UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2007
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 000-51402
FEDERAL HOME LOAN BANK OF BOSTON
(Exact name of registrant as specified in its charter)
Federally chartered corporation |
| 04-6002575 |
(State or other jurisdiction of incorporation or organization) |
| (I.R.S. employer identification number) |
|
|
|
111 Huntington Avenue |
|
|
Boston, MA |
| 02199 |
(Address of principal executive offices) |
| (Zip code) |
(617) 292-9600
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o |
| Accelerated filer o |
| Non-accelerated filer x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes x No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
| Shares outstanding | |
|
| as of July 31, 2007 |
Class B Stock, par value $100 |
| 24,986,188 |
Federal Home Loan Bank of Boston
Form 10-Q
Table of Contents
|
| 1 | ||
|
|
|
|
|
|
| 1 | ||
|
|
| 1 | |
|
|
| 2 | |
|
|
| 3 | |
|
|
| 5 | |
|
|
| 6 | |
|
|
|
|
|
| Management’s Discussion and Analysis of Financial Condition and Results of Operations |
| 20 | |
|
|
| 20 | |
|
|
| 21 | |
|
|
| 22 | |
|
|
| 30 | |
|
|
| 39 | |
|
|
| 42 | |
|
|
| 42 | |
|
|
| 42 | |
|
|
| 43 | |
|
|
|
|
|
|
| 43 | ||
|
|
|
|
|
|
| 54 | ||
|
|
|
|
|
|
| 54 | ||
|
|
|
|
|
|
| 55 | ||
|
|
|
|
|
|
| 55 | ||
|
|
|
|
|
|
| 55 | ||
|
|
|
|
|
|
| 55 | ||
|
|
|
|
|
|
| 55 | ||
|
|
|
|
|
|
| 55 | ||
|
|
|
|
|
|
| 55 | ||
|
|
|
|
|
|
| 55 | ||
|
|
|
|
|
| 55 |
i
Item 1. Financial Statements
FEDERAL HOME LOAN BANK OF BOSTON
(dollars and shares in thousands, except par value)
(unaudited)
|
| June 30, |
| December 31, |
| ||
|
| 2007 |
| 2006 |
| ||
ASSETS |
|
|
|
|
| ||
Cash and due from banks |
| $ | 6,048 |
| $ | 8,197 |
|
Interest-bearing deposits in banks |
| 1,030,050 |
| 940,050 |
| ||
Securities purchased under agreements to resell |
| 2,000,000 |
| 3,250,000 |
| ||
Federal funds sold |
| 5,138,000 |
| 2,606,500 |
| ||
Investments: |
|
|
|
|
| ||
Trading securities |
| 126,080 |
| 151,362 |
| ||
Available-for-sale securities - includes $0 and $54,151 pledged as collateral at June 30, 2007, and December 31, 2006, respectively, that may be repledged |
| 938,516 |
| 988,058 |
| ||
Held-to-maturity securities (a) |
| 7,485,740 |
| 7,306,191 |
| ||
Advances |
| 38,849,820 |
| 37,342,125 |
| ||
Mortgage loans held for portfolio, net of allowance for credit losses of $125 at June 30, 2007, and December 31, 2006 |
| 4,262,671 |
| 4,502,182 |
| ||
Accrued interest receivable |
| 218,635 |
| 213,934 |
| ||
Premises, software, and equipment, net |
| 5,957 |
| 6,370 |
| ||
Derivative assets |
| 174,391 |
| 128,373 |
| ||
Other assets |
| 27,411 |
| 26,439 |
| ||
|
|
|
|
|
| ||
Total Assets |
| $ | 60,263,319 |
| $ | 57,469,781 |
|
|
|
|
|
|
| ||
LIABILITIES |
|
|
|
|
| ||
Deposits: |
|
|
|
|
| ||
Interest-bearing |
| $ | 1,038,094 |
| $ | 1,119,051 |
|
Non-interest-bearing |
| 6,815 |
| 4,958 |
| ||
Total deposits |
| 1,044,909 |
| 1,124,009 |
| ||
|
|
|
|
|
| ||
Consolidated obligations, net: |
|
|
|
|
| ||
Bonds |
| 37,595,157 |
| 35,518,442 |
| ||
Discount notes |
| 18,306,460 |
| 17,723,515 |
| ||
Total consolidated obligations, net |
| 55,901,617 |
| 53,241,957 |
| ||
|
|
|
|
|
| ||
Mandatorily redeemable capital stock |
| 4,288 |
| 12,354 |
| ||
Accrued interest payable |
| 412,864 |
| 357,600 |
| ||
Affordable Housing Program (AHP) |
| 46,688 |
| 44,971 |
| ||
Payable to Resolution Funding Corporation (REFCorp) |
| 10,034 |
| 13,275 |
| ||
Derivative liabilities |
| 54,746 |
| 120,561 |
| ||
Other liabilities |
| 159,900 |
| 22,540 |
| ||
|
|
|
|
|
| ||
Total liabilities |
| 57,635,046 |
| 54,937,267 |
| ||
Commitments and contingencies (Note 15) |
|
|
|
|
| ||
|
|
|
|
|
| ||
CAPITAL |
|
|
|
|
| ||
Capital stock – Class B – putable ($100 par value), 24,277 shares and 23,425 shares issued and outstanding at June 30, 2007, and December 31, 2006, respectively |
| 2,427,656 |
| 2,342,517 |
| ||
Retained earnings |
| 192,346 |
| 187,304 |
| ||
Accumulated other comprehensive income: |
|
|
|
|
| ||
Net unrealized gain on available-for-sale securities |
| 9,988 |
| 3,290 |
| ||
Net unrealized gain relating to hedging activities |
| 1,195 |
| 1,884 |
| ||
Pension and postretirement benefits |
| (2,912 | ) | (2,481 | ) | ||
|
|
|
|
|
| ||
Total capital |
| 2,628,273 |
| 2,532,514 |
| ||
|
|
|
|
|
| ||
Total Liabilities and Capital |
| $ | 60,263,319 |
| $ | 57,469,781 |
|
(a) Fair values of held-to-maturity securities were $7,479,317 and $7,308,008 at June 30, 2007, and December 31, 2006, respectively.
The accompanying notes are an integral part of these financial statements.
1
FEDERAL HOME LOAN BANK OF BOSTON
(dollars in thousands)
(unaudited)
|
| For the Three Months Ended June 30, |
| For the Six Months Ended June 30, |
| ||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
INTEREST INCOME |
|
|
|
|
|
|
|
|
| ||||
Advances |
| $ | 512,146 |
| $ | 499,724 |
| $ | 997,875 |
| $ | 956,899 |
|
Prepayment fees on advances, net |
| 1,815 |
| 13 |
| 2,485 |
| (266 | ) | ||||
Interest-bearing deposits in banks |
| 18,453 |
| 17,229 |
| 36,976 |
| 37,181 |
| ||||
Securities purchased under agreements to resell |
| 17,105 |
| 4,686 |
| 44,842 |
| 11,405 |
| ||||
Federal funds sold |
| 65,971 |
| 46,283 |
| 105,222 |
| 89,100 |
| ||||
Investments: |
|
|
|
|
|
|
|
|
| ||||
Trading securities |
| 1,935 |
| 2,869 |
| 4,006 |
| 5,868 |
| ||||
Available-for-sale securities |
| 11,816 |
| 11,096 |
| 23,537 |
| 21,115 |
| ||||
Held-to-maturity securities |
| 97,607 |
| 85,700 |
| 195,885 |
| 163,779 |
| ||||
Prepayment fees on investments |
| 728 |
| 754 |
| 2,660 |
| 2,513 |
| ||||
Mortgage loans held for portfolio |
| 54,952 |
| 60,112 |
| 111,247 |
| 120,739 |
| ||||
Other |
| — |
| 7 |
| — |
| 7 |
| ||||
Total interest income |
| 782,528 |
| 728,473 |
| 1,524,735 |
| 1,408,340 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
INTEREST EXPENSE |
|
|
|
|
|
|
|
|
| ||||
Consolidated obligations: |
|
|
|
|
|
|
|
|
| ||||
Bonds |
| 443,870 |
| 343,278 |
| 866,932 |
| 651,791 |
| ||||
Discount notes |
| 254,781 |
| 302,476 |
| 492,900 |
| 594,562 |
| ||||
Deposits |
| 11,331 |
| 6,066 |
| 22,135 |
| 10,853 |
| ||||
Mandatorily redeemable capital stock |
| 185 |
| 188 |
| 436 |
| 310 |
| ||||
Other borrowings |
| 45 |
| 121 |
| 49 |
| 293 |
| ||||
Total interest expense |
| 710,212 |
| 652,129 |
| 1,382,452 |
| 1,257,809 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
NET INTEREST INCOME |
| 72,316 |
| 76,344 |
| 142,283 |
| 150,531 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Reduction of provision for credit losses |
| (9 | ) | (18 | ) | (9 | ) | (73 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
NET INTEREST INCOME AFTER REDUCTION OF PROVISION FOR CREDIT LOSSES |
| 72,325 |
| 76,362 |
| 142,292 |
| 150,604 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
OTHER INCOME (LOSS) |
|
|
|
|
|
|
|
|
| ||||
Loss on early extinguishment of debt |
| (641 | ) | — |
| (641 | ) | (215 | ) | ||||
Service fees |
| 937 |
| 802 |
| 2,003 |
| 1,335 |
| ||||
Net unrealized loss on trading securities |
| (785 | ) | (1,055 | ) | (859 | ) | (2,648 | ) | ||||
Net (loss) gain on derivatives and hedging activities |
| (3,979 | ) | (144 | ) | (2,983 | ) | 769 |
| ||||
Other |
| 9 |
| 13 |
| 11 |
| (17 | ) | ||||
Total other loss |
| (4,459 | ) | (384 | ) | (2,469 | ) | (776 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
OTHER EXPENSE |
|
|
|
|
|
|
|
|
| ||||
Operating |
| 12,055 |
| 11,130 |
| 23,614 |
| 21,773 |
| ||||
Finance Board and Office of Finance |
| 897 |
| 840 |
| 1,964 |
| 1,742 |
| ||||
Other |
| 264 |
| 286 |
| 537 |
| 560 |
| ||||
Total other expense |
| 13,216 |
| 12,256 |
| 26,115 |
| 24,075 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
INCOME BEFORE ASSESSMENTS |
| 54,650 |
| 63,722 |
| 113,708 |
| 125,753 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
AHP |
| 4,480 |
| 5,221 |
| 9,327 |
| 10,297 |
| ||||
REFCorp |
| 10,034 |
| 11,700 |
| 20,876 |
| 23,091 |
| ||||
Total assessments |
| 14,514 |
| 16,921 |
| 30,203 |
| 33,388 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
NET INCOME |
| $ | 40,136 |
| $ | 46,801 |
| $ | 83,505 |
| $ | 92,365 |
|
The accompanying notes are an integral part of these financial statements.
2
FEDERAL HOME LOAN BANK OF BOSTON
THREE MONTHS ENDED JUNE 30, 2007 AND 2006
(dollars and shares in thousands)
(unaudited)
|
| Capital Stock |
| Retained |
| Accumulated |
| Total |
| ||||||
|
| Shares |
| Par Value |
| Earnings |
| Income |
| Capital |
| ||||
|
|
|
|
|
|
|
|
|
|
|
| ||||
BALANCE, MARCH 31, 2006 |
| 27,090 |
| $ | 2,709,033 |
| $ | 146,502 |
| $ | 14,150 |
| $ | 2,869,685 |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Proceeds from sale of capital stock |
| 866 |
| 86,637 |
|
|
|
|
| 86,637 |
| ||||
Repurchase/redemption of capital stock |
| (2,544 | ) | (254,452 | ) |
|
|
|
| (254,452 | ) | ||||
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
| ||||
Net income |
|
|
|
|
| 46,801 |
|
|
| 46,801 |
| ||||
Other comprehensive income: |
|
|
|
|
|
|
|
|
|
|
| ||||
Net unrealized gains on available-for-sale securities |
|
|
|
|
|
|
| 4,786 |
| 4,786 |
| ||||
Reclassification adjustment for previously deferred hedging gains and losses included in income |
|
|
|
|
|
|
| (471 | ) | (471 | ) | ||||
Total comprehensive income |
|
|
|
|
|
|
|
|
| 51,116 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
| ||||
BALANCE, JUNE 30, 2006 |
| 25,412 |
| $ | 2,541,218 |
| $ | 193,303 |
| $ | 18,465 |
| $ | 2,752,986 |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
BALANCE, MARCH 31, 2007 |
| 23,790 |
| $ | 2,378,964 |
| $ | 190,881 |
| $ | 3,612 |
| $ | 2,573,457 |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Proceeds from sale of capital stock |
| 545 |
| 54,468 |
|
|
|
|
| 54,468 |
| ||||
Repurchase/redemption of capital stock |
| (58 | ) | (5,776 | ) |
|
|
|
| (5,776 | ) | ||||
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
| ||||
Net income |
|
|
|
|
| 40,136 |
|
|
| 40,136 |
| ||||
Other comprehensive income: |
|
|
|
|
|
|
|
|
|
|
| ||||
Net unrealized gains on available-for-sale securities |
|
|
|
|
|
|
| 5,475 |
| 5,475 |
| ||||
Reclassification adjustment for previously deferred hedging gains and losses included in income |
|
|
|
|
|
|
| (318 | ) | (318 | ) | ||||
Minimum pension liability adjustment |
|
|
|
|
|
|
| (498 | ) | (498 | ) | ||||
Total comprehensive income |
|
|
|
|
|
|
|
|
| 44,795 |
| ||||
Cash dividends on capital stock (6.75%) (1) |
|
|
|
|
| (38,671 | ) |
|
| (38,671 | ) | ||||
|
|
|
|
|
|
|
|
|
|
|
| ||||
BALANCE, JUNE 30, 2007 |
| 24,277 |
| $ | 2,427,656 |
| $ | 192,346 |
| $ | 8,271 |
| $ | 2,628,273 |
|
(1) Dividend rate is annualized.
The accompanying notes are an integral part of these financial statements.
3
FEDERAL HOME LOAN BANK OF BOSTON
STATEMENTS OF CAPITAL
SIX MONTHS ENDED JUNE 30, 2007 AND 2006
(dollars and shares in thousands)
(unaudited)
|
| Capital Stock |
| Retained |
| Accumulated |
| Total |
| ||||||
|
| Shares |
| Par Value |
| Earnings |
| Income |
| Capital |
| ||||
|
|
|
|
|
|
|
|
|
|
|
| ||||
BALANCE, DECEMBER 31, 2005 |
| 25,311 |
| $ | 2,531,145 |
| $ | 135,086 |
| $ | 11,518 |
| $ | 2,677,749 |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Proceeds from sale of capital stock |
| 2,756 |
| 275,626 |
|
|
|
|
| 275,626 |
| ||||
Repurchase/redemption of capital stock |
| (2,586 | ) | (258,625 | ) |
|
|
|
| (258,625 | ) | ||||
Reclassifications of shares to mandatorily redeemable capital stock |
| (69 | ) | (6,928 | ) |
|
|
|
| (6,928 | ) | ||||
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
| ||||
Net income |
|
|
|
|
| 92,365 |
|
|
| 92,365 |
| ||||
Other comprehensive income: |
|
|
|
|
|
|
|
|
|
|
| ||||
Net unrealized gains on available-for-sale securities |
|
|
|
|
|
|
| 7,900 |
| 7,900 |
| ||||
Reclassification adjustment for previously deferred hedging gains and losses included in income |
|
|
|
|
|
|
| (953 | ) | (953 | ) | ||||
Total comprehensive income |
|
|
|
|
|
|
|
|
| 99,312 |
| ||||
Cash dividends on capital stock (2.62%) (1) |
|
|
|
|
| (34,148 | ) |
|
| (34,148 | ) | ||||
|
|
|
|
|
|
|
|
|
|
|
| ||||
BALANCE, JUNE 30, 2006 |
| 25,412 |
| $ | 2,541,218 |
| $ | 193,303 |
| $ | 18,465 |
| $ | 2,752,986 |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
BALANCE, DECEMBER 31, 2006 |
| 23,425 |
| $ | 2,342,517 |
| $ | 187,304 |
| $ | 2,693 |
| $ | 2,532,514 |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Proceeds from sale of capital stock |
| 1,885 |
| 188,492 |
|
|
|
|
| 188,492 |
| ||||
Repurchase/redemption of capital stock |
| (948 | ) | (94,803 | ) |
|
|
|
| (94,803 | ) | ||||
Reclassifications of shares to mandatorily redeemable capital stock |
| (85 | ) | (8,550 | ) |
|
|
|
| (8,550 | ) | ||||
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
| ||||
Net income |
|
|
|
|
| 83,505 |
|
|
| 83,505 |
| ||||
Other comprehensive income: |
|
|
|
|
|
|
|
|
|
|
| ||||
Net unrealized gains on available-for-sale securities |
|
|
|
|
|
|
| 6,698 |
| 6,698 |
| ||||
Reclassification adjustment for previously deferred hedging gains and losses included in income |
|
|
|
|
|
|
| (689 | ) | (689 | ) | ||||
Minimum pension liability adjustment |
|
|
|
|
|
|
| (431 | ) | (431 | ) | ||||
Total comprehensive income |
|
|
|
|
|
|
|
|
| 89,083 |
| ||||
Cash dividends on capital stock (6.69%) (1) |
|
|
|
|
| (78,463 | ) |
|
| (78,463 | ) | ||||
|
|
|
|
|
|
|
|
|
|
|
| ||||
BALANCE, JUNE 30, 2007 |
| 24,277 |
| $ | 2,427,656 |
| $ | 192,346 |
| $ | 8,271 |
| $ | 2,628,273 |
|
(1) Dividend rate is annualized.
The accompanying notes are an integral part of these financial statements.
4
FEDERAL HOME LOAN BANK OF BOSTON
STATEMENTS OF CASH FLOWS
(dollars in thousands)
(unaudited)
|
| Six Months Ended June 30, |
| ||||
|
| 2007 |
| 2006 |
| ||
OPERATING ACTIVITIES |
|
|
|
|
| ||
|
|
|
|
|
| ||
Net income |
| $ | 83,505 |
| $ | 92,365 |
|
Adjustments to reconcile net income to net cash provided by operating activities: |
|
|
|
|
| ||
Depreciation and amortization |
| 29,234 |
| 69,703 |
| ||
Reduction of provision for credit losses on mortgage loans |
| (9 | ) | (73 | ) | ||
Change in net fair-value adjustments on derivatives and hedging activities |
| (3,024 | ) | (5,456 | ) | ||
Other adjustments |
| 641 |
| 226 |
| ||
Net change in: |
|
|
|
|
| ||
Trading securities |
| 25,282 |
| 26,836 |
| ||
Accrued interest receivable |
| (4,701 | ) | (11,090 | ) | ||
Other assets |
| 847 |
| 3,351 |
| ||
Net derivative accrued interest |
| (75,918 | ) | (21,865 | ) | ||
Accrued interest payable |
| 55,264 |
| 25,736 |
| ||
Other liabilities |
| 676 |
| 5,051 |
| ||
|
|
|
|
|
| ||
Total adjustments |
| 28,292 |
| 92,419 |
| ||
Net cash provided by operating activities |
| 111,797 |
| 184,784 |
| ||
|
|
|
|
|
| ||
INVESTING ACTIVITIES |
|
|
|
|
| ||
|
|
|
|
|
| ||
Net change in: |
|
|
|
|
| ||
Interest-bearing deposits in banks |
| (90,000 | ) | 1,365,000 |
| ||
Securities purchased under agreements to resell |
| 1,250,000 |
| (750,000 | ) | ||
Federal funds sold |
| (2,531,500 | ) | (2,529,000 | ) | ||
Premises, software, and equipment |
| (584 | ) | (719 | ) | ||
Available-for-sale securities: |
|
|
|
|
| ||
Proceeds |
| 9,175 |
| — |
| ||
Held-to-maturity securities: |
|
|
|
|
| ||
Net increase in short-term |
| (44,993 | ) | — |
| ||
Proceeds |
| 1,272,844 |
| 1,154,770 |
| ||
Purchases |
| (1,271,554 | ) | (1,750,514 | ) | ||
Advances to members: |
|
|
|
|
| ||
Proceeds |
| 212,340,434 |
| 399,757,355 |
| ||
Disbursements |
| (213,893,087 | ) | (402,385,858 | ) | ||
Mortgage loans held for portfolio: |
|
|
|
|
| ||
Proceeds |
| 315,721 |
| 326,156 |
| ||
Purchases |
| (81,206 | ) | (182,828 | ) | ||
|
|
|
|
|
| ||
Net cash used in investing activities |
| (2,724,750 | ) | (4,995,638 | ) | ||
|
|
|
|
|
| ||
FINANCING ACTIVITIES |
|
|
|
|
| ||
|
|
|
|
|
| ||
Net change in deposits |
| (78,330 | ) | 150,004 |
| ||
Net proceeds from issuance of consolidated obligations: |
|
|
|
|
| ||
Discount notes |
| 399,044,917 |
| 350,614,849 |
| ||
Bonds |
| 15,579,650 |
| 4,645,505 |
| ||
Bonds transferred from other FHLBanks |
| — |
| 19,872 |
| ||
Payments for maturing and retiring consolidated obligations: |
|
|
|
|
| ||
Discount notes |
| (398,452,720 | ) | (347,358,314 | ) | ||
Bonds |
| (13,481,102 | ) | (3,206,678 | ) | ||
Proceeds from issuance of capital stock |
| 188,492 |
| 275,626 |
| ||
Payments for redemption of mandatorily redeemable capital stock |
| (16,616 | ) | (2,862 | ) | ||
Payments for repurchase/redemption of capital stock |
| (94,803 | ) | (258,625 | ) | ||
Cash dividends paid |
| (78,684 | ) | (64,283 | ) | ||
|
|
|
|
|
| ||
Net cash provided by financing activities |
| 2,610,804 |
| 4,815,094 |
| ||
|
|
|
|
|
| ||
Net (decrease) increase in cash and cash equivalents |
| (2,149 | ) | 4,240 |
| ||
|
|
|
|
|
| ||
Cash and cash equivalents at beginning of the year |
| 8,197 |
| 9,683 |
| ||
|
|
|
|
|
| ||
Cash and cash equivalents at yearend |
| $ | 6,048 |
| $ | 13,923 |
|
|
|
|
|
|
| ||
Supplemental disclosure: |
|
|
|
|
| ||
Interest paid |
| $ | 1,384,213 |
| $ | 1,186,251 |
|
AHP payments |
| $ | 5,155 |
| $ | 4,478 |
|
REFCorp assessments paid |
| $ | 24,118 |
| $ | 24,757 |
|
The accompanying notes are an integral part of these financial statements.
5
NOTES TO THE FINANCIAL STATEMENTS
(unaudited)
Note 1 – Basis of Presentation
The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete annual financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals), considered necessary for a fair statement have been included. The presentation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. The results of operations for interim periods are not necessarily indicative of the results to be expected for the year ending December 31, 2007. The unaudited financial statements should be read in conjunction with the Federal Home Loan Bank of Boston (the Bank) audited financial statements and related notes filed in the Bank’s Annual Report on Form 10-K for the year ended December 31, 2006.
Certain amounts in the 2006 financial statements have been reclassified to conform to the 2007 presentation.
Note 2 – Trading Securities
Major Security Types. Trading securities as of June 30, 2007, and December 31, 2006, were as follows (dollars in thousands):
| June 30, 2007 |
| December 31, 2006 |
| |||
Mortgage-backed securities (MBS) |
|
|
|
|
| ||
U.S. government guaranteed |
| $ | 37,334 |
| $ | 42,677 |
|
Government-sponsored enterprises |
| 53,992 |
| 63,685 |
| ||
Other |
| 34,754 |
| 45,000 |
| ||
|
|
|
|
|
| ||
Total |
| $ | 126,080 |
| $ | 151,362 |
|
Net losses on trading securities for the six months ended June 30, 2007 and 2006, include a change in net unrealized holding losses of $859,000 and $2.6 million for securities held on June 30, 2007 and 2006, respectively.
The Bank does not participate in speculative trading practices and holds these investments over a longer time horizon as management periodically evaluates its liquidity needs.
Note 3 – Available-for-Sale Securities
Major Security Types. Available-for-sale securities as of June 30, 2007, were as follows (dollars in thousands):
|
|
|
|
| Amounts Recorded in |
|
|
| ||||||||
|
|
|
| SFAS 133 |
| Accumulated Other |
|
|
| |||||||
|
|
|
| Carrying |
| Comprehensive Income |
|
|
| |||||||
|
| Amortized |
| Value |
| Unrealized |
| Unrealized |
| Estimated |
| |||||
|
| Cost |
| Adjustments |
| Gains |
| Losses |
| Fair Value |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
International agency obligations |
| $ | 350,956 |
| $ | 7,665 |
| $ | 5,953 |
| $ | — |
| $ | 364,574 |
|
U.S. government corporations |
| 213,571 |
| (4,117 | ) | 2,431 |
| — |
| 211,885 |
| |||||
Government-sponsored enterprises |
| 177,517 |
| 695 |
| 843 |
| (4 | ) | 179,051 |
| |||||
Other FHLBanks’ bonds |
| 12,124 |
| 2 |
| 4 |
| — |
| 12,130 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
|
| 754,168 |
| 4,245 |
| 9,231 |
| (4 | ) | 767,640 |
| |||||
Mortgage-backed securities |
|
|
|
|
|
|
|
|
|
|
| |||||
Government-sponsored enterprises |
| 172,219 |
| (2,104 | ) | 761 |
| — |
| 170,876 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Total |
| $ | 926,387 |
| $ | 2,141 |
| $ | 9,992 |
| $ | (4 | ) | $ | 938,516 |
|
6
Available-for-sale securities as of December 31, 2006, were as follows (dollars in thousands):
|
|
|
|
| Amounts Recorded in |
|
|
| ||||||||
|
|
|
| SFAS 133 |
| Accumulated Other |
|
|
| |||||||
|
|
|
| Carrying |
| Comprehensive Income |
|
|
| |||||||
|
| Amortized |
| Value |
| Unrealized |
| Unrealized |
| Estimated |
| |||||
|
| Cost |
| Adjustments |
| Gains |
| Losses |
| Fair Value |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
International agency obligations |
| $ | 351,299 |
| $ | 28,963 |
| $ | 2,366 |
| $ | (144 | ) | $ | 382,484 |
|
U.S. government corporations |
| 213,654 |
| 11,828 |
| 133 |
| — |
| 225,615 |
| |||||
Government-sponsored enterprises |
| 184,342 |
| 7,382 |
| 564 |
| (741 | ) | 191,547 |
| |||||
Other FHLBanks’ bonds |
| 14,685 |
| 15 |
| 16 |
| — |
| 14,716 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
|
| 763,980 |
| 48,188 |
| 3,079 |
| (885 | ) | 814,362 |
| |||||
Mortgage-backed securities |
|
|
|
|
|
|
|
|
|
|
| |||||
Government-sponsored enterprises |
| 172,619 |
| (19 | ) | 1,096 |
| — |
| 173,696 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Total |
| $ | 936,599 |
| $ | 48,169 |
| $ | 4,175 |
| $ | (885 | ) | $ | 988,058 |
|
The Bank has concluded that, based on the creditworthiness of the issuers and any underlying collateral, the unrealized loss on each security in the above tables represents a temporary impairment and does not require an adjustment to the unrealized loss for each security currently recognized in other comprehensive income. The Bank has the ability and intent to hold these investments until a recovery of fair value, which may be maturity.
Redemption Terms. The amortized cost and estimated fair value of available-for-sale securities by contractual maturity at June 30, 2007, and December 31, 2006, are shown below (dollars in thousands). Expected maturities of some securities and MBS will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment fees.
|
| June 30, 2007 |
| December 31, 2006 |
| ||||||||
|
|
|
| Estimated |
|
|
| Estimated |
| ||||
|
| Amortized |
| Fair |
| Amortized |
| Fair |
| ||||
Year of Maturity |
| Cost |
| Value |
| Cost |
| Value |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Due in one year or less |
| $ | 31,588 |
| $ | 31,597 |
| $ | 40,913 |
| $ | 40,974 |
|
Due after one year through five years |
| 54,901 |
| 54,588 |
| 54,904 |
| 54,685 |
| ||||
Due after five years through 10 years |
| 14,441 |
| 14,029 |
| 14,477 |
| 14,053 |
| ||||
Due after 10 years |
| 653,238 |
| 667,426 |
| 653,686 |
| 704,650 |
| ||||
|
| 754,168 |
| 767,640 |
| 763,980 |
| 814,362 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Mortgage-backed securities |
| 172,219 |
| 170,876 |
| 172,619 |
| 173,696 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total |
| $ | 926,387 |
| $ | 938,516 |
| $ | 936,599 |
| $ | 988,058 |
|
As of June 30, 2007, the amortized cost of the Bank’s available-for-sale securities includes net premiums of $44.8 million. Of that amount, $41.8 million relates to non-MBS securities and $3.0 million relates to MBS securities. As of December 31, 2006, the amortized cost of the Bank’s available-for-sale securities includes net premiums of $45.8 million. Of that amount, $42.4 million relates to non-MBS securities and $3.4 million relates to MBS securities.
Note 4 – Held-to-Maturity Securities
Major Security Types. Held-to-maturity securities as of June 30, 2007, were as follows (dollars in thousands):
|
| Amortized |
| Gross |
| Gross |
| Estimated |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Commercial paper |
| $ | 44,993 |
| $ | — |
| $ | (6 | ) | $ | 44,987 |
|
U.S. agency obligations |
| 57,248 |
| 472 |
| (7 | ) | 57,713 |
| ||||
State or local housing-agency obligations |
| 307,844 |
| 3,793 |
| (1,038 | ) | 310,599 |
| ||||
|
| 410,085 |
| 4,265 |
| (1,051 | ) | 413,299 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Mortgage-backed securities |
|
|
|
|
|
|
|
|
| ||||
U.S. government guaranteed |
| 14,853 |
| 457 |
| (1 | ) | 15,309 |
| ||||
Government-sponsored enterprises |
| 1,009,282 |
| 7,149 |
| (14,739 | ) | 1,001,692 |
| ||||
Other |
| 6,051,520 |
| 5,705 |
| (8,208 | ) | 6,049,017 |
| ||||
|
| 7,075,655 |
| 13,311 |
| (22,948 | ) | 7,066,018 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total |
| $ | 7,485,740 |
| $ | 17,576 |
| $ | (23,999 | ) | $ | 7,479,317 |
|
7
Held-to-maturity securities as of December 31, 2006, were as follows (dollars in thousands):
|
| Amortized |
| Gross |
| Gross |
| Estimated |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
U.S. agency obligations |
| $ | 62,823 |
| $ | 879 |
| $ | — |
| $ | 63,702 |
|
State or local housing-agency obligations |
| 315,545 |
| 3,763 |
| (1,394 | ) | 317,914 |
| ||||
|
| 378,368 |
| 4,642 |
| (1,394 | ) | 381,616 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Mortgage-backed securities |
|
|
|
|
|
|
|
|
| ||||
U.S. government guaranteed |
| 16,226 |
| 458 |
| (15 | ) | 16,669 |
| ||||
Government-sponsored enterprises |
| 1,022,039 |
| 7,969 |
| (9,207 | ) | 1,020,801 |
| ||||
Other |
| 5,889,558 |
| 8,992 |
| (9,628 | ) | 5,888,922 |
| ||||
|
| 6,927,823 |
| 17,419 |
| (18,850 | ) | 6,926,392 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total |
| $ | 7,306,191 |
| $ | 22,061 |
| $ | (20,244 | ) | $ | 7,308,008 |
|
The Bank has concluded that, based on the creditworthiness of the issuers and any underlying collateral, the unrealized loss on each security in the above tables represents a temporary impairment and does not require an adjustment to the carrying amount of any of the securities. The Bank has the ability and intent to hold these investments until a recovery of fair value, which may be maturity.
Redemption Terms. The amortized cost and estimated fair value of held-to-maturity securities by contractual maturity at June 30, 2007, and December 31, 2006, are shown below (dollars in thousands). Expected maturities of some securities and MBS will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment fees.
|
| June 30, 2007 |
| December 31, 2006 |
| ||||||||
|
|
|
| Estimated |
|
|
| Estimated |
| ||||
|
| Amortized |
| Fair |
| Amortized |
| Fair |
| ||||
Year of Maturity |
| Cost |
| Value |
| Cost |
| Value |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Due in one year or less |
| $ | 45,848 |
| $ | 45,844 |
| $ | 855 |
| $ | 866 |
|
Due after one year through five years |
| 7,625 |
| 7,854 |
| 8,065 |
| 8,385 |
| ||||
Due after five years through 10 years |
| 4,029 |
| 4,181 |
| 4,265 |
| 4,471 |
| ||||
Due after 10 years |
| 352,583 |
| 355,420 |
| 365,183 |
| 367,894 |
| ||||
|
| 410,085 |
| 413,299 |
| 378,368 |
| 381,616 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Mortgage-backed securities |
| 7,075,655 |
| 7,066,018 |
| 6,927,823 |
| 6,926,392 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total |
| $ | 7,485,740 |
| $ | 7,479,317 |
| $ | 7,306,191 |
| $ | 7,308,008 |
|
As of June 30 2007, the amortized cost of the Bank’s held-to-maturity securities includes net discounts of $4.3 million. Of that amount, $446,000 relates to non-MBS and $3.9 million relates to MBS. As of December 31, 2006, the amortized cost of the Bank’s held-to-maturity securities includes net discounts of $822,000. Of that amount, $471,000 relates to non-MBS and $351,000 relates to MBS.
Note 5 – Advances
Redemption Terms. At June 30, 2007, and December 31, 2006, the Bank had advances outstanding, including AHP advances, at interest rates ranging from zero percent to 8.44 percent, as summarized below (dollars in thousands). Advances with interest rates of zero percent are AHP-subsidized advances.
| June 30, 2007 |
| December 31, 2006 |
| |||||||
Year of Maturity |
| Amount |
| Weighted |
| Amount |
| Weighted |
| ||
|
|
|
|
|
|
|
|
|
| ||
Overdrawn demand-deposit accounts |
| $ | 11,000 |
| 5.63 | % | $ | 8,285 |
| 5.66 | % |
Due in one year or less |
| 22,089,507 |
| 5.15 |
| 21,541,880 |
| 5.12 |
| ||
Due after one year through two years |
| 6,117,169 |
| 4.96 |
| 4,424,213 |
| 4.67 |
| ||
Due after two years through three years |
| 3,150,853 |
| 5.02 |
| 3,811,448 |
| 4.91 |
| ||
Due after three years through four years |
| 2,075,788 |
| 4.88 |
| 2,348,233 |
| 5.06 |
| ||
Due after four years through five years |
| 1,603,475 |
| 4.93 |
| 1,984,555 |
| 4.92 |
| ||
Thereafter |
| 3,863,620 |
| 4.56 |
| 3,240,144 |
| 4.58 |
| ||
|
|
|
|
|
|
|
|
|
| ||
Total par value |
| 38,911,412 |
| 5.03 | % | 37,358,758 |
| 4.98 | % | ||
|
|
|
|
|
|
|
|
|
| ||
Premium on advances |
| 2,824 |
|
|
| 4,031 |
|
|
| ||
Discount on advances |
| (15,651 | ) |
|
| (13,413 | ) |
|
| ||
SFAS 133 hedging adjustments |
| (48,765 | ) |
|
| (7,251 | ) |
|
| ||
|
|
|
|
|
|
|
|
|
| ||
Total |
| $ | 38,849,820 |
|
|
| $ | 37,342,125 |
|
|
|
8
At both June 30, 2007, and December 31, 2006, the Bank had callable advances outstanding totaling $30.0 million.
The following table summarizes advances at June 30, 2007, and December 31, 2006, by year of original maturity or next call date for callable advances (dollars in thousands):
Year of Maturity or Next Call Date |
| June 30, 2007 |
| December 31, 2006 |
| ||
|
|
|
|
|
| ||
Overdrawn demand-deposit accounts |
| $ | 11,000 |
| $ | 8,285 |
|
Due in one year or less |
| 22,119,507 |
| 21,571,880 |
| ||
Due after one year through two years |
| 6,117,169 |
| 4,424,213 |
| ||
Due after two years through three years |
| 3,150,853 |
| 3,811,448 |
| ||
Due after three years through four years |
| 2,045,788 |
| 2,348,233 |
| ||
Due after four years through five years |
| 1,603,475 |
| 1,954,555 |
| ||
Thereafter |
| 3,863,620 |
| 3,240,144 |
| ||
|
|
|
|
|
| ||
Total par value |
| $ | 38,911,412 |
| $ | 37,358,758 |
|
At June 30, 2007, and December 31, 2006, the Bank had putable advances outstanding totaling $6.1 billion and $5.4 billion, respectively.
The following table summarizes advances outstanding at June 30, 2007, and December 31, 2006, by year of original maturity or next put date for putable advances (dollars in thousands):
Year of Maturity or Next Put Date |
| June 30, 2007 |
| December 31, 2006 |
| ||
|
|
|
|
|
| ||
Overdrawn demand-deposit accounts |
| $ | 11,000 |
| $ | 8,285 |
|
Due in one year or less |
| 26,795,932 |
| 25,745,480 |
| ||
Due after one year through two years |
| 6,446,119 |
| 4,476,013 |
| ||
Due after two years through three years |
| 2,328,253 |
| 3,320,798 |
| ||
Due after three years through four years |
| 889,438 |
| 1,120,083 |
| ||
Due after four years through five years |
| 1,029,925 |
| 1,105,255 |
| ||
Thereafter |
| 1,410,745 |
| 1,582,844 |
| ||
|
|
|
|
|
| ||
Total par value |
| $ | 38,911,412 |
| $ | 37,358,758 |
|
Security Terms. The Federal Home Loan Bank Act of 1932 (FHLBank Act) requires the Bank to obtain sufficient collateral on advances 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 on such advances. 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 Class B capital stock in the Bank. At June 30, 2007, and December 31, 2006, the Bank had rights to collateral, on a member-by-member basis, with an estimated value greater than outstanding advances.
Credit Risk. While the Bank has never experienced a credit loss on an advance to a member, the expansion of collateral for CFIs and nonmember housing associates provides the potential for additional credit risk for the Bank. Management of the Bank has policies and procedures in place to appropriately manage this credit risk. Based on these policies, the Bank has not provided any allowances for losses on advances. The Bank’s potential credit risk from advances is concentrated in commercial banks and savings institutions.
9
Interest-Rate-Payment Terms. The following table details additional interest-rate-payment terms for advances at June 30, 2007, and December 31, 2006 (dollars in thousands):
| June 30, 2007 |
| December 31, 2006 |
| |||
Par amount of advances |
|
|
|
|
| ||
Fixed-rate |
| $ | 34,095,052 |
| $ | 32,657,735 |
|
Variable-rate |
| 4,816,360 |
| 4,701,023 |
| ||
|
|
|
|
|
| ||
Total |
| $ | 38,911,412 |
| $ | 37,358,758 |
|
Variable-rate advances noted in the above table include advances outstanding at June 30, 2007, and December 31, 2006, totaling $383.8 million and $393.8 million, respectively, which contain embedded interest-rate caps and floors.
Note 6 – Affordable Housing Program
The Bank charges the amount set aside for AHP to income and recognizes it as a liability. The Bank then relieves the AHP liability as members use subsidies.
An analysis of the AHP liability for the six months ended June 30, 2007, and the year ended December 31, 2006, follows (dollars in thousands):
Roll-Forward of the AHP Liability |
| For the Six |
| For the |
| ||
|
|
|
|
|
| ||
Balance at beginning of period |
| $ | 44,971 |
| $ | 35,957 |
|
AHP expense for the period |
| 9,327 |
| 21,848 |
| ||
AHP direct grant disbursements |
| (5,155 | ) | (11,142 | ) | ||
AHP subsidy for below-market-rate advance disbursements |
| (2,494 | ) | (2,077 | ) | ||
Return of previously disbursed grants and subsidies |
| 39 |
| 385 |
| ||
|
|
|
|
|
| ||
Balance at end of period |
| $ | 46,688 |
| $ | 44,971 |
|
Note 7 – Mortgage Loans Held for Portfolio
The Bank’s Mortgage Partnership FinanceÒ (MPFÒ) program involves investment by the Bank in fixed-rate mortgage loans that are purchased from participating members. All mortgage loans are held for portfolio. Under the MPF program, the Bank’s members originate, service, and credit-enhance home-mortgage loans that are then sold to the Bank.
The following table presents mortgage loans held for portfolio as of June 30, 2007, and December 31, 2006 (dollars in thousands):
| June 30, 2007 |
| December 31, 2006 |
| |||
Real estate |
|
|
|
|
| ||
Fixed-rate 15-year single-family mortgages |
| $ | 1,218,634 |
| $ | 1,321,762 |
|
Fixed-rate 20- and 30-year single-family mortgages |
| 3,019,036 |
| 3,152,175 |
| ||
Premiums |
| 38,290 |
| 42,274 |
| ||
Discounts |
| (11,907 | ) | (12,758 | ) | ||
Deferred derivative gains and losses, net |
| (1,257 | ) | (1,146 | ) | ||
|
|
|
|
|
| ||
Total mortgage loans held for portfolio |
| 4,262,796 |
| 4,502,307 |
| ||
|
|
|
|
|
| ||
Less: allowance for credit losses |
| (125 | ) | (125 | ) | ||
|
|
|
|
|
| ||
Total mortgage loans, net of allowance for credit losses |
| $ | 4,262,671 |
| $ | 4,502,182 |
|
Ò “Mortgage Partnership Finance” and “MPF” are registered trademarks of the Federal Home Loan Bank of Chicago.
10
The following table details the par value of mortgage loans held for portfolio at June 30, 2007, and December 31, 2006 (dollars in thousands):
| June 30, 2007 |
| December 31, 2006 |
| |||
|
|
|
|
|
| ||
Conventional loans |
| $ | 3,770,355 |
| $ | 3,960,692 |
|
Government-insured loans |
| 467,315 |
| 513,245 |
| ||
|
|
|
|
|
| ||
Total par value |
| $ | 4,237,670 |
| $ | 4,473,937 |
|
An analysis of the allowance for credit losses for the three and six months ended June 30, 2007 and 2006, follows (dollars in thousands):
| For the Three Months Ended June 30, |
| For the Six Months Ended June 30, |
| |||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Balance at beginning of period |
| $ | 125 |
| $ | 1,788 |
| $ | 125 |
| $ | 1,843 |
|
Charge-offs |
| — |
| (11 | ) | — |
| (11 | ) | ||||
Recoveries |
| 9 |
| — |
| 9 |
| — |
| ||||
Net recoveries (charge-offs) |
| 9 |
| (11 | ) | 9 |
| (11 | ) | ||||
Reduction of provision for credit losses |
| (9 | ) | (18 | ) | (9 | ) | (73 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Balance at end of period |
| $ | 125 |
| $ | 1,759 |
| $ | 125 |
| $ | 1,759 |
|
Mortgage loans, other than those included in large groups of smaller-balance homogeneous loans, are considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all principal and interest amounts due according to the contractual terms of the mortgage-loan agreement. At June 30, 2007, and December 31, 2006, the Bank had no recorded investments in impaired mortgage loans. Mortgage loans on nonaccrual status at June 30, 2007, and December 31, 2006, totaled $4.9 million and $4.8 million, respectively. The Bank’s mortgage-loan portfolio is geographically diversified on a national basis. There is no concentration of delinquent loans in any geographic region. Real estate owned (REO) at June 30, 2007, and December 31, 2006, totaled $887,000 and $1.3 million, respectively. REO is recorded on the statement of condition in other assets.
Sale of REO Assets. During the six months ended June 30, 2007 and 2006, the Bank sold REO assets with a recorded carrying value of $830,000 and $647,000, respectively. Upon sale of these properties, and inclusive of any proceeds received from primary mortgage-insurance coverage, the Bank recognized net gains totaling $18,000 and $27,000 on the sale of REO assets during the six months ended June 30, 2007 and 2006, respectively. Gains and losses on the sale of REO assets are recorded in other income.
Note 8 – Deposits
The Bank offers demand and overnight deposits for members and qualifying nonmembers. In addition, the Bank offers short-term deposit programs to members. Members that service mortgage loans may deposit in the Bank funds collected in connection with mortgage loans pending disbursement of such funds to the owners of the mortgage loans; the Bank classifies these items as other non-interest bearing deposits in the following table.
The following table details interest-bearing and non-interest-bearing deposits as of June 30, 2007, and December 31, 2006 (dollars in thousands):
| June 30, 2007 |
| December 31, 2006 |
| |||
Interest bearing |
|
|
|
|
| ||
Demand and overnight |
| $ | 1,009,059 |
| $ | 1,087,454 |
|
Term |
| 26,228 |
| 28,756 |
| ||
Other |
| 2,807 |
| 2,841 |
| ||
Non-interest bearing |
|
|
|
|
| ||
Other |
| 6,815 |
| 4,958 |
| ||
|
|
|
|
|
| ||
Total deposits |
| $ | 1,044,909 |
| $ | 1,124,009 |
|
Note 9 – Consolidated Obligations
Consolidated obligations (COs) consist of CO bonds and CO discount notes (DNs) and, as provided by the FHLBank Act or Finance Board regulation, are backed only by the financial resources of the FHLBanks. The FHLBanks issue COs through the Office of Finance, which serves 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 COs for which it is the primary obligor. The Finance Board and the U.S. Secretary of the Treasury have oversight over the issuance of FHLBank debt through the Office of Finance. CO 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. CO DNs are issued to raise short-term funds. These notes sell at less than their face amount and are redeemed at par value when they mature.
11
Redemption Terms. The following is a summary of the Bank’s participation in CO bonds outstanding at June 30, 2007, and December 31, 2006, by year of original maturity (dollars in thousands):
| June 30, 2007 |
| December 31, 2006 |
| |||||||
|
|
|
| Weighted |
|
|
| Weighted |
| ||
|
|
|
| Average |
|
|
| Average |
| ||
Year of Maturity |
| Amount |
| Rate |
| Amount |
| Rate |
| ||
|
|
|
|
|
|
|
|
|
| ||
Due in one year or less |
| $ | 12,503,655 |
| 4.57 | % | $ | 14,211,705 |
| 4.45 | % |
Due after one year through two years |
| 9,194,140 |
| 4.73 |
| 9,091,950 |
| 4.51 |
| ||
Due after two years through three years |
| 5,801,035 |
| 5.17 |
| 3,611,185 |
| 4.52 |
| ||
Due after three years through four years |
| 1,968,340 |
| 4.88 |
| 1,635,770 |
| 4.48 |
| ||
Due after four years through five years |
| 1,402,500 |
| 5.09 |
| 1,289,600 |
| 4.81 |
| ||
Thereafter |
| 9,891,500 |
| 5.64 |
| 8,794,000 |
| 5.66 |
| ||
|
|
|
|
|
|
|
|
|
| ||
Total par value |
| 40,761,170 |
| 4.99 | % | 38,634,210 |
| 4.76 | % | ||
|
|
|
|
|
|
|
|
|
| ||
Bond premium |
| 14,450 |
|
|
| 14,719 |
|
|
| ||
Bond discount |
| (3,012,107 | ) |
|
| (3,009,308 | ) |
|
| ||
SFAS 133 hedging adjustments |
| (168,356 | ) |
|
| (121,179 | ) |
|
| ||
|
|
|
|
|
|
|
|
|
| ||
Total |
| $ | 37,595,157 |
|
|
| $ | 35,518,442 |
|
|
|
The Bank’s CO bonds outstanding at June 30, 2007, and December 31, 2006, included (dollars in thousands):
| June 30, 2007 |
| December 31, 2006 |
| |||
Par amount of consolidated bonds |
|
|
|
|
| ||
Noncallable or non-putable |
| $ | 16,966,470 |
| $ | 16,298,210 |
|
Callable |
| 23,794,700 |
| 22,336,000 |
| ||
|
|
|
|
|
| ||
Total par amount |
| $ | 40,761,170 |
| $ | 38,634,210 |
|
The following table summarizes CO bonds outstanding at June 30, 2007, and December 31, 2006, by year of original maturity or next call date (dollars in thousands):
Year of Maturity or Next Call Date |
| June 30, 2007 |
| December 31, 2006 |
| ||
|
|
|
|
|
| ||
Due in one year or less |
| $ | 30,123,355 |
| $ | 26,892,705 |
|
Due after one year through two years |
| 4,874,140 |
| 5,871,950 |
| ||
Due after two years through three years |
| 1,811,035 |
| 2,176,185 |
| ||
Due after three years through four years |
| 799,640 |
| 715,770 |
| ||
Due after four years through five years |
| 202,500 |
| 569,600 |
| ||
Thereafter |
| 2,950,500 |
| 2,408,000 |
| ||
|
|
|
|
|
| ||
Total par value |
| $ | 40,761,170 |
| $ | 38,634,210 |
|
Interest-Rate-Payment Terms. The following table details CO bonds by interest-rate-payment terms at June 30, 2007, and December 31, 2006 (dollars in thousands):
| June 30, 2007 |
| December 31, 2006 |
| |||
Par amount of CO bonds |
|
|
|
|
| ||
Fixed-rate bonds |
| $ | 35,621,470 |
| $ | 33,153,210 |
|
Step-up bonds |
| 330,000 |
| 795,000 |
| ||
Simple variable-rate bonds |
| 1,000,000 |
| 1,000,000 |
| ||
Zero-coupon bonds |
| 3,809,700 |
| 3,686,000 |
| ||
|
|
|
|
|
| ||
Total par amount |
| $ | 40,761,170 |
| $ | 38,634,210 |
|
12
CO Discount Notes. The Bank’s participation in CO DNs, all of which are due within one year, was as follows (dollars in thousands):
|
|
|
|
| Weighted |
| |||
|
|
|
|
|
| Average |
| ||
|
| Book Value |
| Par Value |
| Rate |
| ||
|
|
|
|
|
|
|
| ||
June 30, 2007 |
| $ | 18,306,460 |
| $ | 18,377,012 |
| 5.13 | % |
|
|
|
|
|
|
|
| ||
December 31, 2006 |
| $ | 17,723,515 |
| $ | 17,780,433 |
| 5.11 | % |
Note 10 – Capital
The Bank is subject to three capital requirements under its capital structure plan and Finance Board rules and regulations. The Bank must maintain at all times:
1. Permanent capital in an amount at least equal to the sum of its credit-risk capital requirement, its market-risk capital requirement, and its operations-risk capital requirement, calculated in accordance with Bank policy and rules and regulations of the Finance Board. Only permanent capital, defined as Class B stock and retained earnings, satisfies this risk-based capital requirement. The Finance Board may require the Bank to maintain a greater amount of permanent capital than is required as defined by the risk-based capital requirements.
2. At least a four percent total capital-to-assets ratio.
3. At least a five percent leverage capital-to-assets ratio. A leverage capital-to-assets ratio is defined as permanent capital weighted 1.5 times divided by total assets.
The following table demonstrates the Bank’s compliance with these capital requirements at June 30, 2007, and December 31, 2006 (dollars in thousands).
| June 30, 2007 |
| December 31, 2006 |
| |||||||||
|
| Required |
| Actual |
| Required |
| Actual |
| ||||
Regulatory Capital Requirements |
|
|
|
|
|
|
|
|
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Risk-based capital |
| $ | 418,320 |
| $ | 2,624,290 |
| $ | 342,352 |
| $ | 2,542,175 |
|
|
|
|
|
|
|
|
|
|
| ||||
Total regulatory capital |
| $ | 2,410,533 |
| $ | 2,624,290 |
| $ | 2,298,791 |
| $ | 2,542,175 |
|
Total capital-to-asset ratio |
| 4.0 | % | 4.4 | % | 4.0 | % | 4.4 | % | ||||
|
|
|
|
|
|
|
|
|
| ||||
Leverage capital |
| $ | 3,013,166 |
| $ | 3,936,435 |
| $ | 2,873,489 |
| $ | 3,813,262 |
|
Leverage ratio |
| 5.0 | % | 6.5 | % | 5.0 | % | 6.6 | % |
Mandatorily redeemable capital stock, which is classified as a liability under GAAP, is considered capital for determining the Bank’s compliance with these regulatory requirements.
Note 11 – Employee Retirement Plans
Employee Retirement Plans. The Bank participates in the Pentegra Defined Benefit Plan for Financial Institutions (Pentegra Defined Benefit Plan), a tax-qualified defined-benefit pension plan, formerly known as the Financial Institutions Retirement Fund. The plan covers substantially all officers and employees of the Bank. Funding and administrative costs of the Pentegra Defined Benefit Plan charged to operating expenses were $816,000 and $610,000 for the three months ended June 30, 2007 and 2006, respectively. Funding and administrative costs of the Pentegra Defined Benefit Plan charged to operating expenses were $1.7 million and $1.3 million for the six months ended June 30, 2007 and 2006, respectively. The Pentegra Defined Benefit Plan is a multi-employer plan in which assets contributed by one participating employer may be used to provide benefits to employees of other participating employers since assets contributed by an employer are not segregated in a separate account or restricted to provide benefits only to employees of that employer. As a result, disclosure of the accumulated benefit obligations, plan assets, and the components of annual pension expense attributable to the Bank are not made.
Additionally, the Bank maintains a nonqualified, unfunded defined benefit plan (supplemental retirement plan) covering certain senior officers, and the Bank sponsors a fully insured retirement benefit program (postretirement benefit plan) that provides life insurance benefits for eligible retirees.
Components of net periodic pension cost for the Bank’s supplemental retirement plan and postretirement benefit plan for the three months and six months ended June 30, 2007 and 2006, were (dollars in thousands):
13
| Supplemental |
| Postretirement |
| |||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Service cost |
| $ | 122 |
| $ | 129 |
| $ | 8 |
| $ | 5 |
|
Interest cost |
| 158 |
| 132 |
| 5 |
| 5 |
| ||||
Amortization of unrecognized prior service cost |
| 6 |
| 6 |
| — |
| — |
| ||||
Amortization of unrecognized net actuarial loss |
| 140 |
| 93 |
| 1 |
| — |
| ||||
Amortization of unrecognized obligation |
| 4 |
| 5 |
| — |
| — |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Net periodic benefit cost |
| $ | 430 |
| $ | 365 |
| $ | 14 |
| $ | 10 |
|
| Supplemental |
| Postretirement |
| |||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Service cost |
| $ | 216 |
| $ | 229 |
| $ | 13 |
| $ | 9 |
|
Interest cost |
| 277 |
| 238 |
| 10 |
| 9 |
| ||||
Amortization of unrecognized prior service cost |
| 11 |
| 14 |
| — |
| — |
| ||||
Amortization of unrecognized net actuarial loss |
| 196 |
| 174 |
| 1 |
| 1 |
| ||||
Amortization of unrecognized obligation |
| 9 |
| 10 |
| — |
| — |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Net periodic benefit cost |
| $ | 709 |
| $ | 665 |
| $ | 24 |
| $ | 19 |
|
Note 12 – Segment Information
Based upon its method of internal reporting, the Bank analyzes its financial performance based on the net interest income of two operating segments: mortgage-loan finance and all other business activity. The products and services provided reflect the manner in which financial information is evaluated by management. The mortgage-loan finance segment includes mortgage loans acquired through the MPF program and the related funding of those mortgage loans. Income from the mortgage-loan finance segment is derived primarily from the difference, or spread, between the yield on mortgage loans and the borrowing and hedging costs related to those assets. The remaining business segment includes products such as advances and investments and their related funding and hedging costs. Income from this segment is derived primarily from the difference, or spread, between the yield on advances and investments and the borrowing and hedging costs related to those assets. Capital is allocated to the segments based upon asset size.
The following table presents net interest income after reduction of provision for credit losses on mortgage loans by business segment, other income/(loss), other expense, and income before assessments for the three months and six months ended June 30, 2007 and 2006 (dollars in thousands):
|
| Net Interest Income after Reduction of Provision for |
|
|
|
|
|
|
| ||||||||||
For the Three |
| Mortgage |
| Other |
| Total |
| Other Income/ |
| Other |
| Income |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
2007 |
| $ | 7,296 |
| $ | 65,029 |
| $ | 72,325 |
| $ | (4,459 | ) | $ | 13,216 |
| $ | 54,650 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
2006 |
| $ | 9,350 |
| $ | 67,012 |
| $ | 76,362 |
| $ | (384 | ) | $ | 12,256 |
| $ | 63,722 |
|
|
| Net Interest Income after Reduction of Provision for |
|
|
|
|
|
|
| ||||||||||
For the Six |
| Mortgage |
| Other |
| Total |
| Other Income/ |
| Other |
| Income |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
2007 |
| $ | 15,197 |
| $ | 127,095 |
| $ | 142,292 |
| $ | (2,469 | ) | $ | 26,115 |
| $ | 113,708 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
2006 |
| $ | 19,198 |
| $ | 131,406 |
| $ | 150,604 |
| $ | (776 | ) | $ | 24,075 |
| $ | 125,753 |
|
14
The following table presents total assets by business segment as of June 30, 2007, and December 31, 2006 (dollars in thousands):
| Total Assets by Segment |
| ||||||||
|
| Mortgage |
| Other |
| Total |
| |||
|
|
|
|
|
|
|
| |||
June 30, 2007 |
| $ | 4,285,037 |
| $ | 55,978,282 |
| $ | 60,263,319 |
|
|
|
|
|
|
|
|
| |||
December 31, 2006 |
| $ | 4,525,354 |
| $ | 52,944,427 |
| $ | 57,469,781 |
|
The following tables present average-earning assets by business segment for the three months and six months ended June 30, 2007 and 2006 (dollars in thousands):
| Total Average-Earning Assets by Segment |
| ||||||||
For the Three Months Ended June 30, |
| Mortgage |
| Other |
| Total |
| |||
|
|
|
|
|
|
|
| |||
2007 |
| $ | 4,329,440 |
| $ | 54,819,824 |
| $ | 59,149,264 |
|
|
|
|
|
|
|
|
| |||
2006 |
| $ | 4,795,371 |
| $ | 54,069,973 |
| $ | 58,865,344 |
|
| Total Average-Earning Assets by Segment |
| ||||||||
For the Six Months Ended June 30, |
| Mortgage |
| Other |
| Total |
| |||
|
|
|
|
|
|
|
| |||
2007 |
| $ | 4,385,971 |
| $ | 53,584,525 |
| $ | 57,970,496 |
|
|
|
|
|
|
|
|
| |||
2006 |
| $ | 4,821,168 |
| $ | 54,453,138 |
| $ | 59,274,306 |
|
Note 13 – Derivatives and Hedging Activities
For the three months ended June 30, 2007 and 2006, the Bank recorded a net loss on derivatives and hedging activities totaling $4.0 million and $144,000, respectively, in other income. For the six months ended June 30, 2007 and 2006, the Bank recorded a net (loss) gain on derivatives and hedging activities totaling $(3.0) million and $769,000, respectively. Net (loss) gain on derivatives and hedging activities for the three months and six months ended June 30, 2007 and 2006, were as follows (dollars in thousands):
| For the Three Months Ended |
| |||||
|
| 2007 |
| 2006 |
| ||
|
|
|
|
|
| ||
Net loss related to fair-value hedge ineffectiveness |
| $ | (4,645 | ) | $ | (541 | ) |
Net gain resulting from economic hedges not receiving hedge accounting |
| 666 |
| 397 |
| ||
|
|
|
|
|
| ||
Net loss on derivatives and hedging activities |
| $ | (3,979 | ) | $ | (144 | ) |
| For the Six Months Ended |
| |||||
|
| 2007 |
| 2006 |
| ||
|
|
|
|
|
| ||
Net loss related to fair-value hedge ineffectiveness |
| $ | (3,522 | ) | $ | (357 | ) |
Net gain resulting from economic hedges not receiving hedge accounting |
| 539 |
| 1,126 |
| ||
|
|
|
|
|
| ||
Net (loss) gain on derivatives and hedging activities |
| $ | (2,983 | ) | $ | 769 |
|
The following table presents outstanding notional balances and estimated fair values of derivatives outstanding at June 30, 2007, and December 31, 2006 (dollars in thousands):
15
| June 30, 2007 |
| December 31, 2006 |
| |||||||||
|
| Notional |
| Estimated |
| Notional |
| Estimated |
| ||||
Interest-rate swaps: |
|
|
|
|
|
|
|
|
| ||||
Fair value |
| $ | 32,276,910 |
| $ | (182,948 | ) | $ | 29,303,303 |
| $ | (219,986 | ) |
Economic |
| 150,500 |
| 233 |
| 172,500 |
| (82 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Interest-rate swaptions: |
|
|
|
|
|
|
|
|
| ||||
Economic |
| — |
| — |
| 150,000 |
| — |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Interest-rate caps/floors: |
|
|
|
|
|
|
|
|
| ||||
Fair value |
| 424,800 |
| 2,378 |
| 454,800 |
| 3,842 |
| ||||
Economic |
| 196,000 |
| — |
| 446,000 |
| — |
| ||||
Member intermediated |
| 20,000 |
| — |
| 20,000 |
| — |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total |
| 33,068,210 |
| (180,337 | ) | 30,546,603 |
| (216,226 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Mortgage-delivery commitments (1) |
| 4,918 |
| 2 |
| 6,573 |
| (24 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Total derivatives |
| $ | 33,073,128 |
| (180,335 | ) | $ | 30,553,176 |
| (216,250 | ) | ||
|
|
|
|
|
|
|
|
|
| ||||
Accrued interest |
|
|
| 299,980 |
|
|
| 224,062 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Net derivatives fair value |
|
|
| $ | 119,645 |
|
|
| $ | 7,812 |
| ||
|
|
|
|
|
|
|
|
|
| ||||
Derivative assets |
|
|
| $ | 174,391 |
|
|
| $ | 128,373 |
| ||
Derivative liabilities |
|
|
| (54,746 | ) |
|
| (120,561 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Net derivatives fair value |
|
|
| $ | 119,645 |
|
|
| $ | 7,812 |
|
(1) Mortgage-delivery commitments are classified as derivatives pursuant to SFAS 149 with changes in fair value recorded in other income.
Credit Risk. At June 30, 2007, and December 31, 2006, the Bank’s credit risk as measured by current replacement cost was approximately $174.4 million and $128.4 million, respectively. These totals include $257.0 million and $180.0 million of net accrued interest receivable at June 30, 2007, and December 31, 2006, respectively. In determining current replacement cost, the Bank considers accrued interest receivable and payable, and the legal right to offset derivative assets and liabilities by counterparty. The Bank held cash and securities, including accrued interest with a fair value of $151.3 million and $133.7 million as collateral as of June 30, 2007, and December 31, 2006, respectively. This collateral has not been sold or repledged. Additionally, collateral 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 generally executes derivatives with counterparties rated single-A or better by either Standard and Poor’s Rating Services (S&P) or Moody’s Investor Service (Moody’s). Some of these counterparties or their affiliates buy, sell, and distribute COs. Note 15 discusses assets pledged by the Bank to these counterparties. The Bank is not a derivatives dealer and does not trade derivatives for short-term profit.
Note 14 – Transactions with Related Parties and Other FHLBanks
Transactions with Related Parties. The Bank defines related parties as those members whose capital stock outstanding was in excess of 10 percent of the Bank’s total capital stock outstanding. The following table presents member holdings of 10 percent or more of the Bank’s total capital stock outstanding at June 30, 2007, and December 31, 2006 (dollars in thousands):
|
| June 30, 2007 |
| December 31, 2006 |
| ||||||
Name |
| Capital Stock |
| Percent |
| Capital Stock |
| Percent |
| ||
|
|
|
|
|
|
|
|
|
| ||
Bank of America Rhode Island, N.A., Providence, RI |
| $ | 424,937 |
| 17.5 | % | $ | 324,338 |
| 13.8 | % |
Citizens Financial Group (1) |
| 358,818 |
| 14.8 |
| 363,544 |
| 15.4 |
| ||
(1) Citizens Financial Group, Inc., a subsidiary of The Royal Bank of Scotland, is the holding company of five of the Bank’s members: Citizens Bank of Rhode Island, Citizens Bank of Massachusetts, Citizens Bank of New Hampshire, Citizens Bank of Connecticut, and RBS National Bank. Capital stock outstanding to these five members is aggregated in the above table.
16
The following table presents outstanding advances and total accrued interest receivable from advances as of June 30, 2007, and December 31, 2006 (dollars in thousands):
|
| Par |
| Percent |
| Total Accrued |
| Percent of Total |
| ||
|
|
|
|
|
|
|
|
|
| ||
As of June 30, 2007 |
|
|
|
|
|
|
|
|
| ||
Bank of America Rhode Island, N.A., Providence, RI |
| $ | 10,183,146 |
| 26.2 | % | $ | 50,290 |
| 32.6 | % |
Citizens Financial Group |
| 6,994,184 |
| 18.0 |
| 27,623 |
| 17.9 |
| ||
|
|
|
|
|
|
|
|
|
| ||
As of December 31, 2006 |
|
|
|
|
|
|
|
|
| ||
Bank of America Rhode Island, N.A., Providence, RI |
| $ | 7,708,372 |
| 20.6 | % | $ | 39,653 |
| 26.7 | % |
Citizens Financial Group |
| 7,005,329 |
| 18.8 |
| 28,647 |
| 19.3 |
|
The Bank recognized interest income on advances outstanding with the above members during the three months and six months ended June 30, 2007 and 2006, as follows (dollars in thousands):
|
| For the Three Months Ended June 30, |
| For the Six Months Ended June 30, |
| ||||||||
Name |
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Bank of America Rhode Island, N.A., Providence, RI |
| $ | 136,067 |
| $ | 136,263 |
| $ | 243,168 |
| $ | 249,766 |
|
Citizens Financial Group |
| 93,250 |
| 74,056 |
| 185,643 |
| 140,171 |
| ||||
The following table presents an analysis of advances activity with related parties for the six months ended June 30, 2007 (dollars in thousands):
|
| Advances |
| For the Six Months Ended |
| Advances |
| ||||||
|
| December 31, |
| Disbursements to |
| Payments from |
| at June 30, |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Bank of America Rhode Island, N.A., Providence, RI |
| $ | 7,708,372 |
| $ | 15,789,416 |
| $ | (13,314,642 | ) | $ | 10,183,146 |
|
Citizens Financial Group |
| 7,005,329 |
| 12,241,500 |
| (12,252,645 | ) | 6,994,184 |
| ||||
The following table presents an analysis of outstanding derivative contracts with members and affiliates of Bank members for June 30, 2007, and December 31, 2006 (dollars in thousands):
|
|
|
|
|
| June 30, 2007 |
| December 31, 2006 |
| ||||||
Derivatives Counterparty |
| Affiliate Member |
|
|
|
|
| Percent of |
| Notional |
| Percent of |
| ||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||
Bank of America NA |
| Bank of America Rhode Island, NA |
| Dealer |
| $ | 2,041,000 |
| 6.17 | % | $ | 1,567,350 |
| 5.13 | % |
Royal Bank of Scotland, PLC |
| Citizens Financial Group |
| Dealer |
| 1,960,000 |
| 5.93 |
| 982,500 |
| 3.22 |
| ||
Auburn Savings Bank |
| Auburn Savings Bank |
| Member |
| 10,000 |
| 0.03 |
| 10,000 |
| 0.03 |
| ||
Standby Letters of Credit. The Bank had $35.7 million and $39.3 million of outstanding standby letters of credit to Bank of America Rhode Island, N.A. as of June 30, 2007, and December 31, 2006, respectively.
Transactions with Other FHLBanks. The Bank may occasionally enter into transactions with other FHLBanks. These transactions are summarized below.
Investments in Consolidated Obligations. The Bank has invested in COs of other FHLBanks. The Bank’s carrying value of other FHLBank COs classified as available-for-sale was $12.1 million and $14.7 million at June 30, 2007, and December 31, 2006, respectively (see Note 3). The Bank recorded interest income of $203,000 and $205,000 from these investment securities for the three months ended June 30, 2007 and 2006, respectively. The Bank recorded interest income of $405,000 and $409,000 from these investment securities for the six months ended June 30, 2007 and 2006, respectively. Purchases of COs issued for other FHLBanks occur at market prices through third-party securities dealers.
17
Consolidated Obligations. From time to time, another FHLBank may transfer to the Bank debt obligations in which the other FHLBank was the primary obligor and upon transfer we became the primary obligor. There were no transfers of debt obligations between the Bank and other FHLBanks during the six months ended June 30, 2007. During the six months ended June 30, 2006, the Bank assumed a debt obligation with a par amount of $20.0 million and a fair value of approximately $19.9 million, which had been the obligation of the FHLBank of Chicago.
Overnight Funds. The Bank may borrow or lend unsecured overnight funds from or to other FHLBanks. All such transactions are at current market rates. Interest income and interest expense related to these transactions with other FHLBanks are included within other interest income and interest expense from other borrowings in the statements of income.
The Bank did not have any borrowings from other FHLBanks outstanding at June 30, 2007, and December 31, 2006. Interest expense on borrowings from other FHLBanks for the three months and six months ended June 30, 2007 and 2006, is shown in the following table, by FHLBank (dollars in thousands):
|
| For the Three Months Ended June 30, |
| For the Six Months Ended June 30, |
| ||||||||
Interest Expense to Other FHLBanks |
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
FHLBank of Chicago |
| $ | — |
| $ | 7 |
| $ | — |
| $ | 7 |
|
FHLBank of Cincinnati |
| 35 |
| 32 |
| 35 |
| 197 |
| ||||
FHLBank of Dallas |
| — |
| 17 |
| — |
| 17 |
| ||||
FHLBank of San Francisco |
| 3 |
| 13 |
| 3 |
| 13 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total |
| $ | 38 |
| $ | 69 |
| $ | 38 |
| $ | 234 |
|
MPF Mortgage Loans. The Bank historically sold to the FHLBank of Chicago participations in mortgage assets that the Bank purchased from its members. During the six months ended June 30, 2007, the Bank did not sell any mortgage-loan participations to the FHLBank of Chicago. During the six months ended June 30, 2006, the Bank sold to the FHLBank of Chicago approximately $109.0 million in such mortgage-loan participations.
The Bank pays a transaction-services fee to the FHLBank of Chicago for the Bank’s participation in the MPF program. This fee is assessed monthly, and is based upon the amount of MPF loans purchased after January 1, 2004, and which remain outstanding on the Bank’s statement of condition. The Bank recorded $260,000 and $269,000 in MPF transaction-services fee expense to the FHLBank of Chicago during the three months ended June 30, 2007 and 2006, respectively, which has been recorded in the statements of income as other expense. The Bank recorded $523,000 and $531,000 in MPF transaction-services fee expense to the FHLBank of Chicago during the six months ended June 30, 2007 and 2006, respectively.
Note 15 – Commitments and Contingencies
As provided by both the FHLBank Act and Finance Board regulation, COs are backed by the financial resources of the FHLBanks. The joint and several liability regulation of the Finance Board authorizes the Finance Board to require any FHLBank to repay all or a portion of the principal and interest on COs for which another FHLBank is the primary obligor. No FHLBank has had to assume or pay the CO of another FHLBank.
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-an Interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34 (FIN 45), and determined it was not necessary to recognize the fair value of the Bank’s joint and several liability for all of the COs. The joint and several obligation is mandated by Finance Board regulation and is not the result of an arms-length transaction among the FHLBanks. The FHLBanks have no control over the amount of the guaranty or the determination of how each FHLBank would perform under the joint and several obligation. Because the FHLBanks are subject to the authority of the Finance Board as it relates to decisions involving the allocation of the joint and several liability for the FHLBank’s COs, the FHLBank’s joint and several obligation is excluded from the initial recognition and measurement provisions of FIN 45. Accordingly, the Bank has not recognized a liability for its joint and several obligation related to other FHLBanks’ COs at June 30, 2007, and December 31, 2006. The par amounts of other FHLBanks’ outstanding COs for which the Bank is jointly and severally liable were approximately $911.7 billion and $895.6 billion at June 30, 2007, and December 31, 2006, respectively.
Commitments to Extend Credit. Commitments that legally bind and unconditionally obligate the Bank for additional advances totaled approximately $70.7 million and $76.4 million at June 30, 2007, and December 31, 2006, respectively. Commitments generally are for periods up to 12 months. Standby letters of credit are executed with members for a fee. Outstanding standby letters of credit as of June 30, 2007, and December 31, 2006, were as follows (dollars in thousands):
18
| June 30, 2007 |
| December 31, 2006 |
| |||
|
|
|
|
|
| ||
Outstanding notional |
| $ | 2,383,541 |
| $ | 1,792,749 |
|
Original terms |
| Three months to 20 years |
| Two months to 20 years |
| ||
Final expiration year |
| 2024 |
| 2024 |
| ||
Unearned fees for transactions prior to 2003 as well as the value of the guarantees related to standby letters of credit entered into after 2002 are recorded in other liabilities and totaled $1.2 million and $579,000 at June 30, 2007, and December 31, 2006, respectively. Based on management’s credit analyses and collateral requirements, the Bank has not deemed it necessary to record any additional liability on these commitments. Commitments are fully collateralized at the time of issuance.
Commitments for unused line-of-credit advances totaled approximately $1.5 billion at both June 30, 2007, and December 31, 2006. Commitments are generally for periods of up to 12 months. Since many of these commitments are not expected to be drawn upon, the total commitment amount does not necessarily represent future cash requirements.
Mortgage Loans. Commitments that obligate the Bank to purchase mortgage loans totaled $4.9 million and $6.6 million at June 30, 2007, and December 31, 2006, respectively. Commitments are generally for periods not to exceed 45 business days. Such commitments are recorded as derivatives at their fair values on the statement of condition.
Standby Bond-Purchase Agreements. The Bank has entered into standby bond-purchase agreements with state housing authorities whereby the Bank, for a fee, agrees to purchase and hold the authority’s bonds until the designated marketing agent can find a suitable investor or the housing authority repurchases the bond according to a schedule established by the standby agreement. Each standby agreement dictates the specific terms that would require the Bank to purchase the bond. The bond-purchase commitments entered into by the Bank expire after five years, no later than 2012. Total commitments for bond purchases were $533.7 million and $537.3 million at June 30, 2007, and December 31, 2006, respectively. The Bank had agreements with three state housing authorities at June 30, 2007, and December 31, 2006. For the six months ended June 30, 2007, the Bank was not required to purchase any bonds under these agreements.
Counterparty Credit Exposure. The Bank generally executes derivatives with counterparties rated single-A or better by either S&P or Moody’s, and generally enters into bilateral-collateral agreements. As of June 30, 2007, the Bank had no collateral pledged out to counterparties. As of December 31, 2006, the Bank had pledged as collateral securities with a carrying value, including accrued interest, of $55.0 million to counterparties that have credit-risk exposure to the Bank related to derivatives. These amounts pledged as collateral were subject to contractual agreements whereby the counterparties had the right to sell or repledge the collateral.
Unsettled Consolidated Obligations. The Bank entered into $32.0 million and $500.0 million par value of CO bonds that had traded but not settled as of June 30, 2007, and December 31, 2006, respectively. Additionally, the Bank entered into $4.4 million and $29.8 million par value of CO DNs that had traded but not settled as of June 30, 2007, and December 31, 2006, respectively.
Legal Proceedings. The Bank from time to time is subject to various pending 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 adverse effect on the Bank’s financial condition or results of operations.
Note 16 – Subsequent Events
On August 7, 2007, the board of directors approved payment of a cash dividend at an annualized rate of 6.50 percent based on average capital stock balances outstanding for the second quarter of 2007. The dividend amounted to $39.0 million and will be paid on September 5, 2007.
On August 8, 2007, the Federal Home Loan Banks of Chicago and Dallas jointly announced that they are engaged in preliminary discussions intended to evaluate the benefits and feasibility of combining the business operations of the two institutions.
19
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Statements contained in this quarterly report on Form 10-Q, including statements describing the objectives, projections, estimates, or predictions of the future of the Federal Home Loan Bank of Boston (the Bank), may be “forward-looking statements.” These statements may use forward-looking terms, 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 risk or uncertainty and that actual results could differ materially from those expressed or implied in these forward-looking statements or could affect the extent to which a particular objective, projection, estimate, or prediction is realized. These forward-looking statements involve risks and uncertainties including, but not limited to, the following:
· economic and market conditions;
· volatility of market prices, rates, and indices;
· political, legislative, regulatory, or judicial events;
· changes in the Bank’s capital structure;
· membership changes;
· changes in the demand by Bank members for Bank advances;
· competitive forces, including the availability of other sources of funding for Bank members;
· changes in investor demand for consolidated obligations and/or the terms of interest-rate-exchange agreements and similar agreements;
· the ability of the Bank to introduce new products and services to meet market demand and to manage successfully the risk associated with new products and services;
· the ability of each of the other FHLBanks to repay the principal and interest on consolidated obligations for which it is the primary obligor and with respect to which the Bank has joint and several liability; and
· timing and volume of market activity.
This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Bank’s interim financial statements and notes, which begin on page 1, and the Bank’s Annual Report on Form 10-K for the year ended December 31, 2006.
FINANCIAL HIGHLIGHTS
The following financial highlights for the year ended December 31, 2006, have been derived from the Bank’s audited financial statements. Financial highlights for the June 30, 2007 and 2006, interim periods have been derived from the Bank’s unaudited financial statements (dollars in thousands).
| June 30, |
| December 31, |
| |||
|
| 2007 |
| 2006 |
| ||
Statement of Condition |
|
|
|
|
| ||
Total assets |
| $ | 60,263,319 |
| $ | 57,469,781 |
|
Investments (1) |
| 14,718,386 |
| 11,992,161 |
| ||
Securities purchased under agreements to resell |
| 2,000,000 |
| 3,250,000 |
| ||
Advances |
| 38,849,820 |
| 37,342,125 |
| ||
Mortgage loans held for portfolio, net |
| 4,262,671 |
| 4,502,182 |
| ||
Deposits and other borrowings |
| 1,044,909 |
| 1,124,009 |
| ||
Consolidated obligations, net |
| 55,901,617 |
| 53,241,957 |
| ||
AHP liability |
| 46,688 |
| 44,971 |
| ||
Payable to REFCorp |
| 10,034 |
| 13,275 |
| ||
Mandatorily redeemable capital stock |
| 4,288 |
| 12,354 |
| ||
Class B capital stock outstanding – putable (2) |
| 2,427,656 |
| 2,342,517 |
| ||
Total capital |
| 2,628,273 |
| 2,532,514 |
| ||
|
|
|
|
|
| ||
Other Information |
|
|
|
|
| ||
Total capital ratio (3) |
| 4.35 | % | 4.42 | % | ||
20
| For the Three Months Ended |
| For the Six Months Ended |
| |||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
Results of Operations |
|
|
|
|
|
|
|
|
| ||||
Net interest income |
| $ | 72,316 |
| $ | 76,344 |
| $ | 142,283 |
| $ | 150,531 |
|
Other loss |
| (4,459 | ) | (384 | ) | (2,469 | ) | (776 | ) | ||||
Other expense |
| 13,216 |
| 12,256 |
| 26,115 |
| 24,075 |
| ||||
AHP and REFCorp assessments |
| 14,514 |
| 16,921 |
| 30,203 |
| 33,388 |
| ||||
Net income |
| 40,136 |
| 46,801 |
| 83,505 |
| 92,365 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Other Information (4) |
|
|
|
|
|
|
|
|
| ||||
Dividends declared |
| $ | 38,671 |
| $ | — |
| $ | 78,463 |
| $ | 34,148 |
|
Dividend payout ratio |
| 96.35 | % | — | % | 93.96 | % | 36.97 | % | ||||
Weighted-average dividend rate (5) (6) |
| 6.75 |
| — |
| 6.69 |
| 2.62 |
| ||||
Return on average equity (7) |
| 6.20 |
| 6.71 |
| 6.59 |
| 6.66 |
| ||||
Return on average assets |
| 0.27 |
| 0.32 |
| 0.29 |
| 0.31 |
| ||||
Net interest margin (8) |
| 0.49 |
| 0.52 |
| 0.50 |
| 0.51 |
|
(1) Investments include available-for-sale securities, held-to-maturity securities, trading securities, interest-bearing deposits in banks, and federal funds sold.
(2) Capital stock is putable at the option of a member.
(3) Total capital ratio is capital stock (including mandatorily redeemable capital stock) plus retained earnings as a percentage of total assets. See Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition - Capital regarding the Bank’s regulatory capital ratios.
(4) Yields are annualized.
(5) Weighted-average dividend rate is dividend amount declared divided by the average daily balance of capital stock eligible for dividends.
(6) Beginning with the second quarter of 2006, dividends were not declared until after the quarter had ended. The second quarter 2006 dividend declared by the board of directors in August 2006 was at a rate of 5.50 percent.
(7) Return on average equity is net income divided by the total of the average daily balance of outstanding Class B capital stock and retained earnings. The average daily balance of accumulated other comprehensive income is not included in the calculation.
(8) Net interest margin is net interest income before mortgage-loan-loss provision as a percentage of average earning assets.
Second Quarter of 2007 compared with Second Quarter of 2006. Net income for the quarter ended June 30, 2007, was $40.1 million, compared with $46.8 million for the same period in 2006. This $6.7 million decrease was due, in part, to a decrease of $4.0 million in net interest income, a $4.1 million increase in other loss, and a $960,000 increase in other expense. These decreases to net income were partially offset by a decrease of $2.4 million in AHP and REFCorp assessments.
Net interest income for the quarter ended June 30, 2007, was $72.3 million, compared with $76.3 million for the same period in 2006. This $4.0 million decrease was primarily attributable to a reduction in net interest spreads relative to funding cost related to the Bank’s advances, MPF and MBS portfolios. Also an increase in the proportion of money market assets relative to total assets, and a decline in average capital balances contributed to the decline in net interest income.
For the quarters ended June 30, 2007 and 2006, average total assets were $59.9 billion and $59.5 billion, respectively, but average total capital was $2.6 billion and $2.8 billion for these respective quarters. Return on average assets and return on average equity were 0.27 percent and 6.20 percent, respectively, for the quarter ended June 30, 2007, compared with 0.32 percent and 6.71 percent, respectively, for the quarter ended June 30, 2006. The return on average assets and return on average equity declined mainly due to the $6.7 million decrease in net income during the period.
Six Months Ended June 30, 2007, compared with Six Months Ended June 30, 2006. Net income for the six months ended June 30, 2007, was $83.5 million, compared with $92.4 million for the same period in 2006. This $8.9 million decrease was due, in part, to a decrease of $8.2 million in net interest income, a $1.7 million increase in other loss, and a $2.0 million increase in other expense. These decreases to net income were partially offset by a $3.2 million decrease in AHP and REFCorp assessments.
Net interest income for the six months ended June 30, 2007, was $142.3 million, compared with $150.5 million for the same period in 2006. This $8.2 million decrease was primarily attributable to lower average asset balances, lower average capital balances, and a reduction in net interest spreads relative to funding cost related to the Bank’s advances, MPF and MBS portfolios, as well as an increase in the proportion of money market assets relative to total assets in 2007 as compared to 2006. This decrease was partially offset by an increase in yields earned on advances and investments, in addition to higher average balances of investment securities.
For the six months ended June 30, 2007 and 2006, average total assets were $58.7 billion and $59.9 billion, respectively. Return on average assets and return on average equity were 0.29 percent and 6.59 percent, respectively, for the six months ended June 30, 2007, compared with 0.31 percent and 6.66 percent, respectively, for the six months ended June 30, 2006. The return on average assets and return on average equity declined mainly due to the $8.9 million decrease in net income during the period.
21
Financial Condition at June 30, 2007, versus December 31, 2006
The composition of the Bank’s total assets changed during the quarter ended June 30, 2007, as follows:
· Advances decreased slightly to 64.5 percent of total assets at June 30, 2007, down from 65.0 percent of total assets at December 31, 2006.
· Short-term money-market investments increased to 13.6 percent of total assets at June 30, 2007, up from 11.8 percent of total assets at December 31, 2006. As of June 30, 2007, federal funds sold and interest-bearing deposits had increased by $2.5 billion and $90.0 million, respectively, while securities purchased under agreements to resell decreased by $1.3 billion.
· Investment securities decreased to 14.2 percent of total assets at June 30, 2007, down from 14.7 percent of total assets at December 31, 2006.
· Net mortgage loans decreased to 7.1 percent of total assets at June 30, 2007, from 7.8 percent of total assets at December 31, 2006. Mortgage loans outstanding at June 30, 2007, totaled $4.3 billion, decreasing $239.5 million from December 31, 2006. The decrease reflects a decline in loan-purchase activity, and the fact that principal repayments outpaced loan-purchase activity during the first and second quarter of 2007.
RESULTS OF OPERATIONS
Net Interest Spread and Net Interest Margin
The following table presents major categories of average balances, related interest income/expense, and average yields for interest-earning assets and interest-bearing liabilities. The primary source of earnings for the Bank is net interest income, which is the interest earned on advances, mortgage loans, and investments less interest paid on COs, deposits, and other borrowings. Net interest spread is the difference between the yields on interest-earning assets and interest-bearing liabilities. Net interest margin is expressed as the percentage of net interest income to average earning assets.
Net Interest Spread and Margin
(dollars in thousands)
|
| For the Three Months Ended June 30, |
| ||||||||||||||
|
| 2007 |
| 2006 |
| ||||||||||||
|
| Average |
| Interest |
| Average |
| Average |
| Interest |
| Average |
| ||||
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Advances |
| $ | 38,971,297 |
| $ | 513,961 |
| 5.29 | % | $ | 40,942,527 |
| $ | 499,737 |
| 4.90 | % |
Interest-bearing deposits in banks |
| 1,383,689 |
| 18,453 |
| 5.35 |
| 1,405,325 |
| 17,229 |
| 4.92 |
| ||||
Securities purchased under agreements to resell |
| 1,284,616 |
| 17,105 |
| 5.34 |
| 376,924 |
| 4,686 |
| 4.99 |
| ||||
Federal funds sold |
| 4,964,547 |
| 65,971 |
| 5.33 |
| 3,737,415 |
| 46,283 |
| 4.97 |
| ||||
Investment securities (2) |
| 8,174,575 |
| 112,086 |
| 5.50 |
| 7,586,210 |
| 100,419 |
| 5.31 |
| ||||
Mortgage loans |
| 4,329,440 |
| 54,952 |
| 5.09 |
| 4,795,371 |
| 60,112 |
| 5.03 |
| ||||
Other earning assets |
| — |
| — |
| — |
| 549 |
| 7 |
| 5.11 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total interest-earning assets |
| 59,108,164 |
| 782,528 |
| 5.31 |
| 58,844,321 |
| 728,473 |
| 4.97 | % | ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Other non-interest-earning assets |
| 813,203 |
|
|
|
|
| 663,074 |
|
|
|
|
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total assets |
| $ | 59,921,367 |
| $ | 782,528 |
| 5.24 | % | $ | 59,507,395 |
| $ | 728,473 |
| 4.91 | % |
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Liabilities and capital |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Consolidated obligations |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Discount notes |
| $ | 19,590,415 |
| $ | 254,781 |
| 5.22 | % | $ | 25,092,055 |
| $ | 302,476 |
| 4.84 | % |
Bonds |
| 35,873,773 |
| 443,870 |
| 4.96 |
| 30,115,322 |
| 343,278 |
| 4.57 |
| ||||
Deposits |
| 924,035 |
| 11,331 |
| 4.92 |
| 549,804 |
| 6,066 |
| 4.43 |
| ||||
Mandatorily redeemable capital stock |
| 8,779 |
| 185 |
| 8.45 |
| 13,412 |
| 188 |
| 5.62 |
| ||||
Other borrowings |
| 4,265 |
| 45 |
| 4.23 |
| 10,822 |
| 121 |
| 4.48 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total interest-bearing liabilities |
| 56,401,267 |
| 710,212 |
| 5.05 |
| 55,781,415 |
| 652,129 |
| 4.69 | % | ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Other non-interest-bearing liabilities |
| 917,045 |
|
|
|
|
| 911,836 |
|
|
|
|
| ||||
Total capital |
| 2,603,055 |
|
|
|
|
| 2,814,144 |
|
|
|
|
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total liabilities and capital |
| $ | 59,921,367 |
| $ | 710,212 |
| 4.75 | % | $ | 59,507,395 |
| $ | 652,129 |
| 4.40 | % |
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Net interest income |
|
|
| $ | 72,316 |
|
|
|
|
| $ | 76,344 |
|
|
| ||
Net interest spread |
|
|
|
|
| 0.26 | % |
|
|
|
| 0.28 | % | ||||
Net interest margin |
|
|
|
|
| 0.49 |
|
|
|
|
| 0.52 |
|
22
|
| For the Six Months Ended June 30, |
| ||||||||||||||
|
| 2007 |
| 2006 |
| ||||||||||||
|
| Average |
| Interest |
| Average |
| Average |
| Interest |
| Average |
| ||||
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Advances |
| $ | 38,256,356 |
| $ | 1,000,360 |
| 5.27 | % | $ | 41,057,753 |
| $ | 956,633 |
| 4.70 | % |
Interest-bearing deposits in banks |
| 1,393,951 |
| 36,976 |
| 5.35 |
| 1,591,100 |
| 37,181 |
| 4.71 |
| ||||
Securities purchased under agreements to resell |
| 1,693,370 |
| 44,842 |
| 5.34 |
| 486,879 |
| 11,405 |
| 4.72 |
| ||||
Federal funds sold |
| 3,981,556 |
| 105,222 |
| 5.33 |
| 3,780,475 |
| 89,100 |
| 4.75 |
| ||||
Investment securities (2) |
| 8,214,101 |
| 226,088 |
| 5.55 |
| 7,489,963 |
| 193,275 |
| 5.20 |
| ||||
Mortgage loans |
| 4,385,971 |
| 111,247 |
| 5.11 |
| 4,821,168 |
| 120,739 |
| 5.05 |
| ||||
Other earning assets |
| — |
| — |
| — |
| 276 |
| 7 |
| 5.11 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total interest-earning assets |
| 57,925,305 |
| 1,524,735 |
| 5.31 |
| 59,227,614 |
| 1,408,340 |
| 4.80 | % | ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Other non-interest-earning assets |
| 800,751 |
|
|
|
|
| 670,609 |
|
|
|
|
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total assets |
| $ | 58,726,056 |
| $ | 1,524,735 |
| 5.24 | % | $ | 59,898,223 |
| $ | 1,408,340 |
| 4.74 | % |
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Liabilities and capital |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Consolidated obligations |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Discount notes |
| $ | 19,033,135 |
| $ | 492,900 |
| 5.22 | % | $ | 25,948,178 |
| $ | 594,562 |
| 4.62 | % |
Bonds |
| 35,282,282 |
| 866,932 |
| 4.95 |
| 29,673,361 |
| 651,791 |
| 4.43 |
| ||||
Deposits |
| 909,112 |
| 22,135 |
| 4.91 |
| 521,779 |
| 10,853 |
| 4.19 |
| ||||
Mandatorily redeemable capital stock |
| 12,091 |
| 436 |
| 7.27 |
| 11,443 |
| 310 |
| 5.46 |
| ||||
Other borrowings |
| 2,941 |
| 49 |
| 3.36 |
| 13,522 |
| 293 |
| 4.37 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total interest-bearing liabilities |
| 55,239,561 |
| 1,382,452 |
| 5.05 |
| 56,168,283 |
| 1,257,809 |
| 4.52 | % | ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Other non-interest-bearing liabilities |
| 927,010 |
|
|
|
|
| 918,770 |
|
|
|
|
| ||||
Total capital |
| 2,559,485 |
|
|
|
|
| 2,811,170 |
|
|
|
|
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total liabilities and capital |
| $ | 58,726,056 |
| $ | 1,382,452 |
| 4.75 | % | $ | 59,898,223 |
| $ | 1,257,809 |
| 4.23 | % |
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Net interest income |
|
|
| $ | 142,283 |
|
|
|
|
| $ | 150,531 |
|
|
| ||
Net interest spread |
|
|
|
|
| 0.26 | % |
|
|
|
| 0.28 | % | ||||
Net interest margin |
|
|
|
|
| 0.50 |
|
|
|
|
| 0.51 |
|
(1) Yields are annualized.
(2) The average balances of available-for-sale securities are reflected at amortized cost; therefore the resulting yields do not give effect to changes in fair value.
Second Quarter of 2007 compared with Second Quarter of 2006. Net interest spread for the second quarter of 2007 was 0.26 percent, a two-basis-point decline from the net interest spread for the same period in 2006. Net interest margin for the second quarter of 2007 and 2006 was 0.49 percent and 0.52 percent, respectively. For the quarter ended June 30, 2007, the average yields on total interest-earning assets increased 34 basis points and yields on total interest-bearing liabilities increased 36 basis points, compared with the same period in 2006.
Included in net interest income are prepayment fees related to advances and investment securities. Prepayment fees make the Bank financially indifferent to the prepayment of advances or investments and are net of fair-value hedging adjustments associated with SFAS 133. Despite the decline in net interest income, prepayment fee income increased during the second quarter of 2007 by approximately $1.8 million from the same period in 2006. During the three months ended June 30, 2007, advances totaling $785.9 million were prepaid, resulting in gross prepayment-fee income of $1.9 million, which was partially offset by a loss of $50,000 related to fair-value hedging adjustments on those prepaid advances. For the three months ended June 30, 2006, advances totaling $35.3 million were prepaid, resulting in gross prepayment-fee income of $13,000. For the quarter ended June 30, 2007 and 2006, net prepayment fees on investments were $728,000 and $754,000, respectively.
23
Six Months Ended June 30, 2007 compared with Six Months Ended June 30, 2006. Net interest spread for the six months ended June 30, 2007 was 0.26 percent, a two-basis-point decline from the net interest spread for the same period in 2006. Net interest margin for the six months ended June 30, 2007 and 2006, was 0.50 percent and 0.51 percent, respectively. For the quarter ended June 30, 2007, the average yields on total interest-earning assets increased 51 basis points and yields on total interest-bearing liabilities increased 53 basis points, compared with the same period in 2006. Also, prepayment-fee income, which is classified within net interest income, increased during the six months ended June 30, 2007, by approximately $2.9 million from the same period in 2006.
During the six months ended June 30, 2007, advances totaling $1.2 billion were prepaid, resulting in gross prepayment-fee income of $3.2 million, which was partially offset by a loss of $683,000 related to fair-value hedging adjustments on those prepaid advances. For the six months ended June 30, 2006, advances totaling $751.0 million were prepaid, resulting in gross prepayment-fee income of $98,000, which was increased by a $51,000 gain related to fair-value hedging adjustments on those prepaid advances and offset by a loss of $415,000 related to the premium write off associated with these prepaid advances. For the six months ended June 30, 2007 and 2006, net prepayment fees on investments were $2.7 million and $2.5 million, respectively.
Prepayment-fee income is unpredictable and inconsistent from period to period, occurring only when advances and investments are prepaid prior to the scheduled maturity or repricing dates. Because prepayment-fee income recognized during these periods does not necessarily represent a trend that will continue in future periods, and due to the fact that prepayment-fee income represents a one-time fee recognized in the period in which the corresponding advance or investment security is prepaid, we believe it is important to review the results of net interest spread and net interest margin excluding the impact of prepayment-fee income. Excluding the impact of prepayment-fee income, net interest spread decreased from 0.27 percent in the second quarter of 2006 to 0.24 percent in the same period in 2007, and net interest margin decreased from 0.52 percent in 2006 to 0.47 percent in 2007. Excluding the impact of prepayment-fee income, net interest spread decreased from 0.27 percent for the six months ended June 30, 2006 to 0.24 percent for the same period in 2007, and net interest margin decreased from 0.50 percent in 2006 to 0.48 percent in 2007. These results are presented in the following tables.
Net Interest Spread and Margin without Prepayment-Fee Income
(dollars in thousands)
| For the Three Months Ended June 30, |
| |||||||||
|
| 2007 |
| 2006 |
| ||||||
|
| Interest |
| Average |
| Interest |
| Average |
| ||
|
|
|
|
|
|
|
|
|
| ||
Advances |
| $ | 512,146 |
| 5.27 | % | $ | 499,724 |
| 4.90 | % |
Investment securities |
| 111,358 |
| 5.46 |
| 99,665 |
| 5.27 |
| ||
Total interest-earning assets |
| 779,985 |
| 5.29 |
| 727,706 |
| 4.96 |
| ||
|
|
|
|
|
|
|
|
|
| ||
Net interest income |
| 69,773 |
|
|
| 75,577 |
|
|
| ||
Net interest spread |
|
|
| 0.24 | % |
|
| 0.27 | % | ||
Net interest margin |
|
|
| 0.47 | % |
|
| 0.52 | % | ||
| For the Six Months Ended June 30, |
| |||||||||
|
| 2007 |
| 2006 |
| ||||||
|
| Interest |
| Average |
| Interest |
| Average |
| ||
|
|
|
|
|
|
|
|
|
| ||
Advances |
| $ | 997,875 |
| 5.26 | % | $ | 956,899 |
| 4.70 | % |
Investment securities |
| 223,428 |
| 5.49 |
| 190,762 |
| 5.14 |
| ||
Total interest-earning assets |
| 1,519,590 |
| 5.29 |
| 1,406,093 |
| 4.79 |
| ||
|
|
|
|
|
|
|
|
|
| ||
Net interest income |
| 137,138 |
|
|
| 148,284 |
|
|
| ||
Net interest spread |
|
|
| 0.24 | % |
|
| 0.27 | % | ||
Net interest margin |
|
|
| 0.48 | % |
|
| 0.50 | % | ||
The decline in net interest spread is attributable to several factors. First, the net interest spread to funding cost on advances, MBS, and MPF loans has been narrower on new transactions relative to expiring transactions, so that over time, average net interest spread has declined. In particular, during the second quarter of 2007, in response to recent declines in advances balances outstanding, the Bank offered discount advances pricing designed to stimulate demand for advances. Second, as the Bank’s MPF portfolio has aged, low-cost short-term debt assigned to the portfolio has expired, narrowing the Bank’s overall net interest spread. Third, the proportion of low-margin money market investments to total assets has increased. All of these factors have contributed to lower net interest spreads, despite the fact that CO debt funding costs have declined relative to broader market interest rates, such as US Dollar interest rate swap yields.
The average balance of total advances decreased $2.8 billion, or 6.8 percent, for the six months ended June 30, 2007, compared with
24
the same period in 2006. The decrease in average advances was attributable to a decrease in member demand for short-term and overnight advances, while long-term fixed-rate and variable-rate advances showed an increase during the six months ended June 30, 2007, as compared to the same period in 2006. The following table summarizes average balances of advances outstanding during the six months ended June 30, 2007 and 2006, by product type.
Average Balances of Advances Outstanding
By Product Type
(dollars in thousands)
| For the Six Months Ended |
| |||||
|
| 2007 |
| 2006 |
| ||
|
|
|
|
|
| ||
Overnight advances – par value |
| $ | 1,106,777 |
| $ | 2,460,797 |
|
|
|
|
|
|
| ||
Fixed-rate advances – par value |
|
|
|
|
| ||
Short-term |
| 15,288,276 |
| 19,877,387 |
| ||
Long-term |
| 8,527,242 |
| 7,902,336 |
| ||
Amortizing |
| 2,443,119 |
| 2,504,526 |
| ||
Putable |
| 5,857,780 |
| 5,502,309 |
| ||
Callable |
| 30,000 |
| 30,000 |
| ||
|
| 32,146,417 |
| 35,816,558 |
| ||
|
|
|
|
|
| ||
Variable-rate advances – par value |
|
|
|
|
| ||
Simple variable |
| 5,016,315 |
| 2,815,187 |
| ||
Putable, convertible to fixed |
| 4,050 |
| — |
| ||
|
| 5,020,365 |
| 2,815,187 |
| ||
|
|
|
|
|
| ||
Total average advances par value |
| 38,273,559 |
| 41,092,542 |
| ||
|
|
|
|
|
| ||
Premiums and discounts |
| (10,551 | ) | (5,993 | ) | ||
SFAS 133 hedging adjustments |
| (6,652 | ) | (28,796 | ) | ||
|
|
|
|
|
| ||
Total average advances |
| $ | 38,256,356 |
| $ | 41,057,753 |
|
As displayed in the above table, the average balance of overnight advances decreased by $1.4 billion from the six months ended June 30, 2006, to the same period in 2007. The interest rate on overnight advances changes on a daily basis, and is based on market indications each day. Total average advances decreased by $2.8 billion from the six months ended June 30, 2006, to the same period in 2007. This decrease is attributable to the activity of the Bank’s larger members. The average balance of short-term fixed-rate advances decreased by approximately $4.6 billion from the six months ended June 30, 2006, to the same period in 2007. All short-term fixed-rate advances have a maturity of one year or less, with interest rates that closely follow short-term market interest-rate trends. The yield spread to the Bank’s funding cost for these advances is generally narrower for these products than for other products with longer terms to maturity. For the six months ended June 30, 2007, the average balance of variable-rate indexed advances increased by $2.2 billion from the average balance for the same period in 2006. These advances have coupon rates that reset on a predetermined basis based on changes in an index, typically one- or three-month London Interbank Offered Rate (LIBOR), or on the offered yield on three-month FHLBank DNs, as determined by the Office of Finance. Additionally, while most putable advances are classified as fixed-rate advances in the table above, substantially all putable advances are hedged with interest-rate-exchange agreements in which a short-term rate is received, typically three-month LIBOR. Therefore, a significant portion of the Bank’s advances contain either a short-term rate or are swapped to a short-term index, resulting in yields that closely follow short-term market interest-rate trends. The average balance of overnight advances, short-term fixed-rate advances, fixed-rate putable advances, and variable-rate advances combined totaled $27.3 billion for the six months ended June 30, 2007, representing 71.3 percent of the total average balance of advances outstanding during the six months ended June 30, 2007. For the same period in 2006, the average balance of these combined advances totaled $30.7 billion, representing 74.6 percent of total average advances outstanding during the period.
In the past, the foregoing trend toward a higher proportion of longer-term advances would generally lead to improved net interest spreads to funding costs for the overall advances portfolio. However, due to diminished advance demand that the Bank experienced in 2007, the Bank has offered advances at net interest spreads that were lower than historical averages for longer-term products, diminishing the favorable impact of long-term advances upon the Bank’s net interest spread.
Average short-term money-market investments, consisting of interest-bearing deposits in banks, securities purchased under agreements to resell, and federal funds sold, increased $1.2 billion, or 20.7 percent, from the average balances for the six months ended June 30, 2006, to June 30, 2007. The higher average balances in the six months ended June 30, 2007, resulted from the increased activity in securities purchased under agreements to resell. The yield earned on short-term money-market investments is tied directly to short-term market interest rates. These investments are used for liquidity management and to manage the Bank’s leverage
25
ratio in response to fluctuations in other asset balances.
Average investment-securities balances increased $724.1 million or 9.7 percent for the six months ended June 30, 2007, compared with the same period in 2006. The growth in average investments is due to the increase in held-to-maturity MBS of $834.4 million. The increase in held-to-maturity MBS is due to the Bank striving to maintain a level of MBS investments near the 300 percent of capital limitation. Moreover, due to impacts on demand for MBS stemming from turmoil in the subprime mortgage market, net interest spread opportunities with respect to all types of MBS improved over the course of the second quarter of 2007, as compared to the same period in 2006. Accordingly, the Bank was able to purchase more MBS at favorable risk-adjusted net interest spreads in 2007 than during corresponding periods in 2006.
Average mortgage-loan balances for the six months ended June 30, 2007, were $435.2 million lower than the average balance for the same period in 2006, representing a decrease of 9.0 percent. This decrease in average mortgage-loan balances was attributable to the following:
· Mortgage-loan purchases during the six months ended June 30, 2007 and 2006, amounted to $81.2 million and $182.8 million, respectively. The decline in purchases is due to the fact that the Bank currently has no master commitments outstanding to Balboa Reinsurance Co., and that the Bank has not participated in any loan purchases from Balboa Reinsurance Co. since April 2006.
· The FHLBank of Chicago has not purchased any participation interests in MPF loans acquired by the Bank since April 2006. See Financial Condition — Mortgage Loans for additional information regarding the FHLBank of Chicago’s participation in MPF loan purchases. As a result, the Bank has avoided entering into large master commitments to purchase large volumes of mortgage loans at unattractive yield spreads.
· As interest rates rose during 2006 and into 2007, mortgage-refinancing activities remained relatively moderate, resulting in relatively low prepayment activity in the Bank’s outstanding loan portfolio.
Overall, the yield on the mortgage-loan portfolio has increased for the quarter ended June 30, 2007, over the quarter ended June 30, 2006. This increase is attributable to the following factors:
· The average stated coupon rate of the mortgage-loan portfolio increased due to the acquisition of loans at higher interest rates in 2006 and into the first six months of 2007 relative to the coupons on pre-existing loans;
· Premium/discount amortization expense has declined $665,000, or 29.8 percent, due to a lower amount of loan prepayments in the quarter ended June 30, 2007, versus the same period in 2006; and
· The above factors were offset by an increase in net premiums on mortgage loans purchased during the quarter ended June 30, 2007, compared with those purchased during the quarter ended June 30, 2006. The book-value adjustment on newly purchased mortgage loans fluctuated from a net discount of $396,000 to a net premium of $116,000 for the three months ended June 30, 2006 and 2007, respectively. The premium balance will result in a decrease to the yield when amortized.
Overall, the yield on the mortgage-loan portfolio has increased for the six months ended June 30, 2007, over the six months ended June 30, 2006. This increase is attributable to the following factors:
· The average stated coupon rate of the mortgage-loan portfolio increased due to the acquisition of loans at higher interest rates in 2006 which continued in 2007 relative to the coupons on pre-existing loans;
· Premium/discount amortization expense has declined $1.3 million, or 27.5 percent, due to a lower amount of loan prepayments in the six months ended June 30, 2007, versus the same period in 2006; and
· The above factors were offset by an increase in net premiums on mortgage loans purchased during the six months ended June 30, 2007, compared to those purchased during the six months ended June 30, 2006. The book-value adjustment on newly purchased mortgage loans fluctuated from a net discount of $952,000 to a net premium of $258,000 for the six months ended June 30, 2006 and 2007, respectively. The premium balance will result in a decrease to the yield when amortized.
26
Composition of the Yields of Mortgage Loans
(dollars in thousands)
| For the Three Months Ended June 30, |
| |||||||||
|
| 2007 |
| 2006 |
| ||||||
|
| Interest |
| Average |
| Interest |
| Average |
| ||
|
|
|
|
|
|
|
|
|
| ||
Coupon accrual |
| $ | 57,705 |
| 5.35 | % | $ | 63,633 |
| 5.32 | % |
Premium/discount amortization |
| (1,570 | ) | (0.15 | ) | (2,235 | ) | (0.18 | ) | ||
Credit-enhancement fees |
| (1,183 | ) | (0.11 | ) | (1,286 | ) | (0.11 | ) | ||
|
|
|
|
|
|
|
|
|
| ||
Total interest income |
| $ | 54,952 |
| 5.09 | % | $ | 60,112 |
| 5.03 | % |
| For the Six Months Ended June 30, |
| |||||||||
|
| 2007 |
| 2006 |
| ||||||
|
| Interest |
| Average |
| Interest |
| Average |
| ||
|
|
|
|
|
|
|
|
|
| ||
Coupon accrual |
| $ | 116,918 |
| 5.37 | % | $ | 127,868 |
| 5.35 | % |
Premium/discount amortization |
| (3,301 | ) | (0.15 | ) | (4,556 | ) | (0.19 | ) | ||
Credit-enhancement fees |
| (2,370 | ) | (0.11 | ) | (2,573 | ) | (0.11 | ) | ||
|
|
|
|
|
|
|
|
|
| ||
Total interest income |
| $ | 111,247 |
| 5.11 | % | $ | 120,739 |
| 5.05 | % |
(1) Yields are annualized.
Average CO balances decreased $1.3 billion, or 2.3 percent, from the six months ended June 30, 2006, to the same period in 2007. This decrease was due to the $6.9 billion reduction in CO DNs, all of which are short term with maturities of one year or less. The decline corresponds to the $5.9 billion decrease in average short-term and overnight advances from the six months ended June 30, 2006, to the same period in 2007. The remainder of the reduction in DNs is attributable to a shift to CO bonds due to relatively more favorable spreads in the CO bond market during the second quarter.
Net interest income includes interest paid and received on those interest-rate-exchange agreements associated with advances, investments, deposits, and debt instruments that qualify for hedge accounting under SFAS 133. The Bank generally utilizes derivative instruments that qualify for hedge accounting as an interest-rate-risk management tool. These derivatives serve to stabilize net interest income and net interest margin when interest rates fluctuate. Accordingly, the impact of derivatives on net interest income and net interest margin should be viewed in the overall context of the Bank’s risk-management strategy. The following table provides a summary of the impact of derivative instruments on interest income and interest expense.
Impact of Derivatives on Gross Interest Income and Gross Interest Expense
(dollars in thousands)
| For the Three Months Ended June 30, |
| For the Six Months Ended June 30, |
| |||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Gross interest income before effect of derivatives |
| $ | 766,693 |
| $ | 719,017 |
| $ | 1,494,572 |
| $ | 1,398,971 |
|
Net interest adjustment for derivatives |
| 15,835 |
| 9,456 |
| 30,163 |
| 9,369 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total interest income reported |
| $ | 782,528 |
| $ | 728,473 |
| $ | 1,524,735 |
| $ | 1,408,340 |
|
|
|
|
|
|
|
|
|
|
| ||||
Gross interest expense before effect of derivatives |
| $ | 702,559 |
| $ | 621,186 |
| $ | 1,360,986 |
| $ | 1,208,858 |
|
Net interest adjustment for derivatives |
| 7,653 |
| 30,943 |
| 21,466 |
| 48,951 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total interest expense reported |
| $ | 710,212 |
| $ | 652,129 |
| $ | 1,382,452 |
| $ | 1,257,809 |
|
Reported net interest margin for the three months ended June 30, 2007 and 2006, was 0.49 percent and 0.52 percent, respectively. If derivative instruments had not been used as hedges to mitigate the impact of interest-rate fluctuations, net interest margin would have been 0.44 percent and 0.67 percent for the three months ended June 30, 2007 and 2006, respectively.
Reported net interest margin for the six months ended June 30, 2007 and 2006, was 0.50 percent and 0.51 percent, respectively. If derivative instruments had not been used as hedges to mitigate the impact of interest-rate fluctuations, net interest margin would have been 0.47 percent and 0.65 percent for the six months ended June 30, 2007 and 2006, respectively.
Interest paid and received on interest-rate-exchange agreements that are used by the Bank in its asset and liability management, but which do not meet hedge-accounting requirements of SFAS 133 (economic hedges), are classified as net gain on derivatives and hedging activities in other income. As shown in the Other Income (Loss) and Operating Expenses section below, interest accruals on derivatives classified as economic hedges totaled a gain of $202,000 and $145,000 for the three months ended June 30, 2007 and 2006, respectively. For the six months ended June 30, 2007 and 2006, interest accruals on derivatives classified as economic hedges totaled a gain of $397,000 and $519,000, respectively.
27
More information about the Bank’s use of derivative instruments to manage interest-rate risk is provided in the Risk Management – Market and Interest-Rate Risk section of this report.
Rate and Volume Analysis
Changes in both average balances (volume) and interest rates influence changes in net interest income and net interest margin. The decrease in net interest income is due primarily to narrower net interest spreads between asset yields and CO yields, lower average capital levels, and a decrease in average advance balances. The following table summarizes changes in interest income and interest expense between the three months and six months ended June 30, 2007 and 2006. Changes in interest income and interest expense that are not identifiable as either volume-related or rate-related, but rather equally attributable to both volume and rate changes, have been allocated to the volume and rate categories based upon the proportion of the volume and rate changes.
Rate and Volume Analysis
(dollars in thousands)
|
| For the Three Months Ended |
| For the Six Months Ended |
| ||||||||||||||
|
| Increase (decrease) due to |
| Increase (decrease) due to |
| ||||||||||||||
|
| Volume |
| Rate |
| Total |
| Volume |
| Rate |
| Total |
| ||||||
Interest income |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Advances |
| $ | (24,060 | ) | $ | 38,284 |
| $ | 14,224 |
| $ | (65,272 | ) | $ | 108,999 |
| $ | 43,727 |
|
Interest-bearing deposits in banks |
| (265 | ) | 1,489 |
| 1,224 |
| (4,607 | ) | 4,402 |
| (205 | ) | ||||||
Securities purchased under agreements to resell |
| 11,285 |
| 1,134 |
| 12,419 |
| 28,262 |
| 5,175 |
| 33,437 |
| ||||||
Federal funds sold |
| 15,196 |
| 4,492 |
| 19,688 |
| 4,739 |
| 11,383 |
| 16,122 |
| ||||||
Investment securities |
| 7,788 |
| 3,879 |
| 11,667 |
| 18,686 |
| 14,127 |
| 32,813 |
| ||||||
Mortgage loans |
| (5,841 | ) | 681 |
| (5,160 | ) | (10,899 | ) | 1,407 |
| (9,492 | ) | ||||||
Other earnings assets |
| (7 | ) | — |
| (7 | ) | (7 | ) | — |
| (7 | ) | ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Total interest income |
| 4,096 |
| 49,959 |
| 54,055 |
| (29,098 | ) | 145,493 |
| 116,395 |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Interest expense |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Consolidated obligations |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Discount notes |
| (66,320 | ) | 18,625 |
| (47,695 | ) | (158,447 | ) | 56,785 |
| (101,662 | ) | ||||||
Bonds |
| 65,639 |
| 34,953 |
| 100,592 |
| 123,203 |
| 91,938 |
| 215,141 |
| ||||||
Deposits |
| 4,129 |
| 1,136 |
| 5,265 |
| 8,057 |
| 3,225 |
| 11,282 |
| ||||||
Mandatorily redeemable capital stock |
| (65 | ) | 62 |
| (3 | ) | 18 |
| 108 |
| 126 |
| ||||||
Other borrowings |
| (73 | ) | (3 | ) | (76 | ) | (229 | ) | (15 | ) | (244 | ) | ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Total interest expense |
| 3,310 |
| 54,773 |
| 58,083 |
| (27,398 | ) | 152,041 |
| 124,643 |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Change in net interest income |
| $ | 786 |
| $ | (4,814 | ) | $ | (4,028 | ) | $ | (1,700 | ) | $ | (6,548 | ) | $ | (8,248 | ) |
Other Income (Loss) and Operating Expenses
The following table presents a summary of other income (loss) for the three months and six months ended June 30, 2007 and 2006. Additionally, detail on the components of net gain (loss) on derivatives and hedging activities is provided, indicating the source of these gains and losses by type of hedging relationship and hedge-accounting treatment.
28
Other Income (Loss)
(dollars in thousands)
|
| For the Three Months Ended |
| For the Six Months Ended |
| ||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
(Losses) gains on derivatives and hedging activities: |
|
|
|
|
|
|
|
|
| ||||
Net losses related to fair-value hedge ineffectiveness |
| $ | (4,645 | ) | $ | (541 | ) | $ | (3,523 | ) | $ | (357 | ) |
Net unrealized (losses) gains related to derivatives not receiving hedge accounting under SFAS 133 associated with: |
|
|
|
|
|
|
|
|
| ||||
Advances |
| 200 |
| 44 |
| 176 |
| 65 |
| ||||
Trading securities |
| 398 |
| 395 |
| 93 |
| 1,904 |
| ||||
Mortgage delivery commitments |
| (134 | ) | (187 | ) | (126 | ) | (1,362 | ) | ||||
Net interest accruals related to derivatives not receiving hedge accounting under SFAS 133 |
| 202 |
| 145 |
| 397 |
| 519 |
| ||||
Net (losses) gains on derivatives and hedging activities |
| (3,979 | ) | (144 | ) | (2,983 | ) | 769 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Loss on early extinguishment of debt |
| (641 | ) | — |
| (641 | ) | (215 | ) | ||||
Service-fee income |
| 937 |
| 802 |
| 2,003 |
| 1,335 |
| ||||
Net unrealized loss on trading securities |
| (785 | ) | (1,055 | ) | (859 | ) | (2,648 | ) | ||||
Other |
| 9 |
| 13 |
| 11 |
| (17 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Total other loss |
| $ | (4,459 | ) | $ | (384 | ) | $ | (2,469 | ) | $ | (776 | ) |
Second Quarter of 2007 compared with Second Quarter of 2006. Net losses related to fair-value hedge ineffectiveness were $4.6 million and $541,000 for the three months ended June 30, 2007 and 2006, respectively. The unfavorable hedge ineffectiveness was largely attributable to the portfolio of hedged CO debt, reflecting the impact of rising interest rates, which caused the expected lives of callable CO debt and associated interest rate swaps to extend.
As noted in the Other Income (Loss) table above, SFAS 133 introduces the potential for considerable timing differences between income recognition from assets or liabilities and income effects of hedging instruments entered into to mitigate interest-rate risk and cash-flow activity.
Losses on early extinguishment of debt totaled $641,000 for the three months ended June 30, 2007. There were no losses on early extinguishment of debt during the three months ended June 30, 2006. Early extinguishment of debt is primarily driven by the prepayment of advances and investments, which generates fee income to the Bank in the form of make-whole prepayment penalties. The Bank may use a portion of the proceeds of prepaid advances and investments to retire higher-costing debt and to manage the relative interest-rate sensitivities of assets and liabilities. During the three months ended June 30, 2007, the Bank extinguished debt with carrying balances totaling $22.3 million. The Bank did not extinguish any debt during the three months ended June 30, 2006.
Changes in the fair value of trading securities are recorded in other income (loss). For the three months ended June 30, 2007 and 2006, net unrealized losses on trading securities of $785,000 and $1.1 million, respectively, were recognized. These securities are economically hedged with interest-rate-exchange agreements that do not qualify for hedge accounting under SFAS 133, but are acceptable hedging strategies under the Bank’s risk-management program. Changes in the fair value of these economic hedges are recorded in current-period earnings and amounted to net gains of $398,000 and $395,000 for the three months ended June 30, 2007 and 2006, respectively. Also included in other income (loss) are interest accruals on these economic hedges, which totaled $202,000 and $145,000 for the three months ended June 30, 2007 and 2006, respectively.
Six Months Ended June 30, 2007, compared with Six Months Ended June 30, 2006. Net losses related to fair-value hedge ineffectiveness were $3.5 million and $357,000 for the six months ended June 30, 2007 and 2006, respectively. The unfavorable hedge ineffectiveness was largely attributable to the portfolio of hedged CO debt, reflecting the impact of rising interest rates, which caused the expected lives of callable CO debt and associated interest rate swaps to extend. This was partially offset by the recapture of unrealized losses during the first quarter of 2007 that were attributable to hedge ineffectiveness that occurred in prior periods as hedges expired.
Losses on early extinguishment of debt totaled $641,000 and $215,000 for the six months ended June 30, 2007 and 2006, respectively. During the six months ended June 30, 2007 and 2006, the Bank extinguished debt with carrying balances totaling $22.3 million and $2.0 million, respectively.
For the six months ended June 30, 2007 and 2006, net unrealized losses on trading securities of $859,000 and $2.6 million, respectively, were recognized. These securities are economically hedged with interest-rate-exchange agreements that do not qualify for hedge accounting under SFAS 133, but are acceptable hedging strategies under the Bank’s risk-management program. Changes in the fair value of these economic hedges are recorded in current-period earnings and amounted to a net gain of $93,000 and $1.9 million for the six months ended June 30, 2007 and 2006, respectively. Also included in other income (loss) are interest accruals on these economic hedges, which totaled $397,000 and $519,000 for the six months ended June 30, 2007 and 2006, respectively.
29
Operating expenses for the three months and six months ended June 30, 2007 and 2006, are summarized in the following table:
Operating Expenses
(dollars in thousands)
|
| For the Three Months Ended |
| For the Six Months Ended |
| ||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Salaries, incentive compensation, and benefits |
| $ | 7,475 |
| $ | 6,661 |
| $ | 15,161 |
| $ | 13,681 |
|
Occupancy costs |
| 964 |
| 1,112 |
| 2,014 |
| 2,164 |
| ||||
Other operating expenses |
| 3,616 |
| 3,357 |
| 6,439 |
| 5,928 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total operating expenses |
| $ | 12,055 |
| $ | 11,130 |
| $ | 23,614 |
| $ | 21,773 |
|
|
|
|
|
|
|
|
|
|
| ||||
Annualized ratio of operating expenses to average assets |
| 0.08 | % | 0.08 | % | 0.08 | % | 0.07 | % |
Second Quarter of 2007 compared with Second Quarter of 2006. For the three months ended June 30, 2007, total operating expenses increased $925,000 from the same period in 2006. This increase was mainly due to an $814,000 increase in salaries and benefits and a $259,000 increase in other operating expenses. The $814,000 increase in salaries and benefits was due primarily to a $277,000 increase in salary expenses attributable to annual merit increases, as well as approximately $500,000 attributable to employee benefits. The increase in employee benefits was primarily attributable to an increase in costs associated with the Bank’s pension plans.
The $259,000 increase in other operating expenses was largely attributable to a $19,000 increase in depreciation of furniture and equipment due to planned furniture and equipment purchases, a $36,000 increase in travel expenses, a $122,000 increase in employee search expenses to fill vacant positions, and a $99,000 increase in professional fees. These were offset by an $81,000 decline in office supplies.
The Bank, together with the other FHLBanks, is charged for the cost of operating the Finance Board and the Office of Finance. These expenses totaled $897,000 and $840,000 for the three months ended June 30, 2007 and 2006, respectively, and are included in other expense.
Six Months Ended June 30, 2007 compared with Six Months Ended June 30, 2006. For the six months ended June 30, 2007, total operating expenses increased $1.8 million from the same period in 2006. This increase was mainly due to a $1.5 million increase in salaries and benefits and a $511,000 increase in other operating expenses. The $1.5 million increase in salaries and benefits was due primarily to a $635,000 increase in salary expenses attributable to annual merit increases, as well as approximately $728,000 attributable to employee benefits. The increase in employee benefits was primarily attributable to an increase in costs associated with the Bank’s pension plans.
The $511,000 increase in other operating expenses is largely attributable to an $82,000 increase in depreciation of furniture and equipment due to planned furniture and equipment purchases, a $111,000 increase in contractual services related to information technology expenses, a $151,000 increase in employee search expenses to fill vacant positions, and a $342,000 increase in professional fees. These were offset by a $63,000 decline in travel expenses, and a $146,000 decrease in office supplies.
The Bank, together with the other FHLBanks, is charged for the cost of operating the Finance Board and the Office of Finance. These expenses totaled $2.0 million and $1.7 million for the six months ended June 30, 2007 and 2006, respectively, and are included in other expense.
FINANCIAL CONDITION
Advances
At June 30, 2007, the advances portfolio totaled $38.8 billion, an increase of $1.5 billion compared with a total of $37.3 billion at December 31, 2006. This increase was primarily the result of increases in fixed-rate and variable-rate advances that were partially offset by a decrease in overnight advances. Fixed-rate advances increased $1.6 billion and variable-rate advances increased $129.7 million as members increased their borrowings during the first six months of 2007 in response to their own balance-sheet demands. These increases were partially offset by a decrease of $175.5 million in overnight advances. The $1.5 billion increase in advances was largely attributable to the activity of the Bank’s top advance holding members. At June 30, 2007, 55.4 percent of total advances outstanding had original maturities of greater than one year, compared with 54.7 percent as of December 31, 2006.
30
The following table summarizes advances outstanding at June 30, 2007, and December 31, 2006, by year of maturity.
Advances Outstanding by Year of Maturity
(dollars in thousands)
| June 30, 2007 |
| December 31, 2006 |
| |||||||
Year of Maturity |
| Amount |
| Weighted |
| Amount |
| Weighted |
| ||
|
|
|
|
|
|
|
|
|
| ||
Overdrawn demand-deposit accounts | �� | $ | 11,000 |
| 5.63 | % | $ | 8,285 |
| 5.66 | % |
Due in one year or less |
| 22,089,507 |
| 5.15 |
| 21,541,880 |
| 5.12 |
| ||
Due after one year through two years |
| 6,117,169 |
| 4.96 |
| 4,424,213 |
| 4.67 |
| ||
Due after two years through three years |
| 3,150,853 |
| 5.02 |
| 3,811,448 |
| 4.91 |
| ||
Due after three years through four years |
| 2,075,788 |
| 4.88 |
| 2,348,233 |
| 5.06 |
| ||
Due after four years through five years |
| 1,603,475 |
| 4.93 |
| 1,984,555 |
| 4.92 |
| ||
Thereafter |
| 3,863,620 |
| 4.56 |
| 3,240,144 |
| 4.58 |
| ||
|
|
|
|
|
|
|
|
|
| ||
Total par value |
| 38,911,412 |
| 5.03 | % | 37,358,758 |
| 4.98 | % | ||
|
|
|
|
|
|
|
|
|
| ||
Premium on advances |
| 2,824 |
|
|
| 4,031 |
|
|
| ||
Discount on advances |
| (15,651 | ) |
|
| (13,413 | ) |
|
| ||
SFAS 133 hedging adjustments |
| (48,765 | ) |
|
| (7,251 | ) |
|
| ||
|
|
|
|
|
|
|
|
|
| ||
Total |
| $ | 38,849,820 |
|
|
| $ | 37,342,125 |
|
|
|
As of June 30, 2007, SFAS 133 hedging adjustments decreased $41.5 million from December 31, 2006. Higher market interest rates during the first six months of 2007, as compared to the fourth quarter of 2006, have resulted in a lower estimated fair value of the hedged advances.
The Bank offers advances to members that may be prepaid on pertinent dates (call dates) without incurring prepayment or termination fees (callable advances). At June 30, 2007, and December 31, 2006, the Bank had outstanding callable advances of $30.0 million.
The following table summarizes advances outstanding at June 30, 2007, and December 31, 2006, by year of maturity or next call date for callable advances.
Advances Outstanding by Year of Maturity or Next Call Date
(dollars in thousands)
Year of Maturity or Next Call Date |
| June 30, 2007 |
| December 31, 2006 |
| ||
|
|
|
|
|
| ||
Overdrawn demand-deposit accounts |
| $ | 11,000 |
| $ | 8,285 |
|
Due in one year or less |
| 22,119,507 |
| 21,571,880 |
| ||
Due after one year through two years |
| 6,117,169 |
| 4,424,213 |
| ||
Due after two years through three years |
| 3,150,853 |
| 3,811,448 |
| ||
Due after three years through four years |
| 2,045,788 |
| 2,348,233 |
| ||
Due after four years through five years |
| 1,603,475 |
| 1,954,555 |
| ||
Thereafter |
| 3,863,620 |
| 3,240,144 |
| ||
|
|
|
|
|
| ||
Total par value |
| $ | 38,911,412 |
| $ | 37,358,758 |
|
The Bank also offers putable advances, in which the Bank purchases a put option from the member that allows the Bank to terminate the advance on specific dates through its term. At June 30, 2007, and December 31, 2006, the Bank had putable advances outstanding totaling $6.1 billion, and $5.4 billion, respectively. The following table summarizes advances outstanding at June 30, 2007, and December 31, 2006, by year of maturity or next put date for putable advances.
Advances Outstanding by Year of Maturity or Next Put Date
(dollars in thousands)
Year of Maturity or Next Put Date |
| June 30, 2007 |
| December 31, 2006 |
| ||
|
|
|
|
|
| ||
Overdrawn demand-deposit accounts |
| $ | 11,000 |
| $ | 8,285 |
|
Due in one year or less |
| 26,795,932 |
| 25,745,480 |
| ||
Due after one year through two years |
| 6,446,119 |
| 4,476,013 |
| ||
Due after two years through three years |
| 2,328,253 |
| 3,320,798 |
| ||
Due after three years through four years |
| 889,438 |
| 1,120,083 |
| ||
Due after four years through five years |
| 1,029,925 |
| 1,105,255 |
| ||
Thereafter |
| 1,410,745 |
| 1,582,844 |
| ||
|
|
|
|
|
| ||
Total par value |
| $ | 38,911,412 |
| $ | 37,358,758 |
|
31
The following table summarizes advances outstanding by product type at June 30, 2007, and December 31, 2006.
Advances Outstanding By Product Type
(dollars in thousands)
| June 30, 2007 |
| December 31, 2006 |
| |||||||
|
|
|
| Percent of |
|
|
| Percent of |
| ||
|
| Balance |
| Total |
| Balance |
| Total |
| ||
|
|
|
|
|
|
|
|
|
| ||
Overnight advances |
| $ | 861,190 |
| 2.2 | % | $ | 1,036,669 |
| 2.8 | % |
|
|
|
|
|
|
|
|
|
| ||
Fixed-rate advances |
|
|
|
|
|
|
|
|
| ||
Short-term |
| 16,030,842 |
| 41.2 |
| 15,231,027 |
| 40.8 |
| ||
Long-term |
| 8,775,674 |
| 22.5 |
| 8,418,729 |
| 22.5 |
| ||
Amortizing |
| 2,333,681 |
| 6.0 |
| 2,593,183 |
| 6.9 |
| ||
Putable |
| 6,106,725 |
| 15.7 |
| 5,405,500 |
| 14.5 |
| ||
Callable |
| 30,000 |
| 0.1 |
| 30,000 |
| 0.1 |
| ||
|
| 33,276,922 |
| 85.5 |
| 31,678,439 |
| 84.8 |
| ||
|
|
|
|
|
|
|
|
|
| ||
Variable-rate advances |
|
|
|
|
|
|
|
|
| ||
Simple variable |
| 4,739,300 |
| 12.2 |
| 4,643,650 |
| 12.4 |
| ||
Putable, convertible to fixed |
| 34,000 |
| 0.1 |
| — |
| — |
| ||
|
| 4,773,300 |
| 12.3 |
| 4,643,650 |
| 12.4 |
| ||
|
|
|
|
|
|
|
|
|
| ||
Total par value |
| $ | 38,911,412 |
| 100.0 | % | $ | 37,358,758 |
| 100.0 | % |
The Bank lends to member financial institutions within the six New England states. At June 30, 2007, the Bank had advances outstanding to 350, or 75.3 percent, of its 465 members. At December 31, 2006, the Bank had advances outstanding to 364, or 78.3 percent, of its 465 members.
Top Five Advance-Holding Members
(dollars in millions)
|
|
|
|
|
| As of June 30, 2007 |
| Advances Interest |
| Advance Interest |
| |||||||
|
|
|
|
|
|
|
| Percent of |
| Weighted- |
| Three Months |
| Six Months |
| |||
|
|
|
|
|
| Par Value of |
| Total |
| Average |
| Ended |
| Ended |
| |||
Name |
| City |
| State |
| Advances |
| Advances |
| Rate (2) |
| June 30, 2007 |
| June 30, 2007 |
| |||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||
Bank of America Rhode Island, N.A |
| Providence |
| RI |
| $ | 10,183.1 |
| 26.2 | % | 5.29 | % | $ | 136.1 |
| $ | 243.2 |
|
Citizens Financial Group (1) |
| Providence |
| RI |
| 6,994.2 |
| 18.0 |
| 5.27 |
| 93.2 |
| 185.6 |
| |||
NewAlliance Bank |
| New Haven |
| CT |
| 1,799.7 |
| 4.6 |
| 4.79 |
| 21.6 |
| 41.6 |
| |||
MetLife Insurance Company of Connecticut |
| Hartford |
| CT |
| 725.0 |
| 1.9 |
| 5.34 |
| 9.7 |
| 22.0 |
| |||
Salem Five Cents Savings Bank |
| Salem |
| MA |
| 554.9 |
| 1.4 |
| 4.74 |
| 6.5 |
| 12.9 |
| |||
(1) Citizens Financial Group, a subsidiary of The Royal Bank of Scotland, is the holding company of five of the Bank’s members: Citizens Bank of Rhode Island, Citizens Bank of Massachusetts, Citizens Bank of New Hampshire, Citizens Bank of Connecticut, and RBS National Bank. Advances outstanding to these five members are aggregated in the above table.
(2) Weighted-average rates are based on the contract rate of each advance without taking into consideration the effects of interest-rate-exchange agreements that may be used by the Bank as a hedging instrument.
Investments
At June 30, 2007, investment securities and short-term money-market instruments totaled $16.7 billion, compared with $15.2 billion at December 31, 2006. The growth in investments was due to an increase of $2.5 billion in federal funds sold, offset by a $1.3 billion decline in securities purchased under agreements to resell. Consistent with Finance Board requirements and Bank policy, additional investments in MBS and certain securities issued by the Small Business Administration (SBA) are prohibited if the Bank’s investments in such securities exceed 300 percent of capital as measured at the previous monthend. At June 30, 2007, and December 31, 2006, the Bank’s MBS and SBA holdings represented 286 percent and 292 percent of capital, respectively.
32
Additional financial data on the Bank’s investment securities as of June 30, 2007, and December 31, 2006, are included in the following tables.
Trading Securities
(dollars in thousands)
| June 30, 2007 |
| December 31, 2006 |
| |||
|
|
|
|
|
| ||
Mortgage-backed securities |
|
|
|
|
| ||
U.S. government guaranteed |
| $ | 37,334 |
| $ | 42,677 |
|
Government-sponsored enterprises |
| 53,992 |
| 63,685 |
| ||
Other |
| 34,754 |
| 45,000 |
| ||
|
|
|
|
|
| ||
Total |
| $ | 126,080 |
| $ | 151,362 |
|
Investment Securities Classified as Available-for-Sale
(dollars in thousands)
| June 30, 2007 |
| December 31, 2006 |
| |||||||||
|
| Amortized |
| Fair |
| Amortized |
| Fair |
| ||||
|
| Cost |
| Value |
| Cost |
| Value |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
International agency obligations |
| $ | 350,956 |
| $ | 364,574 |
| $ | 351,299 |
| $ | 382,484 |
|
U.S. government corporations |
| 213,571 |
| 211,885 |
| 213,654 |
| 225,615 |
| ||||
Government-sponsored enterprises |
| 177,517 |
| 179,051 |
| 184,342 |
| 191,547 |
| ||||
Other FHLBanks’ bonds |
| 12,124 |
| 12,130 |
| 14,685 |
| 14,716 |
| ||||
|
| 754,168 |
| 767,640 |
| 763,980 |
| 814,362 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Mortgage-backed securities |
|
|
|
|
|
|
|
|
| ||||
Government-sponsored enterprises |
| 172,219 |
| 170,876 |
| 172,619 |
| 173,696 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total |
| $ | 926,387 |
| $ | 938,516 |
| $ | 936,599 |
| $ | 988,058 |
|
Investment Securities Classified as Held-to-Maturity
(dollars in thousands)
| June 30, 2007 |
| December 31, 2006 |
| |||||||||
|
| Amortized |
| Fair |
| Amortized |
| Fair |
| ||||
|
| Cost |
| Value |
| Cost |
| Value |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Commercial paper |
| $ | 44,993 |
| $ | 44,987 |
| $ | — |
| $ | — |
|
U.S. agency obligations |
| 57,248 |
| 57,713 |
| 62,823 |
| 63,702 |
| ||||
State or local housing-agency obligations |
| 307,844 |
| 310,599 |
| 315,545 |
| 317,914 |
| ||||
|
| 410,085 |
| 413,299 |
| 378,368 |
| 381,616 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Mortgage-backed securities: |
|
|
|
|
|
|
|
|
| ||||
U.S. government guaranteed |
| 14,853 |
| 15,309 |
| 16,226 |
| 16,669 |
| ||||
Government-sponsored enterprises |
| 1,009,282 |
| 1,001,692 |
| 1,022,039 |
| 1,020,801 |
| ||||
Other |
| 6,051,520 |
| 6,049,017 |
| 5,889,558 |
| 5,888,922 |
| ||||
|
| 7,075,655 |
| 7,066,018 |
| 6,927,823 |
| 6,926,392 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Total |
| $ | 7,485,740 |
| $ | 7,479,317 |
| $ | 7,306,191 |
| $ | 7,308,008 |
|
The Bank’s MBS investment portfolio consists of the following categories of securities as of June 30, 2007, and December 31, 2006.
Mortgage-Backed Securities
| June 30, 2007 |
| December 31, 2006 |
| |
|
|
|
|
|
|
Nonfederal agency residential mortgage-backed securities |
| 74 | % | 72 | % |
U.S. agency residential mortgage-backed securities |
| 17 |
| 18 |
|
Nonfederal agency commercial mortgage-backed securities |
| 8 |
| 9 |
|
Home-equity loans |
| 1 |
| 1 |
|
|
|
|
|
|
|
Total mortgage-backed securities |
| 100 | % | 100 | % |
Mortgage Loans
Mortgage loans as of June 30, 2007, totaled $4.3 billion, a decrease of $239.5 million from the December 31, 2006, balance of $4.5 billion. This decrease was due to loan amortization and prepayments exceeding new loan purchases.
33
The following table presents information relating to the Bank’s mortgage portfolio as of June 30, 2007, and December 31, 2006.
Mortgage Loans Held in Portfolio
(dollars in thousands)
|
| June 30, 2007 |
| December 31, 2006 |
| ||
Real estate |
|
|
|
|
| ||
Fixed-rate 15-year single-family mortgages |
| $ | 1,218,634 |
| $ | 1,321,762 |
|
Fixed-rate 20- and 30-year single-family mortgages |
| 3,019,036 |
| 3,152,175 |
| ||
Premiums |
| 38,290 |
| 42,274 |
| ||
Discounts |
| (11,907 | ) | (12,758 | ) | ||
Deferred derivative gains and losses, net |
| (1,257 | ) | (1,146 | ) | ||
|
|
|
|
|
| ||
Total mortgage loans held for portfolio |
| 4,262,796 |
| 4,502,307 |
| ||
|
|
|
|
|
| ||
Less: allowance for credit losses |
| (125 | ) | (125 | ) | ||
|
|
|
|
|
| ||
Total mortgage loans, net of allowance for credit losses |
| $ | 4,262,671 |
| $ | 4,502,182 |
|
The following table details the par value of mortgage loans held for portfolio at June 30, 2007, and December 31, 2006 (dollars in thousands):
| June 30, 2007 |
| December 31, 2006 |
| |||
|
|
|
|
|
| ||
Conventional loans |
| $ | 3,770,355 |
| $ | 3,960,692 |
|
Government-insured loans |
| 467,315 |
| 513,245 |
| ||
|
|
|
|
|
| ||
Total par value |
| $ | 4,237,670 |
| $ | 4,473,937 |
|
The FHLBank of Chicago, which acts as the MPF provider and provides operational support to the MPF Banks and their participating financial institution members (PFIs), calculates and publishes daily prices, rates, and fees associated with the various MPF products. The Bank has the option, on a daily basis, to opt out of participation in the MPF program. To date, the Bank has never opted out of daily participation. During the first quarter of 2006, the FHLBank of Chicago had advised the Bank that, until further notice, it would no longer purchase participation interests in MPF loans acquired by other MPF Banks including the Bank. As a result, (1) the FHLBank of Chicago will not purchase participation interests in loans originated by the Bank’s PFIs, and (2) in the event that the Bank elects to opt out of purchasing MPF loans on a given day, the FHLBank of Chicago will forgo its option to purchase 100 percent of the loans originated by the Bank’s PFIs on that date. Given currently available information, market conditions, and the Bank’s financial management strategies for the MPF loan portfolio, the Bank’s management does not believe that this business decision by the FHLBank of Chicago will have any material impact on the Bank’s results of operations or financial condition, although it could from time to time require the Bank to restrict the volume of loans that it purchases from its PFIs. However, under different business conditions, the decision could have a material impact on the Bank’s results of operations and financial condition. For example, if the Bank elected to opt out of purchasing MPF loans, it could adversely affect customer relationships and future business flows.
Of the $4.2 billion of mortgage-loan participations held by the Bank as of June 30, 2007, $2.9 billion, or 67.6 percent, were sold to the Bank by Balboa Reinsurance Co., a subsidiary of Countrywide Financial, Inc. The Bank did not purchase any mortgage loans from Balboa Reinsurance Co. during the six months ended June 30, 2007. Mortgage-loan purchases from Balboa Reinsurance Co., amounted to $110.0 million for the year ended December 31, 2006, and represented 42.1 percent of total mortgage-loan purchases for that period. The decline in purchases is primarily due to the fact that the Bank currently has no master commitments outstanding to Balboa Reinsurance Co., and that the Bank has not participated in any loan purchases from Balboa Reinsurance Co. since the second quarter of 2006. The Bank has continued to avoid writing large master commitments with PFIs due to the relatively unattractive spreads available on purchased mortgage loans in recent months and the inability to sell participation interests in these loans to the FHLBank of Chicago. Management cannot predict the extent to which Balboa Reinsurance Co. may sell loans to the Bank in the future.
The following table presents purchases of mortgage loans during the six months ended June 30, 2007 and 2006 (dollars in thousands):
| For the Six Months Ended |
| |||||
|
| 2007 |
| 2006 |
| ||
|
|
|
|
|
| ||
Conventional loans |
|
|
|
|
| ||
Original MPF |
| $ | 59,202 |
| $ | 51,254 |
|
MPF 125 |
| 21,745 |
| 22,495 |
| ||
MPF Plus |
| — |
| 110,031 |
| ||
|
|
|
|
|
| ||
Total par value |
| $ | 80,947 |
| $ | 183,780 |
|
34
Allowance for Credit Losses on Mortgage Loans. The allowance for credit losses on mortgage loans was $125,000 at both June 30, 2007, and December 31, 2006. See the Bank’s Annual Report on Form 10-K Item 7 — Critical Accounting Policies and Estimates — Allowance for Loan Losses for a description of the change to the Bank’s methodology for estimating the allowance for loan losses which was implemented as of December 31, 2006.
The following table presents the Bank’s allowance for credit losses activity.
Allowance for Credit Losses Activity
(dollars in thousands)
| For the Three Months Ended June 30, |
| For the Six Months Ended June 30, |
| |||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Balance at beginning of period |
| $ | 125 |
| $ | 1,788 |
| $ | 125 |
| $ | 1,843 |
|
Charge-offs |
| — |
| (11 | ) | — |
| (11 | ) | ||||
Recoveries |
| 9 |
| — |
| 9 |
| — |
| ||||
Net recoveries (charge-offs) |
| 9 |
| (11 | ) | 9 |
| (11 | ) | ||||
Reduction of provision for credit losses |
| (9 | ) | (18 | ) | (9 | ) | (73 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Balance at end of period |
| $ | 125 |
| $ | 1,759 |
| $ | 125 |
| $ | 1,759 |
|
The Bank places conventional mortgage loans on nonaccrual when the collection of the contractual principal or interest is 90 days or more past due. Accrued interest on nonaccrual loans is reversed against interest income. The Bank monitors the delinquency levels of the mortgage-loan portfolio on a monthly basis. A summary of mortgage-loan delinquencies at June 30, 2007, is provided in the following table.
Summary of Delinquent Mortgage Loans
(dollars in thousands)
Days Delinquent |
| Conventional |
| Government- |
| Total |
| |||
|
|
|
|
|
|
|
| |||
30 days |
| $ | 31,247 |
| $ | 19,776 |
| $ | 51,023 |
|
60 days |
| 4,320 |
| 5,261 |
| 9,581 |
| |||
90 days or more and accruing |
| — |
| 7,790 |
| 7,790 |
| |||
90 days or more and nonaccruing |
| 4,927 |
| — |
| 4,927 |
| |||
|
|
|
|
|
|
|
| |||
Total delinquencies |
| $ | 40,494 |
| $ | 32,827 |
| $ | 73,321 |
|
|
|
|
|
|
|
|
| |||
Total par value of mortgage loans outstanding |
| $ | 3,770,355 |
| $ | 467,315 |
| $ | 4,237,670 |
|
|
|
|
|
|
|
|
| |||
Total delinquencies as a percentage of total par value of mortgage loans outstanding |
| 1.07 | % | 7.02 | % | 1.73 | % | |||
|
|
|
|
|
|
|
| |||
Delinquencies 90 days or more as a percentage of total par value of mortgage loans outstanding |
| 0.13 | % | 1.67 | % | 0.30 | % |
(1) Government-insured loans continue to accrue interest after 90 or more days delinquent since the U.S. government guarantees the repayment of principal and interest.
Sale of REO Assets. During the six months ended June 30, 2007 and 2006, the Bank sold REO assets with a recorded carrying value of $830,000 and $647,000, respectively. Upon sale of these properties, and inclusive of any proceeds received from primary mortgage-insurance coverage, the Bank recognized net gains totaling $18,000 and $27,000 on the sale of REO assets during the six months ended June 30, 2007 and 2006, respectively. Gains and losses on the sale of REO assets are recorded in other income.
Debt Financing — Consolidated Obligations
At June 30, 2007, and December 31, 2006, outstanding COs, including bonds and DNs, totaled $55.9 billion and $53.2 billion, respectively. CO bonds are issued with either fixed-rate coupon-payment terms or variable-rate coupon-payment terms that use a
35
variety of indices for interest-rate resets. In addition, to meet the needs of the Bank and of certain investors in COs, fixed-rate bonds and variable-rate bonds may also contain certain provisions that may result in complex coupon-payment terms and call or amortization features. When such COs (structured bonds) are issued, the Bank either enters into interest-rate-exchange agreements containing offsetting features, which effectively change the characteristics of the bond to those of a simple variable-rate bond, or uses the bond to fund assets with characteristics similar to those of the bond.
The following is a summary of the Bank’s CO bonds outstanding, for which the Bank is primarily liable, at June 30, 2007, and December 31, 2006, by the year of maturity.
Consolidated Obligation Bonds Outstanding
by Year of Maturity
(dollars in thousands)
| June 30, 2007 |
| December 31, 2006 |
| |||||||
Year of Maturity |
| Amount |
| Weighted |
| Amount |
| Weighted |
| ||
|
|
|
|
|
|
|
|
|
| ||
Due in one year or less |
| $ | 12,503,655 |
| 4.57 | % | $ | 14,211,705 |
| 4.45 | % |
Due after one year through two years |
| 9,194,140 |
| 4.73 |
| 9,091,950 |
| 4.51 |
| ||
Due after two years through three years |
| 5,801,035 |
| 5.17 |
| 3,611,185 |
| 4.52 |
| ||
Due after three years through four years |
| 1,968,340 |
| 4.88 |
| 1,635,770 |
| 4.48 |
| ||
Due after four years through five years |
| 1,402,500 |
| 5.09 |
| 1,289,600 |
| 4.81 |
| ||
Thereafter |
| 9,891,500 |
| 5.64 |
| 8,794,000 |
| 5.66 |
| ||
|
|
|
|
|
|
|
|
|
| ||
Total par value |
| 40,761,170 |
| 4.99 | % | 38,634,210 |
| 4.76 | % | ||
|
|
|
|
|
|
|
|
|
| ||
Bond premium |
| 14,450 |
|
|
| 14,719 |
|
|
| ||
Bond discount |
| (3,012,107 | ) |
|
| (3,009,308 | ) |
|
| ||
SFAS 133 hedging adjustments |
| (168,356 | ) |
|
| (121,179 | ) |
|
| ||
|
|
|
|
|
|
|
|
|
| ||
Total |
| $ | 37,595,157 |
|
|
| $ | 35,518,442 |
|
|
|
CO bonds outstanding at June 30, 2007, and December 31, 2006, include callable bonds totaling $23.8 billion and $22.3 billion, respectively. The following table summarizes CO bonds outstanding at June 30, 2007, and December 31, 2006, by the earlier of the year of maturity or next call date.
Consolidated Obligation Bonds Outstanding
by Year of Maturity or Next Call Date
(dollars in thousands)
Year of Maturity or Next Call Date |
| June 30, 2007 |
| December 31, 2006 |
| ||
Due in one year or less |
| $ | 30,123,355 |
| $ | 26,892,705 |
|
Due after one year through two years |
| 4,874,140 |
| 5,871,950 |
| ||
Due after two years through three years |
| 1,811,035 |
| 2,176,185 |
| ||
Due after three years through four years |
| 799,640 |
| 715,770 |
| ||
Due after four years through five years |
| 202,500 |
| 569,600 |
| ||
Thereafter |
| 2,950,500 |
| 2,408,000 |
| ||
|
|
|
|
|
| ||
Total par value |
| $ | 40,761,170 |
| $ | 38,634,210 |
|
CO DNs are also a significant funding source for the Bank. CO DNs are short-term instruments with maturities ranging from overnight to one year. The Bank uses CO DNs to fund short-term advances, longer-term advances with short repricing intervals, and money-market investments. CO DNs comprised 32.7 percent and 33.3 percent of outstanding COs at June 30, 2007, and December 31, 2006, respectively, but accounted for 96.2 percent and 97.7 percent of the proceeds from the issuance of COs for the six months ended June 30, 2007, and the year ended December 31, 2006, respectively, due, in particular, to the Bank’s frequent overnight DN issuance.
The increase in CO DNs and CO bonds outstanding of $582.9 million and $2.1 billion, respectively, at June 30, 2007, compared with December 31, 2006, corresponds with the increase in total assets of $2.8 billion. During the second quarter there was a shift from DNs to CO bonds due to relatively more favorable spreads in the CO bond market during the second quarter.
36
The Bank’s outstanding CO DNs, all of which are due within one year, were as follows:
CO Discount Notes Outstanding
(dollars in thousands)
|
|
|
|
| Weighted |
| |||
|
|
|
|
|
| Average |
| ||
|
| Book Value |
| Par Value |
| Rate |
| ||
June 30, 2007 |
| $ | 18,306,460 |
| $ | 18,377,012 |
| 5.13 | % |
December 31, 2006 |
| 17,723,515 |
| 17,780,433 |
| 5.11 |
| ||
The following tables summarize average balances of COs outstanding during the three months and six months ended June 30, 2007 and 2006:
Average Consolidated Obligations Outstanding
(dollars in thousands)
| For the Three Months Ended June 30, |
| |||||||||
|
| 2007 |
| 2006 |
| ||||||
|
| Average |
|
|
| Average |
|
|
| ||
|
| Balance |
| Yield (1) |
| Balance |
| Yield (1) |
| ||
|
|
|
|
|
|
|
|
|
| ||
Overnight discount notes |
| $ | 2,398,440 |
| 5.17 | % | $ | 1,849,147 |
| 4.84 | % |
Term discount notes |
| 17,191,975 |
| 5.22 |
| 23,242,908 |
| 4.84 |
| ||
Total discount notes |
| 19,590,415 |
| 5.22 |
| 25,092,055 |
| 4.84 |
| ||
|
|
|
|
|
|
|
|
|
| ||
Bonds |
| 35,873,773 |
| 4.96 |
| 30,115,322 |
| 4.57 |
| ||
|
|
|
|
|
|
|
|
|
| ||
Total consolidated obligations |
| $ | 55,464,188 |
| 5.05 | % | $ | 55,207,377 |
| 4.69 | % |
| For the Six Months Ended June 30, |
| |||||||||
|
| 2007 |
| 2006 |
| ||||||
|
| Average |
|
|
| Average |
|
|
| ||
|
| Balance |
| Yield (1) |
| Balance |
| Yield (1) |
| ||
|
|
|
|
|
|
|
|
|
| ||
Overnight discount notes |
| $ | 2,722,753 |
| 5.20 | % | $ | 2,178,464 |
| 4.58 | % |
Term discount notes |
| 16,310,382 |
| 5.23 |
| 23,769,714 |
| 4.62 |
| ||
Total discount notes |
| 19,033,135 |
| 5.22 |
| 25,948,178 |
| 4.62 |
| ||
|
|
|
|
|
|
|
|
|
| ||
Bonds |
| 35,282,282 |
| 4.95 |
| 29,673,361 |
| 4.43 |
| ||
|
|
|
|
|
|
|
|
|
| ||
Total consolidated obligations |
| $ | 54,315,417 |
| 5.05 | % | $ | 55,621,539 |
| 4.52 | % |
(1) Yields are annualized.
The average balances of COs for the six months ended June 30, 2007, were lower than the average balances for the same period in 2006, which is consistent with the decrease in total average assets, primarily short-term advances. This CO decrease was primarily due to a reduction in average DNs. The average balance of term DNs decreased $7.5 billion from the prior period while overnight DNs increased $544.3 million. Average balances of bonds increased $5.6 billion from the prior period. The average balance of DNs represented approximately 35.0 percent of total average COs during the six months ended June 30, 2007, as compared with 46.7 percent of total average COs during the same period in 2006, and the average balance of bonds represented 65.0 percent and 53.3 percent of total average COs outstanding during the six months ended June 30, 2007 and 2006, respectively.
Deposits
As of June 30, 2007, deposits totaled $1.0 billion, a decrease of $79.1 million from the balance at December 31, 2006.
The following table presents term deposits issued in amounts of $100,000 or more at June 30, 2007, and December 31, 2006:
Term Deposits Greater than $100,000
(dollars in thousands)
| June 30, 2007 |
| December 31, 2006 |
| |||||||
Term Deposits by Maturity |
| Amount |
| Weighted |
| Amount |
| Weighted |
| ||
|
|
|
|
|
|
|
|
|
| ||
Three months or less |
| $ | 1,000 |
| 5.02 | % | $ | 3,000 |
| 5.09 | % |
Over three months through six months |
| — |
| — |
| — |
| — |
| ||
Over six months through 12 months |
| — |
| — |
| — |
| — |
| ||
Greater than 12 months (1) |
| 26,300 |
| 4.18 |
| 26,300 |
| 4.18 |
| ||
|
|
|
|
|
|
|
|
|
| ||
Total par value |
| $ | 27,300 |
| 4.21 | % | $ | 29,300 |
| 4.27 | % |
(1) Represents nine term deposit accounts totaling $6.3 million with maturity dates of August 31, 2011, and one term deposit totaling $20.0 million with a maturity date of September 22, 2014.
37
Capital
The Bank is subject to risk-based capital rules established by the Finance Board. Only permanent capital, defined as retained earnings plus Class B stock, can satisfy the risk-based capital requirement.
The Bank was in compliance with these requirements through 2006 and the first six months of 2007 and remains in compliance at June 30, 2007, as noted in the following table.
Risk-Based Capital Requirements
(dollars in thousands)
| June 30, 2007 |
| December 31, 2006 |
| |||
|
|
|
|
|
| ||
Permanent capital |
|
|
|
|
| ||
Class B stock |
| $ | 2,427,656 |
| $ | 2,342,517 |
|
Mandatorily redeemable capital stock |
| 4,288 |
| 12,354 |
| ||
Retained earnings |
| 192,346 |
| 187,304 |
| ||
|
|
|
|
|
| ||
Permanent capital |
| $ | 2,624,290 |
| $ | 2,542,175 |
|
|
|
|
|
|
| ||
Risk-based capital requirement |
|
|
|
|
| ||
Credit-risk capital |
| $ | 150,419 |
| $ | 143,964 |
|
Market-risk capital |
| 171,365 |
| 119,384 |
| ||
Operations-risk capital |
| 96,536 |
| 79,004 |
| ||
|
|
|
|
|
| ||
Risk-based capital requirement |
| $ | 418,320 |
| $ | 342,352 |
|
In addition to the risk-based capital requirements, the Gramm-Leach-Bliley Act of 1999 (GLB Act) specifies a five percent minimum leverage ratio based on total capital using a 1.5 weighting factor applied to permanent capital, and a four percent minimum capital ratio that does not include a weighting factor applicable to permanent capital. The Bank remained in compliance with these requirements through June 30, 2007.
The following table provides the Bank’s capital ratios as of June 30, 2007, and December 31, 2006.
Capital Ratio Requirements
(dollars in thousands)
| June 30, 2007 |
| December 31, 2006 |
| |||
|
|
|
|
|
| ||
Capital ratio |
|
|
|
|
| ||
Minimum capital (4% of total assets) |
| $ | 2,410,533 |
| $ | 2,298,791 |
|
Actual capital (capital stock plus retained earnings) |
| 2,624,290 |
| 2,542,175 |
| ||
Total assets |
| 60,263,319 |
| 57,469,781 |
| ||
Capital ratio (permanent capital as a percentage of total assets) |
| 4.4 | % | 4.4 | % | ||
|
|
|
|
|
| ||
Leverage ratio |
|
|
|
|
| ||
Minimum leverage capital (5% of total assets) |
| $ | 3,013,166 |
| $ | 2,873,489 |
|
Leverage capital (permanent capital multiplied by a 1.5 weighting factor) |
| 3,936,435 |
| 3,813,262 |
| ||
Leverage ratio (leverage capital as a percentage of total assets) |
| 6.5 | % | 6.6 | % |
38
Derivative Instruments
SFAS 133 requires that all derivative instruments be recorded on the statement of condition at fair value, while FASB Interpretation No. 39, Offsetting of Amounts Related to Certain Contracts, allows derivative instruments to be classified as assets or liabilities according to the net fair value of derivatives aggregated by counterparty where the legal right of offset exists. If these netted amounts are positive, they are recorded as an asset; if negative, they are recorded as a liability. Derivative assets’ net fair value totaled $174.4 million and $128.4 million as of June 30, 2007, and December 31, 2006, respectively. Derivative liabilities’ net fair value totaled $54.7 million and $120.6 million as of June 30, 2007, and December 31, 2006, respectively.
The Bank had commitments for which it was obligated to purchase mortgage loans with par values totaling $4.9 million and $6.6 million at June 30, 2007, and December 31, 2006, respectively. Under Statement of Financial Accounting Standard No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (SFAS 149), all mortgage-loan-purchase commitments are recorded at fair value on the statement of condition as derivative instruments. Upon fulfillment of the commitment, the recorded fair value is then reclassified as a basis adjustment of the purchased mortgage assets.
As part of the Bank’s hedging activities as of December 31, 2006, the Bank had entered into derivative contracts with its members in which the Bank acts as an intermediary between the member and a derivative counterparty. Effective February 16, 2007, the Bank no longer offers derivatives to its members on an intermediated basis, but will allow existing transactions to remain outstanding until expiration. The Bank also engages in derivatives directly with affiliates of certain of the Bank’s members, which act as derivatives dealers to the Bank. These derivative contracts are entered into for the Bank’s own risk-management purposes and are not related to requests from the members to enter into such contracts.
Outstanding Derivative Contracts with Members and Affiliates of Bank Members
(dollars in thousands)
|
|
|
|
|
| June 30, 2007 |
| |||
Derivatives Counterparty |
| Affiliate Member |
| Primary |
| Notional |
| Percent of Notional |
| |
|
|
|
|
|
|
|
|
|
| |
Bank of America NA |
| Bank of America Rhode Island, NA |
| Dealer |
| $ | 2,041,000 |
| 6.17 | % |
Royal Bank of Scotland, PLC |
| Citizens Financial Group (1) |
| Dealer |
| 1,960,000 |
| 5.93 |
| |
Auburn Savings Bank |
| Auburn Savings Bank |
| Member |
| 10,000 |
| 0.03 |
| |
(1) Citizens Financial Group, a subsidiary of The Royal Bank of Scotland Group, is the holding company of five of the Bank’s members: Citizens Bank of Rhode Island, Citizens Bank of Massachusetts, Citizens Bank of New Hampshire, Citizens Bank of Connecticut, and RBS National Bank.
LIQUIDITY AND CAPITAL RESOURCES
The Bank’s financial strategies are designed to enable the Bank to expand and contract its assets, liabilities, and capital in response to changes in membership composition and member-credit needs. The Bank’s liquidity and capital resources are designed to support these financial strategies. The Bank’s primary source of liquidity is its access to the capital markets through CO issuance, which is described in the Bank’s Annual Report on Form 10-K in Item 1 – Business – Consolidated Obligations. The Bank’s equity capital resources are governed by the capital plan, which is described in the following Capital section.
Liquidity
The Bank strives to maintain the liquidity necessary to meet member-credit demands, repay maturing COs, meet other obligations and commitments, and respond to changes in membership composition. The Bank monitors its financial position in an effort to ensure that it has ready access to sufficient liquid funds to meet normal transaction requirements, take advantage of investment opportunities, and cover unforeseen liquidity demands.
The Bank is not able to predict future trends in member-credit needs since they are driven by complex interactions among a number of factors, including, but not limited to: mortgage originations, other loan portfolio growth, deposit growth, and the attractiveness of the pricing of advances versus other wholesale borrowing alternatives. However, the Bank regularly monitors current trends and anticipates future debt-issuance needs in an effort to be prepared to fund its members’ credit needs and its investment opportunities.
Short-term liquidity management practices are described in Part 1 Item 3 – Quantitative and Qualitative Disclosures About Market Risk – Liquidity Risk. The Bank manages its liquidity needs to ensure that it is able to meet all of its contractual obligations and operating expenditures as they come due and to support its members’ daily liquidity needs. Through the Bank’s contingency liquidity plans, the Bank attempts to ensure that it is able to meet its obligations and the liquidity needs of members in the event of operational disruptions at the Bank or the Office of Finance or short-term disruptions of the capital markets. For further information and
39
discussion of the Bank’s guarantees and other commitments, see Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources – Off-Balance Sheet Arrangements and Aggregate Contractual Obligations. For further information and discussion of the Bank’s joint and several liability for FHLBank COs, see Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition –Debt Financing-Consolidated Obligations.
On June 23, 2006, the FHLBanks and the Office of Finance entered into the Federal Home Loan Banks P&I Funding and Contingency Plan Agreement (the Agreement). The FHLBanks and the Office of Finance entered into the Agreement in response to the Board of Governors of the Federal Reserve System revising its Policy Statement on Payments System Risk (the Revised Policy) concerning the disbursement by the Federal Reserve Banks of interest and principal payments on securities issued by government-sponsored enterprises (GSEs). The FHLBanks and the Office of Finance entered into the Agreement to facilitate timely funding by the FHLBanks of the principal and interest payments under their respective COs, as made through the Office of Finance, in accordance with the Revised Policy.
Under the Agreement, in the event the Bank does not fund its principal and interest payments under a CO by deadlines established in the Agreement, the 11 other FHLBanks will be obligated to fund any shortfall in funding to the extent that any of the 11 other FHLBanks have a net positive settlement balance (that is, the amount by which end-of-day proceeds received by such FHLBank from the sale of COs on one day exceeds payments by such FHLBank on COs on the same day) in its account with the Office of Finance on the day the shortfall occurs. The Bank would then be required to repay the other FHLBank.
Capital
Total capital as of June 30, 2007, was $2.6 billion, a 3.8 percent increase from $2.5 billion as of December 31, 2006.
The Bank’s ability to expand in response to member credit needs is based primarily on the capital-stock requirements for advances. A member is required to increase its capital-stock investment in the Bank as its outstanding advances increase. The capital-stock requirement for advances is currently:
· 3.0 percent for overnight advances,
· 4.0 percent for advances with an original maturity greater than overnight and up to three months, and
· 4.5 percent for all other advances.
The Bank’s minimum capital-to-assets leverage limit is currently 4.0 percent based on Finance Board requirements. The additional capital stock from higher balances of advances expands the Bank’s capacity to issue COs, which are used not only to support the increase in these balances but also to increase the Bank’s purchases of mortgage loans, MBS, and other investments.
The Bank can also contract its balance-sheet and liquidity requirements in response to members’ reduced credit needs. As member credit needs result in reduced advance and mortgage-loan balances, the member will have capital stock in excess of the amount required by the Bank’s capital plan. The Bank’s capital-stock policies allow the Bank to repurchase excess capital stock if a member reduces its advance balances. In May 2006, the Bank implemented an Excess Stock Repurchase Program (ESRP) to help manage its leverage by reducing the amount of excess capital stock held by members. The Bank may also, at its sole discretion, repurchase shares of excess stock upon request by members. During the six months ended June 30, 2007, the Bank made repurchases of excess capital stock in two months totaling $77.8 million.
Members may submit a written request for redemption of excess capital stock. The stock subject to the request will be redeemed at par value by the Bank upon expiration of a five-year stock-redemption period, provided that the member continues to meet its total stock investment requirement at that time and that the Bank would remain in compliance with its minimum capital requirements. Also subject to a five-year stock-redemption period are shares of stock held by a member that either gives notice of intent to withdraw from membership, or becomes a nonmember due to merger or acquisition, charter termination, or involuntary termination of membership. At June 30, 2007, $4.3 million of capital stock was subject to the five-year stock-redemption period, and it was anticipated that $4.2 million of these shares would be redeemed by June 30, 2010, and $103,000 will be redeemed by June 30, 2011.
At June 30, 2007, and December 31, 2006, members and nonmembers with capital stock outstanding held $186.6 million and $203.0 million, respectively, in excess capital stock. A member may obtain redemption of excess capital stock following a five-year redemption period, subject to certain conditions, by providing a written redemption notice to the Bank. At its discretion, under certain conditions, the Bank may repurchase excess stock at any time before the five-year redemption period has expired by providing a member with written notice. While historically the Bank has repurchased excess stock at the member’s request prior to the expiration of the redemption period, the decision to repurchase remains at the Bank’s discretion.
Retained Earnings Target. In February 2007, the Bank’s board of directors adopted a revised targeted minimum retained earnings level of the greater of $171.0 million, or the required amount as periodically measured by the Bank’s internal retained earnings model, to be achieved by December 31, 2007, based on strategic growth assumptions and market-rate forecasts. This new target is remeasured
40
periodically based on projected changes to the Bank’s balance-sheet composition and on projected market conditions as of December 31, 2007. To the extent that the periodically measured retained earnings requirement as of December 31, 2007, remains below $171.0 million, the targeted minimum retained earnings level is $171.0 million. If the periodically measured retained earnings requirement as of December 31, 2007, exceeds $171.0 million, then the remeasured value becomes the new requirement until such time as a subsequent remeasurement falls below $171.0 million. As of June 30, 2007, the Bank had retained earnings of $192.3 million, and its retained earnings model projected a required retained earnings minimum of $212.8 million as of December 31, 2007. As of December 31, 2006, the Bank’s retained earnings model projected a required retained earning minimum of $159.1 million. The increase was attributable primarily to a rise in the Bank’s value-at-risk measurement. See Item 3 - Quantitative and Qualitative Disclosures about Market Risk – Measurement of Market and Interest Rate Risk regarding the Bank’s value-at-risk disclosure.
The Bank’s retained earnings target could be superseded by Finance Board mandates, either in the form of an order specific to the Bank or by promulgation of new regulations requiring a level of retained earnings that is different from the Bank’s currently targeted level. If this occurs the Bank would continue its initiative to grow retained earnings and may reduce its dividend payout, as considered necessary.
Capital Requirements
The FHLBank Act and Finance Board regulations specify that each FHLBank must meet certain minimum regulatory capital standards. The Bank must maintain (1) total capital in an amount equal to at least 4.0 percent of its total assets, (2) leverage capital in an amount equal to at least 5.0 percent of its total assets, and (3) permanent capital in an amount equal to at least its regulatory risk-based capital requirement. In addition, the Finance Board has indicated that mandatorily redeemable capital stock is considered capital for regulatory purposes. At June 30, 2007, the Bank had a total capital to assets ratio of 4.4 percent, a leverage capital to assets ratio of 6.5 percent, and a risk-based capital requirement of $418.3 million, which was more than satisfied by the Bank’s permanent capital of $2.6 billion. Permanent capital is defined as total capital stock outstanding, including mandatorily redeemable capital stock, plus retained earnings. At December 31, 2006, the Bank had a total capital to assets ratio of 4.4 percent, a leverage capital to assets ratio of 6.6 percent, and a risk-based capital requirement of $342.4 million, which was satisfied by the Bank’s permanent capital of $2.5 billion.
Off-Balance-Sheet Arrangements
Commitments that legally bind and obligate the Bank for additional advances totaled approximately $70.7 million and $76.4 million at June 30, 2007, and December 31, 2006, respectively. Commitments generally are for periods up to 12 months.
Standby letters of credit are executed with members for a fee. If the Bank is required to make a payment for a beneficiary’s draw, these amounts are immediately converted into a collateralized advance to the member. Outstanding standby letters of credit were approximately $2.4 billion (face amount) and $1.8 billion (face amount) at June 30, 2007, and December 31, 2006, respectively, and had original terms of two months to 20 years with a final expiration in 2024. The values of the guarantees related to standby letters of credit entered into after 2002 are recorded in other liabilities and totaled $1.2 million and $579,000 at June 30, 2007, and December 31, 2006, respectively. Based on management’s credit analyses and collateral requirements, the Bank does not deem it necessary to record any additional liability on these standby letters of credit.
Commitments for unused lines-of-credit advances totaled $1.5 billion at both June 30, 2007, and December 31, 2006. Commitments are generally for periods up to 12 months. Since many of the commitments are not expected to be drawn upon, the total commitment amount does not necessarily represent future cash requirements.
The Bank enters into standby bond-purchase agreements with state housing authorities, whereby the Bank, for a fee, agrees to purchase and hold the authority’s bonds until the designated marketing agent can find an investor or the housing authority repurchases the bond according to a schedule established by the standby agreement. Each standby agreement dictates the specific terms under which the Bank would be required to purchase the bond. The bond-purchase commitments entered into by the Bank expire after five years, no later than 2012. Total commitments for bond purchases were $533.7 million and $537.3 million at June 30, 2007, and December 31, 2006, respectively. The Bank was not required to purchase any bonds under these agreements during the six months ended June 30, 2007.
The Bank is required to pay 20 percent of its net earnings (after its AHP obligation) to REFCorp to support payment of part of the interest on bonds issued by REFCorp. The Bank must make these payments to REFCorp until the total amount of payments made by all FHLBanks is equivalent to a $300 million annual annuity with a final maturity date of April 15, 2030. Additionally, the FHLBanks must annually set aside for the AHP the greater of an aggregate of $100 million or 10 percent of the current year’s income before charges for AHP (but after expenses for REFCorp). See the Bank’s 2006 Annual Report on Form 10-K - Item 1 - Business - Assessments section for additional information regarding REFCorp and AHP assessments.
41
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Bank’s financial statements and reported results of operations are based on GAAP, which requires the Bank to use estimates and assumptions that may affect our reported results and disclosures. Management believes the application of the following accounting policies involve the most critical or complex estimates and assumptions used in preparing the Bank’s financial statements: accounting for derivatives, the use of fair-value estimates, amortization of deferred premium/discount associated with prepayable assets, and the allowance for loan losses. The assumptions involved in applying these policies are discussed in the Bank’s 2006 Annual Report on Form 10-K.
As of June 30, 2007, the Bank had not made any significant changes to the estimates and assumptions used in applying its critical accounting policies and estimates from its audited financial statements.
RECENT ACCOUNTING DEVELOPMENTS
SFAS 157, Fair Value Measurements. On September 15, 2006, the FASB issued SFAS 157, which establishes a formal framework for measuring fair value. This statement defines fair value and provides guidance on the appropriate valuation techniques established to determine fair value. This standard requires increased disclosures regarding the prioritization of valuations assigned to fair-value measurements by requiring the Bank to assign one of three possible priority levels to each valuation made for items recorded at fair value on both a recurring and nonrecurring basis. SFAS 157 is effective for fiscal years beginning after November 15, 2007 (January 1, 2008, for the Bank), with earlier adoption allowed as long as the standard is adopted for the first financial statements issued in the fiscal year of adoption. The Bank has not yet determined the effect that the implementation of SFAS 157 will have on our results of operations or financial condition.
SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115 (SFAS 159). On February 15, 2007, the FASB issued SFAS 159, which creates a fair-value option allowing, but not requiring, an entity to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and financial liabilities, with changes in fair value recognized in earnings as they occur. SFAS 159 also requires an entity to report those financial assets and financial liabilities measured at fair value in a manner that separates those reported fair values from the carrying amounts of assets and liabilities measured using another measurement attribute on the face of the statement of financial position. Lastly, SFAS 159 requires an entity to provide information that would allow users to understand the effect on earnings of changes in the fair value on those instruments selected for the fair-value election. SFAS 159 is effective for fiscal years beginning after November 15, 2007 (January 1, 2008,0 for the Bank). Early adoption is permitted at the beginning of the previous fiscal year provided that the entity makes that choice in the first 120 days of that fiscal year and also elects to apply the provisions of SFAS 157. The Bank does not anticipate that the implementation of SFAS 159 will have a material effect on earnings or the statement of condition.
FASB Staff Position No. FIN 39-1, Amendment of FASB Interpretation No. 39 (FSP FIN 39-1). On April 30, 2007, the FASB issued FSP FIN 39-1, which permits an entity to offset fair-value amounts recognized for derivative instruments and fair-value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) arising from derivative instruments recognized at fair value executed with the same counterparty under a master-netting arrangement. Under FSP FIN 39-1, the receivable or payable related to cash collateral may not be offset if the amount recognized does not represent or approximate fair value or arises from instruments in a master-netting arrangement that are not eligible to be offset. The decision whether to offset such fair-value amounts represents an elective accounting policy decision that once elected, must be applied consistently. FSP FIN 39-1 is effective for fiscal years beginning after November 15, 2007 (January 1, 2008, for the Bank), with earlier application permitted. An entity should recognize the effects of applying FSP FIN 39-1 as a change in accounting principle through retrospective application for all financial statements presented unless it is impracticable to do so. Upon adoption of FSP FIN 39-1, an entity is permitted to change its accounting policy to offset or not offset fair-value amounts recognized for derivative instruments under master-netting arrangements. While the current accounting policy of the Bank is to offset derivative instruments of the same counterparty under a master-netting arrangement, the Bank does not anticipate any material impact to our financial condition or results of operations as a result of the adoption of FSP FIN 39-1.
RECENT LEGISLATIVE AND REGULATORY DEVELOPMENTS
Finance Board adopts a process for appointing public interest directors
On March 27, 2007, the Finance Board issued a final rule effective April 2, 2007, that established procedures for the selection of appointed directors to the boards of the FHLBanks. Under the rule, the FHLBanks are responsible for identifying potential directors, conducting a preliminary assessment of their eligibility and qualifications, and submitting up to two nominees for each vacant appointive directorship to the Finance Board for its consideration. The nominations must be accompanied by a completed eligibility form that demonstrates the qualifications of each nominee to serve on the board of an FHLBank. The Finance Board reviews each nomination and decides whether to appoint directors from the submitted list of nominees. On March 30, 2007, the Finance Board appointed six individuals to the Bank’s board of directors. The appointed directors will fill the remainder of three-year terms that began on January 1, 2005, January 1, 2006, or January 1, 2007, depending on the directorship.
42
Proposed changes to GSE regulation
On May 22, 2007, the U.S. House of Representatives approved legislation designed to strengthen the regulation of Fannie Mae, Freddie Mac, and the FHLBanks and to address other GSE reform issues. The legislation would eliminate the Finance Board and replace it with a new regulator overseeing the three GSEs. It is impossible to predict whether the Senate will approve such legislation and whether any change in regulatory structure will be signed into law. Finally, it is impossible to predict when any such change would go into effect if it were to be enacted, and what effect any legislation would ultimately have on the Finance Board or the FHLBanks.
RECENT REGULATORY ACTIONS AND CREDIT RATING AGENCY ACTIONS
All FHLBanks have joint and several liability for FHLBank COs. The joint and several liability regulation of the Finance Board authorizes the Finance Board to require any FHLBank to repay all or a portion of the principal or interest on COs for which another FHLBank is the primary obligor. The Bank has never been asked or required to repay the principal or interest on any CO on behalf of another FHLBank. The par amount of the outstanding COs of all 12 FHLBanks was $970.9 billion at June 30, 2007, and $952.0 billion at December 31, 2006.
Some of the FHLBanks have been the subject of regulatory actions pursuant to which their boards of directors and/or management have agreed with the Office of Supervision of the Finance Board to, among other things, maintain higher levels of capital. While supervisory agreements generally are publicly announced by the Finance Board, the Bank cannot provide assurance that it has been informed or will be informed of regulatory actions taken at other FHLBanks. In addition, the Bank or any other FHLBank may be the subject of regulatory actions in the future. The FHLBank of Chicago continues to operate under its written agreement with the Finance Board.
Moody’s has not downgraded any FHLBanks’ individual long-term credit ratings from triple-A with a stable outlook. Changes in FHLBank individual long-term credit ratings do not necessarily affect the credit rating of the COs issued on behalf of the FHLBanks. Rating agencies may from time to time change a rating because of various factors, including operating results or actions taken, business developments, or changes in their opinion regarding, among other things, the general outlook for a particular industry or the economy. In addition, the Bank cannot provide assurance that rating agencies will not reduce the Bank’s ratings or those of the FHLBank System or any other FHLBank in the future.
The Bank has evaluated the financial condition of the other FHLBanks based on known regulatory actions, publicly available financial information, and individual long-term credit-rating downgrades as of each period-end presented. Management believes that the probability that the Bank will be required by the Finance Board to repay any principal or interest associated with COs for which the Bank is not the primary obligor has not materially increased.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Bank has a comprehensive risk-governance structure. The Bank’s Risk-Management Policy identifies six major risk categories relevant to business activities:
· Credit risk is the risk to earnings or capital of an obligor’s failure to meet the terms of any contract with the Bank or otherwise perform as agreed. The Credit Committee oversees credit risk primarily through ongoing oversight and limits on credit exposure.
· Market risk is the risk to earnings or market value of equity (MVE) due to adverse movements in interest rates or interest-rate spreads. Market risk is primarily overseen by the Asset-Liability Committee through ongoing review of value-at-risk and the economic value of capital. The Asset-Liability Committee also reviews income simulations to oversee potential exposure to future earnings volatility.
· Liquidity risk is the risk that the Bank may be unable to meet its funding requirements, or meet the credit needs of members, at a reasonable cost and in a timely manner. The Asset-Liability Committee, through its regular reviews of funding and liquidity, oversees liquidity risk.
· Business risk is the risk to earnings or capital arising from adverse business decisions or improper implementation of those decisions, or from external factors as may occur in both the short- and long-run. Business risk is overseen by the Management Committee through the development of the Strategic Business Plan.
· Operational risk is the risk of loss resulting from inadequate or failed internal processes and systems, human error, or from internal or external events, inclusive of exposure to potential litigation resulting from inappropriate conduct of Bank personnel. The Operational Risk Committee primarily oversees operational risk.
· Reputation risk is the risk to earnings or capital arising from negative public opinion, which can affect the Bank’s ability to establish new business relationships or to maintain existing business relationships. The Management Committee oversees reputation risk.
43
The board of directors defines the desired risk profile of the Bank and provides risk oversight through the review and approval of the Bank’s Risk-Management Policy. The Finance Committee of the board of directors provides additional oversight for market risk and credit risk. The board’s Audit Committee provides additional oversight for operational risk. The board of directors also reviews the results of an annual risk assessment conducted by management for its major business processes.
Management further delineates the Bank’s risk appetite for specific business activities and provides risk oversight through the following committees:
· Management Committee is the Bank’s overall risk-governance, strategic-planning, and policymaking group. The committee, which is comprised of the Bank’s senior officers, reviews and recommends to the board of directors for approval all revisions to major policies of the organization. All decisions by this committee are subject to final approval by the president of the Bank.
· Asset-Liability Committee is responsible for approving policies and risk limits for the management of market risk, including liquidity and options risks. The Asset-Liability Committee also conducts monitoring and oversight of these risks on an ongoing basis, and promulgates strategies to enhance the Bank’s financial performance within established risk limits consistent with the Strategic Business Plan.
· Credit Committee oversees the Bank’s credit-underwriting functions and collateral-eligibility standards. The committee also reviews the creditworthiness of the Bank’s investments, including purchased mortgage assets, and oversees the classification of the Bank’s assets and the adequacy of its loan-loss reserves.
· Operational Risk Committee reviews and assesses the Bank’s exposure to operational risks and determines tolerances for potential operational threats that may arise from new products and services. The committee may also discuss operational exceptions and assess appropriate control actions to mitigate reoccurrence and improve future detection.
· Information Technology and Security Oversight Committee provides senior management oversight and governance of the information technology, information security, and business-continuity functions of the Bank. The committee approves the major priorities and overall level of funding for these functions within the context of the Bank’s strategic business priorities and established risk-management objectives.
This list of internal management committees or their respective missions may change from time to time based on new business or regulatory requirements.
Credit Risk
Credit Risk – Advances. Advances outstanding to members in blanket-lien status at June 30, 2007, totaled $38.4 billion. For these members, the Bank had access to collateral through security agreements, where the member agrees to hold such collateral for the benefit of the Bank, totaling $67.4 billion as of June 30, 2007. Of this total, $4.6 billion of securities have been delivered to the Bank or to a third-party custodian, an additional $3.0 billion of securities are held by members’ securities corporations, and $21.5 billion of residential mortgage loans have been pledged by members’ real-estate-investment trusts. Additionally, all nonmember borrowers and housing associates are placed in delivery-collateral status.
The following table provides information regarding advances outstanding with members and nonmember borrowers in listing- and delivery-collateral status at June 30, 2007, along with their corresponding collateral balances.
Advances Outstanding by Borrower Collateral Status
As of June 30, 2007
(dollars in thousands)
| Number of |
| Advances |
| Collateral |
| |||
|
|
|
|
|
|
|
| ||
Listing-collateral status |
| 17 |
| $ | 233,178 |
| $ | 471,207 |
|
Delivery-collateral status |
| 13 |
| 295,657 |
| 413,146 |
| ||
|
|
|
|
|
|
|
| ||
Total par value |
| 30 |
| $ | 528,835 |
| $ | 884,353 |
|
Credit Risk – Investments. The Bank is also subject to credit risk on unsecured investments consisting primarily of money-market instruments and bonds issued by U.S. agencies and instrumentalities. The Bank places funds with large, high-quality financial institutions with long-term credit ratings no lower than single-A on an unsecured basis for terms of up to 270 days; most such placements expire within 90 days. Management actively monitors the credit quality of these counterparties. At June 30, 2007, the Bank’s unsecured credit exposure, including accrued interest related to investment securities and money-market instruments was $7.0 billion
44
to 31 counterparties and issuers, of which $5.1 billion was for federal funds sold, and $1.9 billion was for other unsecured investments.
The Bank also invests in and is subject to secured credit risk related to MBS, asset-backed securities (ABS), and state and local housing or economic-development finance agencies (HFA) bonds that are directly or indirectly supported by underlying mortgage loans. Investments in MBS and ABS may be purchased as long as the balance of outstanding MBS/ABS is equal to or less than 300 percent of the Bank’s total capital, and must be rated triple-A at the time of purchase. HFA bonds must carry a credit rating of double- A or higher as of the date of purchase.
Of the Bank’s $7.4 billion of MBS and ABS investments at June 30, 2007, $5.5 billion are private label securities backed by residential mortgage loans. Only $43.4 million of these investments are backed primarily by sub-prime mortgages, while the remaining $5.4 billion of private-label MBS and ABS are backed primarily by loans written to either prime or Alt-A underwriting standards. While there is no universally-accepted definition for prime and Alt-A underwriting standards, in general, prime underwriting implies a borrower without a history of delinquent payments and documented income and a loan amount that is at or less than 80 percent of the market value of the house, while Alt-A underwriting implies a prime borrower with limited income documentation and/or a loan-to-value ratio of higher than 80 percent. All of the Bank’s private label MBS and ABS are currently rated triple-A by at least two rating agencies. The securities attain these ratings through credit enhancement, which generally consists of over-collateralization and the subordination of the claims of other securities. In some cases, including all of its ABS holdings, the credit enhancement includes insurance provided by a triple-A rated monoline financial guarantor. The Bank has conservative investment standards to mitigate the credit risk associated with its MBS and ABS investments. In most cases, the credit protection for investments in MBS and ABS backed by less than prime mortgage loans exceeds that required to achieve a triple-A rating at the time the investment was made. Given the high level of credit protection and the Bank’s low exposure to subprime-backed MBS and ABS, the value of the Bank’s MBS and ABS investments have not been materially affected by the recent weakness in the housing markets. Due to the high level of credit protection associated with these investments, the Bank does not expect any credit losses on its MBS and ABS at this time.
Credit ratings on these investments as of June 30, 2007, are provided in the following table.
Credit Ratings of Investments
As of June 30, 2007
(dollars in thousands)
|
| Long-Term Credit Rating (1) |
| Short-Term |
|
|
| |||||||||
Investment Category |
| Triple-A |
| Double-A |
| Single-A |
| A-1 |
| Unrated |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Money-market instruments (2): |
|
|
|
|
|
|
|
|
|
|
| |||||
Interest-bearing deposits |
| $ | 50 |
| $ | 455,000 |
| $ | 575,000 |
| $ | — |
| $ | — |
|
Securities purchased under agreements to resell (3) |
| — |
| 2,000,000 |
| — |
| — |
| — |
| |||||
Federal funds sold |
| — |
| 3,150,000 |
| 1,988,000 |
| — |
| — |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Investment securities: |
|
|
|
|
|
|
|
|
|
|
| |||||
Commercial paper |
| — |
| — |
| — |
| 44,993 |
| — |
| |||||
U.S. agency obligations |
| 57,248 |
| — |
| — |
| — |
| — |
| |||||
U.S. government corporations |
| 211,885 |
| — |
| — |
| — |
| — |
| |||||
Government-sponsored enterprises |
| 149,064 |
| — |
| — |
| — |
| 29,987 |
| |||||
Other FHLBanks’ bonds |
| 12,130 |
| — |
| — |
| — |
| — |
| |||||
International agency obligations |
| 364,574 |
| — |
| — |
| — |
| — |
| |||||
State or local housing-agency obligations |
| 231,195 |
| 76,649 |
| — |
| — |
| — |
| |||||
MBS issued by government-sponsored enterprises |
| 1,286,337 |
| — |
| — |
| — |
| — |
| |||||
MBS issued by private trusts |
| 6,035,549 |
| — |
| — |
| — |
| — |
| |||||
ABS backed by home-equity loans |
| 50,725 |
| — |
| — |
| — |
| — |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Total investments |
| $ | 8,398,757 |
| $ | 5,681,649 |
| $ | 2,563,000 |
| $ | 44,993 |
| $ | 29,987 |
|
(1) Ratings are obtained from Moody’s, Fitch, and S&P. If there is a split rating, the lowest rating is used. If a rating is on negative credit watch, the rating in the next lower rating category is used and then the lowest rating is determined.
(2) The issuer rating is used.
(3) All securities purchased under agreements to resell are fully collateralized by triple A-rated securities.
Credit Risk – Mortgage Loans. The Bank is subject to credit risk on purchased mortgage loans acquired through the MPF program. All mortgage loans acquired under the MPF program are fixed-rate, fully-amortizing mortgage loans that are not subject to “payment shock”. While Bank management believes this risk is appropriately managed through underwriting standards (the MPF program
45
requires full documentation to conform to standards established by Fannie Mae and Freddie Mac) and member credit enhancements, the Bank also maintains an allowance for credit losses. The Bank’s allowance for credit losses pertaining to mortgage loans was $125,000 at June 30, 2007. As of June 30, 2007, nonaccrual loans amounted to $4.9 million and consisted of 66 loans out of a total of approximately 46,400 loans. During the six months ended June 30, 2007, the Bank did not charge off any mortgage loans. The Bank had $9,000 in recoveries from the resolution of loans previously charged off during the six months ended June 30, 2007. The evaluation of the allowance for credit losses pertaining to mortgage loans is based on analysis of the migration rate of delinquent conventional MPF loans to default, the expected loss severity on defaulted loans, and the risk-mitigating features of the MPF program.
The Bank is exposed to credit risk from mortgage-insurance (MI) companies that provide credit enhancements in place of the PFI, as well as primary MI coverage on individual loans. As of June 30, 2007, the Bank was the beneficiary of primary MI coverage on $231.2 million of conventional mortgage loans, and the Bank was the beneficiary of supplemental mortgage guaranty insurance (SMI) coverage on mortgage pools with a total unpaid principal balance of $2.7 billion. Eight MI companies provide all of the coverage under these policies. All of these companies are rated at least double-A by S&P and Aa by Moody’s. The Bank closely monitors the financial conditions of these MI companies. The Bank has established limits on exposure to individual MI companies to ensure that the insurance coverage is sufficiently diversified. The limit considers the size, capital, and financial strength of the insurance company. The following table shows MI companies as of June 30, 2007, with MI coverage greater than 10 percent of total MI coverage.
Mortgage-insurance companies with MI coverage greater than 10% of total MI coverage
As of June 30, 2007
(dollars in thousands)
MI company |
| MI Coverage |
| Percent of Total MI |
| |
|
|
|
|
|
| |
United Guaranty Residential Insurance Corporation |
| $ | 19,972 |
| 28.3 | % |
|
|
|
|
|
| |
Mortgage Guaranty Insurance Corporation |
| 19,163 |
| 27.2 |
| |
|
|
|
|
|
| |
Genworth Mortgage Insurance Corporation |
| 11,003 |
| 15.6 |
| |
Credit Risk – Derivative Instruments. The Bank is subject to credit risk on derivative instruments. Credit exposure from derivatives arises from the risk of counterparty default on the derivative contract. The amount of loss created by default is the replacement cost, or current positive fair value, of the defaulted contract, net of any collateral held by the Bank. The credit risk to the Bank arising from unsecured credit exposure on derivatives is mitigated by the credit quality of the counterparties. Also, the Bank uses master-netting agreements to reduce its credit exposure from counterparty defaults. The Bank enters into master-netting agreements for interest-rate-exchange agreements only with nonmember institutions that have long-term senior unsecured credit ratings that are at or above single A by S&P and Moody’s. The nonmember agreements generally contain bilateral-collateral-exchange provisions that require credit exposures beyond a defined amount be secured by U.S. government or GSE-issued securities or cash. Exposures are measured daily, and adjustments to collateral positions are made as necessary to minimize the Bank’s exposure to credit risk. The nonmember agreements generally provide for smaller amounts of unsecured exposure to lower-rated counterparties. As of June 30, 2007, the Bank had two derivative contracts outstanding with one member institution which involved no credit exposure since they were sold options.
As illustrated in the following table, the Bank’s maximum credit exposure on interest-rate-exchange agreements is much less than the notional amount of the agreements. Additionally, mortgage-loan-purchase commitments are reflected in the following table as derivative instruments, in accordance with the provisions of SFAS 149. The Bank does not collateralize mortgage-loan-purchase commitments. However, should the PFI fail to deliver the mortgage loans as agreed, the member institution is charged a fee to compensate the Bank for nonperformance of the agreement.
46
Derivative Instruments
(dollars in thousands)
|
| Notional |
| Number of |
| Total Net |
| Net Exposure |
| |||
|
|
|
|
|
|
|
|
|
| |||
As of June 30, 2007 |
|
|
|
|
|
|
|
|
| |||
Interest-rate-exchange agreements: (1) |
|
|
|
|
|
|
|
|
| |||
Triple-A |
| $ | 31,550 |
| 1 |
| $ | — |
| $ | — |
|
Double-A |
| 27,835,728 |
| 14 |
| 153,218 |
| 24,703 |
| |||
Single-A |
| 5,190,932 |
| 4 |
| 21,167 |
| 1,327 |
| |||
Unrated (2) |
| 10,000 |
| 1 |
| — |
| — |
| |||
Total interest-rate-exchange agreements |
| 33,068,210 |
| 20 |
| 174,385 |
| 26,030 |
| |||
Mortgage-loan-purchase commitments (3) |
| 4,918 |
| — |
| 6 |
| — |
| |||
|
|
|
|
|
|
|
|
|
| |||
Total Derivatives |
| $ | 33,073,128 |
| 20 |
| $ | 174,391 |
| $ | 26,030 |
|
|
|
|
|
|
|
|
|
|
| |||
As of December 31, 2006 |
|
|
|
|
|
|
|
|
| |||
Interest-rate-exchange agreements: (1) |
|
|
|
|
|
|
|
|
| |||
Triple-A |
| $ | 40,725 |
| 1 |
| $ | — |
| $ | — |
|
Double-A |
| 22,761,948 |
| 14 |
| 83,210 |
| 4,751 |
| |||
Single-A |
| 7,733,930 |
| 4 |
| 45,163 |
| 296 |
| |||
Unrated (2) |
| 10,000 |
| 1 |
| — |
| — |
| |||
Total interest-rate-exchange agreements |
| 30,546,603 |
| 20 |
| 128,373 |
| 5,047 |
| |||
Mortgage-loan-purchase commitments (3) |
| 6,573 |
| — |
| — |
| — |
| |||
|
|
|
|
|
|
|
|
|
| |||
Total derivatives |
| $ | 30,553,176 |
| 20 |
| $ | 128,373 |
| $ | 5,047 |
|
(1) Ratings are obtained from Moody’s, Fitch, and S&P. If there is a split rating, the lowest rating is used. If a rating is on negative credit watch, the rating in the next lower rating category is used and then the lowest rating is determined.
(2) This represents two contracts with a member institution.
(3) Total fair-value exposures related to mortgage-loan-purchase commitments are offset by pair-off fees from the Bank’s members.
The notional amount of interest-rate-exchange agreements outstanding totaled $33.1 billion and $30.6 billion at June 30, 2007, and December 31, 2006, respectively. The Bank only enters into interest-rate-exchange agreements with major global financial institutions that are rated single A or better by Moody’s or S&P except for derivative contracts with member institutions. The Bank had no interest-rate-exchange agreements outstanding with other FHLBanks as of June 30, 2007.
As of June 30, 2007, and December 31, 2006, the following counterparties represented more than 10 percent of the total notional amount of interest-rate-exchange agreements outstanding (dollars in thousands):
| June 30, 2007 |
| ||||
Counterparty |
| Notional Amount |
| Percent of Total |
| |
|
|
|
|
|
| |
JP Morgan Chase Bank |
| $ | 4,581,630 |
| 13.9 | % |
Citigroup Financial Products Inc. |
| 4,290,575 |
| 13.0 |
| |
Deutsche Bank AG |
| 3,447,460 |
| 10.4 |
| |
| December 31, 2006 |
| ||||
Counterparty |
| Notional Amount |
| Percent of Total |
| |
|
|
|
|
|
| |
JP Morgan Chase Bank |
| $ | 4,211,530 |
| 13.8 | % |
Goldman Sachs Capital Markets LP |
| 4,047,403 |
| 13.3 |
| |
Deutsche Bank AG |
| 3,648,710 |
| 11.9 |
| |
The Bank may deposit funds with these counterparties and their affiliates for short-term money-market investments, including overnight federal funds, term federal funds, and interest-bearing certificates of deposit. Terms for such investments are overnight to 270 days. The Bank also engages in short-term secured reverse-repurchase agreements with affiliates of these counterparties. All of these counterparties and/or their affiliates buy, sell, and distribute the Bank’s COs and DNs.
Market and Interest-Rate Risk
Sources of Market and Interest-Rate Risk
The Bank’s balance sheet is a collection of different portfolios that require different types of market and interest-rate risk-management strategies. The majority of the Bank’s balance sheet is comprised of assets that can be funded individually or collectively without imposing significant residual interest-rate risk on the Bank.
However, the Bank’s mortgage-related assets, including the portfolio of whole loans acquired through the MPF program, its portfolio of MBS and ABS, and its portfolio of bonds issued by HFAs, represent more complex cash-flow structures and contain more risk of prepayment and/or call options. Because many of these assets are backed by residential mortgages that allow the borrower to prepay and refinance at any time, the behavior of these portfolios is asymmetric based on the movement of interest rates. If rates fall,
47
borrowers have an incentive to refinance mortgages without penalty, which could leave the Bank with lower-yielding replacement assets against existing debt assigned to the portfolio. If rates rise, borrowers will tend to hold existing loans longer than they otherwise would, imposing on the Bank the risk of having to refinance maturing debt assigned to these portfolios at a higher rate, thereby narrowing the interest spread generated by the assets.
These risks cannot be profitably managed with a strategy in which each asset is offset by a liability with a substantially identical cash-flow structure. Therefore, the Bank views each portfolio as a whole and allocates funding and hedging to these portfolios based on an evaluation of the collective market and interest-rate risks posed by these portfolios. The Bank measures the estimated impact to fair values of these portfolios as well as the potential for income to decline due to movements in interest rates, and makes adjustments to the funding and hedge instruments assigned as necessary to keep the portfolios within established risk limits.
Types of Market and Interest-Rate Risk
Interest-rate and market risk can be divided into several categories, including repricing risk, yield-curve risk, basis risk, and options risk. Repricing risk refers to differences in the average sensitivities of asset and liability yields attributable to differences in the average timing of maturities and/or coupon resets between assets and liabilities. In isolation, repricing risk assumes that all rates may change by the same magnitude. However, differences in the timing of repricing of assets and liabilities can cause spreads between assets and liabilities to decline.
Yield-curve risk reflects the sensitivity of net income to changes in the shape or slope of the yield curve that could impact the performance of assets and liabilities differently, even though average sensitivities are the same.
When assets and liabilities are affected by yield changes in different markets, basis risk can result. For example, if the Bank invests in LIBOR-based floating-rate assets and funds those assets with short-term DNs, potential compression in the spread between LIBOR and DN rates could adversely affect the Bank’s net income.
The Bank also faces options risk, particularly in its portfolios of advances, mortgage loans, MBS, and HFA bonds. When a member prepays an advance, the Bank could suffer lower future income if the principal portion of the prepaid advance was reinvested in lower-yielding assets that continue to be funded by higher-cost debt. In the mortgage loan, MBS, and HFA-bond portfolios, borrowers or issuers often have the right to redeem their obligations prior to maturity without penalty, potentially requiring the Bank to reinvest the returned principal at lower yields. If interest rates decline, borrowers may be able to refinance existing mortgage loans at lower interest rates, resulting in the prepayment of these existing mortgages and forcing the Bank to reinvest the proceeds in lower-yielding assets. If interest rates rise, borrowers may avoid refinancing mortgage loans for periods longer than the average term of liabilities funding the mortgage loans, causing the Bank to have to refinance the assets at higher cost. This right of redemption is effectively a call option that the Bank has written to the obligor. Another less prominent form of options risk includes coupon-cap risk, which may be embedded into certain MBS and limit the amount by which asset coupons may increase.
Strategies to Manage Market and Interest-Rate Risk
General
The Bank uses various strategies and techniques to manage its market and interest-rate risk. Principal among its tools for interest-rate-risk management is the issuance of debt that is used to match interest-rate-risk exposures of the Bank’s assets. The Bank can issue CO debt with maturities ranging from overnight to 20 years or more. The debt may be noncallable until maturity or callable on and/or after a certain date.
To reduce the earnings exposure to rising interest rates caused by long-term, fixed-rate assets, the Bank may issue long-term, fixed-rate bonds. These bonds may be issued to fund specific assets or to generally manage the overall exposure of a portfolio or the balance sheet. At both June 30, 2007, and December 31, 2006, unswapped fixed-rate noncallable debt amounted to $10.7 billion and unswapped fixed-rate callable debt amounted to $4.0 billion and $4.4 billion at June 30, 2007, and December 31, 2006, respectively.
To achieve certain risk-management objectives, the Bank also uses interest-rate derivatives that alter the effective maturities, repricing frequencies, or option-related characteristics of financial instruments. These may include swaps, swaptions, caps, collars, and floors; futures and forward contracts; and exchange-traded options. For example, as an alternative to issuing a fixed-rate bond to fund a fixed-rate advance, the Bank might enter into an interest-rate swap that receives a floating-rate coupon and pays a fixed-rate coupon, thereby effectively converting the fixed-rate advance to a floating-rate advance.
Advances
In addition to the general strategies described above, one tool that the Bank uses to reduce the interest-rate risk associated with advances is a contractual provision that requires members to pay prepayment fees for advances that, if prepaid prior to maturity, might expose the Bank to a loss of income under certain interest-rate environments. In accordance with applicable regulations, the Bank has
48
an established policy to charge fees sufficient to make the Bank financially indifferent to a member’s decision to repay an advance prior to its maturity. Prepayment fees are recorded as income for the period in which they are received.
Prepayment-fee income can be used to offset the cost of purchasing and retiring high-cost debt in order to maintain the Bank’s asset-liability sensitivity profile. In cases where derivatives are used to hedge prepaid advances, prepayment-fee income can be used to offset the cost of terminating the associated hedge.
Investments
The Bank holds certain long-term bonds issued by U.S. agencies, U.S. government corporations, international agency obligations, and instrumentalities as available-for-sale. To hedge the market and interest-rate risk associated with these assets, the Bank has entered into interest-rate swaps with matching terms to those of the bonds in order to create synthetic floating-rate assets. At June 30, 2007, and December 31, 2006, this portfolio had a value of $754.2 million and $764.0 million, respectively.
The Bank also manages the market and interest-rate risk in its MBS portfolio in several ways. For MBS classified as held-to-maturity, the Bank uses debt that matches the characteristics of the portfolio assets. For example, for floating-rate ABS, the Bank uses debt that reprices on a short-term basis, such as CO DNs or bonds that are swapped to a LIBOR-based floating-rate. For commercial MBS that are nonprepayable or prepayable for a fee for an initial period, the Bank may use fixed-rate debt. For MBS that are classified as trading securities, the Bank uses interest-rate swaps to economically hedge the duration characteristics and interest-rate caps to economically hedge the option risk in these assets.
Mortgage Loans
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 noncallable debt to achieve cash-flow patterns and liability durations similar to those expected on the mortgage loans.
The Bank mitigates much of its exposure to changes in interest rates by funding a significant portion of its mortgage portfolio with callable debt. When interest rates change, the Bank’s option to redeem this debt offsets a large portion of the fair-value change driven by the mortgage-prepayment option. These bonds are effective in managing prepayment risk by allowing the Bank to respond in kind to prepayment activity. Conversely, if interest rates increase the debt may remain outstanding until maturity. The Bank uses various cash instruments including short-term debt, callable, and noncallable long-term debt in order to reprice debt when mortgages prepay faster or slower than expected. The Bank’s debt-repricing capacity depends on market demand for callable and noncallable debt, which fluctuates from time to time. Additionally, because the mortgage-prepayment option is not fully hedged by callable debt, the combined market value of our mortgage assets and debt will be affected by changes in interest rates. As such, the Bank has enacted a more comprehensive strategy incorporating the use of derivatives. Derivatives provide a flexible, liquid, efficient, and cost-effective method to hedge interest-rate and prepayment risks.
To hedge the interest-rate-sensitivity risk due to potentially high prepayment speeds in the event of a drop in interest rates, the Bank has periodically purchased options to receive fixed rates on interest-rate swaps exercisable on specific future dates (receiver swaptions). These derivatives are structured to increase in value as interest rates decline, providing an offset to the loss of market value that might result from rapid prepayments in the event of a downturn in interest rates. With the addition of these option-based derivatives, the market value of the portfolio becomes more stable because a greater portion of prepayment risk is covered. At June 30, 2007, the Bank had no outstanding receiver swaptions.
Interest-rate-risk management activities can significantly affect the level and timing of net income due to a variety of factors. As receiver swaptions are accounted for on a standalone basis and not as part of a hedge relationship under SFAS 133, changes in their fair values are recorded through net income each month. This may increase net income volatility if the offsetting periodic change in the MPF prepayment activity is markedly different from the fair-value change in the receiver swaptions. Additionally, performance of the MPF portfolio is interest-rate-path dependent, while receiver swaptions values are solely based on forward-looking rate expectations.
When the Bank executes transactions to purchase mortgage loans, in some cases the Bank may be exposed to significant market risk until permanent hedging and funding can be obtained in the market. In these cases, the Bank may enter into a forward sale of MBS to be announced (TBA) or other derivatives for forward settlement. As of June 30, 2007, the Bank had no outstanding TBA hedges.
Swapped Consolidated-Obligation Debt
The Bank may also issue bonds in conjunction with interest-rate swaps that receive a coupon that offsets the bond coupon, and that offset any optionality embedded in the bond, thereby effectively creating a floating-rate liability. The Bank employs this strategy to achieve a lower cost of funds than may be available from the issuance of short-term CO DNs. Total debt used in conjunction with interest-rate-exchange agreements was $25.1 billion, or 61.6 percent of the Bank’s total outstanding CO bonds at June 30, 2007, up
49
from $22.6 billion, or 58.4 percent of outstanding CO bonds, at December 31, 2006. Because the interest rate swaps and hedge CO bonds trade in different markets, they are subject to basis risk that is reflected in the Bank’s Value-at-Risk calculations, but that is not reflected in hedge ineffectiveness as measured in accordance with SFAS 133, because these interest rate swaps are designed to hedge changes in fair values of the CO bonds that are attributable to changes in the benchmark LIBOR interest rate.
The Bank also uses interest-rate swaps, caps, and floors to manage the fair-value sensitivity of the portion of its MBS portfolio that is held at fair value. These interest-rate-exchange agreements provide an economic offset to the duration and convexity risks arising from these assets.
The following table presents a summary of the notional amounts and estimated fair values of the Bank’s outstanding derivative financial instruments, excluding accrued interest, and related hedged item by product and type of accounting treatment as of June 30, 2007, and December 31, 2006. The categories “fair value” and “cash flow” represent the hedge classification for transactions that qualify for hedge-accounting treatment in accordance with SFAS 133. The category “economic” represents hedge strategies that do not qualify for hedge accounting under the guidelines of SFAS 133, but are acceptable hedging strategies under the Bank’s risk-management program.
Hedged Item and Hedge-Accounting Treatment
As of June 30, 2007
(dollars in thousands)
|
|
|
|
|
| SFAS 133 |
| Derivative |
| Derivative |
| ||
|
|
|
|
|
| Hedge |
| Notional |
| Estimated |
| ||
Hedged Item |
| Derivative |
| Hedged Risk |
| Designation |
| Amount |
| Fair Value |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Advances |
| Swaps |
| Benchmark interest rate |
| Fair value |
| $ | 9,363,059 |
| $ | 46,489 |
|
|
| Swaps |
| Overall fair value |
| Economic |
| 29,000 |
| 4 |
| ||
|
| Caps and floors |
| Benchmark interest rate |
| Fair value |
| 424,800 |
| 2,378 |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Total associated with advances |
|
|
|
|
|
|
| 9,816,859 |
| 48,871 |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Available-for-sale securities |
| Swaps |
| Benchmark interest rate |
| Fair value |
| 881,581 |
| (45,757 | ) | ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Trading securities |
| Swaps |
| Overall fair value |
| Economic |
| 121,500 |
| 229 |
| ||
|
| Caps |
| Overall fair value |
| Economic |
| 196,000 |
| — |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Total associated with trading securities |
|
|
|
|
|
|
| 317,500 |
| 229 |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Consolidated obligations |
| Swaps |
| Benchmark interest rate |
| Fair value |
| 22,012,270 |
| (186,747 | ) | ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Deposits |
| Swaps |
| Benchmark interest rate |
| Fair value |
| 20,000 |
| 3,067 |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Member intermediated |
| Caps and floors |
| Not applicable |
| Not applicable |
| 20,000 |
| — |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Total |
|
|
|
|
|
|
| 33,068,210 |
| (180,337 | ) | ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Mortgage delivery commitments (1) |
|
|
|
|
|
|
| 4,918 |
| 2 |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Total derivatives |
|
|
|
|
|
|
| $ | 33,073,128 |
| (180,335 | ) | |
|
|
|
|
|
|
|
|
|
|
|
| ||
Accrued interest |
|
|
|
|
|
|
|
|
| 299,980 |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Net derivatives |
|
|
|
|
|
|
|
|
| $ | 119,645 |
| |
|
|
|
|
|
|
|
|
|
|
|
| ||
Derivative asset |
|
|
|
|
|
|
|
|
| $ | 174,391 |
| |
Derivative liability |
|
|
|
|
|
|
|
|
| (54,746 | ) | ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Net derivatives |
|
|
|
|
|
|
|
|
| $ | 119,645 |
|
(1) Mortgage delivery commitments are classified as derivatives pursuant to SFAS 149, with changes in their fair value recorded in other income.
50
Hedged Item and Hedge-Accounting Treatment
As of December 31, 2006
(dollars in thousands)
|
|
|
|
|
| SFAS 133 |
| Derivative |
| Derivative |
| ||
|
|
|
|
|
| Hedge |
| Notional |
| Estimated |
| ||
Hedged Item |
| Derivative |
| Hedged Risk |
| Designation |
| Amount |
| Fair Value |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Advances |
| Swaps |
| Benchmark interest rate |
| Fair value |
| $ | 8,429,974 |
| $ | 3,271 |
|
|
| Swaps |
| Overall fair value |
| Economic |
| 36,000 |
| (219 | ) | ||
|
| Caps and floors |
| Benchmark interest rate |
| Fair value |
| 454,800 |
| 3,842 |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Total associated with advances |
|
|
|
|
|
|
| 8,920,774 |
| 6,894 |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Available-for-sale securities |
| Swaps |
| Benchmark interest rate |
| Fair value |
| 890,756 |
| (92,714 | ) | ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Trading securities |
| Swaps |
| Overall fair value |
| Economic |
| 136,500 |
| 137 |
| ||
|
| Caps |
| Overall fair value |
| Economic |
| 446,000 |
| — |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Total associated with trading securities |
|
|
|
|
|
|
| 582,500 |
| 137 |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Mortgage loans |
| Swaptions |
| Overall fair value |
| Economic |
| 150,000 |
| — |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Consolidated obligations |
| Swaps |
| Benchmark interest rate |
| Fair value |
| 19,962,573 |
| (134,381 | ) | ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Deposits |
| Swaps |
| Benchmark interest rate |
| Fair value |
| 20,000 |
| 3,838 |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Member intermediated |
| Caps and floors |
| Not applicable |
| Not applicable |
| 20,000 |
| — |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Total |
|
|
|
|
|
|
| 30,546,603 |
| (216,226 | ) | ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Mortgage delivery commitments (1) |
|
|
|
|
|
|
| 6,573 |
| (24 | ) | ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Total derivatives |
|
|
|
|
|
|
| $ | 30,553,176 |
| (216,250 | ) | |
|
|
|
|
|
|
|
|
|
|
|
| ||
Accrued interest |
|
|
|
|
|
|
|
|
| 224,062 |
| ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Net derivatives |
|
|
|
|
|
|
|
|
| $ | 7,812 |
| |
|
|
|
|
|
|
|
|
|
|
|
| ||
Derivative asset |
|
|
|
|
|
|
|
|
| $ | 128,373 |
| |
Derivative liability |
|
|
|
|
|
|
|
|
| (120,561 | ) | ||
|
|
|
|
|
|
|
|
|
|
|
| ||
Net derivatives |
|
|
|
|
|
|
|
|
| $ | 7,812 |
|
(1) Mortgage delivery commitments are classified as derivatives pursuant to SFAS 149, with changes in their fair value recorded in other income.
Measurement of Market and Interest-Rate Risk
Market Value of Equity Estimation and Risk Limit. MVE is the net economic value (or net present value) of total assets and liabilities, including any off-balance sheet items. In contrast to the GAAP-based shareholders’ equity account, MVE represents the shareholders’ equity account in present-value terms. Interest-rate-risk analysis using MVE involves evaluating the potential changes in fair values of assets and liabilities and off-balance-sheet items under different potential future interest-rate scenarios and determining the potential impact on MVE according to each scenario and the scenario’s likelihood.
Value-at-risk (VaR) is defined to equal the ninety-ninth percentile potential reduction in MVE based on historical simulation of interest-rate scenarios. These scenarios correspond to interest-rate changes historically observed over 120-business-day periods starting at the most recent monthend and going back monthly to the beginning of 1978. This approach is useful in establishing risk-tolerance limits and is commonly used in asset/liability management; however, it does not imply a forecast of future interest-rate behavior. The Bank’s Risk-Management Policy requires that VaR not exceed the latest quarterend dividend-adjusted level of retained earnings plus the Bank’s most recent quarterly estimate of net income over the next six months.
The table below presents the historical simulation VaR estimate as of June 30, 2007, and December 31, 2006, which represents the estimates of potential reduction to the Bank’s MVE from potential future changes in interest rates and other market factors. Estimated potential risk exposures are expressed as a percentage of then current MVE and are based on historical behavior of interest rates and other market factors over a 120-business-day time horizon.
| Value-at-Risk |
| |||||||||
|
| June 30, 2007 |
| December 31, 2006 |
| ||||||
|
| % of |
|
|
| % of |
|
|
| ||
Confidence Level |
| MVE (1) |
| $ (million) |
| MVE (1) |
| $ (million) |
| ||
|
|
|
|
|
|
|
|
|
| ||
50% |
| -0.24 | % | $ | (6.12 | ) | -0.16 | % | $ | (4.16 | ) |
75% |
| 1.41 |
| 36.66 |
| 0.95 |
| 24.39 |
| ||
95% |
| 3.70 |
| 96.12 |
| 2.79 |
| 71.86 |
| ||
99% |
| 6.60 |
| 171.37 |
| 4.63 |
| 119.38 |
| ||
(1) Loss exposure is expressed as a percentage of base MVE.
51
As measured by VaR, the Bank’s potential losses to MVE due to changes in interest rates and other market factors increased by $52.0 million to $171.4 million as of June 30, 2007, from $119.4 million as of December 31, 2006. The primary driver behind the rise in VaR from December 31, 2006 has been basis risk. Basis risk reflects the impact on valuation when yield curves representing different markets do not move in tandem. For example, as the Bank issues debt as part of the Federal Home Loan Bank system and hedges this debt with interest rate swaps that are priced in a different market, unequal movements between yield curves produce changes in valuation beyond those explained by parallel shifts across all curves. The Bank has found the issuance of CO bonds swapped to short-term LIBOR to be more advantageous in terms of all-in funding costs in recent months than issuing through CO DNs. While this approach has improved the Bank’s funding costs, it has increased the Bank’s VaR as certain scenarios derived from the 1970’s and 1980’s, years from the historic period from which interest scenarios have been selected, experienced pronounced shifts between LIBOR and Federal Home Loan Bank CO yields.
Income Simulation and Repricing Gaps. To provide an additional perspective on market and interest-rate risks, the Bank has an income-simulation model that projects net interest income over a range of potential interest-rate scenarios, including parallel interest-rate shocks, nonparallel interest-rate shocks, and nonlinear changes to the Bank’s funding curve and LIBOR. The Bank measures simulated 12-month net income and return on equity (with an assumption of no prepayment-fee income or related hedge or debt-retirement expense) under these scenarios. Management has put in place escalation-action triggers whereby senior management is explicitly informed of instances where the Bank’s projected return on equity would fall below LIBOR in any of the assumed interest-rate scenarios. The results of this analysis for June 30, 2007, showed that in the worst-case scenario, the Bank’s return on equity would fall to four basis points above the average yield on three-month LIBOR under a scenario where interest rates instantaneously increased by 300 basis points across all points of all yield curves represented in the model.
Liquidity Risk
The Bank maintains operational liquidity in order to ensure that it meets its day-to-day business needs as well as its contractual obligations with normal sources of funding. The Bank’s Risk-Management Policy has established a metric and policy limit within which the Bank is expected to operate. The Bank defines structural liquidity as the difference between contractual sources and uses of funds adjusted to assume that all maturing advances are renewed; member overnight deposits are withdrawn at a rate of 50 percent per day; and commitments (MPF and other commitments) are taken down at a conservatively projected pace. The Bank defines available liquidity as the sources of funds available to the Bank through its access to the capital markets subject to leverage, line, and collateral constraints. The Risk Management Policy requires the Bank to maintain structural liquidity each day so that any excess of uses over sources is covered by available liquidity for the four-week forecast and 50 percent of the excess of uses over sources is covered by available liquidity over the eight- and 12-week forecasts. In addition to these minimum requirements, management measures structural liquidity over a four-month forecast period. If the Bank’s excess of uses over sources is not fully covered by available liquidity over a two-month or three-month forecast period, senior management will be immediately notified so that a decision can be made as to whether immediate remedial action is necessary. The following table shows the Bank’s structural liquidity as of June 30, 2007.
Structural Liquidity
As of June 30, 2007
(dollars in thousands)
|
| Month 1 |
| Month 2 |
| Month 3 |
| |||
|
|
|
|
|
|
|
| |||
Contractual sources of funds |
| $ | 7,519,372 |
| $ | 9,152,175 |
| $ | 10,328,936 |
|
Less: Contractual uses of funds |
| (3,952,304 | ) | (4,039,399 | ) | (3,200,434 | ) | |||
Equals: Net cash flow |
| 3,567,068 |
| 5,112,776 |
| 7,128,502 |
| |||
|
|
|
|
|
|
|
| |||
Less: Cumulative contingent obligations |
| (11,731,740 | ) | (17,384,409 | ) | (22,602,644 | ) | |||
Equals: Net structural liquidity |
| (8,164,672 | ) | (12,271,633 | ) | (15,474,142 | ) | |||
|
|
|
|
|
|
|
| |||
Available borrowing capacity |
| $ | 17,515,190 |
| $ | 20,918,746 |
| $ | 23,501,773 |
|
|
|
|
|
|
|
|
| |||
Ratio of available borrowing capacity to net structural liquidity need |
| 2.15 |
| 1.70 |
| 1.52 |
| |||
Required ratio |
| 1.00 |
| 0.50 |
| 0.50 |
| |||
Management action trigger |
| — |
| 1.00 |
| 1.00 |
|
The Bank also maintains contingency-liquidity plans designed to enable it to meet its obligations in the event of operational disruption at the Bank, the Office of Finance, or the capital markets. The Bank is required to ensure that it can meet its liquidity needs for a
52
minimum of five business days without access to CO debt issuance. As of June 30, 2007, and December 31, 2006, the Bank held a surplus of $9.4 billion and $7.7 billion, respectively, of liquidity (exclusive of access to CO debt issuance) within the first five prospective business days. Management measures liquidity on a daily basis and maintains an adequate base of operating and contingency liquidity by investing in short-term, high-quality, money-market investments that can provide a ready source of liquidity during stressed market conditions. As of June 30, 2007, the Bank’s contingency liquidity, as measured in accordance with Finance Board regulation 12 CFR §917 was determined as follows:
Contingency Liquidity
(dollars in thousands)
| Cumulative Fifth |
| ||
|
|
|
| |
Contractual sources of funds |
| $ | 2,801,390 |
|
Less: contractual uses of funds |
| (6,412,201 | ) | |
Equals: net cash flow |
| (3,610,811 | ) | |
|
|
|
| |
Contingency borrowing capacity (exclusive of CO debt) |
| 13,022,436 |
| |
|
|
|
| |
Net contingency borrowing capacity |
| $ | 9,411,625 |
|
Additional information regarding liquidity is provided in Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.
Management’s strategies for mitigating business risk include annual and long-term strategic planning exercises, continually monitoring key economic indicators and projections, the Bank’s external environment, and developing contingency plans where appropriate. The Bank’s risk-assessment process also considers business risk, where appropriate, for each of the Bank’s major business activities.
Operational Risk
The Bank has instituted a system of controls to mitigate operational risks. The Bank ensures that employees are properly trained for their roles and that written policies and procedures exist to support the key functions of the Bank. The Bank maintains a system of internal controls to ensure that responsibilities are adequately segregated and that the activities of the Bank are appropriately monitored and reported to management and the board of directors. Annual risk assessments review these risks and related controls for efficacy and potential opportunities for enhancement. Additionally, the Bank’s Internal Audit Department, which reports directly to the Audit Committee of the board of directors, regularly monitors the Bank’s adherence to established policies and procedures. However, some operational risks are beyond its control, and the failure of other parties to adequately address their operational risks could adversely affect the Bank.
Disaster-Recovery/Business Continuity Provisions. The Bank maintains a disaster-recovery site in Westborough, Massachusetts to provide continuity of operations in the event that its Boston headquarters becomes unavailable. Data for critical computer systems is backed up regularly and stored offsite to avoid disruption in the event of a computer failure. The Bank also has a reciprocal back-up agreement in place with the FHLBank of Topeka to provide short-term liquidity advances in the event that both of the Massachusetts facilities are inoperable. In the event that the FHLBank of Topeka’s facilities are inoperable, the Bank will provide short-term liquidity advances to its members.
Insurance Coverage. The Bank has insurance coverage for employee fraud, forgery, alteration, and embezzlement, as well as director and officer liability protection for breach of duty, misappropriation of funds, negligence, and acts of omission. Additionally, comprehensive insurance coverage is currently in place for electronic data-processing equipment and software, personal property, leasehold improvements, fire/explosion/water damage, and personal injury including slander and libelous actions. The Bank maintains additional insurance protection as deemed appropriate, which covers automobiles, company credit cards, and business-travel accident and supplemental traveler’s coverage for both directors and staff. The Bank uses the services of an insurance consultant who periodically conducts a comprehensive review of insurance-coverage levels.
Reputation Risk
The Bank has established a code of conduct and operational risk-management procedures to ensure ethical behavior among its staff and directors, and provides training to employees about its code of conduct. The Bank works to ensure that all communications are presented accurately, consistently, and in a timely way to multiple audiences and stakeholders. In particular, the Bank regularly conducts outreach efforts with its membership and with housing and economic-development advocacy organizations throughout New England. The Bank also cultivates relationships with government officials at the federal, state, and municipal levels; key media
53
outlets; nonprofit housing and community-development organizations; and regional and national trade and business associations to foster awareness of the Bank’s mission, activities, and value to members. The Bank works closely with the Council of Federal Home Loan Banks and the Office of Finance to coordinate communications on a broader scale.
Item 4. Controls and Procedures
Not applicable.
Item 4T. Controls and Procedures
Disclosure Controls and Procedures
The Bank’s senior management is responsible for establishing and maintaining a system of disclosure controls and procedures designed to ensure that information required to be disclosed by the Bank in the reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. The Bank’s disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Bank in the reports that it files or submits under the Securities Exchange Act of 1934 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. In designing and evaluating the Bank’s disclosure controls and procedures, the Bank’s management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and the Bank’s management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of controls and procedures.
Management of the Bank has evaluated the effectiveness of the design and operation of its disclosure controls and procedures with the participation of the president and chief executive officer, and chief financial officer as of the end of the period covered by this report. Based on that evaluation, the Bank’s president and chief executive officer, and chief financial officer have concluded that the Bank’s disclosure controls and procedures were effective at a reasonable assurance level as of the end of the fiscal quarter covered by this report.
Internal Control Over Financial Reporting
During the second quarter of 2007, there were no changes in the Bank’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Bank’s internal control over financial reporting.
Consolidated Obligations
The Bank’s disclosure controls and procedures include controls and procedures for accumulating and communicating information in compliance with the Bank’s disclosure and financial reporting requirements relating to the Bank’s joint and several liability for the COs of other FHLBanks. Because the FHLBanks are independently managed and operated, management of the Bank relies on information that is provided or disseminated by the Finance Board, the Office of Finance, or the other FHLBanks, as well as on published FHLBank credit ratings in determining whether the Bank’s contingent joint and several liability is reasonably likely to become a direct obligation or whether it is reasonably possible that the Bank will accrue a direct liability.
Management of the Bank also relies on the operation of the Finance Board’s joint and several liability regulation (12 CFR §966.9). The joint and several liability regulation requires that each FHLBank file with the Finance Board a quarterly certification that it will remain capable of making full and timely payment of all of its current obligations, including direct obligations, coming due during the next quarter. In addition, if an FHLBank cannot make such a certification or if it projects that it may be unable to meet its current obligations during the next quarter on a timely basis, it must file a notice with the Finance Board. Under the joint and several liability regulation, the Finance Board may order any FHLBank to make principal and interest payments on any COs of any other FHLBank, or allocate the outstanding liability of an FHLBank among all remaining FHLBanks on a pro rata basis in proportion to each FHLBank’s participation in all COs outstanding or on any other basis.
54
The Bank from time to time is subject to various pending 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 adverse effect on the Bank’s financial condition or results of operations.
The following information should be read in conjunction with the risk factors and related information previously disclosed in the Bank’s annual report on Form 10-K for the year ended December 31, 2006. This discussion is not exhaustive, and there may be other risks that the Bank faces which are not described below or in the Bank’s annual report on Form 10-K for the year ended December 31, 2006.
Declines in the value of sub-prime or non-traditional residential mortgage loans that serve as collateral may negatively impact the Bank’s business operations, financial condition, and future results of operations.
The Bank accepts collateral from members to secure advances that include some amounts of sub-prime and non-traditional residential mortgage loans, as well as MBS that may be backed sub-prime and not-traditional residential mortgage loans. The Bank also invests in MBS backed by some amounts of sub-prime and non-traditional mortgage loans. In recent months, delinquencies and losses with respect to residential mortgage loans generally have increased, particularly in the sub-prime and non-traditional sectors. In addition, residential property values in many states have declined or remained stable, after extended periods during which those values had appreciated. If delinquency and loss rates on sub-prime and non-traditional mortgages continue to increase, or there is a rapid decline in residential real estate values, the Bank could be exposed to a greater risk that the collateral that has been pledged to secure advances would be inadequate in the event of default on an outstanding advance. Additionally, reduced collateral values could result in lower yields, lower fair values or losses on MBS investments.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
None.
31.1 |
| Certification of the president and chief executive officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|
|
|
31.2 |
| Certification of the chief financial officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|
|
|
32.1 |
| Certification of the president and chief executive officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
|
|
|
32.2 |
| Certification of the chief financial officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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 Boston | ||
|
|
|
|
|
| |
|
|
|
|
|
| |
Date: | August 10, 2007 |
| By: | /s/ | Michael A. Jessee |
|
|
|
|
|
| Michael A. Jessee | |
|
|
|
|
| President and Chief Executive Officer | |
|
|
|
|
| (Principal Executive Officer) | |
|
|
|
|
|
| |
Date: | August 10, 2007 |
| By: | /s/ | Frank Nitkiewicz |
|
|
|
|
|
| Frank Nitkiewicz | |
|
|
|
|
| Executive Vice President and Chief Financial Officer | |
|
|
|
|
| (Principal Financial Officer) |
55