in the district as of the record date are eligible to participate in the election. For each director position to be filled, an eligible institution may cast one vote for each share of capital stock it was required to hold as of the record date (according to the requirements of the Bank's capital plan), except that an eligible institution's votes for each director position to be filled may not exceed the average number of shares of capital stock required to be held by all of the members in that state as of the record date. In the case of an election to fill more than one member director position for a state, an eligible institution may not cumulate or divide its block of eligible votes. Interim vacancies in director positions are filled by the Board. The Board does not solicit proxies, nor are eligible institutions permitted to solicit or use proxies to cast their votes in an election.
Candidates for member director positions are not nominated by the Bank's Board. As provided for in the Federal Home Loan Bank Act of 1932, as amended (FHLBank Act), member director candidates are nominated by the institutions eligible to participate in the election in the relevant state. Candidates for nonmember independent director positions are nominated by the Board, following consultation with the Bank's Affordable Housing Advisory Council, and are reviewed by the Finance Agency. The Bank's Governance Committee performs certain functions that are similar to the functions of a nominating committee with respect to the nomination of nonmember independent directors. If only one individual is nominated by the Board for each open nonmember independent director position, that individual must receive at least 20% of the eligible votes to be declared elected; and if two or more individuals are nominated by the Board for any single open nonmember independent director position, the individual receiving the highest number of votes cast in the election must be declared elected by the Bank.
Each member director must be a citizen of the United States and must be an officer or director of a member of the Bank (located in the state to which the director position has been allocated) that meets all minimum capital requirements established by the member's appropriate Federal banking agency or appropriate state regulator. There are no other eligibility or qualification requirements in the FHLBank Act or the regulations governing the Federal Home Loan Banks (FHLBanks) for member directors. Each nonmember independent director must be a United States citizen and must maintain a principal residence in a state in the Bank’s district (or own or lease a residence in the district and be employed in the district). In addition, the individual may not be an officer of any FHLBank or a director, officer, or employee of any member of the Bank or of any recipient of advances from the Bank. Each nonmember independent director who serves as a public interest director must have more than four years of personal experience in representing consumer or community interests in banking services, credit needs, housing, or
194
financial consumer protection. Each nonmember independent director other than a public interest director must have knowledge of, or experience in, financial management, auditing or accounting, risk management practices, derivatives, project development, organizational management, or law.
The term for each director position is four years, and directors are subject to a limit on the number of consecutive terms they may serve. A director elected to three consecutive full terms on the Board is not eligible for election to a term that begins earlier than two years after the expiration of the third consecutive term. On an annual basis, the Bank's Board performs a Board assessment that includes consideration of the directors' backgrounds, experience, expertise, Board service, and other factors. Also on an annual basis, each director certifies to the Bank that he or she continues to meet all applicable statutory and regulatory eligibility and qualification requirements. In connection with the election or appointment of a nonmember independent director, the nonmember independent director completes an application form providing information to demonstrate his or her eligibility and qualifications to serve on the Board. As of the filing date of this Form 10-K, nothing has come to the attention of the Board or management to indicate that any of the current Board members do not continue to possess the necessary experience, qualifications, attributes, or skills expected of the directors to serve on the Bank's Board, as described in each director's biography below.
Information regarding the current directors and executive officers of the Bank is provided below. There are no family relationships among the directors or executive officers of the Bank. The Bank's Code of Conduct for Senior Officers, which applies to the president, executive vice president, and senior vice presidents, and any amendments or waivers to the code are disclosed on the Bank's website located at www.fhlbsf.com.
The charter of the Audit Committee of the Bank's Board is available on the Bank's website at www.fhlbsf.com.
Board of Directors
The following table sets forth information (ages as of February 29, 2016) regarding each of the Bank's directors.
| Name | Age | Director Since | Expiration of Current Term | |||
Douglas H. (Tad) Lowrey, Chair(1)(7) | 63 | 2006 | 2017 | |||
Melinda Guzman, Vice Chair(2)(7)(8) | 52 | 2009 | 2016 | |||
Bradley W. Beal(3)(6)(8) | 62 | 2014 | 2019 | |||
Craig G. Blunden(1)(5)(7) | 68 | 2012 | 2019 | |||
Steven R. Gardner(1)(6)(8) | 55 | 2014 | 2017 | |||
Richard A. Heldebrant(1)(5) | 63 | 2013 | 2016 | |||
Simone Lagomarsino(1)(5)(7)(8) | 54 | 2013 | 2016 | |||
John F. Luikart(2)(5) | 66 | 2007 | 2017 | |||
Kevin Murray(2) | 55 | 2008 | 2019 | |||
Robert F. Nielsen(2)(8) | 69 | 2009 | 2016 | |||
Brian M. Riley(4)(5)(6) | 51 | 2015 | 2018 | |||
John F. Robinson(1)(5)(7) | 69 | 2011 | 2018 | |||
Scott C. Syphax(2)(6)(8) | 52 | 2002 | 2018 | |||
John T. Wasley(2)(5)(6)(8) | 54 | 2007 | 2017 | |||
| (1) | Elected by the Bank's California members eligible to vote. Mr. Lowrey also served as a California director from January 1, 1996, to September 11, 1998, and from July 23, 1999, to December 31, 2003. Mr. Blunden also served as a California director from January 28, 1999, to December 31, 2006. Mr. Robinson also served as a California director from January 1, 2004, to September 11, 2005, and as a Nevada director from January 25, 2007, to October 9, 2008. |
| (2) | Elected as a nonmember independent director by the Bank members eligible to vote. Ms. Guzman also served as an appointive director from April 19, 2007, to December 31, 2008. Mr. Nielsen also served as an appointive director from April 19, 2007, to December 31, 2008, and from 1999 to 2001. Mr. Wasley also served as an appointive director from 2003 to 2005. With the enactment of the Housing and Economic Recovery Act of 2008 on July 30, |
195
2008, the director positions previously appointed by the Federal Housing Finance Board (appointive director positions) became known as nonmember independent director positions, and the method for filling these positions was changed to election by the Bank members eligible to vote.
| (3) | Mr. Beal was declared elected by the Board as a Nevada director, for a four-year term beginning January 1, 2016. Mr. Beal was selected by the Board to fill the vacant Nevada director position effective May 1, 2014, for a term expiring on December 31, 2015. |
| (4) | Elected by the Bank’s Arizona members eligible to vote. |
| (5) | Member of the Audit Committee in 2016. |
| (6) | Member of the Compensation and Human Resources Committee (previously the EEO-Personnel-Compensation Committee) in 2016. |
| (7) | Member of the Audit Committee in 2015. |
| (8) | Member of the EEO-Personnel-Compensation Committee in 2015. |
The Board has determined that Mr. Luikart is an “audit committee financial expert” within the meaning of the Securities and Exchange Commission (SEC) rules. The Bank is required by SEC rules to disclose whether Mr. Luikart is independent and is required to use a definition of independence from a national securities exchange or national securities association. The Bank has elected to use the National Association of Securities Dealers Automated Quotations (NASDAQ) definition of independence, and under that definition, Mr. Luikart is independent. In addition, Mr. Luikart is independent according to the rules governing the FHLBanks applicable to members of the audit committees of the boards of directors of the FHLBanks and the independence rules under Section 10A(m) of the Securities Exchange Act of 1934.
Douglas H. (Tad) Lowrey, Chair
Douglas H. (Tad) Lowrey has been non-executive chairman of Pacific Western Bank since its acquisition of CapitalSource Bank in April 2014. He has also served as a director of PacWest Bancorp since 2014. Mr. Lowrey served as the chief executive officer of CapitalSource Bank, Los Angeles, California, from July 2008 to April 2014 and served as its chairman from 2012 until April 2014. Since August 2015 he has served as a senior advisor for Alliance Partners, a bank advisory, lending and asset management firm. Mr. Lowrey has held positions as chief executive officer, president, chairman, director, and chief financial officer for several financial institutions since 1983. He is the current Chairman of the California Bankers Association. He also served as vice president of the Thrift Institutions Advisory Council to the Board of Governors of the Federal Reserve Bank, and as a member of the Savings Association Insurance Fund Industry Advisory Committee to the Federal Deposit Insurance Corporation. He previously served on the Bank's Board of Directors from 1996 to 1998 and from 1999 to 2003 and was its vice chairman in 2003. Mr. Lowrey's current position as the chairman of a Bank member; his previous positions as principal executive officer, principal financial officer, director, and chairman of Bank members and other financial institutions; and his involvement in and knowledge of corporate governance, finance, auditing, accounting, internal controls, risk management, financial reporting, and financial management, as indicated by his background, support Mr. Lowrey's qualifications to serve on the Bank's Board.
Melinda Guzman, Vice Chair
Melinda Guzman has been a partner with Freeman & Guzman, LLP, a law firm in Sacramento, California, since 1999. Prior to that, she was a partner with Diepenbrock, Wulff, Plant & Hannegan, LLP, also a law firm in Sacramento. Ms. Guzman's practice focuses on tort, labor, insurance, and commercial matters. She previously served on the Bank's Board of Directors from April 2007 through December 2008. Ms. Guzman's involvement and experience in representing community and consumer interests with respect to banking services, in credit needs, in housing and consumer financial protections, and in corporate governance, as indicated by her background, and her management skills derived from her various legislative appointments and her service from 2002 to 2003 as chair of the Nehemiah Corporation of America (a community development corporation), her service from 2001 to 2004 as chairman of the California Hispanic Chamber of Commerce, and her service with other community-based organizations support Ms. Guzman's qualifications to serve on the Bank's Board.
Bradley W. Beal
Bradley W. Beal has been president and chief executive officer of One Nevada Credit Union, Las Vegas, Nevada, since 1990. Prior to that, Mr. Beal was senior vice president operations, Nevada Federal Credit Union (now One Nevada Credit Union) since 1987, and prior to that, president, Nevada State Employees Federal Credit Union, Carson City, Nevada. Mr. Beal is a member of the American Institute of Certified Public Accountants, the Nevada
196
CPA Society, and a former board member and chairman of the National Association of Federal Credit Unions. Mr. Beal's current position as the principal executive officer of a Bank member and his involvement in and knowledge of corporate governance, finance, auditing, accounting, internal controls, risk management, financial reporting, and financial management, as indicated by his background, support Mr. Beal's qualifications to serve on the Bank's Board.
Craig G. Blunden
Craig G. Blunden has been chairman and chief executive officer of Provident Savings Bank and Provident Financial Holdings, Inc., since 1991 and 1996, respectively. Mr. Blunden served as president of Provident Savings Bank and Provident Financial Holdings, Inc., from 1991 to June 2011 and from 1996 to June 2011, respectively. He previously served on the Bank's Board from 1999 to 2006. He is currently on the board of directors of the California Bankers Association. Mr. Blunden is a past chairman of the Western League of Savings Institutions and served on the Thrift Institutions Advisory Council of the Federal Reserve System for two years. Mr. Blunden's current position as the principal executive officer of a Bank member and its holding company and his involvement in and knowledge of corporate governance, finance, auditing, accounting, internal controls, risk management, financial reporting, and financial management, as indicated by his background, support Mr. Blunden's qualifications to serve on the Bank's Board.
Steven R. Gardner
Steven R. Gardner has been the president and chief executive officer and a director of Pacific Premier Bank and its holding company, Pacific Premier Bancorp, Irvine, California, since September 2000. He was also chief operating officer of the bank and holding company from February 2000 to April 2004. Prior to that, he was senior vice president at Hawthorne Financial from 1997 to January 2000. Mr. Gardner serves on the board of directors of the Federal Reserve Bank of San Francisco. He previously served as the vice chairman of the Federal Reserve Bank of San Francisco’s Community Depository Institutions Advisory Council, as a director of the Executive Committee of the Independent Community Bankers of America (ICBA), and as a director of ICBA Holding Company and ICBA Securities, a registered broker-dealer. Mr. Gardner's current position as the principal executive officer of a Bank member and his involvement in and knowledge of corporate governance, finance, auditing, accounting, internal controls, risk management, financial reporting, and financial management, as indicated by his background, support Mr. Gardner's qualifications to serve on the Bank's Board.
Richard A. Heldebrant
Richard A. Heldebrant has been president and chief executive officer of Star One Credit Union, Sunnyvale, California, since 1997. Prior to that, Mr. Heldebrant held several executive and senior officer positions at credit unions for 16 years. He served on the board of Western Corporate Federal Credit Union from 1994 to 1997. Mr. Heldebrant's current position as the principal executive officer of a Bank member and his involvement in and knowledge of corporate governance, finance, auditing, accounting, internal controls, risk management, financial reporting, and financial management, as indicated by his background, support Mr. Heldebrant's qualifications to serve on the Bank's Board.
Simone Lagomarsino
Simone Lagomarsino has been chief executive officer and a director of Heritage Oaks Bank and president of Heritage Oaks Bancorp, Paso Robles, California, since September 2011. She also held the position of president of Heritage Oaks Bank from January 2012 through December 2014. Prior to that, Ms. Lagomarsino was president and chief executive officer of Kinecta Federal Credit Union from June 2006 through January 2010. Ms. Lagomarsino is a financial services professional with more than 30 years of experience in executive positions. Ms. Lagomarsino's current position as the principal executive officer of a Bank member, her previous positions as chief executive officer or chief financial officer of Bank members or other financial institutions, and her involvement in and knowledge of corporate governance, finance, auditing, accounting, internal controls, risk management, financial
197
reporting, and financial management, as indicated by her background, support Ms. Lagomarsino's qualifications to serve on the Bank's Board.
John F. Luikart
John F. Luikart has been president of Bethany Advisors LLC, San Francisco, California, since February 2007. He has also been a trustee of four asbestos trusts, including the Western Asbestos Settlement Trust, since 2004 and a board member of Wells Fargo Real Estate Investment Trust and Ohio Wesleyan University since 2014. He was senior advisor to the CEO of Red Capital Group from July 2011 to July 2012 and was chairman of Wedbush Securities Inc., Los Angeles, California, from 2006 to 2010. Previously, he was president and chief operating officer of Tucker Anthony Sutro from 2001 to 2002 and chairman and chief executive officer of Sutro & Co. from 1996 to 2002. He joined Sutro & Co. in 1988 as executive vice president of capital markets and became president in 1990. Mr. Luikart's current position as the principal executive officer of an investment and financial advisory firm, his previous positions as director or principal executive officer of investment banking firms (or their affiliates), and his experience in investment management, capital markets, corporate finance, securitization, and mortgage finance and his involvement in and knowledge of corporate governance, finance, auditing, accounting, internal controls, risk management, financial reporting, and financial management, as indicated by his background, support Mr. Luikart's qualifications to serve on the Bank's Board.
Kevin Murray
Kevin Murray has been a principal in The Murray Group, a legal and consulting firm, since its founding in December 2006. Since May 2011, Mr. Murray has served as the president and chief executive officer of the Weingart Center Association. Mr. Murray was senior vice president of the William Morris Agency, Beverly Hills, California, from January 2007 to June 2009, working primarily in the company's corporate consulting division. Mr. Murray served as a California State Senator from December 1998 until November 2006, and as a California State Assembly member from December 1994 until November 1998. Prior to serving in the California State Legislature, Mr. Murray practiced law. Mr. Murray's involvement in legislative matters relating to, among other things, the banking and insurance industries, his experience in law and corporate governance practices, and his management skills, as indicated by his background, support Mr. Murray's qualifications to serve on the Bank's Board.
Robert F. Nielsen
Robert F. Nielsen has been president of Shelter Properties, Inc., a real estate development and management company based in Reno, Nevada, since 1979. Mr. Nielsen is a member of the National Association of Home Builders and was its chairman in 2011. He is also a past chairman of the State of Nevada Housing Division Advisory Committee. He previously served on the Bank's Board of Directors from 1999 to 2001 and from April 2007 through December 2008. Mr. Nielsen's involvement and experience in representing community interests in affordable housing development and his management skills, as indicated by his background, and his role with the Affordable Housing Resource Council (a former nonprofit organization designed to provide technical assistance in affordable housing) and the Neighborhood Development Collaborative (owner and manager of affordable housing rental properties) support Mr. Nielsen's qualifications to serve as a public interest director on the Bank's Board. Mr. Nielsen is a principal shareholder and president of IDN1 Inc., which was created to invest in a multifamily tax credit property in Reno, Nevada. This property is owned by Northwest Partners, L.P., whose general partners are Santorini Corp., IDN1 Inc., and Community Services Agency Development Corporation, a nonprofit corporation under Internal Revenue Code Section 501(c)(3). Northwest Partners, L.P., filed a petition for protection under Chapter 11 of the U.S. Bankruptcy Code on November 17, 2011. A plan of reorganization was confirmed by the court on February 25, 2013. Mr. Nielsen is also a managing member of Karen Partners, LLC, a Nevada limited liability company, which was created to invest in a multifamily tax credit property in Las Vegas, Nevada. This property was owned by Karen Partners, L.P., whose general partners are Karen Partners, LLC, and Community Services Agency Development Corporation. Karen Partners, L.P., filed a petition for protection under Chapter 11 of the U.S. Bankruptcy Code on December 19, 2011. On November 26, 2012, the automatic stay was rescinded, and this property was foreclosed upon on December 19, 2012. Mr. Nielsen is also a manager of Ridge Seniors, LLC, a
198
Nevada limited liability company, which was created to invest in a multifamily tax credit program in Henderson, Nevada. This property is owned by Ridge Partners L.P., whose general partners are Ridge Seniors, LLC, and Silver Sage Manor, Inc. On March 15, 2012, Ridge Partners L.P. filed a petition for protection under Chapter 11 of the U.S. Bankruptcy Code. A plan of reorganization was confirmed by the court on December 5, 2013. Mr. Nielsen is also principal shareholder and president of SUP III, Inc., which is a general partner in a multifamily tax credit property in Las Vegas, Nevada. This property was owned by East Freemont II L.P., whose general partners are SUP III, Inc., and SPE 2, LLC. East Freemont II L.P. filed a petition for protection under Chapter 11 of the U.S. Bankruptcy Code on June 21, 2012. The automatic stay was rescinded and this property was foreclosed upon on October 21, 2013.
Brian M. Riley
Brian M. Riley has been the president and chief executive officer of Mohave State Bank, Lake Havasu City, Arizona, since March, 2009. He was the chief financial officer of the bank from April 2008 to March 2009. Prior to that, he was chief executive officer of Harbor Bank and Trust, a financial institution in organization in Southport, Connecticut. Mr. Riley has over 30 years of experience in banking including serving as president and chief executive officer of PriVest Bank, Costa Mesa, California, and holding other executive positions with Provident Savings Bank, Riverside, California, and Metro Commerce Bank, San Rafael, California. Mr. Riley is a director of the Arizona Bankers Association. Mr. Riley’s current position as the principal executive officer of a Bank member, his previous executive positions with other financial institutions, and his involvement in and knowledge of corporate governance, finance, auditing, accounting, internal controls, risk management, financial reporting, and financial management, as indicated by his background, support Mr. Riley’s qualifications to serve on the Bank's Board.
John F. Robinson
John F. Robinson has been a director of Silicon Valley Bank, Santa Clara, California, and its holding company, SVB Financial Group, since July 2010. From 2002 to 2008, he was executive vice president of Washington Mutual Bank. From 1987 to 2002, he served in several senior bank regulatory roles, including Deputy Comptroller of the Currency for the Western District and Assistant Director for Policy and Western Region Director for the Office of Thrift Supervision. Mr. Robinson previously served on the Bank's Board of Directors from 2004 to 2005 and 2007 to 2008. From 2002 to 2013, he was a member of the national board and executive board for Operation HOPE, an international nonprofit organization focused on financial literacy and empowerment. Mr. Robinson's current position as the director of a Bank member, previous positions as an executive officer of a Bank member and a senior bank regulator, and his involvement in and knowledge of corporate governance, finance, auditing, accounting, internal controls, risk management, financial reporting, and financial management, as indicated by his background, support Mr. Robinson's qualifications to serve on the Bank's Board.
Scott C. Syphax
Scott C. Syphax has been chief executive officer of Nehemiah Corporation of America, a community development corporation in Sacramento, California, since 2001, and is also president and chief executive officer of its affiliates. He also held the position of president of Nehemiah Corporation of America from 2001 through June 2015. From 1999 to 2001, Mr. Syphax was a manager of public affairs for Eli Lilly & Company. He was vice chairman of the Bank's Board of Directors from January 2010 through January 2012. Mr. Syphax's involvement and experience in representing community interests in housing and his management skills, as indicated by his background, support Mr. Syphax's qualifications to serve as a public interest director on the Bank's Board.
John T. Wasley
John T. Wasley has been a managing partner of Caldwell Partners, a retained executive search firm, Los Angeles, California, since April 2013. Prior to that, he was a managing partner with Heidrick & Struggles, Los Angeles, California, since June 2005. Mr. Wasley joined Heidrick & Struggles as a partner in 2001. Previously, he was an
199
executive director with Russell Reynolds Associates and a senior vice president of People's Bank of California. He previously served on the Bank's Board of Directors from 2003 to 2005. Mr. Wasley's involvement in and knowledge of human resources, compensation practices, and corporate governance practices, and his management skills, as indicated by his background above, along with his previous positions as principal executive officer and principal financial officer of real estate investment firms and as an executive officer of a financial institution with which Mr. Wasley had involvement in or knowledge of corporate governance practices, bank relations, financial operations, treasury functions, and financial management, support Mr. Wasley's qualifications to serve on the Bank's Board.
Executive Officers
Dean Schultz
Dean Schultz, 69, has been president and chief executive officer since April 1991. Mr. Schultz is vice chairman of the board of directors of the Office of Finance, which facilitates the issuance and servicing of consolidated obligations for the FHLBanks. Prior to joining the Bank, he was executive vice president of the Federal Home Loan Bank of New York, where he had also served as senior vice president and general counsel. From 1980 to 1984, he was senior vice president and general counsel with First Federal Savings and Loan Association of Rochester, New York. He previously was a partner in a Rochester law firm.
Lisa B. MacMillen
Lisa B. MacMillen, 56, has been executive vice president and chief operating officer since October 2007. Ms. MacMillen also served as senior vice president and corporate secretary from 1998 to October 2007 and as general counsel from 1998 to April 2005. She joined the Bank as a staff attorney in 1986. She was promoted to assistant vice president in 1992 and vice president in 1997.
Elena Andreadakis
Elena Andreadakis, 54, has been senior vice president and chief information officer since May 2011. Prior to joining the Bank, she was a senior vice president at Fidelity Investments, where she had worked since 1992. She most recently led the service and program management group for Fidelity's enterprise infrastructure organization. Prior to that, Ms. Andreadakis held a number of other senior-level business and information technology positions, with responsibility for managing a wide range of systems and business initiatives.
Gregory P. Fontenot
Gregory P. Fontenot, 57, has been senior vice president, human resources, office of minority and women inclusion,
and facilities management since October 2011. Previously, he was senior vice president and director of human resources from January 2006 to October 2011. Mr. Fontenot joined the Bank in March 1996 as assistant vice president, compensation and benefits, and was promoted to vice president, human resources, in 2001. Prior to joining the Bank, he was the director of compensation and benefits for CompuCom Systems, Inc., and held managerial and professional positions in human resources for a number of other companies. Mr. Fontenot holds the Senior Professional in Human Resources designation from the Human Resources Certification Institute and the Society for Human Resource Management Senior Certified Professional designation.
Kevin A. Gong
Kevin A. Gong, 56, has been senior vice president and chief corporate securities counsel since April 2005. Mr. Gong joined the Bank in 1997 as vice president and associate general counsel. He has previous experience as a senior attorney with the Office of Thrift Supervision, as an attorney in private practice, and as an attorney with the SEC in both the Division of Corporation Finance and the Division of Market Regulation.
200
David H. Martens
David H. Martens, 63, has been senior vice president and chief risk officer since June 2010. Previously, Mr. Martens was senior vice president and director of internal audit and enterprise risk management from June 2009 to May 2010. Mr. Martens served as senior vice president, credit and collateral risk management, from 1998 to May 2009 and also had responsibility for enterprise risk management from 2004 to 2009. Mr. Martens was also the senior officer overseeing the Bank's community investment programs from 1998 to 2004. He joined the Bank in April 1996 as vice president and director of internal audit. He has previous experience as chief accountant for the Office of Thrift Supervision, chief accountant for the Federal Home Loan Bank Board and Federal Home Loan Bank System Examination and Supervision, vice president and supervisory agent with the Bank, and independent auditor and audit manager with Ernst & Young LLP. He is a certified public accountant and a certified financial planner.
Kenneth C. Miller
Kenneth C. Miller, 63, has been senior vice president and chief financial officer since August 2011. Previously, Mr. Miller was senior vice president, financial risk management and strategic planning, from 2001 to August 2011. Mr. Miller joined the Bank in July 1994 as vice president, financial risk management. Previously, Mr. Miller held the position of senior vice president, asset liability management, at First Nationwide Bank.
Lawrence H. Parks
Lawrence H. Parks, 54, has been senior vice president, external and legislative affairs, since joining the Bank in 1997. Mr. Parks had previous experience at the U.S. Department of Commerce as senior policy advisor, with the Mortgage Bankers Association as associate legislative counsel/director, and with the U.S. Senate as legislative counsel.
Patricia M. Remch
Patricia M. Remch, 63, has been senior vice president, sales and marketing, since August 2011. Previously, Ms. Remch was senior vice president, mortgage finance sales and product development, from February 2005 to August 2011. Ms. Remch joined the Bank as an economist in 1982. She was promoted to capital markets specialist and became vice president, sales manager, in 1998.
Robert M. Shovlowsky
Robert M. Shovlowsky, 57, joined the Bank in May 2009 as senior vice president, chief credit and collateral risk management officer. Mr. Shovlowsky announced his retirement effective March 11, 2016. Before joining the Bank, Mr. Shovlowsky was a senior bank examiner at the Federal Housing Finance Agency. Prior to that, he was an assistant regional director at the Federal Deposit Insurance Corporation.
Suzanne Titus-Johnson
Suzanne Titus-Johnson, 58, has been senior vice president and general counsel since April 2005, and she has also served as corporate secretary since October 2007. Ms. Titus-Johnson joined the Bank as a staff attorney in 1986 and was promoted to assistant vice president in 1992 and to vice president in 1997.
Stephen P. Traynor
Stephen P. Traynor, 59, has been senior vice president, member financial services and community investment, since July 2004. Mr. Traynor joined the Bank in 1995 as assistant treasurer. He was promoted to senior vice president, sales and marketing, in October 1999. Before joining the Bank, he held vice president positions at Morgan Stanley & Co. and at Homestead Savings in the areas of mortgage banking, fixed income securities, derivatives, and capital markets.
201
Mark J. Watson
Mark J. Watson, 54, joined the Bank in October 2010 as senior vice president and director of internal audit. Before joining the Bank, Mr. Watson was the senior vice president and director of internal audit at Borel Private Bank & Trust Company. He was previously the senior vice president and chief operating officer at Charles Schwab Bank and was a senior vice president in the internal audit department at Charles Schwab & Company. Mr. Watson also held positions at Bankers Trust and KPMG. He is a chartered accountant.
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION DISCUSSION AND ANALYSIS
This section provides information on the compensation program of the Federal Home Loan Bank of San Francisco (Bank) for our named executive officers for 2015. Our named executive officers are our principal executive officers, our principal financial officer, and our other three most highly compensated executive officers.
Compensation and Human Resources Committee
The Compensation and Human Resources Committee (formerly, the EEO-Personnel-Compensation Committee) (Compensation Committee) of the Bank's Board of Directors (Board) is responsible for, among other things, reviewing and making recommendations to the full Board regarding compensation and incentive plan awards for the Bank's executive officers (the president, executive vice president, and senior vice presidents, other than the Director of Internal Audit, for whom compensation is established by the Audit Committee). Beginning in 2016, the Compensation Committee will also be responsible for reviewing and making recommendations regarding compensation for the directors (previously the responsibility of the Bank’s Governance Committee). For 2016, the Compensation Committee consists of five members of the Board. In 2015, the Compensation Committee consisted of seven members of the Board. The Compensation Committee acts pursuant to a Board-approved charter and may rely on the assistance, advice, and recommendations of the Bank's management and other advisors and may refer specific matters to other committees of the Board. In addition, the Risk Committee of the Board is responsible for oversight of the Bank's enterprise-wide risk management framework, including overseeing an annual risk assessment of the Bank's compensation policies and practices for the Bank's employees.
Certain members of senior management assist the Compensation Committee in its responsibilities by providing compensation and performance information regarding our executive officers.
With respect to the compensation of the named executive officers of a Federal Home Loan Bank (FHLBank), the Federal Housing Finance Agency (Finance Agency) requires that an FHLBank provide the Finance Agency with copies of all materials related to the compensation decisions of the FHLBank's board of directors for its review prior to the compensation decisions taking effect.
The Finance Agency’s Advisory Bulletin 2009-AB-02 outlined several principles for sound incentive compensation practices to which the FHLBanks are expected to adhere in setting executive compensation policies and practices. The Finance Agency’s rule setting forth requirements and processes with respect to compensation provided to certain executive officers by FHLBanks and the Office of Finance addresses the authority of the Finance Agency Director to approve, disapprove, prohibit, or withhold compensation of certain executive officers of the FHLBanks and the Office of Finance. The rule also addresses the Director’s authority to approve, in advance, agreements or contracts of certain executive officers that provide compensation in connection with termination of employment. The rule prohibits an FHLBank or the Office of Finance from paying compensation to certain executive officers that is not reasonable and comparable with compensation paid by similar businesses for similar duties and responsibilities.
202
Our Executive Compensation Philosophy and Executive Compensation Program
The Bank has a Board-approved Executive Compensation Philosophy that forms the basis of our executive compensation program. In accordance with our Executive Compensation Philosophy, we believe that to attract and retain outstanding executives we must be able to provide an executive compensation package that appropriately motivates and rewards the executive officers who make contributions of special importance to the success of the Bank's business. Our executive compensation program provides total compensation consisting of base salary, short- and long-term cash incentive compensation, and retirement benefits.
The Bank's Executive Compensation Philosophy states that total compensation is intended to align the interests of the named executive officers and other executives with the short-term and long-term interests of the Bank, to ensure an appropriate level of competitiveness within the marketplace from which the Bank recruits executive talent, and to encourage the named executive officers and other executive employees to remain employed with the Bank. The Bank's Executive Compensation Philosophy provides that total remuneration (base salary, short- and long-term cash incentives, and retirement benefits) is also intended to motivate executives to deliver exceptional performance without encouraging unnecessary or excessive risk-taking.
Total Compensation is Intended to Reward Achievement of Individual Performance Goals and Contribution to the Bank's Corporate Goals and Performance Targets. We have structured our executive compensation program to reward achievement of individual performance goals and contributions in support of the Bank's corporate goals and performance targets, including those set forth in the Bank's strategic plan. In addition to base salary, our short- and long-term cash incentive compensation plans create an award program for executives who contribute to and influence the achievement of the Bank's mission and other key objectives contained in the Bank's strategic plans and who are responsible for the Bank's performance. The Bank's overall executive compensation programs reward sustained performance through the balanced use of short- and long-term incentives, which represent a substantial portion of pay at-risk, and through competitive retirement benefits, which promote the alignment of executive and Bank interests over the long term.
The Bank provides wholesale products and services that help member financial institutions expand the availability of mortgage credit, compete more effectively in their markets, and foster strong and vibrant communities through community and economic development. The Bank also aims to provide a reasonable return to its members consistent with the Bank's public policy purpose, to consistently operate to best practices, and to accomplish its goals with a diverse and highly motivated staff.
Each Year, the Bank Establishes Specific Corporate Goals Consistent with the Bank's Strategic Plan. Similar to 2014, for 2015 the Board adopted three corporate goals: a Risk Management goal, a Community Investment goal, and a Franchise Enhancement goal.
For 2015, the Risk Management goal focused management on enhancing the business value of the Bank’s risk assessment processes and implementing a corporate data protection initiative.
Consistent with the Bank's public policy purposes, the Community Investment goal for 2015 focused management on meeting the Bank's objective to promote and assist housing and community economic development activities, and to provide resources and assistance to members in achieving their community lending goals. These efforts both complement and constitute elements of the Bank's core business and mission endeavors. The Community Investment goal for 2015 focused management on the number of members using the community investment programs and the amount of new advances funded and letters of credit issued under the Bank’s Community Investment Cash Advance credit programs during 2015.
The Franchise Enhancement goal for 2015 helped to align management's interest with the Bank’s objective to remain an integral component of the nation’s housing finance system, promote new business opportunities that increase revenue potential or enhance mission achievement, and to continue to enhance and implement the Bank’s information technology strategic initiatives and provide value to the Bank and service to members.
203
The 2015 Franchise Enhancement goal included milestones for completion of 2014 technology strategic initiatives continued in 2015 and achievement of 2015 technology strategic initiatives relating to digital strategy, collateral management system replacement, Calypso expansion, accounting operations automation, and vendor management and automated procure-to-pay. The 2015 Franchise Enhancement goal also included four member business goals designed to focus management on achieving: (i) advances and letters of credit targeted volumes; (ii) a Mortgage Partnership Finance program target based on the number of new participating financial institutions; (iii) a member engagement target based on the number of on-site visits to members; and (iv) a member recruitment goal based on the number of new members. The Board set the target achievement levels for the member business goals based on various assumptions, such as economic forecasts, detailed member information, potential member business, historical goal performance, industry trends and events, and current market environment and conditions, such that the relative difficulty of achieving the target level was commensurate with extending credit to members and increasing member engagement in a safe and sound manner. The 2015 Franchise Enhancement goal also included a financial goal, called the Adjusted Return on Capital Spread goal. This goal was reasonably challenging to accomplish and required, among other things, that the Bank maintain 2015 average annual balances and spreads for advances, MBS, and mortgage loans close to the 2015 plan projections at a time when member liquidity was high, demand for funding remained low, and there was volatility in the mortgage and capital markets, and to manage operating costs while continuing to meet strategic and operating objectives. Given the Bank’s business model and conservative risk appetite, the achievement levels above target represented significant stretch objectives.
Each Year, the Bank Establishes Individual Goals for Executives Consistent with the Bank's Strategic Plan. The individual performance goals established for executive officers are generally based on the Bank's strategic plan and reflect the strategic objectives that will enable the Bank to successfully achieve its mission. These strategic objectives for 2015 were intended to strengthen the Bank's financial services franchise, improve the efficiency and effectiveness of the Bank's operating infrastructure, promote and enhance the effectiveness of the Bank's Affordable Housing Program and community investment programs, and strengthen the Bank’s organizational effectiveness by enhancing the Bank’s working environment and advancing diversity and inclusion.
The Bank's Short-Term Incentive Compensation Plans Calculate Executive Officers' Achievement Levels on a Weighted Basis to Ensure that a Proper Balance Occurs in Achieving the Bank's Mission in a Safe and Sound Manner. With respect to each of the named executive officers for 2015, the achievement levels of each of the three Bank corporate goals (the Risk Management goal, the Community Investment goal, and the Franchise Enhancement goal) were weighted for each officer type (president, executive vice president, senior vice president, and senior vice president and chief risk officer) relative to the individual goal weighting for that officer type in calculating each named executive officer's individual total weighted achievement level.
The weightings of the Bank's corporate goals are approved by the Board and are designed to appropriately focus senior management on accomplishing the Bank's mission and strategic plan. See “President's Incentive Plan” and “Executive Incentive Plan” below for a discussion of the relative weights given to corporate goals and individual goals for each component of the short-term incentive plans for the named executive officers.
Our Executive Compensation Program is Designed to Enable the Bank to Compete for Highly Qualified Executive Talent. Our members are best served when we attract and retain talented executives with competitive and fair compensation packages. In 2015, our objective was to create an executive compensation program that delivered total compensation packages that generally fell around the median (50th percentile) of the total remuneration in the financial services marketplace from which the Bank recruits executive talent, which may include regional and diversified banks, savings institutions, and mortgage finance companies, among others, while maintaining an appropriate alignment with the practices of other FHLBanks.
The Compensation Committee recognized that comparing our compensation practices to a group of other financial services and banking firms that are similar in total assets presents some challenges because of the special nature of our business and our cooperative ownership structure. We believe that the executive roles of our named executive
204
officers are somewhat comparable to those in the comparison group, although the Bank may have a narrower business focus.
Our named executive officers are required to have the depth of knowledge and experience that is required by comparable financial services and banking firms, but unlike some of these comparable companies with multiple lines of business, our lines of business are limited. For example, in certain areas of the Bank our focus is more like that of a specific subsidiary, division, or business unit of comparable companies with multiple lines of business.
For purposes of developing comparative compensation information, the companies with comparable positions were financial services and banking firms with similar business sophistication and complexity. In supporting compensation decisions, the Compensation Committee uses and considers compensation information about the comparable positions at these companies.
In November 2014, the Compensation Committee engaged McLagan Partners, Inc. (McLagan), a leading global management consulting firm providing consulting and benchmarking services for the financial services industry, for the purpose of providing the Compensation Committee with competitive market compensation benchmarking information. McLagan does not currently provide any other services to the Bank. In April 2015 and July 2015, McLagan assessed the Bank’s competitive market position. McLagan used market data collected from its compensation surveys and publicly available proxy data. McLagan used standardized peer group data from two groups: large commercial banks with assets of $20 billion and greater and Fannie Mae, Freddie Mac, and the Federal Reserve Banks; and public proxy peers with assets between $5 billion and $20 billion. A Federal Home Loan Banks peer group was included as reference. When comparing Bank executives using the large commercial bank peer group, direct reports to the overall head of the function were used. When using the $5 billion to $20 billion peer group, a direct comparison of top paid executives was made using salary rank from the proxies. When using the Federal Home Loan Banks peer group, a direct comparison of overall functional heads was used. The Compensation Committee used the McLagan market data as a reference point for evaluating 2015 executive compensation levels and to check and compare the reasonableness and appropriateness of the levels of compensation provided to our senior executives.
Allocation of Short-Term Cash Incentive Compensation and Long-Term Cash Incentive Compensation. Our objective is to compensate our senior executives, including our named executive officers, with a balanced combination of base salary and short- and long-term cash incentive compensation. We believe that a balanced approach in delivering short- and long-term cash incentive compensation is most appropriate for the Bank because we believe our executives should be focused on achievement of both short- and long-term goals.
Short-term cash incentive compensation rewards the named executive officers and other executive officers for the Bank's achievement of its annual corporate goals and performance targets and for the officer's achievement of his or her individual goals. Long-term cash incentive compensation rewards the named executive officers and other executive officers for the Bank's achievement of its goals and performance targets over a three-year period. Consistent with the Bank's three-year strategic plans and its Executive Compensation Philosophy, long-term cash incentive compensation also helps provide a competitive total cash compensation package and enhances the Bank's ability to attract and retain key executives.
Elements of Our Executive Compensation Program
Base Salary Compensation
Base salary compensation is a key component of the Bank's executive compensation program and helps the Bank successfully attract and retain executive talent. Base salary for the named executive officers is based on a combination of factors, including comparative salary information from industry salary surveys that include the financial institutions in the Bank's peer group. Other factors include the named executive officer's relevant experience and accomplishments, level of responsibility at the Bank, and perceived market competition for executives with comparable levels of experience. The Board considers any base salary adjustments for the named
205
executive officers at the beginning of each year based on the individual's performance and contributions to the Bank's achievements, or to help more appropriately align total remuneration with comparable positions in the financial services marketplace. For the named executive officers, 2016 base salaries were increased from 0% to 3% relative to 2015 base salaries to appropriately align total remuneration with comparable positions in the financial services marketplace.
Short-Term Cash Incentive Plans: President's Incentive Plan and Executive Incentive Plan
For 2015, the Bank provided an annual (short-term) cash incentive compensation plan for achievement of the Bank's corporate goals and individual goals to the Bank's president (2015 President's Incentive Plan, or 2015 PIP) and to the executive vice president and senior vice presidents (2015 Executive Incentive Plan, or 2015 EIP). The 2015 EIP does not apply to the Bank's Director of Internal Audit, who participates in the Bank's Audit Executive Incentive Plan.
The target achievement levels in the 2015 PIP and the 2015 EIP were designed to reward officers for achievement of the Bank's corporate goals to accomplish the Bank's objectives as described above, based on a target level of achievement for all corporate goals and the officer's individual goal(s). The exceeds and far exceeds achievement levels were designed to reward officers when the Bank and the individual officer achievements exceed the target level. The plans define the exceeds achievement level as an optimistic achievement level relative to the target level, and the far exceeds achievement level as the most optimistic achievement level based on reasonable business, market, and economic assumptions and conditions.
We used a scale of 0% to 150% to measure the achievement levels for the Bank's corporate goals and each executive's individual goal(s), with 75% as the threshold level, 100% as the target level, 125% as the exceeds level, and 150% as the far exceeds level.
Awards under both the 2015 PIP and the 2015 EIP were based on the total weighted achievement of the three corporate goals approved by the Board for 2015 (the Risk Management goal, the Community Investment goal, and the Franchise Enhancement goal) and one or more individual goals for each officer. The awards under the 2015 PIP and the 2015 EIP were targeted as a percentage of base salary for the president, executive vice president, and senior vice presidents, based on the total weighted achievement level of Bank and individual goals, and were set as follows: 150% of target: 50% of base salary; 125% of target: 48% of base salary; 100% of target: 40% of base salary; and 75% of target: 20% of base salary.
Under both the 2015 PIP and the 2015 EIP, the Board had discretion to modify goal achievement levels, award determinations, and incentive payments to account for matters not specifically addressed in the plan. Both the 2015 PIP and the 2015 EIP provided that aggregate performance below the threshold achievement level normally would not result in an incentive award, and both the 2015 PIP and the 2015 EIP provided the Board with discretion to modify any and all incentive payments, including, without limit, under the following circumstances: (i) if errors or omissions result in material revisions to the Bank's financial results, information submitted to a regulatory or
reporting agency, or information used to determine incentive compensation payouts; (ii) if information submitted to a regulatory or reporting agency is untimely; or, (iii) if the Bank does not make appropriate progress in the timely remediation of examination, monitoring, or other supervisory findings and matters requiring attention.
The 2015 PIP and the 2015 EIP also provided that actual goal achievement levels were subject to adjustment because of changes in financial strategies or policies, any significant change in Bank membership, and other factors determined by the Board. The 2015 PIP and the 2015 EIP also provided that the impact of credit-related other-than-temporary impairment charges would be excluded from the Adjusted Return on Capital Spread goal achievement level target and performance measurement and the impact of dividend benchmark variances-to-plan would be excluded from the Adjusted Return on Capital Spread goal performance measurement.
President's Incentive Plan. For 2015, we provided the Bank's president with an annual (short-term) cash incentive compensation plan, the 2015 PIP, which rewards the president for the Bank's overall performance and for
206
significantly contributing to and influencing achievement of the Bank's corporate goals and performance targets, as well as for an individual goal.
The 2015 PIP award ranges and plan design were intended to appropriately motivate and reward the Bank’s president based on the total achievement of all goals, taking into account his role in the Bank's performance. The 2015 award ranges as a percentage of base salary were intended to be consistent with our Executive Compensation Philosophy of delivering total cash compensation at target levels generally around the median (50th percentile) of the total remuneration in the financial services marketplace from which the Bank recruits executive talent.
The following table shows the goal weights for the president in the 2015 PIP.
| 2015 PIP | 2015 Goal Weights | |
| Risk Management Goal | 27 | % |
| Community Investment Goal | 18 | |
| Franchise Enhancement Goal | 45 | |
| Individual Goal | 10 | |
| Total | 100 | % |
The president's award under the 2015 PIP was determined by multiplying the percentage achievement for each goal by the respective goal weights to arrive at the president's total weighted achievement level. The president's total weighted achievement level was then used to determine the president's cash incentive compensation award under the 2015 PIP.
For a discussion regarding the award granted to the president under the 2015 PIP, see the discussion in “Compensation Tables – Narrative to Summary Compensation Table and Grants of Non-Equity Incentive Plan-Based Awards Table – Non-Equity Incentive Payments and Non-Equity Long-Term Incentive Payments,” which discussion is herein incorporated by reference.
Executive Incentive Plan. For 2015, we provided an annual (short-term) cash incentive compensation plan, the 2015 EIP, to reward our executive vice president and senior vice presidents (except for the Bank's Director of Internal Audit, who participates in the Bank's Audit Executive Incentive Plan) for the Bank's overall corporate goal achievement and for achievement of their individual goals. The 2015 EIP was designed to reward these senior officers, who are substantially responsible for the Bank's overall performance and who significantly contribute to and influence the achievement of the Bank's corporate goals.
The 2015 EIP award ranges and plan design were intended to appropriately motivate and reward officers based on the total achievement of all goals, taking into account each individual officer's role in the Bank's performance. The 2015 award ranges as a percentage of base salary were intended to be consistent with our Executive Compensation Philosophy of delivering total cash compensation at target levels generally around the median (50th percentile) of the total remuneration in the financial services marketplace from which the Bank recruits executive talent.
The following table shows the goal weights for different categories of officers in the 2015 EIP.
| 2015 Goal Weights | ||||||||
| 2015 EIP | Executive Vice President | Senior Vice President and Chief Risk Officer | Senior Vice President | |||||
| Risk Management Goal | 27 | % | 54 | % | 27 | % | ||
| Community Investment Goal | 18 | % | 12.6 | % | 18 | % | ||
| Franchise Enhancement Goal | 45 | % | 23.4 | % | 45 | % | ||
| Individual Goal | 10 | % | 10 | % | 10 | % | ||
| Total | 100 | % | 100 | % | 100 | % | ||
The awards under the 2015 EIP were determined by multiplying the percentage achievement for each goal by the respective goal weights to arrive at each participating officer's total weighted achievement level. Each participating
207
officer's total weighted achievement level was then used to determine each participating officer's cash incentive compensation award under the 2015 EIP.
For a discussion regarding the awards granted under the 2015 EIP for the named executive officers, see the discussion in “Compensation Tables – Narrative to Summary Compensation Table and Grants of Non-Equity Incentive Plan-Based Awards Table – Non-Equity Incentive Payments and Non-Equity Long-Term Incentive Payments,” which discussion is herein incorporated by reference.
Long-Term Cash Incentive Plan: Executive Performance Unit Plan
We provide our president, executive vice president, and senior vice presidents (other than the Director of Internal Audit, who participates in the Audit Performance Unit Plan) a long-term cash incentive compensation plan, the Executive Performance Unit Plan, or EPUP.
The EPUP rewards our key executives who are substantially responsible for the Bank's overall long-term performance and who significantly contribute to and influence the Bank's long-term goal achievements, which directly support the Bank's three-year strategic plans. The purpose of the EPUP is also to attract and retain outstanding executives as part of a competitive total compensation program.
The EPUP awards are based on three-year performance periods consistent with the Bank's three-year strategic plans. A new three-year performance period is usually established at the beginning of each year, so that there are generally three separate EPUP performance periods in effect at one time. The following EPUPs are currently in effect: the 2016 EPUP for the performance period 2016 through 2018, the 2015 EPUP for the performance period 2015 through 2017, and the 2014 EPUP for the performance period 2014 through 2016. The 2013 EPUP was in effect for the performance period 2013 through 2015.
The EPUP awards are based on the total weighted achievement level of the three-year average achievement levels of two annual Bank corporate goals during the relevant three-year performance period based on a scale of 0% to 150% for the 2015 EPUP, 2014 EPUP, and 2013 EPUP, with 100% as the target achievement level for all performance periods. The Bank's corporate goals for the 2015, 2014, and 2013 EPUPs include the Adjusted Return on Capital Spread goal and the Risk Management goal.
The 2015, 2014, and 2013 EPUPs identified specific Adjusted Return on Capital Spread goal targets for each achievement level and provided that the Adjusted Return on Capital Spread goal achievement levels will be based on a comparison of the actual three-year average results with the three-year projected results from the Bank's 2015, 2014, and 2013 Strategic Plans, respectively. They also provided that the Risk Management goal achievement levels will be based on the three-year average of the actual Risk Management goal achievement levels under each of the three annual incentive plans in effect during the performance period, and will be measured at the end of the performance period.
The two corporate goals in the 2015, 2014, and 2013 EPUPs were weighted 30% for the Adjusted Return on Capital Spread goal and 70% for the Risk Management goal at all achievement levels.
To calculate an EPUP award, the total weighted achievement level for the two Bank corporate goals is multiplied by the officer's target award percentage (the range of awards as a percentage of base salary, discussed below), which is then multiplied by the officer's base salary in the first year of the three-year performance period.
For the 2015, 2014, and 2013 EPUPs, total weighted achievement levels range from 75% of target (threshold) to 150% of target (far exceeds), and the awards as a percentage of base salary for the president, executive vice president, and senior vice presidents, based on the total weighted achievement level of Bank goals, are as follows: 150% of target: 50% of base salary; 125% of target: 48% of base salary; 100% of target: 40% of base salary; and 75% of target: 20% of base salary.
208
Under the 2015, 2014, and 2013 EPUPs, performance below the aggregate threshold achievement level normally will not result in an incentive award. The Board has discretion to modify any and all goal achievement levels, award determinations, and incentive payments to account for matters not specifically addressed in the plan. Under the 2015, 2014, and 2013 EPUPs, incentive compensation reductions may be made in, but are not limited to, the following circumstances: (i) if errors or omissions result in material revisions to the Bank's financial results, information submitted to a regulatory or reporting agency, or information used to determine incentive compensation payouts; (ii) if information submitted to a regulatory or reporting agency is untimely; or (iii) if the Bank does not make appropriate progress in the timely remediation of examination, monitoring, or other supervisory findings and matters requiring attention.
The actual achievement of Bank goals for the 2015, 2014, and 2013 EPUPs is subject to adjustment for changes in financial strategies or policies, any significant change in Bank membership, and other factors determined by the Board.
The 2015, 2014, and 2013 EPUPs provide that the impacts of credit-related other-than-temporary impairment charges are excluded from the Adjusted Return on Capital Spread goal target, but the impacts of actual credit-related other-than-temporary impairment charges are included in the Adjusted Return on Capital Spread goal performance measurement, and the impacts of dividend benchmark variances-to-plan are excluded from the Adjusted Return on Capital Spread goal performance measurement.
The potential target award ranges as a percentage of base salary are intended to be consistent with delivering total compensation packages at target levels generally around the median (50th percentile) of the total remuneration in the financial services marketplace from which the Bank recruits executive talent.
The awards under the EPUPs are designed to be based in large part on the executive's ability to affect the Bank's long-term performance. For additional information, see discussion in “Compensation Tables –Narrative to Summary Compensation Table and Grants of Non-Equity Incentive Plan-Based Awards Table – Non-Equity Incentive Payments and Non-Equity Long-Term Incentive Payments,” which discussion is herein incorporated by reference.
Executive officers whose Bank employment is terminated because of voluntary normal retirement, disability, or death may receive a prorated award. Any awards are paid following Board approval after the end of the three-year performance period and any required regulatory review period.
Savings Plan
The Bank's Savings 401(k) Plan (Savings Plan) is a tax-qualified defined contribution 401(k) retirement benefit plan that is available to all eligible employees, including the named executive officers. Each eligible employee may contribute between 2% and 20% of base salary to the Savings Plan. For employees who have completed six months of service, the Bank matches a portion of the employee's contribution (50% for employees with less than three years of service, 75% for employees with at least three years of service but less than five years of service, and 100% for employees following five years of service), up to a maximum of 6% of base salary. Employees are fully vested in employer matching contributions at all times.
For 2015, the maximum annual before-tax employee contribution to the Savings Plan was limited to $18,000 (or $24,000 for participants age 50 and over), and no more than $265,000 of annual compensation could be taken into account in computing an employee's benefits under the Savings Plan.
Cash Balance Plan and the Financial Institutions Retirement Fund
We began offering benefits under the Cash Balance Plan on January 1, 1996. The Cash Balance Plan is a tax-qualified defined benefit pension plan that covers employees who have completed a minimum of six months of service, including the named executive officers. Each year, eligible employees accrue benefits equal to 6% of their total annual compensation (which includes base salary and short-term cash incentive compensation) plus interest
209
equal to 6% of their account balances accrued through the prior year, referred to as the annual benefit component of the Cash Balance Plan. For 2015, the Internal Revenue Code (IRC) limited the amount of annual compensation that could be considered in calculating an employee's benefits under the Cash Balance Plan to $265,000.
The benefits under the Cash Balance Plan annual benefit component are fully vested after an employee completes three years of service. Vested amounts are generally payable in a lump sum or as an annuity when the employee leaves the Bank.
Prior to offering benefits under the Cash Balance Plan, we participated in the Financial Institutions Retirement Fund, or the FIRF. The FIRF is a multiple-employer tax-qualified defined benefit pension plan. We withdrew from the FIRF on December 31, 1995.
When we withdrew from the FIRF, benefits earned under the FIRF as of December 31, 1995, were fully vested and the value of those benefits was then frozen. As of December 31, 1995, the FIRF calculated each participant's FIRF benefit based on the participant's then-highest three consecutive years' average pay multiplied by the participant's years of service multiplied by 2%, referred to as the frozen FIRF benefit. Upon retirement, participants will be eligible to receive their frozen FIRF benefits.
In addition, to preserve some of the value of the participant's frozen FIRF benefit, we maintain the ratio of each participant's frozen FIRF age 65 annuity to the participant's highest three consecutive years' average pay as of December 31, 1995 (annuity ratio), which we refer to as the net transition benefit component of the Cash Balance Plan. Upon retirement, each participant with a frozen FIRF benefit will receive a net transition benefit under the Cash Balance Plan that equals his or her highest three consecutive years' average pay at retirement multiplied by his or her annuity ratio minus the frozen FIRF benefit.
Benefit Equalization Plan
The Benefit Equalization Plan (BEP) is an unfunded and non-tax-qualified plan that is designed to restore retirement benefits lost under the Savings Plan and Cash Balance Plan because of compensation and benefits limitations imposed on the Savings Plan and the Cash Balance Plan under the IRC.
Annual compensation is determined based on the definition of compensation provided in the respective tax-qualified plans. Participation in the BEP is available to all employees, including the named executive officers, whose benefits under the tax-qualified plans are restricted because of the IRC limitations discussed above.
An employee's benefits that would have been credited under the Cash Balance Plan but for the limitations imposed on the plan under the IRC are credited as Supplemental Cash Balance Benefits under the BEP and the credits accrue interest at an annual rate of 6% until distributed. Each year, employees may also elect to defer compensation earned over the IRC compensation limits to the BEP. For each year that a participant makes deferrals to the BEP, if the amount of the Bank's matching contribution to a participant's account under the Savings Plan is limited because of the IRC compensation limitations, then the Bank will credit to the participant's BEP account an amount equal to the lost matching contribution (up to a maximum of 6% of base salary in the aggregate) under the Savings Plan (participant deferrals and Bank matching contributions are referred to herein as Supplemental BEP Savings Benefits). The make-up benefits under the BEP vest according to the corresponding provisions of the Savings Plan and the Cash Balance Plan.
Effective January 1, 2005, in response to IRC Section 409A, we froze the then-existing BEP (now referred to as the Original BEP) and implemented a new BEP conforming to IRC Section 409A and applicable notices and regulations, which changed the participant election process relating to the time and form of benefit payments (referred to herein as the New BEP).
Under the New BEP, a participant's Supplemental Cash Balance Benefits are payable in the form of a lump sum, single life annuity, 50% survivor annuity or 75% survivor annuity upon termination of employment, a set date or
210
age after termination of employment, becoming disabled after termination of employment, or death. Under the New BEP, a participant's Supplemental BEP Savings Benefits are payable in a lump sum or two to ten annual installments, and payments may commence at termination of employment, retirement, disability, death, or a specific date after termination of employment. In addition, a participant's elections with respect to the time and form of benefit payments are irrevocable unless the election is made 12 months prior to the scheduled distribution date and the new scheduled distribution date is delayed at least five years. If a participant does not elect the time or form of payment, his or her distribution will be a lump sum at termination of employment.
Under the Original BEP, a participant's Supplemental Cash Balance Benefits are paid in a single life annuity commencing at the later of age 65 or termination of employment, unless the participant elects an optional time and form of payment. The optional forms of payment are a lump sum or any other optional form then permitted under the Cash Balance Plan. Under the Original BEP, a participant's Supplemental BEP Savings Benefits are payable in a lump sum or two to ten installments upon retirement, termination of employment, death, or a specific date after termination of employment. Also, a participant can change the time and form of payment for the Supplemental Cash Balance Benefit at any time, but if the election provides for payment prior to age 65, then payment will not be made until 12 months after the date the Bank receives the new written election unless the participant elects an immediate lump sum distribution subject to forfeiture of 10% of the lump sum payment. Similarly, a participant may elect at any time to change the payout schedule of one or more of the participant's Supplemental BEP Savings Benefit accounts, provided that no payments will be made according to the new election until 12 months after the date the Bank receives the new written election, unless the participant elects an immediate lump sum distribution subject to forfeiture of 10% of the lump sum payment.
Participants are permitted to make five separate payout elections (a payout date and form of payment) with respect to the Supplemental BEP Savings Benefit under the Original BEP and under the New BEP.
Deferred Compensation Plan
Our Deferred Compensation Plan (DCP) is an unfunded and non-tax-qualified deferred compensation plan, consisting of three components for employees: (1) employee deferral of current compensation; (2) make-up matching contributions that would have been made by the Bank under the Savings Plan had the base salary compensation not been deferred; and (3) make-up pension benefits that would have been earned under the Cash Balance Plan had any amount of total annual compensation (base salary and short-term cash incentive compensation) not been deferred. See discussion in “Compensation Tables – Narrative to Non-Qualified Deferred Compensation Table.”
The DCP is available to all officers of the Bank, including the named executive officers. Directors are also able to defer their director fees under the DCP. The make-up benefits for employee participants under the DCP vest according to the corresponding provisions of the Savings Plan and the Cash Balance Plan.
Effective January 1, 2005, in response to IRC Section 409A, we froze the then-existing DCP (now referred to as the Original DCP) and implemented a new DCP, conforming to IRC Section 409A, which changed the participant election process related to the time and form of benefit payments (referred to herein as the New DCP).
Under the New DCP, participants' make-up Cash Balance Plan benefits are payable in the form of a lump sum, single life annuity, 50% survivor annuity or 75% survivor annuity upon termination of employment, a set date or age after termination of employment, becoming disabled after termination of employment, or death. If a participant does not elect a time or form of payment, the benefit is paid in a lump sum upon termination of employment. However, if the participant elects to receive his or her distribution at death and survives to the later of age 70½ or termination of employment, the benefit is paid upon the later of the two events in the form of a lump sum. Only a single time and form of distribution may be elected with respect to both the make-up Cash Balance Plan benefits under the New DCP and the make-up Cash Balance Plan benefits under the New BEP.
211
A participant's deferred compensation and the Bank's make-up Savings Plan matching contributions credited under the New DCP (including earnings on such amounts) are payable in a lump sum or two to ten annual installments, and payments may commence at termination of employment, retirement, disability, death, or a specific date no earlier than one year from the end of the deferral period. Participant elections with respect to the time and form of Savings Plan-related benefit payments from the New DCP are irrevocable unless the election is made 12 months prior to the scheduled distribution date and the new scheduled distribution date is delayed at least five years. If a participant does not elect the time or form of payment, his or her distribution will be a lump sum at termination of employment.
For participant-deferred compensation and make-up Bank matching contributions credited under the Original DCP, a participant may elect at any time to change the payout schedule of one or more of the participant's accounts, provided that no payments will be made according to the new election until 12 months after the date the Bank receives the new written election unless the participant elects an immediate lump sum distribution subject to forfeiture of 10% of the lump sum payment.
Participants are permitted to make five separate payout elections (a payout date and form of payment) under each of the New DCP and the Original DCP for distribution of participant deferrals and Bank matching contribution credits.
Under the Original DCP, participants' make-up Cash Balance Plan benefits are payable in the same form and at the same time as the participants' related benefits under the Cash Balance Plan.
Supplemental Executive Retirement Plan
Effective January 1, 2003, we began providing a Supplemental Executive Retirement Plan (SERP) to the Bank's senior officers, including the named executive officers. This plan is an unfunded and non-tax-qualified retirement benefit plan that provides a cash balance benefit to the Bank's senior officers (including the named executive officers) that is in addition to the tax-qualified benefits under the Cash Balance Plan.
The SERP supplements the Cash Balance Plan benefits to provide a competitive postretirement compensation package that is intended to help the Bank attract and retain key senior officers who are critical to the success of the Bank.
Benefits under the SERP are based on total annual compensation (base salary and short-term cash incentive compensation, including any deferrals under the BEP or DCP) and years of credited service as presented in the table below. In addition, participants accrue annual interest equal to 6% of balances accrued through the prior yearend. In addition, SERP benefits are limited to the extent that any participant's total pension retirement income exceeds fifty percent (50%) of the participant's final average pay. Final average pay is defined as a participant's highest average annual compensation during any three consecutive years during which he or she is a participant in the SERP. Annual benefits accrued under the SERP vest at the earlier of three years after they are earned or when the participant reaches age 62.
Years of Credited Service (As Defined in the Plan) | Amount of Contribution for President (Percentage of Total Annual Compensation) | Amount of Contribution for Other Participants (Percentage of Total Annual Compensation) | |||
| Fewer than 10 | 10 | % | 8 | % | |
| 10 or more but less than 15 | 15 | % | 12 | % | |
| 15 or more | 20 | % | 16 | % | |
The normal form and time of payment of benefits under the SERP is a lump sum upon the earlier of termination of employment, disability, or death. Upon a timely election, a participant may elect an optional form of payment to commence after termination of employment as specified in the plan.
212
No benefits are paid under the SERP if a participant's employment is terminated for cause (as defined in the plan). In addition, if a participant terminates employment prior to age 62, the final three years of unvested benefits are forfeited.
Other Elements of Compensation
We provide to all employees, including the named executive officers, health, dental, and vision insurance, and an employee assistance program for the employees and their spouses/partners and children, for which we pay approximately 80% of the premiums and the employee pays approximately 20%. In addition, we provide long-term disability and basic life insurance coverage to all employees at no cost to the employees.
The Bank makes available limited retiree health care benefits for eligible employees who retire from the Bank. To be classified as a Bank retiree eligible to enroll for retiree health care benefits, a Bank employee must be 55 years of age with a minimum of 10 years of Bank service on the date that his or her employment with the Bank terminates.
Perquisites
On occasion, the Bank may pay for resort activities for employees, including our named executive officers, in connection with business-related meetings; and in some cases, the Bank may pay the expenses for spouses/partners accompanying employees to these meetings or other Bank-sponsored events. The president receives use of a Bank-owned vehicle and its designated building parking space. Perquisites are valued at the actual amounts paid to the provider of the perquisites.
213
COMPENSATION COMMITTEE REPORT
The Compensation and Human Resources Committee (Compensation Committee) acts as the compensation committee on behalf of the Bank's Board of Directors. In fulfilling its oversight responsibilities, the Compensation Committee reviewed and discussed with management the Compensation Discussion and Analysis set forth in this annual report on Form 10-K.
Based on the Compensation Committee's review of the Compensation Discussion and Analysis and the discussions the Compensation Committee has had with management, the Compensation Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be included in this annual report on Form 10-K, which will be filed with the Securities and Exchange Commission.
Compensation and Human Resources Committee
Scott C. Syphax, Chair
Bradley W. Beal, Vice Chair
Steven R. Gardner
Brian M. Riley
John T. Wasley
214
COMPENSATION TABLES
| Summary Compensation Table | |||||||||||||||||||||||||||||
| (In whole dollars) | |||||||||||||||||||||||||||||
| Name and Principal Position | Year | Salary | Bonus (1) | Non-Equity Incentive Payment(2) | Non-Equity LTIP Payout(3) | Change in Pension Value and Non-Qualified Deferred Compensation(4) | All Other Compensation(5)(6) | Total | |||||||||||||||||||||
| Dean Schultz | 2015 | $ | 852,800 | $ | 35,533 | $ | 418,200 | $ | 400,100 | $ | — | (7) | $ | 61,106 | $ | 1,767,739 | |||||||||||||
| President and | 2014 | 828,000 | 359,200 | 390,900 | 67,313 | 61,644 | 1,707,057 | ||||||||||||||||||||||
| Chief Executive Officer | 2013 | 811,800 | 399,200 | 655,500 | 414,378 | 61,104 | 2,341,982 | ||||||||||||||||||||||
| Lisa B. MacMillen | 2015 | 546,300 | 22,763 | 270,100 | 256,300 | 49,211 | 40,295 | 1,184,969 | |||||||||||||||||||||
| Executive Vice President and | 2014 | 530,400 | 233,300 | 250,400 | 468,647 | 39,644 | 1,522,391 | ||||||||||||||||||||||
| Chief Operating Officer | 2013 | 520,000 | 255,700 | 335,900 | 113,431 | 39,421 | 1,264,452 | ||||||||||||||||||||||
| Kenneth C. Miller | 2015 | 444,800 | 18,533 | 219,900 | 208,600 | 202,885 | 35,534 | 1,130,252 | |||||||||||||||||||||
| Senior Vice President and | 2014 | 431,800 | 186,500 | 203,800 | 261,675 | 35,448 | 1,119,223 | ||||||||||||||||||||||
| Chief Financial Officer | 2013 | 423,300 | 208,100 | 227,900 | 139,169 | 36,094 | 1,034,563 | ||||||||||||||||||||||
| Lawrence H. Parks | 2015 | 461,376 | (8) | 18,367 | 217,900 | 206,800 | 184,575 | 32,703 | 1,121,721 | ||||||||||||||||||||
| Senior Vice President, | 2014 | 452,691 | (9) | 188,300 | 202,100 | 448,011 | 32,109 | 1,323,211 | |||||||||||||||||||||
| External and Legislative Affairs | 2013 | 439,772 | (10) | 206,300 | 237,100 | 10,087 | 34,686 | 927,945 | |||||||||||||||||||||
| Suzanne Titus-Johnson | 2015 | 395,100 | 116,463 | (11 | ) | 195,300 | 185,300 | 122,730 | 31,914 | 1,046,807 | |||||||||||||||||||
| Senior Vice President and | 2014 | 383,600 | 168,700 | 181,100 | 388,905 | 31,679 | 1,153,984 | ||||||||||||||||||||||
| General Counsel and Corporate Secretary | 2013 | 376,100 | 184,900 | 212,600 | 230,176 | 32,448 | 1,036,224 | ||||||||||||||||||||||
| David H. Martens | 2015 | 404,032 | (12) | 15,942 | 190,200 | 179,500 | 181,993 | 32,212 | 1,003,879 | ||||||||||||||||||||
| Senior Vice President and | 2014 | 385,788 | (13) | 170,000 | 175,400 | 225,329 | 31,745 | 988,262 | |||||||||||||||||||||
| Chief Risk Officer | 2013 | 392,214 | (14) | 178,800 | 205,900 | 124,398 | 40,110 | 941,422 | |||||||||||||||||||||
| (1) | Represents a Board-approved special award, consisting of an amount equal to one additional semi-monthly paycheck for all Bank employees to recognize Bank-wide teamwork and its contribution to the Bank’s exceptional overall performance. |
| (2) | Represents awards earned under the 2015, 2014, and 2013 PIPs and EIPs. See discussion in “Non-Equity Incentive Payments and Non-Equity Long-Term Incentive Payments.” |
| (3) | Represents awards earned under the 2013, 2012, and 2011 EPUPs. See discussion in “Non-Equity Incentive Payments and Non-Equity Long-Term Incentive Payments.” |
| (4) | Represents the aggregate change in actuarial present value of each of the named executive officers' accumulated benefits under the Bank's qualified and non-qualified defined benefit pension plans (Cash Balance Plan; frozen FIRF, if applicable; restored pension benefit under the Benefit Equalization Plan (BEP); make-up pension benefit under the Deferred Compensation Plan (DCP); and Supplemental Executive Retirement Plan (SERP)). There are no above-market or preferential earnings on the named executive officers' DCP accounts. |
| (5) | Includes perquisites and premiums for disability and life insurance paid by the Bank. On occasion, the Bank pays for resort activities for employees in connection with Board meetings and other business-related meetings; and, in some cases, the Bank may pay the expenses for spouses accompanying employees to these meetings or other Bank-sponsored events. The President receives use of a Bank-owned vehicle. Perquisites are valued at the actual amounts paid to the provider of the perquisites. The value of some perquisites is not reasonably quantifiable, but is known to be de minimis. |
| (6) | Includes the Bank’s matching contributions under the Savings Plan and the Bank’s restored and make-up matching amounts credited under the BEP and DCP. |
| (7) | In accordance with SEC rules, negative changes in pension value are not included in this table. The negative change in pension value for Mr. Schultz is $167,764, which is due to certain limitations imposed under the SERP and the post age 65 decreasing annuity factors under the frozen FIRF. |
| (8) | Of this amount, $20,576 represents a vacation cash-out payment. |
| (9) | Of this amount, $24,691 represents a vacation cash-out payment. |
| (10) | Of this amount, $20,172 represents a vacation cash-out payment. |
(11) Of this amount, $100,000 represents a discretionary cash incentive compensation award under the 2015 EIP.
(12) Of this amount, $21,432 represents a vacation cash-out payment.
| (13) | Of this amount, $14,288 represents a vacation cash-out payment. |
| (14) | Of this amount, $28,014 represents a vacation cash-out payment. |
215
| Grants of Non-Equity Incentive Plan-Based Awards | |||||||||||||||||
| (In whole dollars) | Estimated Payout Ranges(1) | ||||||||||||||||
| Name | Plan | Plan Period | Payout Date | Threshold | Target | Maximum | |||||||||||
| Dean Schultz | 2015 EPUP | 2015-2017 | February 2018 | $ | 170,600 | $ | 341,100 | $ | 426,400 | ||||||||
| 2015 PIP | 2015 | February 2016 | 170,600 | 341,100 | 426,400 | ||||||||||||
| Lisa B. MacMillen | 2015 EPUP | 2015-2017 | February 2018 | 109,300 | 218,500 | 273,200 | |||||||||||
| 2015 EIP | 2015 | February 2016 | 109,300 | 218,500 | 273,200 | ||||||||||||
| Kenneth C. Miller | 2015 EPUP | 2015-2017 | February 2018 | 89,000 | 177,900 | 222,400 | |||||||||||
| 2015 EIP | 2015 | February 2016 | 89,000 | 177,900 | 222,400 | ||||||||||||
| Lawrence H. Parks | 2015 EPUP | 2015-2017 | February 2018 | 88,200 | 176,300 | 220,400 | |||||||||||
| 2015 EIP | 2015 | February 2016 | 88,200 | 176,300 | 220,400 | ||||||||||||
| Suzanne Titus-Johnson | 2015 EPUP | 2015-2017 | February 2018 | 79,000 | 158,000 | 197,600 | |||||||||||
| 2015 EIP | 2015 | February 2016 | 79,000 | 158,000 | 197,600 | ||||||||||||
| David H. Martens | 2015 EPUP | 2015-2017 | February 2018 | 76,500 | 153,000 | 191,300 | |||||||||||
| 2015 EIP | 2015 | February 2016 | 76,500 | 153,000 | 191,300 | ||||||||||||
(1) Estimated payouts for the 2015 EPUP three-year performance period are what could be earned and are calculated using the base salaries in effect at
the beginning of each performance period. Awards, if any, under the 2015 EPUP are payable following the end of the three-year performance period
and the completion of regulatory review. See discussion in “Compensation Discussion and Analysis – Elements of our Executive Compensation
Program - Long-Term Cash Incentive Plan: Executive Performance Unit Plan.” The payouts for the 2015 PIP and EIP are the amounts that could
have been earned by the respective executive officers for 2015. Actual amounts earned under the 2015 PIP and 2015 EIP are included in the
Summary Compensation Table.
Narrative to Summary Compensation Table and Grants of Non-Equity Incentive Plan-Based Awards Table
At Will Employees
All employees of the Bank are “at will” employees, including the named executive officers. The named executive officers may resign at any time, and the Bank may terminate their employment at any time, for any reason or no reason, with or without cause and with or without notice.
The 2015 base salaries of the current named executive officers were as follows: Dean Schultz, $852,800; Lisa B. MacMillen, $546,300; Kenneth C. Miller, $444,800; Lawrence H. Parks, $440,800; Suzanne Titus-Johnson, $395,100; and David H. Martens, $382,600. For 2016, the base salaries of the current named executive officers are as follows: Dean Schultz, $852,800; Lisa B. MacMillen, $557,200; Kenneth C. Miller, $458,100; Lawrence H. Parks, $454,000; Suzanne Titus-Johnson, $407,000; and David H. Martens, $394,100.
Corporate Senior Officer Severance Policy. The Corporate Senior Officer Severance Policy (Senior Officers' Policy) is applicable to the president, executive vice president, and senior vice presidents. The Senior Officers' Policy provides severance benefits in the event that the employee's employment is terminated because the employee's job or position is eliminated or because the job or position is substantially modified so that the employee is no longer qualified or cannot perform the revised job. For these officers, severance under the Senior Officers' Policy is equal to the greater of (i) 12 weeks of the officer's base salary, or (ii) the sum of three weeks of the officer's base salary, plus three weeks of the officer's base salary for each full year of service and three weeks of base salary prorated for each partial year of service at the Bank to a maximum of 52 weeks of base salary. The Senior Officers' Policy also provides one month of continued health and life insurance benefits and, at the Bank's discretion, outplacement assistance.
The Senior Officers' Policy also provides severance payments in connection with a “Change in Control” (as defined by the Senior Officers' Policy). Under the Senior Officers' Policy, in the event the president or the executive vice
216
president experiences a termination of employment in connection with a Change in Control, severance and benefits will be payable pursuant to the Change in Control Severance Agreements described below.
The Senior Officers' Policy provides that in the event a senior vice president is involuntarily terminated without “Cause” under certain circumstances or voluntarily terminated with “Good Reason” (as defined by the Senior Officers' Policy) in connection with a Change in Control, upon the Bank's timely receipt of a separation agreement and release, these executive officers will receive severance pay in a lump sum equal to one year of base salary.
In addition, under the Senior Officers' Policy, in the event of a qualifying termination in connection with a Change in Control, each senior vice president will be entitled to continued health and life insurance coverage under the Bank's group health and life insurance policies, at the Bank's expense, for a period of 12 months immediately following the effective date of separation. However, the Bank will immediately cease paying such premiums prior to the end of the 12-month period if the executive officer accepts employment with another employer that provides comparable benefits in terms of cost and scope of coverage during the 12-month period. If the Bank is not in compliance with any applicable regulatory capital or regulatory leverage requirement or if any of the payments required to be made to senior vice presidents pursuant to the Senior Officers' Policy would cause the Bank to fall below such applicable regulatory requirements, such payment will be delayed until the Bank achieves compliance with its regulatory capital requirements.
The Board believes that the level of severance benefits for each named executive officer is appropriate because it is reasonable to believe that finding a comparable position at another institution at a comparable compensation level could take up to one year, and possibly longer, depending on the economic environment at the time, and that the distraction of this uncertainty may have a detrimental impact on the executive's performance. If the employment of any of the named executive officers had been terminated on December 31, 2015, because the employee's job or position had been eliminated or because the job or position had been substantially modified so that the employee was no longer qualified or could not perform the revised job, the approximate value of the severance benefits payable to the executive (subject to Finance Agency regulatory review) would have been as follows: Dean Schultz, $854,834; Lisa B. MacMillen, $549,113; Kenneth C. Miller, $447,872; Lawrence H. Parks, $441,834; Suzanne Titus-Johnson, $397,978; and David H. Martens, $384,552.
Change in Control Agreements. The Board approved Change in Control Severance Agreements for the president and chief executive officer, Dean Schultz, and the executive vice president and chief operating officer, Lisa B. MacMillen (Agreements). The Agreements became effective as of June 1, 2011. Each Agreement provides for a severance payment and continued benefits if the executive's employment terminates under certain circumstances in connection with a “Change in Control” (as defined in the Agreements) of the Bank. In particular, under the terms of each executive's Agreement, if the executive terminates his or her employment for “Good Reason” (as defined in the Agreements), he or she shall be entitled to receive, in lieu of any severance benefits to which the executive may otherwise be entitled under any severance plan or program of the Bank, the following: (i) the executive's fully earned but unpaid base salary through the date of termination (together with all other amounts and benefits to which the executive is entitled under any benefit plan or practice of the Bank other than the Bank's Senior Officers' Policy); (ii) severance pay in an amount equal to the sum of two times the executive's annual base salary plus two times the executive's “Annual Incentive Amounts” (as defined in the Agreements); (iii) continued health and life insurance coverage for up to 180 days after the first anniversary of the date of termination of the executive's employment (or if earlier, the date the executive accepts employment from an employer with comparable benefits); and (iv) executive-level outplacement services at the Bank's expense, not to exceed $25,000. If the Bank is not in compliance with any applicable regulatory capital or regulatory leverage requirement or if any of the payments required to be made pursuant to items (ii) or (iv) above would cause the Bank to fall below such applicable regulatory requirements, the payment will be delayed until the Bank achieves compliance with its regulatory capital requirements. Had the employment of Mr. Schultz or Ms. MacMillen been terminated under certain circumstances in connection with a Change in Control on December 31, 2015, the approximate value of the benefits, excluding amounts of any executive-level outplacement benefits, payable to Mr. Schultz and Ms. MacMillen (subject to Finance Agency regulatory review) would have been $2,508,146 and $1,636,359, respectively
217
Non-Equity Incentive Payments and Non-Equity Long-Term Incentive Payments
For 2015, Dean Schultz, president and chief executive officer, was awarded a cash incentive compensation award under the 2015 President's Incentive Plan (2015 PIP) of $418,200. Mr. Schultz's award was based on the Bank's 2015 achievement level of 134.5% for the Franchise Enhancement goal, 150.0% for the Community Investment goal, and 150.0% for the Risk Management goal, and his 2015 achievement level for his individual goal.
Based on the achievement levels for the Bank's three corporate goals and the achievement levels of named executive officers for their respective individual goals, the following awards under the 2015 EIP were made: Lisa B. MacMillen, $270,100; Kenneth C. Miller, $219,900; Lawrence H. Parks, $217,900; Suzanne Titus-Johnson, $195,300; and David H. Martens, $190,200. Suzanne Titus-Johnson also received a discretionary cash incentive compensation award in the amount of $100,000 under the 2015 EIP for her achievements in overseeing and managing the Bank’s legal projects.
In reviewing the Bank's 2015 performance, the Board recognized the president's leadership and the other named executive officers' management in addressing business, risk, operations, regulatory, and public policy issues, as well as challenging market conditions and a challenging regulatory environment, throughout 2015. In particular, the Board recognized that the president and other executive officers implemented several initiatives to enhance the Bank's risk management and operations while delivering strong financial and community investment results.
The Risk Management goal, which consisted of two goal components, was measured at an aggregate achievement level of 150.0%. In determining the level of achievement, the Board recognized management's accomplishments in identifying a range of industry approaches that could be used to evaluate the maturity of the enterprise and business process risk assessments and using insights from the maturity assessment to evaluate how to enhance the business value of the annual risk assessments. The Board also considered the implementation of processes and technologies necessary to achieve certain milestones in connection with the Bank’s corporate data protection initiative. With respect to the first goal component, the achievement level was based on management completing its evaluation of the maturity of the Bank’s risk assessment processes and redesigning the Annual Risk Assessment processes and methodology. With respect to the second goal component, achievement was based on management’s implementation of processes and technologies necessary to effectively enumerate and classify all Bank data, while enabling more robust monitoring and strengthening protections against potential accidental loss and malicious or unauthorized access to the Bank’s systems. In addition, the Board recognized management’s achievements in the enhancements to the Bank’s risk assessment processes and added business value resulting from the Bank’s risk assessment processes, including new templates and processes that provide a standardized risk event framework for users, a focused compliance section and updated database, risk quantification for the likelihood and impact of risk events, and relative rank ordering of current risks and top emerging risks.
The Bank's Franchise Enhancement goal, which consisted of six goal components, was measured at an aggregate achievement level of 134.5%. The Board recognized the Bank's financial performance in 2015 for the financial performance goal component (which excluded the impact of other-than-temporary impairment charges and litigation settlements gains), the achievements relating to the Bank’s four member business goal components, and the technology initiatives goal component relating to franchise enhancement. With respect to the financial performance goal component, the Adjusted Return on Capital Spread goal target level for 2015 was 3.75% and the Bank achieved a spread of 4.20% (net of adjustments). Although the Bank exceeded the financial performance goal target and far exceeded three of the four member business goal targets, the aggregate achievement level for the Bank's Franchise Enhancement goal was offset by the achievement level of meets (100% of target) in the technology initiatives goal component of the Franchise Enhancement goal.
The Board further noted the Bank's strong performance on its Community Investment goal, which was measured at an achievement level of 150.0% for 2015. The Bank far exceeded the two goal components in the Community Investment goal to increase support of community investment activities.
218
For the 2013 EPUP, covering the three-year period 2013 through 2015, long-term cash incentive compensation awards to the named executive officers were based on the achievement levels for the Bank's Adjusted Return on Capital Spread goal and Risk Management goal over the three-year performance period from 2013 through 2015. The overall achievement level for the goals over this period was 141%, reflecting the effect of above-target performance on the Adjusted Return on Capital Spread goal in 2013, 2014, and 2015. The target level for the three-year period 2013 through 2015 was 2.20%, and the Bank achieved a spread of 3.84% (net of adjustments). The overall achievement level also reflected an achievement level for the Risk Management goal component of 137%, which was the average of the actual Risk Management goal achievement levels under the 2013, 2014, and 2015 annual short-term cash incentive compensation plans.
The awards approved by the Board under the 2013 EPUP were as follows: Dean Schultz, $400,100; Lisa B. MacMillen, $256,300; Kenneth C. Miller, $208,600; Lawrence H. Parks, $206,800; Suzanne Titus-Johnson, $185,300; and David H. Martens, $179,500.
Pension Benefits
The following table provides the present value of accumulated pension and pension-related benefits payable as of December 31, 2015, to each of the named executive officers upon the normal retirement age of 65 under the Bank's qualified and non-qualified defined benefit pension plans.
219
| (In whole dollars) | ||||||||||||
| Name | Plan Name | Years of Credited Service | Present Value of Accumulated Benefits(1) | Payments During Last Fiscal Year | ||||||||
| Dean Schultz | Cash Balance Plan | 30.750 | $ | 590,221 | $ | — | ||||||
| Financial Institutions Retirement Fund | 11.000 | 476,997 | — | |||||||||
| Benefit Equalization Plan | 30.750 | 3,402,317 | — | |||||||||
| Deferred Compensation Plan | 30.750 | 74,886 | — | |||||||||
Supplemental Executive Retirement Plan(2) | 13.000 | 1,894,905 | — | |||||||||
| Lisa B. MacMillen | Cash Balance Plan | 29.417 | 596,042 | — | ||||||||
| Financial Institutions Retirement Fund | 9.417 | 124,423 | — | |||||||||
| Benefit Equalization Plan | 29.417 | 1,059,795 | — | |||||||||
| Deferred Compensation Plan | 29.417 | 441,004 | — | |||||||||
Supplemental Executive Retirement Plan(2) | 13.000 | 1,056,789 | — | |||||||||
| Kenneth C. Miller | Cash Balance Plan | 20.917 | 513,160 | — | ||||||||
| Financial Institutions Retirement Fund | 0.917 | 24,723 | — | |||||||||
| Benefit Equalization Plan | 20.917 | 346,822 | — | |||||||||
| Deferred Compensation Plan | 20.917 | 20,229 | — | |||||||||
Supplemental Executive Retirement Plan(2) | 13.000 | 1,156,705 | — | |||||||||
| Lawrence H. Parks | Cash Balance Plan | 18.333 | 523,131 | — | ||||||||
| Financial Institutions Retirement Fund | N/A | — | — | |||||||||
| Benefit Equalization Plan | 18.333 | 429,524 | — | |||||||||
| Deferred Compensation Plan | 18.333 | 99,932 | — | |||||||||
Supplemental Executive Retirement Plan(2) | 13.000 | 1,444,468 | — | |||||||||
| Suzanne Titus-Johnson | Cash Balance Plan | 29.333 | 780,168 | — | ||||||||
| Financial Institutions Retirement Fund | 9.333 | 132,137 | — | |||||||||
| Benefit Equalization Plan | 29.333 | 770,069 | — | |||||||||
| Deferred Compensation Plan | 29.333 | 36,823 | — | |||||||||
Supplemental Executive Retirement Plan(2) | 10.750 | 936,587 | — | |||||||||
| David H. Martens | Cash Balance Plan | 19.167 | 439,499 | — | ||||||||
| Financial Institutions Retirement Fund | N/A | — | — | |||||||||
| Benefit Equalization Plan | 19.167 | 224,418 | — | |||||||||
| Deferred Compensation Plan | 19.167 | 74,644 | — | |||||||||
Supplemental Executive Retirement Plan(2) | 13.000 | 1,059,922 | — | |||||||||
| (1) | For purposes of this table, the present value of accumulated benefits as of December 31, 2015 (measured December 31, 2015) was calculated using a discount rate of 3.75%, which is consistent with the assumptions used in the Bank's financial statements. Actual benefit payments under each plan may differ based on the applicable discount rate under the terms of the relevant plan. The Bank withdrew from the FIRF, a multiple-employer tax-qualified defined benefit plan, on December 31, 1995. Amounts under the BEP and the DCP represent the present value of only the pension-related benefits accumulated for the named executive officer. |
| (2) | For the purposes of this table, the years of credited service for the SERP represent the years of participation since the inception of the SERP in 2003 or the first year in which the participant initially became active in the SERP. For purposes of determining the amount of Bank contribution in the SERP table, the years of credited service are defined in the SERP. |
Narrative to Pension Benefits Table
For information regarding the plans in the table, see the discussion in our Compensation Discussion and Analysis under “Cash Balance Plan and the Financial Institutions Retirement Fund,” “Benefit Equalization Plan,” “Deferred
220
Compensation Plan,” and “Supplemental Executive Retirement Plan.” The valuation method and material assumptions used in quantifying the present value of the current accrued benefits in the table are consistent with the assumptions used in the Bank's financial statements. See the discussion in “Item 8. Financial Statements and Supplementary Data – Note 16 – Employee Retirement Plans and Incentive Compensation Plans.”
Non-Qualified Deferred Compensation
The following table reflects the non-qualified Deferred Compensation Plan balances for the president, the executive vice president, and the other named executive officers as of December 31, 2015.
| (In whole dollars) | |||||||||||||||||||||||||
| Name and Principal Position | Last Fiscal Year | Beginning of Year Balance | 2015 Executive Contributions(1) | 2015 Bank Contributions(2) | Aggregate Earnings/ (Losses) in 2015 | Aggregate (Withdrawals)/ Distributions in 2015 | Yearend 2015 Aggregate Balance(3) | ||||||||||||||||||
| Dean Schultz | 2015 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||||
| President and | |||||||||||||||||||||||||
| Chief Executive Officer | |||||||||||||||||||||||||
| Lisa B. MacMillen | 2015 | 5,031,212 | 464,907 | — | (83,977 | ) | — | 5,412,142 | |||||||||||||||||
| Executive Vice President and | |||||||||||||||||||||||||
| Chief Operating Officer | |||||||||||||||||||||||||
| Kenneth C. Miller | 2015 | — | — | — | — | — | — | ||||||||||||||||||
| Senior Vice President and | |||||||||||||||||||||||||
| Chief Financial Officer | |||||||||||||||||||||||||
| Lawrence H. Parks | 2015 | 362,683 | 90,000 | 5,400 | 41 | — | 458,124 | ||||||||||||||||||
| Senior Vice President, | |||||||||||||||||||||||||
| External and Legislative Affairs | |||||||||||||||||||||||||
| Suzanne Titus-Johnson | 2015 | — | — | — | — | — | — | ||||||||||||||||||
| Senior Vice President and | |||||||||||||||||||||||||
| General Counsel and Corporate Secretary | |||||||||||||||||||||||||
| David H. Martens | 2015 | 264,498 | 362,659 | 2,016 | (37,598 | ) | — | 591,575 | |||||||||||||||||
| Senior Vice President and | |||||||||||||||||||||||||
| Chief Risk Officer | |||||||||||||||||||||||||
| (1) | The 2015 executive contributions made by Ms. MacMillen are included in the "Non-Equity Incentive Payment" and "Non-Equity LTIP Payout" columns in the Summary Compensation Table (SCT), the 2015 executive contributions made by Mr. Parks are included in the "Salary" column for 2015 in the SCT, and the 2015 executive contributions made by Mr. Martens are included in the "Salary," "Non-Equity Incentive Payment," and “Non-Equity LTIP Payout" columns for 2015 in the SCT. |
| (2) | Represents make-up Bank matching contributions lost under the Savings Plan as a result of deferring compensation. The 2015 Bank contribution made to Mr. Parks and Mr. Martens are included in the “All Other Compensation" column for 2015 in the SCT. |
| (3) | The yearend 2015 aggregate balance for Mr. Parks includes $84,000 and $78,000 reported in the "Salary" Column for 2014 and 2013 in the SCT, respectively, and includes $5,040 and $4,680 reported in the "All Other Compensation" column for 2014 and 2013 in the SCT, respectively. The yearend 2015 aggregate balance for Mr. Martens includes $28,800 reported in the "Salary" column for 2014 in the SCT, and includes $1,728 reported in the "All Other Compensation" column for 2014 in the SCT. |
Narrative to Non-Qualified Deferred Compensation Table
The Non-Qualified Deferred Compensation Table presents information about our Deferred Compensation Plan (DCP), which is designed to allow Bank officers to defer up to 100% of base salary and short- and long-term incentive cash compensation awards, as applicable. Directors may also participate in the DCP to defer up to 100% of their director fees.
221
In addition, since one of the factors involved in determining benefits under the Bank's Savings Plan is an officer's annual base salary compensation, this table also presents make-up matching contributions that would have been made by the Bank under the Savings Plan had the annual base salary compensation not been deferred.
The Bank's matching contribution under the Savings Plan is calculated on the basis of an officer's base salary after deferring base salary compensation under the DCP. As a result, an officer who defers base salary compensation forgoes the Bank's matching contribution on the portion of compensation that is deferred. To compensate for this, the Bank makes a contribution credit to the officer's DCP balance to restore the benefit under the Savings Plan that would otherwise be lost as a result of deferring base salary compensation.
Participants may direct the investments of deferred amounts into core mutual funds or into a brokerage account. Participants may change these investment directions at any time. All investment earnings accumulate to the benefit of the participants on a tax-deferred basis. Brokerage fees relating to purchases and sales are charged against the value of the participant's deferred balance in the plan. The Bank pays all set-up and annual account administration fees.
Income taxes are deferred until a participant receives payment of funds from the plan. Participants may elect payouts in a lump sum or over a payout period from 2 to 10 years. A participant may change any previously elected payment schedule by submitting a written election. Any written election to change the payment schedule must be made at least 12 months prior to the original payout date, and the new payout date, in most cases, must be at least 5 years from the original payout date.
222
Director Compensation
We provide our directors with compensation for the performance of their duties as members of the Board of Directors and for the amount of time spent on the Bank’s business.
| Director Compensation Table For the Year Ended December 31, 2015 | |||
| (In whole dollars) | |||
| Name | Fees Earned or Paid in Cash | ||
John F. Luikart(1) | $ | 100,000 | |
Douglas H. (Tad) Lowrey(2) | 95,000 | ||
| Bradley W. Beal | 88,814 | ||
| Craig G. Blunden | 90,000 | ||
| Steven R. Gardner | 88,814 | ||
| Melinda Guzman | 90,000 | ||
| Richard A. Heldebrant | 90,000 | ||
| Simone Lagomarsino | 90,000 | ||
| Kevin Murray | 90,000 | ||
| Robert F. Nielsen | 90,000 | ||
| Brian M. Riley | 75,000 | ||
| John F. Robinson | 80,791 | ||
| Scott C. Syphax | 90,000 | ||
| John T. Wasley | 90,000 | ||
| Total | $ | 1,248,419 | |
| (1) | Chairman during 2015. |
(2) Vice Chairman during 2015.
The Board of Directors Compensation and Expense Reimbursement Policy for 2015 (2015 Directors Compensation Policy) provided the directors with compensation for the performance of their duties as members of the Board of Directors and the amount of time spent on official Bank business, as set forth below.
| (In whole dollars) | |||||||||||
| Position | Maximum Annual Service Fee | Maximum Annual Meeting Fees | Total Maximum Annual Compensation | ||||||||
| Chairman | $ | 55,000 | $ | 45,000 | $ | 100,000 | |||||
| Vice Chairman | 50,000 | 45,000 | 95,000 | ||||||||
| Committee Chair | 45,000 | 45,000 | 90,000 | ||||||||
| Directors on Audit Committee | 35,000 | 45,000 | 80,000 | ||||||||
| Other Directors | 30,000 | 45,000 | 75,000 | ||||||||
Under the 2015 Directors Compensation Policy, service fees for the above positions were paid for serving as a director during and between regularly scheduled meetings of the Board. The maximum annual service fee was prorated and paid with the meeting fee, if applicable, at the conclusion of each two-month service period on the Board of Directors (monthend February, April, June, August, October, and December). In addition, each director received a fee of $9,000 for attending any portion of five of the six regularly scheduled two-day Board meetings, subject to the annual maximum of $45,000.
223
The 2015 Directors Compensation Policy provided that a director could receive a meeting fee for participation in one regularly scheduled Board meeting by telephone. No other fee was paid for participation in meetings of the Board or committees by telephone or participation in other Bank or FHLBank System activities. The president of the Bank was authorized to interpret the 2015 Directors Compensation Policy, as necessary, according to applicable statutory, regulatory, and policy limits.
Under the 2015 Directors Compensation Policy, the final prorated service fee was to be withheld if a director did not attend at least 75% of all regular and special meetings of the Board and the director's assigned committees for the year, or if the Board determined a director had consistently demonstrated a lack of engagement and participation in meetings attended. In addition, the meeting fee attendance requirement provided that a director would receive a meeting fee only if he or she attended the regular Board meeting as well as at least one assigned committee meeting during the Board's regularly scheduled two-day meetings.
Under the 2015 Directors Compensation Policy, the Bank reimbursed directors for necessary and reasonable travel, subsistence, and other related expenses incurred in connection with the performance of their official duties, which may have included participation in meetings or activities for which no fee was paid.
For expense reimbursement purposes, directors' official duties included:
•Meetings of the Board and Board committees,
•Meetings requested by the Finance Agency and FHLBank System committees,
•Meetings of the Council of FHLBanks and its committees,
•Meetings of the Bank's Affordable Housing Advisory Council,
•Events attended on behalf of the Bank when requested by the president in consultation with the chairman,
•Other events attended on behalf of the Bank with the prior approval of the EEO-Personnel-Compensation
Committee of the Board, and
•Director education events attended with the prior approval of the chairman.
The Board adopted a Board of Directors Compensation and Expense Reimbursement Policy for 2016, which is substantially similar to the 2015 Directors Compensation Policy with the exception that the maximum total director fees were increased by $5,000 for all directors, audit committee directors and committee chairs (except for the chairs of the audit committee and risk committee); and increased by $15,000 for the Board chair and vice chair. In addition, the maximum fee for the chairs of the audit committee and the risk committee are $100,000. Director fees were increased to more closely align with relevant market benchmarks for director compensation and trends at other FHLBanks.
.
224
| ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
The following table sets forth information about those stockholders that are beneficial owners of more than 5% of the Federal Home Loan Bank of San Francisco’s outstanding capital stock, including mandatorily redeemable capital stock, as of February 29, 2016.
| Name and Address of Beneficial Owner | Number of Shares Held | Percentage of Outstanding Shares | |||
JPMorgan Chase Bank, National Association(1)(2) | 3,999,609 | 14.3 | % | ||
| 560 Mission Street | |||||
| San Francisco, CA 94105 | |||||
| Bank of the West | 2,089,956 | 7.5 | |||
| 180 Montgomery Street | |||||
| San Francisco, CA 94104 | |||||
| Total | 6,089,565 | 21.8 | % | ||
| (1) | Nonmember institution. |
(2) Effective August 31, 2015, JPMorgan Bank & Trust Company, National Association (JPMorgan B&T), merged with and into JPMorgan Chase
Bank, National Association (JPMorgan Chase). As a result, JPMorgan B&T is no longer a member of the Bank. Upon the merger, all of the Bank
capital stock held by JPMorgan B&T was transferred to JPMorgan Chase, a nonmember of the Bank, and reclassified as mandatorily redeemable
capital stock, and all advances to JPMorgan B&T were transferred to JPMorgan Chase.
The following table sets forth information about those members (or their holding companies) with officers or directors serving as directors of the Federal Home Loan Bank of San Francisco as of February 29, 2016.
| Director Name | Name of Institution | City | State | Number of Shares Held | Percentage of Outstanding Shares | ||||||
| Bradley W. Beal | One Nevada Credit Union | Las Vegas | NV | 13,915 | 0.1 | % | |||||
| Craig G. Blunden | Provident Savings Bank | Riverside | CA | 80,943 | 0.3 | ||||||
| Steven R. Gardner | Pacific Premier Bank | Irvine | CA | 144,459 | 0.5 | ||||||
| Richard A. Heldebrant | Star One Credit Union | Sunnyvale | CA | 520,689 | 1.8 | ||||||
| Simone Lagomarsino | Heritage Oaks Bank | Paso Robles | CA | 78,531 | 0.3 | ||||||
| Douglas H. (Tad) Lowrey | Pacific Western Bank | Beverly Hills | CA | 237,060 | 0.8 | ||||||
| Brian M. Riley | Mohave State Bank | Lake Havasu City | AZ | 13,263 | 0.1 | ||||||
| John F. Robinson | Silicon Valley Bank | Santa Clara | CA | 172,500 | 0.6 | ||||||
| Total | 1,261,360 | 4.5 | % | ||||||||
| ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE |
Capital stock ownership is a prerequisite to transacting any member business with the Federal Home Loan Bank of San Francisco (Bank). The members, former members, and certain other nonmembers own all the capital stock of the Bank, the majority of the directors of the Bank are officers or directors of members, and the Bank conducts its advances and purchased mortgage loan business almost exclusively with members or member successors. The Bank extends credit in the ordinary course of business to members with officers or directors who serve as directors of the Bank and to members owning more than 5% of the Bank's capital stock (5% shareholders) on market terms that are no more favorable to them than the terms of comparable transactions with other members. In addition, the Bank may transact short-term investments, Federal funds sold, and mortgage-backed securities (MBS) with members and their affiliates that have officers or directors who serve as directors of the Bank or with 5% shareholders. All
225
investments are market rate transactions, and all MBS are purchased through securities brokers or dealers. The Bank may also be the primary obligor on debt issued in the form of Federal Home Loan Bank (FHLBank) System consolidated obligations using underwriters and dealers, and may enter into interest rate exchange agreements with counterparties, that may be affiliates of Bank members with officers or directors who serve as directors of the Bank or affiliates of members and nonmembers owning more than 5% of the Bank's capital stock, which are transactions in the ordinary course of the Bank's business and are market rate transactions.
The FHLBank Act requires the Bank to establish an Affordable Housing Program (AHP). The Bank provides subsidies to members, which use the funds to assist in the purchase, construction, or rehabilitation of housing for very low-, low-, and moderate-income households. Subsidies may be in the form of direct grants or below-market interest rate advances. Only Bank members, along with their nonmember AHP project sponsors, may submit AHP applications. All AHP subsidies are made in the ordinary course of business.
The FHLBank Act also requires the Bank to establish a Community Investment Program (CIP) and authorizes the Bank to offer additional Community Investment Cash Advance (CICA) programs. Under these programs, the Bank provides subsidies in the form of grants and below-market interest rate advances or standby letters of credit to members for community lending and economic development projects. Only Bank members may submit applications for these credit program subsidies. All CICA subsidies are made in the ordinary course of business.
In instances where an AHP or CICA transaction involves a member that owns more than 5% of the Bank's capital stock (or an affiliate of such a member), a member with an officer or director who is a director of the Bank, or an entity with an executive officer, director, controlling shareholder, or general partner who serves as a director of the Bank (and that has a direct or indirect interest in the subsidy), the transaction is subject to the same eligibility and other program criteria and requirements as all other comparable transactions and to the regulations governing the operations of the relevant program.
The Bank may also use members that have officers or directors who serve as directors of the Bank or 5% shareholders or their affiliates as securities custodians and derivative dealer counterparties. These financial relationships are conducted in the ordinary course of business on terms and conditions similar to those that would be available for comparable services if provided by unaffiliated entities.
The Bank does not have a written policy to have the Board of Directors (Board) review, approve, or ratify transactions with members that are outside the ordinary course of business because such transactions rarely occur. However, it has been the Bank's practice to report to the Board all transactions between the Bank and its members that are outside the ordinary course of business, and, on a case-by-case basis, seek Board approval or ratification.
Director Independence
General
Under the rules of the Securities and Exchange Commission (SEC), the Bank is required to identify directors who are independent, and members of the Board's Audit Committee and Compensation and Human Resources Committee and any committee performing similar functions to a nominating committee who are not independent, using the independence definition of a national securities exchange or automated quotation system. The Bank's capital stock is not listed on a national securities exchange or automated quotation system, and the Bank's Board of Directors is not subject to the independence requirement of any such exchange or automated quotation system. The Bank is subject to the independence standards for directors serving on the Bank's Audit Committee set forth in the rules of the Federal Housing Finance Agency, and looks to the Finance Agency independence standards to determine independence for all directors, whether or not they serve on the Audit Committee. In addition, for purposes of compliance with the SEC's disclosure rules only, the Board has evaluated director independence using the definition of independence articulated in the rules of the National Association of Securities Dealers Automated Quotations (NASDAQ).
226
In addition to the independence rules and standards above, the FHLBanks are required to comply with the rules issued by the SEC under Section 10A(m) of the Securities Exchange Act of 1934, which includes a substantive independence rule prohibiting a director from being a member of the Audit Committee if he or she, other than in his or her capacity as a member of the Audit Committee, the Bank's Board of Directors, or any other Board committee, accepts any consulting, advisory, or other compensatory fee from the Bank or is an “affiliated person” of the Bank as defined by the SEC rules (the person controls, is controlled by, or is under common control with the Bank).
Director Independence under the Finance Agency Regulations
The Finance Agency director independence rule provides that a director is sufficiently independent to serve as a member of the Bank's Audit Committee if that director does not have a disqualifying relationship with the Bank or its management that would interfere with the exercise of that director's independent judgment. Disqualifying relationships under the Finance Agency independence standards include, but are not limited to: (i) employment with the Bank at any time during the last five years; (ii) acceptance of compensation from the Bank other than for service as a director; (iii) being a consultant, advisor, promoter, underwriter, or legal counsel for the Bank at any time within the last five years; and (iv) being an immediate family member of an individual who is or who has been a Bank executive officer within the past five years.
Although the Finance Agency's independence standard only applies by regulation to members of the Bank's Audit Committee, the Bank's Board looks to this standard for purposes of determining independence of all Bank directors.
The independence standard imposed on the Audit Committee under the Finance Agency regulations takes into account the fact that the Bank was created by Congress; the Bank has a cooperative ownership structure; the Bank is statutorily required to have member directors who are either an officer or director of a Bank member; the Bank was created to provide its members with products and services; and the Bank's Board of Directors is statutorily required to administer the affairs of the Bank fairly and impartially and without discrimination in favor of or against any member borrower. The Finance Agency's independence standards do not include as a disqualifying relationship any business relationships between a director's member institution and the Bank. Consistent with the rule, the Bank's Board does not believe that the statutorily prescribed business relationships between a director's member institution and the Bank interfere with the director's exercise of his or her independent judgment. The national securities exchanges' independence definition, including those of the NASDAQ, do not generally take into account the cooperative nature of the Bank. Accordingly, the Bank's Board believes that the appropriate standard for measuring director independence is the Finance Agency's independence standards.
Applying the Finance Agency independence standards, the Board has determined that all directors who served in 2015 were, and all current directors are, independent.
Director Independence under the NASDAQ Rules
If the Bank uses the NASDAQ standard for purposes of complying with the SEC disclosure rules, the Board must make an affirmative determination that the director does not have a relationship with the Bank that would impair his or her independence. “Independent director” under the NASDAQ rules means a person other than an executive officer or employee of the company or any other individual having a relationship which, in the opinion of the issuer's board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.
In addition, the NASDAQ rules set forth seven relationships that automatically preclude a determination of director independence. Among other things, a director is not considered to be independent if the director is, or has a family member who is, a partner in, or a controlling shareholder or an executive officer of, any organization to which the Bank made, or from which the Bank received, payments for property or services in the current or any of the past three fiscal years that exceed 5% of the recipient's consolidated gross revenues for that year, or $200,000, whichever is more. This particular relationship is referred to below as the payments/revenues relationship.
227
Using the NASDAQ rules, the Board affirmatively determined that in its opinion Ms. Guzman, Mr. Luikart, Mr. Murray, Mr. Nielsen, Mr. Syphax, and Mr. Wasley, who are current nonmember directors and are not employed by and do not serve as a director of any member institution, are independent and, to the extent they served as nonmember directors in 2015, were independent in 2015 under the NASDAQ rules because they have no relationship with the Bank that would interfere with their exercise of independent judgment in carrying out their responsibilities.
Using the NASDAQ rules, the Board affirmatively determined that in its opinion the following current member directors are independent and, to the extent they served as member directors in 2015, were independent in 2015 under the NASDAQ rules because they have no relationship with the Bank that would interfere with their exercise of independent judgment in carrying out their responsibilities as directors: Mr. Beal, Mr. Blunden, Mr. Gardner, Mr. Heldebrant, Ms. Lagomarsino, Mr. Lowrey, Mr. Riley, and Mr. Robinson.
In making these determinations, the Board recognized that during their directorships the member directors were employed by or served as a director of a member institution that may have conducted business with the Bank in the ordinary course of the Bank's and the member institution’s respective businesses. The Board determined that these ordinary course customer relationships with the member institutions that had or have member directors on the Board would not interfere with the member directors' exercise of independent judgment or their independence from management under the NASDAQ rules. This determination is based on the fact that the Bank was created by Congress, the Bank has a cooperative ownership structure, the Bank is statutorily required to have member directors who are either an officer or director of a Bank member, the Bank was created to provide its members with products and services, and the Board is statutorily required to administer the affairs of the Bank fairly and impartially and without discrimination in favor of or against any member borrower.
Audit Committee Independence
The Board has an Audit Committee. Under the Finance Agency's independence standards and NASDAQ rules, all Audit Committee members who served in 2015 were independent and all current Audit Committee members are independent.
All Audit Committee members who served in 2015 and all current Audit Committee members met the substantive independence rules under Section 10A(m) of the 1934 Act.
Compensation and Human Resources Committee Independence
The Board has a Compensation and Human Resources Committee. Using the Finance Agency's director independence standards and under the NASDAQ rules, all Compensation and Human Resources Committee members who served in 2015 were independent, and all current Compensation and Human Resources Committee members are independent.
Under the NASDAQ rules, to be considered an independent compensation committee member, a director must meet the definition under the general NASDAQ independence rules, and the board of directors must affirmatively determine the independence of any director who will serve on the company’s compensation committee and must consider all factors specifically relevant to determining whether such a director has a relationship to the company that is material to that director’s ability to be independent from management in connection with the duties of a compensation committee member. Relevant factors must include the source of compensation of directors, including any consulting, advisory, or other compensatory fee paid by the company to the directors and whether the director is affiliated with the company.
Governance Committee
The Board has a Governance Committee that performs certain functions that are similar to those of a nominating committee with respect to the nomination of nonmember independent directors. Using the Finance Agency’s
228
director independence standards, all Governance Committee members who served in 2015 were independent and all current Governance Committee members are independent.
| ITEM 14. | PRINCIPAL ACCOUNTING FEES AND SERVICES |
The following table sets forth the aggregate fees billed to the Federal Home Loan Bank of San Francisco (Bank) for the years ended December 31, 2015 and 2014, by its external accounting firm, PricewaterhouseCoopers LLP.
| (In millions) | 2015 | 2014 | |||||
| Audit fees | $ | 0.9 | $ | 0.9 | |||
| All other fees | — | — | |||||
| Total | $ | 0.9 | $ | 0.9 | |||
Audit Fees. Audit fees during 2015 and 2014 were for professional services rendered in connection with the audits of the Bank's annual financial statements, the review of the Bank's quarterly financial statements included in each Quarterly Report on Form 10-Q, and the audit of the Bank's internal control over financial reporting.
All Other Fees. All other fees for 2015 and 2014 were for consulting and advisory services. The Bank is exempt from all federal, state, and local taxation, and no tax consulting fees were paid during 2015 and 2014.
Audit Committee Pre-Approval Policy
In accordance with the Securities and Exchange Commission rules and regulations implementing the Securities Exchange Act of 1934 (SEC rules), all audit, audit-related, and non-audit services proposed to be performed by the Bank's independent auditor must be pre-approved by the Audit Committee to ensure that they do not impair the auditor's independence. The SEC rules require that proposed services either be specifically pre-approved on a case-by-case basis (specific pre-approval services) or be pre-approved without case-by-case review under policies and procedures established by the Audit Committee that are detailed as to the particular service and do not delegate Audit Committee responsibilities to management (general pre-approval services).
The Bank's Audit Committee has adopted a policy, the Independent Auditor Services Pre-Approval Policy (Policy), setting forth the procedures and conditions pursuant to which services proposed to be performed by the Bank's independent auditor may be approved. Under the Policy, unless services to be provided by the independent auditor have received general pre-approval, they require specific pre-approval by the Audit Committee. Any proposed services exceeding the pre-approved maximum fee amounts set forth in the appendices to the Policy will also require specific pre-approval by the Audit Committee.
The Policy is designed to be detailed as to the particular services that may be provided by the independent auditor and to provide for the Audit Committee to be informed of each service provided by the independent auditor. The Policy is also intended to ensure that the Audit Committee does not delegate to management its responsibilities in connection with the approval of services to be provided by the independent auditor.
For both specific pre-approval and general pre-approval of services, the Audit Committee considers whether the proposed services are consistent with the SEC rules on auditor independence and whether the provision of the services by the independent auditor would impair the independent auditor's independence. The Audit Committee also considers (i) whether the independent auditor is positioned to provide effective and efficient services, given its familiarity with the Bank's business, management, culture, accounting systems, risk profile, and other factors, and (ii) whether having the independent auditor provide the service may enhance the Bank's ability to manage or control risk or improve audit quality. The Audit Committee also considers the total amounts of fees for audit, audit-related, and non-audit services for a given calendar year in deciding whether to pre-approve any such services and may choose to determine, for a particular calendar year, the appropriate ratio between the total amount of fees for audit and audit-related services and the total amount of fees for permissible non-audit services.
229
The Audit Committee annually reviews and pre-approves the services that may be provided by the independent auditor during a given calendar year without specific pre-approval from the Audit Committee.
The Audit Committee has delegated to its chair and vice chair individually specific pre-approval authority for additional audit or audit-related services to be provided by the independent auditor, provided that the estimated fee for each type of proposed service does not exceed $50,000 and the total aggregated fees for all services pre-approved by each individual under this delegated authority do not exceed $100,000 in a calendar year. The chair or vice chair, as the case may be, is required to report to the Audit Committee any services pre-approved under the delegated authority.
In 2015 and 2014, 100% of the audit-related fees and all other fees were pre-approved by the Audit Committee.
PART IV.
| ITEM 15. | EXHIBITS, FINANCIAL STATEMENT SCHEDULES |
| (a) (1) | Financial Statements |
The financial statements included as part of this Form 10-K are identified in the Index to Audited Financial Statements appearing in “Item 8. Financial Statements and Supplementary Data” of this Form 10-K, which is incorporated in this Item 15 by reference.
| (2) | Financial Statement Schedules |
All financial statement schedules are omitted because they are either not applicable or the required information is shown in the financial statements or the notes thereto.
(b) Exhibits
| Exhibit No. | Description | ||
| 3.1 | Organization Certificate and resolutions relating to the organization of the Federal Home Loan Bank of San Francisco incorporated by reference to Exhibit 3.1 to the Bank's Registration Statement on Form 10 filed with the Securities and Exchange Commission on June 30, 2005 (Commission File No. 000-51398) | ||
| 3.2 | Bylaws of the Federal Home Loan Bank of San Francisco, as amended and restated on January 31, 2014, incorporated by reference to Exhibit 3.2 to the Bank’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 14, 2014 (Commission File No. 000-51398) | ||
| 4.1 | Capital Plan, as amended and restated effective April 1, 2015, and updated August 3, 2015, to reflect adjustments to activity-based stock requirements | ||
| 10.1 | Summary Sheet: Terms of Employment for Named Executive Officers for 2016 | ||
| 10.2 | Form of Director Indemnification Agreement, incorporated by reference to Exhibit 10.2 to the Bank's Registration Statement on Form 10 filed with the Securities and Exchange Commission on June 30, 2005 (Commission File No. 000-51398) | ||
| 10.3 | Form of Senior Officer Indemnification Agreement, incorporated by reference to Exhibit 10.3 to the Bank's Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 23, 2011 (Commission File No. 000-51398) | ||
| 10.4 | 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) | ||
| 10.5 | 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) | ||
| 10.6 | Board Resolution for 2016 Board of Directors Compensation and Expense Reimbursement Policy, incorporated by reference to Exhibit 10.1 to the Bank's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 6, 2015 (Commission File No. 000-51398) | ||
230
| 10.7+ | 2016 President’s Incentive Plan | ||
| 10.8+ | 2015 President’s Incentive Plan incorporated by reference to Exhibit 10.1 to the Bank’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 8, 2015 (Commission File No. 000-51398) | ||
| 10.9+ | 2016 Executive Incentive Plan | ||
| 10.10+ | 2015 Executive Incentive Plan incorporated by reference to Exhibit 10.2 to the Bank’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 8, 2015 (Commission File No. 000-51398) | ||
| 10.11 | 2016 Executive Performance Unit Plan | ||
| 10.12 | 2015 Executive Performance Unit Plan incorporated by reference to Exhibit 10.3 to the Bank’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 8, 2015 (Commission File No. 000-51398) | ||
| 10.13 | 2014 Executive Performance Unit Plan, incorporated by reference to Exhibit 10.3 to the Bank's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 9, 2014 (Commission File No. 000-51398) | ||
| 10.14 | 2013 Executive Performance Unit Plan, incorporated by reference to Exhibit 10.3 to the Bank's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 10, 2013 (Commission File No. 000-51398) | ||
| 10.15 | Executive Benefit Plan, incorporated by reference to Exhibit 10.11 to the Bank's Registration Statement on Form 10 filed with the Securities and Exchange Commission on June 30, 2005 (Commission File No. 000-51398) | ||
| 10.16 | Original Deferred Compensation Plan, as restated, incorporated by reference to Exhibit 10.13 to Bank's Registration Statement on Form 10 filed with the Securities and Exchange Commission on June 30, 2005 (Commission File No. 000-51398) | ||
| 10.17 | Deferred Compensation Plan Amended and Restated Effective January 1, 2009, incorporated by reference to Exhibit 10.14 to the Bank's Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 23, 2011 (Commission File No. 000-51398) | ||
| 10.18 | Supplemental Executive Retirement Plan, as amended and restated on July 1, 2013, incorporated by reference to Exhibit 10.15 to the Bank’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 14, 2014 (Commission File No. 000-51398) | ||
| 10.19 | Corporate Senior Officer Severance Policy, as amended and restated on August 14, 2013, incorporated by reference to Exhibit 10.16 to the Bank’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 14, 2014 (Commission File No. 000-51398) | ||
| 10.20 | Federal Home Loan Bank P&I Funding and Contingency Plan Agreement, effective as of July 20, 2006, by and among the Office of Finance and each of the Federal Home Loan Banks, incorporated by reference to Exhibit 10.1 to the Bank's Current Report on Form 8-K filed with the Securities and Exchange Commission on June 28, 2006 (Commission File No. 000-51398) | ||
| 10.21 | 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) | ||
| 12.1 | Computation of Ratio of Earnings to Fixed Charges – December 31, 2015 | ||
| 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 | ||
| 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 | ||
| 99.1++ | Audit Committee Report | ||
231
| 101 | Pursuant to Rule 405 of Regulation S-T, the following financial information from the Bank's annual report on Form 10-K for the period ended December 31, 2015, is formatted in XBRL interactive data files: (i) Statements of Condition at December 31, 2015 and 2014; (ii) Statements of Income for the Years Ended December 31, 2015, 2014, and 2013; (iii) Statements of Comprehensive Income for the Years Ended December 31, 2015, 2014, and 2013; (iv) Statements of Capital Accounts for the Years Ended December 31, 2015, 2014, and 2013; (v) Statements of Cash Flows for the Years Ended December 31, 2015, 2014, and 2013; and (vi) Notes to Financial Statements. | ||
| + | Confidential treatment has been requested as to portions of this exhibit. |
| ++ | The report contained in Exhibit 99.1 is being furnished and will not be deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended. |
232
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 March 11, 2016.
FEDERAL HOME LOAN BANK OF SAN FRANCISCO | |
| /S/ DEAN SCHULTZ | |
Dean Schultz President and Chief Executive Officer | |
| March 11, 2016 | |
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 March 11, 2016.
| /S/ DEAN SCHULTZ | |
Dean Schultz President and Chief Executive Officer (principal executive officer) | |
| /S/ LISA B. MACMILLEN | |
Lisa B. MacMillen Executive Vice President and Chief Operating Officer (principal executive officer) | |
| /S/ KENNETH C. MILLER | |
Kenneth C. Miller Senior Vice President and Chief Financial Officer (principal financial officer and principal accounting officer) | |
| /S/ DOUGLAS H. (TAD) LOWREY | |
Douglas H. (Tad) Lowrey Chairman of the Board of Directors | |
| /S/ MELINDA GUZMAN | |
Melinda Guzman Vice Chairman of the Board of Directors | |
| /S/ BRADLEY W. BEAL | |
Bradley W. Beal Director | |
| /S/ CRAIG G. BLUNDEN | |
| Craig G. Blunden Director | |
| /S/ STEVEN R. GARDNER | |
Steven R. Gardner Director | |
233
| /S/ RICHARD A. HELDEBRANT | |
Richard A. Heldebrant Director | |
| /S/ SIMONE LAGOMARSINO | |
Simone Lagomarsino Director | |
| /S/ JOHN F. LUIKART | |
John F. Luikart Director | |
| /S/ KEVIN MURRAY | |
Kevin Murray Director | |
| /S/ ROBERT F. NIELSEN | |
Robert F. Nielsen Director | |
| /S/ BRIAN M. RILEY | |
Brian M. Riley Director | |
| /S/ JOHN F. ROBINSON | |
John F. Robinson Director | |
| /S/ SCOTT C. SYPHAX | |
Scott C. Syphax Director | |
/S/ JOHN T. WASLEY | |
John T. Wasley Director | |
234