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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the quarterly period ended Septembr 30, 2006 | ||
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 Number: 000-51395
FEDERAL HOME LOAN BANK OF PITTSBURGH
(Exact name of registrant as specified in its charter)
Federally Chartered Corporation | 25-6001324 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) | |
601 Grant Street Pittsburgh, PA 15219 (Address of principal executive offices) | 15219 (Zip Code) |
(412) 288-3400
(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. þ Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act. (Check one):
o Large accelerated filer o Accelerated filer þ Non-accelerated filer
Indicate by check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act). o Yes þ No
There were 33,943,960 shares of common stock with a par value of $100 per share outstanding at October 31, 2006.
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PART I — FINANCIAL INFORMATION
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
The Federal Home Loan Bank of Pittsburgh (the “Bank”) is a government-sponsored enterprise (GSE), chartered by Congress to assure the flow of liquidity through its member financial institutions into the American housing market. As a GSE, the Bank’s principal strategic position is driven by its ability to raise funds in the capital markets at narrow spreads to the U.S. Treasury yield curve. This fundamental competitive advantage, coupled with the joint and several cross-guarantee on the Federal Home Loan Bank System (the “FHLBank System”) debt, distinguishes the Bank in the capital markets and enables it to present attractively priced funding to members. Though chartered by Congress, the Bank is privately capitalized by its member institutions, which are voluntary participants in its cooperative structure.
Cooperative. The Bank is a cooperative institution, owned by financial institutions that are also its primary customers. Any building and loan association, savings and loan association, cooperative bank, homestead association, insurance company, savings bank or insured depository institution that maintains its principal place of business in Delaware, Pennsylvania or West Virginia and that meets varying requirements can apply for membership in the Bank. All members are required to purchase capital stock in the Bank as a condition of membership. The capital stock of the Bank can be purchased only by members.
Mission. The Bank’s primary mission is to serve as an intermediary between the capital markets and the housing market through member financial institutions. The Bank issues debt to the public (consolidated obligation bonds and discount notes) in the capital markets through the Office of Finance (OF) and uses these funds to provide its member financial institutions with a reliable source of credit for housing and community development. The United States government does not guarantee, either directly or indirectly, the debt securities or other obligations of the Bank or the FHLBank System. The Bank provides credit for housing and community development through two primary programs. First, it provides members with loans against the security of residential mortgages and other types of high-quality collateral; second, the Bank purchases residential mortgage loans originated by or through member institutions. The Bank also offers other types of credit and non-credit products and services to member institutions. These include letters of credit, interest rate exchange agreements (interest rate swaps, caps, collars, floors, swaptions and similar transactions), affordable housing grants, securities safekeeping, and deposit products and services.
Supervision and Regulation. The Bank is supervised and regulated by the Federal Housing Finance Board (Finance Board), which is an independent agency in the executive branch of the United States government. The Finance Board ensures that the Bank carries out its housing finance mission, remains adequately capitalized and is able to raise funds in the capital markets, and operates in a safe and sound manner. The Finance Board establishes regulations and otherwise supervises the operations of the Bank, primarily via periodic examinations.
Business Segments. The Bank reviews its operations by grouping its products and services within two business segments. The products and services provided through these segments reflect the manner in which financial information is evaluated by management of the Bank. These business segments are:
• | Traditional Member Finance | |
• | Mortgage Partnership Finance® (MPF®) Program (“Mortgage Partnership Finance” and “MPF” are registered trademarks of the Federal Home Loan Bank of Chicago) |
The following is management’s discussion and analysis of the Bank’s earnings performance for the three months and nine months ended September 30, 2006. This discussion should be read in conjunction with the unaudited interim financial statements and notes included in this report as well as the audited financial statements and management’s discussion and analysis for the year ended December 31, 2005 included in the Bank’s registration statement on Form 10, as amended, filed with the SEC.
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Financial Highlights
The results of operations data for the three months and nine months ended September 30, 2006 and 2005, and the statement of condition data as of September 30, 2006 are unaudited and are derived from the financial statements and footnotes included in this report. The statement of condition data as of December 31, 2005 is derived from the audited financial statements included in the registration statement on Form 10, as amended.
Statement of Operations
Three months ended | Nine months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
(in thousands) | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Net interest income before provision (benefit) for credit losses | $ | 89,784 | $ | 77,897 | $ | 255,008 | $ | 232,424 | ||||||||
Provision (benefit) for credit losses | 509 | (102 | ) | 1,125 | 832 | |||||||||||
Other income (loss), excluding net gain on derivatives and hedging activities | 1,728 | (98 | ) | 5,025 | 1,060 | |||||||||||
Net gain (loss) on derivatives and hedging activities | (1,510 | ) | 24,334 | 3,519 | 4,478 | |||||||||||
Other expense | 14,981 | 13,604 | 46,812 | 39,220 | ||||||||||||
Income before assessments | 74,512 | 88,631 | 215,615 | 197,910 | ||||||||||||
Assessments | 19,818 | 23,527 | 57,281 | 52,541 | ||||||||||||
Net income | $ | 54,694 | $ | 65,104 | $ | 158,334 | $ | 145,369 | ||||||||
Earnings per share(1) | $ | 1.68 | $ | 2.20 | $ | 5.03 | $ | 5.30 | ||||||||
Dividends | $ | 42,500 | $ | 20,804 | $ | 108,836 | $ | 56,420 | ||||||||
Weighted average dividend rate(2) | 5.16 | % | 2.78 | % | 4.62 | % | 2.75 | % | ||||||||
Return on average capital | 6.18 | % | 8.30 | % | 6.26 | % | 6.78 | % | ||||||||
Return on average assets | 0.29 | % | 0.38 | % | 0.29 | % | 0.30 | % | ||||||||
Net interest margin(3) | 0.48 | % | 0.45 | % | 0.47 | % | 0.49 | % | ||||||||
Total capital ratio (at period-end)(4) | 4.69 | % | 4.69 | % | 4.69 | % | 4.69 | % | ||||||||
Total average capital to average assets | 4.64 | % | 4.52 | % | 4.58 | % | 4.47 | % | ||||||||
Notes:
(1) | Earnings per share calculated based on net income and weighted average shares outstanding. |
(2) | Weighted average dividend rates are dividends divided by the average of the daily balances of outstanding capital stock during the quarter. |
(3) | Net interest margin is net interest income before provision (benefit) for credit losses as a percentage of average interest-earning assets. |
(4) | Total capital ratio is capital stock plus retained earnings and accumulated other comprehensive income (loss) as a percentage of total assets at period end. |
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Statement of Condition
(in thousands) | September 30, 2006 | December 31, 2005 | ||||||
Loans to members | $ | 49,730,817 | $ | 47,492,959 | ||||
Investments — Federal funds sold, interest-bearing deposits and investment securities(1) | 20,413,816 | 16,945,821 | ||||||
Mortgage loans held for portfolio, net | 7,186,803 | 7,651,914 | ||||||
Total assets | 78,340,232 | 72,898,211 | ||||||
Deposits and other borrowings(2) | 987,997 | 1,079,822 | ||||||
Consolidated obligations, net(3) | 72,827,863 | 67,723,337 | ||||||
AHP payable | 45,973 | 36,707 | ||||||
REFCORP payable | 13,675 | 14,633 | ||||||
Capital stock — putable | 3,439,266 | 3,078,583 | ||||||
Retained earnings | 237,977 | 188,479 | ||||||
Total capital | 3,672,569 | 3,259,546 | ||||||
Notes:
(1) | None of these securities were purchased under agreements to resell. |
(2) | Includes mandatorily redeemable capital stock. |
(3) | Aggregate FHLBank System-wide consolidated obligations (at par) were $958.0 billion and $937.5 billion at September 30, 2006 and December 31, 2005, respectively. |
Forward-Looking Information
Statements contained in Management’s Discussion and Analysis of Financial Condition and Results of Operations, including statements describing the objectives, projections, estimates or future predictions of the Bank and the Office of Finance may be “forward-looking statements.” These statements may use forward-looking terminology, such as “anticipates,” “believes,” “could,” “estimates,” “may,” “should,” “will,” or their negatives or other variations on these terms. The Bank cautions that, by their nature, forward-looking statements involve risks and uncertainties including, but not limited to, the following: economic and market conditions; demand for member loans resulting from changes in the Bank’s member deposit flows and credit demands; volatility of market prices, rates and indices that could affect the value of investments or collateral held by the Bank as security for the obligations of Bank members and counterparties to interest rate exchange agreements and similar agreements; political events, including legislative, regulatory, judicial or other developments, that affect the Bank, its members, its counterpartiesand/or investors in the consolidated obligations of the Bank; competitive forces, including, but not limited to, other sources of funding available to the Bank’s members, other entities borrowing funds in the capital markets, and the ability to attract and retain skilled individuals as employees of the Bank; ability to develop and support technology and information systems, including the Internet, sufficient to manage the risks of the Bank’s business activities effectively; changes in investor demand for consolidated obligationsand/or the terms of interest rate exchange agreements and similar agreements, including changes in the relative attractiveness of consolidated obligations as compared to other investment opportunities; timing and volume of market activity; ability to introduce new Bank products and services, and to successfully manage the risks associated with those products and services, including new types of collateral securing loans; risk of loss arising from litigation that might be filed against the Bank or other FHLBanks; inflation/deflation; and changes in credit ratings and related market pricing associated with the Bank’s investments. This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Bank’s unaudited financial statements and notes included herein and in the Bank’s audited financial statements and notes included in the Form 10, as amended.
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Critical Accounting Policies
The Bank’s financial statements are prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP). Application of these principles requires management to make estimates, assumptions or judgments that affect the amounts reported in the financial statements and accompanying notes. The use of estimates, assumptions and judgments is necessary when financial assets and liabilities are required to be recorded at, or adjusted to reflect, fair value. Assets and liabilities carried at fair value inherently result in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. When such information is not available, valuation adjustments are estimated in good faith by management, primarily through the use of internal cash flow and other financial modeling techniques.
The most significant accounting policies followed by the Bank are presented in Note 2 to the audited financial statements in the Bank’s registration statement on Form 10, as amended. These policies, along with the disclosures presented in the other financial statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Management views critical accounting policies to be those which are highly dependent on subjective or complex judgments, estimates or assumptions, and those for which changes in those estimates or assumptions could have a significant impact on the financial statements.
We discuss the following critical accounting policies in more detail under this same heading in the Bank’s registration statement on Form 10, as amended:
• | Loans to Members and Related Allowance for Credit Losses | |
• | Allowance for Credit Losses on Mortgage Loans Held for Portfolio | |
• | Allowance for Credit Losses on Banking on Business Loans | |
• | Accounting for Premiums and Discounts on Mortgage Loans and Mortgage-Backed Securities | |
• | Guarantees and Consolidated Obligations | |
• | Accounting for Derivatives | |
• | Future REFCORP Payments | |
• | Fair-value Calculations and Methodologies |
The Bank did not implement any material changes to its accounting policies or estimates, nor did the Bank implement any new accounting policies that had an impact on the Bank’s results of operations or financial condition during the quarter ended September 30, 2006.
Earnings Performance
Summary of Financial Results
Net Income and Return on Capital. The Bank’s net income totaled $54.7 million for the third quarter of 2006, a decrease of $10.4 million from the third quarter of 2005. The earnings decrease was primarily due to third quarter 2005 net gains on derivatives and hedging activities of $24.3 million, compared with net losses of $1.5 million in the third quarter of 2006. Net interest income for the third quarter of 2006 increased from third quarter 2005 due to growth in interest-earning assets, primarily loans to members and investments, as well as a higher short-term interest rate environment. These key factors are discussed more fully below. Commensurate with the decrease in net income, the Bank’s return on average capital decreased to 6.18% in the third quarter of 2006, down from a return on average capital of 8.30% in the same year-ago period.
The Bank’s net income totaled $158.3 million for the nine months ended September 30, 2006, an increase of $12.9 million from the nine months ended September 30, 2005, primarily due to higher net interest income, which increased $22.6 million to $255.0 million for the nine months ended September 30, 2006. Driving the growth in net
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interest income over the same year-ago period were increases in interest-earning assets, primarily loans to members and investments, as well as a higher short-term interest rate environment. These key factors are discussed more fully below. The Bank’s return on average capital decreased to 6.26% for the nine months ended 2006, down from a return on average capital of 6.78% in the same year-ago period, as the impact of higher net income was more than offset by an increase in average capital.
Note that these comparisons include differences in hedging and derivatives strategies, which management changed in conjunction with the Bank’s earnings restatement. These strategic changes significantly impact comparisons to prior periods. A full discussion of the restatement is available in the Bank’s registration statement on Form 10, as amended.
Dividend Rate. Because members may purchase and redeem their Bank capital stock shares only at par value, management regards quarterly dividend payments as an important vehicle through which a direct investment return is provided. The Bank’s weighted average dividend rate was 5.16% in the third quarter of 2006, compared to 2.78% in the third quarter of 2005. The weighted average dividend rate for the nine months ended September 30, 2006 was 4.62% compared to 2.75% for the same year-ago period. As further explained on page 23, beginning in the fourth quarter of 2003 through the third quarter of 2005, the Bank limited its quarterly dividend payments to 50% of current period estimated net income in order to increase its retained earnings balance. Retained earnings were $238.0 million as of September 30, 2006, compared with $188.5 million at year-end 2005.
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Net Interest Income
The following tables summarize the rate of interest income or interest expense, the average balance for each of the primary balance sheet classifications and the net interest margin for the three months and nine months ended September 30, 2006 and 2005.
Average Balances and Interest Yields/Rates Paid
Three months ended September 30, | ||||||||||||||||||||||||
2006 | 2005 | |||||||||||||||||||||||
Interest | Avg. | Interest | Avg. | |||||||||||||||||||||
Average | Income/ | Rate | Average | Income/ | Rate | |||||||||||||||||||
(dollars in millions) | Balance | Expense | (%) | Balance | Expense | (%) | ||||||||||||||||||
Assets | ||||||||||||||||||||||||
Federal funds sold(1) | $ | 5,069 | $ | 67 | 5.28 | $ | 1,838 | $ | 16 | 3.40 | ||||||||||||||
Interest-bearing deposits | 3,576 | 49 | 5.38 | 2,265 | 20 | 3.55 | ||||||||||||||||||
Investment securities(2) | 12,100 | 144 | 4.74 | 9,669 | 101 | 4.15 | ||||||||||||||||||
Loans to members | 46,438 | 645 | 5.51 | 46,362 | 422 | 3.61 | ||||||||||||||||||
Mortgage loans held for portfolio(3) | 7,301 | 93 | 5.03 | 8,115 | 97 | 4.73 | ||||||||||||||||||
Total interest-earning assets | 74,484 | $ | 998 | 5.32 | 68,249 | $ | 656 | 3.81 | ||||||||||||||||
Allowance for credit losses | (6 | ) | (5 | ) | ||||||||||||||||||||
Other assets | 1,168 | 619 | ||||||||||||||||||||||
Total assets | $ | 75,646 | $ | 68,863 | ||||||||||||||||||||
Liabilities and capital | ||||||||||||||||||||||||
Deposits | $ | 1,137 | $ | 15 | 5.06 | $ | 994 | $ | 8 | 3.14 | ||||||||||||||
Consolidated obligation discount notes | 13,525 | 179 | 5.25 | 18,556 | 159 | 3.41 | ||||||||||||||||||
Consolidated obligation bonds | 56,414 | 713 | 5.02 | 45,259 | 410 | 3.60 | ||||||||||||||||||
Other borrowings | 60 | 1 | 7.04 | 62 | 1 | 3.48 | ||||||||||||||||||
Total interest-bearing liabilities | 71,136 | $ | 908 | 5.07 | 64,871 | $ | 578 | 3.53 | ||||||||||||||||
Other liabilities | 997 | 880 | ||||||||||||||||||||||
Total capital | 3,513 | 3,112 | ||||||||||||||||||||||
Total liabilities and capital | $ | 75,646 | $ | 68,863 | ||||||||||||||||||||
Net interest spread | 0.25 | 0.28 | ||||||||||||||||||||||
Impact of net noninterest-bearing funds | 0.23 | 0.17 | ||||||||||||||||||||||
Net interest income/net interest margin | $ | 90 | 0.48 | $ | 78 | 0.45 | ||||||||||||||||||
Notes:
(1) | The average balance of Federal funds sold, related interest income and average yield calculations include loans to other FHLBanks. |
(2) | The average balance of investment securitiesavailable-for-sale represents fair values. Related yield, however, is calculated based on cost. |
(3) | Nonaccrual loans are included in average balances in determining the average rate. |
Net interest income increased $12 million, or 15.4%, to $90 million in the third quarter of 2006. Although average interest-earning assets and interest-bearing liabilities increased 9.1% and 9.6%, respectively, compared to the same year-ago period, the increase in net interest income was primarily due to a higher short-term interest rate environment, as indicated in the rate/volume table below. The net interest margin increased 3 basis pointsquarter-over-quarter, as a compression of interest rate spreads on net interest-earning assets of 3 basis points was more than offset by an increase in the impact of net noninterest-bearing funds of 6 basis points.
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Average Balances and Interest Yields/Rates Paid
Nine months ended September 30, | ||||||||||||||||||||||||
2006 | 2005 | |||||||||||||||||||||||
Interest | Avg. | Interest | Avg. | |||||||||||||||||||||
Average | Income/ | Rate | Average | Income/ | Rate | |||||||||||||||||||
(dollars in millions) | Balance | Expense | (%) | Balance | Expense | (%) | ||||||||||||||||||
Assets | ||||||||||||||||||||||||
Federal funds sold(1) | $ | 4,066 | $ | 151 | 4.95 | $ | 1,670 | $ | 37 | 3.00 | ||||||||||||||
Interest-bearing deposits | 3,481 | 130 | 4.98 | 1,283 | 31 | 3.24 | ||||||||||||||||||
Investment securities(2) | 11,602 | 403 | 4.64 | 9,432 | 287 | 4.07 | ||||||||||||||||||
Loans to members | 46,158 | 1,761 | 5.10 | 42,745 | 1,021 | 3.19 | ||||||||||||||||||
Mortgage loans held for portfolio(3) | 7,413 | 281 | 5.08 | 8,481 | 306 | 4.82 | ||||||||||||||||||
Total interest-earning assets | 72,720 | $ | 2,726 | 5.01 | 63,611 | $ | 1,682 | 3.54 | ||||||||||||||||
Allowance for credit losses | (6 | ) | (5 | ) | ||||||||||||||||||||
Other assets | 1,119 | 573 | ||||||||||||||||||||||
Total assets | $ | 73,833 | $ | 64,179 | ||||||||||||||||||||
Liabilities and capital | ||||||||||||||||||||||||
Deposits | $ | 1,202 | $ | 42 | 4.68 | $ | 1,072 | $ | 21 | 2.63 | ||||||||||||||
Consolidated obligation discount notes | 12,004 | 437 | 4.87 | 16,259 | 363 | 2.98 | ||||||||||||||||||
Consolidated obligation bonds | 56,183 | 1,990 | 4.74 | 42,973 | 1,063 | 3.31 | ||||||||||||||||||
Other borrowings | 33 | 2 | 6.04 | 135 | 3 | 2.85 | ||||||||||||||||||
Total interest-bearing liabilities | 69,422 | $ | 2,471 | 4.76 | 60,439 | $ | 1,450 | 3.21 | ||||||||||||||||
Other liabilities | 1,030 | 873 | ||||||||||||||||||||||
Total capital | 3,381 | 2,867 | ||||||||||||||||||||||
Total liabilities and capital | $ | 73,833 | $ | 64,179 | ||||||||||||||||||||
Net interest spread | 0.25 | 0.33 | ||||||||||||||||||||||
Impact of net noninterest-bearing funds | 0.22 | 0.16 | ||||||||||||||||||||||
Net interest income/net interest margin | $ | 255 | 0.47 | $ | 232 | 0.49 | ||||||||||||||||||
Notes:
(1) | The average balance of Federal funds sold, related interest income and average yield calculations include loans to other FHLBanks. |
(2) | The average balance of investment securitiesavailable-for-sale represents fair values. Related yield, however, is calculated based on cost. |
(3) | Nonaccrual loans are included in average balances in determining the average rate. |
Net interest income increased $23 million, or 9.9%, to $255.0 million for the nine months ended September 30, 2006. Although average interest-earning assets and interest-bearing liabilities increased 14.3% and 14.9%, respectively, compared to the same year-ago period, the increase in net interest income was primarily rate driven, as indicated in the table below. The net interest margin decreased 2 basis points to 0.47%. The compression of interest rate spreads resulted in an 8 basis point decrease in the impact of net interest-earning assets. This was partially offset by a 6 basis point increase in the impact of net noninterest-bearing funds.
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Rate/Volume Analysis. Changes in both volume and interest rates influence changes in net interest income and net interest margin. The following table summarizes changes in interest income and interest expense between the applicable periods in 2006 and 2005.
Three months ended | Nine months ended | |||||||||||||||||||||||
September 30 | September 30 | |||||||||||||||||||||||
(in millions) | Volume | Rate | Total | Volume | Rate | Total | ||||||||||||||||||
Increase (decrease) in interest income due to: | ||||||||||||||||||||||||
Federal funds sold | $ | 27 | $ | 24 | $ | 51 | $ | 54 | $ | 60 | $ | 114 | ||||||||||||
Interest-bearing deposits | 12 | 17 | 29 | 53 | 46 | 99 | ||||||||||||||||||
Investment securities | 25 | 18 | 43 | 66 | 50 | 116 | ||||||||||||||||||
Loans to members | 1 | 222 | 223 | 81 | 659 | 740 | ||||||||||||||||||
Mortgage loans held for portfolio | (10 | ) | 6 | (4 | ) | (39 | ) | 14 | (25 | ) | ||||||||||||||
Total | $ | 55 | $ | 287 | $ | 342 | $ | 215 | $ | 829 | $ | 1,044 | ||||||||||||
Increase (decrease) in interest expense due to: | ||||||||||||||||||||||||
Deposits | $ | 1 | $ | 6 | $ | 7 | $ | 3 | $ | 18 | $ | 21 | ||||||||||||
Consolidated obligation discount notes | (43 | ) | 63 | 20 | (95 | ) | 169 | 74 | ||||||||||||||||
Consolidated obligation bonds | 101 | 202 | 303 | 327 | 600 | 927 | ||||||||||||||||||
Other borrowings | - | - | - | (2 | ) | 1 | (1 | ) | ||||||||||||||||
Total | $ | 59 | $ | 271 | $ | 330 | $ | 233 | $ | 788 | $ | 1,021 | ||||||||||||
Increase (decrease) in net interest income | $ | (4 | ) | $ | 16 | $ | 12 | $ | (18 | ) | $ | 41 | $ | 23 | ||||||||||
Note: The changes for each category of interest income and expense are divided between the portion of change attributed to volume or rate for that category. The change in rate/volume variance has been allocated to the volume and rate variances based on their relative sizes.
The increases in average interest-earning assets for the third quarter and the nine months ended September 30, 2006 compared to the same periods in 2005 were a result of increases in investment securities, Federal funds sold, interest-bearing deposits and loans to members. The Bank has focused on increasing liquidity, through increases in short-term investments, in response to the new consolidated obligation repayment funding requirements by the Federal Reserve, which became effective July 20, 2006. As a result of that strategy, the Bank has invested in short-term liquid assets when short-term rates have been increasing, thus providing an increase to interest income from both volume and rates.
The $76 million increase in loans to members in the quarter to quarter comparison and the $3.4 billion increase on a year over year basis also had a positive impact on interest income from the volume side. However, the primary driver, as noted in the above table, was interest rate related. The Bank’s loans to members portfolio has experienced a fundamental shift in the type of loans that the Bank’s members are requiring, with growth in longer-term loans with slightly higher interest rates. The average loans to members portfolio detail is provided in a table below. Note that while there has been an 8.0% growth year over year, the loans to members average balance for the third quarter of 2006 was relatively flat when compared with the second quarter of 2006.
The mortgage loans held for portfolio impact was primarily volume related as this portfolio declined in both the quarter to quarter and year over year comparisons. This decline is due to a reduction in mortgages available to be purchased from members, which resulted in the portfolio run-off exceeding new loans being purchased.
The composition of the consolidated obligation portfolio has changed to longer-term bonds from short-term notes, coinciding with the shift in the Bank’s loans to members portfolio. Consolidated obligation bonds funded the additional asset levels, with averages increasing in both the quarter over quarter and year over year comparisons. Average discount notes negatively impacted interest expense on the volume side. The primary driver of the increase in interest expense on consolidated obligations in total was due to the increase in short-term interest rates.
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Loans to Members Portfolio Detail:
Average Balances | ||||||||||||||||||
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||||
(in millions) | ||||||||||||||||||
Product | Description | 2006 | 2005 | 2006 | 2005 | |||||||||||||
RepoPlus | Short-term fixed-rate loans; principal and interest paid at maturity. | $ | 4,157.2 | $ | 13,291.2 | $ | 4,789.2 | $ | 12,664.8 | |||||||||
Mid-Term RepoPlus | Mid-term fixed-rate and adjustable-rate loans; principal paid at maturity; interest paid quarterly. | 21,165.3 | 14,588.2 | 19,785.5 | 12,140.1 | |||||||||||||
Term Loans | Long-term fixed-rate and adjustable-rate loans; principal paid at maturity; interest paid quarterly; (includes amortizing loans with principal and interest paid monthly); Affordable Housing Loans and Community Investment Loans. | 10,661.6 | 8,723.6 | 10,439.2 | 7,243.2 | |||||||||||||
Convertible Select | Long-term fixed-rate and adjustable-rate loans with conversion options sold by member; principal paid at maturity; interest paid quarterly. | 8,990.2 | 9,145.6 | 9,934.9 | 10,032.7 | |||||||||||||
Hedge Select | Long-term fixed-rate and adjustable-rate loans with embedded options bought by member; principal paid at maturity; interest paid quarterly. | 50.0 | 250.0 | 84.4 | 251.1 | |||||||||||||
Returnable | Loans in which the member has the right to prepay the loan after a specified period. | 1,733.4 | - | 1,390.4 | - | |||||||||||||
Total par value | 46,757.7 | 45,998.6 | 46,423.6 | 42,331.9 | ||||||||||||||
Discount on AHP loans to members | (1.6 | ) | (1.8 | ) | (1.6 | ) | (1.9 | ) | ||||||||||
Deferred prepayment fees | (0.2 | ) | (0.7 | ) | (0.3 | ) | (0.9 | ) | ||||||||||
SFAS 133 hedging adjustment | (317.7 | ) | 365.7 | (264.0 | ) | 416.1 | ||||||||||||
Total book value | $ | 46,438.2 | $ | 46,361.8 | $ | 46,157.7 | $ | 42,745.2 | ||||||||||
As noted in the chart above, there has been a significant shift from the RepoPlus product to the Mid-Term RepoPlus product. This is due in part to management efforts to extend the loans to members portfolio maturity and in part to the short-term interest rate environment. As short-term interest rates rise, overnight Federal funds and other sources of overnight funding become more attractive to members than Bank overnight loans. In addition, the growth of this portfolio is also impacted by the following: (1) the new consolidated obligation repayment funding requirement, discussed in Item 2. Financial Condition, which has put pressure on the Bank’s overnight cost of funds; (2) the slowing housing market; and (3) the Finance Board’s proposed retained earnings rule, discussed in Item 2.
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Financial Condition, which would limit the Bank’s ability to declare dividends. These factors continue to put pressure on the Bank’s ability to grow the loans to members portfolio in the current pricing environment.
Net Interest Income Derivative Effects. The following tables separately quantify the effects of the Bank’s derivative activities on its interest income and interest expense for the three and nine months ended September 30, 2006 and 2005. Derivative and hedging activities are discussed below in the other income (loss) section.
Three months ended September 30, 2006
Interest Inc./ | Avg. | Interest Inc./ | Avg. | Incr./ | ||||||||||||||||||||||||
Average | Exp. with | Rate | Exp. without | Rate | Impact of | (Decr.) | ||||||||||||||||||||||
(dollars in millions) | Balance | Derivatives | (%) | Derivatives | (%) | Derivatives | (%) | |||||||||||||||||||||
Assets | ||||||||||||||||||||||||||||
Federal funds sold | $ | 5,069 | $ | 67 | 5.28 | $ | 67 | 5.28 | ||||||||||||||||||||
Interest-bearing deposits | 3,576 | 49 | 5.38 | 49 | 5.38 | |||||||||||||||||||||||
Investment securities | 12,100 | 144 | 4.74 | 144 | 4.74 | |||||||||||||||||||||||
Loans to members | 46,438 | 645 | 5.51 | 571 | 4.88 | $ | 74 | 0.63 | ||||||||||||||||||||
Mortgage loans held for portfolio | 7,301 | 93 | 5.03 | 94 | 5.09 | (1 | ) | (0.06 | ) | |||||||||||||||||||
Total interest-earning assets | 74,484 | $ | 998 | 5.32 | $ | 925 | 4.93 | $ | 73 | 0.39 | ||||||||||||||||||
Allowance for credit losses | (6 | ) | ||||||||||||||||||||||||||
Other assets | 1,168 | |||||||||||||||||||||||||||
Total assets | $ | 75,646 | ||||||||||||||||||||||||||
Liabilities and capital | ||||||||||||||||||||||||||||
Deposits | $ | 1,137 | $ | 15 | 5.06 | $ | 15 | 5.06 | ||||||||||||||||||||
Consolidated obligation discount notes | 13,525 | 179 | 5.25 | 179 | 5.25 | |||||||||||||||||||||||
Consolidated obligation bonds | 56,414 | 713 | 5.02 | 634 | 4.46 | $ | 79 | 0.56 | ||||||||||||||||||||
Other borrowings | 60 | 1 | 7.04 | 1 | 7.04 | |||||||||||||||||||||||
Total interest-bearing liabilities | 71,136 | $ | 908 | 5.07 | $ | 829 | 4.63 | $ | 79 | 0.44 | ||||||||||||||||||
Other liabilities | 997 | |||||||||||||||||||||||||||
Total capital | 3,513 | |||||||||||||||||||||||||||
Total liabilities and capital | $ | 75,646 | ||||||||||||||||||||||||||
Net interest income/net interest spread | $ | 90 | 0.25 | $ | 96 | 0.30 | $ | (6 | ) | (0.05 | ) | |||||||||||||||||
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Three months ended September 30, 2005
Interest Inc./ | Avg. | Interest Inc./ | Avg. | Incr./ | ||||||||||||||||||||||||
Average | Exp. with | Rate | Exp. without | Rate | Impact of | (Decr.) | ||||||||||||||||||||||
(dollars in millions) | Balance | Derivatives | (%) | Derivatives | (%) | Derivatives | (%) | |||||||||||||||||||||
Assets | ||||||||||||||||||||||||||||
Federal funds sold | $ | 1,838 | $ | 16 | 3.40 | $ | 16 | 3.40 | ||||||||||||||||||||
Interest-bearing deposits | 2,265 | 20 | 3.55 | 20 | 3.55 | |||||||||||||||||||||||
Investment securities | 9,669 | 101 | 4.15 | 101 | 4.15 | |||||||||||||||||||||||
Loans to members | 46,362 | 422 | 3.61 | 462 | 3.95 | $ | (40 | ) | (0.34 | ) | ||||||||||||||||||
Mortgage loans held for portfolio | 8,115 | 97 | 4.73 | 99 | 4.86 | (2 | ) | (0.13 | ) | |||||||||||||||||||
Total interest-earning assets | 68,249 | $ | 656 | 3.81 | $ | 698 | 4.06 | $ | (42 | ) | (0.25 | ) | ||||||||||||||||
Allowance for credit losses | (5 | ) | ||||||||||||||||||||||||||
Other assets | 619 | |||||||||||||||||||||||||||
Total assets | $ | 68,863 | ||||||||||||||||||||||||||
Liabilities and capital | ||||||||||||||||||||||||||||
Deposits | $ | 994 | $ | 8 | 3.14 | $ | 8 | 3.14 | ||||||||||||||||||||
Consolidated obligation discount notes | 18,556 | 159 | 3.41 | 159 | 3.41 | |||||||||||||||||||||||
Consolidated obligation bonds | 45,259 | 410 | 3.60 | 425 | 3.74 | $ | (15 | ) | (0.14 | ) | ||||||||||||||||||
Other borrowings | 62 | 1 | 3.48 | 1 | 3.48 | |||||||||||||||||||||||
Total interest-bearing liabilities | 64,871 | $ | 578 | 3.53 | $ | 593 | 3.63 | $ | (15 | ) | (0.10 | ) | ||||||||||||||||
Other liabilities | 880 | |||||||||||||||||||||||||||
Total capital | 3,112 | |||||||||||||||||||||||||||
Total liabilities and capital | $ | 68,863 | ||||||||||||||||||||||||||
Net interest income/net interest spread | $ | 78 | 0.28 | $ | 105 | 0.43 | $ | (27 | ) | (0.15 | ) | |||||||||||||||||
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Nine months ended September 30, 2006
Interest Inc./ | Avg. | Interest Inc./ | Avg. | Incr./ | ||||||||||||||||||||||||
Average | Exp. with | Rate | Exp. without | Rate | Impact of | (Decr.) | ||||||||||||||||||||||
(dollars in millions) | Balance | Derivatives | (%) | Derivatives | (%) | Derivatives | (%) | |||||||||||||||||||||
Assets | ||||||||||||||||||||||||||||
Federal funds sold | $ | 4,066 | $ | 151 | 4.95 | $ | 151 | 4.95 | ||||||||||||||||||||
Interest-bearing deposits | 3,481 | 130 | 4.98 | 130 | 4.98 | |||||||||||||||||||||||
Investment securities | 11,602 | 403 | 4.64 | 403 | 4.64 | |||||||||||||||||||||||
Loans to members | 46,158 | 1,761 | 5.10 | 1,598 | 4.63 | $ | 163 | 0.47 | ||||||||||||||||||||
Mortgage loans held for portfolio | 7,413 | 281 | 5.08 | 284 | 5.13 | (3 | ) | (0.05 | ) | |||||||||||||||||||
Total interest-earning assets | 72,720 | $ | 2,726 | 5.01 | 2,566 | 4.72 | $ | 160 | 0.29 | |||||||||||||||||||
Allowance for credit losses | (6 | ) | ||||||||||||||||||||||||||
Other assets | 1,119 | |||||||||||||||||||||||||||
Total assets | $ | 73,833 | ||||||||||||||||||||||||||
Liabilities and capital | ||||||||||||||||||||||||||||
Deposits | $ | 1,202 | $ | 42 | 4.68 | $ | 42 | 4.68 | ||||||||||||||||||||
Consolidated obligation discount notes | 12,004 | 437 | 4.87 | 437 | 4.87 | |||||||||||||||||||||||
Consolidated obligation bonds | 56,183 | 1,990 | 4.74 | 1,825 | 4.34 | $ | 165 | 0.40 | ||||||||||||||||||||
Other borrowings | 33 | 2 | �� | 6.04 | 2 | 6.04 | ||||||||||||||||||||||
Total interest-bearing liabilities | 69,422 | $ | 2,471 | 4.76 | $ | 2,306 | 4.44 | $ | 165 | 0.32 | ||||||||||||||||||
Other liabilities | 1,030 | |||||||||||||||||||||||||||
Total capital | 3,381 | |||||||||||||||||||||||||||
Total liabilities and capital | $ | 73,833 | ||||||||||||||||||||||||||
Net interest income/net interest spread | $ | 255 | 0.25 | $ | 260 | 0.28 | $ | (5 | ) | (0.03 | ) | |||||||||||||||||
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Nine months ended September 30, 2005
Interest Inc./ | Avg. | Interest Inc./ | Avg. | Incr./ | ||||||||||||||||||||||||
Average | Exp. with | Rate | Exp. without | Rate | Impact of | (Decr.) | ||||||||||||||||||||||
(dollars in millions) | Balance | Derivatives | (%) | Derivatives | (%) | Derivatives | (%) | |||||||||||||||||||||
Assets | ||||||||||||||||||||||||||||
Federal funds sold | $ | 1,670 | $ | 37 | 3.00 | $ | 37 | 3.00 | ||||||||||||||||||||
Interest-bearing deposits | 1,283 | 31 | 3.24 | 31 | 3.24 | |||||||||||||||||||||||
Investment securities | 9,432 | 287 | 4.07 | 287 | 4.07 | |||||||||||||||||||||||
Loans to members | 42,745 | 1,021 | 3.19 | 1,205 | 3.77 | $ | (184 | ) | (0.58 | ) | ||||||||||||||||||
Mortgage loans held for portfolio | 8,481 | 306 | 4.82 | 313 | 4.94 | (7 | ) | (0.12 | ) | |||||||||||||||||||
Total interest-earning assets | 63,611 | $ | 1,682 | 3.54 | $ | 1,873 | 3.94 | $ | (191 | ) | (0.40 | ) | ||||||||||||||||
Allowance for credit losses | (5 | ) | ||||||||||||||||||||||||||
Other assets | 573 | |||||||||||||||||||||||||||
Total assets | $ | 64,179 | ||||||||||||||||||||||||||
Liabilities and capital | ||||||||||||||||||||||||||||
Deposits | $ | 1,072 | $ | 21 | 2.63 | $ | 21 | 2.63 | ||||||||||||||||||||
Consolidated obligation discount notes | 16,259 | 363 | 2.98 | 363 | 2.98 | |||||||||||||||||||||||
Consolidated obligation bonds | 42,973 | 1,063 | 3.31 | 1,176 | 3.66 | $ | (113 | ) | (0.35 | ) | ||||||||||||||||||
Other borrowings | 135 | 3 | 2.85 | 3 | 2.85 | |||||||||||||||||||||||
Total interest-bearing liabilities | 60,439 | $ | 1,450 | 3.21 | $ | 1,563 | 3.46 | $ | (113 | ) | (0.25 | ) | ||||||||||||||||
Other liabilities | 873 | |||||||||||||||||||||||||||
Total capital | 2,867 | |||||||||||||||||||||||||||
Total liabilities and capital | $ | 64,179 | ||||||||||||||||||||||||||
Net interest income/net interest spread | $ | 232 | 0.33 | $ | 310 | 0.48 | $ | (78 | ) | (0.15 | ) | |||||||||||||||||
The Bank uses derivatives to hedge the fair market value changes attributable to the change in the London Interbank Offer Rate (LIBOR) benchmark interest rate. The hedge strategy generally uses interest rate swaps to hedge a portion of loans to members and consolidated obligations which convert the interest rates on those instruments from a fixed rate to a variable rate based on3-month LIBOR. The purpose of this strategy is to protect the interest rate spread. As a result of the interest rates being converted from fixed to variable, the impact of these relationships can increase or decrease net interest income.
The loans to members and consolidated obligation derivative impact variances from period to period are driven by the change inaverage 3-month LIBOR in a given period and the level of the portfolio being hedged. Average3-month LIBOR has increased approximately 166 basis points from the third quarter of 2005 to the third quarter of 2006. Additionally, the level of the hedge relationships has increased on the loans to members and consolidated obligations by approximately $5 billion for the same periods. The rate increase, along with the increased levels of hedged relationships, contributed to a $(6) million unfavorable derivative impact for the three months ended September 30, 2006 as compared to a $(27) million unfavorable impact in 2005. The nine months ended September 30, 2006 reflected an increase of $8 billion in hedge relationships, combined with a 183 basis point increase in the3-month LIBOR rate, compared to the same year-ago period. These factors contributed to an unfavorable $(5) million derivative impact in the current year compared with a $(78) million unfavorable impact in the prior year.
The mortgage loans held for portfolio derivative impact for the nine months ended September 30, 2006 increased slightly from 2005, to (0.05)% from (0.12)%. This was due to the amortization of fair value adjustments created under previous hedge strategies. The prior strategy hedged the fair value of the commitment to purchase mortgage loans. Currently, the Bank treats mortgage loan commitments as derivatives and no longer applies hedge
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accounting, pursuant to SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities(SFAS 149).
In general, the total effect of the implementation of all of these derivative and hedge strategies was to decrease the interest rate spread 5 basis points in the three months ended September 30, 2006, compared to a reduction of 15 basis points in the same period of 2005. The impact for the nine months ended September 30, 2006 was a decrease to the interest rate spread of 3 basis points compared to a 15 basis point reduction for the same period in 2005.
Mortgage Loan Premium/Discount. When mortgage loans are acquired by the Bank under the MPF Program, a premium or discount is typically paid to the participating financial institution. There are two primary reasons for these premiums or discounts: (1) prevailing market rates change between the date the mortgage loan is priced to the homeowner and the date the originating member locks in a commitment price at which to sell the loans to the Bank; and (2) borrowers elect to pay a higher than market rate on their mortgage loan in exchange for a reduction in up-front loan points, fees,and/or other loan closing costs. This practice of “financing the closing costs” results in a market-wide prevalence of premiums as opposed to discounts, which is reflected in the Bank’s mortgage loan portfolio. When mortgage loans pay off prior to their contractual terms, any associated unamortized premiums or discounts are recorded in net interest income.
The change in the amount of amortization and accretion of premiums and discounts on mortgage loans impacts the total and variability of the Bank’s net interest income. The combination of historically low residential mortgage rates, aggressive marketing by loan originators and the availability of low-cost loan products to prospective borrowers, resulted in high levels of prepayment activity in the Bank’s mortgage loan portfolio in 2005. However, in 2006, residential mortgage rates rose and less product was available for purchase, which resulted in lower amortization and accretion on premiums and discounts in the current periods. The amortization and accretion of mortgage loan premiums and discounts resulted in a net expense of $3.6 million during the third quarter of 2006 compared to $8.0 million during the third quarter of 2005 and $10.9 million for the nine months ended September 30, 2006 compared to $23.3 million for the same period in 2005.
The table below provides key information related to the Bank’s premium/discount on mortgage loans.
Nine months ended | ||||||||||||||||
Three months ended September 30, | September 30, | |||||||||||||||
(dollars in thousands) | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Net premium expense for the period | $ | 3,552 | $ | 8,004 | $ | 10,881 | $ | 23,327 | ||||||||
Mortgage loan related net premium balance at period-end | $ | 55,033 | $ | 76,963 | $ | 55,033 | $ | 76,963 | ||||||||
Mortgage loan par balance at period-end | $ | 7,111,501 | $ | 7,872,856 | $ | 7,111,501 | $ | 7,872,856 | ||||||||
Premium balance as a percent of mortgage loans | 0.77 | % | 0.98 | % | 0.77 | % | 0.98 | % |
Other Income (Loss)
Three months ended | % Change | Nine months ended | % Change | |||||||||||||||||||||
September 30, | 2006/ | September 30, | 2006/ | |||||||||||||||||||||
(dollars in thousands) | 2006 | 2005 | 2005 | 2006 | 2005 | 2005 | ||||||||||||||||||
Services fees | $ | 1,077 | $ | 967 | 11.4 | $ | 3,390 | $ | 2,881 | 17.7 | ||||||||||||||
Net loss on sale of trading securities | - | - | n/m | - | (999 | ) | 100.0 | |||||||||||||||||
Net gain (loss) on derivatives and hedging activities | (1,510 | ) | 24,334 | n/m | 3,519 | 4,478 | (21.4 | ) | ||||||||||||||||
Other, net | 651 | (1,065 | ) | n/m | 1,635 | (822 | ) | n/m | ||||||||||||||||
Total other income (loss) | $ | 218 | $ | 24,236 | n/m | $ | 8,544 | $ | 5,538 | 54.3 | ||||||||||||||
n/m = not meaningful
Third quarter 2006 results included other income of $218 thousand, compared with other income of $24.2 million in third quarter 2005. The prior year income includes $24.3 million of net gains on derivatives
14
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and hedging activities, compared with net losses of $1.5 million in the current year. The large gain in 2005 was due to fair value gains on economic hedges discussed below. In addition, third quarter 2005 results included $1.4 million of asset write-offs for software no longer used by the Bank.
Other income for the nine months ended September 30, 2006 was $8.5 million, compared with other income of $5.5 million for the nine months ended September 30, 2005. Results for 2005 included $4.5 million of net gains on derivatives and hedging activities, compared with $3.5 million of net gains in the current year, as well as $1.0 million of net losses on trading securities and $1.4 million of asset write-offs.
Net gains on derivatives and hedging activities for the first nine months of 2005 included the impact ofindex-amortizing swaps used to economically hedge the fair value of mortgage loans held for portfolio. The fair values of these derivatives were extremely sensitive to changes in interest rates and mortgage prepayment speeds, causing significant volatility in other income. The activity related to gains and losses on derivatives and hedging is discussed in more detail below.
Derivatives and Hedging Activities. The Bank enters into interest rate swaps, caps, floors, swaption agreements and TBA securities, referred to collectively as interest rate exchange agreements and more broadly as derivative instruments. The Bank enters into derivatives transactions to offset all or portions of the financial risk exposures inherent in its member lending, investment and funding activities. All derivatives are recorded on the balance sheet at fair value. Changes in derivatives fair values are either recorded in the statement of operations or accumulated other comprehensive income within the capital section of the statement of condition, depending on the hedge strategy.
The Bank’s hedging strategies generally consist of fair value and economic hedges. Fair value hedges are discussed in more detail below. Economic hedges address specific risks inherent in the Bank’s balance sheet, but they do not qualify for hedge accounting. As a result, income recognition on the derivatives in economic hedges may vary considerably compared to the timing of income recognition on the underlying asset or liability. The Bank does not enter into derivatives for speculative purposes to generate profits.
Regardless of the hedge strategy employed, the Bank’s predominant hedging instrument is an interest rate swap. At the time of inception, the fair market value of an interest rate swap generally equals or is close to a zero value. Notwithstanding the exchange of interest payments made during the life of the swap, which are recorded as either interest income/expense or as a gain (loss) on derivatives, depending upon the accounting classification of the hedge instrument, the fair value of an interest rate swap returns to zero at the end of its contractual term. Therefore, although the fair value of an interest rate swap is likely to change over the course of its full term, upon maturity any unrealized gains and losses net out to zero.
The following tables detail the net gains and losses on derivatives and hedging activities, including hedge ineffectiveness, for the three months and nine months ended September 30, 2006 and 2005, respectively.
Three months ended | ||||||||||
(in thousands) | September 30, | |||||||||
Type of Hedge | Asset/Liability Hedged | 2006 | 2005 | |||||||
Fair value hedge ineffectiveness | Loans to members | $ | 4,037 | $ | (1,002 | ) | ||||
Consolidated obligations | 1,084 | 2,417 | ||||||||
Total fair value hedge ineffectiveness | 5,121 | 1,415 | ||||||||
Cash flow hedge ineffectiveness | - | 5 | ||||||||
Economic hedges | (7,296 | ) | 22,687 | |||||||
Intermediary transactions | (3 | ) | (76 | ) | ||||||
Other | 668 | 303 | ||||||||
Net gain (loss) on derivatives and hedging activities | $ | (1,510 | ) | $ | 24,334 | |||||
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Nine months ended | ||||||||||
(in thousands) | September 30, | |||||||||
Type of Hedge | Asset/Liability Hedged | 2006 | 2005 | |||||||
Fair value hedge ineffectiveness | Loans to members | $ | 5,219 | $ | 168 | |||||
Consolidated obligations | 1,382 | 7,169 | ||||||||
Total fair value hedge ineffectiveness | 6,601 | 7,337 | ||||||||
Cash flow hedge ineffectiveness | - | 5 | ||||||||
Economic hedges | (3,639 | ) | (2,262 | ) | ||||||
Intermediary transactions | (102 | ) | (298 | ) | ||||||
Other | 659 | (304 | ) | |||||||
Net gain (loss) on derivatives and hedging activities | $ | 3,519 | $ | 4,478 | ||||||
Fair Value Hedges. The Bank uses fair value hedge accounting treatment for most of its fixed-rate loans to members and consolidated obligations using interest rate swaps. The interest rate swaps convert these fixed-rate instruments to a variable rate (i.e., LIBOR based). For the third quarter of 2006, total ineffectiveness related to these fair value hedges resulted in a gain of $5.1 million compared to a gain of $1.4 million in third quarter of 2005. For the nine months ended September 30, 2006 and 2005, total ineffectiveness related to fair value hedges resulted in gains of $6.6 million and $7.3 million, respectively. From 2005 to 2006, the overall notional amount increased from $58.1 billion at September 30, 2005 to $67.5 billion at September 30, 2006. Fair value hedge ineffectiveness represents the difference between the change in the fair value of the derivative compared to the change in the fair value of the underlying asset/liability hedged. The $3.7 million increase in fair value hedge ineffectiveness gains in third quarter 2006 compared to third quarter 2005 resulted primarily from changes in the Bank’s portfolio structure as well as fluctuations in interest rate movements during the third quarter of 2006 compared to the third quarter of 2005.
Economic Hedges. For economic hedges, the Bank includes the net interest income and the changes in the fair value of the hedges in net gain (loss) on derivatives and hedging activities. Total amounts recorded for economic hedges were a loss of $7.3 million in third quarter 2006 compared to a gain of $22.7 million in third quarter 2005. The change in fair value between the third quarter of 2005 and the third quarter of 2006 was primarily due to the termination of theindex-amortizing swap portfolio, which had resulted in gains of $30.0 million for the third quarter 2005. These gains were partially offset by the interest expense on these swaps of $8.1 million for the third quarter 2005. The overall notional amount of economic hedges decreased from $4.8 billion in 2005 to $2.7 billion in 2006.
Intermediary Transactions. Derivatives in which the Bank is an intermediary may arise when the Bank enters into derivatives with members and offsetting derivatives with other counterparties to meet the needs of members. The following table details the net gains and losses on intermediary transactions.
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in thousands) | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Contracts with members — fair value change | $ | (128 | ) | $ | 146 | $ | (1,731 | ) | $ | (4,695 | ) | |||||
Contracts with counterparties — fair value change | 117 | (251 | ) | 1,626 | 4,301 | |||||||||||
Net fair value change | (11 | ) | (105 | ) | (105 | ) | (394 | ) | ||||||||
Interest income (expense) due to spread | 8 | 29 | 3 | 96 | ||||||||||||
Net gain (loss) on intermediary derivative activities | $ | (3 | ) | $ | (76 | ) | $ | (102 | ) | $ | (298 | ) | ||||
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Other Expense
Three months ended | Nine months ended | |||||||||||||||||||||||
September 30, | % Change | September 30, | % Change | |||||||||||||||||||||
(dollars in thousands) | 2006 | 2005 | 2006/2005 | 2006 | 2005 | 2006/2005 | ||||||||||||||||||
Operating — salaries and benefits | $ | 8,158 | $ | 8,138 | 0.2 | $ | 26,412 | $ | 22,368 | 18.1 | ||||||||||||||
Operating — occupancy | 871 | 662 | 31.6 | 2,449 | 1,905 | 28.6 | ||||||||||||||||||
Operating — other | 4,973 | 3,747 | 32.7 | 14,849 | 11,615 | 27.8 | ||||||||||||||||||
Finance Board | 581 | 636 | (8.6 | ) | 1,746 | 1,909 | (8.5 | ) | ||||||||||||||||
Office of Finance | 398 | 421 | (5.5 | ) | 1,356 | 1,423 | (4.7 | ) | ||||||||||||||||
Total other expense | $ | 14,981 | $ | 13,604 | 10.1 | $ | 46,812 | $ | 39,220 | 19.4 | ||||||||||||||
Other expense totaled $15.0 million in the third quarter of 2006, compared to $13.6 million in the third quarter of 2005, an increase of 10.1%. Excluding the operating expenses of the Finance Board and Office of Finance described below, total other expense increased $1.5 million, or 11.6%. The majority of the increase in the quarter over quarter comparison was due to higher other operating expenses, which increased $1.2 million over the prior year quarter. This increase was primarily due to higher depreciation expense, professional fees and contract services expense, driven in part by increased infrastructure-related spending.
Other expense totaled $46.8 million for the nine months ended September 30, 2006, compared to $39.2 million for the nine months ended September 30, 2005, an increase of 19.4%. Excluding the operating expenses of the Finance Board and the Office of Finance, total other expense increased $7.8 million, or 21.8%. The majority of the increase in the year over year comparison was due to salaries and employee benefits, which increased $4.0 million for the nine months ended September 30, 2006 compared with the same year-ago period. The 2006 expense included $1.1 million related to a retirement plan lump sum payment made in the first quarter of 2006. At September 30, 2006, full-time equivalent staff totaled 246 positions, an increase of 7 positions from September 30, 2005 and 28 positions from the beginning of 2005. This increase reflects expansion of staffing levels in the capital markets, mortgage finance, accounting, risk management and information technology departments. In addition, other operating expenses increased $3.2 million for the nine months ended September 30, 2006. The increase was mainly attributable to depreciation expense, professional fees, and contract services expense.
Collectively, the twelve FHLBanks are responsible for the operating expenses of the Finance Board and the Office of Finance. These payments, allocated among the FHLBanks according to a cost-sharing formula, are reported as other expense on the Bank’s statement of operations. These expenses totaled $1.0 million and $1.1 million for the third quarter 2006 and 2005, respectively, a decrease of 7.4%. For the first nine months of 2006 and 2005, these expenses totaled $3.1 million and $3.3 million respectively, a decrease of 6.9%. The Bank has no control over the operating expenses of the Finance Board. The FHLBanks are able to exert a limited degree of control over the operating expenses of the Office of Finance due to the fact that two directors of the Office of Finance are also FHLBank presidents.
Affordable Housing Program (AHP) and Resolution Funding Corp. (REFCORP) Assessments
Three months ended | Nine months ended | |||||||||||||||||||||||
September 30, | % Change | September 30, | % Change | |||||||||||||||||||||
(in thousands) | 2006 | 2005 | 2006/2005 | 2006 | 2005 | 2006/2005 | ||||||||||||||||||
AHP | $ | 6,142 | $ | 7,251 | (15.3 | ) | $ | 17,695 | $ | 16,199 | 9.2 | |||||||||||||
REFCORP | 13,676 | 16,276 | (16.0 | ) | 39,586 | 36,342 | 8.9 | |||||||||||||||||
Total assessments | $ | 19,818 | $ | 23,527 | (15.8 | ) | $ | 57,281 | $ | 52,541 | 9.0 | |||||||||||||
Assessment Calculations. Although the FHLBanks are not subject to federal or state income taxes, the combined financial obligations of making payments to REFCORP (20%) and AHP contributions (10%) equate to a proportion of the Bank’s net income comparable to that paid in income tax by fully taxable entities. Inasmuch as both the REFCORP and AHP payments are each separately subtracted from earnings prior to the assessment of each, the combined effective rate is less than the simple sum of both (i.e., less than 30%). In passing the Financial
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Services Modernization Act of 1999, Congress established a fixed 20% annual REFCORP payment rate beginning in 2000 for each FHLBank. The fixed percentage replaced a fixed-dollar annual payment of $300 million which had previously been divided among the twelve FHLBanks through a complex allocation formula. The law also calls for an adjustment to be made to the total number of REFCORP payments due in future years so that, on a present value basis, the combined REFCORP payments of all twelve FHLBanks are equal in amount to what had been required under the previous calculation method. The FHLBanks’ aggregate payments through the third quarter of 2006 exceeded the scheduled payments, effectively accelerating payment of the REFCORP obligation and shortening its remaining term to the first quarter of 2016. This date assumes that the FHLBanks pay exactly $300 million annually until 2017. The cumulative amount to be paid to REFCORP by the FHLBank is not determinable at this time due to the interrelationships of the future earnings of all FHLBanks and interest rates.
Theyear-to-year changes in REFCORP and AHP assessments reflect the changes in income before assessments.
Financial Condition
The following is management’s discussion and analysis of the Bank’s financial condition at September 30, 2006 compared to December 31, 2005. This should be read in conjunction with the unaudited interim financial statements and notes included in this report.
Total assets increased $5.4 billion, or 7.5%, to $78.3 billion at September 30, 2006, up from $72.9 billion at December 31, 2005. This increase from year-end was primarily due to increases in loans to members of $2.2 billion, Federal funds sold of $1.8 billion, investment securities of $1.1 billion and interest-bearing deposits of $599.9 million. Offsetting these increases was a decrease in net mortgage loans held for portfolio of $465.1 million.
Total housing finance-related assets, which include MPF Program loans, loans to members, mortgage-backed securities and other mission-related investments, increased $2.3 billion, or 3.4%, to $68.1 billion at September 30, 2006, from $65.8 billion at year-end 2005. Total housing finance-related assets accounted for 86.9% of assets as of September 30, 2006.
Beginning July 20, 2006, the Federal Reserve required Reserve Banks to release interest and principal payments on the FHLBank System consolidated obligations only when there are sufficient funds in the FHLBanks’ account to cover these payments. This requirement is a fundamental change from the Federal Reserve’s past policy applicable to GSEs and certain international organizations of processing and posting these payments in the morning, even if these entities had not fully funded their payments. Further discussion of this repayment funding requirement is included in the Bank’s registration statement on Form 10, as amended. To comply with this new requirement, the Bank has taken the following actions: (1) limit the use of overnight discount notes as a source of short-term liquidity, (2) change the time that principal and interest payments are made on consolidated obligations, (3) change cash management and liquidity management practices to increase liquid investments and early availability of cash,and/or (4) identify alternative sources, if any, of intraday private funding. These actions may reduce the ability of the Bank to provide liquidity on demand to its members.
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Loans to Members. At September 30, 2006, total loans to members were $49.7 billion, compared to $47.5 billion as of year-end 2005, representing an increase of 4.7%. The number of the Bank’s members using the Bank’s loan products continues to be high by historical measures, although it has fallen slightly since year end. Additionally, the Bank continues to see a significant concentration of the loans from its seven largest borrowers. The following table provides a distribution of the number of members, categorized by individual member asset size, that had an outstanding loan balance at September 30, 2006 and December 31, 2005.
September 30, | December 31, | |||||||
Member Asset Size | 2006 | 2005 | ||||||
Less than $100 million | 53 | 61 | ||||||
Between $100 and $500 million | 136 | 140 | ||||||
Between $500 million and $1 billion | 43 | 39 | ||||||
Between $1 and $5 billion | 25 | 28 | ||||||
Greater than $5 billion | 13 | 12 | ||||||
Total borrowing members | 270 | 280 | ||||||
Total membership | 333 | 334 | ||||||
Percent of members borrowing | 81.1 | % | 83.8 | % | ||||
Typically, the Bank’s members tend to rely on the Bank for their funding requirements in rising interest rate environments. Potentially, this allows the members to delay the increase in competition and higher rates required to grow deposits. In addition, some members have been opportunistically funding their balance sheets. However, as noted in the net interest income discussion, the rise in short-term interest rates has made overnight Federal funds and other sources of overnight funding more attractive to the Bank’s members than Bank overnight loans. The growth of this portfolio is also impacted by the following: (1) the new consolidated obligation repayment funding requirement, discussed in Item 2. Financial Condition, which has put pressure on the Bank’s overnight cost of funds; (2) the slowing housing market; and (3) the Finance Board’s proposed retained earnings rule, discussed in Item 2. Financial Condition, which would limit the Bank’s ability to declare dividends. These factors result in additional pressure on the Bank’s ability to grow the loans to members portfolio.
Mortgage Loans Held for Portfolio. Mortgage loan balances have declined $465.1 million, totaling $7.2 billion at September 30, 2006, compared to $7.7 billion at December 31, 2005. This decrease is primarily due to a reduction in the availability of mortgages to be purchased from members and the run-off of the existing portfolio. Based on MPF Program total dollar volume purchased from participating members, National City Bank, as successor by merger to National City Bank of Pennsylvania, represented 85.3% and 85.2% of the volume purchased for the three and nine months ended September 30, 2006. At September 30, 2006, National City Bank accounted for 89.8% of the par value of mortgage loans outstanding. National City Bank of Pennsylvania consolidated its membership in another FHLBank district and ceased to be a member of the Bank as of July 22, 2006.
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Loan Portfolio Analysis. The Bank’s outstanding loans, nonaccrual loans and loans 90 days or more past due and accruing interest are as presented in the following table.
September 30, | December 31, | |||||||
(in thousands) | 2006 | 2005 | ||||||
Loans to members | $ | 49,730,817 | $ | 47,492,959 | ||||
Mortgage loans held for portfolio, net(1) | 7,186,803 | 7,651,914 | ||||||
Nonaccrual mortgage loans, net | 18,826 | 19,451 | ||||||
Mortgage loans past due 90 days or more and still accruing interest(2) | 15,072 | 21,018 | ||||||
Banking on Business (BOB) loans, net(3) | 11,125 | 10,653 | ||||||
Notes:
(1) | All of the real estate mortgages held in portfolio by the Bank are fixed-rate. Balances are reflected net of allowance for credit losses. |
(2) | Government-insured loans (e.g., FHA, VA) continue to accrue after 90 days or more delinquent. |
(3) | Due to the nature of the program, all Banking on Business loans are considered nonaccrual loans. Balances are reflected net of allowance for credit losses. |
Allowance for Credit Losses. The allowance for credit losses is evaluated on a quarterly basis by management to identify the losses inherent within the portfolio and to determine the likelihood of collectibility. The allowance methodology determines an estimated probable loss for the impairment of the mortgage loan portfolio consistent with the provisions of Statement of Financial Accounting Standards No. 5,Accounting for Contingencies. The Bank has not incurred any losses on loans to members since inception. Due to the collateral held as security and the repayment history for member loans, management believes that an allowance for credit losses for member loans is unnecessary.
The Bank purchases government-insured FHA and VA residential mortgage loans and conventional fixed-rate residential mortgage loans. Because the credit risk on the government-insured loans is predominantly assumed by the FHA and VA, only conventional mortgage loans are evaluated for an allowance for credit losses. The Bank’s conventional mortgage loan portfolio is comprised of large groups of smaller-balance homogeneous loans made to consumers that are secured by residential real estate. A mortgage loan is considered impaired when it is probable that all contractual principal and interest payments will not be collected as scheduled in the loan agreement based on current information and events. The Bank collectively evaluates the homogeneous mortgage loan portfolio for impairment and is therefore excluded from the scope of Statement of Financial Accounting Standards No. 114,Accounting by Creditors for Impairment of a Loan. Mortgage loans are generally identified as impaired when they become 90 days or more delinquent, at which time the loans are placed on nonaccrual status. The Bank records cash payments received on nonaccrual loans as a reduction of principal. Charge-offs against the allowance for credit losses are recorded when title to the collateral is received in the foreclosure process. Subsequent recoveries, if any, are credited to the allowance. At September 30, 2006 and December 31, 2005, the allowance for credit losses on the mortgage loans held for portfolio was $584 thousand and $657 thousand, respectively.
The allowance for credit losses for the BOB program is based on Small Business Administration (SBA) loan loss statistics, which provide a reasonable estimate of losses inherent in the BOB portfolio based on the portfolio’s characteristics. Both probability of default and loss given default are determined and used to estimate the allowance for credit losses. Loss given default is considered to be 100% due to the fact that the BOB program has no collateral or credit enhancement requirements. All of the loans in the BOB program are classified as nonaccrual loans. At September 30, 2006 and December 31, 2005, the allowance for credit losses on the BOB loans was $5.9 million and $4.9 million, respectively.
Interest-bearing Deposits and Federal Funds Sold. At September 30, 2006, these short-term investments totaled $8.0 billion, an increase of $2.4 billion, or 43.0%, from the December 31, 2005 balance. In order to be able to comply with the new consolidated obligation repayment funding requirement discussed above, the Bank has continued to increase its short-term liquidity position.
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Investment Securities. The $1.1 billion, or 9.4%, increase in investment securities from December 31, 2005 to September 30, 2006 was primarily due to increases inheld-to-maturity mortgage-backed securities (MBS) and U.S. government-sponsored enterprises partially offset by a decrease inavailable-for-sale MBS. The MBS investments are collateralized and provide a return that can significantly exceed the return on other types of investments. However, the amount that the Bank can invest in MBS is limited by regulation to 300% of capital at the time of acquisition. The following tables summarize key investment securities portfolio statistics.
September 30, | December 31, | |||||||
(in thousands) | 2006 | 2005 | ||||||
Available-for-sale securities: | ||||||||
Equity mutual funds | $ | 5,053 | $ | 4,773 | ||||
Mortgage-backed securities | 81,864 | 326,524 | ||||||
Totalavailable-for-sale securities | $ | 86,917 | $ | 331,297 | ||||
Held-to-maturity securities: | ||||||||
Commercial paper | $ | 352,325 | $ | 149,405 | ||||
State or local housing agency obligations | 795,766 | 815,533 | ||||||
Other U.S. obligations | - | 3,663 | ||||||
U.S. government-sponsored enterprises | 940,603 | 556,260 | ||||||
Mortgage-backed securities | 10,258,423 | 9,509,769 | ||||||
Totalheld-to-maturity securities | $ | 12,347,117 | $ | 11,034,630 | ||||
As of September 30, 2006, investment securities had the following maturity and yield characteristics.
Book | Yield | |||||||
(dollars in thousands) | Value | (%) | ||||||
Available-for-sale securities: | ||||||||
Equity mutual funds | $ | 5,053 | n/a | |||||
Mortgage-backed securities | 81,864 | 5.87 | ||||||
Totalavailable-for-sale securities | $ | 86,917 | 5.87 | |||||
Held-to-maturity securities: | ||||||||
Commercial paper due within one year | $ | 352,325 | 5.41 | |||||
State or local housing agency obligations: | ||||||||
After one but within five years | 372,216 | 5.84 | ||||||
After five but within ten years | 27,050 | 4.91 | ||||||
After ten years | 396,500 | 5.61 | ||||||
Total state or local housing agency obligations | 795,766 | 5.70 | ||||||
U.S. government-sponsored enterprises: | ||||||||
After one but within five years | 800,000 | 5.12 | ||||||
After five but within ten years | 140,603 | 4.17 | ||||||
Total U.S. government-sponsored enterprises | 940,603 | 5.00 | ||||||
Mortgage-backed securities | 10,258,423 | 4.59 | ||||||
Totalheld-to-maturity securities | $ | 12,347,117 | 4.71 | |||||
As of September 30, 2006, theheld-to-maturity securities portfolio included unrealized losses of $224.5 million, which are considered temporary. The basis for determination that these declines in fair value are temporary is explained in detail in Note 5 of the unaudited financial statements.
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As of September 30, 2006, the Bank held securities from the following issuers with a book value greater than 10% of Bank total capital.
Total | Total | |||||||
(in thousands) | Book Value | Fair Value | ||||||
Federal Home Loan Mortgage Corporation | $ | 1,507,058 | $ | 1,481,063 | ||||
Federal National Mortgage Association | 1,111,322 | 1,077,504 | ||||||
J.P. Morgan Mortgage Trust | 1,177,020 | 1,171,220 | ||||||
Wells Fargo Mortgage Backed Securities Trust | 944,201 | 931,470 | ||||||
Countrywide Home Loans | 641,793 | 627,368 | ||||||
Structured Adjustable Rate Mortgage Loan Trust | 587,727 | 584,250 | ||||||
Citigroup Mortgage Loan Trust | 420,627 | 416,618 | ||||||
Washington Mutual | 377,047 | 364,031 | ||||||
Structured Asset Securities Corporation | 488,656 | 473,688 | ||||||
Bear Stearns Adjustable Rate Mortgages | 407,513 | 402,155 | ||||||
Total | $ | 7,662,964 | $ | 7,529,367 | ||||
Deposits. At September 30, 2006, time deposits in denominations of $100,000 or more totaled $3.9 million. The table below presents the maturities for time deposits in denominations of $100,000 or more.
Over 3 months | Over 6 months | |||||||||||||||
(in thousands) | 3 months | but within | but within | |||||||||||||
By Remaining Maturity at September 30, 2006 | or less | 6 months | 12 months | Total | ||||||||||||
Time certificates of deposit ($100,000 or more) | $ | 3,610 | $ | 311 | $ | - | $ | 3,921 | ||||||||
Commitment and Off-balance Sheet Items. At September 30, 2006, the Bank is obligated to fund approximately $239.8 million in additional loans to members, $8.1 million of mortgage loans, $1,047.6 million in outstanding standby letters of credit, and $690.0 million in consolidated obligations. The Bank does not have any special purpose entities or any other type of off-balance sheet conduits.
Retained Earnings. The Finance Board has issued regulatory guidance to the FHLBanks relating to capital management and retained earnings. The guidance directs each FHLBank to assess, at least annually, the adequacy of its retained earnings with consideration given to future possible financial and economic scenarios. The guidance also outlines the considerations that each FHLBank should undertake in assessing the adequacy of the Bank’s retained earnings.
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At September 30, 2006, Bank retained earnings stood at $238.0 million, representing an increase of $49.5 million, or 26.3%, over December 31, 2005. The Bank has exceeded its longer-term retained earnings target of $200 million. Prior to reaching the retained earnings target, the Bank paid out less than 100% of net income in dividends. Any future dividend payments are subject to the approval of the Board of Directors. The retained earnings target has not been established as a static figure; it is subject to modification as conditions warrant and, as a matter of policy, the Bank’s Board of Directors continues to evaluate this target in light of prevailing conditions. On March 8, 2006, the Finance Board published a proposed rule, “Excess Stock Restrictions and Retained Earnings Requirements for the Federal Home Loan Banks.” This proposal would limit the issuance or maintenance of excess stock by FHLBanks. Excess stock is defined as the amount of capital stock greater than the members’ minimum capital stock requirements. Moreover, the proposed rule would increase each FHLBank’s minimum retained earnings requirement to $50 million plus 1.0% of a FHLBank’s non-member loan assets. The retained earnings proposal states that FHLBanks that do not meet the minimum retained earnings requirement will be limited in their ability to declare dividends. It is unclear whether the proposal will be adopted in its current form. The Bank has studied the proposal and has provided comments to the Finance Board on its potential impact to the Bank’s members. The following table summarizes the change in retained earnings.
Nine months ended | ||||||||
September 30, | ||||||||
(in thousands) | 2006 | 2005 | ||||||
Balance, beginning of period | $ | 188,479 | $ | 77,190 | ||||
Net income | 158,334 | 145,369 | ||||||
Dividends | (108,836 | ) | (56,420 | ) | ||||
Balance, end of period | $ | 237,977 | $ | 166,139 | ||||
Payout ratio (dividends/net income) | 68.7% | 38.8% | ||||||
Operating Segment Results
The following is management’s discussion and analysis of the Bank’s operating segment results for the three and nine months ended September 30, 2006. This discussion should be read in conjunction with the unaudited financial statements and notes included in this report.
The Bank operates two segments differentiated by products. The first segment entitled Traditional Member Finance encompasses a majority of the Bank’s activities, including, but not limited to, providing loans to members; investments; and deposit products. The second segment, the MPF Program or Mortgage Finance, purchases loans from members and funds and hedges the resulting portfolio.
Results of segments are presented based on management accounting practices and the Bank’s management structure. There is no comprehensive, authoritative body of guidance for management accounting equivalent to Generally Accepted Accounting Principles. Therefore, the financial results of the segments are not necessarily comparable with similar information at other banks or any other company.
The management accounting process uses various balance sheet and income statement assignments and transfers to measure performance of the segment. Methodologies are refined from time to time as management accounting practices change. Borrowings are allocated to the Mortgage Finance segment based on loans outstanding. All remaining borrowings, noninterest-bearing liabilities and all capital remain in the Traditional Member Finance business. The allowance for credit losses pertaining to mortgage loans held for portfolio is allocated to the Mortgage Finance segment and the allowance for credit losses pertaining to BOB loans is allocated to Traditional Member Finance. Derivatives are allocated to segments consistent with hedging strategies. Cost incurred by support areas not directly aligned with the segment are allocated based on estimated usage of services.
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The following tables set forth the Bank’s financial performance by operating segment for the three months and nine months ended September 30, 2006 and 2005, respectively.
Three months ended September 30,
Traditional | MPF Program or | |||||||||||
Member | Mortgage | |||||||||||
(in thousands) | Finance | Finance | Total | |||||||||
2006 | ||||||||||||
Net interest income | $ | 83,255 | $ | 6,529 | $ | 89,784 | ||||||
Provision (benefit) for credit losses | 605 | (96 | ) | 509 | ||||||||
Other income (loss) | 4,923 | (4,705 | ) | 218 | ||||||||
Other expense | 13,757 | 1,224 | 14,981 | |||||||||
Income before assessments | 73,816 | 696 | 74,512 | |||||||||
Affordable Housing Program | 6,085 | 57 | 6,142 | |||||||||
REFCORP | 13,548 | 128 | 13,676 | |||||||||
Total assessments | 19,633 | 185 | 19,818 | |||||||||
Net income | $ | 54,183 | $ | 511 | $ | 54,694 | ||||||
Total assets | $ | 71,153,429 | $ | 7,186,803 | $ | 78,340,232 | ||||||
2005 | ||||||||||||
Net interest income | $ | 64,607 | $ | 13,290 | $ | 77,897 | ||||||
Provision (benefit) for credit losses | (207 | ) | 105 | (102 | ) | |||||||
Other income (loss) | (10,389 | ) | 34,625 | 24,236 | ||||||||
Other expense | 12,616 | 988 | 13,604 | |||||||||
Income before assessments | 41,809 | 46,822 | 88,631 | |||||||||
Affordable Housing Program | 3,429 | 3,822 | 7,251 | |||||||||
REFCORP | 7,676 | 8,600 | 16,276 | |||||||||
Total assessments | 11,105 | 12,422 | 23,527 | |||||||||
Net income | $ | 30,704 | $ | 34,400 | $ | 65,104 | ||||||
Total assets | $ | 63,894,795 | $ | 7,976,066 | $ | 71,870,861 | ||||||
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Nine months ended September 30,
Traditional | MPF Program or | |||||||||||
Member | Mortgage | |||||||||||
(in thousands) | Finance | Finance | Total | |||||||||
2006 | ||||||||||||
Net interest income | $ | 232,492 | $ | 22,516 | $ | 255,008 | ||||||
Provision (benefit) for credit losses | 1,359 | (234 | ) | 1,125 | ||||||||
Other income (loss) | 13,201 | (4,657 | ) | 8,544 | ||||||||
Other expense | 43,249 | 3,563 | 46,812 | |||||||||
Income before assessments | 201,085 | 14,530 | 215,615 | |||||||||
Affordable Housing Program | 16,509 | 1,186 | 17,695 | |||||||||
REFCORP | 36,917 | 2,669 | 39,586 | |||||||||
Total assessments | 53,426 | 3,855 | 57,281 | |||||||||
Net income | $ | 147,659 | $ | 10,675 | $ | 158,334 | ||||||
Total assets | $ | 71,153,429 | $ | 7,186,803 | $ | 78,340,232 | ||||||
2005 | ||||||||||||
Net interest income | $ | 165,403 | $ | 67,021 | $ | 232,424 | ||||||
Provision for credit losses | 459 | 373 | 832 | |||||||||
Other income (loss) | 9,063 | (3,525 | ) | 5,538 | ||||||||
Other expense | 36,480 | 2,740 | 39,220 | |||||||||
Income before assessments | 137,527 | 60,383 | 197,910 | |||||||||
Affordable Housing Program | 11,270 | 4,929 | 16,199 | |||||||||
REFCORP | 25,251 | 11,091 | 36,342 | |||||||||
Total assessments | 36,521 | 16,020 | 52,541 | |||||||||
Net income | $ | 101,006 | $ | 44,363 | $ | 145,369 | ||||||
Total assets | $ | 63,894,795 | $ | 7,976,066 | $ | 71,870,861 | ||||||
Results of Operations. Third quarter 2006 net income decreased to $54.7 million, down $10.4 million from $65.1 million in third quarter 2005. This decrease was driven by a $33.9 million decrease in the net income of the Mortgage Finance segment, which more than offset a $23.5 million increase in the Traditional Member Finance segment net income.
Net income for the nine months ended September 30, 2006 increased to $158.3 million, up $12.9 million from $145.4 million in the same year-ago period. This increase was driven by a $46.6 million increase in the net income of the Traditional Member Finance segment, partially offset by a $33.7 million decrease in the net income of the Mortgage Finance segment.
Traditional Member Finance Segment. The $23.5 million increase in third quarter 2006 net income in the Traditional Member Finance segment, from $30.7 million in third quarter 2005 to $54.2 million, was primarily due to a $18.6 million increase in net interest income as well as other income of $4.9 million in the current quarter, compared with other losses of $10.4 million in the prior year period.
For the nine months ended September 30, 2006, net income increased $46.6 million, from $101.0 million in the prior year to $147.6 million in the current year. This increase was primarily due to a $67.1 million increase in net interest income, partially offset by a $6.8 million increase in other expenses.
The increase in net interest income in both comparisons was due to both growth in total interest-earning assets, primarily short-term investments, and the impact of a rising rate environment. The increase in other income in both comparisons was due in part to fluctuations in the fair value hedge ineffectiveness on the loans to members and consolidated obligations portfolios.
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Mortgage Finance Segment. Net income decreased $33.9 million in the third quarter of 2006 in the Mortgage Finance segment, from $34.4 million in third quarter 2005 to $511 thousand in the current period. This decline was primarily due to net derivatives and hedging losses included in the current quarter other loss of $4.7 million, compared with net gains included in other income of $34.6 million in the prior year quarter, due to changes in hedging strategies discussed below, as well as a $6.8 million decrease in net interest income.
For the nine months ended September 30, 2006, net income decreased $33.7 million, from $44.4 million in the prior year to $10.7 million in the current year. This decrease was primarily due to lower net interest income, which decreased from $67.0 million in 2005 to $22.5 million in 2006, and was attributable to the use ofindex-amortizing swaps as discussed below.
The decrease in net interest income in both comparisons was due primarily to a change in the hedging strategies of the portfolio discussed in more detail below, and to a lesser extent the continued run-off of the mortgage loan portfolio.
In 2005,index-amortizing swaps were used to economically hedge the fair value of mortgage loans held for portfolio. Included in other income (loss) was a net increase in fair value of theindex-amortizing swaps for the third quarter and the nine months ended September 30, 2005 of $30.0 million and $43.5 million, respectively. In addition, net interest expense on these economic hedges of $8.1 million and $44.6 million, respectively, for the third quarter and nine months ended September 30, 2005 was booked to other income (loss). These swaps were terminated in 2005 and funding of these mortgage loans for 2006 was accomplished primarily via amortizing debt issuances. The interest expense on this debt in 2006 was reflected in net interest income.
Capital Resources
The following is management’s discussion and analysis of the Bank’s capital resources as of September 30, 2006. This discussion should be read in conjunction with the unaudited interim financial statements and notes included in this report.
Liquidity and Funding. Please refer to the discussion on the Bank’s liquidity and funding risk in Item 2. Risk Management — Liquidity and Funding Risk.
Risk-Based Capital (RBC)
The Bank became subject to the Finance Board’s Risk-Based Capital (RBC) regulations upon implementation of its capital plan on December 16, 2002. This regulatory framework requires the Bank to maintain sufficient permanent capital, defined as retained earnings plus capital stock, to meet its combined credit risk, market risk and operational risk. Each of these components is computed as specified in directives issued by the Finance Board.
September 30, | December 31, | |||||||
(in thousands) | 2006 | 2005 | ||||||
Permanent capital: | ||||||||
Capital stock(1) | $ | 3,452,738 | $ | 3,095,314 | ||||
Retained earnings | 237,977 | 188,479 | ||||||
Total permanent capital | $ | 3,690,715 | $ | 3,283,793 | ||||
Risk-based capital requirement: | ||||||||
Credit risk capital | $ | 191,340 | $ | 179,986 | ||||
Market risk capital | 214,447 | 204,080 | ||||||
Operations risk capital | 121,736 | 115,220 | ||||||
Total risk-based capital | $ | 527,523 | $ | 499,286 | ||||
Note:
(1) | Capital stock includes mandatorily redeemable capital stock. |
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The Bank held excess permanent capital over RBC requirements of $3.2 billion and $2.8 billion at September 30, 2006 and December 31, 2005, respectively.
Capital and Leverage Ratios
In addition to the requirements for RBC, the Finance Board has mandated maintenance of certain capital and leverage ratios. The Bank must maintain total capital and leverage ratios of at least 4.0% and 5.0% of total assets, respectively. Management has an ongoing program to measure and monitor compliance with the ratio requirements. As a matter of policy, the Board of Directors has established an operating range for capitalization that calls for the capital ratio to be maintained between 4.08% and 5.0%. To enhance overall returns, it has been the Bank’s practice to utilize as much leverage as permitted within this operating range when market conditions permit, while maintaining compliance with statutory, regulatory and Bank policy limits.
September 30, | December 31, | |||||||
(dollars in thousands) | 2006 | 2005 | ||||||
Capital Ratio | ||||||||
Minimum capital (4.0% of total assets) | $ | 3,133,609 | $ | 2,915,950 | ||||
Actual capital (permanent capital plus loan loss reserves) | 3,697,221 | 3,289,318 | ||||||
Total assets | 78,340,232 | 72,898,211 | ||||||
Capital ratio (actual capital as a percent of total assets) | 4.7 | % | 4.5 | % | ||||
Leverage Ratio | ||||||||
Minimum leverage capital (5.0% of total assets) | $ | 3,917,012 | $ | 3,644,911 | ||||
Leverage capital (permanent capital multiplied by a 1.5 weighting factor plus loan loss reserves) | 5,542,579 | 4,931,216 | ||||||
Leverage ratio (leverage capital as a percent of total assets) | 7.1 | % | 6.8 | % |
The Bank’s capital ratio increased modestly from 4.5% at December 31, 2005, to 4.7% at September 30, 2006. Under the Bank’s capital plan, overall capital stock levels are tied to both the level of member borrowings and unused borrowing capacity. Therefore, the Bank’s capital ratios often fluctuate in response to changes in member borrowing activity and unused capacity.
Management reviews, on a routine basis, projections of capital leverage that incorporate anticipated changes in assets, liabilities, and capital stock levels as a tool to manage overall balance sheet leverage within the Board’s operating range. In connection with this review, when management believes that adjustments to the current member stock purchase requirements within the ranges established in the capital plan are warranted, a recommendation is presented for Board consideration. The member stock purchase requirements have been adjusted multiple times since the implementation of the capital plan in December 2002, and management expects that future adjustments are likely in response to future changes in borrowing activity.
As of September 30, 2006 and December 31, 2005, excess capital stock available for repurchase at a member’s request and at the Bank’s discretion totaled $105.9 million and $85.0 million, respectively. The Bank actively repurchases the excess capital stock of its members. The Bank does not honor other repurchase requests where the capital stock subject to the request is required to meet a member’s minimum capital stock purchase requirement.
Management believes that based on the Bank’s business profile, balance sheet composition and various potential economic scenarios, the current capital and leverage ratios are adequate to ensure the safe and sound operation of the Bank.
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Risk Management
Risk Governance
The Bank’s lending, investment and funding activities and its use of derivative hedging instruments expose the Bank to a number of risks, including the following: market and interest rate risk, credit risk, liquidity and funding risk and other risks, such as operating risk and business risk.
The Bank’s Board of Directors has the responsibility to set broad risk governance philosophy and framework as well as oversee the Bank’s risk management process. The Board and its committees have adopted a comprehensive risk governance structure to manage the Bank’s risk exposures. Under this structure, the Finance and Risk Management Committee of the Board has responsibility to focus on balance sheet management and all risk management issues. The Audit Committee has responsibility for monitoring certain operating and business risks. The Board has also established a risk governance policy to comply with and supplement Finance Board requirements. The Finance Board conducts an annual onsite examination of the Bank, as well as periodic offsite evaluations, and also requires the Bank to submit periodic compliance reports. Additionally, the Bank conducts a Bank-wide risk self-assessment which is reviewed and approved annually by the Board.
In order to implement the risk management framework and provide effective oversight for risk management strategies, policies and action plans, executive management has created a reporting structure implemented by six management risk committees. The Risk Management Committee is responsible for general risk management oversight, business risks and the Bank-wide risk self-assessment. The Asset/Liability Committee (ALCO) focuses on financial management issues and is responsible for planning, organizing, developing, directing and executing the financial risk management process within Board-approved parameters. To provide effective oversight for credit risk management, the Credit Risk Committee oversees the Bank’s credit policies, procedures, positions and underwriting standards as well as decisions relating to extension and denials of credit and the adequacy of the allowance for credit losses. The Operating Risk Committee (ORC) is responsible for oversight of the Bank’s operating risks. Finally, the Technology and Project Steering Committee (TAPS) and Disclosure Committee are responsible for specific operating risks, notably technology risk and financial and accounting disclosure risk, respectively.
The Bank’s registration statement on Form 10, as amended, for the year ended December 31, 2005, filed on June 9, 2006, and effective as of August 8, 2006, provides information as to the types of policies, processes, instruments and measures used by the Bank to manage risk. For information regarding the Bank’s use of, and accounting policies for, derivative hedging instruments, see Note 10 to the unaudited financial statements included in this report. Additionally, see the Capital Resources section above for further information regarding the Bank’s risk-based capital and regulatory capital ratios. The following sections provide summary information on each of the Bank’s main risks listed above. As of September 30, 2006, there were no material changes in the Bank’s risk exposures since December 31, 2005.
Market and Interest Rate Risk
Market risk is defined as the risk of loss arising from adverse changes in market rates and prices, such as interest rates, and other relevant market rate or price changes, such as basis changes. Interest rate risk is the risk that relative and absolute changes in prevailing market interest rates may adversely affect an institution’s financial performance or condition. The goal of an interest rate risk management strategy is not necessarily to eliminate interest rate risk, but to manage it by setting and operating within appropriate limits. The Bank’s general approach toward managing interest rate risk is to acquire and maintain a portfolio of assets, liabilities and hedges, which, taken together, limit the Bank’s expected exposure to market and interest rate risk. Management regularly monitors the Bank’s sensitivity to interest rate changes. Multiple methodologies are used to calculate the Bank’s potential exposure to these changes. These methodologies include measuring repricing gaps, duration and convexity under assumed changes in interest rates, the shape of the yield curve and market volatility as implied in currently observable market prices. Interest rate exposure is managed by the use of appropriate funding instruments and by employing hedging strategies. Hedging may occur for a single transaction or group of transactions as well as for the overall portfolio. The Bank’s hedge positions are evaluated regularly and are adjusted as deemed necessary by management.
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The Bank uses an externally developed model to perform its interest rate risk and market valuation modeling. This model, its approach and the underlying assumptions were subject to Finance Board review and approval prior to its implementation. Duration of equity and market value of equity volatility measurements are currently the primary tools used by the Bank to manage its interest rate risk exposure. Although since implementing its capital plan the Bank is no longer required by Finance Board regulation to operate within a specified duration of equity limit, the Bank’s policies specify acceptable ranges for duration of equity, and the Bank’s exposures are measured and managed against these limits. The Bank’s asset/liability management policy approved by the Board of Directors calls for duration of equity to be maintained within a ±4.5 year range in the base case and within ±7 years in an instantaneous parallel interest rate shock of ±200 basis points. Further, the Board has established a policy limit that the market value of equity should decline by no more than five percent given a hypothetical ±100 basis point instantaneous parallel change in interest rates. Management analyzes the duration of equity and market value of equity exposures against these policy limits on a daily basis. The Bank was in compliance with all of these limits throughout the nine months ended September 30, 2006.
Credit Risk
Credit risk is the risk that the market value of an obligation will decline as a result of deterioration in the obligor’s creditworthiness. Credit risk arises when Bank funds are extended, committed, invested or otherwise exposed through actual or implied contractual agreements. The financial condition of Bank members and all investment, mortgage loan and derivative counterparties is monitored to ensure that the Bank’s financial exposure to each member and counterparty is in compliance with the Bank’s credit policies and Finance Board regulations. Financial monitoring reports evaluating each member and counterparty’s financial condition are produced and reviewed by the Bank’s Credit Risk Committee on an annual basis, or more often if circumstances warrant.
The Bank protects against credit risk on loans to members by monitoring the financial condition of borrowers and by requiring borrowers or their affiliates to pledge sufficient eligible collateral for all loans. In addition, the Bank has the ability to call for additional or substitute collateral during the life of a loan to protect its security interest. The Bank’s member loan portfolio is concentrated in commercial banks and thrift institutions. At September 30, 2006, the Bank had a concentration of loans to its ten largest borrowers totaling $38.0 billion, or 76.3% of total loans outstanding, an increase from $32.8 billion or 69.1% as of December 31, 2005. As of September 30, 2006, and December 31, 2005, the Bank’s top borrower, Sovereign Bank, held loans totaling $18.1 billion and $13.1 billion, respectively, which represented 36.4% and 27.6% of the total loan portfolio. The Bank has implemented special credit and collateral review procedures for loans to its top borrowers. Management believes that it has access to eligible collateral under written security agreements in which the member agrees to hold such collateral for the benefit of the Bank significantly in excess of outstanding loan balances. Therefore, the Bank has not established an allowance for credit losses on loans to members.
In addition to loans to members, the Bank is also subject to credit risk on investments, mortgage loans, BOB loans, derivatives and off-balance sheet arrangements and guarantees as described below. None of the Bank’s credit risk policy parameters have materially changed since December 31, 2005. Further information regarding nonaccrual loan balances and related allowances, including delinquency ratios and a roll-forward of the Bank’s allowance for credit losses, is provided in the Bank’s registration statement on Form 10, as amended. Substantially all of the Bank’s credit losses occur in the BOB program.
The Bank is subject to credit risk on investments consisting primarily of money market investments and investment securities. The Bank places money market investments on an unsecured basis with large, high-quality financial institutions with long-term credit ratings of triple-A and double-A for terms up to nine months, with credit ratings of single-A for terms up to 90 days and with credit ratings of triple-B for terms up to 30 days. Most money market investments mature within 90 days. Management actively monitors the credit quality of these investment counterparties. The Bank also invests in and is subject to credit risk related to MBS that are directly supported by underlying mortgage loans. Investments in private label MBS are permitted as long as they are rated triple-A at the time of purchase.
The Bank has established a mortgage loan purchase program as a service to members where the Bank acquires mortgage loans from members under a shared credit risk structure, including the necessary external credit
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enhancement, which give them the approximate equivalent of a double-A credit rating. The mortgage loan program uses insurance companies to provide both primary and supplemental mortgage insurance. All insurance providers must have a credit rating of double-A or better. For the full year 2005 and first half of 2006, National City Bank of Pennsylvania accounted for 88% and 85%, respectively, of the volume of mortgage loans purchased by the Bank. On July 21, 2006, National City Bank consolidated all of its bank charters into its existing Ohio charter and as of July 22, 2006, National City Bank of Pennsylvania ceased to be a member of the Bank.
Members may also participate in the BOB loan program, which is targeted to small businesses in the Bank’s district. The program’s objective is to assist in the growth and development of small businesses, including both thestart-up and expansion of these businesses. The BOB program is an unsecured loan program and the outstanding loan balance is classified as nonaccrual due to doubt regarding the ultimate collection of the contractual principal and interest of the loan.
Finally, the Bank is subject to credit risk arising from the potential nonperformance by derivative counterparties with respect to the agreements entered into with the Bank, as well as certain operational risks related to the management of the derivative portfolio. Unsecured credit exposure to any counterparty is limited by the credit quality and capital level of the counterparty and by the capital level of the Bank. Derivative counterparty credit risk is managed through the combined use of credit analysis, collateral management and other risk mitigation techniques. The Bank requires collateral agreements on derivative financial instrument contracts. The extent to which the Bank is exposed to counterparty risk on derivatives is partially mitigated through the use of netting procedures contained in the Bank’s master agreement contracts with counterparties. All derivative counterpartiesand/or guarantors are rated at least single-A.
Liquidity and Funding Risk
The Bank is required to maintain liquidity in accordance with certain Finance Board regulations and with policies established by management and the Board of Directors. The Bank needs liquidity to satisfy member demand for short- and long-term funds, repay maturing consolidated obligations and meet other obligations. The Bank also maintains liquidity to repurchase excess capital stock at its discretion and upon the request of a member. Further, the Finance Board and the Bank’s funds management policy require the Bank to hold contingency liquidity sufficient to meet the Bank’s needs for a minimum of five business days without access to the consolidated obligation debt markets. The Bank’s sources of contingency liquidity include maturing overnight and short-term investments, maturing loans to members, securities available for repurchase agreements,available-for-sale securities maturing in one year or less and MBS repayments. Uses of contingency liquidity include net settlements of consolidated obligations, member loan commitments, mortgage loan purchase commitments, deposit outflows and maturing other borrowed funds. As of September 30, 2006, the Bank was in compliance with all Board and regulatory requirements.
In response to the Federal Reserve’s Policy Statement on Payments System Risk which became effective on July 20, 2006, the Bank has implemented various changes to its cash and liquidity management practices, including maintaining a high level of short-term money market investments. At September 30, 2006, money market investments consisting of interest-bearing deposits and Federal funds sold, totaled $8.0 billion, an increase of 42.9% from $5.6 billion at December 31, 2005.
In October 2003, Standard & Poor’s issued a report placing the Bank on “negative outlook” for possible future downgrade, while retaining the Bank’s triple-A counterparty credit rating. The outlook change and rating affirmation reflected the change in the Bank’s business profile of increased mortgage loan balances and their impact on interest rate risk exposure. In August 2005, Standard & Poor’s reaffirmed the Bank’s credit ratings. On September 21, 2006, Standard & Poor’s issued a report which revised its outlook on the Bank to “stable” from “negative” and reaffirmed the Bank’s triple-A counterparty credit rating. In revising the Bank’s outlook, the report cited progress in following a traditional low-risk member loan business profile and an increase in retained earnings to counter incremental risks and accounting volatility.
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Other Risks
The Bank is subject to other risks such as operating risk and business risk. Various operating risks are managed by the Bank’s ORC, TAPS and Disclosure Committees and are defined as the risk of unexpected loss resulting from human error, systems malfunctions, man-made or natural disasters, fraud, or circumvention or failure of internal controls. The Bank has established financial and operating policies and procedures and insurance coverage is in force, to mitigate the potential for material losses from such occurrences. The Bank’s Internal Audit department, which reports directly to the Audit Committee of the Board, as well as the Corporate Risk Management department regularly monitor compliance with established policies and procedures. In addition, the Bank has a business continuity plan that is designed to maintain critical business processes and systems in the event of a disaster or business disruption.
Business risk is defined as the risk of an adverse impact on the Bank’s profitability or financial or business strategies resulting from external factors that may occur in the short termand/or long term. The Risk Management Committee continually monitors economic indicators and the external environment in which the Bank operates and attempts to mitigate this risk through long-term strategic planning.
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Item 1: Financial Statements
Unaudited Financial Statements for the Three Months and Nine Months ended September 30, 2006 and 2005
Federal Home Loan Bank of Pittsburgh
Statement of Operations(unaudited)
For the three months | For the nine months | |||||||||||||||
ended September 30, | ended September 30, | |||||||||||||||
(in thousands, except per share amounts) | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Interest income | ||||||||||||||||
Loans to members | $ | 644,996 | $ | 421,491 | $ | 1,761,317 | $ | 1,019,083 | ||||||||
Prepayment fees on loans to members, net | 66 | 339 | 258 | 1,785 | ||||||||||||
Interest-bearing deposits | 48,492 | 20,271 | 129,696 | 31,060 | ||||||||||||
Federal funds sold | 67,407 | 15,765 | 150,657 | 37,412 | ||||||||||||
Investment securities | 144,462 | 101,230 | 402,905 | 287,343 | ||||||||||||
Mortgage loans held for portfolio | 92,485 | 96,738 | 281,431 | 306,040 | ||||||||||||
Total interest income | 997,908 | 655,834 | 2,726,264 | 1,682,723 | ||||||||||||
Interest expense | ||||||||||||||||
Consolidated obligation bonds | 713,477 | 410,250 | 1,990,277 | 1,063,622 | ||||||||||||
Consolidated obligation discount notes | 179,070 | 159,285 | 437,415 | 362,729 | ||||||||||||
Deposits | 14,508 | 7,862 | 42,065 | 21,078 | ||||||||||||
Mandatorily redeemable capital stock | 483 | 153 | 824 | 421 | ||||||||||||
Other borrowings | 586 | 387 | 675 | 2,449 | ||||||||||||
Total interest expense | 908,124 | 577,937 | 2,471,256 | 1,450,299 | ||||||||||||
Net interest income before provision (benefit) for credit losses | 89,784 | 77,897 | 255,008 | 232,424 | ||||||||||||
Provision (benefit) for credit losses | 509 | (102 | ) | 1,125 | 832 | |||||||||||
Net interest income after provision (benefit) for credit losses | 89,275 | 77,999 | 253,883 | 231,592 | ||||||||||||
Other income (loss) | ||||||||||||||||
Service fees | 1,077 | 967 | 3,390 | 2,881 | ||||||||||||
Net loss on sale of trading securities | - | - | - | (999 | ) | |||||||||||
Net gain (loss) on derivatives and hedging activities | (1,510 | ) | 24,334 | 3,519 | 4,478 | |||||||||||
Other, net | 651 | (1,065 | ) | 1,635 | (822 | ) | ||||||||||
Total other income (loss) | 218 | 24,236 | 8,544 | 5,538 | ||||||||||||
Other expense | ||||||||||||||||
Salaries and benefits | 8,158 | 8,138 | 26,412 | 22,368 | ||||||||||||
Other operating expense | 5,844 | 4,409 | 17,298 | 13,520 | ||||||||||||
Finance Board and Office of Finance | 979 | 1,057 | 3,102 | 3,332 | ||||||||||||
Total other expense | 14,981 | 13,604 | 46,812 | 39,220 | ||||||||||||
Income before assessments | 74,512 | 88,631 | 215,615 | 197,910 | ||||||||||||
Affordable Housing Program | 6,142 | 7,251 | 17,695 | 16,199 | ||||||||||||
REFCORP | 13,676 | 16,276 | 39,586 | 36,342 | ||||||||||||
Total assessments | 19,818 | 23,527 | 57,281 | 52,541 | ||||||||||||
Net income | $ | 54,694 | $ | 65,104 | $ | 158,334 | $ | 145,369 | ||||||||
Earnings per share | ||||||||||||||||
Weighted average shares outstanding | 32,651 | 29,647 | 31,508 | 27,430 | ||||||||||||
Basic and diluted earnings per share | $ | 1.68 | $ | 2.20 | $ | 5.03 | $ | 5.30 | ||||||||
Dividends per share | $ | 1.30 | $ | 0.70 | $ | 3.45 | $ | 2.06 | ||||||||
The accompanying notes are an integral part of these financial statements.
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Federal Home Loan Bank of Pittsburgh
Statement of Condition(unaudited)
September 30, | December 31, | |||||||
(in thousands, except par value) | 2006 | 2005 | ||||||
ASSETS | ||||||||
Cash and due from banks | $ | 72,180 | $ | 115,370 | ||||
Interest-bearing deposits | 3,859,782 | 3,259,894 | ||||||
Federal funds sold | 4,120,000 | 2,320,000 | ||||||
Investment securities: | ||||||||
Available-for-sale securities, at fair value; amortized cost of $85,699 and $330,434, respectively (Note 4) | 86,917 | 331,297 | ||||||
Held-to-maturity securities, at amortized cost; fair value of $12,150,362 and $10,828,384, respectively (Note 5) | 12,347,117 | 11,034,630 | ||||||
Loans to members (Note 6) | 49,730,817 | 47,492,959 | ||||||
Mortgage loans held for portfolio, net of allowance for credit losses of $584 and $657, respectively (Note 7) | 7,186,803 | 7,651,914 | ||||||
Banking on Business loans, net of allowance for credit losses of $5,922 and $4,868, respectively | 11,125 | 10,653 | ||||||
Accrued interest receivable | 410,503 | 304,193 | ||||||
Premises and equipment, net of accumulated depreciation of $22,910 and $21,318, respectively | 20,699 | 14,918 | ||||||
Derivative assets (Note 10) | 438,948 | 317,033 | ||||||
Other assets | 55,341 | 45,350 | ||||||
Total assets | $ | 78,340,232 | $ | 72,898,211 | ||||
LIABILITIES AND CAPITAL | ||||||||
Liabilities | ||||||||
Deposits: | ||||||||
Interest-bearing | $ | 972,738 | $ | 1,060,605 | ||||
Noninterest-bearing | 1,787 | 2,486 | ||||||
Consolidated obligations, net: (Note 8) | ||||||||
Bonds | 56,763,725 | 53,142,937 | ||||||
Discount notes | 16,064,138 | 14,580,400 | ||||||
Total consolidated obligations, net | 72,827,863 | 67,723,337 | ||||||
Mandatorily redeemable capital stock (Note 9) | 13,472 | 16,731 | ||||||
Accrued interest payable | 571,224 | 436,214 | ||||||
Affordable Housing Program | 45,973 | 36,707 | ||||||
Payable to REFCORP | 13,675 | 14,633 | ||||||
Derivative liabilities (Note 10) | 177,856 | 278,444 | ||||||
Other liabilities | 43,075 | 69,508 | ||||||
Total liabilities | 74,667,663 | 69,638,665 | ||||||
Commitments and contingencies (Note 13) | - | - | ||||||
Capital(Note 9) | ||||||||
Capital stock — putable ($100 par value) issued and outstanding shares: | ||||||||
34,393 and 30,786 shares in 2006 and 2005, respectively | 3,439,266 | 3,078,583 | ||||||
Retained earnings | 237,977 | 188,479 | ||||||
Accumulated other comprehensive income (loss) (Note 9) | (4,674 | ) | (7,516 | ) | ||||
Total capital | 3,672,569 | 3,259,546 | ||||||
Total liabilities and capital | $ | 78,340,232 | $ | 72,898,211 | ||||
The accompanying notes are an integral part of these financial statements.
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Federal Home Loan Bank of Pittsburgh
Statement of Cash Flows(unaudited)
For the nine months ended | ||||||||
September 30, | ||||||||
(in thousands) | 2006 | 2005 | ||||||
OPERATING ACTIVITIES | ||||||||
Net income | $ | 158,334 | $ | 145,369 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation, amortization and accretion: | ||||||||
Net premiums and discounts on consolidated obligations and investments | 132,052 | 26,925 | ||||||
Net premiums and discounts on mortgage loans | 14,474 | 31,748 | ||||||
Concessions on consolidated obligation bonds | 8,429 | 9,363 | ||||||
Bank premises and equipment | 2,493 | 2,036 | ||||||
Provision for credit losses | 1,125 | 832 | ||||||
Net realized loss on trading securities | - | 999 | ||||||
Net realized loss on disposal of Bank premises and equipment | 4 | 238 | ||||||
(Gain)/loss due to change in net fair value adjustment on derivative and hedging activities | 110,432 | 314,111 | ||||||
Total adjustments | 269,009 | 386,252 | ||||||
Changes in assets and liabilities: | ||||||||
Trading securities, net of transfers | - | 88,307 | ||||||
Accrued interest receivable | (106,310 | ) | (68,370 | ) | ||||
Derivative asset net accrued interest | (122,041 | ) | (83,816 | ) | ||||
Derivative liability net accrued interest | (101,277 | ) | (312,851 | ) | ||||
Other assets | (3,305 | ) | 2,404 | |||||
Affordable Housing Program (AHP) liability and discount on AHP loans to members | 9,100 | 12,942 | ||||||
Accrued interest payable | 135,010 | 56,683 | ||||||
Payable to REFCORP | (958 | ) | 10,839 | |||||
Other liabilities | (3,075 | ) | 1,262 | |||||
Total changes in assets and liabilities | (192,856 | ) | (292,600 | ) | ||||
Net cash provided by operating activities | $ | 234,487 | $ | 239,021 | ||||
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Federal Home Loan Bank of Pittsburgh
Statement of Cash Flows (continued) (unaudited)
For the nine months ended | ||||||||
September 30, | ||||||||
(in thousands) | 2006 | 2005 | ||||||
INVESTING ACTIVITIES | ||||||||
Net change in: | ||||||||
Interest-bearing deposits | $ | (600,591 | ) | $ | (1,573,625 | ) | ||
Federal funds sold | (1,800,000 | ) | (171,000 | ) | ||||
Commercial paper | (196,310 | ) | (58,162 | ) | ||||
Deposits to other FHLBanks | 703 | 378 | ||||||
Proceeds from: | ||||||||
Maturities ofheld-to-maturity securities, except commercial paper | 1,182,161 | 1,692,256 | ||||||
Maturities ofavailable-for-sale securities | 244,748 | 225,709 | ||||||
Sale of Bank premises and equipment | 10 | 15 | ||||||
Purchases of: | ||||||||
Held-to-maturity securities, except commercial paper | (2,288,338 | ) | (2,547,810 | ) | ||||
Mortgage loans held for portfolio | (364,566 | ) | (843,697 | ) | ||||
Bank premises and equipment | (6,280 | ) | (6,205 | ) | ||||
Principal collected on members loans and BOB loans | 532,978,563 | 1,765,950,626 | ||||||
Loans made to members, including BOB loans | (535,249,666 | ) | (1,775,453,624 | ) | ||||
Principal collected on mortgage loans held for portfolio | 814,097 | 1,478,772 | ||||||
Net cash (used in) investing activities | $ | (5,285,469 | ) | $ | (11,306,367 | ) | ||
FINANCING ACTIVITIES | ||||||||
Net change in: | ||||||||
Deposits | $ | (89,967 | ) | $ | (113,857 | ) | ||
Net proceeds from issuance of consolidated obligations: | ||||||||
Discount notes | 132,173,176 | 828,860,569 | ||||||
Bonds | 14,986,402 | 17,078,307 | ||||||
Payments for maturing or called consolidated obligations: | ||||||||
Discount notes | (130,786,434 | ) | (824,180,739 | ) | ||||
Bonds | (11,499,866 | ) | (11,060,720 | ) | ||||
Proceeds from issuance of capital stock | 3,798,541 | 6,889,996 | ||||||
Payments for redemption/repurchase of capital stock | (3,406,046 | ) | (6,371,019 | ) | ||||
Payments for redemption/repurchase of mandatorily redeemable capital stock | (35,071 | ) | (1,956 | ) | ||||
Cash dividends paid | (132,943 | ) | (51,750 | ) | ||||
Net cash provided by financing activities | $ | 5,007,792 | $ | 11,048,831 | ||||
Net (decrease) in cash and due from banks | $ | (43,190 | ) | $ | (18,515 | ) | ||
Cash and due from banks, beginning of period | 115,370 | 92,245 | ||||||
Cash and due from banks, end of period | $ | 72,180 | $ | 73,730 | ||||
Supplemental disclosures: | ||||||||
Interest paid during the year | $ | 1,677,043 | $ | 976,818 | ||||
Affordable Housing Program payments, net | 8,429 | 3,087 | ||||||
REFCORP payments | 40,544 | 25,504 |
The accompanying notes are an integral part of these financial statements.
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Federal Home Loan Bank of Pittsburgh
Statement of Changes in Capital(unaudited)
For the Nine Months ended September 30, 2006 and 2005
Accumulated | ||||||||||||||||||||
Other | ||||||||||||||||||||
Capital Stock - Putable | Retained | Comprehensive | ||||||||||||||||||
(in thousands, except shares) | Shares | Par Value | Earnings | Income | Total Capital | |||||||||||||||
Balance December 31, 2004 | 26,958 | $ | 2,695,802 | $ | 77,190 | $ | (11,668 | ) | $ | 2,761,324 | ||||||||||
Sale of capital stock | 68,900 | 6,889,996 | 6,889,996 | |||||||||||||||||
Redemption/repurchase of capital stock | (63,710 | ) | (6,371,019 | ) | (6,371,019 | ) | ||||||||||||||
Shares reclassified to mandatorily redeemable capital stock | (39 | ) | (3,899 | ) | (3,899 | ) | ||||||||||||||
Comprehensive income: | ||||||||||||||||||||
Net income | 145,369 | 145,369 | ||||||||||||||||||
Net unrealized gain onavailable-for-sale securities | 93 | 93 | ||||||||||||||||||
Net gain relating to hedging activities | 3,217 | 3,217 | ||||||||||||||||||
Total comprehensive income | 145,369 | 3,310 | 148,679 | |||||||||||||||||
Cash dividends on capital stock | (56,420 | ) | (56,420 | ) | ||||||||||||||||
Balance September 30, 2005 | 32,109 | $ | 3,210,880 | $ | 166,139 | $ | (8,358 | ) | $ | 3,368,661 | ||||||||||
Balance December 31, 2005 | 30,786 | $ | 3,078,583 | $ | 188,479 | $ | (7,516 | ) | $ | 3,259,546 | ||||||||||
Sale of capital stock | 37,985 | 3,798,541 | 3,798,541 | |||||||||||||||||
Redemption/repurchase of capital stock | (34,060 | ) | (3,406,046 | ) | (3,406,046 | ) | ||||||||||||||
Shares reclassified to mandatorily redeemable capital stock | (318 | ) | (31,812 | ) | (31,812 | ) | ||||||||||||||
Comprehensive income: | ||||||||||||||||||||
Net income | 158,334 | 158,334 | ||||||||||||||||||
Net unrealized gain onavailable-for-sale securities | 355 | 355 | ||||||||||||||||||
Net gain relating to hedging activities | 2,487 | 2,487 | ||||||||||||||||||
Total comprehensive income | 158,334 | 2,842 | 161,176 | |||||||||||||||||
Cash dividends on capital stock | (108,836 | ) | (108,836 | ) | ||||||||||||||||
Balance September 30, 2006 | 34,393 | $ | 3,439,266 | $ | 237,977 | $ | (4,674 | ) | $ | 3,672,569 | ||||||||||
The accompanying notes are an integral part of these financial statements.
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Federal Home Loan Bank of Pittsburgh
Notes to Unaudited Financial Statements
Notes to Unaudited Financial Statements
Note 1 – Basis of Presentation
The Federal Home Loan Bank of Pittsburgh (Bank), a federally chartered corporation and a member-owned cooperative, is one of twelve Federal Home Loan Banks (FHLBanks) which, with the Federal Housing Finance Board (Finance Board) and the Office of Finance, comprise the Federal Home Loan Bank System (System). The twelve FHLBanks are government-sponsored enterprises (GSEs) of the United States of America and are organized under the Federal Home Loan Bank Act of 1932, as amended (Act). Each FHLBank has members in a specifically defined geographic district. The Bank’s defined geographic district is the states of Delaware, Pennsylvania and West Virginia. The Bank provides credit for housing and community development through two primary programs. First, it provides members with loans against the security of residential mortgages and other types of high-quality collateral; second, the Bank purchases residential mortgage loans originated by or through member institutions. The Bank also offers other types of credit and non-credit products and services to member institutions, including letters of credit, interest rate exchange agreements, affordable housing grants, securities safekeeping and deposit products and services.
The accounting and financial reporting policies of the Bank conform to generally accepted accounting principles (GAAP). Preparation of the unaudited financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, as well as the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses. Actual results could differ from those estimates. In addition, certain amounts in the prior period have been reclassified to conform to the current presentation. In the opinion of management, all normal recurring adjustments have been included for a fair statement of this interim financial information. These unaudited financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2005 included in the Bank’s registration statement on Form 10, as amended, filed with the Securities and Exchange Commission (SEC).
Note 2 – Restatement of Previously Issued Financial Statements
Results for the nine months ended September 30, 2005 included restated results for the first quarter of 2005. During the third quarter of 2005, in the course of preparing for registration of its equity securities with the SEC, the Bank determined that corrections needed to be made primarily due to the manner in which the Bank applied Statement of Financial Accounting Standards No. 133,Accounting for Derivative Instruments and Hedging Activities, as amended (SFAS 133). Therefore, the Bank restated its financial statements for the quarter ended March 31, 2005 and the years ended December 31, 2004, 2003, 2002 and 2001. Please refer to the Bank’s registration statement on Form 10, as amended, for additional information on the restatement.
Note 3 – Accounting Adjustments, Changes in Accounting Principle and Recently Issued Accounting Standards and Interpretations
Statement of Financial Accounting Standards No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans (SFAS 158). In September 2006, the FASB issued SFAS 158 which requires that benefit plan sponsors recognize the funded status of each benefit plan on the balance sheet. The aggregate of all overfunded plans will be recognized as an asset and the aggregate of all underfunded plans will be recognized as a liability with an offsetting entry to accumulated other comprehensive income. The Bank will adopt SFAS 158 effective December 31, 2006 and does not expect that the provisions of this standard will have a material impact on its results of operation or statement of condition.
Statement of Financial Accounting Standards No. 157, Fair Value Measurement (SFAS 157). In September 2006, the FASB issued SFAS 157 which addresses how to measure fair value. SFAS 157 provides a single definition of fair value, establishes a framework for measuring fair value, and requires expanded disclosures about fair value. SFAS 157 provides different disclosure requirements for assets and liabilities measured on a recurring
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basis than assets and liabilities measured on a nonrecurring basis. SFAS 157 is effective for the Bank’s fiscal year beginning on January 1, 2008. The Bank is currently evaluating what impact the adoption of this standard will have on its results of operation and statement of condition.
Statement of Financial Accounting Standards No. 155, Accounting for Certain Hybrid Financial Instruments — an Amendment of FASB Statements No. 133 and 140 (SFAS 155). In February 2006, the FASB issued SFAS 155 which resolves issues addressed in Derivative Implementation Group Implementation Issue No. D1,Application of Statement 133 to Beneficial Interests in Securitized Financial Assets(D1). SFAS 155 is effective for all financial instruments acquired or issued after the beginning of the first fiscal year that begins after September 15, 2006 (January 1, 2007 for the Bank). The FASB recently began to discuss making limited exceptions to the scope of SFAS 155. The Bank does not expect that the provisions of this standard will have a material impact on its results of operation or statement of condition. The Bank will assess any impact related to the scope exceptions when the FASB reaches final consensus on the issue.
Note 4 –Available-for-Sale Securities
Available-for-sale securities as of September 30, 2006 and December 31, 2005 were as follows:
September 30, 2006 | ||||||||||||||||
Gross Unrealized | Gross Unrealized | Estimated Fair | ||||||||||||||
(in thousands) | Amortized Cost | Gains | Losses | Value | ||||||||||||
Equity mutual funds offsetting deferred compensation | $ | 4,014 | $ | 1,039 | - | $ | 5,053 | |||||||||
Private label mortgage-backed securities | 81,685 | 179 | - | 81,864 | ||||||||||||
Totalavailable-for-sale securities | $ | 85,699 | $ | 1,218 | - | $ | 86,917 | |||||||||
December 31, 2005 | ||||||||||||||||
Gross Unrealized | Gross Unrealized | Estimated Fair | ||||||||||||||
(in thousands) | Amortized Cost | Gains | Losses | Value | ||||||||||||
Equity mutual funds offsetting deferred compensation | $ | 4,014 | $ | 759 | $ | - | $ | 4,773 | ||||||||
Private label mortgage-backed securities | 326,420 | 129 | (25 | ) | 326,524 | |||||||||||
Totalavailable-for-sale securities | $ | 330,434 | $ | 888 | $ | (25 | ) | $ | 331,297 | |||||||
Certain equity mutual funds within theavailable-for-sale portfolio are maintained to generate returns that seek to offset changes in liabilities related to the equity market risk of certain deferred compensation arrangements. These deferred compensation liabilities were $5.6 million and $6.2 million at September 30, 2006 and December 31, 2005, respectively, and are included in other liabilities on the statement of condition.
There were noavailable-for-sale securities with unrealized losses at September 30, 2006. There was oneavailable-for-sale security in an unrealized loss position as of December 31, 2005, with a fair value of $20.0 million. This security had been in an unrealized loss position for more than 12 months. As of September 30, 2006, it was in a unrealized gain position.
The Bank reviewed its entire investment securities portfolio and determined that all unrealized losses, as reflected above as of December 31, 2005, were temporary. The determination that the declines in fair value are temporary was based on several factors, including the fact that the Bank has the ability and the intent to hold such securities through to recovery of the unrealized losses. Specific to the MBS portfolio, all investments were rated AAA, except for one with an AA rating. A portion of these securities were guaranteed payment of principal and interest by FNMA and FHLMC. Additionally, the Bank reviewed the credit ratings of the entire portfolio and noted that there had been no downgrades. The unrealized loss position that occurred in the portfolio was primarily due to
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the upward movement in interest rates over the last eight quarters; therefore, the Bank determined that all declines in fair value were temporary.
Redemption Terms. The amortized cost of the Bank’s mortgage-backed securities classified asavailable-for-sale includes net discounts of $18 thousand and $31 thousand at September 30, 2006 and December 31, 2005, respectively. Contractual maturity will occur over a period exceeding ten years. Expected maturities will differ from contractual maturities because borrowers will have the right to call or prepay obligations with or without call or prepayment fees.
Interest Rate Payment Terms. All mortgage-backed securities are variable-rate.
Realized Gains and Losses. No gains or losses were reported for the three months and nine months ended September 30, 2006 and 2005.
Note 5 –Held-to-Maturity Securities
Held-to-maturity securities as of September 30, 2006 and December 31, 2005:
September 30, 2006 | ||||||||||||||||
Gross Unrealized | Gross Unrealized | Estimated Fair | ||||||||||||||
(in thousands) | Amortized Cost | Gains | Losses | Value | ||||||||||||
Commercial paper | $ | 352,325 | $ | - | $ | - | $ | 352,325 | ||||||||
Other U.S. obligations | - | - | - | - | ||||||||||||
Government-sponsored enterprises | 940,603 | 1,083 | (8,006 | ) | 933,680 | |||||||||||
State or local agency obligations | 795,766 | 8,532 | (3,933 | ) | 800,365 | |||||||||||
2,088,694 | 9,615 | (11,939 | ) | 2,086,370 | ||||||||||||
Mortgage-backed securities: | ||||||||||||||||
U.S. agency | 75,896 | 169 | (2,906 | ) | 73,159 | |||||||||||
Government-sponsored enterprises | 1,777,777 | 5,147 | (57,818 | ) | 1,725,106 | |||||||||||
Private label | 8,404,750 | 12,861 | (151,884 | ) | 8,265,727 | |||||||||||
Total mortgage-backed securities | 10,258,423 | 18,177 | (212,608 | ) | 10,063,992 | |||||||||||
Totalheld-to-maturity securities | $ | 12,347,117 | $ | 27,792 | $ | (224,547 | ) | $ | 12,150,362 | |||||||
December 31, 2005 | ||||||||||||||||
Gross Unrealized | Gross Unrealized | Estimated Fair | ||||||||||||||
(in thousands) | Amortized Cost | Gains | Losses | Value | ||||||||||||
Commercial paper | $ | 149,405 | $ | - | $ | - | $ | 149,405 | ||||||||
Other U.S. obligations | 3,663 | 27 | - | 3,690 | ||||||||||||
Government-sponsored enterprises | 556,260 | 340 | (4,809 | ) | 551,791 | |||||||||||
State or local agency obligations | 815,533 | 11,140 | (1,663 | ) | 825,010 | |||||||||||
1,524,861 | 11,507 | (6,472 | ) | 1,529,896 | ||||||||||||
Mortgage-backed securities: | ||||||||||||||||
U.S. agency | 95,074 | 197 | (3,359 | ) | 91,912 | |||||||||||
Government-sponsored enterprises | 1,747,012 | 1,781 | (63,028 | ) | 1,685,765 | |||||||||||
Private label | 7,667,683 | 711 | (147,583 | ) | 7,520,811 | |||||||||||
Total mortgage-backed securities | 9,509,769 | 2,689 | (213,970 | ) | 9,298,488 | |||||||||||
Totalheld-to-maturity securities | $ | 11,034,630 | $ | 14,196 | $ | (220,442 | ) | $ | 10,828,384 | |||||||
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Notes to Unaudited Financial Statements (continued)
Restricted securities relating to the MPF Shared Funding® Program (“MPF Shared Funding” is a registered trademark of the Federal Home Loan Bank of Chicago) are classified asheld-to-maturity and are included in private label mortgage-backed securities above. They are reported at amortized cost of $62.3 million and $69.4 million as of September 30, 2006 and December 31, 2005, respectively. Noheld-to-maturity securities were pledged as collateral as of September 30, 2006 and December 31, 2005.
The following tables summarize theheld-to-maturity securities with unrealized losses as of September 30, 2006 and December 31, 2005. The unrealized losses are aggregated by major security type and length of time that individual securities have been in a continuous unrealized loss position.
September 30, 2006 | ||||||||||||||||||||||||
Less than 12 Months | Greater than 12 Months | Total | ||||||||||||||||||||||
Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
(in thousands) | Value | Losses | Value | Losses | Value | Losses | ||||||||||||||||||
Government-sponsored enterprises | $ | 532,597 | $ | (8,006 | ) | $ | - | $ | - | $ | 532,597 | $ | (8,006 | ) | ||||||||||
State or local agency obligations | 285,717 | (3,933 | ) | - | - | 285,717 | (3,933 | ) | ||||||||||||||||
818,314 | (11,939 | ) | - | - | 818,314 | (11,939 | ) | |||||||||||||||||
Mortgage-backed securities: | ||||||||||||||||||||||||
U.S. agency | 53,775 | (2,907 | ) | - | - | 53,775 | (2,907 | ) | ||||||||||||||||
Government-sponsored enterprises | 186,207 | (1,795 | ) | 1,105,157 | (56,023 | ) | 1,291,364 | (57,818 | ) | |||||||||||||||
Private label | 1,714,548 | (16,250 | ) | 4,922,543 | (135,633 | ) | 6,637,091 | (151,883 | ) | |||||||||||||||
Total mortgage-backed securities | 1,954,530 | (20,952 | ) | 6,027,700 | (191,656 | ) | 7,982,230 | (212,608 | ) | |||||||||||||||
Totalheld-to-maturity securities | $ | 2,772,844 | $ | (32,891 | ) | $ | 6,027,700 | $ | (191,656 | ) | $ | 8,800,544 | $ | (224,547 | ) | |||||||||
December 31, 2005 | ||||||||||||||||||||||||
Less than 12 Months | Greater than 12 Months | Total | ||||||||||||||||||||||
Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
(in thousands) | Value | Losses | Value | Losses | Value | Losses | ||||||||||||||||||
Government-sponsored enterprises | $ | 351,451 | $ | (4,809 | ) | $ | - | $ | - | $ | 351,451 | $ | (4,809 | ) | ||||||||||
State or local agency obligations | 28,977 | (1,169 | ) | 10,831 | (494 | ) | 39,808 | (1,663 | ) | |||||||||||||||
380,428 | (5,978 | ) | 10,831 | (494 | ) | 391,259 | (6,472 | ) | ||||||||||||||||
Mortgage-backed securities: | ||||||||||||||||||||||||
U.S. agency | 4,003 | (17 | ) | 66,801 | (3,342 | ) | 70,804 | (3,359 | ) | |||||||||||||||
Government-sponsored enterprises | 508,297 | (7,832 | ) | 852,175 | (55,196 | ) | 1,360,472 | (63,028 | ) | |||||||||||||||
Private label | 4,333,808 | (50,820 | ) | 2,904,967 | (96,763 | ) | 7,238,775 | (147,583 | ) | |||||||||||||||
Total mortgage-backed securities | 4,846,108 | (58,669 | ) | 3,823,943 | (155,301 | ) | 8,670,051 | (213,970 | ) | |||||||||||||||
Totalheld-to-maturity securities | $ | 5,226,536 | $ | (64,647 | ) | $ | 3,834,774 | $ | (155,795 | ) | $ | 9,061,310 | $ | (220,442 | ) | |||||||||
The Bank reviewed its entire investment securities portfolio and determined that all unrealized losses, as reflected above, as of September 30, 2006 and December 31, 2005 were temporary. The determination that the declines in fair value are temporary was based on several factors, including the fact that the Bank has the ability and the intent to hold such securities through to recovery of the unrealized losses. Specific to the MBS portfolio, all investments were rated AAA, except for one with an AA rating. A portion of these securities were guaranteed
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payment of principal and interest by FNMA and FHLMC. Additionally, the Bank reviewed the credit ratings of the entire portfolio and noted that there had been no downgrades. The unrealized loss position that occurred in the portfolio was primarily due to the upward movement in interest rates over the last eight quarters; therefore, the Bank determined that all declines in fair value were temporary.
Redemption Terms. The amortized cost and estimated fair value ofheld-to-maturity securities by contractual maturity are shown below. Expected maturities of some securities and mortgage-backed securities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment fees.
(in thousands) | September 30, 2006 | December 31, 2005 | ||||||||||||||
Estimated Fair | Estimated Fair | |||||||||||||||
Year of Maturity | Amortized Cost | Value | Amortized Cost | Value | ||||||||||||
Due in one year or less | $ | 352,325 | $ | 352,325 | $ | 153,068 | $ | 153,096 | ||||||||
Due after one year through five years | 1,172,216 | 1,179,693 | 707,203 | 711,879 | ||||||||||||
Due after five years through ten years | 167,653 | 160,228 | 255,965 | 256,070 | ||||||||||||
Due after ten years | 396,500 | 394,124 | 408,625 | 408,852 | ||||||||||||
2,088,694 | 2,086,370 | 1,524,861 | 1,529,897 | |||||||||||||
Mortgage-backed securities | 10,258,423 | 10,063,992 | 9,509,769 | 9,298,487 | ||||||||||||
Total | $ | 12,347,117 | $ | 12,150,362 | $ | 11,034,630 | $ | 10,828,384 | ||||||||
The amortized cost of the Bank’s mortgage-backed securities classified asheld-to-maturity includes net discounts of $83.6 million and $67.7 million at September 30, 2006 and December 31, 2005, respectively.
Interest Rate Payment Terms. The following table details interest rate payment terms forheld-to-maturity securities at September 30, 2006 and December 31, 2005.
September 30, | December 31, | |||||||
(in thousands) | 2006 | 2005 | ||||||
Amortized cost ofheld-to-maturity securities other than mortgage-backed securities: | ||||||||
Fixed-rate | $ | 1,448,319 | $ | 870,571 | ||||
Variable-rate | 640,375 | 654,290 | ||||||
2,088,694 | 1,524,861 | |||||||
Amortized cost ofheld-to-maturity mortgage-backed securities: | ||||||||
Fixed-rate | 9,713,671 | 8,842,935 | ||||||
Variable-rate | 544,752 | 666,834 | ||||||
10,258,423 | 9,509,769 | |||||||
Totalheld-to-maturity securities | $ | 12,347,117 | $ | 11,034,630 | ||||
Realized Gains and Losses. There were no realized gains or realized losses on sales ofheld-to-maturity securities for the three months and nine months ended September 30, 2006 and 2005.
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Note 6 – Loans to Members
Redemption Terms. At September 30, 2006, the Bank had loans to members outstanding, including Affordable Housing Program (AHP) loans, at interest rates ranging from 0% to 8.56%. AHP subsidized loans have interest rates ranging between 0% and 6.50%.
September 30, 2006 | December 31, 2005 | |||||||||||||||
Weighted | Weighted | |||||||||||||||
(dollars in thousands) | Average | Average | ||||||||||||||
Year of Maturity | Amount | Interest Rate | Amount | Interest Rate | ||||||||||||
Due in 1 year or less | $ | 18,592,373 | 5.03 | $ | 21,436,691 | 3.99 | ||||||||||
Due after 1 year through 2 years | 7,566,392 | 4.65 | 5,535,899 | 3.90 | ||||||||||||
Due after 2 years through 3 years | 7,010,880 | 4.82 | 5,452,546 | 4.38 | ||||||||||||
Due after 3 years through 4 years | 3,712,190 | 5.21 | 3,590,495 | 4.40 | ||||||||||||
Due after 4 years through 5 years | 3,919,837 | 5.13 | 4,348,065 | 5.12 | ||||||||||||
Thereafter | 8,936,465 | 4.52 | 7,089,095 | 4.87 | �� | |||||||||||
Index amortizing loans to members | 48,498 | 5.72 | 64,267 | 4.34 | ||||||||||||
Total par value | $ | 49,786,635 | 4.87 | $ | 47,517,058 | 4.28 | ||||||||||
Discount on AHP loans to members | (1,547 | ) | (1,714 | ) | ||||||||||||
Deferred prepayment fees | (220 | ) | (347 | ) | ||||||||||||
SFAS 133 hedging adjustments | (54,051 | ) | (22,038 | ) | ||||||||||||
Total book value | $ | 49,730,817 | $ | 47,492,959 | ||||||||||||
Index amortizing loans require repayment according to predetermined amortization schedules linked to the level of various indices. Usually, as market interest rates rise (fall), the maturity of an index amortizing loan to a member extends (contracts).
The Bank offers loans to members that may be prepaid on pertinent dates without incurring prepayment fees (returnable loans). Other loans to members may only be prepaid by paying a fee (prepayment fee) to the Bank that makes the Bank financially indifferent to the prepayment of the loan. At September 30, 2006 and December 31, 2005, the Bank had returnable loans of $2.1 billion and $846 million, respectively. The following table summarizes loans to members by year of maturity or next call date for returnable loans to members.
(in thousands) | September 30, | December 31, | ||||||
Year of Maturity or Next Call Date | 2006 | 2005 | ||||||
Due or callable in 1 year or less | $ | 20,559,873 | $ | 22,137,191 | ||||
Due or callable after 1 year through 2 years | 7,709,892 | 5,535,899 | ||||||
Due or callable after 2 years through 3 years | 6,855,880 | 5,591,046 | ||||||
Due or callable after 3 years through 4 years | 3,282,190 | 3,395,495 | ||||||
Due or callable after 4 years through 5 years | 3,133,837 | 4,013,065 | ||||||
Thereafter | 8,196,465 | 6,780,095 | ||||||
Index amortizing loans to members | 48,498 | 64,267 | ||||||
Total par value | $ | 49,786,635 | $ | 47,517,058 | ||||
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The Bank also offers convertible loans. With a convertible loan, the Bank purchases an option from the member that allows the Bank to convert the interest rate from fixed to floating by terminating the fixed loan, which the Bank normally would exercise when interest rates increase, and offering a floating-rate loan. At September 30, 2006 and December 31, 2005, the Bank had convertible loans outstanding of $8.9 billion and $8.8 billion, respectively. The following table summarizes loans to members by year of maturity or next convertible date for convertible loans.
(in thousands) | September 30, | December 31, | ||||||
Year of Maturity or Next Convertible Date | 2006 | 2005 | ||||||
Due or convertible in 1 year or less | $ | 26,766,543 | $ | 29,298,286 | ||||
Due or convertible after 1 year through 2 years | 7,174,392 | 5,733,399 | ||||||
Due or convertible after 2 years through 3 years | 6,557,880 | 4,192,046 | ||||||
Due or convertible after 3 years through 4 years | 2,458,470 | 2,539,745 | ||||||
Due or convertible after 4 years through 5 years | 2,361,737 | 1,991,845 | ||||||
Thereafter | 4,419,115 | 3,697,470 | ||||||
Index amortizing loans to members | 48,498 | 64,267 | ||||||
Total par value | $ | 49,786,635 | $ | 47,517,058 | ||||
Security Terms. The Bank lends to financial institutions involved in housing finance within its district according to Federal statutes, including the Federal Home Loan Bank Act (Act). The Act requires the Bank to obtain sufficient collateral for loans to members to protect against losses and to accept only certain U.S. government or government agency securities, residential mortgage loans, cash or deposits and member capital stock in the Bank, and other eligible real estate-related assets as collateral for such loans to members. Community Financial Institutions (CFIs) are eligible under expanded statutory collateral rules to use secured small business, small farm and small agriculture loans and securities representing a whole interest in such secured loans. As additional security, the Bank has a statutory lien on each borrower’s capital in the Bank. At September 30, 2006 and December 31, 2005, the Bank had rights to collateral with an estimated value greater than its outstanding loans to members. On the basis of the financial condition of the member, the type of security agreement, and other factors, the Bank imposes one of two requirements to protect the collateral pledged:
(1) | Allows a member to retain possession of the collateral pledged to the Bank, under a written security agreement that requires the member to hold such collateral for the benefit of the Bank; or | |
(2) | Requires the member to place physical custody of the pledged collateral with the Bank or its third-party custodian. |
Beyond these provisions, the Act affords any security interest granted by a member to the Bank priority over the claims or rights of any other party. The exceptions are those claims that would be entitled to priority under otherwise applicable law and are held bybona fidepurchasers for value or by secured parties with perfected security interests.
Credit Risk. While the Bank has never experienced a loan loss on a loan to a member, the expansion of collateral for CFIs and nonmember housing associates provides the potential for additional credit risk for the Bank. The management of the Bank has the policies and procedures in place to appropriately manage this credit risk. Accordingly, the Bank has not provided any allowances for loan losses on loans to members.
The Bank’s potential credit risk from loans to members is concentrated in commercial banks and savings institutions. As of September 30, 2006, the Bank had loans to members of $31.1 billion outstanding to three members, which represented 62.4% of total loans outstanding. As of December 31, 2005, the Bank had outstanding loans of $18.3 billion to two members, which represented 38.4% of total loans outstanding. The Bank held sufficient collateral to secure loans to members and the Bank does not expect to incur any losses on these loans. See Note 11 for further information on transactions with related parties.
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Interest Rate Payment Terms. The following table details additional interest rate payment terms for loans to members.
September 30, | December 31, | |||||||
(in thousands) | 2006 | 2005 | ||||||
Fixed rate — overnight | $ | 2,775,677 | $ | 6,505,251 | ||||
Fixed rate — term | 38,828,742 | 36,021,775 | ||||||
Variable-rate | 8,182,216 | 4,990,032 | ||||||
Total par value | $ | 49,786,635 | $ | 47,517,058 | ||||
For loans to members due beyond one year, at September 30, 2006, the Bank had $24.3 billion of fixed-rate loans and $6.9 billion of variable-rate loans.
Note 7 – Mortgage Loans Held for Portfolio
The MPF Program involves investment by the Bank in mortgage loans, which are purchased from its participating members. The total loans representheld-for-portfolio loans under the MPF Program whereby the Bank’s members originate, service, and credit enhance home mortgage loans that are then sold to the Bank. The Bank sells participation interests in some of its MPF Program loans to other FHLBanks and holds the rest in portfolio. See Note 11 for further information on transactions with related parties.
September 30, | December 31, | |||||||
(in thousands) | 2006 | 2005 | ||||||
Fixed medium-term single-family mortgages(1) | $ | 1,363,752 | $ | 1,529,441 | ||||
Fixed long-term single-family mortgages(1) | 5,747,749 | 6,029,531 | ||||||
Total par value | 7,111,501 | 7,558,972 | ||||||
Premiums | 83,027 | 97,055 | ||||||
Discounts | (27,994 | ) | (27,444 | ) | ||||
SFAS 133 hedging adjustments | 20,853 | 23,988 | ||||||
Total mortgage loans held for portfolio | $ | 7,187,387 | $ | 7,652,571 | ||||
Note:
(1) | Medium-term is defined as an original term of 15 years or less. Long-term is defined as greater than 15 years. |
The following tables detail the par value of mortgage loans held for portfolio outstanding categorized by type and maturity.
September 30, | December 31, | |||||||
(in thousands) | 2006 | 2005 | ||||||
Government-insured loans | $ | 653,321 | $ | 740,307 | ||||
Conventional loans | 6,458,180 | 6,818,665 | ||||||
Total par value | $ | 7,111,501 | $ | 7,558,972 | ||||
Year of maturity | ||||||||
Due in one year or less | $ | 3 | $ | - | ||||
Due after one year through five years | 610 | 624 | ||||||
Due after five years | 7,110,888 | 7,558,348 | ||||||
Total | $ | 7,111,501 | $ | 7,558,972 | ||||
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Note 8 – Consolidated Obligations
Consolidated obligations are the joint and several obligations of the FHLBanks and consist of consolidated bonds and discount notes. The FHLBanks issue consolidated obligations through the Office of Finance as their agent. In connection with each debt issuance, each FHLBank specifies the amount of debt it wants issued on its behalf. The Office of Finance tracks the amount of debt issued on behalf of each FHLBank. In addition, the Bank separately tracks and records as a liability its specific portion of consolidated obligations and is the primary obligor for its specific portion of consolidated obligations issued. The Finance Board and the U.S. Secretary of the Treasury have oversight over the issuance of FHLBank debt through the Office of Finance. Consolidated bonds are issued primarily to raise intermediate and long-term funds for the FHLBanks and are not subject to any statutory or regulatory limits on maturity. Consolidated discount notes are issued primarily to raise short-term funds. These notes sell at less than their face amount and are redeemed at par value when they mature.
Although the Bank is primarily liable for its portion of consolidated obligations (i.e., those issued on its behalf), the Bank is also jointly and severally liable with the other eleven FHLBanks for the payment of principal and interest on all consolidated obligations of each of the FHLBanks. The Finance Board, at its discretion, may require any FHLBank to make principal or interest payments due on any consolidated obligations whether or not the consolidated obligation represents a primary liability of such FHLBank. Although it has never occurred, to the extent that an FHLBank makes any payment on a consolidated obligation on behalf of another FHLBank that is primarily liable for such consolidated obligation, Finance Board regulations provide that the paying FHLBank is entitled to reimbursement from the noncomplying FHLBank for any payments made on its behalf and other associated costs (including interest to be determined by the Finance Board). However, if the Finance Board determines that the noncomplying FHLBank is unable to satisfy its repayment obligations, then the Finance Board may allocate the outstanding liabilities of the noncomplying FHLBank among the remaining FHLBanks on apro ratabasis in proportion to each FHLBank’s participation in all consolidated obligations outstanding. The Finance Board reserves the right to allocate the outstanding liabilities for the consolidated obligations between the FHLBanks in any other manner it may determine to ensure that the FHLBanks operate in a safe and sound manner.
General Terms. Consolidated obligations are issued with either fixed-rate coupon payment terms or variable-rate coupon payment terms that use a variety of indices for interest rate resets including the London Interbank Offered Rate (LIBOR), Constant Maturity Treasury (CMT), 11th District Cost of Funds Index (COFI), and others. In addition, to meet the expected specific needs of certain investors in consolidated obligations, both fixed-rate bonds and variable-rate bonds may also contain certain features, which may result in complex coupon payment terms and call options. When such consolidated obligations are issued, the Bank generally enters into derivatives containing offsetting features that effectively convert the terms of the bond to those of a simple variable-rate bond or a fixed-rate bond. The Bank has no outstanding consolidated obligations denominated in currencies other than U.S. dollars.
These consolidated obligations, beyond having fixed-rate or simple variable-rate coupon payment terms, may also have the following broad terms regarding either principal repayment or coupon payment terms:
Indexed Principal Redemption Bonds(index amortizing notes) repay principal according to predetermined amortization schedules that are linked to the level of a certain index. A form of an indexed principal redemption bond that is common to the Bank is an Amortizing Prepayment Linked Security (APLS). The APLS redeems based on the prepayments of FNMA, FHLMC or GNMA reference pools. As of September 30, 2006 and December 31, 2005, most of the index amortizing notes had fixed-rate coupon payment terms. Usually, as market interest rates rise (fall), the maturity of the index amortizing notes extends (contracts).
Optional Principal Redemption Bonds(callable bonds) are bonds that the Bank may redeem in whole or in part at its discretion on predetermined call dates according to the terms of the bond offerings.
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Interest Rate Payment Terms. With respect to interest payments, consolidated obligation bonds may also have the following terms:
Step-up Bondsgenerally pay interest at increasing fixed rates at specified intervals over the life of the bond. These bonds generally contain provisions enabling the Bank to call bonds at its option on thestep-up dates;
Conversion Bondshave coupons that the Bank may convert from fixed to floating, or floating to fixed, or from one U.S. or other currency index to another, at its discretion on predetermined dates according to the terms of the bond offerings;
Range Bondspay interest at fixed or variable rates provided a specified index is within a specified range. The computation of the variable interest rate differs for each bond issue, but the bond generally pays zero interest or a minimal rate of interest if the specified index is outside the specified range; and
Zero-coupon Bondsare long-term discounted instruments that earn a fixed yield to maturity or the optional principal redemption date. All principal and interest are paid at maturity or on the optional principal redemption date, if exercised prior to maturity.
The following table details interest rate payment terms for consolidated obligation bonds.
September 30, | December 31, | |||||||
(in thousands) | 2006 | 2005 | ||||||
Fixed-rate | $ | 48,121,390 | $ | 44,275,256 | ||||
Floating-rate | 2,229,380 | 1,660,000 | ||||||
Step-up | 4,885,150 | 5,435,150 | ||||||
Conversion bonds: | ||||||||
Fixed to floating | 320,000 | 569,380 | ||||||
Floating to fixed | 171,000 | 286,000 | ||||||
Range bonds | 463,000 | 463,000 | ||||||
Zero-coupon | 4,028,000 | 4,028,000 | ||||||
Total par value | $ | 60,217,920 | $ | 56,716,786 | ||||
Maturity Terms. The following is a summary of the Bank’s participation in consolidated obligation bonds outstanding by year of maturity.
September 30, 2006 | December 31, 2005 | |||||||||||||||
(dollars in thousands) | ||||||||||||||||
Weighted Average | Weighted Average | |||||||||||||||
Year of Maturity | Amount | Interest Rate | Amount | Interest Rate | ||||||||||||
Due in 1 year or less | $ | 16,173,033 | 3.97 | $ | 14,017,772 | 3.19 | ||||||||||
Due after 1 year through 2 years | 14,181,000 | 4.45 | 10,612,660 | 3.82 | ||||||||||||
Due after 2 years through 3 years | 5,513,380 | 4.36 | 8,267,000 | 4.20 | ||||||||||||
Due after 3 years through 4 years | 5,031,150 | 4.68 | 3,825,530 | 3.89 | ||||||||||||
Due after 4 years through 5 years | 3,237,000 | 4.93 | 4,728,000 | 4.52 | ||||||||||||
Thereafter | 12,351,000 | 3.28 | 11,659,000 | 3.06 | ||||||||||||
Index amortizing notes | 3,731,357 | 4.79 | 3,606,824 | 4.63 | ||||||||||||
Total par value | $ | 60,217,920 | 4.14 | $ | 56,716,786 | 3.68 | ||||||||||
Bond premiums | 21,419 | 28,039 | ||||||||||||||
Bond discounts | (3,150,717 | ) | (3,197,715 | ) | ||||||||||||
SFAS 133 hedging adjustments | (324,897 | ) | (404,173 | ) | ||||||||||||
Total book value | $ | 56,763,725 | $ | 53,142,937 | ||||||||||||
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Notes to Unaudited Financial Statements (continued)
Consolidated obligation bonds outstanding at September 30, 2006 and December 31, 2005, include callable bonds totaling $36.1 billion and $30.2 billion, respectively. The Bank uses fixed-rate callable debt to finance returnable loans to members (see Note 6) and mortgage-backed securities. Simultaneously with such a debt issue, the Bank may also enter an interest rate swap (in which the Bank pays variable and receives fixed) with a call feature that mirrors the option embedded in the debt (a sold callable interest rate swap). The combined sold callable interest rate swap and callable debt allows the Bank to provide members attractively priced loans. The par value of the Bank’s non-callable consolidated obligation bonds at September 30, 2006 and December 31, 2005, was $24.1 billion and $26.5 billion, respectively.
The following table summarizes consolidated obligation bonds outstanding by year of maturity or next call date.
(in thousands) | September 30, | December 31, | ||||||
Year of Maturity or Next Call Date | 2006 | 2005 | ||||||
Due or callable in 1 year or less | $ | 36,367,563 | $ | 36,452,302 | ||||
Due or callable after 1 year through 2 years | 10,901,000 | 4,468,660 | ||||||
Due or callable after 2 years through 3 years | 4,111,000 | 6,103,000 | ||||||
Due or callable after 3 years through 4 years | 1,635,000 | 2,572,000 | ||||||
Due or callable after 4 years through 5 years | 1,113,000 | 1,375,000 | ||||||
Thereafter | 2,359,000 | 2,139,000 | ||||||
Index amortizing notes | 3,731,357 | 3,606,824 | ||||||
Total par value | $ | 60,217,920 | $ | 56,716,786 | ||||
Consolidated Obligation Discount Notes. Consolidated obligation discount notes are issued to raise short-term funds. Discount notes are consolidated obligations with original maturities up to 360 days. These notes are issued at less than their face amount and redeemed at par value when they mature. The Bank’s participation in consolidated discount notes, all of which are due within one year, was as follows:
September 30, | December 31, | |||||||
(dollars in thousands) | 2006 | 2005 | ||||||
Book value | $ | 16,064,138 | $ | 14,580,400 | ||||
Par value | $ | 16,154,964 | $ | 14,620,012 | ||||
Weighted average interest rate | 5.28 | % | 4.11 | % |
The Act authorizes the Secretary of the Treasury, at his or her discretion, to purchase consolidated obligations of the FHLBanks aggregating not more than $4.0 billion under certain conditions. The terms, conditions, and interest rates are determined by the Secretary of the Treasury. There were no such purchases by the U.S. Treasury during the nine months ended September 30, 2006 or the year ended December 31, 2005.
Note 9 – Capital
The Gramm-Leach-Bliley Act (GLB Act) resulted in a number of changes in the capital structure of the FHLBanks. The final Finance Board capital rule was published on January 30, 2001, and required each FHLBank to submit a capital structure plan to the Finance Board by October 29, 2001 in accordance with the provisions of the GLB Act and final capital rules. The Finance Board approved the Bank’s capital plan on May 8, 2002. The Bank converted to its new capital structure on December 16, 2002, and was in compliance with its capital plan on the conversion date. The conversion was considered a capital transaction and was accounted for at par value.
The Bank is subject to three capital requirements under the current capital structure plan. First, the Bank shall maintain at all times permanent capital in an amount at least equal to the sum of its credit risk, market risk and operations risk capital requirements, calculated in accordance with the Finance Board regulations. Only permanent capital, defined as retained earnings plus capital stock, satisfies the risk-based capital requirement. The Finance
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Board may require the Bank to maintain a greater amount of permanent capital than is required by the risk-based capital requirements, as defined. In addition, the GLB Act requires the Bank to maintain at all times at least a 4.0%capital-to-asset ratio and at least a 5.0% leverage ratio, defined as the sum of permanent capital weighed 1.5 times plus loan loss reserves divided by total assets. The Bank was in compliance with the aforementioned capital rules and requirements at September 30, 2006 and December 31, 2005, as shown in the following table.
September 30, 2006 | December 31, 2005 | |||||||||||||||
(dollars in thousands) | Required | Actual | Required | Actual | ||||||||||||
Risk-based capital | $ | 527,523 | $ | 3,690,715 | $ | 499,286 | $ | 3,283,793 | ||||||||
Totalcapital-to-asset ratio | 4.0 | % | 4.7 | % | 4.0 | % | 4.5 | % | ||||||||
Total capital | $ | 3,133,609 | $ | 3,697,221 | $ | 2,915,950 | $ | 3,289,318 | ||||||||
Leverage ratio | 5.0 | % | 7.1 | % | 5.0 | % | 6.8 | % | ||||||||
Leverage capital | $ | 3,917,012 | $ | 5,542,579 | $ | 3,644,911 | $ | 4,931,216 |
Under the capital plan, member institutions are required to maintain capital stock in an amount equal to no less than the sum of three amounts: (1) a specified percentage of their outstanding loans from the Bank; (2) a specified percentage of their unused borrowing capacity (defined generally as the remaining collateral value that can be borrowed against) with the Bank; and (3) a specified percentage of the principal balance of residential mortgage loans previously sold to the Bank and still held by the Bank (any increase in this percentage will be applied on a prospective basis only). These specified percentages may be adjusted by the Bank’s Board of Directors within pre-established ranges as contained in the capital plan.
The stock purchase requirement for unused borrowing capacity is referred to as the membership capital stock purchase requirement because it applies to all members. The other two stock purchase requirements are referred to as activity-based requirements. The Bank determines membership capital stock purchase requirements by considering the aggregate amount of capital necessary to prudently capitalize the Bank’s business activities. The amount of capital is dependent upon the size of the current balance sheet, expected members’ borrowing requirements and other forecasted balance sheet changes.
The GLB Act made membership voluntary for all members. The Bank issues stock that may be redeemed subject to certain restrictions by giving five years’ notice. The Bank is not required to redeem activity-based stock until the latter of the expiration of the notice of redemption or the activity no longer remains outstanding. In accordance with the Bank’s current practice, if activity-based stock becomes excess stock as a result of an activity no longer remaining outstanding, the Bank may choose to repurchase the excess activity-based stock. Before being readmitted to membership in any FHLBank, a member that withdraws from membership must wait five years from the divestiture date for all capital stock that is held as a condition of membership, as that requirement is set out in the Bank’s capital plan. A member may cancel or revoke its written notice of redemption or its notice of withdrawal from membership prior to the end of the five-year redemption period. The Bank’s capital plan provides that the Bank may charge the member a cancellation fee. The Board of Directors may change the cancellation fee with prior written notice to members.
Capital Concentrations. The following table presents member holdings of ten percent or more of the Bank’s total capital stock including mandatorily redeemable capital stock outstanding as of September 30, 2006 and December 31, 2005.
September 30, 2006 | December 31, 2005 | |||||||||||||||
(dollars in thousands) | Percent of | Percent of | ||||||||||||||
Member | Capital Stock | total | Capital Stock | total | ||||||||||||
Sovereign Bank, Reading PA | $ | 914,253 | 26.5 | $ | 643,401 | 20.8 | ||||||||||
Citicorp Trust Bank, FSB, Newark DE | 450,232 | 13.0 | 331,911 | 10.7 |
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Mandatorily Redeemable Capital Stock. The FHLBanks adopted Statement of Financial Accounting Standards No. 150,Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity(SFAS 150) as of January 1, 2004. In compliance with SFAS 150, the FHLBanks reclassified the stock subject to mandatory redemption from capital to liability once a member exercises a written redemption right, gives notice of intent to withdraw from membership, or attains nonmember status by merger or acquisition, charter termination, or involuntary termination from membership. Mandatorily redeemable shares are reclassified to a liability at fair value. Dividends related to capital stock classified as a liability are accrued at the expected dividend rate and reported as interest expense in the statement of operations. The repayment of these mandatorily redeemable financial instruments is reflected as a cash outflow in the financing activities section of the statement of cash flows. If a member cancels its written notice of redemption or notice of withdrawal, the Bank reclassifies mandatorily redeemable capital stock from a liability to equity in compliance with SFAS 150. After the reclassification, dividends on the capital stock are no longer classified as interest expense.
The Finance Board has confirmed that the liability accounting treatment for certain shares of its capital stock does not affect the definition of total capital for purposes of determining the Bank���s compliance with its regulatory capital requirements, calculating its mortgage securities investment authority (300% of total capital), calculating its unsecured credit exposure limit to other government-sponsored enterprises (100% of total capital), or calculating its unsecured credit limits to other counterparties (various percentages of total capital depending on the rating of the counterparty).
At September 30, 2006 and December 31, 2005, respectively, the Bank had $13.5 million and $16.7 million in capital stock subject to mandatory redemption with payment subject to a five-year waiting period and the Bank meeting its minimum regulatory capital requirements. For the third quarters of 2006 and 2005, dividends on mandatorily redeemable capital stock in the amount of $482 thousand and $153 thousand, respectively, were recorded as interest expense. For the nine months ended September 30, 2006 and 2005, the dividends recorded as interest expenses were $823 thousand and $421 thousand, respectively. There have been no reclassifications of mandatorily redeemable capital stock back into capital.
As of September 30, 2006, two members had notified the Bank to voluntarily redeem their capital stock and withdraw from membership. This redemption was not complete as of September 30, 2006. The following table shows the amount of mandatorily redeemable capital stock by contractual year of redemption. Actual redemption could occur sooner in the case of a member whose membership has been terminated as a result of a merger or other consolidation into a non-member or a member of another FHLBank.
September 30, | December 31, | |||||||
(in thousands) | 2006 | 2005 | ||||||
Due in 1 year or less | $ | 940 | $ | 540 | ||||
Due after 1 year through 2 years | 1 | 7 | ||||||
Due after 2 years through 3 years | 5 | 1,365 | ||||||
Due after 3 years through 4 years | 11,804 | - | ||||||
Due after 4 years through 5 years | 708 | 13,227 | ||||||
Thereafter | 14 | 1,592 | ||||||
Total | $ | 13,472 | $ | 16,731 | ||||
The Bank repurchased capital stock related toout-of-district mergers totaling $35.1 million and $19.5 million for the nine months ended September 30, 2006 and 2005, respectively.
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A rollforward of the Bank’s mandatorily redeemable capital stock activity for the nine months ended September 30, 2006 and 2005 is presented in the following table.
Nine months ended September 30, | ||||||||
(in thousands) | 2006 | 2005 | ||||||
Balance, beginning of period | $ | 16,731 | $ | 18,208 | ||||
Capital stock subject to mandatory redemption reclassified from equity due to withdrawals | 31,812 | 3,899 | ||||||
Redemption of mandatorily redeemable capital stock due to withdrawals | (35,071 | ) | (1,956 | ) | ||||
Balance, end of period | $ | 13,472 | $ | 20,151 | ||||
Statutory and Regulatory Restrictions on Capital Stock Redemption. In accordance with the GLB Act, Bank stock is considered putable with restrictions given the significant restrictions on the obligation/right to redeem and the limitation of the redemption privilege to a small fraction of outstanding stock. Statutory and regulatory restrictions on the redemption of Bank stock include the following:
• | In no case may the Bank redeem any capital stock if, following such redemption, the Bank would fail to satisfy its minimum capital requirements (i.e., a statutory capital / asset ratio requirement, established by the GLB Act, and a regulatory risk-basedcapital-to-asset ratio requirement established by the Finance Board). By law, all member holdings of Bank stock immediately become non-redeemable if the Bank becomes undercapitalized and only a minimal portion of outstanding stock qualifies for redemption consideration. | |
• | In no case may the Bank redeem any capital stock if either its Board of Directors or the Finance Board determine that it has incurred, or is likely to incur, losses resulting, or expected to result, in a charge against capital. | |
• | In addition to possessing the authority to prohibit stock redemptions, the Bank’s Board of Directors has a right and an obligation to call for additional capital stock purchases by its members, as needed to satisfy statutory and regulatory capital requirements. | |
• | If, during the period between receipt of a stock redemption notification from a member and the actual redemption (which may last indefinitely if the Bank is undercapitalized, does not have the required credit rating, etc.), the Bank becomes insolvent and is either liquidated or forced to merge with another FHLBank, the redemption value of the stock will be established either through the market liquidation process or through negotiation with the merger partner. In either case all senior claims must first be settled at par, and there are no claims which are subordinated to the rights of Bank stockholders. | |
• | The GLB Act states that the Bank may repurchase, in its sole discretion, stock investments which exceed the required minimum amount. | |
• | In no case may the Bank redeem or repurchase any capital stock if the principal or interest payment due on any consolidated obligation issued by the Office of Finance has not been paid in full. | |
• | In no case may the Bank redeem or repurchase any capital stock if the Bank has failed to provide the Finance Board with the necessary quarterly certification required by Section 966.9(b)(1) of the Finance Board’s regulations prior to declaring or paying dividends for a quarter. | |
• | In no case may the Bank redeem or repurchase any capital stock if the Bank is unable to provide the required certification, projects that it will fail to comply with statutory or regulatory liquidity requirements or will be unable to timely and fully meet all of its obligations, actually fails to satisfy these requirements or obligations, or negotiates to enter or enters into an agreement with another Bank to obtain financial assistance to meet its current obligations. |
Dividends. Until the Bank’s registration statement with the SEC became effective on August 8, 2006, a dividend could be declared only following consultation with and approval by the Finance Board’s Office of
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Supervision. Beginning with the third quarter of 2006, all dividends declared need to be approved only by the Board of Directors. Dividends may be paid in either capital stock or cash; the Bank has historically paid cash dividends only.
Proposed Finance Board Capital Regulation. On March 8, 2006, the Finance Board published a proposed rule, “Excess Stock Restrictions and Retained Earnings Requirements for the Federal Home Loan Banks.” This proposal would limit the issuance or maintenance of excess stock by FHLBanks. Excess stock is defined as the amount of capital stock greater than the members’ minimum capital stock requirements. Moreover, the proposed rule would increase each FHLBank’s minimum retained earnings requirement to $50 million plus 1.0% of a FHLBank’s non member loan assets. The retained earnings proposal states that FHLBanks that do not meet the minimum retained earnings requirement will be limited in their ability to declare dividends. It is unclear whether the proposal will be adopted in its current form. The Bank has studied the proposal and has provided comments to the Finance Board on its potential impact to the Bank’s members.
Accumulated Other Comprehensive Income (Loss). The following table summarizes the components of accumulated other comprehensive loss.
September 30, | December 31, | |||||||
(in thousands) | 2006 | 2005 | ||||||
Deferred compensation | $ | (506 | ) | $ | (506 | ) | ||
Net unrealized gains onavailable-for-sale securities | 1,218 | 863 | ||||||
Net unrealized loss relating to hedging activities | (5,386 | ) | (7,873 | ) | ||||
Total | $ | (4,674 | ) | $ | (7,516 | ) | ||
Earnings per Share of Capital. The following table sets forth the computation of earnings per share of capital.
For the three months ended September 30, | For the nine months ended September 30, | |||||||||||||||
(dollars in thousands) | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Net income available to stockholders | $ | 54,694 | $ | 65,104 | $ | 158,334 | $ | 145,369 | ||||||||
Weighted average number of shares of capital used to calculate earnings per share(1) | 32,651 | 29,647 | 31,508 | 27,430 | ||||||||||||
Basic and diluted earnings per share of capital | $ | 1.68 | $ | 2.20 | $ | 5.03 | $ | 5.30 | ||||||||
Note:
(1) Weighted average shares excludes capital stock reclassified as a liability in accordance with SFAS 150.
Note 10 – Derivatives and Hedging Activities
The Bank may enter into interest rate swaps (including callable and putable swaps), swaptions, interest rate cap and floor agreements, and TBA securities (collectively, derivatives) to manage its exposure to changes in interest rates. Through derivatives, the Bank may adjust the effective maturity, repricing frequency or option characteristics of financial instruments to achieve risk management objectives. The Bank uses derivatives in several ways: (1) by designating them as either a fair value or cash flow hedge of an underlying financial instrument or a forecasted transaction; (2) by acting as an intermediary; or (3) in asset / liability management (i.e., an economic hedge). For example, the Bank uses derivatives in its overall interest rate risk management to adjust the interest rate sensitivity of consolidated obligations to approximate more closely the interest rate sensitivity of assets (loans to members, investment securities, and mortgage loans),and/or to adjust the interest rate sensitivity of loans to members, investment securities, or mortgage loans to approximate more closely the interest rate sensitivity of liabilities. In addition to using derivatives to manage mismatches of interest rates between assets and liabilities, the Bank also uses derivatives as follows: (1) to manage embedded options in assets and liabilities; (2) to hedge the market value
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of existing assets and liabilities and anticipated transactions; (3) to hedge the duration risk of prepayable instruments; (4) to exactly offset other derivatives executed with members (the Bank serves as an intermediary); and (5) to reduce funding costs.
Consistent with Finance Board regulation, the Bank enters into derivatives only to reduce the interest rate risk exposures inherent in otherwise unhedged assets and funding positions, to achieve the Bank’s risk management objectives or to act as an intermediary between its members and counterparties. Bank management uses derivatives when they are considered to be the most cost-effective alternative to achieve the Bank’s financial and risk management objectives. Accordingly, the Bank may enter into derivatives that do not necessarily qualify for hedge accounting (economic hedges). An economic hedge is defined as a derivative hedging specific or non-specific underlying assets, liabilities or firm commitments that does not qualify or was not designated for hedge accounting, but is an acceptable hedging strategy under the Bank’s risk management program. Economic hedging strategies also comply with Finance Board regulatory requirements prohibiting speculative hedge transactions. By definition, an economic hedge introduces the potential for earnings variability due to the changes in fair value recorded on the derivatives that are recorded but not offset by corresponding changes in the value of the economically hedged assets, liabilities or firm commitments. As a result, the Bank recognizes only the change in fair value of these derivatives in other income as “net gain (loss) on derivatives and hedging activities” with no offsetting fair value adjustments for the asset, liability or firm commitment.
The components of net gain (loss) on derivatives and hedging activities for the three and nine months ended September 30, 2006 and 2005 are presented in the following table.
Net Gain (Loss) on Derivatives and Hedging Activities
For the three months ended | For the nine months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
(in thousands) | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Gain (loss) related to fair value hedge ineffectiveness | $ | 5,121 | $ | 1,415 | $ | 6,601 | $ | 7,337 | ||||||||
Gain (loss) related to cash flow hedge ineffectiveness | - | 5 | - | 5 | ||||||||||||
Gain (loss) on economic hedges | (7,296 | ) | 22,687 | (3,639 | ) | (2,262 | ) | |||||||||
Other | 668 | 303 | 659 | (304 | ) | |||||||||||
Gain (loss) on intermediary hedges | (3 | ) | (76 | ) | (102 | ) | (298 | ) | ||||||||
Net gain (loss) on derivatives and hedging activities | $ | (1,510 | ) | $ | 24,334 | $ | 3,519 | $ | 4,478 | |||||||
The fluctuations in the various gain (loss) categories in the table above were primarily due to changes in the structure of the Bank’s portfolio as well as changes in interest rate movements during the third quarter of 2006 compared to the third quarter of 2005. As of September 30, 2006, the deferred net losses on derivative instruments accumulated in other comprehensive income expected to be reclassified to earnings during the next twelve months was $3.1 million. Normally, the maximum length of time over which the Bank hedges its exposure to the variability in future cash flows for forecasted transactions, excluding those forecasted transactions related to the payment of variable interest on existing financial instruments, is 45 days or less. The Bank did not have any hedges related to the exposure to the variability in future cash flows for forecasted transactions at September 30, 2006.
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The following table represents outstanding notional balances and estimated fair values of the derivatives outstanding at September 30, 2006 and December 31, 2005.
September 30, 2006 | December 31, 2005 | |||||||||||||||
Estimated | Estimated | |||||||||||||||
(in thousands) | Notional | Fair Value | Notional | Fair Value | ||||||||||||
Interest rate swaps | ||||||||||||||||
Fair value | $ | 67,237,512 | $ | 83,779 | $ | 62,959,218 | $ | (73,529 | ) | |||||||
Economic | 1,461,119 | (1,925 | ) | 3,333,667 | (9,761 | ) | ||||||||||
Intermediation | 32,290 | 42 | 94,442 | 147 | ||||||||||||
Interest rate swaptions | ||||||||||||||||
Economic | 1,200,000 | - | 525,000 | 650 | ||||||||||||
Interest rate forward settlement agreements | ||||||||||||||||
Fair value | 214,000 | (337 | ) | 1,056,000 | 1,452 | |||||||||||
Mortgage delivery commitments | ||||||||||||||||
Economic | 8,068 | 45 | 17,727 | (13 | ) | |||||||||||
Other | ||||||||||||||||
Economic | - | - | 11,250 | 13 | ||||||||||||
Total | $ | 70,152,989 | $ | 81,604 | $ | 67,997,304 | $ | (81,041 | ) | |||||||
Total derivatives excluding accrued interest | $ | 81,604 | $ | (81,041 | ) | |||||||||||
Accrued interest | 179,488 | 119,630 | ||||||||||||||
Net derivative balances | $ | 261,092 | $ | 38,589 | ||||||||||||
Net derivative asset balances | $ | 438,948 | $ | 317,033 | ||||||||||||
Net derivative liability balances | (177,856 | ) | (278,444 | ) | ||||||||||||
Net derivative balances | $ | 261,092 | $ | 38,589 | ||||||||||||
Hedge Documentation and Effectiveness. The Bank formally documents all relationships between derivatives designated as hedging instruments and hedged items, its risk management objectives and strategies for undertaking various hedge transactions, and its method of assessing effectiveness. This process includes linking all derivatives that are designated as fair value or cash flow hedges to: (1) assets and liabilities on the statement of condition; (2) firm commitments; or (3) forecasted transactions. The Bank also formally assesses (both at the hedge’s inception and monthly on an ongoing basis) whether the derivatives that are used in hedging transactions have been effective in offsetting changes in the fair value or cash flows of hedged items and whether those derivatives may be expected to remain effective in future periods. The Bank uses regression analyses to assess the effectiveness of its hedges.
The Bank discontinues hedge accounting prospectively when: (1) it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item (including hedged items such as firm commitments or forecasted transactions); (2) the derivativeand/or the hedged item expires or is sold, terminated, or exercised; (3) it is no longer probable that the forecasted transaction will occur in the originally expected period; (4) a hedged firm commitment no longer meets the definition of a firm commitment; or (5) management determines that designating the derivative as a hedging instrument in accordance with SFAS 133 is no longer appropriate.
The Bank is not a derivative dealer and thus does not trade derivatives for short-term profit.
Investment Securities. The Bank invests in U.S. agency obligations, government-sponsored enterprise obligations, mortgage-backed securities and the taxable portion of state or local agency obligations. The interest rate and prepayment risk associated with these investment securities is managed through a combination of debt issuance and derivatives. The Bank may manage the prepayment and interest rate risk by funding investment
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securities with consolidated obligations that have call features or by hedging the prepayment risk with caps or floors, callable swaps or swaptions. These investment securities may be classified asheld-to-maturity,available-for-sale or trading securities. The Bank does not apply hedge accounting to these transactions.
The Bank may also manage the risk arising from changing market prices or cash flows of investment securities classified as trading by entering into derivatives (economic hedges) that offset the changes in fair value or cash flows of the securities. The market value changes of both the trading securities and the associated derivatives are included in other income in the statement of operations and presented as part of the “net gains (loss) on trading securities” and “net gain (loss) on derivatives and hedging activities.”
Loans to Members. With issuances of certain types of convertible loans to members, the Bank may purchase from the member a put option that enables the Bank to convert a loan to a member from a fixed rate to a floating rate if interest rates increase. Upon conversion, the member has the option to prepay the loan and request the Bank to issue additional loans on new terms. The Bank may hedge a convertible loan to a member by entering into a cancelable derivative with a counterparty pursuant to which the Bank pays a fixed rate and receives a variable rate. This type of hedge is treated as a fair value hedge. The derivative counterparty may cancel the derivative on the put date, which the counterparty normally would exercise in a rising rate environment, and the Bank can convert the loan to a floating rate.
The optionality embedded in certain financial instruments held by the Bank can create interest rate risk. When a member prepays a loan, the Bank could suffer lower future income if the principal portion of the prepaid loan were invested in lower yielding assets that continue to be funded by higher cost debt. To protect against this risk, the Bank generally charges a prepayment fee that makes it financially indifferent to a member’s decision to prepay a loan. When the Bank offers loans (other than short-term) that a member may prepay without a prepayment fee, it usually finances such loans with callable debt or otherwise hedges this option.
Mortgage Loans Held for Portfolio. The Bank invests in fixed-rate mortgage loans. The prepayment options embedded in mortgage loans can result in extensions or contractions in the expected repayment of these loans, depending on changes in estimated prepayment speeds. The Bank manages the interest rate and prepayment risk associated with mortgages through a combination of debt issuance and derivatives. The Bank issues both callable and non-callable debt to achieve cash flow patterns and liability durations similar to those expected on the mortgage loans. The Bank may use derivatives to match the expected prepayment characteristics of the mortgages. The Bank did not apply hedge accounting to these derivatives, referred to as index amortizing swaps, as they only hedged the mortgage loan pools for a partial term. These swaps were terminated in 2005. The Bank has not entered into any of these types of hedging strategies in 2006.
The Bank may also purchase interest rate caps and floors, swaptions and callable swaps to minimize the prepayment risk embedded in the mortgage loans. Although these derivatives are valid economic hedges against the prepayment risk of the loans, they are not specifically linked to individual loans and, therefore, do not receive either fair value or cash flow hedge accounting. The derivatives aremarked-to-market through current period earnings.
Consolidated Obligations. While consolidated obligations are the joint and several obligations of the FHLBanks, each FHLBank has consolidated obligations for which it is the primary obligor. The Bank enters into derivatives to hedge the interest rate risk associated with its specific debt issuances.
For instance, in a typical transaction, fixed-rate consolidated obligations are issued for one or more FHLBanks and the Bank simultaneously enters into a matching derivative in which the counterparty pays fixed cash flows to the Bank designed to mirror in timing and amount the cash outflows the Bank pays on the consolidated obligation. These transactions are treated as fair value hedges. In this typical transaction, the Bank pays a variable cash flow that closely matches the interest payments it receives on short-term or variable-rate loans to members, typically three-month LIBOR. This intermediation between the capital and derivative markets permits the Bank to raise funds at lower costs than would otherwise be available through the issuance of simple fixed- or floating-rate consolidated obligations in the capital markets.
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Anticipated Streams of Future Cash Flows. The Bank may enter into an option to hedge a specified future variable cash stream as a result of rolling over short-term, fixed-rate financial instruments such as consolidated obligation discount notes. The option will effectively cap the variable cash stream at a predetermined target rate. At September 30, 2006 and December 31, 2005, the Bank did not have a position in these types of options.
Firm Commitment Strategies. In accordance with Statement of Financial Accounting Standards SFAS 149,Amendment of Statement 133 on Derivative Instruments and Hedging Activities(SFAS 149), the types of mortgage purchase commitments entered into after June 30, 2003, are considered derivatives. Accordingly, the mortgage purchase commitment is recorded as a derivative asset or derivative liability at fair value, with changes in fair value recognized in the current period earnings. When the mortgage purchase commitment derivative settles, the current market value of the commitment is included with the basis of the mortgage loan and amortized accordingly.
The Bank may also fair value hedge an unrecognized firm commitment to provide a forward starting loan to a member through the use of an interest rate swap. For firm commitments that are not considered regular way trades, the swap will function as the hedging instrument for both the unrecognized firm commitment and the subsequent loan to member in separately designated qualifying hedging relationships.
Anticipated Debt Issuance. The Bank may enter into interest rate swaps for the anticipated issuance offixed-rate consolidated obligation bonds to lock in the cost of funding. The interest rate swap is terminated upon issuance of the fixed-rate bond, with the realized gain or loss on the interest rate swap recorded in other comprehensive income. Realized gains and losses reported in accumulated other comprehensive income (loss) are recognized as earnings in the periods in which earnings are affected by the cash flows of the fixed-rate bonds. The Bank entered into only one anticipated debt forward starting swap transaction during 2005 with a notional balance of $500 million. The derivative was not outstanding as of December 31, 2005.
Intermediation. Derivatives in which the Bank is an intermediary may arise when the Bank enters into derivatives with members and offsetting derivatives with other counterparties to meet the needs of members. Intermediation between members and the capital markets allows smaller members access to the derivatives market. The derivatives used in intermediary activities do not qualify for SFAS 133 hedge accounting treatment and are separatelymarked-to-market through earnings. The net result of the accounting for these derivatives does not significantly affect the operating results of the Bank. These amounts are recorded in other income and presented as “net gain (loss) on derivatives and hedging activities.”
Credit Risk. The Bank is subject to credit risk due to the risk of nonperformance by counterparties to the derivative agreements. The degree of counterparty risk depends on the extent to which master netting arrangements are included in such contracts to mitigate the risk. The Bank manages counterparty credit risk through credit analysis, collateral requirements and adherence to the requirements set forth in the Bank’s policy and Finance Board regulations. Based on credit analyses and collateral requirements, the management of the Bank does not anticipate any material credit losses on its derivative agreements.
The contractual or notional amount of derivatives reflects the involvement of the Bank in the various classes of financial instruments. The notional amount of derivatives does not measure the credit risk exposure of the Bank, and the maximum credit exposure of the Bank is substantially less than the notional amount. The Bank requires collateral agreements on all derivatives that establish collateral thresholds. The maximum credit risk is the estimated cost of replacing the derivative contracts that have a net positive market value if the counterparty defaults, and the related collateral, if any, is of no value to the Bank. This collateral has not been sold or repledged.
At September 30, 2006 and December 31, 2005, the Bank’s maximum credit risk, as defined above, was approximately $438.9 million and $317.0 million, respectively. These totals include $117.4 million and $69.8 million, respectively, of net accrued interest receivable. In determining maximum credit risk, the Bank considers accrued interest receivables and payables, and the legal right to offset derivative assets and liabilities by counterparty. The Bank held securities and cash with a fair value of $328.2 million and $203.4 million as collateral as of September 30, 2006 and December 31, 2005, respectively. Three counterparties comprise 19%, 17% and 17% of the Bank’s total credit risk when measured after consideration for related collateral as of September 30, 2006. Additionally, collateral
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with respect to derivatives with member institutions includes collateral assigned to the Bank, as evidenced by a written security agreement and held by the member institution for the benefit of the Bank.
The Bank transacts most of its derivatives with large banks and major broker-dealers. Some of these banks and broker-dealers or their affiliates buy, sell, and distribute consolidated obligations. See Note 13 for further discussion regarding assets pledged by the Bank to these counterparties.
Note 11 – Transactions with Related Parties
The Bank is a cooperative whose member institutions own the capital stock of the Bank and may receive dividends on their investments. In addition, certain former members that still have outstanding transactions are also required to maintain their investment in Bank capital stock until the transactions mature or are paid off. All loans, including BOB loans, are issued to members and all mortgage loans held for portfolio are purchased from members. The Bank also maintains demand deposit accounts for members primarily to facilitate settlement activities that are directly related to loans to members and mortgage loan purchases. All transactions with members are entered into in the normal course of business. In instances where the member also has an officer who is a director of the Bank, those transactions are subject to the same eligibility and credit criteria, as well as the same terms and conditions, as comparable transactions with other members. In accordance with Statement of Financial Accounting Standards (SFAS) No. 57,Related Party Disclosures, the Bank defines related parties as other FHLBanks in the System, members with capital stock outstanding in excess of 10% of total capital stock outstanding and members that have an officer or director who is a director of the Bank. The following table includes outstanding related party member balances.
September 30, | December 31, | |||||||
(in thousands) | 2006 | 2005 | ||||||
Loans to members | $ | 27,063,012 | $ | 20,939,245 | ||||
Deposits | 25,467 | 31,723 | ||||||
Capital stock | 1,490,753 | 1,119,588 |
The following table summarizes the statement of operations effects corresponding to the above related party member balances.
For the three months ended | For the nine months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
(in thousands) | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Interest income on loans to members | $ | 257,409 | $ | 151,320 | $ | 706,386 | $ | 356,074 | ||||||||
Interest expense on deposits | 373 | 225 | 817 | 1,446 |
Total mortgage loan volume purchased from related party members during third quarter 2006 was $104 thousand. There were no related party mortgage loans purchased during third quarter 2005. Interest income on outstanding mortgage loans purchased was $2.0 million and $2.5 million for the third quarter of 2006 and 2005, respectively.
Total mortgage loan volume purchased from related party members for the nine months ended September 30, 2006 and 2005 was $0.6 million and $1.7 million, respectively. Interest income on outstanding mortgage loans purchased was $6.3 million and $7.8 million for the nine months ended September 30, 2006 and 2005.
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From time to time, the Bank may borrow from or lend to other FHLBanks on a short-term uncollateralized basis. The following table includes gross amounts transacted under these arrangements.
For the three months ended | For the nine months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
(in millions) | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Borrowed from other FHLBanks | $ | 1 | $ | 1,545 | $ | 121 | $ | 7,147 | ||||||||
Repaid to other FHLBanks | 1 | 1,545 | 121 | 7,147 | ||||||||||||
Loaned to other FHLBanks | 50 | - | 400 | - | ||||||||||||
Repaid by other FHLBanks | 50 | - | 400 | - |
On occasion, an FHLBank may transfer its primary debt obligations to another FHLBank, which becomes the primary obligor on the transferred debt upon completion of the transfer. During the nine months ended September 30, 2006, there was no transfer of primary debt obligations. During the nine months ended September 30, 2005, in a series of transactions, the Bank assumed the debt of other FHLBanks having a total par value of $65.0 million and a total fair value of $65.6 million. In addition, during the nine months ended September 30, 2005, the Bank sold debt to another FHLBank having a total par and fair value of $50.0 million.
Previously, the Bank regularly sold participation interests in the mortgage loans purchased from members to the FHLBank of Chicago. For the third quarter of 2006 and 2005, the par values of the mortgage loans participated to the FHLBank of Chicago were $13.3 million and $56.6 million, respectively. For the nine months ended September 30, 2006 and 2005, the par values of the mortgage loans participated to the FHLBank of Chicago were $88.0 million and $260.3 million, respectively. In addition, at September 30, 2006 and December 31, 2005, the Bank had deposits with FHLBank of Chicago totaling $4.8 million and $5.5 million, respectively.
Note 12 – Segments
The Bank operates two segments differentiated by products. The first segment entitled Traditional Member Finance houses a majority of the Bank’s activities, including but not limited to, providing loans to members, investments and deposit products. The MPF Program or Mortgage Finance segment purchases loans from members and funds and hedges the resulting portfolio.
Results of segments are presented based on management accounting practices and the Bank’s management structure. There is no comprehensive, authoritative body of guidance for management accounting equivalent to Generally Accepted Accounting Principles. Therefore, the financial results of the segments are not necessarily comparable with similar information at other FHLBanks or any other company.
The management accounting process uses various balance sheet and income statement assignments and transfers to measure performance of the segment. Methodologies are refined from time to time as management accounting practices change. Net mortgage loans held for portfolio are the only significant assets related to the operations of the Mortgage Finance segment. Borrowings are allocated to the Mortgage Finance segment based on loans outstanding. All remaining borrowings, noninterest-bearing liabilities, and all capital remain in the Traditional Member Finance business. The allowance for credit losses pertaining to the mortgage loans held for portfolio is allocated to the Mortgage Finance segment and the allowance for credit losses pertaining to BOB loans is allocated to Traditional Member Finance. Derivatives are allocated to segments consistent with hedging strategies. Costs incurred by support areas not directly aligned with the segment are allocated based on estimated usage of services.
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The following table sets forth the Bank’s financial performance by operating segment for the three months and nine months ended September 30, 2006 and 2005, respectively.
Three months ended September 30,
Traditional | MPF Program or | |||||||||||
Member | Mortgage | |||||||||||
(in thousands) | Finance | Finance | Total | |||||||||
2006 | ||||||||||||
Net interest income | $ | 83,255 | $ | 6,529 | $ | 89,784 | ||||||
Provision (benefit) for credit losses | 605 | (96 | ) | 509 | ||||||||
Other income (loss) | 4,923 | (4,705 | ) | 218 | ||||||||
Other expense | 13,757 | 1,224 | 14,981 | |||||||||
Income before assessments | 73,816 | 696 | 74,512 | |||||||||
Affordable Housing Program | 6,085 | 57 | 6,142 | |||||||||
REFCORP | 13,548 | 128 | 13,676 | |||||||||
Total assessments | 19,633 | 185 | 19,818 | |||||||||
Net income | $ | 54,183 | $ | 511 | $ | 54,694 | ||||||
Total assets | $ | 71,153,429 | $ | 7,186,803 | $ | 78,340,232 | ||||||
2005 | ||||||||||||
Net interest income | $ | 64,607 | $ | 13,290 | $ | 77,897 | ||||||
Provision (benefit) for credit losses | (207 | ) | 105 | (102 | ) | |||||||
Other income (loss) | (10,389 | ) | 34,625 | 24,236 | ||||||||
Other expense | 12,616 | 988 | 13,604 | |||||||||
Income before assessments | 41,809 | 46,822 | 88,631 | |||||||||
Affordable Housing Program | 3,429 | 3,822 | 7,251 | |||||||||
REFCORP | 7,676 | 8,600 | 16,276 | |||||||||
Total assessments | 11,105 | 12,422 | 23,527 | |||||||||
Net income | $ | 30,704 | $ | 34,400 | $ | 65,104 | ||||||
Total assets | $ | 63,894,795 | $ | 7,976,066 | $ | 71,870,861 | ||||||
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Nine months ended September 30,
Traditional | MPF Program or | |||||||||||
Member | Mortgage | |||||||||||
(in thousands) | Finance | Finance | Total | |||||||||
2006 | ||||||||||||
Net interest income | $ | 232,492 | $ | 22,516 | $ | 255,008 | ||||||
Provision (benefit) for credit losses | 1,359 | (234 | ) | 1,125 | ||||||||
Other income (loss) | 13,201 | (4,657 | ) | 8,544 | ||||||||
Other expense | 43,249 | 3,563 | 46,812 | |||||||||
Income before assessments | 201,085 | 14,530 | 215,615 | |||||||||
Affordable Housing Program | 16,509 | 1,186 | 17,695 | |||||||||
REFCORP | 36,917 | 2,669 | 39,586 | |||||||||
Total assessments | 53,426 | 3,855 | 57,281 | |||||||||
Net income | $ | 147,659 | $ | 10,675 | $ | 158,334 | ||||||
Total assets | $ | 71,153,429 | $ | 7,186,803 | $ | 78,340,232 | ||||||
2005 | ||||||||||||
Net interest income | $ | 165,403 | $ | 67,021 | $ | 232,424 | ||||||
Provision for credit losses | 459 | 373 | 832 | |||||||||
Other income (loss) | 9,063 | (3,525 | ) | 5,538 | ||||||||
Other expense | 36,480 | 2,740 | 39,220 | |||||||||
Income before assessments | 137,527 | 60,383 | 197,910 | |||||||||
Affordable Housing Program | 11,270 | 4,929 | 16,199 | |||||||||
REFCORP | 25,251 | 11,091 | 36,342 | |||||||||
Total assessments | 36,521 | 16,020 | 52,541 | |||||||||
Net income | $ | 101,006 | $ | 44,363 | $ | 145,369 | ||||||
Total assets | $ | 63,894,795 | $ | 7,976,066 | $ | 71,870,861 | ||||||
Note 13 – Commitments and Contingencies
As described in Note 8, the twelve FHLBanks have joint and several liability for all the consolidated obligations issued on their behalf. Accordingly, should one or more of the FHLBanks be unable to repay its participation in the consolidated obligations, each of the other FHLBanks could be called upon to repay all or part of such obligations, as determined or approved by the Finance Board. No FHLBank has had to assume or pay the consolidated obligation of another FHLBank. The Finance Board, in its discretion and notwithstanding any other provision, may at any time order any FHLBank to make principal or interest payments due on any consolidated obligation, even in the absence of default by the primary obligor.
The Bank considered the guidance under FASB Interpretation No. 45,Guarantor’s Accounting and Disclosure Requirements for Guarantees, including indirect guarantees of indebtedness of others(FIN 45), and determined it was not necessary to recognize the fair value of the FHLBank’s joint and several liability for all of the consolidated obligations. The Bank considers the joint and several liability as a related party guarantee. Related party guarantees meet the recognition scope exceptions in FIN 45. Accordingly, the Bank has not recognized a liability for its joint and several obligation related to other FHLBanks’ consolidated obligations at September 30, 2006 and December 31, 2005.
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Commitments that legally bind and unconditionally obligate the Bank for additional loans to members, including Banking On Business (BOB) loans, totaled approximately $239.8 million and $1,067.3 million at September 30, 2006 and December 31, 2005, respectively. Commitments generally are for periods up to twelve months. Standby letters of credit are issued for members for a fee. A standby letter of credit is a short-term financing arrangement between the Bank and its member. If the Bank is required to make payment for a beneficiary’s draw, these amounts are converted into a collateralized loan to the member. Outstanding standby letters of credit were approximately $1,047.6 million and $892.8 million at September 30, 2006 and December 31, 2005, respectively, and had original terms of up to six years with a final expiration in 2007. Based on management’s credit analyses, collateral requirements, and adherence to the requirements set forth in Bank policy and Finance Board regulations, the Bank has not recorded any additional liability on these commitments and standby letters of credit. Excluding BOB, commitments and standby letters of credit are fully collateralized at the time of issuance. See Note 6 for further information.
Commitments that unconditionally obligate the Bank to purchase mortgage loans totaled $8.1 million and $17.7 million at September 30, 2006 and December 31, 2005, respectively. Commitments are generally for periods not to exceed 365 days. In accordance with SFAS 149, such commitments entered into after June 30, 2003, are recorded as derivatives at their fair value.
The Bank generally executes derivatives with major banks and broker-dealers and generally enters into bilateral collateral agreements. The Bank had pledged as collateral cash to counterparties that have market risk exposure from the Bank related to derivative agreements. The Bank had no cash pledged at September 30, 2006 and $1.4 million cash pledged at December 31, 2005. There were no securities pledged as of September 30, 2006 and December 31, 2005.
The Bank charged to operating expense rental costs of approximately $0.9 million and $0.7 million for the three months ended September 30, 2006 and 2005, respectively, and $2.5 million and $1.9 million for the nine months ended September 30, 2006 and 2005, respectively.
Lease agreements for Bank premises generally provide for increases in the basic rentals resulting from increases in property taxes and maintenance expenses. Such increases are not expected to have a material effect on the Bank.
As of September 30, 2006, the Bank has committed to issue or purchase consolidated obligations totaling $690 million in 2006. As of December 31, 2005, the Bank had committed to issue or purchase consolidated obligations totaling $163 million and derivative notional value of $40 million in 2006.
Note 14 – Estimated Fair Values
The following estimated fair value amounts have been determined by the Bank using available market information and the Bank’s best judgment of appropriate valuation methods. These estimates are based on pertinent information available to the Bank as of September 30, 2006 and December 31, 2005. Although the Bank uses its best judgment in estimating the fair value of these financial instruments, there are inherent limitations in any estimation technique or valuation methodology. For example, because an active secondary market does not exist for a portion of the Bank’s financial instruments, in certain cases fair values are not subject to precise quantification or verification and may change as economic and market factors and evaluation of those factors change. Therefore, these estimated fair values are not necessarily indicative of the amounts that would be realized in current market transactions. The fair value summary tables do not represent an estimate of the overall market value of the Bank as a going concern, which would take into account future business opportunities.
Cash and Due From Banks. The estimated fair value approximates the recorded book balance.
Interest-bearing Deposits and Investment Securities. The estimated fair value is determined based on quoted prices, excluding accrued interest, as of the last business day of the period for instruments with more than three months to maturity. When quoted prices are not available, the estimated fair value is determined by calculating
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the present value of the expected future cash flows and reducing the amount for accrued interest receivable. For instruments with three months or less to maturity, the recorded book balance approximates the estimated fair value.
Federal Funds Sold. The estimated fair value is determined by calculating the present value of the expected future cash flows for instruments with more than three months to maturity. The discount rates used in these calculations are the rates for Federal funds with similar terms. The estimated fair value approximates the recorded book balance of Federal funds with three months or less to maturity.
Loans to Members and Other Loans. The Bank determines the estimated fair value of loans to members with fixed rates and more than three months to maturity and loans to members with complex floating rates by calculating the present value of expected future cash flows from the loans and excluding the amount for accrued interest receivable. The discount rates used in these calculations are the replacement loan rates for loans to members with similar terms. Under Finance Board regulations, loans to members with a maturity and repricing period greater than six months require a prepayment fee sufficient to make the Bank financially indifferent to the borrower’s decision to prepay the loans. Therefore, the estimated fair value of loans to members does not assume prepayment risk. The estimated fair value approximates the recorded book balance of loans to members with floating rates and fixed rates with three months or less to maturity or repricing.
Mortgage Loans Held for Portfolio. The estimated fair values for mortgage loans are determined based on quoted market prices of similar mortgage loans. These prices, however, can change rapidly based upon market conditions and are highly dependent upon the underlying prepayment assumptions.
Accrued Interest Receivable and Payable. The estimated fair value approximates the recorded book value. Derivative accrued interest receivable and payable are excluded and are valued as described below.
Derivative Assets/Liabilities. The Bank bases the estimated fair values of derivatives with similar terms on available market prices including derivative accrued interest receivable and payable. However, active markets do not exist for many types of financial instruments. Consequently, fair values for these instruments must be estimated using techniques such as discounted cash flow analysis and comparisons to similar instruments. Estimates developed using these methods are highly subjective and require judgments regarding significant matters such as the amount and timing of future cash flows and the selection of discount rates that appropriately reflect market and credit risks. Changes in these judgments often have a material effect on the fair value estimates. Because these estimates are made as of a specific point in time, they are susceptible to material near term changes. The fair values are netted by counterparty where such legal right exists. If these netted amounts are positive, they are classified as an asset and if negative, a liability.
Other Assets/Liabilities. With the exception of unamortized concession fees for which fair value is considered to be zero, the fair value of the other assets (including BOB loans) and other liabilities approximates carrying value.
Deposits. The Bank determines estimated fair values of Bank deposits with fixed rates and more than three months to maturity 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. The estimated fair value approximates the recorded book balance for deposits with floating rates and fixed rates with three months or less to maturity or repricing.
Consolidated Obligations. The Bank estimates fair values based on the cost of raising comparable term debt. The estimated cost of issuing debt includes non-interest selling costs.
Borrowings. The Bank determines the estimated fair value of borrowings with fixed rates and more than three months to maturity by calculating the present value of expected future cash flows from the borrowings and reducing this amount for accrued interest payable. The discount rates used in these calculations are the cost of borrowings with similar terms. For borrowings with floating rates and fixed rates with three months or less to maturity or repricing, the estimated fair value approximates the recorded book balance.
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Mandatorily Redeemable Capital Stock. The fair value of capital stock subject to mandatory redemption is generally equal to par value. Fair value also includes the estimated dividend earned at the time of reclassification from equity to liabilities, until such amount is paid, and any subsequently declared dividends. Capital stock can be acquired by members only at par value and redeemed or repurchased at par value. Capital stock is not traded and no market mechanism exists for the exchange of stock outside the cooperative structure of the Bank.
Commitments. The estimated fair value of the Bank’s unrecognized commitments to extend credit, including standby letters of credit, was immaterial at September 30, 2006 and December 31, 2005. The estimated fair value of the Bank’s commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The estimated fair value of standby letters of credit is based on the present value of fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties.
Commitments to Extend Credit for Mortgage Loans. In accordance with SFAS 149, certain mortgage loan purchase commitments entered into after June 30, 2003, are recorded as derivatives at their fair value.
The carrying value and estimated fair values of the Bank’s financial instruments at September 30, 2006 and December 31, 2005 are presented in the tables below.
September 30, 2006
Fair Value Summary Table
Fair Value Summary Table
Net | ||||||||||||
Carrying | Unrealized | Estimated | ||||||||||
(in thousands) | Value | Gains (Losses) | Fair Value | |||||||||
Assets | ||||||||||||
Cash and due from banks | $ | 72,180 | $ | - | $ | 72,180 | ||||||
Interest-bearing deposits | 3,859,782 | (1,201 | ) | 3,858,581 | ||||||||
Federal funds sold | 4,120,000 | 14 | 4,120,014 | |||||||||
Available-for-sale securities | 86,917 | - | 86,917 | |||||||||
Held-to-maturity securities | 12,347,117 | (196,755 | ) | 12,150,362 | ||||||||
Loans to members | 49,730,817 | (35,125 | ) | 49,695,692 | ||||||||
Mortgage loans held for portfolio, net | 7,186,803 | (168,511 | ) | 7,018,292 | ||||||||
Accrued interest receivable | 410,503 | - | 410,503 | |||||||||
Derivative assets | 438,948 | - | 438,948 | |||||||||
Other assets, including Banking On Business loans | 87,165 | (37,032 | ) | 50,133 | ||||||||
Liabilities | ||||||||||||
Deposits | $ | 974,525 | $ | - | $ | 974,525 | ||||||
Mandatorily redeemable capital stock | 13,472 | - | 13,472 | |||||||||
Consolidated obligations: | ||||||||||||
Discount notes | 16,064,138 | (296 | ) | 16,063,842 | ||||||||
Bonds | 56,763,725 | (228,538 | ) | 56,535,187 | ||||||||
Accrued interest payable | 571,224 | - | 571,224 | |||||||||
Derivative liabilities | 177,856 | - | 177,856 | |||||||||
Other liabilities | 102,723 | - | 102,723 |
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Notes to Unaudited Financial Statements (continued)
December 31, 2005
Fair Value Summary Table
Fair Value Summary Table
Net | ||||||||||||
Carrying | Unrealized | Estimated | ||||||||||
(in thousands) | Value | Gains (Losses) | Fair Value | |||||||||
Assets | ||||||||||||
Cash and due from banks | $ | 115,370 | $ | - | $ | 115,370 | ||||||
Interest-bearing deposits | 3,259,894 | (1,077 | ) | 3,258,817 | ||||||||
Federal funds sold | 2,320,000 | (504 | ) | 2,319,496 | ||||||||
Available-for-sale securities | 331,297 | - | 331,297 | |||||||||
Held-to-maturity securities | 11,034,630 | (206,246 | ) | 10,828,384 | ||||||||
Loans to members | 47,492,959 | 50,546 | 47,543,505 | |||||||||
Mortgage loans held for portfolio, net | 7,651,914 | (243,562 | ) | 7,408,352 | ||||||||
Accrued interest receivable | 304,193 | - | 304,193 | |||||||||
Derivative assets | 317,033 | - | 317,033 | |||||||||
Other assets, including Banking On Business loans | 70,921 | (38,447 | ) | 32,474 | ||||||||
Liabilities | ||||||||||||
Deposits | $ | 1,063,091 | $ | - | $ | 1,063,091 | ||||||
Mandatorily redeemable capital stock | 16,731 | - | 16,731 | |||||||||
Consolidated obligations: | ||||||||||||
Discount notes | 14,580,400 | (2,121 | ) | 14,578,279 | ||||||||
Bonds | 53,142,937 | 155,123 | 53,298,060 | |||||||||
Accrued interest payable | 436,214 | - | 436,214 | |||||||||
Derivative liabilities | 278,444 | - | 278,444 | |||||||||
Other liabilities | 120,848 | - | 120,848 |
Note 15 – Other Developments
The Bank is subject to 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 Bank’s financial condition or results of operations.
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Item 3: Quantitative and Qualitative Disclosures about Market Risk
See “Management’s Discussion and Analysis of Results of Operations and Financial Condition — Risk Management” in Part 1 — Item 2 of thisForm 10-Q.
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Item 4: Controls and Procedures
Disclosure Controls and Procedures
Under the supervision and with the participation of the Bank’s management, including its principal executive officer and principal financial officer, the Bank conducted an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures, as defined inRules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended, as of September 30, 2006. Based on this evaluation, the Bank’s principal executive officer and principal financial officer concluded that the Bank’s disclosure controls and procedures were effective to ensure that such information relating to the Bank that is required to be disclosed in reports filed with the SEC (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to the Bank’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. There was a material weakness that management identified during 2005 that led to the restatement of certain financial information primarily related to the accounting for derivatives, as discussed in the Bank’s registration statement on Form 10, as amended. See Restatement of Financial Statements in Management’s Discussion and Analysis in Item 2 of the Form 10 for a complete discussion of the material weakness determination. Several actions have since been taken to address this material weakness, including (1) increasing the level of technical expertise among accounting, capital markets and risk management personnel in regard to the proper application of SFAS 133; and (2) creating and disseminating well-documented SFAS 133 accounting policies. Management believes that this material weakness has been fully remediated as of November 9, 2006. However, testing of the related operating controls will take place in conjunction with the filing of the Bank’s 2006Form 10-K.
Internal Control Over Financial Reporting
For the third quarter of 2006, there were no changes in the Bank’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Bank’s internal control over financial reporting.
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Part II — Other Information
Item 1: Legal Proceedings
The Bank may be subject to various legal proceedings arising in the normal course of business. After consultation with legal counsel, management is not aware of any such proceedings that might result in the Bank’s ultimate liability in an amount that will have a material effect on the Bank’s financial condition or results of operations.
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Item 1A: Risk Factors
Management believes that there has been no material change to the Bank’s Risk Factors since December 31, 2005 as presented in Item 1A, Risk Factors of the Bank’s Form 10, as amended, except as noted below.
FHLB System Ratings | ||||||||||||||||
Moody’s Investor Service | Last Update | Standard & Poor’s | Last Update | |||||||||||||
Consolidated obligation discount notes | P-1 | 7/18/94 | A-1+ | 9/23/97 | ||||||||||||
Consolidated obligation bonds | Aaa | 1/31/94 | AAA | 9/23/00 |
Federal Home Loan Bank Ratings | ||||||||||||||||
Moody’s Senior | S&P Senior | |||||||||||||||
Unsecured Long-Term | Unsecured Long-Term | |||||||||||||||
FHLBank | Debt Rating/Outlook | Last Update | Debt Rating/Outlook | Last Update | ||||||||||||
Atlanta | Aaa/Stable | 6/1/88 | AAA/Stable | 4/19/05 | ||||||||||||
Boston | Aaa/Stable | 6/1/88 | AAA/Stable | 4/18/96 | ||||||||||||
Chicago | Aaa/Stable | 9/2/88 | AA+/Negative | 7/01/04 | ||||||||||||
Cincinnati | Aaa/Stable | 3/9/95 | AAA/Stable | 4/18/96 | ||||||||||||
Dallas | Aaa/Stable | 7/23/99 | AAA/Stable | 9/21/06 | ||||||||||||
Des Moines | Aaa/Stable | 9/16/02 | AAA/Negative | 9/21/06 | ||||||||||||
Indianapolis | Aaa/Stable | 6/1/88 | AAA/Negative | 11/17/03 | ||||||||||||
New York | Aaa/Stable | 6/1/88 | AAA/Stable | 9/21/06 | ||||||||||||
Pittsburgh | Aaa/Stable | 4/27/95 | AAA/Stable | 9/21/06 | ||||||||||||
San Francisco | Aaa/Stable | 6/1/88 | AAA/Stable | 4/18/96 | ||||||||||||
Seattle | Aaa/Stable | 6/1/88 | AA+/Negative | 4/19/05 | ||||||||||||
Topeka | Aaa/Stable | 8/5/88 | AAA/Stable | 11/08/99 |
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Item 6: Exhibits
Exhibit 31(a) | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Chief Executive Officer | |
Exhibit 31(b) | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Chief Financial Officer | |
Exhibit 32(a) | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for the Chief Executive Officer | |
Exhibit 32(b) | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for the Chief Financial Officer |
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Federal Home Loan Bank of Pittsburgh
(Registrant)
Date: November 9, 2006
By: | /s/ Kristina K. Williams |
Kristina K. Williams
Chief Financial Officer
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