UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2011
or
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from __________ to __________.
Commission File No. 000-51399
FEDERAL HOME LOAN BANK OF CINCINNATI
(Exact name of registrant as specified in its charter)
Federally chartered corporation | 31-6000228 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
1000 Atrium Two, P.O. Box 598, | ||
Cincinnati, Ohio | 45201-0598 | |
(Address of principal executive offices) | (Zip Code) |
(513) 852-7500
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
x Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions 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 | Smaller reporting company o |
(Do not check if a smaller reporting company) |
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
As of October 31, 2011, the registrant had 31,083,064 shares of capital stock outstanding. The capital stock of the Federal Home Loan Bank of Cincinnati is not listed on any securities exchange or quoted on any automated quotation system, only may be owned by members and former members and is transferable only at its par value of $100 per share.
Page 1
Table of Contents
PART I - FINANCIAL INFORMATION | ||
Item 1. | Financial Statements (Unaudited): | |
Statements of Condition - September 30, 2011 and December 31, 2010 | ||
Statements of Income - Three and nine months ended September 30, 2011 and 2010 | ||
Statements of Capital - Nine months ended September 30, 2011 and 2010 | ||
Statements of Cash Flows - Nine months ended September 30, 2011 and 2010 | ||
Notes to Unaudited Financial Statements | ||
Item 2. | Management's Discussion and Analysis of Financial Condition and Results of Operations | |
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | |
Item 4. | Controls and Procedures | |
PART II - OTHER INFORMATION | ||
Item 1A. | Risk Factors | |
Item 6. | Exhibits | |
Signatures |
2
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
FEDERAL HOME LOAN BANK OF CINCINNATI
STATEMENTS OF CONDITION
(In thousands, except par value)
(Unaudited)
September 30, 2011 | December 31, 2010 | ||||||
ASSETS | |||||||
Cash and due from banks | $ | 2,385,145 | $ | 197,623 | |||
Interest-bearing deposits | 181 | 108 | |||||
Securities purchased under agreements to resell | 1,900,000 | 2,950,000 | |||||
Federal funds sold | 3,690,000 | 5,480,000 | |||||
Investment securities: | |||||||
Trading securities | 4,386,554 | 6,402,781 | |||||
Available-for-sale securities | 3,619,364 | 5,789,736 | |||||
Held-to-maturity securities (includes $0 and $0 pledged as collateral at September 30, 2011 and December 31, 2010, respectively, that may be repledged) (a) | 12,457,939 | 12,691,545 | |||||
Total investment securities | 20,463,857 | 24,884,062 | |||||
Advances | 30,345,120 | 30,181,017 | |||||
Mortgage loans held for portfolio: | |||||||
Mortgage loans held for portfolio | 7,888,701 | 7,782,140 | |||||
Less: allowance for credit losses on mortgage loans | 15,300 | 12,100 | |||||
Mortgage loans held for portfolio, net | 7,873,401 | 7,770,040 | |||||
Accrued interest receivable | 125,730 | 132,355 | |||||
Premises, software, and equipment, net | 9,609 | 10,441 | |||||
Derivative assets | 5,276 | 2,499 | |||||
Other assets | 123,120 | 23,117 | |||||
TOTAL ASSETS | $ | 66,921,439 | $ | 71,631,262 | |||
LIABILITIES | |||||||
Deposits: | |||||||
Interest bearing | $ | 1,275,174 | $ | 1,437,671 | |||
Non-interest bearing | 14,366 | 14,756 | |||||
Total deposits | 1,289,540 | 1,452,427 | |||||
Consolidated Obligations, net: | |||||||
Discount Notes | 33,339,516 | 35,003,280 | |||||
Bonds (includes $4,107,393 and $0 at fair value under fair value option at September 30, 2011 and December 31, 2010) | 27,510,687 | 30,696,791 | |||||
Total Consolidated Obligations, net | 60,850,203 | 65,700,071 | |||||
Mandatorily redeemable capital stock | 330,894 | 356,702 | |||||
Accrued interest payable | 153,299 | 190,728 | |||||
Affordable Housing Program payable | 75,881 | 88,037 | |||||
Payable to REFCORP | — | 11,002 | |||||
Derivative liabilities | 100,416 | 227,982 | |||||
Other liabilities | 586,800 | 81,785 | |||||
Total liabilities | 63,387,033 | 68,108,734 | |||||
Commitments and contingencies | |||||||
CAPITAL | |||||||
Capital stock Class B putable ($100 par value); 31,060 and 30,924 shares issued and outstanding at September 30, 2011 and December 31, 2010, respectively | 3,105,991 | 3,092,377 | |||||
Retained earnings: | |||||||
Unrestricted | 432,089 | 437,874 | |||||
Restricted | 3,723 | — | |||||
Total retained earnings | 435,812 | 437,874 | |||||
Accumulated other comprehensive loss: | |||||||
Net unrealized loss on available-for-sale securities | (617 | ) | (264 | ) | |||
Pension and postretirement plans benefits | (6,780 | ) | (7,459 | ) | |||
Total accumulated other comprehensive loss | (7,397 | ) | (7,723 | ) | |||
Total capital | 3,534,406 | 3,522,528 | |||||
TOTAL LIABILITIES AND CAPITAL | $ | 66,921,439 | $ | 71,631,262 |
(a) | Fair values: $12,918,884 and $13,019,799 at September 30, 2011 and December 31, 2010, respectively. |
The accompanying notes are an integral part of these financial statements.
3
FEDERAL HOME LOAN BANK OF CINCINNATI
STATEMENTS OF INCOME
(In thousands)
(Unaudited)
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2011 | 2010 | 2011 | 2010 | ||||||||||||
INTEREST INCOME: | |||||||||||||||
Advances | $ | 54,801 | $ | 76,966 | $ | 173,365 | $ | 220,064 | |||||||
Prepayment fees on Advances, net | 2,579 | 889 | 3,809 | 4,102 | |||||||||||
Interest-bearing deposits | 113 | 275 | 370 | 664 | |||||||||||
Securities purchased under agreements to resell | 252 | 1,387 | 1,816 | 2,489 | |||||||||||
Federal funds sold | 946 | 2,776 | 3,949 | 8,831 | |||||||||||
Trading securities | 9,715 | 140 | 28,896 | 1,080 | |||||||||||
Available-for-sale securities | 917 | 3,516 | 6,546 | 8,872 | |||||||||||
Held-to-maturity securities | 84,765 | 125,110 | 298,872 | 396,710 | |||||||||||
Mortgage loans held for portfolio | 76,734 | 93,698 | 253,209 | 309,638 | |||||||||||
Loans to other FHLBanks | — | 3 | 3 | 6 | |||||||||||
Total interest income | 230,822 | 304,760 | 770,835 | 952,456 | |||||||||||
INTEREST EXPENSE: | |||||||||||||||
Consolidated Obligations - Discount Notes | 5,987 | 11,348 | 24,089 | 27,803 | |||||||||||
Consolidated Obligations - Bonds | 177,421 | 228,758 | 554,124 | 717,030 | |||||||||||
Deposits | 99 | 381 | 508 | 1,059 | |||||||||||
Loans from other FHLBanks | — | — | — | 1 | |||||||||||
Mandatorily redeemable capital stock | 2,881 | 4,398 | 10,785 | 14,532 | |||||||||||
Total interest expense | 186,388 | 244,885 | 589,506 | 760,425 | |||||||||||
NET INTEREST INCOME | 44,434 | 59,875 | 181,329 | 192,031 | |||||||||||
Provision for credit losses | 2,289 | 3,827 | 5,967 | 3,827 | |||||||||||
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES | 42,145 | 56,048 | 175,362 | 188,204 | |||||||||||
OTHER (LOSS) INCOME: | |||||||||||||||
Service fees | 397 | 436 | 1,199 | 1,291 | |||||||||||
Net (losses) gains on trading securities | (7,637 | ) | 273 | (18,231 | ) | 56 | |||||||||
Net realized losses from sale of available-for-sale securities | — | — | — | (90 | ) | ||||||||||
Net realized gains from sale of held-to-maturity securities | 2,830 | 1,517 | 8,849 | 7,967 | |||||||||||
Net losses on Consolidated Obligation Bonds held under fair value option | (355 | ) | — | (893 | ) | — | |||||||||
Net (losses) gains on derivatives and hedging activities | (3,316 | ) | 3,800 | 1,848 | 2,682 | ||||||||||
Other, net | 1,613 | 1,831 | 4,461 | 4,281 | |||||||||||
Total other (loss) income | (6,468 | ) | 7,857 | (2,767 | ) | 16,187 | |||||||||
OTHER EXPENSE: | |||||||||||||||
Compensation and benefits | 8,157 | 7,850 | 23,718 | 22,385 | |||||||||||
Other operating | 3,909 | 3,906 | 11,208 | 10,806 | |||||||||||
Finance Agency | 1,336 | 897 | 3,570 | 2,799 | |||||||||||
Office of Finance | 874 | 675 | 2,643 | 2,156 | |||||||||||
Other | 398 | 203 | 1,200 | 737 | |||||||||||
Total other expense | 14,674 | 13,531 | 42,339 | 38,883 | |||||||||||
INCOME BEFORE ASSESSMENTS | 21,003 | 50,374 | 130,256 | 165,508 | |||||||||||
Affordable Housing Program | 2,388 | 4,561 | 12,139 | 14,994 | |||||||||||
REFCORP | — | 9,163 | 19,644 | 30,103 | |||||||||||
Total assessments | 2,388 | 13,724 | 31,783 | 45,097 | |||||||||||
NET INCOME | $ | 18,615 | $ | 36,650 | $ | 98,473 | $ | 120,411 |
The accompanying notes are an integral part of these financial statements.
4
FEDERAL HOME LOAN BANK OF CINCINNATI
STATEMENTS OF CAPITAL
Nine Months Ended September 30, 2011 and 2010
(In thousands)
(Unaudited)
Capital Stock Class B - Putable | Retained Earnings | |||||||||||||||||||||||
Shares | Par Value | Unrestricted | Restricted | Total | Accumulated Other Comprehensive Loss | Total Capital | ||||||||||||||||||
BALANCE, DECEMBER 31, 2009 | 30,635 | $ | 3,063,473 | $ | 411,782 | $ | — | $ | 411,782 | $ | (8,108 | ) | $ | 3,467,147 | ||||||||||
Proceeds from sale of capital stock | 660 | 66,034 | 66,034 | |||||||||||||||||||||
Net shares reclassified to mandatorily redeemable capital stock | (208 | ) | (20,827 | ) | (20,827 | ) | ||||||||||||||||||
Comprehensive income: | ||||||||||||||||||||||||
Net income | 120,411 | — | 120,411 | 120,411 | ||||||||||||||||||||
Other comprehensive income: | ||||||||||||||||||||||||
Net unrealized losses on available-for-sale securities | (41 | ) | (41 | ) | ||||||||||||||||||||
Pension and postretirement benefits | 572 | 572 | ||||||||||||||||||||||
Total comprehensive income | 120,942 | |||||||||||||||||||||||
Dividends on capital stock: | ||||||||||||||||||||||||
Cash | (106,984 | ) | (106,984 | ) | (106,984 | ) | ||||||||||||||||||
BALANCE, SEPTEMBER 30, 2010 | 31,087 | $ | 3,108,680 | $ | 425,209 | $ | — | $ | 425,209 | $ | (7,577 | ) | $ | 3,526,312 | ||||||||||
BALANCE, DECEMBER 31, 2010 | 30,924 | $ | 3,092,377 | $ | 437,874 | $ | — | $ | 437,874 | $ | (7,723 | ) | $ | 3,522,528 | ||||||||||
Proceeds from sale of capital stock | 266 | 26,590 | 26,590 | |||||||||||||||||||||
Net shares reclassified to mandatorily redeemable capital stock | (130 | ) | (12,976 | ) | (12,976 | ) | ||||||||||||||||||
Comprehensive income: | ||||||||||||||||||||||||
Net income | 94,750 | 3,723 | 98,473 | 98,473 | ||||||||||||||||||||
Other comprehensive income: | ||||||||||||||||||||||||
Net unrealized losses on available-for-sale securities | (353 | ) | (353 | ) | ||||||||||||||||||||
Pension and postretirement benefits | 679 | 679 | ||||||||||||||||||||||
Total comprehensive income | 98,799 | |||||||||||||||||||||||
Dividends on capital stock: | ||||||||||||||||||||||||
Cash | (100,535 | ) | (100,535 | ) | (100,535 | ) | ||||||||||||||||||
BALANCE, SEPTEMBER 30, 2011 | 31,060 | $ | 3,105,991 | $ | 432,089 | $ | 3,723 | $ | 435,812 | $ | (7,397 | ) | $ | 3,534,406 |
The accompanying notes are an integral part of these financial statements.
5
FEDERAL HOME LOAN BANK OF CINCINNATI
STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended September 30, | |||||||
2011 | 2010 | ||||||
OPERATING ACTIVITIES: | |||||||
Net income | $ | 98,473 | $ | 120,411 | |||
Adjustments to reconcile net income to net cash provided by operating activities: | |||||||
Depreciation and amortization | 38,656 | 29,533 | |||||
Change in net fair value adjustment on derivative and hedging activities | 121,871 | 164,604 | |||||
Net change in fair value adjustments on trading securities | 18,231 | (56 | ) | ||||
Net change in fair value adjustments on Consolidated Obligation Bonds held at fair value | 893 | — | |||||
Other adjustments | (2,891 | ) | (4,009 | ) | |||
Net change in: | |||||||
Accrued interest receivable | 6,655 | 14,299 | |||||
Other assets | 4,299 | 3,761 | |||||
Accrued interest payable | (35,929 | ) | (101,554 | ) | |||
Other liabilities | 32,429 | (26,336 | ) | ||||
Total adjustments | 184,214 | 80,242 | |||||
Net cash provided by operating activities | 282,687 | 200,653 | |||||
INVESTING ACTIVITIES: | |||||||
Net change in: | |||||||
Interest-bearing deposits | (127,714 | ) | (143,735 | ) | |||
Securities purchased under agreements to resell | 1,050,000 | (2,400,000 | ) | ||||
Federal funds sold | 1,790,000 | (3,815,000 | ) | ||||
Premises, software, and equipment | (1,108 | ) | (2,231 | ) | |||
Trading securities: | |||||||
Net decrease in short-term | 2,004,674 | 2,093,332 | |||||
Proceeds from maturities of long-term | 226 | 184 | |||||
Available-for-sale securities: | |||||||
Net decrease in short-term | 2,170,126 | 814,878 | |||||
Held-to-maturity securities: | |||||||
Net increase in short-term | (125,937 | ) | (893 | ) | |||
Proceeds from maturities of long-term | 2,568,875 | 2,699,455 | |||||
Proceeds from sale of long-term | 231,748 | 325,453 | |||||
Purchases of long-term | (2,118,192 | ) | (2,610,391 | ) | |||
Advances: | |||||||
Proceeds | 155,553,336 | 250,312,451 | |||||
Made | (155,728,280 | ) | (244,702,303 | ) | |||
Mortgage loans held for portfolio: | |||||||
Principal collected | 1,238,388 | 1,528,141 | |||||
Purchases | (1,357,523 | ) | (514,223 | ) | |||
Net cash provided by investing activities | 7,148,619 | 3,585,118 |
The accompanying notes are an integral part of these financial statements.
6
(continued from previous page)
FEDERAL HOME LOAN BANK OF CINCINNATI
STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended September 30, | |||||||
2011 | 2010 | ||||||
FINANCING ACTIVITIES: | |||||||
Net decrease in deposits and pass-through reserves | $ | (163,687 | ) | $ | (586,948 | ) | |
Net payments on derivative contracts with financing elements | (128,121 | ) | (132,241 | ) | |||
Net proceeds from issuance of Consolidated Obligations: | |||||||
Discount Notes | 376,084,644 | 447,681,790 | |||||
Bonds | 13,374,401 | 14,427,413 | |||||
Payments for maturing and retiring Consolidated Obligations: | |||||||
Discount Notes | (377,749,716 | ) | (442,405,057 | ) | |||
Bonds | (16,548,576 | ) | (24,170,154 | ) | |||
Proceeds from issuance of capital stock | 26,590 | 66,034 | |||||
Payments for redemption of mandatorily redeemable capital stock | (38,784 | ) | (328,376 | ) | |||
Cash dividends paid | (100,535 | ) | (106,984 | ) | |||
Net cash used in financing activities | (5,243,784 | ) | (5,554,523 | ) | |||
Net increase (decrease) in cash and cash equivalents | 2,187,522 | (1,768,752 | ) | ||||
Cash and cash equivalents at beginning of the period | 197,623 | 1,807,343 | |||||
Cash and cash equivalents at end of the period | $ | 2,385,145 | $ | 38,591 | |||
Supplemental Disclosures: | |||||||
Interest paid | $ | 621,901 | $ | 799,846 | |||
AHP payments, net | $ | 24,295 | $ | 25,015 | |||
REFCORP assessments paid | $ | 30,646 | $ | 33,131 |
The accompanying notes are an integral part of these financial statements.
7
FEDERAL HOME LOAN BANK OF CINCINNATI
NOTES TO UNAUDITED FINANCIAL STATEMENTS
Background Information
The Federal Home Loan Bank of Cincinnati (the FHLBank), a federally chartered corporation, is one of 12 District Federal Home Loan Banks (FHLBanks). The FHLBanks serve the public by enhancing the availability of credit for residential mortgages and targeted community development. The FHLBank is regulated by the Federal Housing Finance Agency (Finance Agency).
Note 1 - Basis of Presentation
The accompanying interim financial statements of the FHLBank have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The preparation of financial statements in accordance with GAAP requires management to make assumptions and estimates. These assumptions and estimates affect the reported amount of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of income and expenses. Actual results could differ from these estimates. The interim financial statements presented are unaudited, but they include all adjustments (consisting of only normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of the financial condition, results of operations, and cash flows for such periods. These financial statements do not include all disclosures associated with annual financial statements and accordingly should be read in conjunction with the audited financial statements and notes included in the FHLBank's annual report on Form 10-K for the year ended December 31, 2010 filed with the Securities and Exchange Commission (SEC). Results for the three and nine months ended September 30, 2011 are not necessarily indicative of operating results for the full year.
The FHLBank has evaluated subsequent events for potential recognition or disclosure through the issuance of these financial statements and believes there have been no material subsequent events requiring additional disclosure or recognition in these financial statements.
Note 2 - Recently Issued Accounting Standards and Interpretations
Disclosures about an Employer's Participation in a Multiemployer Plan. On September 21, 2011, the Financial Accounting Standards Board (FASB) issued guidance to enhance disclosures about an employer's participation in a multiemployer pension plan. This guidance is effective for annual periods ending after December 15, 2011 (December 31, 2011 for the FHLBank) and should be applied retrospectively for all periods presented. Early adoption is permitted. The adoption of this guidance will result in increased annual financial statement disclosures, but will not effect the FHLBank's financial condition, results of operations, or cash flows.
Presentation of Comprehensive Income. On June 16, 2011, FASB issued guidance to increase the prominence of other comprehensive income in financial statements. This guidance requires an entity that reports items of other comprehensive income to present comprehensive income in either a single statement or in two consecutive statements. This guidance eliminates the option to present other comprehensive income in a statement of capital. This guidance is effective for interim and annual periods beginning after December 15, 2011 (January 1, 2012 for the FHLBank) and should be applied retrospectively for all periods presented. Early adoption is permitted. The FHLBank plans to elect the two-statement approach beginning on January 1, 2012. The adoption of this guidance is expected to be limited to the presentation of its financial statements.
Fair Value Measurement and Disclosure Convergence. On May 12, 2011, the FASB and the International Accounting Standards Board issued substantially converged guidance on fair value measurement and disclosure requirements. This guidance clarifies how fair value accounting should be applied where its use is already required or permitted by other standards within GAAP or International Financial Reporting Standards; these amendments do not require additional fair value measurements. This guidance generally represents clarifications to the application of existing fair value measurement and disclosure requirements, as well as some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This guidance is effective for interim and annual periods beginning on or after December 15, 2011 (January 1, 2012 for the FHLBank) and should be applied prospectively. The adoption of this guidance may result in increased financial statement disclosures, but is not expected to have a material effect on the FHLBank's financial condition, results of operations, or cash flows.
8
Reconsideration of Effective Control for Repurchase Agreements. On April 29, 2011, the FASB issued guidance to improve the accounting for repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. The new guidance removes from the assessment of effective control: (1) the criterion requiring the transferor to have the ability to repurchase or redeem financial assets before their maturity on substantially the agreed terms, even in the event of the transferee's default, and (2) the collateral maintenance implementation guidance related to that criterion. This guidance is effective for interim and annual reporting periods beginning on or after December 15, 2011 (January 1, 2012 for the FHLBank). This guidance will be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. The FHLBank does not believe the adoption of this guidance will have a material effect on its financial condition, results of operations, or cash flows.
A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. On April 5, 2011, the FASB issued guidance to clarify which debt modifications constitute troubled debt restructurings. This guidance is intended to help creditors determine whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for presenting previously deferred disclosures related to troubled debt restructurings. The required disclosures were effective for interim and annual reporting periods beginning on or after June 15, 2011 (July 1, 2011 for the FHLBank) and applied retrospectively to troubled debt restructurings occurring on or after the beginning of the annual period of adoption. The adoption of this amended guidance resulted in increased financial statement disclosures, but did not materially affect the FHLBank's financial condition, results of operations, or cash flows. See Note 9 for additional disclosures required under this guidance.
Note 3 - Trading Securities
Major Security Types.
Table 3.1 - Trading Securities by Major Security Types (in thousands)
September 30, 2011 | December 31, 2010 | ||||||
Fair Value | Fair Value | ||||||
U.S. Treasury obligations | $ | 722,483 | $ | 1,904,834 | |||
Government-sponsored enterprises * | 3,661,867 | 4,495,516 | |||||
Mortgage-backed securities: | |||||||
Other U.S. obligation residential mortgage-backed securities ** | 2,204 | 2,431 | |||||
Total | $ | 4,386,554 | $ | 6,402,781 |
* | Consists of either debt securities issued and effectively guaranteed by Federal Home Loan Mortgage Corporation (Freddie Mac) or Federal National Mortgage Association (Fannie Mae) which have the backing of the U.S. government, although they are not obligations of the U.S. government, and/or debt securities issued by Federal Farm Credit Bank (FFCB). | |
** | Consists of Government National Mortgage Association (Ginnie Mae) mortgage-backed securities. |
Table 3.2 - Net (Losses) Gains on Trading Securities (in thousands)
Nine Months Ended September 30, | |||||||
2011 | 2010 | ||||||
Net (losses) gains on trading securities held at period end | $ | (11,883 | ) | $ | 285 | ||
Net losses on securities matured during the period | (6,348 | ) | (229 | ) | |||
Net (losses) gains on trading securities | $ | (18,231 | ) | $ | 56 |
9
Note 4 - Available-for-Sale Securities
Major Security Types.
Table 4.1 - Available-for-Sale Securities by Major Security Types (in thousands)
September 30, 2011 | |||||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized (Losses) | Fair Value | ||||||||||||
Commercial paper | $ | 299,988 | $ | — | $ | (37 | ) | $ | 299,951 | ||||||
Certificates of deposit | 3,245,000 | — | (576 | ) | 3,244,424 | ||||||||||
Other * | 74,993 | — | (4 | ) | 74,989 | ||||||||||
Total | $ | 3,619,981 | $ | — | $ | (617 | ) | $ | 3,619,364 | ||||||
December 31, 2010 | |||||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized (Losses) | Fair Value | ||||||||||||
Certificates of deposit | $ | 5,790,000 | $ | 28 | $ | (292 | ) | $ | 5,789,736 |
* | Consists of debt securities issued by International Bank for Reconstruction and Development. |
All securities outstanding with gross unrealized losses at September 30, 2011 have been in a continuous unrealized loss position for less than 12 months.
Redemption Terms.
Table 4.2 - Available-for-Sale Securities by Contractual Maturity (in thousands)
September 30, 2011 | December 31, 2010 | ||||||||||||||
Year of Maturity | Amortized Cost | Fair Value | Amortized Cost | Fair Value | |||||||||||
Due in one year or less | $ | 3,619,981 | $ | 3,619,364 | $ | 5,790,000 | $ | 5,789,736 |
Interest Rate Payment Terms.
Table 4.3 - Available-for-Sale Securities with Additional Interest Rate Payment Terms (in thousands)
September 30, 2011 | December 31, 2010 | ||||||
Amortized cost of available-for-sale securities: | |||||||
Fixed-rate | $ | 3,619,981 | $ | 5,790,000 |
Realized Gains and Losses. The FHLBank did not sell any securities out of its available-for-sale portfolio during the nine months ended September 30, 2011. The FHLBank received (in thousands) $854,910 in proceeds and realized (in thousands) $90 in gross losses and no gross gains from the sale of available-for-sale securities during the nine months ended September 30, 2010.
10
Note 5 - Held-to-Maturity Securities
Table 5.1 - Held-to-Maturity Securities by Major Security Types (in thousands)
September 30, 2011 | |||||||||||||||
Amortized Cost (1) | Gross Unrecognized Holding Gains | Gross Unrecognized Holding (Losses) | Fair Value | ||||||||||||
Government-sponsored enterprises * | $ | 23,893 | $ | 8 | $ | — | $ | 23,901 | |||||||
State or local housing agency obligations | 2,655 | — | — | 2,655 | |||||||||||
TLGP ** | 1,129,232 | 28 | (108 | ) | 1,129,152 | ||||||||||
Mortgage-backed securities: | |||||||||||||||
Other U.S. obligation residential mortgage-backed securities *** | 1,458,877 | 2,037 | — | 1,460,914 | |||||||||||
Government-sponsored enterprise residential mortgage-backed securities **** | 9,823,763 | 459,669 | (1,035 | ) | 10,282,397 | ||||||||||
Private-label residential mortgage-backed securities | 19,519 | 346 | — | 19,865 | |||||||||||
Total mortgage-backed securities | 11,302,159 | 462,052 | (1,035 | ) | 11,763,176 | ||||||||||
Total | $ | 12,457,939 | $ | 462,088 | $ | (1,143 | ) | $ | 12,918,884 | ||||||
December 31, 2010 | |||||||||||||||
Amortized Cost (1) | Gross Unrecognized Holding Gains | Gross Unrecognized Holding (Losses) | Fair Value | ||||||||||||
Government-sponsored enterprises * | $ | 22,108 | $ | — | $ | (1 | ) | $ | 22,107 | ||||||
State or local housing agency obligations | 2,955 | — | (148 | ) | 2,807 | ||||||||||
TLGP ** | 1,011,260 | 33 | (142 | ) | 1,011,151 | ||||||||||
Mortgage-backed securities: | |||||||||||||||
Other U.S. obligation residential mortgage-backed securities *** | 910,284 | — | (1,502 | ) | 908,782 | ||||||||||
Government-sponsored enterprise residential mortgage-backed securities **** | 10,656,957 | 367,285 | (39,050 | ) | 10,985,192 | ||||||||||
Private-label residential mortgage-backed securities | 87,981 | 1,779 | — | 89,760 | |||||||||||
Total mortgage-backed securities | 11,655,222 | 369,064 | (40,552 | ) | 11,983,734 | ||||||||||
Total | $ | 12,691,545 | $ | 369,097 | $ | (40,843 | ) | $ | 13,019,799 |
(1) | Carrying value equals amortized cost. | |
* | Consists of debt securities issued and effectively guaranteed by Freddie Mac and/or Fannie Mae, which have the backing of the U.S. government, although they are not obligations of the U.S. government. | |
** | Represents corporate debentures issued or guaranteed by the Federal Deposit Insurance Corporation (FDIC) under the Temporary Liquidity Guarantee Program (TLGP). | |
*** | Consists of mortgage-backed securities issued or guaranteed by the National Credit Union Administration (NCUA) and the U.S. government. | |
**** | Consists of mortgage-backed securities issued and effectively guaranteed by Freddie Mac and/or Fannie Mae, which have the backing of the U.S. government, although they are not obligations of the U.S. government. |
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Table 5.2 summarizes the held-to-maturity securities with unrealized losses, which are aggregated by major security type and length of time that individual securities have been in a continuous unrealized loss position.
Table 5.2 - Held-to-Maturity Securities in a Continuous Unrealized Loss Position (in thousands)
September 30, 2011 | |||||||||||||||||||||||
Less than 12 Months | 12 Months or more | Total | |||||||||||||||||||||
Fair Value | Gross Unrealized (Losses) | Fair Value | Gross Unrealized (Losses) | Fair Value | Gross Unrealized (Losses) | ||||||||||||||||||
TLGP * | $ | 701,870 | $ | (108 | ) | $ | — | $ | — | $ | 701,870 | $ | (108 | ) | |||||||||
Mortgage-backed securities: | |||||||||||||||||||||||
Government-sponsored enterprise residential mortgage-backed securities ** | 211,572 | (1,035 | ) | — | — | 211,572 | (1,035 | ) | |||||||||||||||
Total temporarily impaired | $ | 913,442 | $ | (1,143 | ) | $ | — | $ | — | $ | 913,442 | $ | (1,143 | ) | |||||||||
December 31, 2010 | |||||||||||||||||||||||
Less than 12 Months | 12 Months or more | Total | |||||||||||||||||||||
Fair Value | Gross Unrealized (Losses) | Fair Value | Gross Unrealized (Losses) | Fair Value | Gross Unrealized (Losses) | ||||||||||||||||||
Government-sponsored enterprises *** | $ | 22,107 | $ | (1 | ) | $ | — | $ | — | $ | 22,107 | $ | (1 | ) | |||||||||
State or local housing agency obligations | — | — | 2,807 | (148 | ) | 2,807 | (148 | ) | |||||||||||||||
TLGP * | 634,041 | (142 | ) | — | — | 634,041 | (142 | ) | |||||||||||||||
Mortgage-backed securities: | |||||||||||||||||||||||
Other U.S. obligation residential mortgage-backed securities **** | 908,782 | (1,502 | ) | — | — | 908,782 | (1,502 | ) | |||||||||||||||
Government-sponsored enterprise residential mortgage-backed securities ** | 1,493,725 | (39,050 | ) | — | — | 1,493,725 | (39,050 | ) | |||||||||||||||
Total temporarily impaired | $ | 3,058,655 | $ | (40,695 | ) | $ | 2,807 | $ | (148 | ) | $ | 3,061,462 | $ | (40,843 | ) |
* | Represents corporate debentures issued or guaranteed by the FDIC under the TLGP. | |
** | Consists of mortgage-backed securities issued and effectively guaranteed by Freddie Mac and/or Fannie Mae, which have the backing of the U.S. government, although they are not obligations of the U.S. government. | |
*** | Consists of debt securities issued and effectively guaranteed by Freddie Mac and/or Fannie Mae, which have the backing of the U.S. government, although they are not obligations of the U.S. government. | |
**** | Consists of mortgage-backed securities issued or guaranteed by the NCUA and the U.S. government. |
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Table 5.3 - Held-to-Maturity Securities by Contractual Maturity (in thousands)
September 30, 2011 | December 31, 2010 | ||||||||||||||
Year of Maturity | Amortized Cost (1) | Fair Value | Amortized Cost (1) | Fair Value | |||||||||||
Other than mortgage-backed securities: | |||||||||||||||
Due in 1 year or less | $ | 1,153,125 | $ | 1,153,053 | $ | 1,033,368 | $ | 1,033,258 | |||||||
Due after 1 year through 5 years | — | — | — | — | |||||||||||
Due after 5 years through 10 years | 2,655 | 2,655 | 2,955 | 2,807 | |||||||||||
Due after 10 years | — | — | — | — | |||||||||||
Total other | 1,155,780 | 1,155,708 | 1,036,323 | 1,036,065 | |||||||||||
Mortgage-backed securities | 11,302,159 | 11,763,176 | 11,655,222 | 11,983,734 | |||||||||||
Total | $ | 12,457,939 | $ | 12,918,884 | $ | 12,691,545 | $ | 13,019,799 |
(1) Carrying value equals amortized cost.
Expected maturities of some securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment fees.
Table 5.4 - Held-to-Maturity Securities with Additional Interest Rate Payment Terms (in thousands)
September 30, 2011 | December 31, 2010 | ||||||
Amortized cost of held-to-maturity securities other than mortgage-backed securities: | |||||||
Fixed-rate | $ | 1,153,125 | $ | 1,033,368 | |||
Variable-rate | 2,655 | 2,955 | |||||
Total other | 1,155,780 | 1,036,323 | |||||
Amortized cost of held-to-maturity mortgage-backed securities: | |||||||
Fixed-rate | 9,478,033 | 10,744,938 | |||||
Variable-rate | 1,824,126 | 910,284 | |||||
Total mortgage-backed securities | 11,302,159 | 11,655,222 | |||||
Total | $ | 12,457,939 | $ | 12,691,545 |
The amortized cost of the FHLBank's mortgage-backed securities classified as held-to-maturity includes net purchased premiums (in thousands) of $46,974 and $66,518 at September 30, 2011 and December 31, 2010.
Realized Gains and Losses. The FHLBank sold securities out of its held-to-maturity portfolio during the three and nine months ended September 30, 2011 and 2010, each of which had less than 15 percent of the acquired principal outstanding at the time of the sale. These sales are considered maturities for the purposes of security classification.
Table 5.5 - Proceeds and Gross Gains from Sale of Held-to-Maturity Securities (in thousands)
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2011 | 2010 | 2011 | 2010 | ||||||||||||
Proceeds from sale of long-term securities | $ | 106,098 | $ | 111,833 | $ | 337,846 | $ | 325,453 | |||||||
Gross gains from sale of held-to-maturity securities | 2,830 | 1,517 | 8,849 | 7,967 |
Note 6 - Other-Than-Temporary Impairment Analysis
The FHLBank evaluates its individual available-for-sale and held-to-maturity investment securities holdings in an unrealized loss position for other-than-temporary impairment on a quarterly basis. As part of its securities' evaluation for other-than-temporary impairment, the FHLBank considers its intent to sell each debt security and whether it is more likely than not that the FHLBank will be required to sell the security before its anticipated recovery. If either of these conditions is met, the
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FHLBank recognizes an other-than-temporary impairment in earnings equal to the entire difference between the security's amortized cost basis and its fair value at the balance sheet date. For securities in unrealized loss positions that meet neither of these conditions, the FHLBank performs analyses to determine if any of these securities are other-than-temporarily impaired. At September 30, 2011, the FHLBank's private-label residential mortgage-back security was in an unrealized gain position. As a result, the FHLBank did not consider this investment to be other-than-temporarily impaired at September 30, 2011.
For its other U.S. obligations, government-sponsored enterprise investments (mortgage-backed securities and non-mortgage-backed securities), and TLGP investments, the FHLBank determined that the strength of the issuers' guarantees through direct obligations or support from the U.S. government is sufficient to protect the FHLBank from losses based on current expectations. As a result, the FHLBank determined that, as of September 30, 2011, all of the gross unrealized losses on these investments were temporary as the declines in market value of these securities were not attributable to credit quality. Furthermore, the FHLBank does not intend to sell the investments, and it is not more likely than not that the FHLBank will be required to sell the investments before recovery of their amortized cost bases. As a result, the FHLBank did not consider any of these investments to be other-than-temporarily impaired at September 30, 2011.
The FHLBank also reviewed its available-for-sale securities and the remainder of its held-to-maturity securities that have experienced unrealized losses at September 30, 2011 and determined that the unrealized losses were temporary, based on the creditworthiness of the issuers and the related collateral characteristics, and that the FHLBank will recover its entire amortized cost basis. Additionally, because the FHLBank does not intend to sell these securities, nor is it more likely than not that the FHLBank will be required to sell the securities before recovery, it did not consider the investments to be other-than-temporarily impaired at September 30, 2011.
The FHLBank did not consider any of its investments to be other-than-temporarily impaired at December 31, 2010.
Note 7 - Advances
General Terms. The FHLBank offers a wide range of fixed- and variable-rate Advance products with different maturities, interest rates, payment characteristics and optionality. At September 30, 2011 and December 31, 2010, the FHLBank had Advances outstanding, including Affordable Housing Program (AHP) Advances (see Note 13), at interest rates ranging from 0.00 percent to 9.20 percent. Advances with interest rates of 0.00 percent are AHP-subsidized Advances.
Table 7.1 - Advance Redemption Terms (dollars in thousands)
September 30, 2011 | December 31, 2010 | |||||||||||||
Year of Contractual Maturity | Amount | Weighted Average Interest Rate | Amount | Weighted Average Interest Rate | ||||||||||
Overdrawn demand deposit accounts | $ | 19,990 | 0.10 | % | $ | — | — | % | ||||||
Due in 1 year or less | 11,842,448 | 1.83 | 6,418,438 | 1.39 | ||||||||||
Due after 1 year through 2 years | 3,932,441 | 1.69 | 6,603,018 | 3.43 | ||||||||||
Due after 2 years through 3 years | 1,843,948 | 2.25 | 3,908,985 | 1.35 | ||||||||||
Due after 3 years through 4 years | 3,295,205 | 1.40 | 2,778,172 | 1.65 | ||||||||||
Due after 4 years through 5 years | 3,531,688 | 1.87 | 1,943,751 | 1.57 | ||||||||||
Thereafter | 5,224,984 | 2.37 | 7,859,330 | 2.30 | ||||||||||
Total par value | 29,690,704 | 1.89 | 29,511,694 | 2.12 | ||||||||||
Commitment fees | (1,036 | ) | (1,095 | ) | ||||||||||
Discount on AHP Advances | (23,878 | ) | (26,738 | ) | ||||||||||
Premiums | 4,213 | 4,469 | ||||||||||||
Discount | (14,274 | ) | (13,318 | ) | ||||||||||
Hedging adjustments | 689,391 | 706,005 | ||||||||||||
Total | $ | 30,345,120 | $ | 30,181,017 |
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The FHLBank offers Advances to members that may be prepaid on specified dates (call dates) without incurring prepayment or termination fees (callable Advances). Other Advances may only be prepaid subject to a fee to the FHLBank (prepayment fee) that makes the FHLBank financially indifferent to the prepayment of the Advance. At September 30, 2011 and December 31, 2010, the FHLBank had callable Advances (in thousands) of $10,568,079 and $10,525,489.
Table 7.2 - Advances Redemption Terms: Year of Contractual Maturity or Next Call Date for Callable Advances (in thousands)
Year of Contractual Maturity or Next Call Date | September 30, 2011 | December 31, 2010 | |||||
Overdrawn demand deposit accounts | $ | 19,990 | $ | — | |||
Due in 1 year or less | 19,890,461 | 14,935,025 | |||||
Due after 1 year through 2 years | 2,122,696 | 5,968,018 | |||||
Due after 2 years through 3 years | 1,524,320 | 1,951,934 | |||||
Due after 3 years through 4 years | 1,413,055 | 1,351,351 | |||||
Due after 4 years through 5 years | 1,480,658 | 923,101 | |||||
Thereafter | 3,239,524 | 4,382,265 | |||||
Total par value | $ | 29,690,704 | $ | 29,511,694 |
The FHLBank also offers putable Advances. With a putable Advance, the FHLBank effectively purchases a put option from the member that allows the FHLBank to terminate the Advance at predetermined dates. The FHLBank normally would exercise its option when interest rates increase relative to contractual rates. At September 30, 2011 and December 31, 2010, the FHLBank had putable Advances, excluding those where the related put options have expired, totaling (in thousands) $6,258,950 and $6,658,150.
Through December 2005, the FHLBank offered convertible Advances. At September 30, 2011 and December 31, 2010, the FHLBank had convertible Advances, excluding those where the related conversion options have expired, totaling (in thousands) $1,208,500 and $1,356,000.
Table 7.3 - Advances Redemption Terms: Year of Contractual Maturity or Next Put/Convert Date for Putable/Convertible Advances (in thousands)
Year of Contractual Maturity or Next Put/Convert Date | September 30, 2011 | December 31, 2010 | |||||
Overdrawn demand deposit accounts | $ | 19,990 | $ | — | |||
Due in 1 year or less | 15,957,498 | 14,071,588 | |||||
Due after 1 year through 2 years | 3,658,941 | 3,025,518 | |||||
Due after 2 years through 3 years | 1,632,248 | 3,763,585 | |||||
Due after 3 years through 4 years | 2,704,005 | 2,334,772 | |||||
Due after 4 years through 5 years | 2,512,688 | 1,523,551 | |||||
Thereafter | 3,205,334 | 4,792,680 | |||||
Total par value | $ | 29,690,704 | $ | 29,511,694 |
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Table 7.4 - Advances by Interest Rate Payment Terms (in thousands)
September 30, 2011 | December 31, 2010 | ||||||
Par value of Advances | |||||||
Fixed-rate (1) | |||||||
Due in one year or less | $ | 9,115,072 | $ | 4,812,906 | |||
Due after one year | 9,908,563 | 13,494,298 | |||||
Total fixed-rate | 19,023,635 | 18,307,204 | |||||
Variable-rate (1) | |||||||
Due in one year or less | 2,344,686 | 1,605,532 | |||||
Due after one year | 8,322,383 | 9,598,958 | |||||
Total variable-rate | 10,667,069 | 11,204,490 | |||||
Total par value | $ | 29,690,704 | $ | 29,511,694 |
(1) | Payment terms based on current interest rate terms, which would reflect any option exercises or rate conversions subsequent to the related Advance issuance. |
At September 30, 2011 and December 31, 2010, 52 percent and 58 percent, respectively, of the FHLBank's fixed-rate Advances were swapped to a floating rate.
Table 7.5 - Borrowers Holding Five Percent or more of Total Advances, Including Any Known Affiliates that are Members of the FHLBank (dollars in millions)
September 30, 2011 | December 31, 2010 | |||||||||||||
Principal | % of Total | Principal | % of Total | |||||||||||
U.S. Bank, N.A. | $ | 7,315 | 25 | % | U.S. Bank, N.A. | $ | 7,315 | 25 | % | |||||
PNC Bank, N.A. (1) | 3,997 | 13 | PNC Bank, N.A. (1) | 4,000 | 14 | |||||||||
Fifth Third Bank | 3,935 | 13 | Fifth Third Bank | 1,536 | 5 | |||||||||
Total | $ | 15,247 | 51 | % | Total | $ | 12,851 | 44 | % |
(1) | Former member. |
Note 8 - Mortgage Loans Held for Portfolio
Table 8.1 - Mortgage Loans Held for Portfolio (in thousands)
September 30, 2011 | December 31, 2010 | ||||||
Real Estate: | |||||||
Fixed rate medium-term single-family mortgages (1) | $ | 1,479,382 | $ | 1,062,384 | |||
Fixed rate long-term single-family mortgages | 6,304,762 | 6,638,284 | |||||
Subtotal fixed rate single-family mortgages | 7,784,144 | 7,700,668 | |||||
Premiums | 94,833 | 88,811 | |||||
Discounts | (4,599 | ) | (7,516 | ) | |||
Hedging basis adjustments | 14,323 | 177 | |||||
Total mortgage loans held for portfolio | $ | 7,888,701 | $ | 7,782,140 |
(1) | Medium-term is defined as a term of 15 years or less. |
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Table 8.2 - Outstanding Unpaid Principal Balance of Mortgage Loans Held for Portfolio (in thousands)
September 30, 2011 | December 31, 2010 | ||||||
Conventional loans | $ | 6,485,965 | $ | 6,284,952 | |||
Government-guaranteed/insured loans | 1,298,179 | 1,415,716 | |||||
Total unpaid principal balance | $ | 7,784,144 | $ | 7,700,668 |
For information related to the FHLBank's credit risk on mortgage loans and allowance for credit losses, see Note 9 - Allowance for Credit Losses.
Table 8.3 - Members, Including Any Known Affiliates that are Members of the FHLBank, and Former Members Supplying Five Percent or more of Total Unpaid Principal (dollars in millions)
September 30, 2011 | December 31, 2010 | ||||||||||||
Principal | % of Total | Principal | % of Total | ||||||||||
PNC Bank, N.A. (1) | $ | 2,485 | 32 | % | $ | 2,896 | 38 | % | |||||
Union Savings Bank | 2,040 | 26 | 1,772 | 23 | |||||||||
Guardian Savings Bank FSB | 668 | 9 | 500 | 6 | |||||||||
Liberty Savings Bank | 436 | 6 | 475 | 6 | |||||||||
Total | $ | 5,629 | 73 | % | $ | 5,643 | 73 | % |
(1) | Former member. |
Note 9 - Allowance for Credit Losses
The FHLBank has established an allowance methodology for each of the FHLBank's portfolio segments: credit products; government-guaranteed or insured mortgage loans held for portfolio; and conventional mortgage loans held for portfolio.
Credit products
The FHLBank manages its credit exposure to credit products through an integrated approach that provides for a credit limit to be established for each borrower, includes an ongoing review of each borrower's financial condition and is coupled with detailed collateral/lending policies to limit risk of loss while balancing borrowers' needs for a reliable source of funding. In addition, the FHLBank lends to its members in accordance with federal statutes, including the Federal Home Loan Bank Act (FHLBank Act), and Finance Agency Regulations, which require the FHLBank to obtain sufficient collateral to fully secure credit products. The estimated value of the collateral required to secure each member's credit products is calculated by applying collateral discounts, or haircuts, to the value of the collateral. The FHLBank accepts certain investment securities, residential mortgage loans, deposits, and other real estate related assets as collateral. In addition, community financial institutions (CFIs) are eligible to utilize expanded statutory collateral provisions for small business and agriculture loans. The FHLBank's capital stock owned by the member is also pledged as collateral. Collateral arrangements and a member’s borrowing capacity vary based on the financial condition and performance of the institution, the types of collateral pledged and the overall quality of those assets. The FHLBank can call for additional or substitute collateral to protect its security interest. Management of the FHLBank believes that these policies effectively manage the FHLBank's credit risk from credit products.
Members experiencing financial difficulties are subject to FHLBank-performed “stress tests” of the impact of poorly performing assets on the member’s capital and loss reserve positions. Depending on the results of these tests and the level of overcollateralization, a member may be allowed to maintain pledged loan assets in its custody, may be required to deliver those loans into the custody of the FHLBank or its agent, and/or may be required to provide details on these loans to facilitate an estimate of their fair value. The FHLBank perfects its security interest in all pledged collateral. The FHLBank Act affords any security interest granted to the FHLBank by a member priority over the claims or rights of any other party except for claims or rights of a third party that would be entitled to priority under otherwise applicable law and that are held by a bona fide purchaser for value or by a secured party holding a prior perfected security interest.
Using a risk-based approach, the FHLBank considers the payment status, collateral types and concentration levels, and borrower's financial condition to be indicators of credit quality on its credit products. At September 30, 2011 and December 31, 2010, the FHLBank had rights to collateral on a member-by-member basis with an estimated value in excess of its outstanding extensions of credit.
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At September 30, 2011 and December 31, 2010, the FHLBank did not have any Advances that were past due, in non-accrual status, or impaired. In addition, there were no troubled debt restructurings related to credit products of the FHLBank during the nine months ended September 30, 2011 or 2010.
The FHLBank has not experienced any credit losses on Advances since it was founded in 1932. Based upon the collateral held as security, its credit extension and collateral policies, management's credit analysis and the repayment history on credit products, the FHLBank has not incurred any credit losses on credit products as of September 30, 2011 or December 31, 2010. Accordingly, the FHLBank has not recorded any allowance for credit losses on Advances.
At September 30, 2011 and December 31, 2010, no liability to reflect an allowance for credit losses for off-balance sheet credit exposures was recorded. See Note 20 for additional information on the FHLBank's off-balance sheet credit exposure.
Mortgage Loans - Government-guaranteed or Insured
The FHLBank invests in government-guaranteed or insured fixed-rate mortgage loans secured by one-to-four family residential properties. Government-guaranteed mortgage loans are mortgage loans guaranteed or insured by the Federal Housing Administration (FHA). Any losses from such loans are expected to be recovered from the FHA. Any losses from such loans that are not recovered from the FHA would be due to a claim rejection by the FHA and, as such, would be recoverable from the selling participating financial institutions (PFIs). Therefore, the FHLBank only has credit risk for these loans if the servicer fails to pay for losses not covered by the FHA. Based on an assessment of the PFIs, the FHLBank did not establish an allowance for credit losses on government-guaranteed or insured mortgage loans.
Mortgage Loans - Conventional Mortgage Purchase Program
The allowance for conventional loans is determined by analyses that include consideration of various data observations such as past performance, current performance, loan portfolio characteristics, collateral-related characteristics, industry data, and prevailing economic conditions. The measurement of the allowance for credit losses consists of: (1) collectively evaluating homogeneous pools of residential mortgage loans; (2) reviewing specifically identified loans for impairment; and (3) estimating a margin of imprecision.
Collectively Evaluated Mortgage Loans. The credit risk analysis of conventional loans evaluated collectively for impairment considers historical delinquency migration, applies estimated loss severities, and incorporates the credit enhancements of the Mortgage Purchase Program in order to determine the FHLBank's best estimate of probable incurred losses. The credit risk analysis of all conventional mortgage loans is performed at the individual Master Commitment Contract level to properly determine the credit enhancements available to recover losses on loans under each individual Master Commitment Contract. The Master Commitment Contract is an agreement with a member in which the member agrees to make every attempt to sell a specific dollar amount of loans to the FHLBank over a one-year period. Migration analysis is a methodology for determining, through the FHLBank's experience over a historical period, the rate of default on pools of similar loans. The FHLBank applies migration analysis to loans based on payment status categories such as current, 30, 60, and 90 days past due. The FHLBank then estimates how many loans in these categories may migrate to a loss realization event and applies a current loss severity to estimate losses incurred at the Statement of Condition date.
Individually Evaluated Mortgage Loans. Conventional mortgage loans that are considered troubled debt restructurings are specifically identified for purposes of calculating the allowance for credit losses. The FHLBank measures impairment of these specifically identified loans by either estimating the present value of expected cash flows, or estimating the loan's observable market price. Specifically identified loans evaluated for impairment are removed from the collectively evaluated mortgage loan population.
Estimating a Margin of Imprecision. The FHLBank also assesses a factor for the margin of imprecision to the estimation of loan losses for the homogeneous population. This amount represents a subjective management judgment, based on facts and circumstances that exist as of the reporting date, that is unallocated to any specific measurable economic or credit event and is intended to cover other inherent losses that may not otherwise be captured in the methodology described above.
Non-accrual Loans. The FHLBank places a conventional mortgage loan on non-accrual status if it is determined that either (1) the collection of interest or principal is doubtful, or (2) interest or principal is past due for 90 days or more, except when the loan is well-secured and in the process of collection (e.g., through credit enhancements and with monthly settlements on a schedule/scheduled basis). For those mortgage loans placed on non-accrual status, accrued but uncollected interest is reversed against interest income. The FHLBank records cash payments received on non-accrual loans first as interest income and then as
18
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, cash payments received are 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 FHLBank expects repayment of the remaining contractual interest and principal, or (2) it otherwise becomes well secured and in the process of collection.
Rollforward of Allowance for Credit Losses on Mortgage Loans. The following tables present a rollforward of the allowance for credit losses on conventional mortgage loans as well as the recorded investment in mortgage loans by impairment methodology. The recorded investment in a loan is the unpaid principal balance of the loan adjusted for accrued interest, unamortized premiums or discounts, and direct write-downs. The recorded investment is not net of any allowance.
Table 9.1 - Allowance Rollforward for Credit Losses on Conventional Mortgage Loans (in thousands)
Three Months Ended September 30, | |||||||
Allowance for credit losses: | 2011 | 2010 | |||||
Balance, beginning of period | $ | 14,800 | $ | — | |||
Charge-offs | (1,789 | ) | (827 | ) | |||
Provision for credit losses | 2,289 | 3,827 | |||||
Balance, end of period | $ | 15,300 | $ | 3,000 |
Nine Months Ended September 30, | |||||||
Allowance for credit losses: | 2011 | 2010 | |||||
Balance, beginning of year | $ | 12,100 | $ | — | |||
Charge-offs | (2,767 | ) | (827 | ) | |||
Provision for credit losses | 5,967 | 3,827 | |||||
Balance, end of period | $ | 15,300 | $ | 3,000 |
Table 9.2 - Allowance for Credit Losses and Recorded Investment on Conventional Mortgage Loans by Impairment Methodology (in thousands)
Allowance for credit losses, end of period: | September 30, 2011 | December 31, 2010 | |||||
Ending balance, collectively evaluated for impairment | $ | 15,240 | $ | 12,100 | |||
Ending balance, individually evaluated for impairment | $ | 60 | $ | — | |||
Recorded investment, end of period: | |||||||
Collectively evaluated for impairment | $ | 6,601,208 | $ | 6,376,435 | |||
Individually evaluated for impairment | 2,400 | — | |||||
Total recorded investment | $ | 6,603,608 | $ | 6,376,435 |
Credit Enhancements. The FHLBank's allowance for credit losses considers the credit enhancements associated with conventional mortgage loans. These credit enhancements apply after a homeowner's equity is exhausted. The amount of credit enhancements needed to protect the FHLBank against credit losses is determined through use of a third-party default model. The totality of the credit enhancements have historically protected the FHLBank against credit risk exposure on each conventional loan down to approximately a 50 percent “loan-to-value” level at the time of origination, subject, in certain cases, to an aggregate stop-loss feature in the Supplemental Mortgage Insurance policy. This means that the loan's value (observed from a sale price or appraisal) can fall to approximately half of its value at the time the loan was originated before the FHLBank would be exposed to a potential credit loss. Any incurred losses that are expected to be recovered from the credit enhancements are not reserved as part of the FHLBank's allowance for credit losses.
The conventional mortgage loans under the Mortgage Purchase Program are supported by some combination of credit enhancements (primary mortgage insurance (PMI), supplemental mortgage insurance (SMI) and the Lender Risk Account (LRA), including pooled LRA for those members participating in an aggregated Mortgage Purchase Program pool), in addition to the associated property as collateral. The LRA is funded by the FHLBank as a portion of the purchase proceeds to cover expected losses. Excess funds over required balances are distributed to the member in accordance with a step-down schedule that is established at the time of a Master Commitment Contract, subject to performance of the related loan pool.
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Table 9.3 - Changes in the LRA (in thousands)
Nine Months Ended | |||
September 30, 2011 | |||
Lender Risk Account at beginning of year | $ | 44,104 | |
Additions | 20,058 | ||
Claims | (3,648 | ) | |
Scheduled distributions | (1,300 | ) | |
Lender Risk Account at end of period | $ | 59,214 |
Credit Quality Indicators. Key credit quality indicators for mortgage loans include the migration of past due loans, non-accrual loans, and loans in process of foreclosure. The table below summarizes the FHLBank's key credit quality indicators for mortgage loans.
Table 9.4 - Recorded Investment in Delinquent Mortgage Loans (dollars in thousands)
September 30, 2011 | |||||||||||
Conventional Mortgage Purchase Program Loans | Government-Guaranteed or Insured Loans | Total | |||||||||
Past due 30-59 days delinquent | $ | 63,923 | $ | 77,400 | $ | 141,323 | |||||
Past due 60-89 days delinquent | 19,333 | 26,777 | 46,110 | ||||||||
Past due 90 days or more delinquent | 86,400 | 49,881 | 136,281 | ||||||||
Total past due | 169,656 | 154,058 | 323,714 | ||||||||
Total current loans | 6,433,952 | 1,162,939 | 7,596,891 | ||||||||
Total mortgage loans | $ | 6,603,608 | $ | 1,316,997 | $ | 7,920,605 | |||||
Other delinquency statistics: | |||||||||||
In process of foreclosure, included above (1) | $ | 72,478 | $ | 23,689 | $ | 96,167 | |||||
Serious delinquency rate (2) | 1.31 | % | 3.82 | % | 1.73 | % | |||||
Past due 90 days or more still accruing interest | $ | 86,400 | $ | 49,881 | $ | 136,281 | |||||
Loans on non-accrual status, included above | $ | 1,055 | $ | — | $ | 1,055 | |||||
December 31, 2010 | |||||||||||
Conventional Mortgage Purchase Program Loans | Government-Guaranteed or Insured Loans | Total | |||||||||
Past due 30-59 days delinquent | $ | 72,914 | $ | 85,791 | $ | 158,705 | |||||
Past due 60-89 days delinquent | 23,291 | 32,555 | 55,846 | ||||||||
Past due 90 days or more delinquent | 78,468 | 56,062 | 134,530 | ||||||||
Total past due | 174,673 | 174,408 | 349,081 | ||||||||
Total current loans | 6,201,762 | 1,264,033 | 7,465,795 | ||||||||
Total mortgage loans | $ | 6,376,435 | $ | 1,438,441 | $ | 7,814,876 | |||||
Other delinquency statistics: | |||||||||||
In process of foreclosure, included above (1) | $ | 55,075 | $ | 25,418 | $ | 80,493 | |||||
Serious delinquency rate (2) | 1.23 | % | 3.90 | % | 1.72 | % | |||||
Past due 90 days or more still accruing interest | $ | 78,468 | $ | 56,062 | $ | 134,530 | |||||
Loans on non-accrual status, included above | $ | — | $ | — | $ | — |
(1) | Includes loans where the decision of foreclosure or a similar alternative such as pursuit of deed-in-lieu has been reported. Loans in process of foreclosure are included in past due or current loans dependent on their delinquency status. |
(2) | Loans that are 90 days or more past due or in the process of foreclosure (including past due or current loans in the process of foreclosure) expressed as a percentage of the total loan portfolio class recorded investment amount. |
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For the period ends presented, each conventional loan past due 90 days or more is on a schedule/scheduled monthly settlement basis and contains one or more credit enhancements. Loans that are well secured and in the process of collection as a result of remaining credit enhancements and schedule/scheduled settlement are not placed on non-accrual status.
The FHLBank did not have any real estate owned at September 30, 2011 or December 31, 2010.
Troubled Debt Restructurings. A troubled debt restructuring is considered to have occurred when a concession is granted to the debtor that would not otherwise be considered for economic or legal reasons related to the debtor's financial difficulties. As a result of adopting the new accounting guidance on a creditor's determination of whether a restructuring is a troubled debt restructuring discussed in Note 2, the FHLBank reassessed all restructurings that occurred on or after January 1, 2011 for identification as troubled debt restructurings.
The FHLBank's troubled debt restructurings primarily involve loans where an agreement permits the recapitalization of past due amounts up to the original loan amount. Under this type of modification, no other terms of the original loan are modified, including the borrower's original interest rate and contractual maturity.
A loan considered a troubled debt restructuring is individually evaluated for impairment when determining its related allowance for credit losses. Credit loss is measured by factoring in expected cash shortfalls (i.e., loss severity rate) incurred as of the reporting date.
Table 9.5 - Recorded Investment in Troubled Debt Restructurings (in thousands)
September 30, 2011 | |||
Conventional Mortgage Purchase Program Loans | $ | 2,400 |
Due to the minimal change in terms of modified loans (i.e., no principal forgiven), the FHLBank's pre-modification recorded investment was not materially different than the post-modification recorded investment in troubled debt restructurings during the three and nine months ended September 30, 2011.
Certain conventional Mortgage Purchase Program loans modified within the previous twelve months and considered troubled debt restructurings experienced a payment default during the three and nine months ended September 30, 2011 as noted in the table below.
Table 9.6 - Recorded Investment of Financing Receivables Modified within the Previous 12 Months and Considered Troubled Debt Restructurings that Subsequently Defaulted (in thousands)
Three Months Ended | Nine Months Ended | ||||||
September 30, 2011 | September 30, 2011 | ||||||
Defaulted troubled debt restructurings: | |||||||
Conventional Mortgage Purchase Program Loans | $ | 273 | $ | 273 |
Modified loans that subsequently default recognize a higher probability of loss when calculating the allowance for credit losses.
As a result of adopting the new accounting guidance discussed in Note 2, the FHLBank identified certain receivables as troubled debt restructurings as shown in the table below. The allowance for credit losses on these receivables had previously been measured under the collective evaluation methodology. Upon identifying those receivables as troubled debt restructurings, the FHLBank identified them as impaired and applied the impairment measurement guidance for those receivables prospectively.
Table 9.7 - Newly Identified Troubled Debt Restructurings (in thousands)
September 30, 2011 | |||||||
Newly impaired loans identified as troubled debt restructurings: | Recorded Investment | Related Allowance | |||||
Conventional Mortgage Purchase Program Loans | $ | 1,285 | $ | 18 |
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Individually Evaluated Impaired Loans. At September 30, 2011, only certain conventional Mortgage Purchase Program loans individually evaluated for impairment required an allowance for credit losses. Table 9.7 presents the recorded investment, unpaid principal balance, and related allowance associated with these loans. The FHLBank did not evaluate any loans individually at December 31, 2010.
Table 9.8 - Individually Evaluated Impaired Loan Statistics by Product Class Level (in thousands)
September 30, 2011 | |||||||||||
Conventional Mortgage Purchase Program loans: | Recorded Investment | Unpaid Principal Balance | Related Allowance | ||||||||
With no related allowance | $ | 1,345 | $ | 1,330 | $ | — | |||||
With an allowance | 1,055 | 1,044 | 60 | ||||||||
Total | $ | 2,400 | $ | 2,374 | $ | 60 |
Table 9.9 - Average Recorded Investment of Individually Evaluated Impaired Loans and Related Interest Income Recognized (in thousands)
Three Months Ended | Nine Months Ended | ||||||||||||||
September 30, 2011 | September 30, 2011 | ||||||||||||||
Individually impaired loans: | Average Recorded Investment | Interest Income Recognized | Average Recorded Investment | Interest Income Recognized | |||||||||||
Conventional Mortgage Purchase Program Loans | $ | 2,202 | $ | 30 | $ | 1,193 | $ | 49 |
Note 10 - Derivatives and Hedging Activities
Nature of Business Activity
The FHLBank is exposed to interest rate risk primarily from the effect of interest rate changes on its interest-earning assets and on the funding sources that finance these assets. The goal of the FHLBank's interest-rate risk management strategies is not to eliminate interest-rate risk, but to manage it within appropriate limits. To mitigate the risk of loss, the FHLBank has established policies and procedures, which include guidelines on the amount of exposure to interest rate changes it is willing to accept. In addition, the FHLBank monitors the risk to its interest income, net interest margin and average maturity of interest-earning assets and funding sources.
Consistent with Finance Agency Regulations, the FHLBank enters into derivatives to manage the interest rate risk exposures inherent in otherwise unhedged assets and funding positions, to achieve the FHLBank's risk management objectives and to act as an intermediary between its members and counterparties. The use of derivatives is an integral part of the FHLBank's financial management strategy. However, Finance Agency Regulations and the FHLBank's financial management policy prohibit trading in or the speculative use of derivative instruments and limit credit risk arising from them.
The most common ways in which the FHLBank uses derivatives are to:
▪ | reduce the interest rate sensitivity and repricing gaps of assets and liabilities; |
▪ | manage embedded options in assets and liabilities; |
▪ | reduce funding costs by combining a derivative with a Consolidated Obligation, as the cost of a combined funding structure can be lower than the cost of a comparable Consolidated Obligation Bond; |
▪ | preserve a favorable interest rate spread between the yield of an asset (e.g., an Advance) and the cost of the related liability (e.g., the Consolidated Obligation Bond used to fund the Advance); without the use of derivatives, this interest rate spread could be reduced or eliminated when a change in the interest rate on the Advance does not match a change in the interest rate on the Bond; and |
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▪ | protect the value of existing asset or liability positions. |
Types of Derivatives
The FHLBank may enter into interest rate swaps (including callable and putable swaps), swaptions, interest rate cap and floor agreements, calls, puts, futures, and forward contracts to manage its exposure to changes in interest rates.
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, this party receives cash flows equivalent to the interest on the same notional principal amount at a variable-rate index for the same period of time. The variable-rate received by the FHLBank in its derivatives is the London Interbank Offered Rate (LIBOR).
Application of Interest Rate Swaps
The FHLBank generally uses derivatives as fair value hedges of underlying financial instruments. However, because the FHLBank uses interest rate swaps when they are considered to be the most cost-effective alternative to achieve the FHLBank's financial and risk management objectives, it may enter into interest rate swaps that do not necessarily qualify for hedge accounting (economic hedges). The FHLBank re-evaluates its hedging strategies from time to time and may change the hedging techniques it uses or adopt new strategies.
Types of Hedged Items
The FHLBank documents at inception all relationships between derivatives designated as hedging instruments and the hedged items, its risk management objectives and strategies for undertaking various hedge transactions, and its method of assessing effectiveness. This process includes linking all derivatives that are designated as fair value hedges to assets and liabilities on the Statements of Condition. The FHLBank also formally assesses (both at the hedge's inception and at least quarterly) whether the derivatives that are used in hedging transactions have been effective in offsetting changes in the fair value of the hedged items and whether those derivatives may be expected to remain effective in future periods. The FHLBank currently uses regression analyses to assess the effectiveness of its hedges. The types of assets and liabilities currently hedged with derivatives are:
▪ | Consolidated Obligations |
▪ | Advances |
▪ | Firm Commitments |
Managing Credit Risk on Derivatives
The FHLBank is subject to credit risk due to nonperformance by counterparties to its derivative agreements. The degree of counterparty risk depends on the extent to which master netting arrangements are included in the contracts to mitigate the risk. The FHLBank manages counterparty credit risk through credit analysis, collateral requirements and adherence to the requirements set forth in FHLBank policies and Finance Agency Regulations. The FHLBank requires collateral agreements on all derivatives that establish collateral delivery thresholds. Based on credit analyses and collateral requirements at September 30, 2011, the management of the FHLBank does not anticipate any credit losses on its derivative agreements. See Note 19 for discussion regarding the FHLBank's fair value methodology for derivative assets/liabilities, including the evaluation of the potential for the fair value of these instruments to be affected by counterparty credit risk.
Table 10.1 presents credit risk exposure on derivative instruments, excluding circumstances where a counterparty's pledged collateral to the FHLBank exceeds the FHLBank's net position.
Table 10.1 - Credit Risk Exposure (in thousands)
September 30, 2011 | December 31, 2010 | ||||||
Total net exposure at fair value (1) | $ | 8,476 | $ | 6,499 | |||
Cash collateral | 3,200 | 4,000 | |||||
Net positive exposure after cash collateral | $ | 5,276 | $ | 2,499 |
(1) | Includes net accrued interest receivables of (in thousands) $843 and $1,722 at September 30, 2011 and December 31, 2010. |
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Certain of the FHLBank's interest rate swap contracts contain provisions that require the FHLBank to post additional collateral with its counterparties if there is deterioration in the FHLBank's credit ratings. The aggregate fair value of all interest rate swaps with credit-risk-related contingent features that were in a liability position at September 30, 2011 was (in thousands) $670,369, for which the FHLBank had posted collateral of (in thousands) $571,685 in the normal course of business, resulting in a net balance of (in thousands) $98,684. The collateral posted reflects the August 8, 2011, Standard & Poor's Rating Services downgrade of the long-term credit ratings of the 10 FHLBanks with AAA ratings from AAA to AA+ (the FHLBanks of Chicago and Seattle were already rated AA+). The ratings of the FHLBanks were constrained by the long-term credit rating of the United States of America. On August 5, 2011, Standard & Poor's lowered its long-term credit rating on the United States of America from AAA to AA+ with a negative outlook. The outlook for the 12 FHLBanks is negative. Standard & Poor's actions did not affect the short-term A-1+ ratings of the FHLBanks.
If one of the FHLBank's credit ratings had been lowered to the next lower rating that would have triggered additional collateral to be delivered, the FHLBank would have been required to deliver up to an additional (in thousands) $35,000 of collateral (at fair value) to its derivatives counterparties at September 30, 2011.
The FHLBank 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. The FHLBank is not a derivatives dealer and thus does not trade derivatives for short-term profit.
Financial Statement Effect and Additional Financial Information
The notional amount of derivatives serves as a factor in determining periodic interest payments or cash flows received and paid. The notional amount represents neither the actual amounts exchanged nor the overall exposure of the FHLBank to credit and market risk. The risks of derivatives only can be measured meaningfully on a portfolio basis that takes into account the derivatives, the items being hedged and any offsets between the two.
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Table 10.2 summarizes the fair value of derivative instruments. For purposes of this disclosure, the derivative values include the fair value of derivatives and the related accrued interest.
Table 10.2 - Derivative Instruments Fair Value (in thousands)
September 30, 2011 | |||||||||||
Notional Amount of Derivatives | Derivative Assets | Derivative Liabilities | |||||||||
Derivatives designated as fair value hedging instruments: | |||||||||||
Interest rate swaps | $ | 12,133,975 | $ | 88,429 | $ | (737,670 | ) | ||||
Derivatives not designated as hedging instruments: | |||||||||||
Interest rate swaps | 4,569,000 | 959 | (15,953 | ) | |||||||
Forward rate agreements | 140,000 | — | (1,633 | ) | |||||||
Mortgage delivery commitments | 276,628 | 2,342 | (99 | ) | |||||||
Total derivatives not designated as hedging instruments | 4,985,628 | 3,301 | (17,685 | ) | |||||||
Total derivatives before netting and collateral adjustments | $ | 17,119,603 | 91,730 | (755,355 | ) | ||||||
Netting adjustments | (83,254 | ) | 83,254 | ||||||||
Cash collateral and related accrued interest | (3,200 | ) | 571,685 | ||||||||
Total collateral and netting adjustments (1) | (86,454 | ) | 654,939 | ||||||||
Derivative assets and derivative liabilities as reported on the Statement of Condition | $ | 5,276 | $ | (100,416 | ) | ||||||
December 31, 2010 | |||||||||||
Notional Amount of Derivatives | Derivative Assets | Derivative Liabilities | |||||||||
Derivatives designated as fair value hedging instruments: | |||||||||||
Interest rate swaps | $ | 18,694,035 | $ | 112,905 | $ | (771,864 | ) | ||||
Derivatives not designated as hedging instruments: | |||||||||||
Interest rate swaps | 1,234,000 | 4,212 | (10,601 | ) | |||||||
Forward rate agreements | 40,000 | — | (124 | ) | |||||||
Mortgage delivery commitments | 92,274 | 295 | (381 | ) | |||||||
Total derivatives not designated as hedging instruments | 1,366,274 | 4,507 | (11,106 | ) | |||||||
Total derivatives before netting and collateral adjustments | $ | 20,060,309 | 117,412 | (782,970 | ) | ||||||
Netting adjustments | (110,913 | ) | 110,913 | ||||||||
Cash collateral and related accrued interest | (4,000 | ) | 444,075 | ||||||||
Total collateral and netting adjustments (1) | (114,913 | ) | 554,988 | ||||||||
Derivative assets and derivative liabilities as reported on the Statement of Condition | $ | 2,499 | $ | (227,982 | ) |
(1) | Amounts represent the effects of legally enforceable master netting agreements that allow the FHLBank to settle positive and negative positions and of cash collateral held or placed with the same counterparties. |
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Table 10.3 presents the components of net (losses) gains on derivatives and hedging activities as presented in the Statements of Income.
Table 10.3 - Net (Losses) Gains on Derivatives and Hedging Instruments (in thousands)
Three Months Ended September 30, | |||||||
2011 | 2010 | ||||||
Derivatives and hedged items in fair value hedging relationships: | |||||||
Interest rate swaps | $ | (571 | ) | $ | 5,147 | ||
Derivatives not designated as hedging instruments: | |||||||
Economic Hedges: | |||||||
Interest rate swaps | (5,892 | ) | (4,010 | ) | |||
Forward rate agreements | (13,209 | ) | (70 | ) | |||
Net interest settlements | 755 | 1,667 | |||||
Mortgage delivery commitments | 15,601 | 1,066 | |||||
Total net losses related to derivatives not designated as hedging instruments | (2,745 | ) | (1,347 | ) | |||
Net (loss) gain on derivatives and hedging activities | $ | (3,316 | ) | $ | 3,800 |
Nine Months Ended September 30, | |||||||
2011 | 2010 | ||||||
Derivatives and hedged items in fair value hedging relationships: | |||||||
Interest rate swaps | $ | 6,946 | $ | 4,053 | |||
Derivatives not designated as hedging instruments: | |||||||
Economic Hedges: | |||||||
Interest rate swaps | (7,235 | ) | (9,433 | ) | |||
Forward rate agreements | (17,257 | ) | (93 | ) | |||
Net interest settlements | 3,276 | 3,046 | |||||
Mortgage delivery commitments | 16,118 | 5,109 | |||||
Total net losses related to derivatives not designated as hedging instruments | (5,098 | ) | (1,371 | ) | |||
Net gains on derivatives and hedging activities | $ | 1,848 | $ | 2,682 |
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Table 10.4 presents by type of hedged item, the gains (losses) on derivatives and the related hedged items in fair value hedging relationships and the impact of those derivatives on the FHLBank's net interest income.
Table 10.4 - Effect of Fair Value Hedge Related Derivative Instruments (in thousands)
Three Months Ended September 30, | |||||||||||||||
2011 | Gain/(Loss) on Derivative | Gain/(Loss) on Hedged Item | Net Fair Value Hedge Ineffectiveness | Effect of Derivatives on Net Interest Income(1) | |||||||||||
Hedged Item Type: | |||||||||||||||
Advances | $ | (59,691 | ) | $ | 58,671 | $ | (1,020 | ) | $ | (91,942 | ) | ||||
Consolidated Bonds | 4,961 | (4,512 | ) | 449 | 12,986 | ||||||||||
$ | (54,730 | ) | $ | 54,159 | $ | (571 | ) | $ | (78,956 | ) | |||||
2010 | |||||||||||||||
Hedged Item Type: | |||||||||||||||
Advances | $ | (64,574 | ) | $ | 70,769 | $ | 6,195 | $ | (105,953 | ) | |||||
Consolidated Bonds | 13,500 | (14,548 | ) | (1,048 | ) | 19,843 | |||||||||
$ | (51,074 | ) | $ | 56,221 | $ | 5,147 | $ | (86,110 | ) |
Nine Months Ended September 30, | |||||||||||||||
2011 | Gain/(Loss) on Derivative | Gain/(Loss) on Hedged Item | Net Fair Value Hedge Ineffectiveness | Effect of Derivatives on Net Interest Income(1) | |||||||||||
Hedged Item Type: | |||||||||||||||
Advances | $ | 21,667 | $ | (15,000 | ) | $ | 6,667 | $ | (279,399 | ) | |||||
Consolidated Bonds | (5,397 | ) | 5,676 | 279 | 53,165 | ||||||||||
$ | 16,270 | $ | (9,324 | ) | $ | 6,946 | $ | (226,234 | ) | ||||||
2010 | |||||||||||||||
Hedged Item Type: | |||||||||||||||
Advances | $ | (160,111 | ) | $ | 164,028 | $ | 3,917 | $ | (339,041 | ) | |||||
Consolidated Bonds | 18,296 | (18,160 | ) | 136 | 93,783 | ||||||||||
$ | (141,815 | ) | $ | 145,868 | $ | 4,053 | $ | (245,258 | ) |
(1) | The net interest on derivatives in fair value hedge relationships is included in the interest income/expense line item of the respective hedged item. |
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Note 11 - Deposits
Table 11.1- Deposits (in thousands)
September 30, 2011 | December 31, 2010 | ||||||
Interest bearing: | |||||||
Demand and overnight | $ | 1,142,106 | $ | 1,199,619 | |||
Term | 111,325 | 210,625 | |||||
Other | 21,743 | 27,427 | |||||
Total interest bearing | 1,275,174 | 1,437,671 | |||||
Non-interest bearing: | |||||||
Other | 14,366 | 14,756 | |||||
Total non-interest bearing | 14,366 | 14,756 | |||||
Total deposits | $ | 1,289,540 | $ | 1,452,427 |
The average interest rates paid on interest bearing deposits were 0.03 percent and 0.09 percent in the three months ended September 30, 2011 and 2010, respectively, and 0.05 percent and 0.08 percent in the nine months ended September 30, 2011 and 2010, respectively.
Note 12 - Consolidated Obligations
Table 12.1 - Consolidated Bonds Outstanding by Contractual Maturity (dollars in thousands)
September 30, 2011 | December 31, 2010 | |||||||||||||
Year of Contractual Maturity | Amount | Weighted Average Interest Rate | Amount | Weighted Average Interest Rate | ||||||||||
Due in 1 year or less | $ | 8,053,000 | 1.71 | % | $ | 8,271,750 | 1.91 | % | ||||||
Due after 1 year through 2 years | 6,341,050 | 2.24 | 6,703,600 | 2.34 | ||||||||||
Due after 2 years through 3 years | 3,180,500 | 3.10 | 4,635,450 | 3.10 | ||||||||||
Due after 3 years through 4 years | 1,752,000 | 2.84 | 2,918,500 | 3.29 | ||||||||||
Due after 4 years through 5 years | 1,629,000 | 3.61 | 987,000 | 3.49 | ||||||||||
Thereafter | 6,288,000 | 3.70 | 6,878,000 | 3.97 | ||||||||||
Index amortizing notes | 128,214 | 4.99 | 156,041 | 4.99 | ||||||||||
Total par value | 27,371,764 | 2.65 | 30,550,341 | 2.85 | ||||||||||
Premiums | 79,939 | 86,114 | ||||||||||||
Discounts | (20,921 | ) | (23,293 | ) | ||||||||||
Hedging adjustments | 77,512 | 83,629 | ||||||||||||
Fair value option valuation adjustment and accrued interest | 2,393 | — | ||||||||||||
Total | $ | 27,510,687 | $ | 30,696,791 |
Table 12.2 - Consolidated Bonds Outstanding by Features (in thousands)
September 30, 2011 | December 31, 2010 | ||||||
Par value of Consolidated Bonds: | |||||||
Non-callable/nonputable | $ | 20,692,764 | $ | 20,541,341 | |||
Callable | 6,679,000 | 10,009,000 | |||||
Total par value | $ | 27,371,764 | $ | 30,550,341 |
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Table 12.3 - Consolidated Bonds Outstanding by Contractual Maturity or Next Call Date (in thousands)
Year of Contractual Maturity or Next Call Date | September 30, 2011 | December 31, 2010 | ||||||
Due in 1 year or less | $ | 13,190,000 | $ | 17,196,750 | ||||
Due after 1 year through 2 years | 6,473,050 | 4,285,600 | ||||||
Due after 2 years through 3 years | 2,803,500 | 3,672,450 | ||||||
Due after 3 years through 4 years | 1,237,000 | 1,861,500 | ||||||
Due after 4 years through 5 years | 1,214,000 | 792,000 | ||||||
Thereafter | 2,326,000 | 2,586,000 | ||||||
Index amortizing notes | 128,214 | 156,041 | ||||||
Total par value | $ | 27,371,764 | $ | 30,550,341 |
Interest Rate Payment Terms.
Table 12.4 - Consolidated Bonds by Interest-rate Payment Type (in thousands)
September 30, 2011 | December 31, 2010 | ||||||
Par value of Consolidated Bonds: | |||||||
Fixed-rate | $ | 26,121,764 | $ | 30,550,341 | |||
Variable-rate | 1,250,000 | — | |||||
Total par value | $ | 27,371,764 | $ | 30,550,341 |
At September 30, 2011 and December 31, 2010, 26 percent and 30 percent of the FHLBank's fixed-rate Consolidated Bonds were swapped to a floating rate.
Consolidated Discount Notes. Discount Notes are Consolidated Obligations with original maturities up to one year. Table 12.5 summarizes the FHLBank's participation in Consolidated Discount Notes, all of which are due within one year.
Table 12.5 - Consolidated Discount Notes (dollars in thousands)
Book Value | Par Value | Weighted Average Interest Rate(1) | ||||||||
September 30, 2011 | $ | 33,339,516 | $ | 33,342,251 | 0.05 | % | ||||
December 31, 2010 | $ | 35,003,280 | $ | 35,008,410 | 0.11 | % |
(1) | Represents an implied rate without consideration of concessions. |
Concessions on Consolidated Obligations. Unamortized concessions included in other assets were (in thousands) $12,594 and $14,261 at September 30, 2011 and December 31, 2010. The amortization of such concessions is included in Consolidated Obligation interest expense and totaled (in thousands) $6,195 and $8,835 during the three months ended September 30, 2011 and 2010, respectively, and (in thousands) $12,520 and $20,320 during the nine months ended September 30, 2011 and 2010, respectively.
Note 13 - Affordable Housing Program (AHP)
Table 13.1 - Analysis of the FHLBank's AHP Liability (in thousands)
Balance at December 31, 2010 | $ | 88,037 | |
Expense (current year additions) | 12,139 | ||
Subsidy uses, net | (24,295 | ) | |
Balance at September 30, 2011 | $ | 75,881 |
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Note 14 - Resolution Funding Corporation (REFCORP)
Table 14.1 - Analysis of FHLBank's REFCORP Liability (in thousands)
Balance at December 31, 2010 | $ | 11,002 | |
Expense | 19,644 | ||
Cash payment | (30,646 | ) | |
Balance at September 30, 2011 | $ | — |
Note 15 - Capital
Table 15.1 - Capital Requirements (dollars in thousands)
September 30, 2011 | December 31, 2010 | ||||||||||||||
Required | Actual | Required | Actual | ||||||||||||
Risk-based capital | $ | 396,087 | $ | 3,872,697 | $ | 443,823 | $ | 3,886,953 | |||||||
Capital-to-assets ratio (regulatory) | 4.00 | % | 5.79 | % | 4.00 | % | 5.43 | % | |||||||
Regulatory capital | $ | 2,676,858 | $ | 3,872,697 | $ | 2,865,250 | $ | 3,886,953 | |||||||
Leverage capital-to-assets ratio (regulatory) | 5.00 | % | 8.68 | % | 5.00 | % | 8.14 | % | |||||||
Leverage capital | $ | 3,346,072 | $ | 5,809,046 | $ | 3,581,563 | $ | 5,830,430 |
Joint Capital Enhancement Agreement and REFCORP Certification. The 12 FHLBanks have entered into a Joint Capital Enhancement Agreement (Capital Agreement), which is intended to enhance the capital position of each FHLBank. The intent of the Capital Agreement is to allocate that portion of each FHLBank's earnings historically paid to satisfy its REFCORP obligation to a separate retained earnings account at that FHLBank.
Each FHLBank had been required to contribute 20 percent of its earnings toward payment of the interest on REFCORP bonds until satisfaction of the REFCORP obligation. The Capital Agreement provides that, upon full satisfaction of the REFCORP obligation, each FHLBank will contribute 20 percent of its net income each quarter to a restricted retained earnings account until the balance of that account equals at least one percent of that FHLBank's average balance of outstanding Consolidated Obligations for the previous quarter. These restricted retained earnings will not be available to pay dividends.
The FHLBank amended its Capital Plan to implement the provisions of the Capital Agreement. The Finance Agency approved the Capital Plan amendments on August 5, 2011.
On August 5, 2011, the Finance Agency certified that the FHLBanks had fully satisfied their REFCORP obligation. In accordance with the Capital Agreement, starting in the third quarter of 2011, each FHLBank began to allocate 20 percent of its net income to a separate restricted retained earnings account. At September 30, 2011, the FHLBank had (in thousands) $3,723 in restricted retained earnings.
Mandatorily Redeemable Capital Stock. As of September 30, 2011 and December 31, 2010, the FHLBank had (in thousands) $330,894 and $356,702 in capital stock classified as mandatorily redeemable on its Statements of Condition.
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Table 15.2 - Mandatorily Redeemable Capital Stock Roll Forward (in thousands)
Balance, December 31, 2010 | $ | 356,702 | |
Capital stock subject to mandatory redemption reclassified from equity: | |||
Withdrawals | 12,137 | ||
Other redemptions | 839 | ||
Redemption (or other reduction) of mandatorily redeemable capital stock: | |||
Withdrawals | (17,945 | ) | |
Other redemptions | (20,839 | ) | |
Balance, September 30, 2011 | $ | 330,894 |
Table 15.3 - Mandatorily Redeemable Capital Stock by Contractual Year of Redemption (in thousands)
Contractual Year of Redemption | September 30, 2011 | December 31, 2010 | ||||||
Due in 1 year or less | $ | 36,854 | $ | 2,758 | ||||
Due after 1 year through 2 years | 5,668 | 36,826 | ||||||
Due after 2 years through 3 years | 762 | 6,819 | ||||||
Due after 3 years through 4 years | 273,836 | 289,277 | ||||||
Due after 4 years through 5 years | 12,124 | 21,022 | ||||||
Past contractual redemption date due to remaining activity(1) | 1,650 | — | ||||||
Total par value | $ | 330,894 | $ | 356,702 |
(1) | Represents mandatorily redeemable capital stock that is past the end of the contractual redemption period because there is activity outstanding to which the mandatorily redeemable capital stock relates. |
Note 16 - Comprehensive Income
Table 16.1 - Comprehensive Income (in thousands)
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2011 | 2010 | 2011 | 2010 | ||||||||||||
Net income | $ | 18,615 | $ | 36,650 | $ | 98,473 | $ | 120,411 | |||||||
Other comprehensive income: | |||||||||||||||
Net unrealized (loss) gain on available-for-sale securities | (264 | ) | 137 | (353 | ) | (41 | ) | ||||||||
Pension and postretirement benefits | 246 | 121 | 679 | 572 | |||||||||||
Total other comprehensive (loss) income | (18 | ) | 258 | 326 | 531 | ||||||||||
Total comprehensive income | $ | 18,597 | $ | 36,908 | $ | 98,799 | $ | 120,942 |
Note 17 - Pension and Postretirement Benefit Plans
Qualified Defined Benefit Multi-employer Plan. The FHLBank participates in the Pentegra Defined Benefit Plan for Financial Institutions (Pentegra Defined Benefit Plan), a tax-qualified defined benefit pension plan. The Pentegra Defined Benefit Plan is a multi-employer plan in which assets contributed by one participating employer may be used to provide benefits to employees of other participating employers; assets contributed by an employer are not segregated in a separate account or restricted to provide benefits only to employees of that employer. The Pentegra Defined Benefit Plan covers substantially all officers and employees of the FHLBank who meet certain eligibility requirements. Contributions to the Pentegra Defined Benefit Plan charged to compensation and benefit expense were $1,639,000 and $1,226,000 in the three months ended September 30, 2011
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and 2010, respectively, and $3,734,000 and $2,794,000 in the nine months ended September 30, 2011 and 2010, respectively.
Qualified Defined Contribution Plan. The FHLBank also participates in the Pentegra Defined Contribution Plan for Financial Institutions, a tax-qualified, defined contribution pension plan. The FHLBank contributes a percentage of the participants' compensation by making a matching contribution equal to a percentage of voluntary employee contributions, subject to certain limitations. The FHLBank contributed $181,000 and $170,000 to this Plan in the three months ended September 30, 2011 and 2010, respectively, and $673,000 and $656,000 in the nine months ended September 30, 2011 and 2010, respectively.
Nonqualified Supplemental Defined Benefit Retirement Plan. The FHLBank maintains a nonqualified, unfunded defined benefit plan. The plan ensures that participants receive the full amount of benefits to which they would have been entitled under the qualified defined benefit plan in the absence of limits on benefit levels imposed by the IRS. There are no funded plan assets. The FHLBank has established a grantor trust to meet future benefit obligations and current payments to beneficiaries.
Postretirement Benefits Plan. The FHLBank also sponsors a postretirement benefits plan that includes health care and life insurance benefits for eligible retirees. There are no funded plan assets that have been designated to provide postretirement benefits.
Table 17.1 - Net Periodic Benefit Cost (in thousands)
Three Months Ended September 30, | |||||||||||||||
Defined Benefit Retirement Plan | Postretirement Benefits Plan | ||||||||||||||
2011 | 2010 | 2011 | 2010 | ||||||||||||
Net Periodic Benefit Cost | |||||||||||||||
Service cost | $ | 103 | $ | 141 | $ | 13 | $ | 12 | |||||||
Interest cost | 289 | 255 | 50 | 47 | |||||||||||
Amortization of unrecognized prior service benefit | (1 | ) | (1 | ) | — | — | |||||||||
Amortization of unrecognized net loss | 247 | 122 | — | — | |||||||||||
Net periodic benefit cost | $ | 638 | $ | 517 | $ | 63 | $ | 59 |
Nine Months Ended September 30, | |||||||||||||||
Defined Benefit Retirement Plan | Postretirement Benefits Plan | ||||||||||||||
2011 | 2010 | 2011 | 2010 | ||||||||||||
Net Periodic Benefit Cost | |||||||||||||||
Service cost | $ | 355 | $ | 396 | $ | 40 | $ | 35 | |||||||
Interest cost | 846 | 842 | 148 | 144 | |||||||||||
Amortization of unrecognized prior service benefit | (1 | ) | (1 | ) | — | — | |||||||||
Amortization of unrecognized net loss | 680 | 573 | — | — | |||||||||||
Net periodic benefit cost | $ | 1,880 | $ | 1,810 | $ | 188 | $ | 179 |
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Note 18 - Segment Information
The FHLBank has identified two primary operating segments based on its method of internal reporting: Traditional Member Finance and the Mortgage Purchase Program. These segments reflect the FHLBank's two primary Mission Asset Activities and the manner in which they are managed from the perspective of development, resource allocation, product delivery, pricing, credit risk and operational administration. The segments identify the principal ways the FHLBank provides services to member stockholders.
Table 18.1 - Financial Performance by Operating Segment (in thousands)
Three Months Ended September 30, | |||||||||||
Traditional Member Finance | Mortgage Purchase Program | Total | |||||||||
2011 | |||||||||||
Net interest income | $ | 35,395 | $ | 9,039 | $ | 44,434 | |||||
Provision for credit losses | — | 2,289 | 2,289 | ||||||||
Net interest income after provision for credit losses | 35,395 | 6,750 | 42,145 | ||||||||
Other (loss) income | (8,860 | ) | 2,392 | (6,468 | ) | ||||||
Other expenses | 12,442 | 2,232 | 14,674 | ||||||||
Income before assessments | 14,093 | 6,910 | 21,003 | ||||||||
Affordable Housing Program | 1,697 | 691 | 2,388 | ||||||||
REFCORP | — | — | — | ||||||||
Total assessments | 1,697 | 691 | 2,388 | ||||||||
Net income | $ | 12,396 | $ | 6,219 | $ | 18,615 | |||||
Average assets | $ | 58,762,933 | $ | 7,781,506 | $ | 66,544,439 | |||||
Total assets | $ | 59,014,837 | $ | 7,906,602 | $ | 66,921,439 | |||||
2010 | |||||||||||
Net interest income | $ | 45,299 | $ | 14,576 | $ | 59,875 | |||||
Provision for credit losses | — | 3,827 | 3,827 | ||||||||
Net interest income after provision for credit losses | 45,299 | 10,749 | 56,048 | ||||||||
Other income | 6,858 | 999 | 7,857 | ||||||||
Other expenses | 11,363 | 2,168 | 13,531 | ||||||||
Income before assessments | 40,794 | 9,580 | 50,374 | ||||||||
Affordable Housing Program | 3,779 | 782 | 4,561 | ||||||||
REFCORP | 7,404 | 1,759 | 9,163 | ||||||||
Total assessments | 11,183 | 2,541 | 13,724 | ||||||||
Net income | $ | 29,611 | $ | 7,039 | $ | 36,650 | |||||
Average assets | $ | 57,891,970 | $ | 8,657,470 | $ | 66,549,440 | |||||
Total assets | $ | 58,014,277 | $ | 8,364,447 | $ | 66,378,724 |
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Nine Months Ended September 30, | |||||||||||
Traditional Member Finance | Mortgage Purchase Program | Total | |||||||||
2011 | |||||||||||
Net interest income | $ | 126,591 | $ | 54,738 | $ | 181,329 | |||||
Provision for credit losses | — | 5,967 | 5,967 | ||||||||
Net interest income after provision for credit losses | 126,591 | 48,771 | 175,362 | ||||||||
Other loss | (1,633 | ) | (1,134 | ) | (2,767 | ) | |||||
Other expenses | 36,182 | 6,157 | 42,339 | ||||||||
Income before assessments | 88,776 | 41,480 | 130,256 | ||||||||
Affordable Housing Program | 8,618 | 3,521 | 12,139 | ||||||||
REFCORP | 13,378 | 6,266 | 19,644 | ||||||||
Total assessments | 21,996 | 9,787 | 31,783 | ||||||||
Net income | $ | 66,780 | $ | 31,693 | $ | 98,473 | |||||
Average assets | $ | 60,784,407 | $ | 7,663,337 | $ | 68,447,744 | |||||
Total assets | $ | 59,014,837 | $ | 7,906,602 | $ | 66,921,439 | |||||
2010 | |||||||||||
Net interest income | $ | 130,469 | $ | 61,562 | $ | 192,031 | |||||
Provision for credit losses | — | 3,827 | 3,827 | ||||||||
Net interest income after provision for credit losses | 130,469 | 57,735 | 188,204 | ||||||||
Other income | 11,165 | 5,022 | 16,187 | ||||||||
Other expenses | 32,864 | 6,019 | 38,883 | ||||||||
Income before assessments | 108,770 | 56,738 | 165,508 | ||||||||
Affordable Housing Program | 10,362 | 4,632 | 14,994 | ||||||||
REFCORP | 19,682 | 10,421 | 30,103 | ||||||||
Total assessments | 30,044 | 15,053 | 45,097 | ||||||||
Net income | $ | 78,726 | $ | 41,685 | $ | 120,411 | |||||
Average assets | $ | 60,160,194 | $ | 8,944,768 | $ | 69,104,962 | |||||
Total assets | $ | 58,014,277 | $ | 8,364,447 | $ | 66,378,724 |
Note 19 - Fair Value Disclosures
The fair value amounts recorded on the Statements of Condition and presented in the related note disclosures have been determined by the FHLBank using available market information and the FHLBank's best judgment of appropriate valuation methods. These estimates are based on pertinent information available to the FHLBank as of September 30, 2011 and December 31, 2010. The fair values reflect the FHLBank's judgment of how a market participant would estimate the fair values.
The Fair Value Summary Table included in this note does not represent an estimate of the overall market value of the FHLBank as a going concern, which would take into account future business opportunities and the net profitability of assets versus liabilities.
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Table 19.1 - Fair Value Summary Table (in thousands)
September 30, 2011 | December 31, 2010 | ||||||||||||||
Financial Instruments | Carrying Value | Fair Value | Carrying Value | Fair Value | |||||||||||
Assets: | |||||||||||||||
Cash and due from banks | $ | 2,385,145 | $ | 2,385,145 | $ | 197,623 | $ | 197,623 | |||||||
Interest-bearing deposits | 181 | 181 | 108 | 108 | |||||||||||
Securities purchased under resale agreements | 1,900,000 | 1,900,000 | 2,950,000 | 2,950,000 | |||||||||||
Federal funds sold | 3,690,000 | 3,690,000 | 5,480,000 | 5,480,000 | |||||||||||
Trading securities | 4,386,554 | 4,386,554 | 6,402,781 | 6,402,781 | |||||||||||
Available-for-sale securities | 3,619,364 | 3,619,364 | 5,789,736 | 5,789,736 | |||||||||||
Held-to-maturity securities | 12,457,939 | 12,918,884 | 12,691,545 | 13,019,799 | |||||||||||
Advances | 30,345,120 | 30,611,059 | 30,181,017 | 30,386,792 | |||||||||||
Mortgage loans held for portfolio, net | 7,873,401 | 8,371,821 | 7,770,040 | 8,094,128 | |||||||||||
Accrued interest receivable | 125,730 | 125,730 | 132,355 | 132,355 | |||||||||||
Derivative assets | 5,276 | 5,276 | 2,499 | 2,499 | |||||||||||
Liabilities: | |||||||||||||||
Deposits | 1,289,540 | 1,289,399 | 1,452,427 | 1,452,333 | |||||||||||
Consolidated Obligations: | |||||||||||||||
Discount Notes | 33,339,516 | 33,340,916 | 35,003,280 | 35,003,517 | |||||||||||
Bonds (1) | 27,510,687 | 28,430,744 | 30,696,791 | 31,414,061 | |||||||||||
Mandatorily redeemable capital stock | 330,894 | 330,894 | 356,702 | 356,702 | |||||||||||
Accrued interest payable | 153,299 | 153,299 | 190,728 | 190,728 | |||||||||||
Derivative liabilities | 100,416 | 100,416 | 227,982 | 227,982 | |||||||||||
Other: | |||||||||||||||
Standby bond purchase agreements | — | 1,833 | — | 2,361 |
(1) | Includes (in thousands) $4,107,393 and $0 of Consolidated Bonds recorded under the fair value option at September 30, 2011 and December 31, 2010, respectively. |
Fair Value Hierarchy. The FHLBank records trading securities, available-for-sale securities, derivative assets, derivative liabilities and certain Consolidated Obligation Bonds at fair value. The fair value hierarchy is used to prioritize the inputs of 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 measurement is determined. This overall level is an indication of how market observable the fair value measurement is.
Outlined below is the application of the fair value hierarchy to the FHLBank's financial assets and financial liabilities that are carried at fair value.
Level 1 - defined as those instruments for which inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 - defined as those instruments for which inputs to the valuation methodology include quoted prices for similar instruments in active markets, and for which inputs are observable, either directly or indirectly, for substantially the full term of the financial instrument. The FHLBank's trading securities, available-for-sale securities, Consolidated Obligations Bonds and derivative instruments are considered Level 2 instruments based on the inputs utilized to derive fair value.
Level 3 - defined as those instruments for which inputs to the valuation methodology are unobservable and significant to the fair value measurement.
The FHLBank utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs.
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For instruments carried at fair value, the FHLBank reviews the fair value hierarchy classifications on a quarterly basis. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets or liabilities. Such reclassifications are reported as transfers in/out at fair value as of the beginning of the quarter in which the changes occur. The FHLBank did not have any transfers during the nine months ended September 30, 2011 or 2010.
Valuation Techniques and Significant Inputs.
Cash and due from banks: The fair value equals the carrying value.
Interest-bearing deposits: The fair value is determined based on each security's quoted prices, excluding accrued interest, as of the last business day of the period.
Securities purchased under agreements to resell: The fair value approximates the carrying value.
Federal funds sold: The fair value of overnight Federal funds sold approximates the carrying value. The fair value of term Federal funds sold is determined by calculating the present value of the expected future cash flows. The discount rates used in these calculations are the rates for Federal funds with similar terms, as approximated by adding an estimated current spread to the LIBOR swap curve for Federal funds with similar terms. The fair value excludes accrued interest.
Trading securities: The FHLBank's trading portfolio consists of U.S. Treasury obligations, discount notes and bonds issued by Freddie Mac, Fannie Mae and/or the Federal Farm Credit Bank (non-mortgage-backed securities), and mortgage-backed securities issued by Ginnie Mae. Quoted market prices in active markets are not available for these securities.
In general, in order to determine the fair value of its non-mortgage backed securities, the FHLBank can use either (a) an income approach based on a market-observable interest rate curve that may be adjusted for a spread, or (b) prices received from third-party pricing vendors. The income approach uses indicative fair values derived from a discounted cash flow methodology. The FHLBank believes that both methodologies result in fair values that are reasonable and similar in all material respects based on the nature of the financial instruments being measured.
For its U.S. Treasury obligations and discount notes and bonds issued by Freddie Mac, Fannie Mae and/or the Federal Farm Credit Bank, the FHLBank determines the fair value using the income approach.
Table 19.2 - Significant Inputs for Non-Mortgage-Backed Securities in the Trading Portfolio Carried at Level 2 Within the Fair Value Hierarchy as of September 30, 2011 (in thousands)
Interest Rate Curve/ Pricing Services | Spread Range to the Interest Rate Curve | Fair Value | |||||
U.S. Treasury obligations | Treasury | - | $ | 722,483 | |||
Government-sponsored enterprises | Agency Discount Note Curve | - | $ | 3,661,867 |
For mortgage-backed securities, the FHLBank's valuation technique incorporates prices from up to four designated third-party pricing vendors when available. These pricing vendors use methods that generally employ, but are not limited to, benchmark yields, recent trades, dealer estimates, valuation models, benchmarking of like securities, sector groupings, and/or matrix pricing. The FHLBank establishes a price for each mortgage-backed security using a formula that is based upon the number of prices received. If four prices are received, the average of the middle two prices is used; if three prices are received, the middle price is used; if two prices are received, the average of the two prices is used; and if one price is received, it is used subject to some type of validation as described below. In addition to using specified price tolerance thresholds, the computed prices are tested for reasonableness through a comparison to the FHLBank's expectation of prices based on its knowledge of the securities and their expected price sensitivity relative to changes in market rates. Computed prices within the established thresholds and expectations are generally accepted unless strong evidence suggests that using the formula-driven price would not be appropriate. Preliminary estimated fair values that are outside the tolerance thresholds, or that management believes may not be appropriate based on all available information (including those limited instances in which only one price is received), are subject to further analysis, including but not limited to, a comparison to the prices for similar securities and/or to non-binding dealer estimates and/or use of an internal model that is deemed most appropriate after consideration of all relevant facts and circumstances that a market participant would consider.
As of September 30, 2011, all of the FHLBank's mortgage-backed securities holdings were priced using the valuation technique incorporating prices from third-party pricing vendors. The relative lack of dispersion among the vendor prices received for each
36
of the securities supported the FHLBank's conclusion that the final computed prices are reasonable estimates of fair value.
Available-for-sale securities: The FHLBank's available-for-sale portfolio consists of commercial paper, certificates of deposit and discount notes. Quoted market prices in active markets are not available for these securities. Therefore, the fair value is determined based on each security's indicative fair value obtained from a third-party vendor. The FHLBank performs several validation steps in order to verify the accuracy and reasonableness of these fair values. These steps may include, but are not limited to, a detailed review of instruments with significant periodic price changes and a derived fair value from an option-adjusted discounted cash flow methodology using market-observed inputs for the interest rate environment and similar instruments.
Table 19.3 - Significant Inputs for Non-Mortgage-Backed Securities in the Available-for-Sale Portfolio Carried at Level 2 Within the Fair Value Hierarchy as of September 30, 2011 (in thousands)
Interest Rate Curve/ Pricing Services | Spread Range to the Interest Rate Curve | Fair Value | |||||
Commercial paper | Pricing Services | N/A | $ | 299,951 | |||
Certificates of deposit | Pricing Services | N/A | $ | 3,244,424 | |||
Other * | Pricing Services | N/A | $ | 74,989 |
* | Consists of debt securities issued by International Bank for Reconstruction and Development. |
Held-to-maturity securities: The FHLBank's held-to-maturity portfolio consists of discount notes issued by Freddie Mac and/or Fannie Mae, taxable municipal bonds, TLGP notes, and mortgage-backed securities. Quoted market prices are not available for these securities. The fair value for each individual mortgage-backed security is determined by using the third-party vendor approach described above. The fair value for discount notes is determined using the income approach described above. The fair value for taxable municipal bonds and TLGP notes is determined based on each security's indicative market price obtained from a third-party vendor excluding accrued interest. The FHLBank uses various techniques to validate the fair values received from third-party vendors for accuracy and reasonableness.
Advances: The FHLBank determines the fair values of Advances by calculating the present value of expected future cash flows from the Advances excluding accrued interest. The discount rates used in these calculations are the replacement rates for Advances with similar terms, as approximated either by adding an estimated current spread to the LIBOR swap curve or by using current indicative market yields, as indicated by the FHLBank's pricing methodologies for Advances with similar current terms. Advance pricing is determined based on the FHLBank's rates on Consolidated Obligations. In accordance with Finance Agency Regulations, Advances with a maturity and repricing period greater than six months require a prepayment fee sufficient to make the FHLBank financially indifferent to the borrower's decision to prepay the Advances. Therefore, the fair value of Advances does not assume prepayment risk.
For swapped option-based Advances, the fair value is determined (independently of the related derivative) by the discounted cash flow methodology based on the LIBOR swap curve and forward rates at period end adjusted for the estimated current spread on new swapped Advances to the swap curve. For swapped Advances with a conversion option, the conversion option is valued by taking into account the LIBOR swap curve and forward rates at period end and the market's expectations of future interest rate volatility implied from current market prices of similar options.
Mortgage loans held for portfolio, net: The fair values of mortgage loans are determined based on quoted market prices offered to approved members as indicated by the FHLBank's Mortgage Purchase Program pricing methodologies for mortgage loans with similar current terms excluding accrued interest. The quoted prices offered to members are based on Fannie Mae price indications on to-be-announced mortgage-backed securities and FHA price indications on government-guaranteed loans; the FHLBank then adjusts these indicative prices to account for particular features of the FHLBank's Mortgage Purchase Program that differ from the Fannie Mae and FHA securities. These features include, but may not be limited to:
▪ | the Mortgage Purchase Program's credit enhancements; and |
▪ | marketing adjustments that reflect the FHLBank's cooperative business model and preferences for particular kinds of loans and mortgage note rates. |
These quoted prices, however, can change rapidly based upon market conditions and are highly dependent upon the underlying prepayment assumptions.
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In order to determine the fair values, the adjusted prices are also reduced for the FHLBank's estimate of expected net credit losses.
Accrued interest receivable and payable: The fair value approximates the carrying value.
Derivative assets/liabilities: The FHLBank's derivative assets/liabilities consist of interest rate swaps, to-be-announced mortgage-backed securities (forward rate agreements), and mortgage delivery commitments. The FHLBank's interest rate swaps are not listed on an exchange. Therefore, the FHLBank determines the fair value of each individual interest rate swap using market value models that use readily observable market inputs as their basis (inputs that are actively quoted and can be validated to external sources). The FHLBank uses a mid-market pricing convention as a practical expedient for fair value measurements within a bid-ask spread. These models reflect the contractual terms of the interest rate swaps, including the period to maturity, as well as the significant inputs noted below. The fair value determination uses the standard valuation technique of discounted cash flow analysis.
The FHLBank performs several validation steps to verify the reasonableness of the fair value output generated by the primary market value model. In addition to an annual model validation, the FHLBank prepares a monthly reconciliation of the model's fair values to estimates of fair values provided by the derivative counterparties and to another third-party model. The FHLBank believes these processes provide a reasonable basis for it to place continued reliance on the derivative fair values generated by the primary model.
The fair value of TBA mortgage-backed securities is based on independent indicative and/or quoted prices generated by market transactions involving comparable instruments. The FHLBank determines the fair value of mortgage delivery commitments using market prices from the TBA/mortgage-backed security market or TBA/Ginnie Mae market and adjustments noted below.
The discounted cash flow analysis utilizes market-observable inputs (inputs that are actively quoted and can be validated to external sources). Significant inputs, by class of derivative, are as follows:
Interest-rate swaps:
▪ | LIBOR swap curve; and |
▪ | Volatility assumption. Market-based expectations of future interest rate volatility implied from current market prices for similar options. |
To-be-announced mortgage-backed securities:
▪ | Market-based prices by coupon class and expected term until settlement. |
Mortgage delivery commitments:
▪ | TBA price. Market-based prices of TBAs by coupon class and expected term until settlement, adjusted to reflect the contractual terms of the mortgage delivery commitments, similar to the mortgage loans held for portfolio process. The adjustments to the market prices are market observable, or can be corroborated with observable market data. |
The FHLBank is subject to credit risk in derivatives transactions due to potential nonperformance by its derivatives counterparties, all of which are highly rated institutions. To mitigate this risk, the FHLBank has entered into master netting agreements with all of its derivative counterparties. In addition, to limit the FHLBank's net unsecured credit exposure to these counterparties, the FHLBank has entered into bilateral security agreements with all active derivatives dealer counterparties that provide for delivery of collateral at specified levels tied to counterparty credit ratings. The FHLBank has evaluated the potential for the fair value of the instruments to be impacted by counterparty credit risk and has determined that no adjustments were significant or necessary to the overall fair value measurements at September 30, 2011 or December 31, 2010.
The fair values of the FHLBank's derivatives 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 due to their short-term nature. The fair values of derivatives are netted by counterparty pursuant to the provisions of the FHLBank's master netting agreements. If these netted amounts are positive, they are classified as an asset and if negative, they are classified as a liability.
Deposits: The FHLBank determines the fair values of FHLBank deposits with fixed rates by calculating the present value of expected future cash flows from the deposits and reducing this amount for accrued interest payable. The discount rates used in these calculations are the cost of deposits with similar terms.
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Consolidated Obligations: The FHLBank determines the fair values of Discount Notes by calculating the present value of expected future cash flows from the Discount Notes excluding accrued interest. The discount rates used in these calculations are current replacement rates for Discount Notes with similar current terms, as approximated by adding an estimated current spread to the LIBOR swap curve. Each month's cash flow is discounted at that month's replacement rate.
The FHLBank determines the fair values of non-callable Consolidated Obligation Bonds (both unswapped and swapped) by calculating the present value of scheduled future cash flows from the bonds excluding accrued interest. Significant inputs used to determine fair value of these Consolidated Obligation Bonds are as follows:
▪ | The discount rates used, which are estimated current market yields, as indicated by the Office of Finance, for bonds with similar current terms. There was no spread adjustment to the Office of Finance indications used to value the non-callable Consolidated Obligations carried at fair value on the Statements of Condition. |
The FHLBank determines the fair values of callable Consolidated Obligation Bonds (both unswapped and swapped) by calculating the present value of expected future cash flows from the bonds excluding accrued interest. The fair values are determined by the discounted cash flow methodology based on the following significant inputs for these Consolidated Obligations:
▪ | LIBOR swap curve; |
▪ | Volatility assumption. Market-based expectations of future interest rate volatility implied from current market prices for similar options; and |
▪ | Spread assumption. As of September 30, 2011 the spread adjustment to the LIBOR Swap Curve was -24 to 20 basis points for callable Consolidated Obligations carried at fair value on the Statements of Condition. |
Adjustments may be necessary to reflect the 12 FHLBanks' credit quality when valuing Consolidated Obligation Bonds measured at fair value. Due to the joint and several liability for Consolidated Obligations, the FHLBank monitors its own creditworthiness and the creditworthiness of the other FHLBanks to determine whether any credit adjustments are necessary in its fair value measurement of Consolidated Obligation Bonds. The credit ratings of the FHLBanks and any changes to these credit ratings are the basis for the FHLBanks to determine whether the fair values of Consolidated Obligation Bonds have been significantly affected during the reporting period by changes in the instrument-specific credit risk. The FHLBank had no adjustments during the nine months ended September 30, 2011 or 2010.
Mandatorily redeemable capital stock: The fair value of capital stock subject to mandatory redemption is par value for the dates presented, as indicated by member contemporaneous purchases and sales at par value. FHLBank stock can only be acquired by members at par value and redeemed at par value. FHLBank stock is not traded and no market mechanism exists for the exchange of stock outside the cooperative structure.
Commitments: The fair values of standby bond purchase agreements are based on the present value of the estimated fees taking into account the remaining terms of the agreements.
Subjectivity of estimates. Estimates of the fair values of Advances with options, mortgage instruments, derivatives with embedded options and bonds with options using the methods described above and other methods are highly subjective and require judgments regarding significant matters such as the amount and timing of future cash flows, prepayment speeds, interest rate volatility, distributions of future interest rates used to value options, and discount rates that appropriately reflect market and credit risks. The judgments also include the parameters, methods, and assumptions used in models to value the options. The use of different assumptions could have a material effect on the fair value estimates. Since these estimates are made as of a specific point in time, they are susceptible to material near term changes.
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Fair Value on a Recurring Basis.
Table 19.4 presents the fair value of financial assets and liabilities, by level, within the fair value hierarchy which are recorded on a recurring basis at September 30, 2011 and December 31, 2010.
Table 19.4 - Hierarchy Level for Assets and Liabilities (in thousands)
Fair Value Measurements at September 30, 2011 | |||||||||||||||||||
Level 1 | Level 2 | Level 3 | Netting Adjustment and Cash Collateral (1) | Total | |||||||||||||||
Assets | |||||||||||||||||||
Trading securities: | |||||||||||||||||||
U.S. Treasury obligations | $ | — | $ | 722,483 | $ | — | $ | — | $ | 722,483 | |||||||||
Government-sponsored enterprises debt securities | — | 3,661,867 | — | — | 3,661,867 | ||||||||||||||
Other U.S. obligation residential mortgage-backed securities | — | 2,204 | — | — | 2,204 | ||||||||||||||
Total trading securities | — | 4,386,554 | — | — | 4,386,554 | ||||||||||||||
Available-for-sale securities: | |||||||||||||||||||
Commercial paper | — | 299,951 | — | — | 299,951 | ||||||||||||||
Certificates of deposit | — | 3,244,424 | — | — | 3,244,424 | ||||||||||||||
Other non-mortgage-backed securities | — | 74,989 | — | — | 74,989 | ||||||||||||||
Total available-for-sale securities | — | 3,619,364 | — | — | 3,619,364 | ||||||||||||||
Derivative assets: | |||||||||||||||||||
Interest rate swaps | — | 89,388 | — | (86,454 | ) | 2,934 | |||||||||||||
Mortgage delivery commitments | — | 2,342 | — | — | 2,342 | ||||||||||||||
Total derivative assets | — | 91,730 | — | (86,454 | ) | 5,276 | |||||||||||||
Total assets at fair value | $ | — | $ | 8,097,648 | $ | — | $ | (86,454 | ) | $ | 8,011,194 | ||||||||
Liabilities | |||||||||||||||||||
Consolidated Obligation Bonds (2) | $ | — | $ | 4,107,393 | $ | — | $ | — | $ | 4,107,393 | |||||||||
Derivative liabilities: | |||||||||||||||||||
Interest rate swaps | — | 753,623 | — | (654,939 | ) | 98,684 | |||||||||||||
Forward rate agreement | — | 1,633 | — | — | 1,633 | ||||||||||||||
Mortgage delivery commitments | — | 99 | — | — | 99 | ||||||||||||||
Total derivative liabilities | — | 755,355 | — | (654,939 | ) | 100,416 | |||||||||||||
Total liabilities at fair value | $ | — | $ | 4,862,748 | $ | — | $ | (654,939 | ) | $ | 4,207,809 |
(1) | Amounts represent the effects of legally enforceable master netting agreements that allow the FHLBank to settle positive and negative positions and of cash collateral held or placed with the same counterparties. |
(2) | Includes Consolidated Obligation Bonds recorded under the fair value option. |
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Fair Value Measurements at December 31, 2010 | |||||||||||||||||||
Level 1 | Level 2 | Level 3 | Netting Adjustment and Cash Collateral (1) | Total | |||||||||||||||
Assets | |||||||||||||||||||
Trading securities: | |||||||||||||||||||
U.S. Treasury obligations | $ | — | $ | 1,904,834 | $ | — | $ | — | $ | 1,904,834 | |||||||||
Government-sponsored enterprises debt securities | — | 4,495,516 | — | — | 4,495,516 | ||||||||||||||
Other U.S. obligation residential mortgage-backed securities | — | 2,431 | — | — | 2,431 | ||||||||||||||
Total trading securities | — | 6,402,781 | — | — | 6,402,781 | ||||||||||||||
Available-for-sale securities: | |||||||||||||||||||
Certificates of deposit | — | 5,789,736 | — | — | 5,789,736 | ||||||||||||||
Derivative assets: | |||||||||||||||||||
Interest rate swaps | — | 117,117 | — | (114,913 | ) | 2,204 | |||||||||||||
Mortgage delivery commitments | — | 295 | — | — | 295 | ||||||||||||||
Total derivative assets | — | 117,412 | — | (114,913 | ) | 2,499 | |||||||||||||
Total assets at fair value | $ | — | $ | 12,309,929 | $ | — | $ | (114,913 | ) | $ | 12,195,016 | ||||||||
Liabilities | |||||||||||||||||||
Derivative liabilities: | |||||||||||||||||||
Interest rate swaps | $ | — | $ | 782,465 | $ | — | $ | (554,988 | ) | $ | 227,477 | ||||||||
Forward rate agreements | — | 124 | — | — | 124 | ||||||||||||||
Mortgage delivery commitments | — | 381 | — | — | 381 | ||||||||||||||
Total derivative liabilities | — | 782,970 | — | (554,988 | ) | 227,982 | |||||||||||||
Total liabilities at fair value | $ | — | $ | 782,970 | $ | — | $ | (554,988 | ) | $ | 227,982 |
(1) | Amounts represent the effects of legally enforceable master netting agreements that allow the FHLBank to settle positive and negative positions and of cash collateral held or placed with the same counterparties. |
Fair Value Option. The fair value option provides 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 a company to display the fair value of those assets and liabilities for which it 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. If elected, interest income and interest expense on Advances and Consolidated Bonds carried at fair value are recognized based solely on the contractual amount of interest due or unpaid and any transaction fees or costs are immediately recognized into other non-interest income or other non-interest expense. Additionally, concessions paid on Consolidated Obligations designated under the fair value option are expensed as incurred in other non-interest expense.
During the nine months ended September 30, 2011, the FHLBank elected the fair value option for certain Consolidated Obligation Bond transactions. The FHLBank elected the fair value option for these transactions so as to mitigate the income statement volatility that can arise when only the corresponding derivatives are marked at fair value in transactions that do not, or may not, meet hedge effectiveness requirements or otherwise qualify for hedge accounting (i.e., economic hedging transactions).
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The following table summarizes the activity related to financial liabilities for which the fair value option was elected during the three and nine months ended September 30, 2011.
Table 19.5 – Fair Value Option Financial Liabilities (in thousands)
Three Months Ended September 30, 2011 | |||
Consolidated Bonds | |||
Balance at June 30, 2011 | $ | (2,231,866 | ) |
New transactions elected for fair value option | (2,560,000 | ) | |
Maturities and terminations | 685,000 | ||
Net losses on instruments held under fair value option | (355 | ) | |
Change in accrued interest | (172 | ) | |
Balance at September 30, 2011 | $ | (4,107,393 | ) |
Nine Months Ended September 30, 2011 | |||
Consolidated Bonds | |||
Balance at December 31, 2010 | $ | — | |
New transactions elected for fair value option | (6,356,000 | ) | |
Maturities and terminations | 2,251,000 | ||
Net losses on instruments held under fair value option | (893 | ) | |
Change in accrued interest | (1,500 | ) | |
Balance at September 30, 2011 | $ | (4,107,393 | ) |
Table 19.6 – Changes in Fair Values for Items Measured at Fair Value Pursuant to the Election of the Fair Value Option (in thousands)
Three Months Ended September 30, 2011 | |||||||||||
Interest Expense | Net Losses on Changes in Fair Value Under Fair Value Option | Total Changes in Fair Value Included in Current Period Earnings | |||||||||
Consolidated Bonds | $ | (2,460 | ) | $ | (355 | ) | $ | (2,815 | ) |
Nine Months Ended September 30, 2011 | |||||||||||
Interest Expense | Net Losses on Changes in Fair Value Under Fair Value Option | Total Changes in Fair Value Included in Current Period Earnings | |||||||||
Consolidated Bonds | $ | (5,768 | ) | $ | (893 | ) | $ | (6,661 | ) |
For items recorded under the fair value option, the related contractual interest income and contractual interest expense are recorded as part of net interest income on the Statement of Income. The remaining changes in fair value for instruments in which the fair value option has been elected are recorded as “Net losses on Consolidated Obligation Bonds held under fair value option” in the Statements of Income. The change in fair value does not include changes in instrument-specific credit risk. The FHLBank has determined that no adjustments to the fair values of its instruments recorded under the fair value option for instrument-specific credit risk were necessary as of September 30, 2011.
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The following table reflects the difference between the aggregate unpaid principal balance outstanding and the aggregate fair value for Consolidated Bonds for which the fair value option has been elected.
Table 19.7 – Aggregate Unpaid Balance and Aggregate Fair Value at September 30, 2011 (in thousands)
Aggregate Unpaid Principal Balance | Aggregate Fair Value | Fair Value Over/(Under) Aggregate Unpaid Principal Balance | |||||||||
Consolidated Bonds | $ | 4,105,000 | $ | 4,107,393 | $ | 2,393 |
Note 20 - Commitments and Contingencies
Table 20.1 - Off-Balance Sheet Commitments (in thousands)
September 30, 2011 | December 31, 2010 | ||||||||||||||||||||||
Notional Amount | Expire within one year | Expire after one year | Total | Expire within one year | Expire after one year | Total | |||||||||||||||||
Standby Letters of Credit outstanding | $ | 4,362,553 | $ | 168,508 | $ | 4,531,061 | $ | 6,651,149 | $ | 148,231 | $ | 6,799,380 | |||||||||||
Commitments for standby bond purchases | 54,990 | 343,790 | 398,780 | 12,930 | 386,895 | 399,825 | |||||||||||||||||
Commitment to purchase mortgage loans | 276,628 | — | 276,628 | 92,274 | — | 92,274 | |||||||||||||||||
Unsettled Consolidated Bonds, at par (1) (2) | 105,000 | — | 105,000 | — | — | — | |||||||||||||||||
Unsettled Consolidated Discount Notes, at par (2) | 33,604 | — | 33,604 | 12,547 | — | 12,547 |
(1) | Of the total unsettled Consolidated Bonds, $15,000 (in thousands) were hedged with associated interest rate swaps at September 30, 2011. |
(2) | Expiration is based on settlement period rather than underlying contractual maturity of Consolidated Obligations. |
In addition, the 12 FHLBanks have joint and several liability for the par amount of all of the Consolidated Obligations issued on their behalves. The par values of the outstanding Consolidated Obligations of all 12 FHLBanks were $696.6 billion and $796.4 billion at September 30, 2011 and December 31, 2010, respectively.
Legal Proceedings. The FHLBank is subject to legal proceedings arising in the normal course of business. In early March 2010, the FHLBank was advised by representatives of the Lehman Brothers Holdings, Inc. bankruptcy estate that they believed that the FHLBank had been unjustly enriched in connection with the close out of its interest rate swap transactions with Lehman at the time of the Lehman bankruptcy in 2008 and that the bankruptcy estate was entitled to the $43 million difference between the settlement amount the FHLBank paid Lehman in connection with the automatic early termination of those transactions and the market value fee the FHLBank received when replacing the swaps with new swaps transacted with other counterparties. In early May 2010, the FHLBank received a Derivatives Alternative Dispute Resolution notice from the Lehman bankruptcy estate with a settlement demand of $65.8 million, plus interest accruing primarily at LIBOR plus 14.5 percent since the bankruptcy filing, based on their view of how the settlement amount should have been calculated. In accordance with the Alternative Dispute Resolution Order of the Bankruptcy Court administering the Lehman estate, senior management of the FHLBank participated in a non-binding mediation in New York on August 25, 2010, and counsel for the FHLBank continued discussions with the court-appointed mediator for several weeks thereafter. The mediation concluded on October 15, 2010 without a settlement of the claims asserted by the Lehman bankruptcy estate. The FHLBank believes that it correctly calculated, and fully satisfied its obligation to Lehman in September 2008, and the FHLBank intends to vigorously dispute any claim for additional amounts.
The FHLBank also is subject to other legal proceedings arising in the normal course of business. After consultation with legal counsel, management does not anticipate that the ultimate liability, if any, arising out of these matters will have a material effect on the FHLBank's financial condition or results of operations.
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Note 21 - Transactions with Other FHLBanks
The FHLBank notes all transactions with other FHLBanks on the face of its financial statements. Occasionally, the FHLBank loans short-term funds to and borrows short-term funds from other FHLBanks. These loans and borrowings are transacted at then current market rates when traded. There were no such loans or borrowings outstanding at September 30, 2011 or December 31, 2010. The following table details the average daily balance of lending and borrowing between the FHLBank and other FHLBanks for the nine months ended September 30.
Table 21.1 - Lending and Borrowing Between the FHLBank and Other FHLBanks (in thousands)
Average Daily Balances for the Nine Months Ended September 30, | |||||||
2011 | 2010 | ||||||
Loans to other FHLBanks | $ | 3,833 | $ | 5,275 | |||
Borrowings from other FHLBanks | — | 458 |
The FHLBank may, from time to time, assume the outstanding primary liability for Consolidated Obligations of another FHLBank (at then current market rates on the day when the transfer is traded) rather than issuing new debt for which the FHLBank is the primary obligor. The FHLBank then becomes the primary obligor on the transferred debt. There were no Consolidated Obligations transferred to the FHLBank during the nine months ended September 30, 2011 or 2010. The FHLBank did not transfer any Consolidated Obligations to other FHLBanks during these periods.
Note 22 - Transactions with Stockholders
Transactions with Directors' Financial Institutions. In the ordinary course of its business, the FHLBank may provide products and services to members whose officers or directors serve as directors of the FHLBank (Directors' Financial Institutions). Finance Agency Regulations require that transactions with Directors' Financial Institutions be made on the same terms as those with any other member. The following table reflects balances with Directors' Financial Institutions for the items indicated below.
Table 22.1 - Transactions with Directors' Financial Institutions (dollars in millions)
September 30, 2011 | December 31, 2010 | ||||||||||||
Balance | % of Total (1) | Balance | % of Total (1) | ||||||||||
Advances | $ | 558 | 1.9 | % | $ | 609 | 2.1 | % | |||||
Mortgage Purchase Program | 46 | 0.6 | 51 | 0.7 | |||||||||
Mortgage-backed securities | — | — | — | — | |||||||||
Regulatory capital stock | 161 | 4.7 | 158 | 4.6 | |||||||||
Derivatives | — | — | — | — |
(1) | Percentage of total principal (Advances), unpaid principal balance (Mortgage Purchase Program), principal balance (mortgage-backed securities), regulatory capital stock, and notional balances (derivatives). |
Concentrations. The following table shows regulatory capital stock balances, outstanding Advance principal balances, and unpaid principal balances of mortgage loans held for portfolio at the dates indicated to members and former members holding five percent or more of regulatory capital stock and include any known affiliates that are members of the FHLBank.
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Table 22.2 - Capital Stock, Advances, and MPP Principal Balances to Members and Former Members (dollars in millions)
�� | Mortgage Purchase | |||||||||||||
Regulatory Capital Stock | Advance | Program Unpaid | ||||||||||||
September 30, 2011 | Balance | % of Total | Principal | Principal Balance | ||||||||||
U.S. Bank, N.A. | $ | 591 | 17 | % | $ | 7,315 | $ | 71 | ||||||
Fifth Third Bank | 401 | 12 | 3,935 | 8 | ||||||||||
PNC Bank, N.A. (1) | 248 | 7 | 3,997 | 2,485 | ||||||||||
KeyBank, N.A. | 179 | 5 | 221 | — | ||||||||||
Total | $ | 1,419 | 41 | % | $ | 15,468 | $ | 2,564 |
(1) | Former member. |
Mortgage Purchase | ||||||||||||||
Regulatory Capital Stock | Advance | Program Unpaid | ||||||||||||
December 31, 2010 | Balance | % of Total | Principal | Principal Balance | ||||||||||
U.S. Bank, N.A. | $ | 591 | 17 | % | $ | 7,315 | $ | 78 | ||||||
Fifth Third Bank | 401 | 12 | 1,536 | 9 | ||||||||||
PNC Bank, N.A. (1) | 262 | 8 | 4,000 | 2,896 | ||||||||||
KeyBank, N.A. | 179 | 5 | 905 | — | ||||||||||
Total | $ | 1,433 | 42 | % | $ | 13,756 | $ | 2,983 |
(1) | Former member. |
Nonmember Affiliates. The FHLBank has relationships with two nonmember affiliates, the Kentucky Housing Corporation and the Ohio Housing Finance Agency. The nature of these relationships is twofold: one as an approved borrower from the FHLBank and one in which the FHLBank invests in the purchase of these nonmembers' bonds. The Kentucky Housing Corporation and the Ohio Housing Finance Agency had no borrowings during the nine months ended September 30, 2011 or 2010. The FHLBank had principal investments in the bonds of the Kentucky Housing Corporation of $2,655,000 and $2,955,000 as of September 30, 2011 and December 31, 2010, respectively. The FHLBank did not have any investments in the bonds of the Ohio Housing Finance Agency as of September 30, 2011 or December 31, 2010. The FHLBank did not have any investments in or borrowings extended to any other nonmember affiliates during the nine months ended September 30, 2011 or 2010.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
This document contains forward-looking statements that describe the objectives, expectations, estimates, and assessments of the Federal Home Loan Bank of Cincinnati (FHLBank). These statements use words such as “anticipates,” “expects,” “believes,” “could,” “estimates,” “may,” and “should.” By their nature, forward-looking statements relate to matters involving risks or uncertainties, some of which we may not be able to know, control, or completely manage. Actual future results could differ materially from those expressed or implied in forward-looking statements or could affect the extent to which we are able to realize an objective, expectation, estimate, or assessment. Some of the risks and uncertainties that could affect our forward-looking statements include the following:
▪ | the effects of economic, financial, credit, market, and member conditions on our financial condition and results of operations, including changes in economic growth, general liquidity conditions, inflation and deflation, interest rates, interest rate spreads, interest rate volatility, mortgage originations, prepayment activity, housing prices, asset delinquencies, and members' mergers and consolidations, deposit flows, liquidity needs, and loan demand; |
▪ | political events, including legislative, regulatory, federal government, judicial or other developments that could affect us, our members, our counterparties, other FHLBanks and other government-sponsored enterprises (GSEs), and/or investors in the Federal Home Loan Bank System's (FHLBank System) debt securities, which are called Consolidated Obligations or Obligations; |
▪ | competitive forces, including those related to other sources of funding available to members, to purchases of mortgage loans, and to our issuance of Consolidated Obligations; |
▪ | the financial results and actions of other FHLBanks that could affect our ability, in relation to the FHLBank System's joint and several liability for Consolidated Obligations, to access the capital markets on favorable terms or preserve our profitability, or could alter the regulations and legislation to which we are subject; |
▪ | changes in ratings assigned to FHLBank System Obligations or our FHLBank that could raise our funding cost; |
▪ | changes in investor demand for Obligations; |
▪ | the volatility of market prices, interest rates, credit quality, and other indices that could affect the value of investments and collateral we hold as security for member obligations and/or for counterparty obligations; |
▪ | the ability to attract and retain skilled management and other key employees; |
▪ | the ability to develop and support technology and information systems that effectively manage the risks we face; |
▪ | the ability to successfully manage new products and services; and |
▪ | the risk of loss arising from litigation filed against us or one or more other FHLBanks. |
We do not undertake any obligation to update any forward-looking statements made in this document.
In this filing, the interrelated disruptions in the financial, credit, housing, capital, and mortgage markets during 2008 and 2009 are referred to generally as the “financial crisis.”
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EXECUTIVE OVERVIEW
Financial Highlights
The following table presents selected Statement of Condition information, Statement of Income data and financial ratios for the periods indicated.
(Dollars in millions) | September 30, 2011 | June 30, 2011 | March 31, 2011 | December 31, 2010 | September 30, 2010 | ||||||||||||||
STATEMENT OF CONDITION DATA AT QUARTER END: | |||||||||||||||||||
Total assets | $ | 66,921 | $ | 66,618 | $ | 71,326 | $ | 71,631 | $ | 66,379 | |||||||||
Advances | 30,345 | 29,173 | 28,292 | 30,181 | 30,375 | ||||||||||||||
Mortgage loans held for portfolio | 7,889 | 7,561 | 7,473 | 7,782 | 8,331 | ||||||||||||||
Allowance for credit losses on mortgage loans | 15 | 15 | 14 | 12 | 3 | ||||||||||||||
Investments (1) | 26,054 | 27,940 | 32,080 | 33,314 | 27,462 | ||||||||||||||
Consolidated Obligations, net: | |||||||||||||||||||
Discount Notes | 33,339 | 32,916 | 35,160 | 35,003 | 28,468 | ||||||||||||||
Bonds | 27,511 | 28,052 | 30,155 | 30,697 | 31,504 | ||||||||||||||
Total Consolidated Obligations, net | 60,850 | 60,968 | 65,315 | 65,700 | 59,972 | ||||||||||||||
Mandatorily redeemable capital stock | 331 | 324 | 331 | 357 | 368 | ||||||||||||||
Capital: | |||||||||||||||||||
Capital stock - putable | 3,106 | 3,113 | 3,096 | 3,092 | 3,109 | ||||||||||||||
Retained earnings | 436 | 448 | 445 | 438 | 425 | ||||||||||||||
Accumulated other comprehensive loss | (8 | ) | (7 | ) | (8 | ) | (7 | ) | (8 | ) | |||||||||
Total capital | 3,534 | 3,554 | 3,533 | 3,523 | 3,526 | ||||||||||||||
STATEMENT OF INCOME DATA FOR THE QUARTER: | |||||||||||||||||||
Net interest income | $ | 44 | $ | 66 | $ | 70 | $ | 83 | $ | 60 | |||||||||
Provision for credit losses | 2 | 1 | 2 | 10 | 4 | ||||||||||||||
Other (loss) income | (6 | ) | — | 4 | 4 | 8 | |||||||||||||
Other expenses | 15 | 13 | 14 | 17 | 13 | ||||||||||||||
Assessments | 2 | 14 | 16 | 16 | 14 | ||||||||||||||
Net income | $ | 19 | $ | 38 | $ | 42 | $ | 44 | $ | 37 | |||||||||
Dividend payout ratio (2) | 167 | % | 91 | % | 84 | % | 71 | % | 95 | % | |||||||||
Weighted average dividend rate (3) | 4.00 | % | 4.50 | % | 4.50 | % | 4.00 | % | 4.50 | % | |||||||||
Return on average equity | 2.07 | 4.28 | 4.80 | 4.94 | 4.11 | ||||||||||||||
Return on average assets | 0.11 | 0.22 | 0.24 | 0.25 | 0.22 | ||||||||||||||
Net interest margin (4) | 0.27 | 0.39 | 0.40 | 0.47 | 0.36 | ||||||||||||||
Average equity to average assets | 5.36 | 5.23 | 5.01 | 5.04 | 5.32 | ||||||||||||||
Regulatory capital ratio (5) | 5.79 | 5.83 | 5.43 | 5.43 | 5.88 | ||||||||||||||
Operating expense to average assets | 0.072 | 0.065 | 0.068 | 0.088 | 0.070 |
(1) | Investments include interest bearing deposits in banks, securities purchased under agreements to resell, Federal funds sold, trading securities, available-for-sale securities, and held-to-maturity securities. |
(2) | Dividend payout ratio is dividends declared in the period as a percentage of net income. |
(3) | Weighted average dividend rates are dividends paid in stock and cash divided by the average number of shares of capital stock eligible for dividends. |
(4) | Net interest margin is net interest income before provision for credit losses as a percentage of average earning assets. |
(5) | Regulatory capital ratio is period-end regulatory capital (capital stock, mandatorily redeemable capital stock and retained earnings) as a percentage of period-end total assets. |
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Financial Condition
Assets and Mission Asset Activity
The following table summarizes our financial condition.
Ending Balances | Average Balances | ||||||||||||||||||||||
September 30, | December 31, | Nine Months Ended September 30, | Year Ended December 31, | ||||||||||||||||||||
(In millions) | 2011 | 2010 | 2010 | 2011 | 2010 | 2010 | |||||||||||||||||
Total Assets | $ | 66,921 | $ | 66,379 | $ | 71,631 | $ | 68,448 | $ | 69,105 | $ | 69,367 | |||||||||||
Mission Asset Activity: | |||||||||||||||||||||||
Advances (principal) | 29,691 | 29,520 | 29,512 | 28,697 | 32,175 | 31,382 | |||||||||||||||||
Mortgage Purchase Program: | |||||||||||||||||||||||
Mortgage loans held for portfolio (principal) | 7,784 | 8,257 | 7,701 | 7,554 | 8,822 | 8,616 | |||||||||||||||||
Mandatory Delivery Contracts (notional) | 277 | 204 | 92 | 254 | 96 | 105 | |||||||||||||||||
Total Mortgage Purchase Program | 8,061 | 8,461 | 7,793 | 7,808 | 8,918 | 8,721 | |||||||||||||||||
Letters of Credit (notional) | 4,531 | 5,950 | 6,799 | 5,413 | 4,570 | 5,174 | |||||||||||||||||
Total Mission Asset Activity | $ | 42,283 | $ | 43,931 | $ | 44,104 | $ | 41,918 | $ | 45,663 | $ | 45,277 |
The first nine months of 2011 continued trends in our financial condition experienced since Mission Asset Activity peaked in the fourth quarter of 2008. Our business is cyclical and Mission Asset Activity normally stabilizes or declines in difficult macro-economic conditions, when financial institutions have ample liquidity, or when there is significant growth in the money supply.
A weak economy brought slow growth in new consumer, mortgage and commercial loans, which resulted in members' on-going subdued demand for Advances in the first nine months of 2011. In addition, significant government funding and liquidity programs continued to be available to members. We would expect to see increased Advance demand when the economy improves, the Federal Reserve System's monetary policy tightens, and the government's liquidity programs wind down.
Total assets at September 30, 2011 were $4.7 billion (seven percent) lower than at year-end 2010, with the reduction led by declines in investment balances. However, average asset balances in the first nine months of the year were only $0.7 billion lower than in the same period of 2010. The decline in average asset balances resulted from a decrease in members' Advance demand and lower loan balances in the Mortgage Purchase Program, which were offset by higher average investment balances.
The ending balance of Mission Asset Activity (comprising Advances, Letters of Credit, and the Mortgage Purchase Program) was $42.3 billion at September 30, 2011 compared to $44.1 billion at year-end 2010. The principal balance of Advances grew one percent from year-end 2010 to $29.7 billion at September 30, 2011. The average Advance principal balances in the first nine months of 2011 were $28.7 billion, a decrease of 11 percent from the same period of 2010.
The principal balance of mortgage loans held for portfolio (the Mortgage Purchase Program) was $7.8 billion at September 30, 2011, an increase of $0.1 billion (one percent) from year-end 2010. In the first nine months of the year, the FHLBank purchased $1.3 billion of mortgage loans, while principal paydowns totaled $1.2 billion. In addition, at September 30, 2011, there were $277 million of mandatory delivery contracts outstanding.
Despite the recent years' difficulties in the economy and housing market and lower overall Mission Asset Activity, we continued to fulfill our mission of providing reliable and attractively priced wholesale funding to our members. As of September 30, 2011, members funded on average almost four percent of their assets with Advances, the penetration rate was relatively stable with almost 80 percent of members holding Mission Asset Activity, and the number of active sellers and participants in the Mortgage Purchase Program remained at elevated levels compared to years prior to 2010.
Other Assets
The balance of investments at September 30, 2011 was $26.1 billion, a decrease of $7.3 billion (22 percent), from year-end 2010. The change reflected normal day-to-day fluctuation in short-term investment balances, including our decision to hold $2.4 billion in Federal Reserve deposits at the end of the third quarter due to the extremely low yields available on some investments at quarter end. Average investment balances in the first nine months of the year were $31.1 billion, an increase of 15 percent from the same period of 2010. Total investments at September 30, 2011 included $11.3 billion of mortgage-backed securities and $14.8 billion of other instruments, which are generally short-term and held to support members' potential
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unforeseen funding needs, protect against the potential inability to access capital markets for debt issuances, and augment earnings. All but one of our mortgage-backed securities held are issued and guaranteed by Fannie Mae, Freddie Mac or a U.S. agency. We owned one private-label mortgage-backed security (which was triple-A rated) with a principal balance of $20 million at September 30, 2011.
Capital
Capital adequacy continued to be strong, exceeding all minimum regulatory capital requirements. The amounts of GAAP and regulatory capital changed less than one percent between December 31, 2010 and September 30, 2011. The GAAP capital-to-assets ratio at September 30, 2011 was 5.28 percent, while the regulatory capital-to-assets ratio was 5.79 percent. Both ratios were well above the regulatory required minimum of 4.00 percent. Regulatory capital includes mandatorily redeemable capital stock accounted for as a liability under GAAP.
Retained earnings were $436 million at September 30, 2011, a decrease of $2 million from year-end 2010 and $12 million from June 30, 2011. Retained earnings are well above the $350 million needed to protect against impairment risk of capital stock as assessed by the FHLBank.
Results of Operations
The table below summarizes our results of operations.
Three Months Ended September 30, | Nine Months Ended September 30, | Year Ended December 31, | |||||||||||||||||
(Dollars in millions) | 2011 | 2010 | 2011 | 2010 | 2010 | ||||||||||||||
Net income | $ | 19 | $ | 37 | $ | 98 | $ | 120 | $ | 164 | |||||||||
Affordable Housing Program accrual | 2 | 5 | 12 | 15 | 20 | ||||||||||||||
Return on average equity (ROE) | 2.07 | % | 4.11 | % | 3.70 | % | 4.58 | % | 4.67 | % | |||||||||
Return on average assets | 0.11 | 0.22 | 0.19 | 0.23 | 0.24 | ||||||||||||||
Weighted average dividend rate | 4.00 | 4.50 | 4.33 | 4.50 | 4.38 | ||||||||||||||
Average 3-month LIBOR | 0.30 | 0.39 | 0.29 | 0.36 | 0.34 | ||||||||||||||
Average overnight Federal funds effective rate | 0.08 | 0.19 | 0.11 | 0.17 | 0.18 | ||||||||||||||
ROE spread to 3-month LIBOR | 1.77 | 3.72 | 3.41 | 4.22 | 4.33 | ||||||||||||||
Dividend rate spread to 3-month LIBOR | 3.70 | 4.11 | 4.04 | 4.14 | 4.04 | ||||||||||||||
ROE spread to Federal funds effective rate | 1.99 | 3.92 | 3.59 | 4.41 | 4.49 | ||||||||||||||
Dividend rate spread to Federal funds effective rate | 3.92 | 4.31 | 4.22 | 4.33 | 4.20 |
The ROE spreads to 3-month LIBOR and the Federal funds effective rate are two market benchmarks we believe stockholders use to assess the competitiveness of return on their capital investment. These spreads were substantially below those in the same periods of 2010. However, for the first three quarters of 2011, the spreads continued to represent competitive returns to stockholders. We paid stockholders a 4.50 percent annualized cash dividend in the first two quarters and a 4.00 percent annualized cash dividend in the third quarter.
The lower operating results and profitability for the two periods shown in 2011 compared to the same periods in 2010 are primarily related to the reductions in long-term interest rates that occurred in 2011. The primary negative factors on net income are listed below in estimated order of impact:
▪ | a significant increase ($29 million in the nine months comparison and $20 million in the three months comparison) in the amortization of mortgage asset purchase premiums, as lower mortgage rates accelerated actual and projected prepayment speeds; |
▪ | a decrease in earnings from a lower yield on total interest-earning assets, a portion of which are funded with interest-free capital. The lower yield resulted mostly from the continued repricing of new mortgage assets in the historically low interest rate environment; |
▪ | a lower average balance on loans in the Mortgage Purchase Program, which normally earn wider spreads than most other assets; |
▪ | narrower spreads on new mortgage assets compared to spreads earned on mortgage assets that were pre-paid; and |
▪ | modest net reductions in unrealized market values of derivatives, within the range of historical experience. |
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Positive factors partially offset the negative factors as listed below in estimated order of impact:
▪ | interest expense declined from retiring a significant amount of relatively high-cost Consolidated Obligation Bonds before their final maturities during the last twelve months; |
▪ | a decrease ($16 million in the nine months comparison and $5 million in the three months comparison) in net amortization of premiums/discounts and concession costs on Obligations as fewer callable Bonds were retired in 2011 than in the comparable 2010 period; and |
▪ | the FHLBank System's REFCORP obligation was satisfied at the end of the second quarter 2011. REFCORP, which had been recorded as a reduction to net income, has been replaced with a 20 percent allocation of net income to restricted retained earnings. This change had a $4 million favorable impact to the third quarter results. |
Based on our earnings, we added $12 million in the first nine months of 2011 for future use in the Affordable Housing Program, which will be awarded to members in 2012, continuing the trend of adding to the available funds each quarter since the inception of the program in 1990. In addition to the Affordable Housing Program, the FHLBank maintains a voluntary housing program with a commitment of $1 million to help provide ramps for persons with mobility restrictions and accessibility rehab for special needs and elderly homeowners.
Update on Business Outlook, Risk Factors, and Risk Exposure
This section summarizes and updates from the Form 10-K filing our major current risk exposures and current business outlook. “Quantitative and Qualitative Disclosures About Risk Management” provides details on current risk exposures.
Strategic/Business Risk
We cannot predict the future trend of Mission Asset Activity because it depends on, among other things, the state of the economy, conditions in the housing markets, the government's liquidity programs, the willingness and ability of financial institutions to expand lending, and regulatory initiatives that could affect demand for our Mission Asset Activity. When improvements occur in economic conditions, including expansion of members' loan demand from a stronger recovery, tightening in the Federal Reserve System's monetary policy, and the winding down of the government's liquidity programs, we would expect Advance demand to grow. However, without these improvements, it will be a challenge to replace the expected paydowns over the next several years of the sizeable amount of Advances ($5.8 billion) currently held by nonmembers.
Our strategy for the Mortgage Purchase Program is for moderate growth, with a prudent limit on the Program's size relative to capital to help ensure that our exposure to market and credit risk remains consistent with our conservative risk management principles. We will continue to emphasize the business model of recruiting community financial institution members to the Program and increasing the number of regular sellers. We could continue to experience moderate growth in the intermediate term based on the low level of mortgage rates that promote mortgage refinancing activity, several new mid-sized sellers joining the Program, and renewed activity with our two largest sellers. However, the Program's balances continue to be pressured by the continuing stresses in the housing markets. Higher mortgage rates would likely also slow growth.
We are concerned about several regulatory initiatives that could affect our balances of Mission Asset Activity. One ruling already implemented increased FDIC assessments for large financial institutions that utilize Advances, effectively raising the cost of borrowing from an FHLBank. Potential regulatory changes that could affect our business include: limitations on Advance lending to large financial institutions; prohibition under Basel III for institutions to incorporate unused FHLBank System borrowing capacity as sources of liquidity; members' implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act; and changes to the Home Affordable Refinance Program intended to assist more eligible borrowers with refinancing.
Liquidity and Funding Risk
Our liquidity position remained strong in the first nine months of 2011. We had ample asset liquidity and we continued to be able to fund operations through Consolidated Obligation issuances on suitable terms and costs. Although there can be no assurances, the possibility of a funding or liquidity crisis in the FHLBank System that would impair our FHLBank's ability to access the capital markets, service debt or pay competitive dividends is considered to be remote.
Although the government continues to face serious fiscal challenges and Standard & Poor's downgraded the United States and subsequently the FHLBank System's debt to AA+, the System did not, and continues to not, experience any uninterrupted access on acceptable terms to the capital markets for its debt issuance and funding needs. Investors continue to favor the
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System's debt issuances; spreads on the System's longer-term Consolidated Obligations to U.S. Treasury rates and LIBOR have not changed materially; and, after experiencing modest and temporary increases in late July and early August, the System's short-term debt costs returned by mid-August to the historically normal range.
Capital
The 12 Federal Home Loan Banks entered into a Joint Capital Enhancement Agreement (the “Capital Agreement”) in February 2011. The Capital Agreement will bolster each FHLBank's capital adequacy by allocating that portion of each FHLBank's earnings historically paid to satisfy its REFCORP obligation to a separate restricted retained earnings account at that FHLBank which is not available to be distributed as dividends. In August 2011, the Finance Agency certified that the FHLBanks had fully satisfied their REFCORP obligation. In accordance with the Capital Agreement, starting in the third quarter of 2011, we began to allocate 20 percent of net income to a separate restricted retained earnings account, which totaled $4 million in the quarter.
Although we have always maintained compliance with our capital requirements, the Capital Agreement will enhance risk mitigation by building a larger capital buffer over time to absorb unexpected losses, if any, that we may experience. Therefore, the Capital Agreement is expected to result in additional protection against impairment risk to stockholders' capital investment. We believe the Capital Agreement will also provide even greater certainty to investors about the FHLBank's ability to pay principal and interest on Consolidated Obligations, augment the stability of members' returns on their capital investment, and strengthen the long-term viability of the Affordable Housing Program, which will receive increased contributions as a result of this change.
Earnings and Market Risk
Market risk exposure in the first nine months of 2011 was moderate, well within policy limits, and consistent with long-term historical average exposure. We expect our business will continue to generate a competitive return on member stockholders' capital investment relative to market interest rates, except potentially in the most extreme cases of interest rate movements and deterioration in our business volumes. We believe that profitability would not become uncompetitive unless long-term rates were to increase immediately and permanently by 4.00 percentage points or more combined with short-term rates increasing to at least eight percent. Declines of 2.00 percentage points in long-term interest rates (which would put fixed-rate mortgages at two percent or less) would result in ROE still being well above market interest rates. However, sharp reductions in long-term rates could result in an immediate, one-time large amount of net amortization of mortgage purchase premiums, which could negatively impact our results of operations for one quarter.
Credit Risk
We continue to have a minimal amount of residual credit risk exposure related to our credit services (Advances and Letters of Credit), purchases of investments, and transactions in derivatives and a moderate amount of credit risk exposure related to the Mortgage Purchase Program. Based on analysis of credit risk exposures and application of GAAP, we continued to require no loss reserve for Advances and considered no investments to be other-than-temporarily impaired. We believe our policies and procedures related to credit underwriting, Advance collateral management, and transactions with investment and derivatives counterparties continue to mitigate our credit risk exposure on these instruments.
Beginning in 2010, credit risk exposure in the Mortgage Purchase Program increased, reflecting the sharp decline in home prices in many areas of the country since 2006 and the resulting increase in loan defaults. The allowance for credit losses in the Program was $15 million at September 30, 2011. We believe the portfolio's credit risk will remain moderate. However, in an adverse scenario of further large reductions in home prices, sustained elevated levels of unemployment, or failure of one or more mortgage insurance providers, credit losses experienced in the portfolio could increase significantly.
CONDITIONS IN THE ECONOMY AND FINANCIAL MARKETS
Effect of Economy and Financial Markets on Mission Asset Activity
The primary external factors that affect our Mission Asset Activity and earnings are the general state and trends of the economy and financial institutions, especially in our Fifth District (comprised of Kentucky, Ohio, and Tennessee); conditions in the financial, credit, mortgage, and housing markets; interest rates; and competitive alternatives to our products, such as retail deposits and other sources of wholesale funding. To date, the economic recovery from the recession and financial crisis of 2008-2009 has been weak by historical standards.
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Some indications of the weak economy include only modest growth in gross domestic product since the end of the recession, lackluster consumer and business demand, sluggish loan growth at depository institutions, small reductions in unemployment rates, ongoing distress in housing markets, and continued financial difficulties experienced by many of our members that are making them hesitant to increase lending. Some observers are concerned that the United States may be in a period of slow growth or even entering another recession. It is clear that the economy is in a prolonged period of de-leveraging consumer and commercial debt that had been built up over many years, especially mortgage debt.
The weak economic recovery has resulted in minimal growth, or even reductions, in new consumer, mortgage and commercial loans, which has limited members' demand for Advances and wholesale funding in general. From June 30, 2010 to June 30, 2011 (the most recent data period available), Fifth District depository institutions' aggregate loan portfolios grew only $3.2 billion (0.6 percent) while their aggregate deposit balances increased $29.1 billion (five percent); and aggregate loan portfolios fell $6.7 billion in the first two quarters of 2011. All of the loan growth and almost all of the deposit growth came from our largest member and borrower (U.S. Bank, N.A.). Excluding the impact of this member, aggregate loans fell $4.6 billion (1.3 percent) in the 12-month period ending June 30, 2011 while aggregate deposits grew only $1.3 billion.
Also continuing to significantly lower demand for our credit services is the substantial liquidity still being made available to depository institutions by the federal government in an attempt to stimulate economic growth, extending a practice that began in late 2008. The government's activities are being led by the Federal Reserve System and its quantitative easing programs, which have resulted in an historic expansion of its balance sheet and in the banking system holding extremely large and unprecedented levels of excess reserves instead of using the liquidity to expand lending.
Analysis of this and other data suggests that the sluggish economy is impacting our Advance growth mostly through reduced lending growth by our members. We have no reason to believe that these trends changed materially during the third quarter.
In addition, many financial institutions, as well as other companies, appear uncertain as to the future political environment conditions, including the federal government's fiscal challenges and the effect of the massive and still-evolving changes in the financial regulatory environment. Some of the actual and potential regulatory changes are identified in the "Executive Overview." We believe these sources of uncertainty are likely another factor constraining economic activity and, therefore, our Advance demand.
To the extent the economic and monetary conditions continue, we expect Advance activity across our membership to remain slow. Based on numerous indications of a further slowdown in the economy in the third quarter, our Advance activity could experience additional reductions in the near-term future. The weak economy also continued to negatively affect Mortgage Purchase Program balances in the first nine months in 2011, as the ongoing difficulties in the mortgage and housing markets resulted in relatively subdued refinancings of mortgage loans and small amounts of new loan originations, compared to the amount of this activity that would be expected in more normal conditions.
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Interest Rates
Trends in market interest rates affect members' demand for Mission Asset Activity, earnings, spreads on assets, funding costs and decisions in managing the tradeoffs in our market risk/return profile. The following table presents key market interest rates (obtained from Bloomberg L.P.).
Nine Months Ended September 30, | |||||||||||||||||||||||||||||
Quarter 3 2011 | Quarter 2 2011 | Quarter 1 2011 | 2011 | 2010 | Year 2010 | ||||||||||||||||||||||||
Average | Ending | Average | Ending | Average | Ending | Average | Average | Average | Ending | ||||||||||||||||||||
Federal funds target | 0-0.25% | 0-0.25% | 0-0.25% | 0-0.25% | 0-0.25% | 0-0.25% | 0-0.25% | 0-0.25% | 0-0.25% | 0-0.25% | |||||||||||||||||||
Federal funds effective | 0.08 | 0.06 | 0.09 | 0.07 | 0.15 | 0.10 | 0.11 | 0.17 | 0.18 | 0.13 | |||||||||||||||||||
3-month LIBOR | 0.30 | 0.37 | 0.26 | 0.25 | 0.31 | 0.30 | 0.29 | 0.36 | 0.34 | 0.30 | |||||||||||||||||||
2-year LIBOR | 0.56 | 0.58 | 0.75 | 0.70 | 0.89 | 1.00 | 0.73 | 1.02 | 0.93 | 0.79 | |||||||||||||||||||
5-year LIBOR | 1.45 | 1.26 | 2.08 | 2.04 | 2.32 | 2.47 | 1.95 | 2.32 | 2.17 | 2.17 | |||||||||||||||||||
10-year LIBOR | 2.58 | 2.10 | 3.29 | 3.28 | 3.54 | 3.58 | 3.13 | 3.36 | 3.26 | 3.38 | |||||||||||||||||||
2-year U.S. Treasury | 0.27 | 0.25 | 0.55 | 0.46 | 0.67 | 0.83 | 0.50 | 0.76 | 0.69 | 0.60 | |||||||||||||||||||
5-year U.S. Treasury | 1.15 | 0.95 | 1.84 | 1.76 | 2.10 | 2.28 | 1.69 | 2.06 | 1.92 | 2.01 | |||||||||||||||||||
10-year U.S. Treasury | 2.41 | 1.92 | 3.19 | 3.16 | 3.44 | 3.47 | 3.01 | 3.32 | 3.20 | 3.30 | |||||||||||||||||||
15-year mortgage current coupon (1) | 2.45 | 2.11 | 3.15 | 3.08 | 3.46 | 3.48 | 3.01 | 3.24 | 3.14 | 3.43 | |||||||||||||||||||
30-year mortgage current coupon (1) | 3.51 | 2.98 | 4.06 | 4.04 | 4.26 | 4.33 | 3.94 | 4.06 | 3.98 | 4.15 | |||||||||||||||||||
15-year mortgage note rate (2) | 3.47 | 3.28 | 3.84 | 3.69 | 4.12 | 4.09 | 3.81 | 4.19 | 4.10 | 4.20 | |||||||||||||||||||
30-year mortgage note rate (2) | 4.29 | 4.01 | 4.65 | 4.51 | 4.85 | 4.86 | 4.60 | 4.77 | 4.69 | 4.86 |
(1) | Simple average of current coupon rates of Fannie Mae and Freddie Mac mortgage-backed securities. |
(2) | Simple weekly average of 125 national lenders' mortgage rates for prime borrowers having a 20 percent down payment as surveyed and published by Freddie Mac. |
Short-term rates remained at historic lows. The Federal Reserve maintained the overnight Federal funds target and effective rates between zero and 0.25 percent, with other short-term rates generally consistent with their historical relationships to Federal funds. The Federal Reserve has indicated that it currently plans to hold short-term rates at near zero until at least mid-2013. Intermediate- and long-term rates showed a substantial downward trend, especially in the third quarter. These rate reductions had several impacts on our 2011 results of operations, as discussed in the "Executive Overview" and the "Results of Operations."
Despite the lower intermediate- and long-term rates in the second and third quarters of 2011 which negatively impacted our earnings, the interest rate environment remained favorable for our FHLBank's results of operations in terms of the longer-term trend level of profitability compared to the levels of interest rates. This difference, or spread, averaged 3.41 percentage points (relative to three-month LIBOR) in the first nine months of 2011 and 4.22 percentage points in the same period of 2010. In the ten years prior to 2011, this spread averaged 3.18 percentage points.
The rate environment has been a net benefit to our relative profitability (i.e., ROE compared with market rates) for several reasons. In general, lower market rates raise our relative ROE compared to market rates. The Consolidated Obligation yield curves continues to be steep by historical standards, which increases gains from a moderate amount of short funding of longer-term assets. The lower intermediate- and long-term rates have provided us the opportunity to retire many Consolidated Bonds before their final maturities and replace them with lower cost Obligations. Finally, earnings generated from funding assets with interest-free capital have not decreased as much as the reduction in overall interest rates because long-term assets do not reprice immediately to the lower rates. However, if interest rates remain low for a prolonged period of time, as suggested by the Federal Reserve's indications, the earnings we can generate from funding assets with interest-free capital will continue to decline.
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In addition, the current rate environment has lowered profitability due to lower balances, or modest growth in, Mission Asset Activity resulting from the weak economy.
ANALYSIS OF FINANCIAL CONDITION
Credit Services
The table below shows information regarding Advance balances by major programs and the notional amount of Letters of Credit.
(Dollars in millions) | September 30, 2011 | June 30, 2011 | March 31, 2011 | December 31, 2010 | |||||||||||||||||||
Balance | Percent(1) | Balance | Percent(1) | Balance | Percent(1) | Balance | Percent(1) | ||||||||||||||||
Adjustable/Variable Rate Indexed: | |||||||||||||||||||||||
LIBOR | $ | 10,480 | 35 | % | $ | 10,885 | 38 | % | $ | 10,881 | 39 | % | $ | 10,917 | 37 | % | |||||||
Other | 167 | 1 | 201 | 1 | 156 | 1 | 288 | 1 | |||||||||||||||
Total | 10,647 | 36 | 11,086 | 39 | 11,037 | 40 | 11,205 | 38 | |||||||||||||||
Fixed-Rate: | |||||||||||||||||||||||
REPO | 3,921 | 13 | 1,905 | 6 | 750 | 3 | 2,266 | 8 | |||||||||||||||
Regular Fixed Rate | 5,152 | 17 | 5,404 | 19 | 5,650 | 20 | 5,620 | 19 | |||||||||||||||
Putable (2) (3) | 6,259 | 21 | 6,514 | 23 | 6,592 | 24 | 6,658 | 22 | |||||||||||||||
Convertible (2) (3) | 1,209 | 4 | 1,228 | 4 | 1,282 | 4 | 1,356 | 5 | |||||||||||||||
Amortizing/Mortgage Matched | 2,235 | 8 | 2,240 | 8 | 2,222 | 8 | 2,165 | 7 | |||||||||||||||
Other | 248 | 1 | 201 | 1 | 188 | 1 | 242 | 1 | |||||||||||||||
Total | 19,024 | 64 | 17,492 | 61 | 16,684 | 60 | 18,307 | 62 | |||||||||||||||
Other Advances | 20 | — | — | — | — | — | — | — | |||||||||||||||
Total Advances Principal | $ | 29,691 | 100 | % | $ | 28,578 | 100 | % | $ | 27,721 | 100 | % | $ | 29,512 | 100 | % | |||||||
Letters of Credit (notional) | $ | 4,531 | $ | 5,302 | $ | 5,387 | $ | 6,799 |
(1) | As a percentage of total Advances principal. |
(2) | Related interest rate swaps executed to hedge these Advances convert them to an adjustable-rate tied to LIBOR. |
(3) | Excludes Putable/Convertible Advances where the related put/conversion options have expired. Such Advances are classified based on their current terms. |
The lower level of Advance balances experienced in the past two years continued in the first nine months of 2011. However, Advances were more stable this year compared to the last four years. This was due mostly to the actions of a few larger members; Advances outstanding to other members continued to decline. It is too soon to predict whether Advances may have begun to stabilize, especially because it appears the economy may be entering a new phase of even slower growth. "Executive Overview" and "Conditions in the Economy and Financial Markets," above, discuss reasons for the trends in Advance balances, which are related mostly to the weak economy and to liquidity being provided by the Federal Reserve. An additional factor putting downward pressure on Advance balances is that former members hold $5.8 billion (19 percent) of Advances, which will pay down without opportunity for replacement with new Advances from the former members.
Members reduced their available lines in the Letters of Credit program in the first nine months of the year by $2,268 million. The lines fell principally because of decreased activity from a few large members who heavily use Letters of Credit and whose usage can be volatile. We earn fees on Letters of Credit based on the actual notional amount of the Letters utilized, which normally is less than the available lines.
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The following tables present the principal balances for our top five Advance borrowers.
(Dollars in millions) | ||||||||||||||||
September 30, 2011 | December 31, 2010 | |||||||||||||||
Name | Par Value of Advances | Percent of Total Par Value of Advances | Name | Par Value of Advances | Percent of Total Par Value of Advances | |||||||||||
U.S. Bank, N.A. | $ | 7,315 | 25 | % | U.S. Bank, N.A. | $ | 7,315 | 25 | % | |||||||
PNC Bank, N.A. (1) | 3,997 | 13 | PNC Bank, N.A. (1) | 4,000 | 14 | |||||||||||
Fifth Third Bank | 3,935 | 13 | Fifth Third Bank | 1,536 | 5 | |||||||||||
Protective Life Insurance Company | 1,075 | 4 | Western-Southern Life Assurance Co. | 1,225 | 4 | |||||||||||
RBS Citizens, N.A. (1) | 1,007 | 3 | RBS Citizens, N.A. (1) | 1,007 | 3 | |||||||||||
Total of Top 5 | $ | 17,329 | 58 | % | Total of Top 5 | $ | 15,083 | 51 | % |
(1)Former member.
Advances continued to be concentrated among a small number of members, with the concentration ratio of the top five borrowers fluctuating in the range of 50 to 65 percent in the last several years. As indicated in the table above, a substantial portion of Advances to our top five borrowers were held by nonmembers.
The following table shows the unweighted average ratio of each member's Advance balance to its most-recently available figures for total assets. Continuing a trend from the last several years and consistent with the trends in balances, Advance usage ratios declined in the first nine months of 2011, although the rate of decline slowed noticeably in the second and third quarters. Despite the difficult economic environment, our membership still funded over 3.5 percent of their assets with our secured Advances.
September 30, 2011 | June 30, 2011 | March 31, 2011 | December 31, 2010 | ||||||||
Average Advances-to-Assets for Members | |||||||||||
Assets less than $1.0 billion (682 members) | 3.72 | % | 3.76 | % | 3.88 | % | 4.12 | % | |||
Assets over $1.0 billion (59 members) | 3.01 | % | 3.10 | % | 3.12 | % | 3.54 | % | |||
All members | 3.67 | % | 3.71 | % | 3.82 | % | 4.07 | % |
Mortgage Purchase Program (Mortgage Loans Held for Portfolio)
The table below shows principal paydowns and purchases for the first nine months of 2011.
(In millions) | Mortgage Purchase Program Principal | |||
Balance at December 31, 2010 | $ | 7,701 | ||
Principal purchases | 1,323 | |||
Principal paydowns | (1,240 | ) | ||
Balance at September 30, 2011 | $ | 7,784 |
The principal loan balance in the Mortgage Purchase Program grew $83 million (one percent) in the first nine months of 2011. The increase in outstanding principal was due to the declines in mortgage rates, which prompted an increase in net loan refinancings among our sellers, an increase in the number of regular sellers, and renewed activity with our two largest sellers.
We closely track the refinancing incentives of our mortgage assets because the option for homeowners to change their principal payments normally represents almost all of our market risk exposure. The $1,240 million of principal paydowns in the first nine months equated to a 17 percent annual constant prepayment rate, modestly lower than 2010's 22 percent rate. The Program’s composition of balances, by loan type and original final maturity, did not change materially. As in the last three years, yields earned in the first three quarters of 2011 on new mortgage loans in the Program, relative to funding costs, offered acceptable
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risk-adjusted returns due in part to the steep Consolidated Obligation yield curve.
Investments
We hold a substantial amount of investments in order to provide liquidity, enhance earnings, help manage market risk, and, in the case of mortgage-backed securities, help support the housing market. We hold both shorter-term investments, which we refer to as "liquidity investments" because most of them serve to augment asset liquidity, and longer-term mortgage-backed securities. It is normal for daily balances of the liquidity portfolio to experience substantial fluctuation in response to market conditions, supply, and spreads available relative to funding costs.
In the first nine months of 2011, as in 2010, we continued, on average, to maintain balances in liquidity investments at higher levels compared to our long-term historical experience. This reflected both a decision to hold more asset liquidity and a desire to offset a portion of earnings lost from the declines in Mission Asset Activity balances over the last three years. Beginning in the second half of 2010 and continuing in the 2011, in order to bolster asset liquidity, we increased purchases of short-term trading securities, including U.S. Treasury obligations and debt securities of Fannie Mae and Freddie Mac. There was a resulting decrease in other short-term investments which include interest bearing deposits, securities purchased under agreements to resell, and overnight Federal funds sold.
The book balance of the liquidity portfolio averaged $19,655 million in the first nine months of the year, compared to $16,358 million in all of 2010. The balance at September 30, 2011 was $14,747 million compared to $21,654 million at the end of 2010. The reduction at the end of the third quarter occurred because of our decision to not lend as many funds, due to the extremely low yields available on some investments at quarter end. A portion of these funds not lent were held in deposits at the Federal Reserve.
Our ongoing strategy for mortgage-backed securities is to maximize their holdings close to the regulatory maximum of three times capital. When market conditions are unfavorable, as they were at times in the first nine months of 2011, we may purchase fewer securities. The book balance of the mortgage-backed securities portfolio averaged $11,023 million in the first nine months of the year. The $11,304 million outstanding at September 30, 2011 amounted to a multiple of regulatory capital of 2.92, slightly below the regulatory limit of three times, and consisted of $9,824 million of securities issued by Fannie Mae or Freddie Mac, $1,459 million of floating-rate securities issued by the National Credit Union Administration, $19 million of fixed-rate private-label mortgage-backed securities, and $2 million of securities issued by Ginnie Mae.
The table below shows principal purchases, paydowns and sales of our mortgage-backed securities for the first nine months of 2011.
(In millions) | Mortgage-backed Securities Principal | |||
Balance at December 31, 2010 | $ | 11,591 | ||
Principal purchases | 2,564 | |||
Principal paydowns | (2,569 | ) | ||
Principal sales | (329 | ) | ||
Balance at September 30, 2011 | $ | 11,257 |
The $2,569 million of principal paydowns in the first nine months of 2011 equated to a 27 percent annual constant prepayment rate, modestly lower than 2010's 30 percent rate. As in the last three years, yields earned in the first three quarters of 2011 on new mortgage-backed securities, relative to funding costs, offered acceptable risk-adjusted returns due in part to the steep Consolidated Obligation yield curve.
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Consolidated Obligations
The table below presents the ending and average balances of our participations in Consolidated Obligations.
Nine Months Ended | Year Ended | ||||||||||||||
(In millions) | September 30, 2011 | December 31, 2010 | |||||||||||||
Ending Balance | Average Balance | Ending Balance | Average Balance | ||||||||||||
Consolidated Discount Notes: | |||||||||||||||
Par | $ | 33,342 | $ | 33,256 | $ | 35,008 | $ | 27,918 | |||||||
Discount | (3 | ) | (4 | ) | (5 | ) | (4 | ) | |||||||
Total Consolidated Discount Notes | 33,339 | 33,252 | 35,003 | 27,914 | |||||||||||
Consolidated Bonds: | |||||||||||||||
Unswapped fixed-rate | 19,447 | 20,419 | 21,256 | 23,677 | |||||||||||
Unswapped adjustable-rate | 1,250 | 452 | — | 852 | |||||||||||
Swapped fixed-rate | 6,675 | 8,008 | 9,294 | 9,974 | |||||||||||
Total par Consolidated Bonds | 27,372 | 28,879 | 30,550 | 34,503 | |||||||||||
Other items (1) | 139 | 141 | 147 | 148 | |||||||||||
Total Consolidated Bonds | 27,511 | 29,020 | 30,697 | 34,651 | |||||||||||
Total Consolidated Obligations (2) | $ | 60,850 | $ | 62,272 | $ | 65,700 | $ | 62,565 |
(1) | Includes unamortized premiums/discounts, fair value option valuation adjustments, hedging and other basis adjustments. |
(2) | The 12 FHLBanks have joint and several liability for the par amount of all of the Consolidated Obligations issued on their behalves. The par amount of the outstanding Consolidated Obligations of all 12 FHLBanks was (in millions) $696,606 and $796,374 at September 30, 2011 and December 31, 2010, respectively. |
Balances of total Obligations fluctuate in accordance with changes in the amount of total assets. Changes to the mix of Obligations fluctuate in response to relative changes in short-term versus long-term assets, relative changes in fixed-rate and adjustable-rate assets, decisions on market risk management (particularly the amount of funding of longer-term assets with short-term Obligations), and differences in relative costs of various Obligations. We fund short-term and adjustable-rate Advances, Advances hedged with interest rate swaps, and most liquidity investments with a combination of Discount Notes, unswapped adjustable-rate Bonds, and swapped fixed-rate Bonds (which effectively create short-term funding). In order to effectively reduce market risk exposure, we fund long-term assets principally with unswapped fixed-rate Bonds.
The $4,850 million decrease in the total ending balance of Consolidated Obligations from the end of 2010 to September 30, 2011 corresponded to the decrease in total assets (primarily short-term liquidity investments) and the relatively stable amount of deposits and capital. The slight $293 million decrease in the average balance of Obligations in the first nine months of 2011 compared to the full year average for 2010 reflected the stable balance in total average assets in these two periods.
Long-term Consolidated Obligation Bonds normally have an interest cost at a spread above U.S. Treasury securities and below LIBOR. The spreads and volatility of the spreads were at levels comparable to historical averages in the first nine months of the year.
Deposits
Members' deposits with us are normally a relatively minor source of low-cost funding. Total interest bearing deposits at September 30, 2011 were $1,275 million, a decrease of $162 million (11 percent) from year-end 2010. As shown on the “Average Balance Sheet and Rates” table in “Results of Operations,” the average balance of total interest bearing deposits in the first nine months of 2011 was $1,262 million, a decrease of $407 million (24 percent) from the average balance in the same period of 2010.
Deposit balances, which can change substantially based on the actions of a few larger members, fell over the last year despite members' substantial increase in excess reserves and their stagnant loan demand. We believe this may be due to the higher interest rates that the Federal Reserve currently offers on member deposits compared to those we can offer at acceptable profitability.
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Derivatives Hedging Activity and Liquidity
Our use of and accounting for derivatives is discussed in the "Effect of the Use of Derivatives on Net Interest Income" section in "Results of Operations." Liquidity is discussed in the "Liquidity Risk" section in “Quantitative and Qualitative Disclosures About Risk Management.” We did not change our strategy of using derivatives solely to manage market risk exposure in the first nine months of 2011.
Capital Resources
The following tables present capital amounts and capital-to-assets ratios, on both a GAAP and regulatory basis.
GAAP and Regulatory Capital | Nine Months Ended | Year Ended | |||||||||||||
September 30, 2011 | December 31, 2010 | ||||||||||||||
(In millions) | Period End | Average | Period End | Average | |||||||||||
GAAP Capital Stock | $ | 3,106 | $ | 3,107 | $ | 3,092 | $ | 3,093 | |||||||
Mandatorily Redeemable Capital Stock | 331 | 331 | 357 | 413 | |||||||||||
Regulatory Capital Stock | 3,437 | 3,438 | 3,449 | 3,506 | |||||||||||
Retained Earnings | 436 | 456 | 438 | 436 | |||||||||||
Regulatory Capital | $ | 3,873 | $ | 3,894 | $ | 3,887 | $ | 3,942 |
GAAP and Regulatory Capital-to-Assets Ratio | Nine Months Ended | Year Ended | |||||||||
September 30, 2011 | December 31, 2010 | ||||||||||
Period End | Average | Period End | Average | ||||||||
GAAP | 5.28 | % | 5.19 | % | 4.92 | % | 5.08 | % | |||
Regulatory | 5.79 | 5.69 | 5.43 | 5.68 |
Finance Agency Regulations specify limits on how much we can leverage capital by requiring that we maintain, at all times, at least a 4.00 percent regulatory capital-to-assets ratio. A lower ratio indicates more leverage. We consider the regulatory capital-to-assets ratio to be a better representation of financial leverage than the GAAP ratio because the GAAP ratio treats mandatorily redeemable capital stock as a liability, although it provides the same economic function as GAAP capital stock and retained earnings in protecting investors in our debt.
Our capital base was relatively stable in the first nine months of 2011, with the amount of regulatory capital changing only $14 million from the end of 2010. Similarly, average GAAP and regulatory financial leverage, as represented by the average capital-to-assets ratio, did not change materially in the first three quarters of this year compared to the 2010 average. Financial leverage ratios were higher at the end of the third quarter compared to the end of 2010 due to the smaller balance of total assets at quarter end.
The table below shows the amount of excess capital stock.
(In millions) | September 30, 2011 | December 31, 2010 | |||||
Excess capital stock (Capital Plan definition) | $ | 1,148 | $ | 1,192 | |||
Cooperative utilization of capital stock | $ | 184 | $ | 179 | |||
Mission Asset Activity capitalized with cooperative capital stock | $ | 4,596 | $ | 4,483 |
The amount of excess capital stock and other metrics shown for the two dates presented in the table showed little change. This reflected the small change in Mission Asset Activity between these two dates. A Finance Agency Regulation prohibits us from paying stock dividends if the amount of our regulatory excess stock (defined by the Finance Agency to include stock used cooperatively) exceeds one percent of our total assets on a dividend payment date. Since the end of 2008, we have exceeded the regulatory threshold and, therefore, have been required to pay cash dividends. Until Advances grow again by a large amount, we expect to continue paying cash dividends.
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Retained earnings at September 30, 2011 totaled $436 million, which included $4 million added to restricted retained earnings in the third quarter. After increasing in each quarter since 2001, total retained earnings declined $12 million in the third quarter.
Membership and Stockholders
On September 30, 2011, we had 741 member stockholders. During the first three quarters of 2011, 15 financial institutions became new members and stockholders and nine members merged into other Fifth District members, producing a net gain of six member stockholders. Membership changes are a normal and ongoing part of our business operations. We will continue to recruit institutions eligible for membership in order to maintain and expand our customer base, with a focus continuing on insurance companies. In the first nine months of the year, there were no material changes in the allocation of membership by state, charter type, or asset size.
RESULTS OF OPERATIONS
Components of Earnings and Return on Equity
The following table is a summary income statement for the three- and nine-months ended September 30, 2011 and 2010. Each ROE percentage is computed by dividing income or expense for the category by the average amount of stockholders' equity for the period.
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||||||
(Dollars in millions) | 2011 | 2010 | 2011 | 2010 | |||||||||||||||||||||||
Amount | ROE (a) | Amount | ROE (a) | Amount | ROE (a) | Amount | ROE (a) | ||||||||||||||||||||
Net interest income | $ | 44 | 4.42 | % | $ | 60 | 4.89 | % | $ | 181 | 5.26 | % | $ | 192 | 5.32 | % | |||||||||||
Provision for credit losses | (2 | ) | (0.23 | ) | (4 | ) | (0.31 | ) | (6 | ) | (0.18 | ) | (4 | ) | (0.11 | ) | |||||||||||
Net interest income after provision for credit losses | 42 | 4.19 | 56 | 4.58 | 175 | 5.08 | 188 | 5.21 | |||||||||||||||||||
Net (losses) gains on derivatives and hedging activities | (3 | ) | (0.33 | ) | 4 | 0.31 | 2 | 0.03 | 3 | 0.08 | |||||||||||||||||
Other non-interest (loss) income | (3 | ) | (0.32 | ) | 4 | 0.33 | (5 | ) | (0.15 | ) | 13 | 0.38 | |||||||||||||||
Total non-interest (loss) income | (6 | ) | (0.65 | ) | 8 | 0.64 | (3 | ) | (0.12 | ) | 16 | 0.46 | |||||||||||||||
Total revenue | 36 | 3.54 | 64 | 5.22 | 172 | 4.96 | 204 | 5.67 | |||||||||||||||||||
Total other expense | (15 | ) | (1.47 | ) | (13 | ) | (1.11 | ) | (42 | ) | (1.26 | ) | (39 | ) | (1.09 | ) | |||||||||||
Assessments | (2 | ) | (b) | (14 | ) | (b) | (32 | ) | (b) | (45 | ) | (b) | |||||||||||||||
Net income | $ | 19 | 2.07 | % | $ | 37 | 4.11 | % | $ | 98 | 3.70 | % | $ | 120 | 4.58 | % |
(a) | The ROE amounts have been computed using dollars in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) in this table may produce nominally different results. |
(b) | The effect on ROE of the REFCORP and/or Affordable Housing Program assessments is pro-rated within the other categories. |
The primary factor contributing to the decline in profitability for each of the comparison periods was a sharp reduction in long-term interest rates, especially mortgage rates, which led to a significant increase in the amortization of purchased premiums on mortgage-related assets. Details for the categories of the summary income statement are discussed in subsequent sections.
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Net Interest Income
Components of Net Interest Income
The following table shows the major components of net interest income for the three- and nine-months ended September 30, 2011 and 2010. Reasons for the variance in net interest income between the two comparison periods are discussed below.
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
(Dollars in millions) | 2011 | 2010 | 2011 | 2010 | |||||||||||||||||||
Amount | Pct of Earning Assets | Amount | Pct of Earning Assets | Amount | Pct of Earning Assets | Amount | Pct of Earning Assets | ||||||||||||||||
Components of net interest rate spread: | |||||||||||||||||||||||
Other components of net interest rate spread | $ | 61 | 0.37 | % | $ | 57 | 0.34 | % | $ | 181 | 0.36 | % | $ | 165 | 0.32 | % | |||||||
Net (amortization)/accretion (1) (2) | (32 | ) | (0.19 | ) | (16 | ) | (0.10 | ) | (43 | ) | (0.09 | ) | (30 | ) | (0.06 | ) | |||||||
Prepayment fees on Advances, net (2) | 3 | 0.02 | 1 | 0.01 | 4 | 0.01 | 4 | 0.01 | |||||||||||||||
Total net interest rate spread | 32 | 0.20 | 42 | 0.25 | 142 | 0.28 | 139 | 0.27 | |||||||||||||||
Earnings from funding assets with interest-free capital | 12 | 0.07 | 18 | 0.11 | 39 | 0.08 | 53 | 0.10 | |||||||||||||||
Total net interest income/net interest margin (3) | $ | 44 | 0.27 | % | $ | 60 | 0.36 | % | $ | 181 | 0.36 | % | $ | 192 | 0.37 | % |
(1) | Includes (amortization)/accretion of premiums/discounts on mortgage assets and Consolidated Obligations and deferred transaction costs (concession fees) for Consolidated Obligations. |
(2) | These components of net interest rate spread have been segregated here to display their relative impact. |
(3) | Net interest margin is net interest income before provision for credit losses as a percentage of average total interest earning assets. |
Earnings From Capital. Earnings generated from funding interest-earning assets with interest-free capital fluctuate in the same direction as changes in asset yields. The reduction in earnings from capital for both comparison periods was due to the continuing trend of reductions in market interest rates, especially long-term rates. As assets matured or paid down, they were replaced with new assets at lower yields. The effect on earnings from this factor was primarily due to a decline in the yield on mortgage assets. As shown in the "Average Balance Sheet and Rates" table, the average rate on earning assets fell 0.34 percentage points in the first nine months of 2011 compared to the same period in 2010.
Net Amortization/Accretion. Net amortization/accretion includes recognition of premiums and discounts paid on purchases of mortgage assets (which include loans in the Mortgage Purchase Program and investments in mortgage-backed securities) and premiums, discounts and concessions paid on most Consolidated Bonds. Our mortgage assets had a net premium balance of $137 million at September 30, 2011. The amount of mortgage assets with premium balances has risen substantially in the last two years, primarily because we purchased more mortgage-backed securities at premium prices (and above market rates) than in the past due to conditions prevailing in the mortgage markets, especially in 2010, that reduced the risk-return attractiveness of such securities with prices closer to par or at discounts.
Amortization of premiums and accretion of discounts on mortgage assets can be significantly volatile because it is recorded, and adjusted monthly, in accordance with actual and expected principal paydowns to approximate a level yield amortization schedule. Amortization/accretion is accelerated when mortgage paydowns speed up (normally in response to lower mortgage rates) and is decelerated when they slow down (normally in response to higher mortgage rates). Interest rates also affect the amortization of Bond concessions by changing the amount of Bonds we call before maturity. When Bonds are called, remaining concessions are recognized immediately.
The higher net amortization in both the three- and nine-months comparisons resulted from the substantial reductions in mortgage rates in the third quarter of 2011. Mortgage amortization increased by $20 million in the three-month comparison and by $29 million in the nine-months comparison. These amounts were partially offset by smaller amortization of Bonds concession costs and larger amortization of Bond premiums.
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Prepayment Fees on Advances. Fees for members' early repayment of certain Advances are designed to make us economically indifferent to whether members hold Advances to maturity or repay them before maturity. Prepayments in one period do not necessarily indicate a trend that will continue in future periods. Although Advance prepayment fees can be, and in the past have been, significant, they were relatively small in each of the first three quarters of both 2011 and 2010.
Other Components of Net Interest Rate Spread. Excluding net amortization and prepayment fees, the other components of the net interest rate spread increased by $16 million (10 percent) in the nine-months comparison and by $4 million (7 percent) in the three-months comparison. Several factors, discussed below in estimated order of impact from largest to smallest, were primarily responsible for the changes in the net interest spread due to other components.
Nine-Months Comparison
▪ | Re-issuing called Consolidated Bonds at lower debt costs-Favorable: In the last three months of 2010 and the first nine months of 2011, reductions in intermediate- and long-term interest rates enabled us to call $5.9 billion of unswapped Bonds before their final maturities and to replace them with new Consolidated Obligations. Most of the new Consolidated Obligations had substantially lower rates than the Bonds that were called. We also called a large amount of Bonds in the third quarter of 2010, which benefited our earnings more in 2011 than in 2010. |
▪ | Decrease in mortgage assets balances-Unfavorable: Although the average book balance of interest-earnings assets declined by only $777 million, the average book balance of mortgage assets--which are normally our most profitable assets--declined by $1,661 million. |
▪ | Trading securities-Favorable: In the second half of 2010 and continuing in the first nine months of 2011, we began holding a large amount of investments in short-term trading securities (which included instruments of the U.S. Treasury and government-sponsored enterprises) in order to enhance asset liquidity. Many of the trading securities were purchased with above-market coupon rates, which resulted in an estimated $19 million increase in net interest income. However, this was offset by earnings reductions in other non-interest income (net unrealized market value losses on trading securities), with the resulting combined earnings from the trading securities reflecting at-market rates. See “Non-Interest Income and Non-Interest Expense” below for a discussion of the net losses on trading securities. |
▪ | Narrower net spreads on new mortgage assets-Unfavorable: In the last three months of 2010 and the first nine months of 2011, we purchased $5.9 billion of new mortgage assets. Net spreads relative to funding costs on the purchased assets were on average narrower than the net spreads that had been earned on the mortgages that paid down. |
Three-Months Comparison
For the three-months comparison, the same factors generally affected the other components of net interest rate spread as in the nine-months comparison and in approximately the same relative magnitude. The impact of lower mortgage asset balances, however, was not as large in the three-months comparison.
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Average Balance Sheet and Rates
The following table provides average rates and average balances for major balance sheet accounts, which determine the changes in the net interest rate spread. All data include the impact of interest rate swaps, which we allocate to each asset and liability category according to their designated hedging relationship. The changes in the net interest rate spread and net interest margin for the three-months and nine-months comparisons occurred mostly from the net impact of the factors discussed above in “Components of Net Interest Income.”
(Dollars in millions) | Three Months Ended | Three Months Ended | |||||||||||||||||||
September 30, 2011 | September 30, 2010 | ||||||||||||||||||||
Average Balance | Interest | Average Rate (1) | Average Balance | Interest | Average Rate (1) | ||||||||||||||||
Assets | |||||||||||||||||||||
Advances | $ | 30,269 | $ | 57 | 0.75 | % | $ | 32,612 | $ | 78 | 0.95 | % | |||||||||
Mortgage loans held for portfolio (2) | 7,761 | 77 | 3.92 | 8,616 | 94 | 4.31 | |||||||||||||||
Federal funds sold and securities purchased under resale agreements | 6,644 | 1 | 0.07 | 8,571 | 4 | 0.19 | |||||||||||||||
Interest-bearing deposits in banks (3) (4) | 2,514 | 1 | 0.15 | 5,333 | 4 | 0.28 | |||||||||||||||
Mortgage-backed securities | 10,475 | 84 | 3.17 | 10,962 | 125 | 4.53 | |||||||||||||||
Other investments | 8,254 | 11 | 0.52 | 268 | — | 0.20 | |||||||||||||||
Loans to other FHLBanks | — | — | — | 7 | — | 0.16 | |||||||||||||||
Total earning assets | 65,917 | 231 | 1.39 | 66,369 | 305 | 1.82 | |||||||||||||||
Less: allowance for credit losses on mortgage loans | 15 | — | |||||||||||||||||||
Other assets | 642 | 180 | |||||||||||||||||||
Total assets | $ | 66,544 | $ | 66,549 | |||||||||||||||||
Liabilities and Capital | |||||||||||||||||||||
Term deposits | $ | 131 | — | 0.22 | $ | 269 | — | 0.36 | |||||||||||||
Other interest bearing deposits (4) | 1,023 | — | 0.01 | 1,322 | — | 0.04 | |||||||||||||||
Short-term borrowings | 33,243 | 6 | 0.07 | 26,673 | 11 | 0.17 | |||||||||||||||
Unswapped fixed-rate Consolidated Bonds | 20,084 | 173 | 3.43 | 23,126 | 220 | 3.77 | |||||||||||||||
Unswapped adjustable-rate Consolidated Bonds | 1,250 | 1 | 0.15 | 1,000 | 1 | 0.21 | |||||||||||||||
Swapped Consolidated Bonds | 5,890 | 4 | 0.24 | 8,978 | 8 | 0.37 | |||||||||||||||
Mandatorily redeemable capital stock | 326 | 3 | 3.50 | 388 | 5 | 4.50 | |||||||||||||||
Other borrowings | — | — | — | — | — | — | |||||||||||||||
Total interest-bearing liabilities | 61,947 | 187 | 1.19 | 61,756 | 245 | 1.57 | |||||||||||||||
Non-interest bearing deposits | 14 | 9 | |||||||||||||||||||
Other liabilities | 1,019 | 1,246 | |||||||||||||||||||
Total capital | 3,564 | 3,538 | |||||||||||||||||||
Total liabilities and capital | $ | 66,544 | $ | 66,549 | |||||||||||||||||
Net interest rate spread | 0.20 | % | 0.25 | % | |||||||||||||||||
Net interest income and net interest margin (5) | $ | 44 | 0.27 | % | $ | 60 | 0.36 | % | |||||||||||||
Average interest-earning assets to interest-bearing liabilities | 106.41 | % | 107.47 | % |
(1 | ) | Amounts used to calculate average rates are based on dollars in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results. |
(2 | ) | Non-accrual loans are included in average balances used to determine average rate. |
(3 | ) | Includes certificates of deposit and bank notes that are classified as available-for-sale securities, based on their amortized costs. The yield information does not give effect to changes in fair value that are reflected as a component of stockholders' equity for available-for-sale securities. |
(4 | ) | The average balance amounts include the rights or obligations to cash collateral, which are included in the fair value of derivative assets or derivative liabilities on the Statements of Condition at period end. |
(5 | ) | Net interest margin is net interest income before provision for credit losses as a percentage of average total interest earning assets. |
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(Dollars in millions) | Nine Months Ended | Nine Months Ended | |||||||||||||||||||
September 30, 2011 | September 30, 2010 | ||||||||||||||||||||
Average Balance | Interest | Average Rate (1) | Average Balance | Interest | Average Rate (1) | ||||||||||||||||
Assets | |||||||||||||||||||||
Advances | $ | 29,323 | $ | 177 | 0.81 | % | $ | 32,938 | $ | 224 | 0.91 | % | |||||||||
Mortgage loans held for portfolio (2) | 7,642 | 253 | 4.43 | 8,903 | 310 | 4.65 | |||||||||||||||
Federal funds sold and securities purchased under resale agreements | 7,337 | 6 | 0.11 | 9,022 | 11 | 0.17 | |||||||||||||||
Interest-bearing deposits in banks (3) (4) | 4,354 | 7 | 0.21 | 5,386 | 9 | 0.24 | |||||||||||||||
Mortgage-backed securities | 11,023 | 296 | 3.59 | 11,423 | 397 | 4.64 | |||||||||||||||
Other investments | 8,413 | 32 | 0.51 | 1,196 | 1 | 0.13 | |||||||||||||||
Loans to other FHLBanks | 4 | — | 0.10 | 5 | — | 0.15 | |||||||||||||||
Total earning assets | 68,096 | 771 | 1.51 | 68,873 | 952 | 1.85 | |||||||||||||||
Less: allowance for credit losses on mortgage loans | 14 | — | |||||||||||||||||||
Other assets | 366 | 232 | |||||||||||||||||||
Total assets | $ | 68,448 | $ | 69,105 | |||||||||||||||||
Liabilities and Capital | |||||||||||||||||||||
Term deposits | $ | 182 | — | 0.24 | $ | 217 | 1 | 0.39 | |||||||||||||
Other interest bearing deposits (4) | 1,080 | — | 0.02 | 1,452 | — | 0.04 | |||||||||||||||
Short-term borrowings | 33,252 | 24 | 0.10 | 26,211 | 28 | 0.14 | |||||||||||||||
Unswapped fixed-rate Consolidated Bonds | 20,483 | 540 | 3.52 | 24,316 | 699 | 3.85 | |||||||||||||||
Unswapped adjustable-rate Consolidated Bonds | 452 | 1 | 0.15 | 1,000 | 1 | 0.14 | |||||||||||||||
Swapped Consolidated Bonds | 8,085 | 14 | 0.23 | 10,730 | 16 | 0.21 | |||||||||||||||
Mandatorily redeemable capital stock | 331 | 11 | 4.35 | 431 | 15 | 4.51 | |||||||||||||||
Other borrowings | — | — | — | 1 | — | 0.21 | |||||||||||||||
Total interest-bearing liabilities | 63,865 | 590 | 1.23 | 64,358 | 760 | 1.58 | |||||||||||||||
Non-interest bearing deposits | 13 | 8 | |||||||||||||||||||
Other liabilities | 1,014 | 1,222 | |||||||||||||||||||
Total capital | 3,556 | 3,517 | |||||||||||||||||||
Total liabilities and capital | $ | 68,448 | $ | 69,105 | |||||||||||||||||
Net interest rate spread | 0.28 | % | 0.27 | % | |||||||||||||||||
Net interest income and net interest margin (5) | $ | 181 | 0.36 | % | $ | 192 | 0.37 | % | |||||||||||||
Average interest-earning assets to interest-bearing liabilities | 106.62 | % | 107.02 | % |
(1 | ) | Amounts used to calculate average rates are based on dollars in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results. |
(2 | ) | Non-accrual loans are included in average balances used to determine average rate. |
(3 | ) | Includes certificates of deposit and bank notes that are classified as available-for-sale securities, based on their amortized costs. The yield information does not give effect to changes in fair value that are reflected as a component of stockholders' equity for available-for-sale securities. |
(4 | ) | The average balance amounts include the rights or obligations to cash collateral, which are included in the fair value of derivative assets or derivative liabilities on the Statements of Condition at period end. |
(5 | ) | Net interest margin is net interest income before provision for credit losses as a percentage of average total interest earning assets. |
For both comparison periods, the average rate on both total earning assets and interest-bearing liabilities decreased, driven by lower average rates on long-term assets and long-term liability accounts, which include mortgage loans held for portfolio, mortgage-backed securities, and unswapped fixed-rate Consolidated Bonds. This reflects the trend in the last several years of sharply lower intermediate- and long-term market rates; as the long-term assets and liabilities mature or are paid down over time, new long-term assets and liabilities are put on the balance sheet at lower rates, which cumulatively builds over time to reduced portfolio rates. The higher amortization of mortgage purchase premiums, discussed above, also contributed to the declines in average rates on earnings assets.
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Short-term rates were relatively stable in the first nine months of 2011. Many of our short-term and adjustable-rate assets and liabilities have rates tied to overnight Federal funds and short-term LIBOR. The rate on swapped Consolidated Obligation liability account and adjustable-rate Bonds, which are both tied to short-term LIBOR, rose slightly in the nine-months comparison due to normal modest fluctuations in short-term LIBOR. The average rate on other investments in both comparison periods rose for two reasons. First, we held a larger amount of short-term liquidity investments that had longer final maturities than the typical liquidity investment we purchase and the yield curve for liquidity investments is upward sloping. Second, many of these investments were trading securities purchased at above market rates (with corresponding premiums paid reflected in other non-interest income as losses to the securities' fair values).
Volume/Rate Analysis
Changes in both average balances (volume) and interest rates influence changes in net interest income. The following table summarizes these changes and trends in interest income and interest expense.
Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
(In millions) | September 30, 2011 over 2010 | September 30, 2011 over 2010 | |||||||||||||||||||||
Volume (1)(3) | Rate (2)(3) | Total | Volume (1)(3) | Rate (2)(3) | Total | ||||||||||||||||||
Increase (decrease) in interest income | |||||||||||||||||||||||
Advances | $ | (5 | ) | $ | (16 | ) | $ | (21 | ) | $ | (23 | ) | $ | (24 | ) | $ | (47 | ) | |||||
Mortgage loans held for portfolio | (9 | ) | (8 | ) | (17 | ) | (43 | ) | (14 | ) | (57 | ) | |||||||||||
Federal funds sold and securities purchased under resale agreements | (1 | ) | (2 | ) | (3 | ) | (2 | ) | (3 | ) | (5 | ) | |||||||||||
Interest-bearing deposits in banks | (2 | ) | (1 | ) | (3 | ) | (1 | ) | (1 | ) | (2 | ) | |||||||||||
Mortgage-backed securities | (5 | ) | (36 | ) | (41 | ) | (13 | ) | (88 | ) | (101 | ) | |||||||||||
Other investments | 10 | 1 | 11 | 21 | 10 | 31 | |||||||||||||||||
Loans to other FHLBanks | — | — | — | — | — | — | |||||||||||||||||
Total | (12 | ) | (62 | ) | (74 | ) | (61 | ) | (120 | ) | (181 | ) | |||||||||||
Increase (decrease) in interest expense | |||||||||||||||||||||||
Term deposits | — | — | — | (1 | ) | — | (1 | ) | |||||||||||||||
Other interest-bearing deposits | — | — | — | — | — | — | |||||||||||||||||
Short-term borrowings | 3 | (8 | ) | (5 | ) | 6 | (10 | ) | (4 | ) | |||||||||||||
Unswapped fixed-rate Consolidated Bonds | (28 | ) | (19 | ) | (47 | ) | (104 | ) | (55 | ) | (159 | ) | |||||||||||
Unswapped adjustable-rate Consolidated Bonds | — | — | — | — | — | — | |||||||||||||||||
Swapped Consolidated Bonds | (2 | ) | (2 | ) | (4 | ) | (4 | ) | 2 | (2 | ) | ||||||||||||
Mandatorily redeemable capital stock | (1 | ) | (1 | ) | (2 | ) | (3 | ) | (1 | ) | (4 | ) | |||||||||||
Other borrowings | — | — | — | — | — | — | |||||||||||||||||
Total | (28 | ) | (30 | ) | (58 | ) | (106 | ) | (64 | ) | (170 | ) | |||||||||||
Increase (decrease) in net interest income | $ | 16 | $ | (32 | ) | $ | (16 | ) | $ | 45 | $ | (56 | ) | $ | (11 | ) |
(1) | Volume changes are calculated as the change in volume multiplied by the prior year rate. |
(2) | Rate changes are calculated as the change in rate multiplied by the prior year average balance. |
(3) | Changes that are not identifiable as either volume-related or rate-related, but rather are equally attributable to both volume and rate changes, have been allocated to the volume and rate categories based upon the proportion of the absolute value of the volume and rate changes. |
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Effect of the Use of Derivatives on Net Interest Income
The following table shows the effect of using derivatives on net interest income. The table does not show the effect on earnings from the non-interest components of derivatives related to market value adjustments; this is provided in the next section “Non-Interest Income and Non-Interest Expense.”
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
(In millions) | 2011 | 2010 | 2011 | 2010 | |||||||||||
Advances: | |||||||||||||||
Amortization/accretion of hedging activities in net interest income | $ | (1 | ) | $ | — | $ | (2 | ) | $ | — | |||||
Net interest settlements included in net interest income | (91 | ) | (106 | ) | (278 | ) | (339 | ) | |||||||
Mortgage loans: | |||||||||||||||
Amortization of derivative fair value adjustments in net interest income | — | 1 | 1 | — | |||||||||||
Consolidated Obligation Bonds: | |||||||||||||||
Amortization/accretion of hedging activities in net interest income | — | 1 | — | 1 | |||||||||||
Net interest settlements included in net interest income | 13 | 19 | 53 | 93 | |||||||||||
Decrease to net interest income | $ | (79 | ) | $ | (85 | ) | $ | (226 | ) | $ | (245 | ) |
The primary reasons we use derivatives, most of which have historically been interest rate swaps, are to manage market risk exposure and lower funding costs on Consolidated Obligation Bonds. Most of our derivatives synthetically convert the intermediate- and long-term fixed interest rates on certain Advances and Consolidated Obligation Bonds to adjustable-coupon rates tied to short-term LIBOR (mostly three-month). These adjustable-rate coupons normally have lower interest rates than the fixed rates.
Use of derivatives results in a much closer match of actual cash flows between assets and liabilities than would occur otherwise, which, as designed, reduces market risk exposure. It can also lower earnings when short-term rates are lower than intermediate- and long-term rates (as is normally the case) if the reduction in net interest income from Advance-related derivatives exceeds the increase in net interest income from Bond-related derivatives. This was the case in the three- and nine-months periods of both 2011 and 2010, primarily because the Advances that were swapped to short-term LIBOR had higher fixed interest rates than the Bonds that were swapped to short-term LIBOR. The reduction in earnings from using derivatives was acceptable because it enabled us to significantly lower market risk exposure.
Provision for Credit Losses
In the first nine months of 2011, charge-offs on loans in the Mortgage Purchase Program totaled $3 million and we recorded a $6 million provision for future credit losses in the Program, compared to charge-offs of $1 million and a provision of $4 million in the first nine months of 2010. The increase in the provision was based on an assessment of additional incurred losses primarily as a result of further modest declines in historical home prices. The allowance for credit losses increased by $3 million in the first nine months of the year, with the allowance at September 30, 2011 totaling $15 million. For further information, see the "Credit Risk - Mortgage Purchase Program" section in "Quantitative and Qualitative Disclosures About Risk Management" and Note 9 of the Notes to Unaudited Financial Statements.
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Non-Interest Income and Non-Interest Expense
The following table presents non-interest income and non-interest expense.
(Dollars in millions) | Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||
2011 | 2010 | 2011 | 2010 | ||||||||||||
Other Income | |||||||||||||||
Net gains on held-to-maturity securities | $ | 3 | $ | 1 | $ | 9 | $ | 8 | |||||||
Net (losses) gains on derivatives and hedging activities | (3 | ) | 4 | 2 | 3 | ||||||||||
Other non-interest (loss) income, net | (6 | ) | 3 | (14 | ) | 5 | |||||||||
Total other (loss) income | $ | (6 | ) | $ | 8 | $ | (3 | ) | $ | 16 | |||||
Other Expense | |||||||||||||||
Compensation and benefits | $ | 8 | $ | 8 | $ | 24 | $ | 22 | |||||||
Other operating expense | 4 | 4 | 11 | 11 | |||||||||||
Finance Agency | 1 | 1 | 3 | 3 | |||||||||||
Office of Finance | 1 | — | 3 | 2 | |||||||||||
Other | 1 | — | 1 | 1 | |||||||||||
Total other expense | $ | 15 | $ | 13 | $ | 42 | $ | 39 | |||||||
Average total assets | $ | 66,544 | $ | 66,549 | $ | 68,448 | $ | 69,105 | |||||||
Average regulatory capital | 3,898 | 3,934 | 3,894 | 3,955 | |||||||||||
Total other expense to average total assets (1) | 0.09 | % | 0.08 | % | 0.08 | % | 0.08 | % | |||||||
Total other expense to average regulatory capital (1) | 1.49 | 1.36 | 1.45 | 1.31 |
(1) | Amounts used to calculate percentages are based on dollars in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results. |
The net gains on held-to-maturity securities for each period occurred from our sales of certain mortgage-backed securities. Each of the securities sold had less than 15 percent of the original acquired principal outstanding at the time of the sale.
The decreases in other non-interest (loss) income between the two comparison periods were mostly due to losses on trading securities in 2011. As discussed above in “Components of Net Interest Income,” these losses were driven by certain securities purchased with above-market coupon rates and, therefore, prices above par. The related premiums paid are reflected as losses to the securities' fair value as they approach maturity.
Total other expenses rose eight percent and nine percent in the three and nine months ended September 30, 2011, respectively. All categories shown experienced slight increases. The ratio of other expense to regulatory capital rose in each comparison period due to both higher other expense amounts and decreases in average regulatory capital. We continue to maintain a sharp focus on controlling operating costs.
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Detail on Net Gains (Losses) on Derivatives and Hedging Activities
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
(In millions) | 2011 | 2010 | 2011 | 2010 | |||||||||||
Net (losses) gains on derivatives and hedging activities | |||||||||||||||
Advances: | |||||||||||||||
(Losses) gains on fair value hedges | $ | (1 | ) | $ | 6 | $ | 7 | $ | 4 | ||||||
Losses on derivatives not receiving hedge accounting | (5 | ) | (4 | ) | (8 | ) | (9 | ) | |||||||
Mortgage loans: | |||||||||||||||
Gains (losses) on derivatives not receiving hedge accounting | 2 | 1 | (1 | ) | 5 | ||||||||||
Consolidated Obligation Bonds: | |||||||||||||||
Gains (losses) on fair value hedges | 1 | (1 | ) | — | — | ||||||||||
Gains on derivatives not receiving hedge accounting | — | 2 | 4 | 3 | |||||||||||
Total net (losses) gains on derivatives and hedging activities | (3 | ) | 4 | 2 | 3 | ||||||||||
Net losses on financial instruments held at fair value (1) | (1 | ) | — | (1 | ) | — | |||||||||
Total net effect of derivatives and hedging activities | $ | (4 | ) | $ | 4 | $ | 1 | $ | 3 |
(1) | Includes only those gains or losses on financial instruments held at fair value that have an economic derivative "assigned." |
The amount of income volatility in derivatives and hedging activities in the periods noted was modest, well within the range of normal historical fluctuation relative to the notional amount of derivatives, and consistent with the close hedging relationships of our derivative transactions. The losses in the derivatives and hedging activities primarily represented unrealized market value adjustments, which resulted from the trend reductions in interest rates and the amortization of market value gains. For all four periods shown, the market value adjustments, as a percentage of notional derivatives principal, were less than 0.04 percentage points.
REFCORP and Affordable Housing Program Assessments
Until the third quarter of 2011, assessments against earnings had included a REFCORP obligation and expenses for the Affordable Housing Program. The FHLBank System's REFCORP obligation was satisfied at the end of the second quarter of 2011. Under the Capital Agreement agreed to by all 12 FHLBanks, REFCORP, which had been recorded as reduction to net income, has been replaced with a 20 percent allocation of net income to restricted retained earnings. See the "Executive Overview" for more information. The restricted retained earnings are not recorded in the income statement and are not available to be distributed as dividends to stockholders. This change resulted in a $4 million increase in net income in the third quarter and a corresponding reduction in assessments. There has been no change in our Affordable Housing Program. For further information, see the "Executive Overview" and Note 15 of the Unaudited Notes to Financial Statements.
In the first nine months of 2011, assessments totaled $32 million, which reduced ROE by 1.20 percentage points. In the same period of 2010, assessments totaled $45 million, which reduced ROE by 1.71 percentage points. The smaller impact of assessments on ROE in 2011 was due to the reductions in earnings, as discussed above, and the replacement of REFCORP with restricted retained earnings.
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Segment Information
Note 18 of the Notes to Unaudited Financial Statements presents information on our two operating business segments. We manage financial operations and market risk exposure primarily at the level, and within the context, of the entire balance sheet, rather than exclusively at the level of individual segments. Under this approach, the market risk/return profile of each segment may not match, or possibly even have the same trends as, what would occur if we managed each segment on a stand-alone basis. The table below summarizes each segment's operating results.
(Dollars in millions) | Traditional Member Finance | Mortgage Purchase Program | Total | ||||||||
Three Months Ended September 30, 2011 | |||||||||||
Net interest income after provision for credit losses | $ | 35 | $ | 7 | $ | 42 | |||||
Net income | $ | 13 | $ | 6 | $ | 19 | |||||
Average assets | $ | 58,763 | $ | 7,781 | $ | 66,544 | |||||
Assumed average capital allocation | $ | 3,150 | $ | 414 | $ | 3,564 | |||||
Return on Average Assets (1) | 0.08 | % | 0.32 | % | 0.11 | % | |||||
Return on Average Equity (1) | 1.56 | % | 5.95 | % | 2.07 | % | |||||
Three Months Ended September 30, 2010 | |||||||||||
Net interest income after provision for credit losses | $ | 45 | $ | 11 | $ | 56 | |||||
Net income | $ | 30 | $ | 7 | $ | 37 | |||||
Average assets | $ | 57,892 | $ | 8,657 | $ | 66,549 | |||||
Assumed average capital allocation | $ | 3,079 | $ | 459 | $ | 3,538 | |||||
Return on Average Assets (1) | 0.20 | % | 0.32 | % | 0.22 | % | |||||
Return on Average Equity (1) | 3.82 | % | 6.07 | % | 4.11 | % |
(1) | Amounts used to calculate returns are based on numbers in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results. |
(Dollars in millions) | Traditional Member Finance | Mortgage Purchase Program | Total | ||||||||
Nine Months Ended September 30, 2011 | |||||||||||
Net interest income after provision for credit losses | $ | 126 | $ | 49 | $ | 175 | |||||
Net income | $ | 67 | $ | 31 | $ | 98 | |||||
Average assets | $ | 60,785 | $ | 7,663 | $ | 68,448 | |||||
Assumed average capital allocation | $ | 3,158 | $ | 398 | $ | 3,556 | |||||
Return on Average Assets (1) | 0.15 | % | 0.55 | % | 0.19 | % | |||||
Return on Average Equity (1) | 2.83 | % | 10.65 | % | 3.70 | % | |||||
Nine Months Ended September 30, 2010 | |||||||||||
Net interest income after provision for credit losses | $ | 130 | $ | 58 | $ | 188 | |||||
Net income | $ | 79 | $ | 41 | $ | 120 | |||||
Average assets | $ | 60,160 | $ | 8,945 | $ | 69,105 | |||||
Assumed average capital allocation | $ | 3,062 | $ | 455 | $ | 3,517 | |||||
Return on Average Assets (1) | 0.17 | % | 0.62 | % | 0.23 | % | |||||
Return on Average Equity (1) | 3.44 | % | 12.24 | % | 4.58 | % |
(1) | Amounts used to calculate returns are based on numbers in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results. |
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Traditional Member Finance Segment
The decrease in net income and ROE for both the three- and nine-months comparison periods primarily reflected the following factors each of which is discussed in more detail above: increases in net amortization of purchased premiums related to mortgage-backed securities; lower yields on assets funded with interest-free capital; smaller average balances of mortgage-backed securities; and (for the three-months comparison) unrealized losses on derivatives market values. These factors were partially offset by calls of Consolidated Bonds that funded mortgage-backed securities and their replacement with lower cost debt and gains from sales of mortgage-backed securities. See the discussion above in “Components of Net Interest Income.”
Mortgage Purchase Program Segment
The profitability of the Mortgage Purchase Program continued to be at a substantial level over market interest rates, with a moderate amount of market risk and credit risk. In the first nine months of 2011, the Program averaged 11 percent of total average assets but accounted for 32 percent of earnings. The decrease in the Program's ROE for the nine-months comparison reflected, for 2011, the increases in net amortization of mortgage purchase premiums, a higher provision for credit losses, and narrower spreads on new loans in the Program compared to spreads earned on assets that paid down. These factors were partially offset by replacing called Bonds funding Program loans with lower cost debt.
The segment's ROE for both the third quarter of 2011 and 2010 was well below the segment's historical ROEs. This was due primarily to an abnormally large amount of net amortization, as mortgage rates declined substantially in both quarters. Without the excess volatility in net amortization, the segment's ROE in the third quarter of 2011 would have been approximately 13.5 percent, in line with historical average ROE.
Compared to the Traditional Member Finance segment, the Mortgage Purchase Program segment can exhibit more earnings volatility relative to short-term interest rates and more credit risk exposure. The Mortgage Purchase Program also provides the opportunity for enhanced risk-adjusted returns which can augment earnings. As discussed elsewhere, although mortgage assets are the largest source of our market risk, we believe that we have historically managed the risk prudently and that these assets do not excessively elevate the balance sheet's overall market risk exposure.
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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT RISK MANAGEMENT
Market Risk
Market Value of Equity and Duration of Equity - Entire Balance Sheet
Market risk exposure is the risk that net income and the value of stockholders' capital investment in the FHLBank may decrease, and that profitability may be uncompetitive, as a result of unexpected changes and volatility in the market environment and business conditions. Along with business/strategic risk, market risk is normally one of our largest residual risks. We attempt to manage market risk exposure within a prudent range while earning a competitive return on members' capital stock investment.
Two key measures of long-term market risk exposure are the sensitivities of the market value of equity and the duration of equity to changes in interest rates and other variables, as presented in the following tables for various instantaneous and permanent interest rate shocks. Average results are compiled using data for each month end. Given the very low level of rates, the down rate shocks are nonparallel scenarios, with short-term rates decreased less than long-term rates so that no rate falls below zero.
Market Value of Equity
(Dollars in millions) | Down 300 | Down 200 | Down 100 | Flat Rates | Up 100 | Up 200 | Up 300 | ||||||||||||||||||||
Average Results | |||||||||||||||||||||||||||
2011 Year-to-Date | |||||||||||||||||||||||||||
Market Value of Equity | $ | 3,929 | $ | 3,964 | $ | 4,026 | $ | 4,111 | $ | 4,048 | $ | 3,864 | $ | 3,651 | |||||||||||||
% Change from Flat Case | (4.4 | )% | (3.6 | )% | (2.1 | )% | — | (1.5 | )% | (6.0 | )% | (11.2 | )% | ||||||||||||||
2010 Full Year | |||||||||||||||||||||||||||
Market Value of Equity | $ | 3,849 | $ | 3,894 | $ | 3,978 | $ | 4,113 | $ | 4,141 | $ | 4,017 | $ | 3,846 | |||||||||||||
% Change from Flat Case | (6.4 | )% | (5.3 | )% | (3.3 | )% | — | 0.7 | % | (2.3 | )% | (6.5 | )% | ||||||||||||||
Month-End Results | |||||||||||||||||||||||||||
September 30, 2011 | |||||||||||||||||||||||||||
Market Value of Equity | $ | 4,016 | $ | 4,030 | $ | 4,074 | $ | 4,183 | $ | 4,314 | $ | 4,214 | $ | 3,991 | |||||||||||||
% Change from Flat Case | (4.0 | )% | (3.7 | )% | (2.6 | )% | — | 3.1 | % | 0.7 | % | (4.6 | )% | ||||||||||||||
December 31, 2010 | |||||||||||||||||||||||||||
Market Value of Equity | $ | 3,832 | $ | 3,870 | $ | 3,944 | $ | 4,021 | $ | 3,882 | $ | 3,661 | $ | 3,434 | |||||||||||||
% Change from Flat Case | (4.7 | )% | (3.8 | )% | (1.9 | )% | — | (3.5 | )% | (9.0 | )% | (14.6 | )% |
Duration of Equity
(In years) | Down 300 | Down 200 | Down 100 | Flat Rates | Up 100 | Up 200 | Up 300 | |||||||||||||
Average Results | ||||||||||||||||||||
2011 Year-to-Date | (0.5 | ) | (1.0 | ) | (1.6 | ) | (0.5 | ) | 3.7 | 5.5 | 6.0 | |||||||||
2010 Full Year | (1.5 | ) | (1.9 | ) | (3.0 | ) | (2.9 | ) | 1.8 | 4.2 | 4.7 | |||||||||
Month-End Results | ||||||||||||||||||||
September 30, 2011 | (0.5 | ) | (0.9 | ) | (2.0 | ) | (3.9 | ) | 0.1 | 4.3 | 6.2 | |||||||||
December 31, 2010 | (0.5 | ) | (1.2 | ) | (2.0 | ) | 1.7 | 5.1 | 6.5 | 6.8 |
In the first nine months of 2011, the average market risk exposure to higher rates was moderate, well within policy limits, and consistent with long-term historical average exposure. The average market risk exposure in this period indicated more exposure to higher interest rates compared to 2010's average exposure because 2010's exposure was at low levels. However, market risk exposure to higher interest rates at September 30, 2011 was below historical levels and below the exposure at the end of 2010. This resulted mostly from the reductions in long-term rates that occurred in the third quarter of 2011. When mortgage rates rise 0.50 percentage points or more, we would expect market risk exposure to further rate increases to return to levels more
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consistent with historical positioning.
In the first nine months of 2011 and at September 30, 2011, market risk exposure to lower rates was also moderate, well within policy limits, and consistent with long-term historical average exposure. Although lower rates would accelerate mortgage prepayment speeds and require reinvestment of asset principal paydowns at lower rates, this effect on earnings would be significantly offset by the ability to call Consolidated Bonds before their final maturities and replace them at lower funding costs. The result would be that, if interest rates fell further, earnings would decrease moderately and profitability would remain competitive compared with market interest rates.
These market risk metrics do not provide reliable estimates of the effects on earnings from changes in recorded net amortization of mortgage purchase premiums. The market value metrics include net amortization on an economic basis, not an accounting basis.
The market risk metrics are computed for parallel changes in interest rates (except for down rate shocks, as explained above). If interest rates were to increase sharply, we believe based on historical movements in rates, short-term rates would increase more than longer-term rates. In this scenario, the market value and duration metrics indicate that market risk exposure would be materially less than under the parallel shock metrics provided above.
Based on analysis of all of our market risk metrics, we expect that our profitability, defined as the level of ROE compared with short-term market rates, will remain competitive unless interest rates change by extremely large amounts in a short period of time. Declines of 2.00 percentage points in long-term interest rates (which would put fixed-rate mortgages at two percent or less) would result in ROE still being well above market interest rates. We believe that profitability would not become uncompetitive unless long-term rates were to increase immediately and permanently by 4.00 percentage points or more combined with short-term rates increasing to at least eight percent. Such large changes in interest rates would not result in negative earnings, unless these rate environments occurred quickly, lasted for a long period of time, and were coupled with very unfavorable changes in other market and business variables or our business model. We believe such a scenario is extremely unlikely to occur.
Market Capitalization Ratio
The following table presents the market capitalization ratio for the current (flat rate) interest rate environment.
September 30, 2011 | December 31, 2010 | ||||
Market Value of Equity to Par Value of Regulatory Capital Stock | 122 | % | 117 | % |
The ratio of the market value of equity to the par value of regulatory capital stock excludes retained earnings in the denominator and therefore shows the ability of the market value of equity to protect the value of stockholders' investment in our company. To the extent the ratio differs from 100 percent, it can represent potential real economic gains or losses, unrealized opportunity benefits or costs, temporary fluctuations in asset or liability prices, or market value remaining under a company liquidation under which all assets were sold and all liabilities were terminated or transferred. The ratio does not sufficiently measure the value of our company as a going concern because it does not consider franchise value, future new business activity, future risk management strategies, or the net profitability of assets after funding costs.
As in recent years, the market capitalization ratio continued to be well above 100 percent. This provides additional support for our assessment that we have a moderate amount of market risk exposure. Currently the ratio is at a favorable (high) level due primarily to the fact that retained earnings currently comprise 13 percent of regulatory capital stock.
Market Risk Exposure of the Mortgage Assets Portfolio
The mortgage assets portfolio accounts for almost all of our market risk exposure because of prepayment volatility that we cannot completely hedge while maintaining positive net spreads. Sensitivities of the market value of equity for the mortgage assets portfolio under interest rate shocks (in basis points) are shown below. Average results are compiled using data for each month-end.
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% Change in Market Value of Equity-Mortgage Assets Portfolio
Down 300 | Down 200 | Down 100 | Flat Rates | Up 100 | Up 200 | Up 300 | |||||||||||||
Average Results | |||||||||||||||||||
2011 Year-to-Date | (21.5 | )% | (16.6 | )% | (9.3 | )% | — | (3.5 | )% | (18.3 | )% | (35.8 | )% | ||||||
2010 Full Year | (22.8 | )% | (18.4 | )% | (11.1 | )% | — | 2.7 | % | (6.4 | )% | (19.3 | )% | ||||||
Month-End Results | |||||||||||||||||||
September 30, 2011 | (19.4 | )% | (16.8 | )% | (11.0 | )% | — | 11.4 | % | 2.8 | % | (16.4 | )% | ||||||
December 31, 2010 | (20.7 | )% | (15.9 | )% | (8.2 | )% | — | (9.0 | )% | (25.5 | )% | (42.8 | )% |
These measures indicate that for the first nine months of 2011, the average market risk exposure of the mortgage assets portfolio had similar trends across interest rate shocks as those of the entire balance sheet. As expected, the mortgage assets portfolio had substantially greater risk than the entire balance sheet. Market risk exposure to higher rates at September 30, 2011 was lower than that at the end of 2010. The average exposure to higher interest rates over the first nine months of 2011 was consistent with historical average market risk exposure and substantially greater than 2010's average exposure to higher rates because 2010's exposure was at a very low average level.
We believe that the mortgage assets portfolio continues to have a moderate amount of market risk exposure that is consistent with our conservative risk philosophy, cooperative business model, and the risk exposure generally associated with investing in mortgage assets.
Use of Derivatives in Market Risk Management
In addition to issuing long-term Consolidated Bonds, an important way that we manage and hedge market risk exposure is by engaging in derivatives transactions, primarily interest rate swaps. Our hedging and risk management strategies in using derivatives did not change in the first nine months of 2011 compared to historical strategies, nor were there changes in the accounting treatment of new or existing derivative hedge transactions that materially impacted our results of operations. Because of this, and the fact that total assets did not change materially in the first nine months compared to the end of 2010, the notional principal balances of derivatives also did not change materially. For further information, see Note 10 of the Notes to Unaudited Financial Statements.
Capital Adequacy
Prudent risk management dictates that we maintain effective financial leverage to minimize risk to our capital stock while preserving profitability and that we hold an adequate amount of retained earnings. We have always complied with each of our regulatory capital requirements, the primary requirement being that the regulatory capital-to-assets ratio must exceed 4.00 percent. This ratio averaged 5.69 percent in the first nine months of 2011 and at September 30 was 5.79 percent. Given the amount of regulatory capital at September 30, 2011, total assets could increase by $30.0 billion before the capital-to-assets ratio would fall to 4.00 percent. This amount of growth in assets is unlikely to occur and, if it did, we would require additional amounts of capital under our Capital Plan before the 4.00 percent policy limit on capitalization would be reached.
Our Retained Earnings Policy sets forth a range for the amount of retained earnings we believe is needed to mitigate impairment risk and augment dividend stability in light of the risks we face. In September 2011, the Board of Directors approved a retained earnings requirement of $350 million, based on mitigating all of our combined risks under stress scenarios to at least a 99 percentile level. Given the recent financial and regulatory environment, we have been carrying a greater amount of retained earnings in the last several years than required by the Policy. On September 30, 2011, we had $436 million of retained earnings. As discussed in the "Capital Resources" section of "Analysis of Financial Condition," we will continue to bolster capital adequacy over time by allocating a portion of earnings to a separate restricted retained earnings account in accordance with the Capital Agreement.
Credit Risk
Overview
We assume a substantial amount of inherent credit risk exposure in our dealings with members, purchases of investments, and transactions of derivatives. For the reasons detailed below, we believe we have a minimal overall amount of residual credit risk exposure related to our Credit Services, purchases of investments, and transactions in derivatives and a moderate amount of legacy credit risk exposure related to the Mortgage Purchase Program.
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Credit Services
Overview. We have policies and practices to manage credit risk exposure from our secured lending activities, which include Advances and Letters of Credit. The objective of our credit risk management is to equalize risk exposure across members and counterparties to a zero level of expected losses. Despite ongoing deterioration in the credit conditions of many of our members and in the value of some pledged collateral, which began in 2008, we believe that credit risk exposure in our secured lending activities continued to be minimal in the first nine months of 2011. We base this assessment on the following factors:
▪ | a conservative approach to collateralizing credit services that results in significant over-collateralization; |
▪ | close monitoring of members' financial conditions and repayment capacities; |
▪ | a risk-focused process for reviewing and verifying the quality, documentation, and administration of pledged loan collateral; |
▪ | significant upward adjustments on collateral margins assigned to almost all of the subprime and nontraditional mortgages pledged as collateral; and |
▪ | a history of never experiencing a credit loss or delinquency on any Advance. |
Because of these factors, we have never established a loan loss reserve for Advances. We expect to collect all amounts due according to the contractual terms of Advances and Letters of Credit.
Collateral. We require each member to provide us a security interest in eligible collateral before it can undertake any secured borrowing. At September 30, 2011, our policy on over-collateralization resulted in total collateral pledged of $151.7 billion with total borrowing capacity of $98.6 billion. Lower borrowing capacity results because we apply Collateral Maintenance Requirements (CMRs) to discount the value of pledged collateral in order to recognize market, credit, and liquidity risks that may affect the collateral's realizable value in the event we must liquidate it.
As indicated in the table below, the allocation of total pledged collateral (unadjusted for CMRs) between September 30, 2011 and December 31, 2010 did not change materially. At September 30, 2011, 79 percent of collateral was related to residential mortgage lending in single family loans and home equity lines.
September 30, 2011 | December 31, 2010 | ||||||||||||
Percent of Total | Collateral Amount | Percent of Total | Collateral Amount | ||||||||||
Pledged Collateral | ($ Billions) | Pledged Collateral | ($ Billions) | ||||||||||
Single family loans | 61 | % | $ | 92.7 | 62 | % | $ | 93.4 | |||||
Home equity loans/lines of credit | 18 | 27.0 | 19 | 28.0 | |||||||||
Commercial real estate | 11 | 17.2 | 10 | 15.5 | |||||||||
Bond securities | 8 | 11.8 | 7 | 10.6 | |||||||||
Multi-family loans | 2 | 2.5 | 2 | 2.5 | |||||||||
Farm real estate | (a) | 0.5 | (a) | 0.5 | |||||||||
Total | 100 | % | $ | 151.7 | 100 | % | $ | 150.5 |
(a) | Less than one percent of total pledged collateral. |
We assign each member one of four levels of collateral status, listed in order of least restrictive to most restrictive: Blanket, Securities, Listing, and Physical Delivery. We determine each member's collateral status based on a credit rating (described below) and other credit risk factors. Blanket collateral status, which does not require the member to provide loan level detail on pledged loans, is assigned to approximately 85 percent of members and borrowing nonmembers, over 90 percent of single family mortgage loan collateral and commercial real estate collateral, and almost all home equity loan collateral. All bond securities are under physical delivery collateral status.
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Applying CMRs results in conservative adjustments of borrowing capacity for all collateral types. Members and collateral with a higher risk profile, more risky credit quality, and/or less favorable performance are generally assigned higher CMRs. The table below indicates the range of lendable values remaining after the application of CMRs for each major collateral type pledged at September 30, 2011. The ranges of lendable values are expressed as percentages of collateral market value and exclude subprime and nontraditional mortgage loan collateral. Loans pledged under a Blanket status generally are haircut more aggressively than loans on which we have detailed loan structure and underwriting information.
Lending Values Applied to Collateral | |
Blanket Status | |
Single family loans | 67-83% |
Multi-family loans | 41-53% |
Home equity loans/lines of credit | 37-63% |
Commercial real estate | 44-56% |
Other loan collateral | 51-69% |
Listing Status/Physical Delivery | |
Cash/U.S. Government/U.S. Treasury/U.S. agency securities | 93-100% |
U.S. agency MBS/CMOs | 88-96% |
Private-label MBS/CMOs | 63-80% |
Commercial mortgage-backed securities | 49-83% |
Single family loans | 70-83% |
Other government-guaranteed loans | 91% |
Multi-family loans | 49-63% |
Home equity loans/lines of credit | 53-69% |
Commercial real estate | 53-67% |
Subprime and Nontraditional Mortgage Loan Collateral. Based on our collateral reviews, we estimate that approximately 20 to 25 percent of pledged residential loan collateral has one or more subprime characteristics and that approximately five to seven percent of pledged collateral meets the definition of “nontraditional.” These percentages have increased slightly over the last several years. We apply significantly higher adjustments to the standard CMRs on almost all collateral identified as subprime and/or nontraditional mortgages. No security known to have more than one-third subprime collateral is eligible for pledge to support additional credit borrowings.
Internal Credit Ratings of Members. We assign each borrower an internal credit rating, based on a combination of internal credit analysis and consideration of available credit ratings from independent credit rating organizations. The analysis focuses on asset quality, financial performance, earnings quality, liquidity, and capital adequacy. The credit ratings are used in conjunction with other measures of the credit risk posed by members and pledged collateral, as described above, in managing credit risk exposure of Advances. A lower internal credit rating can cause us to 1) decrease the institution's borrowing capacity via higher CMRs, 2) require the institution to provide an increased level of detail on pledged collateral, 3) require it to deliver collateral to us in custody, and/or 4) prompt us to more closely and/or frequently monitor the institution using several established processes.
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The following tables show the distribution of internal credit ratings we assigned to member and nonmember borrowers, which we use to help manage credit risk exposure. The lower the numerical rating, the higher our assessment of the member's credit quality. A “4” rating is our assessment of the lowest level of satisfactory performance.
(Dollars in billions) | ||||||||||||||||
September 30, 2011 | December 31, 2010 | |||||||||||||||
All Members and Borrowing Nonmembers | All Members and Borrowing Nonmembers | |||||||||||||||
Collateral-Based | Collateral-Based | |||||||||||||||
Credit | Borrowing | Credit | Borrowing | |||||||||||||
Rating | Number | Capacity | Rating | Number | Capacity | |||||||||||
1-3 | 416 | $ | 53.6 | 1-3 | 394 | $ | 50.7 | |||||||||
4 | 178 | 37.3 | 4 | 186 | 32.5 | |||||||||||
5 | 79 | 5.2 | 5 | 72 | 4.7 | |||||||||||
6 | 36 | 0.9 | 6 | 53 | 1.8 | |||||||||||
7 | 45 | 1.6 | 7 | 43 | 1.9 | |||||||||||
Total | 754 | $ | 98.6 | Total | 748 | $ | 91.6 |
There has been a significant downward trend since 2007 in member credit ratings. Many members continue to be adversely affected by the last recession, the weak economic recovery, and the continued distress in the housing market. As of September 30, 2011, 160 members and borrowing nonmembers (21 percent of the total) had credit ratings of 5 or below, with $7.7 billion of borrowing capacity. There has been a modest improvement in our members' overall financial health in 2011, as indicated by the net movement of eight members from the 5-7 ratings band to the 1-4 band and a net movement of 15 members out of the two lowest credit ratings levels.
Member Failures, Closures, and Receiverships. There were no member failures in our District in the first nine months of 2011.
Mortgage Purchase Program
Overview. We believe that the residual amount of credit risk exposure to loans in the Mortgage Purchase Program is moderate, an assessment made based on the following factors:
▪ | various credit enhancements for conventional loans, which generally protect us against losses to a 50 percent loss severity on each loan; |
▪ | conservative underwriting and loan characteristics consistent with favorable expected credit performance; |
▪ | a relatively moderate overall amount of delinquencies and defaults experienced when compared to national averages; |
▪ | only $4.3 million of program-to-date charge-offs through September 30, 2011; |
▪ | our estimate that $15 million of additional losses have been incurred in the Program as of September 30, as recognized in our allowance for credit losses, which represent only 0.24 percentage points of the unpaid principal balance of conventional mortgages; and |
▪ | financial analysis suggesting that future credit losses will not materially harm capital adequacy and will not significantly affect profitability except under the most extreme and unlikely conditions for mortgage defaults. |
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Portfolio Loan Characteristics. The following table shows Fair Isaac and Company (FICO®) credit scores of homeowners at origination dates for the conventional loan portfolio. There was little change in the FICO® score distribution in the first nine months of 2011 compared with prior periods. We believe the distribution of FICO® scores is one indication of the portfolio's overall favorable credit quality, with two-thirds of the portfolio having scores above an excellent level of 740 and over 85 percent having scores above 700 which is generally considered indicative of homeowners' good credit quality.
FICO® Score (1) | September 30, 2011 | December 31, 2010 | ||||
< 620 | — | % | — | % | ||
620 to < 660 | 4 | 4 | ||||
660 to < 700 | 10 | 11 | ||||
700 to < 740 | 19 | 20 | ||||
>= 740 | 67 | 65 | ||||
Weighted Average | 753 | 750 |
(1) | Represents the original FICO® score. |
The following tables show loan-to-value ratios for conventional loans based on values estimated at the origination dates and current values estimated at the noted periods. The estimated current ratios are based on original loan values, principal paydowns that have occurred since origination, and a third-party estimate of changes in historical home prices for the metropolitan statistical area in which each loan resides. Both measures are weighted by current unpaid principal.
Based on Estimated Origination Value | Based On Estimated Current Value | |||||||||||||
Loan-to-Value | September 30, 2011 | December 31, 2010 | Loan-to-Value | September 30, 2011 | December 31, 2010 | |||||||||
<= 60% | 21 | % | 20 | % | <= 60% | 28 | % | 27 | % | |||||
> 60% to 70% | 18 | 18 | > 60% to 70% | 17 | 17 | |||||||||
> 70% to 80% | 53 | 54 | > 70% to 80% | 26 | 28 | |||||||||
> 80% to 90% | 5 | 5 | > 80% to 90% | 15 | 16 | |||||||||
> 90% | 3 | 3 | > 90% to 100% | 6 | 6 | |||||||||
> 100% | 8 | 6 | ||||||||||||
Weighted Average | 70 | % | 70 | % | Weighted Average | 71 | % | 71 | % |
High loan-to-value ratios, in which homeowners have little or no equity at stake, are key drivers in many mortgage delinquencies and defaults. Overall loan-to-value ratios deteriorated moderately in the first nine months of 2011. At September 30, 2011, 14 percent of loans were estimated to have current loan-to-value ratios above 90 percent, up from three percent at origination, despite significant deterioration in national average housing prices in recent years. There has been a more substantial increase in the percentage of loans with current loan-to-value ratios between 80 and 90 percent, from five percent at origination to 15 percent at September 30, 2011. Further significant reductions in home prices could move the ratios on these loans above 100 percent and increase loan defaults.
Based on the available data, we believe we have little exposure to loans in the Program considered to have characteristics of “subprime” or “alternative/nontraditional” loans. Further, we do not knowingly purchase any loan that violates the terms of our Anti-Predatory Lending Policy.
Lender Risk Account. Conventional mortgage loans are supported against credit losses by various combinations of primary mortgage insurance, supplemental mortgage insurance and the Lender Risk Account. The Lender Risk Account is funded by the FHLBank as a portion of the purchase proceeds to cover expected credit losses. The amount of loss claims against the Lender Risk Account in the first nine months of 2011 was approximately $4 million. The Lender Risk Account had balances of $59 million and $44 million at September 30, 2011 and December 31, 2010, respectively. The Lender Risk Account increased in 2011 as a result of implementing the new credit enhanced program that replaces the supplemental mortgage insurance with an increased use of the Lender Risk Account. See also Note 9 of the Notes to Unaudited Financial Statements.
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Credit Performance. The table below provides an analysis of conventional loans delinquent or in foreclosure, along with the national average serious delinquency rate.
Conventional Loan Delinquencies | |||||||
(Dollars in millions) | September 30, 2011 | December 31, 2010 | |||||
Early stage delinquencies - unpaid principal balance (1) | $ | 82 | $ | 94 | |||
Serious delinquencies - unpaid principal balance (2) | 86 | 78 | |||||
Early stage delinquency rate (3) | 1.3 | % | 1.5 | % | |||
Serious delinquency rate (4) | 1.3 | 1.2 | |||||
National average serious delinquency rate (5) | 4.2 | 4.6 |
(1) | Includes conventional loans 30 to 89 days delinquent and not in foreclosure. |
(2) | Includes conventional loans that are 90 days or more past due or where the decision of foreclosure or a similar alternative such as pursuit of deed-in-lieu has been reported. |
(3) | Early stage delinquencies expressed as a percentage of the total conventional loan portfolio. |
(4) | Serious delinquencies expressed as a percentage of the total conventional loan portfolio. |
(5) | National average number of fixed-rate prime conventional loans that are 90 days or more past due or in the process of foreclosure is based on the most recent national delinquency data available. The September 30, 2011 rate is based on June 30, 2011 data. |
The Mortgage Purchase Program has had a moderate amount of delinquencies and foreclosures. Over the past few years, delinquency/foreclosure rates on our conventional loans have increased substantially but continued to be well below the national averages. We expect this to continue to be the case. Growth in our overall delinquency rates slowed in the first nine months of 2011, with early stage delinquency rates actually falling. We do not know if these data indicate a sustainable trend of a subsiding of stresses in the housing market or a respite based on slowdown of the rate at which financial institutions are initiating foreclosures.
We consider a high risk loan as having a current loan-to-value ratio above 100 percent. At September 30, 2011, high risk loans had experienced relatively moderate serious delinquencies (i.e., delinquencies that are 90 days or more past due or in the process of foreclosure). For example, of the $497 million of conventional principal balances with current loan-to-values above 100 percent, only $34 million (seven percent) were seriously delinquent. We believe these data further support our view that the overall portfolio is comprised of high quality loans.
Credit Losses. The following table shows the effects of credit enhancements on the determination of the allowance for credit losses at the noted periods:
(In millions) | September 30, 2011 | December 31, 2010 | |||||
Estimated credit losses, before credit enhancements | $ | (56 | ) | $ | (49 | ) | |
Estimated amounts to be covered by: | |||||||
Primary mortgage insurance | 5 | 4 | |||||
Supplemental mortgage insurance | 28 | 25 | |||||
Lender Risk Account | 8 | 8 | |||||
Allowance for credit losses, after credit enhancements | $ | (15 | ) | $ | (12 | ) |
The data presented above are aggregated, which provide useful information on the health of the overall portfolio. Credit risk exposure depends on the actual and potential credit performance of the loans in each pool compared to the pool's equity (on individual loans) and credit enhancements, including primary mortgage insurance (for individual loans), the Lender Risk Account, and supplemental mortgage insurance. Although the overwhelming majority of pools have not experienced credit losses and are not projected to do so except under extremely stressful economic conditions including further home price declines, some pools have experienced credit losses beginning in 2010.
Although we establish credit enhancements in each mortgage pool at the time of the pool's origination that are sufficient to absorb loan losses of approximately 50 percent, the magnitude of the declines in home prices, increase in unemployment rates, and increase in delinquencies in some areas since 2006 has resulted in losses in some of the mortgage pools that have exhausted credit enhancements. Some of our mortgage pools have a concentration of loans originated in states and localities (e.g., California, Arizona, Florida, and Nevada) that have had the most severe declines in home prices. We purchased most of these loan pools from a former member that stopped selling us mortgage loans in 2007. When a mortgage pool's credit enhancements
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are exhausted, the FHLBank realizes any additional loan losses in that pool.
In addition to the analysis performed to determine the allowance for credit losses as discussed in Note 9 of the Notes to Unaudited Financial Statements, we perform analysis using recognized third-party credit and prepayment models, which are updated periodically, to estimate potential ranges of lifetime credit risk exposure for the loans in the Program. We believe that future credit losses will be moderate. Based on the latest market data, we expect incurred credit losses to increase. Even under adverse scenarios for home prices or unemployment rates (and assuming the two SMI providers continue to pay claims), we do not expect further credit losses to significantly decrease our overall profitability or annual dividends payable to members, or to materially affect our capital adequacy. For example, for an additional 20 percent decline in all home prices over the next two years, we estimate that our lifetime credit losses could increase by approximately $84 million, which would decrease annual return on equity by 0.35 percentage points over the next five years (most of the losses are estimated to occur in the next five years).
Credit Risk Exposure to Insurance Providers.
Primary Mortgage Insurance
Some of our conventional loans carry primary mortgage insurance (PMI) as a credit enhancement feature. Based on the guidelines of the Mortgage Purchase Program, we have assessed that we do not have any credit risk exposure to the primary mortgage insurance providers.
Supplemental Mortgage Insurance
Another credit enhancement feature is Supplemental Mortgage Insurance (SMI) purchased from Genworth and MGIC. Beginning February 1, 2011, we no longer use SMI as a credit enhancement for new business; instead, we augment credit enhancements with a greater amount of the purchase proceeds added to the Lender Risk Account. However, we have outstanding SMI coverage through Genworth and MGIC. Although we discontinued committing new business with MGIC in 2008, 48 percent of our outstanding loans had SMI underwritten by MGIC at September 30, 2011.
We subject both SMI providers to a standard credit underwriting analysis. Both providers have experienced weakened financial conditions in the last several years. The lowest credit rating from NRSROs is B+ for MGIC and BB- for Genworth, with both on negative outlook. Our exposure to these providers is that they may be unable to fulfill their contractual coverage on loss claims. In a scenario in which home prices do not change and both providers fail to fulfill any of their insurance coverage on defaulting loans (with an assumption that we would obtain only a limited recovery rate), our exposure at September 30, 2011 to the providers over the life of the loans is estimated to be in the range of $10-$25 million. In a more adverse scenario in which home prices decline an additional 20 percent over the next two years and both providers fail to pay claims (with the same limited recovery rate assumption), our exposure is estimated to be in the range of $20-$40 million.
At this time, we do not expect either of the providers to fail to fulfill their insurance contracts. Over time, as existing business in the Mortgage Purchase Program pays off and is replaced with new business which does not rely on SMI, this exposure will diminish.
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Investments
Liquidity Investments. The following table presents the carrying value of liquidity investments outstanding in relation to the counterparties' lowest long-term credit ratings provided by Standard & Poor's, Moody's, and/or Fitch Advisory Services.
(In millions) | September 30, 2011 | ||||||||||||||
Long-Term Rating or Short-Term Equivalent | |||||||||||||||
AAA | AA | A | Total | ||||||||||||
Unsecured Liquidity Investments | |||||||||||||||
Federal funds sold | $ | — | $ | 1,960 | $ | 1,730 | $ | 3,690 | |||||||
Certificates of deposit | — | 1,869 | 1,375 | 3,244 | |||||||||||
Commercial paper | — | 300 | — | 300 | |||||||||||
Other (1) | 75 | — | — | 75 | |||||||||||
Total unsecured liquidity investments | 75 | 4,129 | 3,105 | 7,309 | |||||||||||
Guaranteed/Secured Liquidity Investments | |||||||||||||||
Securities purchased under agreements to resell (2) | — | 1,900 | — | 1,900 | |||||||||||
U.S. Treasury obligations | — | 723 | — | 723 | |||||||||||
Government-sponsored enterprises (3) | — | 3,686 | — | 3,686 | |||||||||||
TLGP (4) | — | 1,129 | — | 1,129 | |||||||||||
Total guaranteed/secured liquidity investments | — | 7,438 | — | 7,438 | |||||||||||
Total liquidity investments | $ | 75 | $ | 11,567 | $ | 3,105 | $ | 14,747 |
December 31, 2010 | |||||||||||||||
Long-Term Rating or Short-Term Equivalent | |||||||||||||||
AAA | AA | A | Total | ||||||||||||
Unsecured Liquidity Investments | |||||||||||||||
Federal funds sold | $ | — | $ | 2,930 | $ | 2,550 | $ | 5,480 | |||||||
Certificates of deposit | — | 4,715 | 1,075 | 5,790 | |||||||||||
Total unsecured liquidity investments | — | 7,645 | 3,625 | 11,270 | |||||||||||
Guaranteed/Secured Liquidity Investments | |||||||||||||||
Securities purchased under agreements to resell (2) | 2,950 | — | — | 2,950 | |||||||||||
U.S. Treasury obligations | 1,905 | — | — | 1,905 | |||||||||||
Government-sponsored enterprises (3) | 4,518 | — | — | 4,518 | |||||||||||
TLGP (4) | 1,011 | — | — | 1,011 | |||||||||||
Total guaranteed/secured liquidity investments | 10,384 | — | — | 10,384 | |||||||||||
Total liquidity investments | $ | 10,384 | $ | 7,645 | $ | 3,625 | $ | 21,654 |
(1) | Consists of debt securities issued by International Bank for Reconstruction and Development. |
(2) | Securities purchased under agreements to resell are considered collateralized financing arrangements and effectively represent short-term loans with highly rated counterparties. |
(3) | Consists of either securities that are issued and effectively guaranteed by Fannie Mae and/or Freddie Mac, which have the backing of the U.S. government, although they are not obligations of the U.S. government, and/or debt securities issued by Federal Farm Credit Bank (FFCB). |
(4) | Represents corporate debentures issued or guaranteed by the Federal Deposit Insurance Corporation (FDIC) under the Temporary Liquidity Guarantee Program (TLGP). |
We believe these investments were purchased from counterparties that have a strong ability to repay principal and interest. At September 30, 2011, 50 percent of our liquidity investments were purchased from counterparties that provide explicit guarantees from the U.S. government (Treasuries and TLGP securities), that are effectively guaranteed (government-sponsored enterprises), or that are secured with collateral (securities purchased under agreements to resell). Despite Standard & Poor's downgrade of certain of these securities, we believe they continue to represent minimal credit risk exposure to us.
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Mortgage-Backed Securities
GSE Mortgage-Backed Securities. We have never held any asset-backed securities other than mortgage-backed securities. Historically, almost all of our mortgage-backed securities have been residential GSE securities issued by Fannie Mae and Freddie Mac, which provide credit safeguards by guaranteeing either timely or ultimate payments of principal and interest, and agency securities issued by Ginnie Mae, which the federal government guarantees. We believe that the conservatorships of Fannie Mae and Freddie Mac lower the chance that they would not be able to fulfill their credit guarantees. In addition, based on the data available to us and on our purchase practices, we believe that most of the mortgage loans backing our GSE mortgage-backed securities are of high quality with strong credit performance.
As indicated in Note 5 of the Notes to Unaudited Financial Statements, at September 30, 2011, our GSE mortgage-backed securities had a total book value of $9,824 million and an estimated net unrealized market value gain totaling $459 million, which resulted in a market value of 105 percent of book value. The market value gain reflects the lower overall level of mortgage rates at September 30, compared to when the securities were originated, and elevated market prices on GSE mortgage-backed securities. The elevated market prices are commonly attributed to the combination of the high demand for mortgage-related securities, the view of market participants that GSE mortgage-backed securities have little if any credit risk, and a relative lack of supply of new mortgage securities.
Mortgage-Backed Securities Issued by Other Government Agencies. Beginning in the fourth quarter of 2010, we invested in mortgage-backed securities issued and guaranteed by the National Credit Union Administration. These securities have floating rate coupons tied to one-month LIBOR with interest rate caps ranging from seven to eight percent. At September 30, 2011, their book value totaled $1,459 million, with an estimated net market value gain of $2 million. The strength of the issuer's guarantee and backing by the full faith and credit of the U.S. government is sufficient to protect us against credit losses on these securities.
Private Label Mortgage-Backed Securities. The following table presents information on the one private-label mortgage-backed security we had outstanding at September 30, 2011. We sold four of these types of securities in the third quarter of 2011.
(Dollars in millions) | Investment Rating | Fair Value | Unpaid Principal Balance | Fair Value as a Percent of Unpaid Principal Balance | ||||||||
September 30, 2011 | AAA | $ | 20 | $ | 20 | 101.8 | % | |||||
December 31, 2010 | AAA | 90 | 88 | 102.1 |
Unlike GSE and agency mortgage-backed securities, our holdings of private-label mortgage-backed securities expose us to credit risk because the issuers do not guarantee principal and interest payments. We believe our private-label security is composed of high quality mortgages and have had, and will continue to have, a minimal amount of credit risk. It carries increased credit subordination, is collateralized primarily by prime, fixed-rate, first lien mortgages originated in 2003, has a current estimated average loan-to-value ratio of 43 percent, and has an average serious delinquency rate of only 1.48 percent at September 30, 2011. We have never considered any of our private-label mortgage-backed securities to be other-than-temporarily impaired on any date.
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Derivatives
Credit Risk Exposure. The table below presents the gross credit risk exposure (i.e., the market value) and net exposure of derivatives outstanding at September 30, 2011. On this date, and throughout 2011 we had a minimal amount of residual credit risk exposure.
(In millions) | |||||||||||||||
Credit Rating (1) | Total Notional | Gross Credit Exposure | Cash Collateral Held | Credit Exposure Net of Cash Collateral Held | |||||||||||
Aaa/AAA | $ | — | $ | — | $ | — | $ | — | |||||||
Aa/AA | 6,689 | 2 | — | 2 | |||||||||||
A | 10,154 | 4 | (3 | ) | 1 | ||||||||||
Member institutions (2) | 277 | 2 | — | 2 | |||||||||||
Total | $ | 17,120 | $ | 8 | $ | (3 | ) | $ | 5 |
(1) | Each category includes the related plus (+) and minus (-) ratings (i.e., “A” includes “A+” and “A-” ratings). |
(2) | Represents Mandatory Delivery Contracts. |
The following table presents counterparties that provided 10 percent or more of the total notional amount of interest rate swap derivatives outstanding. Although we cannot predict if we will realize credit risk losses from any of our derivatives counterparties, we continue to have no reason to believe any of them will be unable to continue making timely interest payments or, more generally, to continue to satisfy the terms and conditions of their derivative contracts with us.
(In millions) | ||||||||||||||||||
September 30, 2011 | December 31, 2010 | |||||||||||||||||
Counterparty | Credit Rating Category | Notional Principal | Net Unsecured Exposure | Counterparty | Credit Rating Category | Notional Principal | Net Unsecured Exposure | |||||||||||
Barclays Bank PLC | Aa/AA | $ | 3,597 | $ | — | Barclays Bank PLC | Aa/AA | $ | 4,866 | $ | — | |||||||
Royal Bank of Scotland PLC | A | 2,022 | — | Credit Suisse International | A | 3,030 | — | |||||||||||
Deutsche Bank AG | A | 2,355 | — | Morgan Stanley Capital Services | A | 2,414 | — | |||||||||||
Morgan Stanley Capital Services | A | 1,693 | — | All others (11 counterparties) | A to Aa/AA | 9,618 | 2 | |||||||||||
All others (8 counterparties) | A to Aa/AA | 7,036 | 3 | Total | $ | 19,928 | $ | 2 | ||||||||||
Total | $ | 16,703 | $ | 3 |
Lehman Brothers Derivatives. On September 15, 2008, Lehman Brothers Holdings, Inc. ("Lehman Brothers") filed a petition for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. We had 87 derivative transactions (interest rate swaps) outstanding with a subsidiary of Lehman Brothers, Lehman Brothers Special Financing, Inc. ("LBSF"), with a total notional principal amount of $5.7 billion. Under the provisions of our master agreement with LBSF, all of these swaps automatically terminated immediately prior to the bankruptcy filing by Lehman Brothers. The close-out provisions of the Agreement required us to pay LBSF a net fee of approximately $189 million, which represented the swaps' total estimated market value at the close of business on Friday, September 12, 2008. We paid LBSF approximately $14 million to settle all of the transactions, comprised of the $189 million market value fee minus the value of collateral we had delivered previously and other interest and expenses. On Tuesday, September 16, 2008, we replaced these swaps with new swaps transacted with other counterparties. The new swaps had the same terms and conditions as the terminated LBSF swaps. The counterparties to the new swaps paid us a net fee of approximately $232 million to enter into these transactions based on the estimated market values at the time we replaced the swaps.
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The $43 million difference between the settlement amount we paid Lehman and the market value fee we received on the replacement swaps represented an economic gain to us based on changes in the interest rate environment between the termination date and the replacement date. Although the difference was a gain to us in this instance, because it represented exposure from terminating and replacing derivatives, it could have been a loss if the interest rate environment had been different. We are amortizing the gain into earnings according to the swaps' final maturities, most of which will occur by the end of 2012.
In early March 2010, representatives of the Lehman bankruptcy estate advised us that they believed that we had been unjustly enriched and that the bankruptcy estate was entitled to the $43 million difference between the settlement amount we paid Lehman and the market value fee we received on the replacement swaps. In early May 2010, we received a Derivatives Alternative Dispute Resolution notice from the Lehman bankruptcy estate with a settlement demand of $65.8 million, plus interest accruing primarily at LIBOR plus 14.5 percent since the bankruptcy filing, based on their view of how the settlement amount should have been calculated. In accordance with the Alternative Dispute Resolution Order of the Bankruptcy Court administering the Lehman estate, senior management participated in a non-binding mediation in New York on August 25, 2010, and our legal counsel continued discussions with the court-appointed mediator for several weeks thereafter. The mediation concluded on October 15, 2010 without a settlement of the claims asserted by the Lehman bankruptcy estate. We believe that we correctly calculated, and fully satisfied, our obligation to Lehman in September 2008, and we intend to vigorously dispute any claim for additional amounts.
Liquidity Risk
Liquidity Overview
Our principal long-term source of funding and liquidity is through cost effective access to the capital markets for participation in the issuance of FHLBank System debt securities (Consolidated Obligations) and for execution of derivative transactions. We also raise liquidity via our liquidity investment portfolio and the ability to sell certain investments without significant accounting consequences. As shown on the Statements of Cash Flows, in the first nine months of 2011, our share of participations in debt issuances totaled $376.1 billion for Discount Notes and $13.4 billion for Consolidated Bonds. The System's favorable debt ratings, the implicit U.S. government backing of our debt, and our effective funding management were, and continue to be, instrumental in ensuring satisfactory access to the capital markets.
Our liquidity position remained strong in the first nine months of 2011 and our overall ability to fund our operations through debt issuance at acceptable interest costs remained sufficient. Although we can make no assurances, we expect this to continue to be the case, and we believe the possibility of a liquidity or funding crisis in the FHLBank System that would impair our FHLBank's ability to participate in issuances of new debt, service outstanding debt or pay competitive dividends is remote.
Beginning in the second half of 2010 and continuing in the first three quarters of 2011, we held additional asset liquidity by investing in short-term U.S. Treasury securities and GSE discount notes. This reflected both a decision to hold more liquidity and our desire to offset a portion of earnings lost from the declines in Mission Asset Activity balances over the last several years.
Although the government continues to face serious fiscal challenges and Standard & Poor's downgraded the FHLBank System's debt to AA+, the System did not, and continues to not, experience any uninterrupted access on acceptable terms to the capital markets for its debt issuance and funding needs. Investors continue to favor the System's debt issuances; spreads on the System's longer-term Consolidated Obligations to U.S. Treasury rates and LIBOR have not changed materially; and, after experiencing modest and temporary increases in late July and early August, the System's short-term debt costs returned by mid-August to the historically normal range.
We must meet both operational and contingency liquidity requirements. We satisfied the operational liquidity requirement both as a function of meeting the contingency liquidity requirement and because we were able to adequately access the capital markets to issue Obligations. In addition, Finance Agency guidance requires us to target at least 15 consecutive days of positive liquidity based on specific assumptions. In practice, we tend to hold over 20 days of positive liquidity. The amount of liquidity per the Finance Agency guidance tended to average in the range of $4 billion to $6 billion during the first nine months of 2011.
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Contingency Liquidity Requirement
Contingency liquidity risk is the potential inability to meet liquidity needs because our access to the capital markets to issue Consolidated Obligations is restricted or suspended for a period of time due to a market disruption, operational failure, or real or perceived credit quality problems. We continued to hold an ample amount of liquidity reserves to protect against contingency liquidity risk.
Contingency Liquidity Requirement (in millions) | September 30, 2011 | December 31, 2010 | ||||||
Total Contingency Liquidity Reserves (1) | $ | 28,313 | $ | 35,292 | ||||
Total Requirement (2) | (8,428 | ) | (13,268 | ) | ||||
Excess Contingency Liquidity Available | $ | 19,885 | $ | 22,024 |
(1) | Includes, among others, cash, overnight Federal funds, overnight deposits, self-liquidating term Federal funds, 95 percent of the market value of available-for-sale negotiable securities, and 75 percent of the market value of certain held-to-maturity obligations, including obligations of the United States, U.S. government agency obligations and mortgage-backed securities. |
(2) | Includes maturing net liabilities in the next seven business days, assets traded not yet settled, Advance commitments outstanding, Advances maturing in the next seven business days, and a three percent hypothetical increase in Advances. |
Deposit Reserve Requirement
To support our member deposits, we also must meet a statutory deposit reserve requirement. The following table presents the components of this liquidity requirement.
Deposit Reserve Requirement (in millions) | September 30, 2011 | December 31, 2010 | ||||||
Total Eligible Deposit Reserves | $ | 31,391 | $ | 29,755 | ||||
Total Member Deposits | (1,275 | ) | (1,438 | ) | ||||
Excess Deposit Reserves | $ | 30,116 | $ | 28,317 |
Contractual Obligations
The following table summarizes our contractual obligations at September 30, 2011. The allocations according to the expiration terms and payment due dates of these obligations were not materially different from those at the end of 2010, and changes reflected normal business variations. We believe that, as in the past, we will continue to have sufficient liquidity, including from access to the debt markets to issue Consolidated Obligations, to satisfy these obligations timely.
(In millions) | < 1 year | 1<3 years | 3<5 years | > 5 years | Total | ||||||||||||||
Contractual Obligations | |||||||||||||||||||
Long-term debt (Consolidated Bonds) - par (1) | $ | 8,085 | $ | 9,528 | $ | 3,471 | $ | 6,288 | $ | 27,372 | |||||||||
Operating leases (include premises and equipment) | 1 | 2 | — | — | 3 | ||||||||||||||
Mandatorily redeemable capital stock | 39 | 6 | 286 | — | 331 | ||||||||||||||
Commitments to fund mortgage loans | 277 | — | — | — | 277 | ||||||||||||||
Pension and other postretirement benefit obligations | 1 | 4 | 4 | 16 | 25 | ||||||||||||||
Total Contractual Obligations | $ | 8,403 | $ | 9,540 | $ | 3,761 | $ | 6,304 | $ | 28,008 |
(1) | Does not include Discount Notes and contractual interest payments related to Consolidated Bonds. Total is based on contractual maturities; the actual timing of payments could be affected by factors affecting redemptions. |
Off-Balance Sheet Arrangements
The following table summarizes our off-balance sheet items at September 30, 2011. The allocations according to the expiration terms and payment due dates of these items were not materially different from those at the end of 2010, and changes reflected normal business variations.
(In millions) | < 1 year | 1<3 years | 3<5 years | > 5 years | Total | ||||||||||||||
Off-balance sheet items (1) | |||||||||||||||||||
Standby Letters of Credit | $ | 4,363 | $ | 76 | $ | 33 | $ | 59 | $ | 4,531 | |||||||||
Standby bond purchase agreements | 55 | 331 | 13 | — | 399 | ||||||||||||||
Consolidated Obligations traded, not yet settled | 34 | — | — | 105 | 139 | ||||||||||||||
Total off-balance sheet items | $ | 4,452 | $ | 407 | $ | 46 | $ | 164 | $ | 5,069 |
(1) | Represents notional amount of off-balance sheet obligations. |
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Operational Risk
There were no material developments regarding our operational risk during the first nine months of 2011.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Information required by this Item is set forth under the caption “Quantitative and Qualitative Disclosures About Risk Management” in Part I, Item 2, of this filing.
Item 4. Controls and Procedures.
DISCLOSURE CONTROLS AND PROCEDURES
As of September 30, 2011, the FHLBank's management, including its principal executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”). Based upon that evaluation, these two officers each concluded that as of September 30, 2011, the FHLBank maintained effective disclosure controls and procedures to ensure that information required to be disclosed in the reports that it files under the Exchange Act is (1) accumulated and communicated to management as appropriate to allow timely decisions regarding disclosure and (2) recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
As of September 30, 2011, the FHLBank's management, including its principal executive officer and principal financial officer, evaluated the FHLBank's internal control over financial reporting. Based upon that evaluation, these two officers each concluded that there were no changes in the FHLBank's internal control over financial reporting that occurred during the quarter ended September 30, 2011 that materially affected, or are reasonably likely to materially affect, the FHLBank's internal control over financial reporting.
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PART II - OTHER INFORMATION
Item 1A. Risk Factors.
Information relating to this Item is set forth under the caption “Update on Business Outlook, Risk Factors, and Risk Exposure” in Part I, Item 2, of this filing.
Item 6. | Exhibits. |
(a) | Exhibits. |
See Index of Exhibits
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, as of the 10th day of November 2011.
FEDERAL HOME LOAN BANK OF CINCINNATI
(Registrant)
By: | /s/ David H. Hehman | |
David H. Hehman | ||
President and Chief Executive Officer (principal executive officer) | ||
By: | /s/ Donald R. Able | |
Donald R. Able | ||
Senior Vice President - Chief Accounting and Technology Officer (principal financial officer) |
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INDEX OF EXHIBITS
Exhibit Number (1) | Description of exhibit | Document incorporated by reference, filed or furnished, as indicated below | ||
4 | Capital Plan, as amended through July 21, 2011 | Form 8-K, filed August 5, 2011 | ||
10 | Joint Capital Enhancement Agreement, as amended on August 5, 2011, by and among each of the Federal Home Loan Banks | Form 8-K, filed August 5, 2011 | ||
31.1 | Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer | Filed Herewith | ||
31.2 | Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer | Filed Herewith | ||
32 | Section 1350 Certifications | Furnished Herewith | ||
101.INS | XBRL Instance Document | Furnished Herewith | ||
101.SCH | XBRL Taxonomy Extension Schema Document | Furnished Herewith | ||
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | Furnished Herewith | ||
101.LAB | XBRL Taxonomy Extension Label Linkbase Document | Furnished Herewith | ||
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document | Furnished Herewith | ||
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document | Furnished Herewith | ||
(1) | Numbers coincide with Item 601 of Regulation S-K. |
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