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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 March 31, 2008
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number: 000-51845
FEDERAL HOME LOAN BANK OF ATLANTA
(Exact name of registrant as specified in its charter)
Federally chartered corporation | 56-6000442 | |||||||
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |||||||
1475 Peachtree Street, NE, Atlanta, Ga. | 30309 | |||||||
(Address of principal executive offices) | (Zip Code) | |||||||
Registrant’s telephone number, including area code: (404) 888-8000 |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing for the past 90 days.
x Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
¨ Large accelerated filer | ¨ Accelerated filer | x Non-accelerated filer | ¨ Smaller reporting company | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No
The number of shares outstanding of the registrant’s Class B Stock, par value $100, as of April 30, 2008, was 81,207,317.
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PART I. | 1 | |||
Item 1. | Financial Statements | 1 | ||
1 | ||||
2 | ||||
3 | ||||
4 | ||||
6 | ||||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 24 | ||
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 46 | ||
Item 4. | Controls and Procedures | 49 | ||
Item 4T. | Controls and Procedures | 49 | ||
PART II. | OTHER INFORMATION | 50 | ||
Item 1. | Legal Proceedings | 50 | ||
Item 1A. | Risk Factors | 50 | ||
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 51 | ||
Item 3. | Defaults Upon Senior Securities | 51 | ||
Item 4. | Submission of Matters to a Vote of Security Holders | 51 | ||
Item 5. | Other Information | 51 | ||
Item 6. | Exhibits | 51 | ||
SIGNATURES | 52 |
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PART I. | FINANCIAL INFORMATION |
Item 1. | Financial Statements |
FEDERAL HOME LOAN BANK OF ATLANTA
STATEMENTS OF CONDITION
(Unaudited)
(In thousands, except par value)
As of | ||||||
March 31, 2008 | December 31, 2007 | |||||
ASSETS | ||||||
Cash and due from banks | $ | 19,080 | $ | 18,927 | ||
Interest-bearing deposits (includes deposits with other FHLBanks of $3,273 and $3,405 as of March 31, 2008 and December 31, 2007, respectively) | 478,273 | 803,403 | ||||
Federal funds sold | 8,868,000 | 14,835,000 | ||||
Trading securities (includes other FHLBanks’ bonds of $290,807 and $284,542 as of March 31, 2008 and December 31, 2007, respectively) | 5,247,451 | 4,627,545 | ||||
Held-to-maturity securities, net (fair value of $23,538,411 and $20,777,339 as of March 31, 2008 and December 31, 2007, respectively) | 24,272,648 | 21,260,517 | ||||
Mortgage loans held for portfolio, net of allowance for credit losses on mortgage loans of $1,001 and $846 as of March 31, 2008 and December 31, 2007, respectively | 3,515,402 | 3,526,582 | ||||
Advances, net | 152,104,807 | 142,867,373 | ||||
Accrued interest receivable | 722,897 | 824,815 | ||||
Premises and equipment, net | 29,873 | 30,652 | ||||
Derivative assets | 66,705 | 43,039 | ||||
Other assets | 100,796 | 99,911 | ||||
TOTAL ASSETS | $ | 195,425,932 | $ | 188,937,764 | ||
LIABILITIES | ||||||
Deposits: | ||||||
Interest-bearing | $ | 8,014,756 | $ | 7,115,183 | ||
Noninterest-bearing | 14,522 | 19,844 | ||||
Total deposits | 8,029,278 | 7,135,027 | ||||
Consolidated obligations, net: | ||||||
Discount notes | 30,703,505 | 28,347,939 | ||||
Bonds | 143,791,182 | 142,237,042 | ||||
Total consolidated obligations, net | 174,494,687 | 170,584,981 | ||||
Mandatorily redeemable capital stock | 36,881 | 55,538 | ||||
Accrued interest payable | 1,286,982 | 1,460,114 | ||||
Affordable Housing Program | 160,551 | 156,184 | ||||
Payable to REFCORP | 29,021 | 30,681 | ||||
Derivative liabilities | 1,862,924 | 1,305,131 | ||||
Other liabilities | 1,095,976 | 187,872 | ||||
Total liabilities | 186,996,300 | 180,915,528 | ||||
Commitments and contingencies (Note 10) | ||||||
CAPITAL | ||||||
Capital stock Class B putable ($100 par value) issued and outstanding shares: | ||||||
Subclass B1 issued and outstanding shares: 14,013 and 12,900 as of March 31, 2008 and December 31, 2007, respectively | 1,401,256 | 1,289,973 | ||||
Subclass B2 issued and outstanding shares: 65,599 and 62,660 as of March 31, 2008 and December 31, 2007, respectively | 6,559,941 | 6,266,043 | ||||
Total capital stock Class B putable | 7,961,197 | 7,556,016 | ||||
Retained earnings | 470,981 | 468,779 | ||||
Accumulated other comprehensive loss | (2,546) | (2,559) | ||||
Total capital | 8,429,632 | 8,022,236 | ||||
TOTAL LIABILITIES AND CAPITAL | $ | 195,425,932 | $ | 188,937,764 | ||
The accompanying notes are an integral part of these financial statements.
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FEDERAL HOME LOAN BANK OF ATLANTA
STATEMENTS OF INCOME
(Unaudited)
(In thousands)
Three Months Ended March 31, | ||||||
2008 | 2007 | |||||
INTEREST INCOME | ||||||
Advances | $ | 1,476,035 | $ | 1,368,674 | ||
Prepayment fees on advances, net | 952 | 493 | ||||
Interest-bearing deposits | 22,067 | 9,418 | ||||
Federal funds sold | 78,372 | 127,829 | ||||
Trading securities | 67,733 | 66,344 | ||||
Held-to-maturity securities | 268,532 | 231,413 | ||||
Mortgage loans held for portfolio | 46,827 | 40,264 | ||||
Loans to other FHLBanks | 29 | 3 | ||||
Total interest income | 1,960,547 | 1,844,438 | ||||
INTEREST EXPENSE | ||||||
Consolidated obligations: | ||||||
Discount notes | 270,931 | 76,049 | ||||
Bonds | 1,433,406 | 1,541,693 | ||||
Deposits | 47,807 | 59,021 | ||||
Borrowings from other FHLBanks | 12 | — | ||||
Securities sold under agreements to repurchase | — | 6,124 | ||||
Mandatorily redeemable capital stock | 585 | 3,183 | ||||
Other borrowings | 90 | 23 | ||||
Total interest expense | 1,752,831 | 1,686,093 | ||||
NET INTEREST INCOME | 207,716 | 158,345 | ||||
Provision (reversal) for credit losses on mortgage loans held for portfolio | 155 | (128) | ||||
NET INTEREST INCOME AFTER PROVISION (REVERSAL) FOR CREDIT LOSSES | 207,561 | 158,473 | ||||
OTHER INCOME (LOSS) | ||||||
Service fees | 672 | 674 | ||||
Net gains on trading securities | 106,588 | 4,918 | ||||
Net losses on derivatives and hedging activities | (129,042) | (9,322) | ||||
Other | (138) | 101 | ||||
Total other loss | (21,920) | (3,629) | ||||
OTHER EXPENSE | ||||||
Operating | 23,598 | 21,067 | ||||
Finance Board | 1,705 | 1,252 | ||||
Office of Finance | 1,158 | 1,013 | ||||
Other | 354 | 768 | ||||
Total other expense | 26,815 | 24,100 | ||||
INCOME BEFORE ASSESSMENTS | 158,826 | 130,744 | ||||
Affordable Housing Program | 13,025 | 10,998 | ||||
REFCORP | 29,160 | 23,949 | ||||
Total assessments | 42,185 | 34,947 | ||||
NET INCOME | $ | 116,641 | $ | 95,797 | ||
The accompanying notes are an integral part of these financial statements.
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FEDERAL HOME LOAN BANK OF ATLANTA
STATEMENTS OF CAPITAL
FOR THE THREE MONTHS ENDED MARCH 31, 2008 AND 2007
(Unaudited)
(In thousands)
Capital Stock Class B Putable | Retained Earnings | Accumulated Other Comprehensive Loss | Total Capital | |||||||||||
Shares | Par Value | |||||||||||||
BALANCE, DECEMBER 31, 2006 | 57,718 | $ | 5,771,798 | $ | 406,376 | $ | (4,537) | $ | 6,173,637 | |||||
Issuance of capital stock | 9,834 | 983,423 | — | — | 983,423 | |||||||||
Repurchase/redemption of capital stock | (10,395) | (1,039,593) | — | — | (1,039,593) | |||||||||
Net shares reclassified to mandatorily redeemable capital stock | (344) | (34,370) | — | — | (34,370) | |||||||||
Comprehensive income: | ||||||||||||||
Net income | — | — | 95,797 | — | 95,797 | |||||||||
Other comprehensive loss: | ||||||||||||||
Benefit plans: | ||||||||||||||
Amortization of net loss | — | — | — | 260 | 260 | |||||||||
Amortization of net prior service credit | — | — | — | (181) | (181) | |||||||||
Amortization of net transition obligation | — | — | — | 10 | 10 | |||||||||
Total comprehensive income | — | — | — | — | 95,886 | |||||||||
Cash dividends on capital stock | — | — | (83,929) | — | (83,929) | |||||||||
BALANCE, MARCH 31, 2007 | 56,813 | $ | 5,681,258 | $ | 418,244 | $ | (4,448) | $ | 6,095,054 | |||||
BALANCE, DECEMBER 31, 2007 | 75,560 | $ | 7,556,016 | $ | 468,779 | $ | (2,559) | $ | 8,022,236 | |||||
Issuance of capital stock | 14,587 | 1,458,689 | — | — | 1,458,689 | |||||||||
Repurchase/redemption of capital stock | (10,455) | (1,045,461) | — | — | (1,045,461) | |||||||||
Net shares reclassified to mandatorily redeemable capital stock | (80) | (8,047) | — | — | (8,047) | |||||||||
Comprehensive income: | ||||||||||||||
Net income | — | — | 116,641 | — | 116,641 | |||||||||
Other comprehensive loss: | ||||||||||||||
Benefit plans: | ||||||||||||||
Amortization of net loss | — | — | — | 175 | 175 | |||||||||
Amortization of net prior service credit | — | — | — | (175) | (175) | |||||||||
Amortization of net transition obligation | — | — | — | 13 | 13 | |||||||||
Total comprehensive income | — | — | — | — | 116,654 | |||||||||
Cash dividends on capital stock | — | — | (114,439) | — | (114,439) | |||||||||
BALANCE, MARCH 31, 2008 | 79,612 | $ | 7,961,197 | $ | 470,981 | $ | (2,546) | $ | 8,429,632 | |||||
The accompanying notes are an integral part of these financial statements.
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FEDERAL HOME LOAN BANK OF ATLANTA
STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
Three Months Ended March 31, | ||||||
2008 | 2007 | |||||
OPERATING ACTIVITIES | ||||||
Net income | $ | 116,641 | $ | 95,797 | ||
Adjustments to reconcile net income to net cash provided by (used in) operating activities: | ||||||
Depreciation and amortization: | ||||||
Net premiums and discounts on consolidated obligations | 105,950 | 5,572 | ||||
Net premiums and discounts on investments | (2,956) | (771) | ||||
Net premiums and discounts on mortgage loans | 1,030 | (196) | ||||
Concessions on consolidated obligations | 15,188 | 7,709 | ||||
Net deferred loss on derivatives | 77 | 70 | ||||
Premises and equipment | 707 | 597 | ||||
Capitalized software | 1,242 | 1,107 | ||||
Other | (3,558) | (2,754) | ||||
Provision (reversal) for credit losses on mortgage loans held for the portfolio | 155 | (128) | ||||
Loss (gain) due to change in net fair value adjustment on derivative and hedging activities | 101,772 | (56,205) | ||||
Fair value adjustment on trading securities | (106,588) | (4,918) | ||||
Net change in: | ||||||
Accrued interest receivable (excluding derivative accrued interest) | 99,414 | 68,506 | ||||
Other assets | (5,157) | 1,337 | ||||
Affordable Housing Program (AHP) liability | 3,841 | 3,937 | ||||
Accrued interest payable (excluding derivative accrued interest) | (173,064) | (236,920) | ||||
Payable to REFCORP | (1,660) | 165 | ||||
Other liabilities | (3,559) | (1,853) | ||||
Total adjustments | 32,834 | (214,745) | ||||
Net cash provided by (used in) operating activities | 149,475 | (118,948) | ||||
INVESTING ACTIVITIES | ||||||
Net change in: | ||||||
Interest-bearing deposits | (1,399,194) | (273,544) | ||||
Federal funds sold | 5,967,000 | (644,000) | ||||
Deposits to other FHLBanks for mortgage loan programs | 132 | 1,306 | ||||
Trading Securities: | ||||||
Proceeds from maturities | 250,000 | — | ||||
Purchases | (761,888) | — | ||||
Held-to-maturity securities: | ||||||
Proceeds | 739,568 | 704,647 | ||||
Purchases | (2,839,012) | (447,083) | ||||
Advances: | ||||||
Proceeds from principal collected | 51,833,079 | 39,928,319 | ||||
Made | (57,977,477) | (39,584,491) | ||||
Mortgage loans held for portfolio: | ||||||
Proceeds from principal collected | 117,146 | 87,172 | ||||
Purchases | (106,452) | (244,796) | ||||
Capital expenditures: | ||||||
Purchase of premises and equipment | (11) | (427) | ||||
Purchase of software | (310) | (710) | ||||
Net cash used in investing activities | (4,177,419) | (473,607) | ||||
The accompanying notes are an integral part of these financial statements.
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Three Months Ended March 31, | ||||||
2008 | 2007 | |||||
FINANCING ACTIVITIES | ||||||
Net change in deposits | 929,931 | 1,545,379 | ||||
Proceeds from derivatives containing a financial element | 15,587 | — | ||||
Payments on derivatives containing a financial element | (3,699) | — | ||||
Proceeds from issuance of consolidated obligations: | ||||||
Discount notes | 87,750,483 | 199,667,034 | ||||
Bonds | 39,337,594 | 29,063,282 | ||||
Payments for debt issuance costs | (11,774) | (3,423) | ||||
Payments for maturing and retiring consolidated obligations: | ||||||
Discount notes | (85,407,896) | (197,872,584) | ||||
Bonds | (38,854,725) | (31,669,650) | ||||
Proceeds from issuance of capital stock | 1,458,689 | 983,423 | ||||
Payments for repurchase/redemption of capital stock | (1,045,461) | (1,039,593) | ||||
Payments for repurchase/redemption of mandatorily redeemable capital stock | (26,704) | (2,719) | ||||
Cash dividends paid | (113,928) | (87,208) | ||||
Net cash provided by financing activities | 4,028,097 | 583,941 | ||||
Net increase (decrease) in cash and cash equivalents | 153 | (8,614) | ||||
Cash and cash equivalents at beginning of the period | 18,927 | 28,671 | ||||
Cash and cash equivalents at end of the period | $ | 19,080 | $ | 20,057 | ||
Supplemental disclosures of cash flow information: | ||||||
Cash paid for: | ||||||
Interest paid | $ | 1,641,747 | $ | 1,833,549 | ||
AHP assessments paid, net | $ | 8,658 | $ | 6,931 | ||
REFCORP assessments paid | $ | 30,820 | $ | 23,784 | ||
Noncash investing and financing activities: | ||||||
Dividends declared but not paid | $ | 114,439 | $ | 83,929 | ||
Net shares reclassified to mandatorily redeemable capital stock | $ | 8,047 | $ | 34,370 | ||
Securities acquired with accrued liabilities | $ | 911,162 | $ | — | ||
The accompanying notes are an integral part of these financial statements.
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FEDERAL HOME LOAN BANK OF ATLANTA
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
Note 1– Basis of Presentation
The accompanying unaudited interim financial statements of the Federal Home Loan Bank of Atlanta (the “Bank”) have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”). To prepare the financial statements in conformity with GAAP, management must make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and income and expenses during the reporting period. Actual results could be different from these estimates. The foregoing interim financial statements are unaudited; however, in the opinion of management, all adjustments, consisting only of normal recurring adjustments necessary for a fair statement of the results for the interim periods, have been included. The results of operations for interim periods are not necessarily indicative of results to be expected for the year ending December 31, 2008, or for other interim periods. The unaudited interim financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2007, which are contained in the Bank’s 2007 Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March 27, 2008 (“Form 10-K”).
Descriptions of the significant accounting policies of the Bank are included in Note 1 to the 2007 audited financial statements. There have been no material changes to these policies as of March 31, 2008.
Certain reclassifications have been made in the prior-year financial statements to conform to current presentation.
Cash Flows from Trading Securities.Statement of Financial Accounting Standards (“SFAS”) No. 159,The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115 (“SFAS 159”), amends SFAS No. 95,Statement of Cash Flows (“SFAS 95”), and SFAS No.115,Accounting for Certain Investments in Debt and Equity Securities (“SFAS 115”), to specify that cash flows from trading securities (which include securities for which an entity has elected the fair value option) should be classified in the Statements of Cash Flows based on the nature of and purpose for which the securities were acquired. Prior to this amendment, SFAS 95 and SFAS 115 specified that all cash flows from trading securities must be classified as cash flows from operating activities.
The Bank classified purchases, sales and maturities of trading securities held for investment purposes as cash flows from investing activities. Cash flows related to trading securities held for trading purposes continue to be reported as cash flows from operating activities. Previously, all cash flows associated with trading securities were reflected in the Statements of Cash Flows as operating activities. While the Bank classifies certain investments acquired for purposes of liquidity and asset/liability management as trading and carries them at fair value, the Bank does not participate in speculative trading practices and may hold certain trading investments indefinitely as the Bank periodically evaluates its liquidity needs.
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Note 2– Recently Adopted and Issued Accounting Standards
SFAS No. 157, Fair Value Measurements(“SFAS 157”) was issued in September 2006. In defining fair value, SFAS 157 retains the exchange price notion in earlier definitions of fair value. However, the definition of fair value under SFAS 157 focuses on the price that would be received to sell an asset or paid to transfer a liability (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price). SFAS 157 applies whenever other accounting pronouncements require or permit assets or liabilities to be measured at fair value. Accordingly, SFAS 157 does not expand the use of fair value in any new circumstances. SFAS 157 also establishes a fair value hierarchy that prioritizes the information used to develop assumptions used to determine the exit price. Under this standard, fair value measurements would be disclosed separately by level within the fair value hierarchy. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years, with early adoption permitted. The Bank adopted SFAS 157 effective January 1, 2008. The adoption of SFAS 157 had no effect on the Bank’s financial condition or results of operations. For additional information on the fair value of certain financial assets and liabilities, see Note 9 to the financial statements.
SFAS 159, issued in February 2007, creates a fair value option allowing 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 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. SFAS 159 also 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, with early adoption permitted. The Bank adopted SFAS 159 effective January 1, 2008. As of March 31, 2008, the Bank elected not to measure any financial assets or liabilities using the fair value option under SFAS 159; therefore the adoption of SFAS 159 had no effect on the Bank’s financial condition or results of operations.
FASB Staff Position No. FIN 39-1, Amendment of FASB Interpretation No. 39 (“FSP FIN 39-1”), issued in April 2007, 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. 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. FSP FIN 39-1 is effective for fiscal years beginning after November 15, 2007, with earlier application permitted. The Bank adopted FSP FIN 39-1 effective January 1, 2008 and retroactively applied its requirements to all prior periods. The Bank has not changed its accounting policy of offsetting fair value amounts recognized for derivative instruments under the same master netting arrangement. As of March 31, 2008 and December 31, 2007, the fair value of derivative assets reported were reduced by $35.8 million and $9 thousand, respectively, for amounts recognized for
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the right to return cash collateral received under master netting agreements with derivative counterparties. As of March 31, 2008 and December 31, 2007, the fair value of derivative liabilities reported were reduced by $2.5 billion and $808.4 million, respectively, for amounts recognized for the right to reclaim cash collateral paid under master netting agreements with derivative counterparties.
Statement 133 Implementation Issue No. 23(“Issue E23”),Issues Involving Application of the Shortcut Method under Paragraph 68, issued in January 2008 amends SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”), explicitly to permit the use of the shortcut method for those hedging relationships in which (1) the interest rate swap has a nonzero fair value at the inception of the hedging relationship, attributable solely to differing prices within the bid-ask spread; and/or (2) the hedged item has a trade date that differs from its settlement date because of generally established conventions in the marketplace in which the transaction to acquire or issue the hedged item is executed. Issue E23 is effective for hedging relationships designated on or after January 1, 2008. At adoption, preexisting hedging relationships utilizing the shortcut method that did not meet the requirements of Issue E23 as of the inception of the hedging relationship must be dedesignated prospectively. The effects of applying hedge accounting prior to the effective date may not be reversed. A hedging relationship that does not qualify for the shortcut method based on Issue E23 could be redesignated without the application of the shortcut method if that hedging relationship meets the applicable requirements of SFAS 133. The Bank adopted Issue E23 effective January 1, 2008. The Bank concluded that no dedesignations were required as a result of the adoption of Issue E23. In addition, since May 31, 2005, the Bank no longer applies the short-cut method to new hedging relationships. Therefore the adoption of Issue E23 had no effect on the Bank’s financial condition or results of operations.
SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities an amendment of FASB Statement No. 133(“SFAS 161”), issued in March 2008, requires enhanced disclosures about an entity’s derivative and hedging activities. These enhanced disclosures will discuss (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedged items are accounted for under SFAS 133, and its related interpretations; and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS 161 is effective for financial statements issued for fiscal years beginning after November 15, 2008 with earlier adoption allowed. The Bank does not believe that the adoption of SFAS 161 will have a material effect on its financial condition or results of operations.
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Note 3—Held-to-maturity Securities
Major Security Types.Held-to-maturity securities were as follows (in thousands):
As of March 31, 2008 | As of December 31, 2007 | |||||||||||||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | |||||||||||||||||
State or local housing agency obligations | $ | 125,628 | $ | 4,138 | $ | 22 | $ | 129,744 | $ | 117,988 | $ | 4,933 | $ | 65 | $ | 122,856 | ||||||||
Mortgage-backed securities: | ||||||||||||||||||||||||
U.S. agency obligations- guaranteed | 44,542 | 1,148 | 22 | 45,668 | 47,460 | 779 | — | 48,239 | ||||||||||||||||
Government-sponsored enterprises | 6,106,351 | 42,281 | 19,302 | 6,129,330 | 2,968,441 | 8,591 | 37,260 | 2,939,772 | ||||||||||||||||
Private label | 17,996,127 | 4,279 | 766,737 | 17,233,669 | 18,126,628 | 2,068 | 462,224 | 17,666,472 | ||||||||||||||||
Total | $ | 24,272,648 | $ | 51,846 | $ | 786,083 | $ | 23,538,411 | $ | 21,260,517 | $ | 16,371 | $ | 499,549 | $ | 20,777,339 | ||||||||
As of March 31, 2008, the Bank had 304 held-to-maturity investment securities in an unrealized loss position. The Bank reviewed its held-to-maturity investments and has determined that all unrealized losses reflected above are temporary based on the creditworthiness of the issuers and the underlying collateral. Management believes it is probable that the Bank will be able to collect all amounts due according to the contractual terms of the individual securities. Additionally, the Bank has the ability and the intent to hold such investments to maturity, at which time it will recover the unrealized losses.
The following tables summarize the held-to-maturity securities with unrealized losses (in thousands). The unrealized losses are aggregated by major security type and length of time that individual securities have been in a continuous unrealized loss position.
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As of March 31, 2008 | ||||||||||||||||||
Less than 12 Months | 12 Months or More | Total | ||||||||||||||||
Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||||
State or local housing agency obligations | $ | 13,328 | $ | 22 | $ | — | $ | — | $ | 13,328 | $ | 22 | ||||||
Mortgage-backed securities: | ||||||||||||||||||
U.S. agency obligations, guaranteed | 1,862 | 22 | — | — | 1,862 | 22 | ||||||||||||
Government-sponsored enterprises | 573,325 | 3,478 | 1,113,068 | 15,824 | 1,686,393 | 19,302 | ||||||||||||
Private label | 8,619,531 | 344,630 | 8,205,798 | 422,107 | 16,825,329 | 766,737 | ||||||||||||
Total | $ | 9,208,046 | $ | 348,152 | $ | 9,318,866 | $ | 437,931 | $ | 18,526,912 | $ | 786,083 | ||||||
As of December 31, 2007 | ||||||||||||||||||
Less than 12 Months | 12 Months or More | Total | ||||||||||||||||
Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||||
State or local housing agency obligations | $ | — | $ | — | $ | 5,125 | $ | 65 | $ | 5,125 | $ | 65 | ||||||
Mortgage-backed securities: | ||||||||||||||||||
Government-sponsored enterprises | 250,137 | 707 | 1,609,791 | 36,553 | 1,859,928 | 37,260 | ||||||||||||
Private label | 6,762,719 | 126,604 | 10,392,842 | 335,620 | 17,155,561 | 462,224 | ||||||||||||
Total | $ | 7,012,856 | $ | 127,311 | $ | 12,007,758 | $ | 372,238 | $ | 19,020,614 | $ | 499,549 | ||||||
Note 4—Advances
Redemption Terms.The Bank had advances outstanding, as summarized below (in thousands):
As of March 31, 2008 | As of December 31, 2007 | |||||
Year of contractual maturity: | ||||||
Overdrawn demand deposit accounts | $ | 7,395 | $ | 18,219 | ||
Due in one year or less | 28,826,804 | 34,062,503 | ||||
Due after one year through two years | 25,986,071 | 19,356,806 | ||||
Due after two years through three years | 28,652,692 | 22,684,160 | ||||
Due after three years through four years | 15,871,402 | 18,326,931 | ||||
Due after four years through five years | 15,732,670 | 16,430,434 | ||||
Due after five years | 31,303,684 | 29,350,652 | ||||
Total par value | 146,380,718 | 140,229,705 | ||||
Discount on AHP advances | (13,145) | (13,461) | ||||
Discount on EDGE* advances | (13,881) | (14,091) | ||||
SFAS 133 hedging adjustments | 5,753,467 | 2,667,120 | ||||
Deferred commitment fees | (2,352) | (1,900) | ||||
Total | $ | 152,104,807 | $ | 142,867,373 | ||
* | The Economic Development and Growth Enhancement Program |
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The following table summarizes advances by year of contractual maturity or, for convertible advances, next conversion date (in thousands):
As of March 31, 2008 | |||
Year of contractual maturity or next convert date: | |||
Overdrawn demand deposit accounts | $ | 7,395 | |
Due or convertible in one year or less | 49,886,844 | ||
Due or convertible after one year through two years | 29,192,451 | ||
Due or convertible after two years through three years | 28,434,692 | ||
Due or convertible after three years through four years | 14,121,252 | ||
Due or convertible after four years through five years | 12,167,665 | ||
Due or convertible after five years | 12,570,419 | ||
Total par value | $ | 146,380,718 | |
The Bank has never experienced a credit loss on advances. Based on the collateral pledged as security for advances, management’s credit analysis of members’ financial conditions, and prior repayment history, management believes no allowance for credit losses on advances is deemed necessary. No advance was past due as of March 31, 2008 or December 31, 2007.
Interest-rate Payment Terms.The following table details interest-rate payment terms for advances (in thousands):
As of March 31, 2008 | As of December 31, 2007 | |||||
Par value of advances: | ||||||
Fixed-rate | $ | 123,751,182 | $ | 115,846,392 | ||
Variable-rate | 22,629,536 | 24,383,313 | ||||
Total | $ | 146,380,718 | $ | 140,229,705 | ||
Note 5—Consolidated Obligations
Consolidated obligations, consisting of consolidated obligation bonds and discount notes, are the joint and several obligations of the 12 Federal Home Loan Banks (“FHLBanks”) and are backed only by the financial resources of the FHLBanks. The Federal Home Loan Banks Office of Finance (“Office of Finance”) tracks the amount of debt issued on behalf of each FHLBank. In addition, the Bank separately tracks and records as a liability its specific portion of consolidated obligations for which it is the primary obligor.
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Interest-rate Payment Terms.The following table details consolidated obligation bonds by interest-rate payment type (in thousands):
As of March 31, 2008 | As of December 31, 2007 | |||||
Par value of consolidated bonds: | ||||||
Fixed-rate | $ | 110,640,690 | $ | 112,134,915 | ||
Step | 4,670,000 | 8,951,550 | ||||
Simple variable-rate | 25,286,900 | 18,311,900 | ||||
Variable-rate capped floater | 503,000 | 908,000 | ||||
Fixed-rate that converts to variable-rate | 110,000 | 259,950 | ||||
Zero-coupon | 484,060 | 659,060 | ||||
Variable-rate that converts to fixed-rate | 670,000 | 670,000 | ||||
Inverse floating-rate | 24,500 | 24,500 | ||||
Total | $ | 142,389,150 | $ | 141,919,875 | ||
Redemption Terms.The following is a summary of the Bank’s participation in consolidated obligation bonds outstanding, by year of contractual maturity (dollar amounts in thousands):
As of March 31, 2008 | As of December 31, 2007 | |||||||||
Amount | Weighted Average Interest Rate | Amount | Weighted Average Interest Rate | |||||||
Year of contractual maturity: | ||||||||||
Due in one year or less | $ | 69,847,080 | 3.58% | $ | 62,826,705 | 4.56% | ||||
Due after one year through two years | 26,646,075 | 3.97% | 29,721,925 | 4.64% | ||||||
Due after two years through three years | 11,888,395 | 4.42% | 14,448,245 | 4.63% | ||||||
Due after three years through four years | 4,679,250 | 4.77% | 4,665,400 | 4.93% | ||||||
Due after four years through five years | 10,738,000 | 4.46% | 7,851,500 | 5.06% | ||||||
Due after five years | 18,590,350 | 5.05% | 22,406,100 | 5.08% | ||||||
Total par value | 142,389,150 | 4.03% | 141,919,875 | 4.70% | ||||||
Premiums | 27,207 | 19,479 | ||||||||
Discounts | (280,769) | (375,211) | ||||||||
SFAS 133 hedging adjustments | 1,656,583 | 673,965 | ||||||||
Deferred net losses on terminated hedges | (989) | (1,066) | ||||||||
Total | $ | 143,791,182 | $ | 142,237,042 | ||||||
The Bank’s consolidated obligation bonds outstanding included (in thousands):
As of March 31, 2008 | As of December 31, 2007 | |||||
Par value of consolidated bonds: | ||||||
Noncallable | $ | 87,269,000 | $ | 71,188,475 | ||
Callable | 55,120,150 | 70,731,400 | ||||
Total | $ | 142,389,150 | $ | 141,919,875 | ||
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The following table summarizes consolidated obligation bonds outstanding, by year of contractual maturity or, for callable consolidated obligation bonds, next call date (in thousands):
As of March 31, 2008 | |||
Year of contractual maturity or next call date: | |||
Due or callable in one year or less | $ | 98,235,930 | |
Due or callable after one year through two years | 20,824,075 | ||
Due or callable after two years through three years | 8,571,395 | ||
Due or callable after three years through four years | 1,700,750 | ||
Due or callable after four years through five years | 3,158,000 | ||
Due or callable after five years | 9,899,000 | ||
Total par value | $ | 142,389,150 | |
Consolidated Obligation Discount Notes.The Bank’s participation in consolidated obligation discount notes, all of which are due within one year, was as follows (dollar amounts in thousands):
Book Value | Par Value | Weighted Average Interest Rate | ||||||
As of March 31, 2008 | $ | 30,703,505 | $ | 30,786,389 | 2.62% | |||
As of December 31, 2007 | $ | 28,347,939 | $ | 28,514,466 | 4.23% | |||
Note 6—Capital and Mandatorily Redeemable Capital Stock
Capital.The Bank was in compliance with the regulatory capital rules and requirements of the Federal Housing Finance Board (the “Finance Board”) as shown in the following table (dollar amounts in thousands):
As of March 31, 2008 | As of December 31, 2007 | |||||||||||
Required | Actual | Required | Actual | |||||||||
Regulatory capital requirements: | ||||||||||||
Risk-based capital | $ | 1,243,399 | $ | 8,469,059 | $ | 981,647 | $ | 8,080,333 | ||||
Total capital-to-assets ratio | 4.00% | 4.33% | 4.00% | 4.28% | ||||||||
Total regulatory capital* | $ | 7,817,037 | $ | 8,469,059 | $ | 7,557,511 | $ | 8,080,333 | ||||
Leverage ratio | 5.00% | 6.50% | 5.00% | 6.42% | ||||||||
Leverage capital | $ | 9,771,297 | $ | 12,703,589 | $ | 9,446,888 | $ | 12,120,499 |
* Finance Board staff has indicated that mandatorily redeemable capital stock is considered capital for regulatory purposes, and “total regulatory capital” includes the Bank’s $36.9 million and $55.5 million in mandatorily redeemable capital stock at March 31, 2008 and December 31, 2007, respectively.
Mandatorily Redeemable Capital Stock.The following table provides the number of members that attained nonmember status and the number of nonmembers for which the Bank has completed the repurchase/redemption of mandatorily redeemable capital stock:
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Three Months Ended March 31, | ||||
2008 | 2007 | |||
Beginning of period | 11 | 9 | ||
Attainment of nonmember status | 1 | 2 | ||
Repurchase/redemption during the period | (1) | (1) | ||
End of period | 11 | 10 | ||
The Bank’s activity for mandatorily redeemable capital stock was as follows (in thousands):
Three Months Ended March 31, | ||||||
2008 | 2007 | |||||
Balance, beginning of period | $ | 55,538 | $ | 215,705 | ||
Capital stock subject to mandatory redemption reclassified from equity during the period due to attainment of nonmember status | 8,615 | 34,370 | ||||
Capital stock no longer subject to redemption due to a nonmember becoming a member | (568) | — | ||||
Repurchase/redemption of mandatorily redeemable capital stock during the period | (26,704) | (2,719) | ||||
Balance, end of period | $ | 36,881 | $ | 247,356 | ||
The following table shows the amount of mandatorily redeemable capital stock by year of redemption (in thousands). The year of redemption in the table is the end of the five-year redemption period, or, with respect to activity-based stock, the later of the expiration of the five-year redemption period or the activity’s maturity date:
As of March 31, 2008 | As of December 31, 2007 | |||||
Contractual year of redemption: | ||||||
Due in one year or less | $ | 5,018 | $ | 28,758 | ||
Due after one year through two years | 1,530 | 786 | ||||
Due after two years through three years | 2,318 | 625 | ||||
Due after three years through four years | 2,289 | 3,600 | ||||
Due after four years through five years | 5,760 | 4,727 | ||||
Due after five years | 19,966 | 17,042 | ||||
Total | $ | 36,881 | $ | 55,538 | ||
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Note 7—Employee Retirement Plans
Components of the net periodic benefit cost for the Bank’s supplemental defined benefit pension plan and postretirement health benefit plan for the three months ended March 31, 2008 and 2007 were as follows (in thousands):
Supplemental Defined Benefit Pension Plan | Postretirement Health Benefit Plan | |||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||
Net periodic benefit cost | ||||||||||||
Service cost | $ | 125 | $ | 200 | $ | 75 | $ | 147 | ||||
Interest cost | 138 | 150 | 100 | 133 | ||||||||
Amortization of net transition obligation | — | — | 13 | 10 | ||||||||
Amortization of prior service credit | (25) | (31) | (150) | (150) | ||||||||
Amortization of net loss | 100 | 150 | 75 | 110 | ||||||||
Net periodic benefit cost | $ | 338 | $ | 469 | $ | 113 | $ | 250 | ||||
Note 8—Derivatives and Hedging Activities
For accounting policies and additional information concerning derivatives and hedging activities, see Note 14 to the 2007 audited financial statements included in the Bank’s Form 10-K.
Net losses on derivatives and hedging activities were as follows (in thousands):
Three Months Ended March 31, | ||||||
2008 | 2007 | |||||
Gains related to fair-value hedge ineffectiveness | $ | 4,819 | $ | 9,262 | ||
Losses on SFAS 133 non-qualifying hedges and other | (133,861) | (18,584) | ||||
Net losses on derivatives and hedging activities | $ | (129,042) | $ | (9,322) | ||
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The following table represents outstanding notional balances and estimated fair values of the derivatives outstanding used for fair value hedges and stand alone derivatives that are SFAS 133 non-qualifying hedges (in thousands):
As of March 31, 2008 | As of December 31, 2007 | |||||||||||
Notional | Estimated Fair Value | Notional | Estimated Fair Value | |||||||||
Interest-rate swaps: | ||||||||||||
Fair value hedges | $ | 207,060,847 | $ | (4,194,224) | $ | 207,143,643 | $ | (2,031,901) | ||||
SFAS 133 non-qualifying hedges | 19,454,972 | (431,531) | 12,338,065 | (263,429) | ||||||||
Interest-rate swaptions: | ||||||||||||
SFAS 133 non-qualifying hedges | 2,000,000 | 1,507 | 115,000 | 10,823 | ||||||||
Interest-rate caps/floors: | ||||||||||||
SFAS 133 non-qualifying hedges | 3,260,000 | 58,714 | 3,260,000 | 25,980 | ||||||||
Interest-rate futures/forwards: | ||||||||||||
SFAS 133 non-qualifying hedges | 1,500 | 147 | 1,500 | 109 | ||||||||
Mortgage delivery commitments: | ||||||||||||
SFAS 133 non-qualifying hedges | 25,762 | 37 | 9,309 | 41 | ||||||||
Total | $ | 231,803,081 | $ | (4,565,350) | $ | 222,867,517 | $ | (2,258,377) | ||||
Total derivatives excluding accrued interest | $ | (4,565,350) | $ | (2,258,377) | ||||||||
Accrued interest | 269,830 | 187,934 | ||||||||||
Cash collateral held by counterparty - assets | 2,535,056 | 808,360 | ||||||||||
Cash collateral held from counterparty - liabilities | (35,755) | (9) | ||||||||||
Net derivative balances | $ | (1,796,219) | $ | (1,262,092) | ||||||||
Net derivative assets balance | $ | 66,705 | $ | 43,039 | ||||||||
Net derivative liabilities balance | (1,862,924) | (1,305,131) | ||||||||||
Net derivative balances | $ | (1,796,219) | $ | (1,262,092) | ||||||||
The fair values of bifurcated embedded derivatives presented on a combined basis with the host contract and not included in the above table are as follows (in thousands):
As of March 31, 2008 | As of December 31, 2007 | |||||
Host contract: | ||||||
Advances | $ | 20,662 | $ | 8,459 | ||
Callable bonds | 13 | 408 | ||||
Total | $ | 20,675 | $ | 8,867 | ||
The Bank is subject to credit risk due to the risk of nonperformance by counterparties to the derivative agreements. The amount of counterparty risk on derivative agreements depends on the extent to which master netting arrangements are included in such contracts to mitigate the risk. The Bank manages counterparty credit risk through credit analysis, collateral requirements and adherence to the requirements set forth in Bank policy and Finance Board regulations. Based on credit analyses and collateral requirements, Bank management presently does not anticipate any credit losses on its derivative agreements.
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The contractual or notional amount of derivatives reflects the involvement of the Bank in the various classes of financial instruments. The notional amount of derivatives does not measure the credit risk exposure of the Bank, and the maximum credit exposure of the Bank is substantially less than the notional amount. The Bank requires collateral agreements that establish collateral delivery thresholds for all derivatives. The maximum credit risk is the estimated cost of replacing favorable interest-rate swaps, forward agreements, mandatory delivery contracts for mortgage loans, and purchased caps and floors that have a net positive market value, if the counterparty defaults and the related collateral, if any, is of no value to the Bank. This collateral has not been sold or repledged.
As of March 31, 2008 and December 31, 2007, the Bank’s maximum credit risk, as defined above, was approximately $102.5 million and $43.0 million, respectively. These totals include $21.7 million and $11.0 million, respectively, of net accrued interest receivable. In determining maximum credit risk, the Bank considers accrued interest receivables and payables, and the legal right to offset derivative assets and liabilities by counterparty. Cash and securities held and pledged to the Bank as collateral for derivatives were $37.2 million and $0 as of March 31, 2008 and December 31, 2007, respectively. 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.
Note 9—Estimated Fair Values
As discussed in Note 2 to the financial statements, the Bank adopted SFAS 157 and SFAS 159 on January 1, 2008. SFAS 157 defines fair value, establishes a framework for measuring fair value under GAAP and expands disclosures about fair value measurements. SFAS 157 applies whenever other accounting pronouncements require or permit assets or liabilities to be measured at fair value. Accordingly, SFAS 157 does not expand the use of fair value in any new circumstances. SFAS 159 provides companies with an option to report selected financial assets and liabilities at fair value.
The Bank records trading securities and derivative assets and liabilities at fair value. Fair value is a market-based measurement and is defined as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the assets or owes the liability. In general, the transaction price will equal the exit price and, therefore, represent the fair value of the asset or liability at initial recognition. In determining whether a transaction price represents the fair value of the asset or liability at initial recognition, each reporting entity is required to consider factors specific to the transaction and the asset or liability, the principal or most advantageous market for the asset or liability, and market participants with whom the entity would transact in the market.
SFAS 159 provides an option to elect fair value as an alternative measurement for selected financial assets, financial liabilities, unrecognized firm commitments, and written loan commitments not previously carried at fair value. It requires entities to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the Statements of Condition. In addition, unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. Under SFAS 159, fair value is used for both the initial and subsequent measurement of the designated assets, liabilities and commitments, with the changes in fair value recognized in net income. As of March 31, 2008, the Bank
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had not elected to measure any financial assets or liabilities using the fair value option under SFAS 159, therefore the adoption of SFAS 159 had no effect on the Bank’s financial condition or results of operations.
SFAS 157 establishes a fair value hierarchy to prioritize the inputs of valuation techniques used to measure fair value. The inputs are evaluated and an overall level for the fair value measurement is determined. This overall level is an indication of how market observable the fair value measurement is and defines the level of disclosure. SFAS 157 clarifies fair value in terms of the price in an orderly transaction between market participants to sell an asset or transfer a liability in the principal (or most advantageous) market for the asset or liability at the measurement date (an exit price). In order to determine the fair value or the exit price, entities must determine the unit of account, highest and best use, principal market, and market participants. These determinations allow the reporting entity to define the inputs for fair value and level of hierarchy.
Outlined below is the application of the fair value hierarchy established by SFAS 157 to the Bank’s financial assets and financial liabilities that are carried at fair value.
Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. An active market for the asset or liability is a market in which the transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. As of March 31, 2008, the Bank did not carry any financial assets and liabilities at fair value hierarchy level 1.
Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. As of March 31, 2008, the types of financial assets and liabilities carried at fair value hierarchy level 2 included trading securities and derivatives.
Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement. Unobservable inputs are supported by little or no market activity or by the entity’s own assumptions. As of March 31, 2008, the Bank did not carry any financial assets or liabilities at fair value hierarchy level 3.
The Bank utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs.
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The following table presents for each SFAS 157 hierarchy level, the Bank’s financial assets and financial liabilities that are measured at fair value on a recurring basis on its Statements of Condition (in thousands):
As of March 31, 2008 | |||||||||||||||
Fair Value Measurements Using | |||||||||||||||
Level 1 | Level 2 | Level 3 | Netting Adjustment* | Total | |||||||||||
Assets | |||||||||||||||
Trading securities | $ | — | $ | 5,247,451 | $ | — | $ | — | $ | 5,247,451 | |||||
Derivative assets | — | 102,460 | — | (35,755) | 66,705 | ||||||||||
Total assets at fair value | $ | — | $ | 5,349,911 | $ | — | $ | (35,755) | $ | 5,314,156 | |||||
Liabilities | |||||||||||||||
Derivative liabilities | $ | — | $ | (4,397,980) | $ | — | $ | 2,535,056 | $ | (1,862,924) | |||||
Total liabilities at fair value | $ | — | $ | (4,397,980) | $ | — | $ | 2,535,056 | $ | (1,862,924) | |||||
* | Amounts represent the effect of legally enforceable master netting agreements that allow the Bank to net settle positive and negative positions and also cash collateral held or placed with the same counterparties. |
For instruments carried at fair value, the Bank reviews the fair value hierarchy classification of financial assets and liabilities on a quarterly basis.
Described below are the Bank’s fair value measurement methodologies for financial assets and liabilities measured or disclosed at fair value.
Cash and due from banks and interest-bearing deposits.The estimated fair value approximates the recorded book balance.
Trading securities. The estimated fair value of trading securities is determined by calculating the present value of the expected future cash flows based on market observable inputs obtained from an outside source that are input into the Bank’s valuation model.
Held-to-maturity securities.The estimated fair value of held-to-maturity securities is determined based on independent market-based prices received from a third party pricing service, excluding accrued interest. The Bank’s principal markets for securities portfolios are the secondary institutional markets, with an exit price that is predominantly reflective of bid level pricing in that market. When prices are not available, the estimated fair value is determined by calculating the present value of the expected future cash flows discounted with a market observable rate, predominately the London Interbank Offered Rate (“LIBOR”), and reducing the amount for accrued interest receivable. In obtaining such valuation information from third parties, the Bank generally evaluates the valuation methodologies used to develop the fair values in order to determine whether such valuations are representative of an exit price in the Bank’s principal markets. Further, the Bank performs an internal independent price verification function that tests valuations received from third parties.
Federal funds sold.The estimated fair value is determined by calculating the present value of the expected future cash flows. The discount rates used in these calculations are the rates for federal funds with similar terms and represent market observable rates.
Advances.The Bank determines the estimated fair values of advances by calculating the present value of expected future cash flows from the advances and excluding the amount of the accrued interest receivable. The discount rates used in these calculations are the replacement advance rates based on the market
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observable LIBOR curve for advances with similar terms as of March 31, 2008 and December 31, 2007. In accordance with the Finance Board’s advances regulations, advances with a maturity or repricing period greater than six months require a prepayment fee sufficient to make the Bank financially indifferent to the borrower’s decision to prepay the advances, thereby removing prepayment risk from the fair value calculation.
Mortgage loans held for portfolio.The estimated fair values for mortgage loans are determined based on quoted market prices of similar mortgage loans available in the pass-through securities market. These prices, however, can change rapidly based upon market conditions and are highly dependent upon the underlying prepayment assumptions.
Accrued interest receivable and payable.The estimated fair value approximates the recorded book value.
Derivative assets and liabilities.The Bank calculates the fair value of derivatives using a present value of future cash flows discounted by a market observable rate, predominately LIBOR. The fair values are based on a AA credit rating which is maintained through the use of collateral agreements.
Deposits.The Bank determines estimated fair values of Bank deposits by calculating the present value of expected future cash flows from the deposits and reducing this amount for accrued interest payable. The discount rates used in these calculations are based on LIBOR.
Borrowings. The Bank determines the estimated fair value of borrowings by calculating the present value of expected future cash flows from the borrowings and reducing this amount for accrued interest payable. The discount rates used in these calculations are based on market observable rates, predominantly LIBOR.
Consolidated obligations.The Bank calculates the fair value of consolidated obligation bonds and discount notes by using the present value of future cash flows using a cost of funds as the discount rate. The cost of funds discount curves are based primarily on the market observable LIBOR rate and to some extent on the Office of Finance cost of funds curve that also is market observable.
Mandatorily redeemable capital stock. The fair value of mandatorily redeemable capital stock is par value, including estimated dividends earned at the time of reclassification from equity to liabilities, until such amount is paid. Capital stock can be acquired by members only at par value and redeemed by the Bank at par value. Capital stock is not traded and no market mechanism exists for the exchange of capital stock outside the cooperative structure.
Commitments to extend credit for mortgage loans. Mortgage loan purchase commitments are recorded as derivatives at their fair values.
The following estimated fair value amounts have been determined by the Bank using available market information and the Bank’s best judgment of appropriate valuation methods. These estimates are based on pertinent information available to the Bank at March 31, 2008 and December 31, 2007. Although the Bank uses its best judgment in estimating the fair values of these financial instruments, there are inherent limitations in any estimation technique or valuation methodology. For example, because an active secondary market does not exist for a portion of the Bank’s financial instruments, in certain cases, fair values are not subject to precise quantification or verification and may change as economic and market factors and evaluation of those factors change. Therefore, these estimated fair values are not necessarily indicative of the amounts that would be realized in current market transactions. The Fair Value Summary Tables do not represent an estimate of the overall market value of the Bank as a going concern, which would take into account future business opportunities and the net profitability of assets versus liabilities.
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The carrying values and estimated fair values of the Bank’s financial instruments as of March 31, 2008 were as follows (in thousands):
2008 FAIR VALUE SUMMARY TABLE
Financial Instruments | Carrying Value | Net Unrealized Gains (Losses) | Estimated Fair Value | ||||||
Assets: | |||||||||
Cash and due from banks | $ | 19,080 | $ | – | $ | 19,080 | |||
Interest-bearing deposits | 478,273 | – | 478,273 | ||||||
Federal funds sold | 8,868,000 | 526 | 8,868,526 | ||||||
Trading securities | 5,247,451 | – | 5,247,451 | ||||||
Held-to-maturity securities | 24,272,648 | (734,237) | 23,538,411 | ||||||
Mortgage loans held for portfolio, net | 3,515,402 | 42,388 | 3,557,790 | ||||||
Advances, net | 152,104,807 | 217,155 | 152,321,962 | ||||||
Accrued interest receivable | 722,897 | – | 722,897 | ||||||
Derivative assets | 66,705 | – | 66,705 | ||||||
Liabilities: | |||||||||
Deposits | (8,029,278) | (32) | (8,029,310) | ||||||
Consolidated obligations, net: | |||||||||
Discount notes | (30,703,505) | 35,716 | (30,667,789) | ||||||
Bonds | (143,791,182) | (577,484) | (144,368,666) | ||||||
Mandatorily redeemable capital stock | (36,881) | (41) | (36,922) | ||||||
Accrued interest payable | (1,286,982) | – | (1,286,982) | ||||||
Derivative liabilities | (1,862,924) | – | (1,862,924) |
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The carrying values and estimated fair values of the Bank’s financial instruments as of December 31, 2007 were as follows (in thousands):
2007 FAIR VALUE SUMMARY TABLE
Financial Instruments | Carrying Value | Net Unrealized Gains (Losses) | Estimated Fair Value | ||||||
Assets: | |||||||||
Cash and due from banks | $ | 18,927 | $ | — | $ | 18,927 | |||
Interest-bearing deposits | 803,403 | — | 803,403 | ||||||
Federal funds sold | 14,835,000 | 955 | 14,835,955 | ||||||
Trading securities | 4,627,545 | — | 4,627,545 | ||||||
Held-to-maturity securities | 21,260,517 | (483,178) | 20,777,339 | ||||||
Mortgage loans held for portfolio, net | 3,526,582 | (11,961) | 3,514,621 | ||||||
Advances, net | 142,867,373 | 14,669 | 142,882,042 | ||||||
Accrued interest receivable | 824,815 | — | 824,815 | ||||||
Derivative assets | 43,039 | — | 43,039 | ||||||
Liabilities: | |||||||||
Deposits | (7,135,027) | 80 | (7,134,947) | ||||||
Consolidated obligations, net: | |||||||||
Discount notes | (28,347,939) | 14,989 | (28,332,950) | ||||||
Bonds | (142,237,042) | (194,267) | (142,431,309) | ||||||
Mandatorily redeemable capital stock | (55,538) | (29) | (55,567) | ||||||
Accrued interest payable | (1,460,114) | — | (1,460,114) | ||||||
Derivative liabilities | (1,305,131) | — | (1,305,131) |
Note 10—Commitments and Contingencies
As described in Note 5, consolidated obligations are backed only by the financial resources of the 12 FHLBanks. The Finance Board, under 12 CFR Section 966.9(d), may at any time require any FHLBank to make principal or interest payments due on any consolidated obligations, whether or not the primary obligor FHLBank has defaulted on the payment of that obligation. No FHLBank has had to assume or pay the consolidated obligation of another FHLBank.
The par value of the FHLBanks’ outstanding consolidated obligations for which the Bank is jointly and severally liable was approximately $1.0 trillion as of March 31, 2008 and December 31, 2007, respectively, exclusive of the Bank’s own outstanding consolidated obligations.
The Bank’s outstanding standby letters of credit were as follows:
As of March 31, 2008 | As of December 31, 2007 | |||
Outstanding notional (in thousands) | $ 7,649,300 | $ 6,443,273 | ||
Original terms | Less than three months to 15 years | Less than three months to 15 years | ||
Final expiration year | 2022 | 2022 |
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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 amounted to $27.5 million and $23.1 million as of March 31, 2008 and December 31, 2007, respectively. Based on management’s credit analyses and collateral requirements, the Bank does not deem it necessary to record any additional liability on these commitments.
Commitments that unconditionally obligate the Bank to purchase closed mortgage loans totaled $25.8 million and $9.3 million as of March 31, 2008 and December 31, 2007, respectively. Commitments are generally for periods not to exceed 45 days. Such commitments are recorded as derivatives at their fair values under SFAS No. 149,Amendment of Statement 133 on Derivative Instruments and Hedging Activities.
The Bank executes derivatives with major banks and broker-dealers and generally enters into bilateral collateral agreements. As of March 31, 2008 and December 31, 2007, the Bank had pledged, as collateral to broker-dealers who have market risk exposure from the Bank related to derivatives, securities with a carrying value of $1.3 billion and $592.1 million, respectively, which can be sold or repledged.
The Bank committed to issue $4.8 billion (par value) of consolidated obligation bonds and $8.0 million (par value) of consolidated obligation discount notes that had traded but not settled at March 31, 2008. There were no related interest rate swaps associated with the issuance of these consolidated obligations.
The Bank is subject to legal proceedings arising in the normal course of business. After consultation with legal counsel, management does not, as of the date of the financial statements, anticipate that the ultimate liability, if any, arising out of these matters will have a material effect on the Bank’s financial condition or results of operations.
Note 11—Transactions with Members and their Affiliates and with Housing Associates
The Bank is a cooperative whose member institutions own almost all of the capital stock of the Bank. Former members own the remaining capital stock to support business transactions still carried on the Bank’s Statements of Condition. All holders of the Bank’s capital stock are able to receive dividends on their investments, to the extent declared by the Bank’s board of directors. All advances are issued to members and eligible “housing associates” under the Federal Home Loan Bank Act of 1932, as amended (“FHLBank Act”), and mortgage loans held for portfolio are purchased from members. The Bank also maintains demand deposit accounts primarily to facilitate settlement activities that are related directly to advances and mortgage loan purchases. All transactions with members are entered into in the ordinary course of the Bank’s business. Transactions with any member that has an officer or director who also is a director of the Bank are subject to the same Bank policies as transactions with other members.
The Bank defines related parties as each of the other FHLBanks and those members with regulatory capital stock outstanding in excess of 10 percent of total regulatory capital stock. Based on this definition, one member institution, Countrywide Bank, FSB (“Countrywide”), which held 26.2 percent of the Bank’s total regulatory capital stock as of March 31, 2008, was considered a related party. Total advances outstanding to Countrywide were $46.0 billion and $47.7 billion as of March 31, 2008 and December 31, 2007, respectively. Total deposits held in the name of Countrywide were $1.3 billion and $2.5 billion as of March 31, 2008 and December 31, 2007, respectively. No mortgage loans were acquired from Countrywide during the three months ended March 31, 2008 and 2007, respectively. Total mortgage-backed securities acquired from Countrywide were $0 and $323.9 million for the three months ended March 31, 2008 and 2007, respectively.
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Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Forward-Looking Information
Some of the statements made in this quarterly report on Form 10-Q may be “forward-looking statements,” which include statements with respect to the plans, objectives, expectations, estimates and future performance of the Bank and involve known and unknown risks, uncertainties, and other factors, many of which may be beyond the Bank’s control and which may cause the Bank’s actual results, performance, or achievements to be materially different from future results, performance, or achievements expressed or implied by the forward-looking statements. All statements other than statements of historical fact are statements that could be forward-looking statements. The reader can identify these forward-looking statements through the Bank’s use of words such as “may,” “will,” “anticipate,” “hope,” “project,” “assume,” “should,” “indicate,” ���would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “plan,” “point to,” “could,” “intend,” “seek,” “target,” and other similar words and expressions of the future. Such forward-looking statements include statements regarding any one or more of the following topics:
• | The Bank’s business strategy and changes in operations, including, without limitation, product growth and change in product mix |
• | Future performance, including profitability, developments, or market forecasts |
• | Forward-looking accounting and financial statement effects. |
The forward-looking statements may not be realized due to a variety of factors, including, without limitation, those risk factors provided under Item 1A of the Bank’s Form 10-K and those risk factors presented under Item 1A in Part II of this quarterly report on Form 10-Q.
All written or oral statements that are made by or are attributable to the Bank are expressly qualified in their entirety by this cautionary notice. The reader should not place undue reliance on forward-looking statements, since the statements speak only as of the date that they are made. The Bank has no obligation and does not undertake publicly to update, revise, or correct any of the forward-looking statements after the date of this quarterly report, or after the respective dates on which these statements otherwise are made, whether as a result of new information, future events, or otherwise.
The discussion presented below provides an analysis of the Bank’s results of operations and financial condition for the three months ended March 31, 2008 and 2007. Management’s discussion and analysis should be read in conjunction with the financial statements and accompanying notes presented elsewhere in the report, as well as the Bank’s audited financial statements for the year ended December 31, 2007.
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Executive Summary
General Overview
The Bank is a cooperative whose primary business activity is providing loans, which the Bank refers to as “advances,” to its members and eligible housing associates. The Bank also purchases one-to-four family residential mortgage loans from members, makes grants and subsidized advances under AHP, and provides certain cash management services to members and eligible nonmembers. The consolidated obligations (“COs”) issued by the Office of Finance on behalf of the Federal Home Loan Banks are the principal funding source for Bank assets. The Bank is primarily liable for repayment of consolidated obligations issued on its behalf and is jointly and severally liable for the consolidated obligations issued on behalf of the other FHLBanks. Deposits, other borrowings, and the issuance of capital stock provide additional funding to the Bank. The Bank delivers low-cost credit to help its members meet the credit needs of their communities while historically paying members a competitive dividend.
Financial Condition
As of March 31, 2008, total assets were $195.4 billion, an increase of $6.5 billion, or 3.43 percent, from December 31, 2007, primarily as a result of an increase in advances and held-to-maturity securities, partially offset by a decrease in federal funds sold. Advances, the largest asset on the Bank’s balance sheet, increased $9.2 billion, or 6.47 percent, during the first quarter of 2008. During this same period, held-to-maturity securities increased $3.0 billion, or 14.2 percent, due primarily to the purchase of $3.7 billion in mortgage-backed securities (“MBS”) less $739.6 million in proceeds received for pay-downs on the Bank’s MBS portfolio. These increases during the period were offset partially by a $3.8 billion decrease in overnight federal funds sold and a $2.2 billion decrease in term federal funds sold.
As of March 31, 2008, total liabilities were $187.0 billion, an increase of $6.1 billion, or 3.36 percent, from December 31, 2007, primarily as a result of increases in consolidated obligations, other liabilities and interest-bearing deposits. Consolidated obligations, the largest liability on the Bank’s balance sheet, increased by $3.9 billion, or 2.29 percent, during the first quarter of 2008. During this same period, other liabilities increased $908.1 million, or 483.4 percent, and interest-bearing deposits increased by $899.6 million, or 12.6 percent. The increase in other liabilities was due primarily to the purchase of $911.2 million in MBS prior to quarter-end that had not settled as of March 31, 2008.
As of March 31, 2008, total capital was $8.4 billion, an increase of $407.4 million, or 5.08 percent, from December 31, 2007, primarily as a result of an increase in the Bank’s activity-based stock. The Bank continues to meet capital-to-assets regulatory ratios and liquidity requirements at levels well above regulatory minimums.
Results of Operations
The Bank attempts to provide a return on investment which, when combined with providing members access to low-cost funding, will be competitive with comparable investments. The Bank assesses the effectiveness of its dividend goal by comparing the dividend rate on its capital stock to three-month average LIBOR. This benchmark is consistent with the Bank’s interest rate risk and capital management goals.
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The Bank’s annualized return on equity (“ROE”) was 5.72 percent for the first quarter of 2008, compared to 6.25 percent for the first quarter of 2007. However, the ROE spread to three-month average LIBOR improved between the periods, equaling 2.43 percent for the quarter ended March 31, 2008 as compared to 0.89 percent for the quarter ended March 31, 2007. The increase in this spread was due primarily to reduced funding costs for consolidated obligation debt relative to LIBOR due to increased demand for FHLBank debt.
The Bank’s annualized return on average assets was 0.25 percent for the first quarter of 2008, compared to 0.27 percent for the same period in 2007. The Bank’s interest rate spread decreased by two basis points for the first quarter of 2008 compared to the first quarter of 2007. This decrease was primarily due to interest rate changes and the impact of those changes on the effects of SFAS 133.
The Bank’s earnings can be affected by the shape of the yield curve. Although interest rates declined from March 31, 2007 to March 31, 2008, the slope of the yield curve remained relatively constant, resulting in little interest-rate induced changes in profitability.
The Bank’s net income for the first quarter of 2008 totaled $116.6 million, an increase of 21.8 percent from $95.8 million for the first quarter of 2007. The increase in net income was due to an increase in net interest income, resulting from higher average advances and MBS balances during the period. The increase in net interest income was offset partially by a decrease in other income, which resulted from the effect of the interaction of interest rates on the Bank’s trading securities and derivative and hedging activities, and the two basis point decrease in interest rate spread.
Business Outlook
Advance demand continued to rise during the first quarter of 2008 due to the state of the credit markets, although not nearly at the same rate as during the second half of 2007. If credit market disruptions continue to settle, the Bank does not expect that new advance activity will continue to increase at the 2007 rate. On April 2, 2008, the Bank announced that in light of the condition of the mortgage and credit markets, effective May 1, 2008, the Bank would increase the discount it applies to residential first mortgage collateral, resulting in a lendable collateral value (“LCV”) of 75 percent of unpaid principal balance, as compared to the existing discount that had resulted in an LCV of 80 percent of unpaid principal balance. The Bank does not expect this change to have a material effect on advance demand.
The relationship between short- and long-term interest rates affects the Bank’s profitability. The two most unfavorable interest-rate scenarios are (1) a dramatic rise in short-term rates coupled with a modest or no increase in long-term rates and (2) a dramatic decrease in long-term rates coupled with little change in short-term rates. Under the first scenario the ability to generate additional returns by managing the interest-rate risk associated with retaining longer term assets and funding with shorter liabilities is limited. This environment, if sustained for a long period of time, could reduce the Bank’s ability to generate competitive returns. The second scenario would be expected to result in significant mortgage prepayments, which would result in lower investment yields.
The FHLBank System continues to experience favorable CO debt funding costs in light of the current credit market situation. The Bank cannot predict how long these favorable funding costs will continue. Further, while the liquidity in the MBS market improved during the first quarter of 2008, the continued inability of the Bank to be fully leveraged in MBS may continue to have a negative effect on the Bank’s profitability.
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Management expects to continue to use interest-rate derivatives to hedge the Bank’s MBS and mortgage portfolios. These derivatives assist in mitigating interest-rate and prepayment risk. However, to the extent that they do not qualify for hedge accounting treatment under GAAP, their use could result in earnings volatility. Management also uses derivative instruments to hedge other macro-level risks that do not qualify for hedge accounting treatment under GAAP. However, management seeks to contain the magnitude of mark-to-market adjustments by limiting the use of derivative instruments to hedge macro-level risks.
Management strives to maintain relatively low operating expenses, consistent with a wholesale banking structure, without sacrificing adequate systems and staffing. Management expects that operating expenses as a percent of assets generally should remain stable over the next few years, and that operating expenses on an absolute basis should increase moderately due to increased staffing and system expenses. These increases should not have a material adverse effect on the Bank’s financial performance.
On January 11, 2008, Bank of America Corporation (“Bank of America”) and Countrywide Financial Corporation (“CFC”), the parent of the Bank’s largest borrower, Countrywide Bank, FSB, announced they had signed an agreement and plan of merger dated January 11, 2008. The announcement stated that the merger agreement has been approved by the board of directors of Bank of America and CFC and is subject to customary closing conditions, including regulatory and CFC stockholder approvals. Bank of America recently became a member of the Bank; however, the effect of this acquisition on the Bank’s financial condition or results of operation cannot be determined at this time.
For the remainder of 2008, the Bank expects to continue to focus on delivering member value by striving to meet members’ expectations and credit needs while balancing this effort with sound risk management policies.
Financial Condition
The Bank’s principal assets consist of advances, short- and long-term investments, and mortgage loans held for portfolio. The Bank obtains funding to support its business primarily through the issuance by the Office of Finance on the Bank’s behalf of debt securities in the form of consolidated obligations.
The following table presents the distribution of the Bank’s total assets, liabilities, and capital by major class as of the dates indicated (dollar amounts in thousands). These items are discussed in more detail below:
As of March 31, 2008 | As of December 31, 2007 | Increase/(Decrease) | |||||||||||||
Amount | Percent of Total | Amount | Percent of Total | Amount | Percent | ||||||||||
Advances, net | $ | 152,104,807 | 77.83 | $ | 142,867,373 | 75.62 | $ | 9,237,434 | 6.47 | ||||||
Long-term investments | 29,520,099 | 15.11 | 25,888,062 | 13.70 | 3,632,037 | 14.03 | |||||||||
Federal funds sold | 8,868,000 | 4.54 | 14,835,000 | 7.85 | (5,967,000) | (40.22) | |||||||||
Mortgage loans, net | 3,515,402 | 1.80 | 3,526,582 | 1.87 | (11,180) | (0.32) | |||||||||
Interest-bearing deposits | 478,273 | 0.24 | 803,403 | 0.42 | (325,130) | (40.47) | |||||||||
Other assets | 939,351 | 0.48 | 1,017,344 | 0.54 | (77,993) | (7.67) | |||||||||
Total assets | $ | 195,425,932 | 100.00 | $ | 188,937,764 | 100.00 | $ | 6,488,168 | 3.43 | ||||||
Consolidated obligations, net: | |||||||||||||||
Bonds | $ | 143,791,182 | 76.90 | $ | 142,237,042 | 78.62 | $ | 1,554,140 | 1.09 | ||||||
Discount notes | 30,703,505 | 16.42 | 28,347,939 | 15.67 | 2,355,566 | 8.31 | |||||||||
Deposits | 8,029,278 | 4.29 | 7,135,027 | 3.94 | 894,251 | 12.53 | |||||||||
Other total liabilities | 4,472,335 | 2.39 | 3,195,520 | 1.77 | 1,276,815 | 39.96 | |||||||||
Total liabilities | $ | 186,996,300 | 100.00 | $ | 180,915,528 | 100.00 | $ | 6,080,772 | 3.36 | ||||||
Capital stock | $ | 7,961,197 | 94.44 | $ | 7,556,016 | 94.19 | $ | 405,181 | 5.36 | ||||||
Retained earnings | 470,981 | 5.59 | 468,779 | 5.84 | 2,202 | 0.47 | |||||||||
Accumulated other comprehensive loss | (2,546) | (0.03) | (2,559) | (0.03) | 13 | 0.51 | |||||||||
Total capital | $ | 8,429,632 | 100.00 | $ | 8,022,236 | 100.00 | $ | 407,396 | 5.08 | ||||||
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Advances
Advances were $152.1 billion at March 31, 2008, an increase of $9.2 billion, or 6.47 percent, from December 31, 2007. Advances at March 31, 2008 included net unrealized gains of $5.8 billion resulting from fair value hedge basis adjustments in accordance with SFAS 133 hedge accounting requirements, compared to net unrealized gains of $2.7 billion at December 31, 2007 for these adjustments. The $3.1 billion increase in fair value hedge basis adjustments during the first quarter of 2008 was due to declining interest rates. During this same period, the par amount of advances increased by $6.2 billion, or 4.39 percent, which consisted of a $7.9 billion increase in fixed-rate advances and a $1.8 billion decrease in variable-rate advances. At March 31, 2008, 84.5 percent of the Bank’s advances were fixed-rate. As of March 31, 2008, the Bank has determined to report certain structured advance products that it previously had reported as variable-rate as fixed-rate to reflect more appropriately the terms of those products. At March 31, 2008, the majority of the Bank’s variable-rate advances were indexed primarily to LIBOR. The Bank also offers variable-rate advances tied to the federal funds rate, prime rate and CMS (constant maturity swap) rates.
The concentration of the Bank’s advances to its 10 largest borrowing member institutions was as follows:
Advances to 10 largest borrowing member institutions | Percent of total advances outstanding | |||
March 31, 2008 | $101.7 billion | 69.5% | ||
December 31, 2007 | $ 97.6 billion | 69.6% |
Investments
The Bank maintains a portfolio of investments for liquidity purposes, to provide for the availability of funds to meet member credit needs and to provide additional earnings. Investment income also enhances the Bank’s capacity to meet its commitment to affordable housing and community investment, to cover operating expenses, and to satisfy the Bank’s annual Resolution Funding Corporation (“REFCORP”) assessment.
The Bank’s short-term investments consist of overnight and term federal funds, and interest-bearing deposits. The Bank’s long-term investments consist of MBS issued by government-sponsored mortgage agencies or private securities that carry the highest rating from Moody’s or S&P when purchased,
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securities issued by the U.S. government or U.S. government agencies, and consolidated obligations issued by other FHLBanks. The long-term investment portfolio generally provides the Bank with higher returns than those available in the short-term money markets. The following table sets forth more detailed information regarding short- and long-term investments held by the Bank (dollar amounts in thousands):
Increase/ (Decrease) | |||||||||||
As of March 31, 2008 | As of December 31, 2007 | Amount | Percent | ||||||||
Short-term investments: | |||||||||||
Interest-bearing deposits | $ | 478,273 | $ | 803,403 | $ | (325,130) | (40.47) | ||||
Federal funds sold | 8,868,000 | 14,835,000 | (5,967,000) | (40.22) | |||||||
Total short-term investments | $ | 9,346,273 | $ | 15,638,403 | $ | (6,292,130) | (40.24) | ||||
Long-term investments: | |||||||||||
Trading securities: | |||||||||||
Government-sponsored enterprises debt obligations | $ | 4,897,155 | $ | 4,283,519 | $ | 613,636 | 14.33 | ||||
Other FHLBanks’ bonds | 290,807 | 284,542 | 6,265 | 2.20 | |||||||
State or local housing agency obligations | 59,489 | 59,484 | 5 | 0.01 | |||||||
Held-to-maturity securities: | |||||||||||
State or local housing agency obligations | 125,628 | 117,988 | 7,640 | 6.48 | |||||||
Mortgage-backed securities: | |||||||||||
U.S. agency obligations-guaranteed | 44,542 | 47,460 | (2,918) | (6.15) | |||||||
Government-sponsored enterprises | 6,106,351 | 2,968,441 | 3,137,910 | 105.71 | |||||||
Private label | 17,996,127 | 18,126,628 | (130,501) | (0.72) | |||||||
Total long-term investments | $ | 29,520,099 | $ | 25,888,062 | $ | 3,632,037 | 14.03 | ||||
As of March 31, 2008, total short-term investments were $9.3 billion, a decrease of $6.3 billion from December 31, 2007. This decrease was primarily the result of increased advances and long-term investments during the first quarter of 2008, resulting in decreased amounts of liquidity at quarter end.
As of March 31, 2008, total long-term investments were $29.5 billion, an increase of $3.6 billion from December 31, 2007. This increase was due primarily to the Bank’s purchase of $3.7 billion of government-sponsored enterprise MBS during the first quarter of 2008.
The Finance Board limits an FHLBank’s investment in MBS and asset-backed securities by requiring that the total book value of MBS owned by the FHLBank may not exceed 300 percent of the FHLBank’s previous month-end capital plus its mandatorily redeemable capital stock on the day it purchases the securities. The Bank attempts to maintain MBS investments at 295 percent to 300 percent of total capital. Management believes that these investment levels help to maximize and stabilize earnings. These investments amounted to 262 percent and 285 percent of total capital plus mandatorily redeemable capital stock at December 31, 2007 and March 31, 2008, respectively. Management expects this ratio to trend back towards target levels during 2008.
On March 24, 2008, the Finance Board passed a resolution authorizing the FHLBanks to increase their purchases of agency MBS, effective immediately. Pursuant to the resolution, the limit on MBS investment authority would increase from 300 percent of capital to 600 percent of capital for two years. The resolution requires an FHLBank to notify the Finance Board prior to its first acquisition under the expanded authority and include in its notification a description of the risk management principles underlying its purchases. The expanded authority is limited to Fannie Mae and Freddie Mac securities. The
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securities purchased under the increased authority must be backed by mortgages that were originated consistent with, and subsequent to, federal bank regulatory guidance on nontraditional and subprime mortgage lending. The Bank currently is assessing the effect of this resolution.
Held-to-maturity securities are evaluated for impairment on a quarterly basis, or more frequently if events or changes in circumstances indicate that these investments are impaired. The Bank would record an impairment charge when a held-to-maturity security has experienced an other-than-temporary decline in fair value, or its cost may not be recoverable. The Bank reviewed its held-to-maturity securities as of March 31, 2008 and has determined that all unrealized losses are temporary based on the creditworthiness of the issuers and the underlying collateral, as well as changes in interest rates. Management believes it is probable that the Bank will be able to collect all amounts due according to the contractually terms of the individual securities. Additionally, the Bank has the ability and the intent to hold such investments to maturity, at which time the unrealized losses will be recovered.
Mortgage Loans Held for Portfolio
Mortgage loans purchased from participating financial institutions under the Mortgage Purchase Program (“MPP”) and the Mortgage Partnership Finance® Program (“MPF® Program”) and loan participations purchased under the Affordable Multifamily Participation Program (“AMPP”) comprised 1.80 percent of the Bank’s total assets as of March 31, 2008, compared to 1.87 percent as of December 31, 2007. The mortgage loan balance remained relatively flat at $3.5 billion at March 31, 2008 and December 31, 2007. The Bank’s current plan is for slow, modest growth in its MPP loan portfolio.
In 2006, the Bank ceased purchasing assets under AMPP and in 2008 the Bank ceased purchasing assets under the MPF Program. The Bank plans to retain its existing portfolios, which eventually will be reduced to zero in accordance with the ordinary course of the maturities of the assets.
As of March 31, 2008 and December 31, 2007, the Bank’s mortgage loan portfolio was concentrated in the Southeast because those members selling loans to the Bank were located primarily in the Southeast.
Consolidated Obligations
The Bank funds its assets primarily through the issuance of consolidated obligation bonds and, to a lesser extent, consolidated obligation discount notes. Consolidated obligation issuances financed 89.3 percent of the $195.4 billion in total assets at March 31, 2008, a slight decrease from the financing ratio of 90.3 percent as of December 31, 2007.
As of March 31, 2008, the Bank had outstanding consolidated bonds totaling $143.8 billion, compared to $142.2 billion as of December 31, 2007. Consolidated obligation bonds outstanding at March 31, 2008 and December 31, 2007 were primarily fixed-rate debt. However, the Bank often enters into derivatives simultaneously with the issuance of consolidated obligation bonds to convert the rates on them, in effect, into a short-term interest rate, usually based on LIBOR. Of the par value of $142.4 billion of consolidated obligation bonds outstanding as of March 31, 2008, $102.5 billion, or 72.0 percent, had their terms reconfigured through the use of interest rate exchange agreements. Of the par value of $141.9 billion of consolidated obligation bonds outstanding as of December 31, 2007, $102.7 billion, or 72.4 percent, had their terms reconfigured through the use of interest rate exchange agreements.
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As of March 31, 2008, the Bank had outstanding consolidated discount notes totaling $30.7 billion, compared to $28.3 billion as of December 31, 2007. The 1.09 percent increase in consolidated obligation bonds and the 8.31 percent increase in discount notes from December 31, 2007 to March 31, 2008 was due primarily to the Bank’s increased use of overnight discount notes and decreased use of bonds due to more attractive pricing and the Bank’s overall funding needs.
Deposits
The Bank offers demand and overnight deposit programs to members primarily as a liquidity management service. In addition, a member that services mortgage loans may deposit in the Bank funds collected in connection with the mortgage loans, pending disbursement of those funds to the owners of the mortgage loan. For demand deposits, the Bank pays interest at the overnight rate.
Most of these deposits represent member liquidity investments, which members may withdraw on demand. Therefore, the total account balance of the Bank’s deposits may be quite volatile. As a matter of prudence, the Bank typically invests deposit funds in liquid short-term assets. Member loan demand, deposit flows, and liquidity management strategies influence the amount and volatility of deposit balances carried with the Bank. Deposits totaled $8.0 billion as of March 31, 2008, compared to $7.1 billion as of December 31, 2007. Demand deposits comprised the largest percentage of deposits, representing 99.8 percent of total deposits as of March 31, 2008 compared to 99.7 percent as of December 31, 2007.
To support its member deposits, the FHLBank Act requires the Bank to have as a reserve an amount equal to or greater than the current deposits received from members. These reserves are required to be invested in obligations of the United States, deposits in eligible banks or trust companies, or advances with maturities not exceeding five years. The Bank was in compliance with this depository liquidity requirement as of March 31, 2008.
Other Liabilities
The $1.3 billion, or 40.0 percent, increase in other liabilities to $4.5 billion at March 31, 2008 from the 2007 year-end balance was due primarily to:
• | A $911.2 million increase in payables related to securities purchased but not yet delivered; |
• | a $557.8 million increase in derivative liabilities due to the interaction of interest rates on associated derivatives; and |
• | a $173.1 million decrease in accrued interest payable. |
Capital
As of March 31, 2008, the Bank had total capital of $8.4 billion, an increase of $407.4 million, or 5.08 percent, from the 2007 year-end balance. An increase in advance balances that resulted in an increase in the Bank’s activity-based stock was the primary factor causing the increase in the Bank’s total capital.
The FHLBank Act and Finance Board regulations specify that each FHLBank must meet certain minimum regulatory capital standards. The Bank was in compliance with the Finance Board’s regulatory capital rules and requirements as shown in the following table (dollar amounts in thousands):
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As of March 31, 2008 | As of December 31, 2007 | |||||||||||
Required | Actual | Required | Actual | |||||||||
Regulatory capital requirements: | ||||||||||||
Risk-based capital | $ | 1,243,399 | $ | 8,469,059 | $ | 981,647 | $ | 8,080,333 | ||||
Total capital-to-assets ratio | 4.00% | 4.33% | 4.00% | 4.28% | ||||||||
Total regulatory capital* | $ | 7,817,037 | $ | 8,469,059 | $ | 7,557,511 | $ | 8,080,333 | ||||
Leverage ratio | 5.00% | 6.50% | 5.00% | 6.42% | ||||||||
Leverage capital | $ | 9,771,297 | $ | 12,703,589 | $ | 9,446,888 | $ | 12,120,499 |
* | Finance Board staff has indicated that mandatorily redeemable capital stock is considered capital for regulatory purposes, and “total regulatory capital” includes the Bank’s $36.9 million and $55.5 million in mandatorily redeemable capital stock at March 31, 2008 and December 31, 2007, respectively. |
As of March 31, 2008, the Bank had capital stock subject to mandatory redemption from 11 members and former members, consisting of B1 membership stock and B2 activity-based stock. The Bank is not required to redeem or repurchase such stock until the expiration of the five-year redemption period or, with respect to activity-based stock, the later of the expiration of the five-year redemption period or the activity’s maturity date. In accordance with the Bank’s current practice, if activity-based stock becomes excess stock as a result of an activity no longer remaining outstanding, the Bank will repurchase the excess activity-based stock if the dollar amount of excess stock exceeds the threshold specified by the Bank, which is currently $100 thousand. As of March 31, 2008 and December 31, 2007, the Bank’s activity-based stock included $11.6 million and $12.4 million, respectively, of excess shares subject to repurchase by the Bank at its discretion. The Bank’s excess stock threshold and standard repurchase practice may be changed at the Bank’s discretion with proper notice to members.
Results of Operations
Net Income
The following table sets forth the Bank’s significant income items for the quarters ended March 31, 2008 and 2007 and provides information regarding the changes during the periods (dollar amounts in thousands):
Quarters Ended March 31 | Increase/ (Decrease) | Increase/ (Decrease) % | |||||||||
2008 | 2007 | ||||||||||
Net interest income | $ | 207,716 | $ | 158,345 | $ | 49,371 | 31.18 | ||||
Other income (loss) | (21,920) | (3,629) | (18,291) | (504.02) | |||||||
Other expense | 26,815 | 24,100 | 2,715 | 11.27 | |||||||
Total assessments | 42,185 | 34,947 | 7,238 | 20.71 | |||||||
Net income | 116,641 | 95,797 | 20,844 | 21.76 |
Net income increased during the first quarter of 2008, compared to the first quarter of 2007, as a result of an increase in net interest income partially offset by a decrease in other income during the period.
Net Interest Income
The primary source of the Bank’s earnings is net interest income. Net interest income equals interest earned on assets (including member advances, mortgage loans, MBS held in portfolio, and other investments), less the interest expense incurred on consolidated obligations, deposits, and other
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borrowings. Also included in net interest income are miscellaneous related items such as prepayment fees earned and the amortization of debt issuance discounts, concession fees and SFAS 133-related adjustments.
The following table presents spreads between the average yield on total interest-earning assets and the average cost of interest-bearing liabilities for the quarters ended March 31, 2008 and 2007 (dollar amounts in thousands). The interest rate spread is affected by the inclusion or exclusion of net interest income/expense associated with the Bank’s derivatives. For example, if the derivatives qualify for fair-value hedge accounting under SFAS 133, the net interest income/expense associated with the derivative is included in the calculation of interest rate spread. If the derivatives do not qualify for fair-value hedge accounting under SFAS 133 (“SFAS 133 non-qualifying hedges”), the net interest income/expense associated with the derivatives is excluded from the calculation of the interest rate spread. There are also numerous amortizations associated with SFAS 133 basis adjustments that are reflected in net interest income and affects interest rate spread. As is noted in the table, the interest rate spread decreased by two basis points during the quarter ended March 31, 2008, compared to the quarter ended March 31, 2007. This decrease was primarily due to interest rate changes and the impact of those changes on the fair value of derivatives in SFAS 133 non-qualifying hedges that are reported in other income (loss) rather than net interest income, changes in the amounts of amortizations associated with SFAS 133 that are reflected in net interest income, and increases in the SFAS 133 basis adjustment due to fair value hedges on advances and consolidated obligations.
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Spread and Yield Analysis
Quarters Ended March 31, | ||||||||||||||||
2008 | 2007 | |||||||||||||||
Average Balance | Interest | Yield/ Rate | Average Balance | Interest | Yield/ Rate | |||||||||||
Assets | ||||||||||||||||
Federal funds sold | $ | 8,877,177 | $ | 78,372 | 3.55% | $ | 9,694,240 | $ | 127,829 | 5.35% | ||||||
Interest-bearing deposits (3) | 2,585,829 | 22,067 | 3.43% | 704,374 | 9,418 | 5.42% | ||||||||||
Long-term investments (1) | 26,372,264 | 336,265 | 5.13% | 23,466,004 | 297,757 | 5.15% | ||||||||||
Advances | 146,496,926 | 1,476,987 | 4.05% | 102,196,440 | 1,369,167 | 5.43% | ||||||||||
Mortgage loans held for portfolio (2) | 3,531,715 | 46,827 | 5.33% | 3,065,886 | 40,264 | 5.33% | ||||||||||
Loans to other FHLBanks | 4,066 | 29 | 2.87% | 222 | 3 | 5.48% | ||||||||||
Total interest-earning assets | 187,867,977 | 1,960,547 | 4.20% | 139,127,166 | 1,844,438 | 5.38% | ||||||||||
Allowance for credit losses on mortgage loans | (951) | (771) | ||||||||||||||
Other assets | 2,899,971 | 2,572,858 | ||||||||||||||
Total assets | $ | 190,766,997 | $ | 141,699,253 | ||||||||||||
Liabilities and Capital | ||||||||||||||||
Demand and overnight deposits | $ | 6,083,542 | 47,606 | 3.15% | $ | 4,416,353 | 57,000 | 5.23% | ||||||||
Term deposits | — | — | 0.00% | 11,867 | 154 | 5.26% | ||||||||||
Other interest-bearing deposits (4) | 25,822 | 201 | 3.13% | 142,175 | 1,867 | 5.33% | ||||||||||
Short-term borrowings | 29,573,606 | 271,033 | 3.69% | 5,886,860 | 76,072 | 5.24% | ||||||||||
Long-term debt | 140,209,909 | 1,433,406 | 4.11% | 120,971,753 | 1,541,693 | 5.17% | ||||||||||
Other borrowings | 39,238 | 585 | 6.00% | 718,796 | 9,307 | 5.25% | ||||||||||
Total interest-bearing liabilities | 175,932,117 | 1,752,831 | 4.01% | 132,147,804 | 1,686,093 | 5.17% | ||||||||||
Noninterest-bearing deposits | 20,600 | 23,994 | ||||||||||||||
Other liabilities | 6,608,264 | 3,307,309 | ||||||||||||||
Total capital | 8,206,016 | 6,220,146 | ||||||||||||||
Total liabilities and capital | $ | 190,766,997 | $ | 141,699,253 | ||||||||||||
Net interest income and net yield on interest-earning assets | $ | 207,716 | 0.44% | $ | 158,345 | 0.46% | ||||||||||
Interest rate spread | 0.19% | 0.21% | ||||||||||||||
Average interest-earning assets to interest-bearing liabilities | 106.78% | 105.28% | ||||||||||||||
Notes
(1) | Trading securities are included in the Long-term investments line at fair value. |
(2) | Nonperforming loans are included in average balances used to determine average rate. |
(3) | Interest-bearing deposits includes amounts recognized for the right to reclaim cash collateral paid under master netting agreements with derivative counterparties. |
(4) | Other interest-bearing deposits includes amounts recognized for the right to return cash collateral received under master netting agreements with derivative counterparties. |
Net interest income for the periods presented was affected by changes in average balances (volume change) and changes in average rates (rate change) of interest-earning assets and interest-bearing liabilities. The following table presents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities affected the Bank’s interest income and interest expense (in thousands). As noted in the table, the overall change in net interest income during the quarter ended March 31, 2008, compared to the quarter ended March 31, 2007 was primarily volume related.
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Volume and Rate Table *
First Quarter 2008 vs. First Quarter 2007 | |||||||||
Volume | Rate | Increase (Decrease) | |||||||
Increase (decrease) in interest income: | |||||||||
Federal funds sold | $ | (10,050) | $ | (39,407) | $ | (49,457) | |||
Interest-bearing deposits in banks | 17,142 | (4,493) | 12,649 | ||||||
Long-term investments | 37,050 | 1,458 | 38,508 | ||||||
Advances | 500,014 | (392,194) | 107,820 | ||||||
Mortgage loans held for portfolio | 6,173 | 390 | 6,563 | ||||||
Loans to other FHLBanks | 28 | (2) | 26 | ||||||
Total | 550,357 | (434,248) | 116,109 | ||||||
Increase (decrease) in interest expense: | |||||||||
Demand and overnight deposits | 17,371 | (26,765) | (9,394) | ||||||
Term deposits | (77) | (77) | (154) | ||||||
Other interest-bearing deposits | (1,112) | (554) | (1,666) | ||||||
Short-term borrowings | 223,081 | (28,120) | 194,961 | ||||||
Long-term debt | 223,562 | (331,849) | (108,287) | ||||||
Other borrowings | (9,948) | 1,226 | (8,722) | ||||||
Total | 452,877 | (386,139) | 66,738 | ||||||
Increase (decrease) in net interest income | $ | 97,480 | $ | (48,109) | $ | 49,371 | |||
* | Volume change is calculated as the change in volume multiplied by the previous rate, while rate change is the change in rate multiplied by the previous volume. The rate/volume change, change in rate multiplied by change in volume, is allocated between volume change and rate change at the ratio each component bears to the absolute value of its total. |
The table below outlines the overall effect of hedging activities on net interest income and other income related results (in thousands). For a description regarding the individual interest components discussed below, see the Bank’s Form 10-K.
Quarters Ended March 31, | ||||||
2008 | 2007 | |||||
Net interest income | $ | 207,716 | $ | 158,345 | ||
Interest components of hedging activities included in net interest income: | ||||||
Hedging advances | $ | (96,683) | $ | 159,231 | ||
Hedging consolidated obligations | 121,115 | (119,767) | ||||
Hedging related amortization | (2,980) | (6,515) | ||||
Net increase in net interest income | $ | 21,452 | $ | 32,949 | ||
Interest components of derivative activity included in other income (loss): | ||||||
Purchased options | $ | 1,550 | $ | 329 | ||
Synthetic macro funding | (5,690) | (2,364) | ||||
Trading securities | (14,258) | (4,789) | ||||
Other | 23 | 26 | ||||
Net decrease in other income (loss) | $ | (18,375) | $ | (6,798) | ||
Other Income (Loss)
The Bank’s other income (loss) is composed primarily of net gains on trading securities and net losses on derivatives and hedging activities. The following table presents the components of other income (loss) (in thousands):
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Quarters Ended March 31, | |||||||||
2008 | 2007 | Increase (Decrease) | |||||||
Other Income (Loss): | |||||||||
Service fees | $ | 672 | $ | 674 | $ | (2) | |||
Net gains on trading securities | 106,588 | 4,918 | 101,670 | ||||||
Net losses on derivatives and hedging activities | (129,042) | (9,322) | (119,720) | ||||||
Other | (138) | 101 | (239) | ||||||
Total other loss | $ | (21,920) | $ | (3,629) | $ | (18,291) | |||
The Bank hedges trading securities with derivative transactions, and the income effect of the market-value change for these securities under SFAS 115 during the quarters ended March 31, 2008 and 2007 was offset by market-value changes in the related derivatives. The overall changes in other income (loss) for the quarter ended March 31, 2008, compared to the quarter ended March 31, 2007 were caused primarily by the adjustments required to report trading securities at fair value, as required by GAAP, and hedging-related adjustments, which are reported in the overall hedging activities (including those related to trading securities).
The Bank also records all gains or losses, comprising changes in fair value and interest paid or received, of SFAS 133 non-qualifying hedges in the net losses on derivatives and hedging activities classification. The following table details each of the components of net losses on derivatives and hedging activities (in thousands):
Net Losses on Derivatives and Hedging Activities
Advances | Purchased Options, Macro Hedging and Synthetic Macro Funding | Investments | MPF/MPP Loans | Consolidated Obligations Bonds | Consolidated Obligations Discount Notes | Intermediary Positions | Total | |||||||||||||||||
Quarter Ended March 31, 2008 | ||||||||||||||||||||||||
Interest-related | $ | — | $ | (4,139) | $ | (14,258) | $ | — | $ | — | $ | — | $ | 23 | $ | (18,374) | ||||||||
SFAS 133 qualifying fair value hedges | 12,190 | — | — | — | (6,925) | (446) | — | 4,819 | ||||||||||||||||
SFAS 133 non-qualifying hedges | — | 15,209 | (130,941) | 92 | — | — | 153 | (115,487) | ||||||||||||||||
Total gains (losses) | $ | 12,190 | $ | 11,070 | $ | (145,199) | $ | 92 | $ | (6,925) | $ | (446) | $ | 176 | $ | (129,042) | ||||||||
Quarter Ended March 31, 2007 | ||||||||||||||||||||||||
Interest-related | $ | — | $ | (2,035) | $ | (4,789) | $ | — | $ | — | $ | — | $ | 26 | $ | (6,798) | ||||||||
SFAS 133 qualifying fair value hedges | 6,065 | — | — | — | 3,197 | — | — | 9,262 | ||||||||||||||||
SFAS 133 non-qualifying hedges | — | (1,295) | (10,471) | 5 | — | — | (25) | (11,786) | ||||||||||||||||
Total gains (losses) | $ | 6,065 | $ | (3,330) | $ | (15,260) | $ | 5 | $ | 3,197 | $ | — | $ | 1 | $ | (9,322) | ||||||||
Management generally uses derivative instruments to hedge net interest income, with a primary goal of stabilizing the interest-rate spread over time and mitigating interest-rate risk and cash-flow variability.
Non-interest Expense
Non-interest expense increased 16.9 percent for the quarter ended March 31, 2008, compared to the same period in 2007. The increase during this period was due primarily to increased AHP and REFCORP assessments. The REFCORP assessment is established as a fixed percent of GAAP net income, and AHP assessment is established as a fixed percent of regulatory net income (which is the Bank’s net income before interest expense related to mandatorily redeemable capital stock under SFAS No. 150,Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity).
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Liquidity and Capital Resources
Liquidity is necessary to satisfy members’ borrowing needs on a timely basis, repay maturing and called consolidated obligations, and meet other obligations and operating requirements. Many members rely on the Bank as a source of standby liquidity, and the Bank attempts to be in a position to meet member funding needs on a timely basis.
The Bank attempts to maintain sufficient liquidity to service debt obligations for at least 90 days, assuming restricted debt market access. In addition, Finance Board regulations and Bank policy require the Bank to maintain contingent liquidity in an amount sufficient to meet its liquidity needs for five business days if it is unable to access the capital markets. The Bank was in compliance with these requirements at March 31, 2008.
The Bank’s principal source of liquidity is consolidated obligation debt instruments, which enjoy government-sponsored enterprise status and are rated Aaa/P-1 by Moody’s and AAA/A-1+ by S&P. To provide liquidity, the Bank also may use other short-term borrowings, such as federal funds purchased, securities sold under agreements to repurchase, and loans from other FHLBanks. These funding sources depend on the Bank’s ability to access the capital markets at competitive market rates. Although the Bank maintains secured and unsecured lines of credit with money market counterparties, the Bank’s income and liquidity would be affected adversely if it were not able to access the capital markets at competitive rates for a long period. Historically, the FHLBanks have had excellent capital market access.
Contingency plans are in place that prioritize the allocation of liquidity resources in the event of operational disruptions at the Bank or the Office of Finance, as well as systemic Federal Reserve wire transfer system disruptions. Additionally, the FHLBank Act authorizes the Secretary of Treasury, at his or her discretion, to purchase consolidated obligations up to an aggregate principal amount of $4 billion. No borrowings under this authority have been outstanding since 1977.
Off-balance Sheet Commitments
The Bank’s primary off-balance sheet commitments are as follows:
• | The Bank has joint and several liability for all of the consolidated obligations issued by the Office of Finance on behalf of the FHLBanks |
• | The Bank has outstanding commitments arising from standby letters of credit. |
Should an FHLBank be unable to satisfy its payment obligation under a consolidated obligation for which it is the primary obligor, any of the other FHLBanks, including the Bank, could be called upon to repay all or any part of such payment obligation, as determined or approved by the Finance Board. The Bank considers the joint and several liability as a related party guarantee. These related party guarantees meet the scope exceptions in Financial Interpretation Number 45,Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. Accordingly, the Bank has not recognized a liability for its joint and several obligations related to other FHLBanks’ consolidated obligations at March 31, 2008 or December 31, 2007. As of March 31, 2008, the FHLBanks had $1.2 trillion in aggregate par value of consolidated obligations issued and outstanding, $173.2 billion of which was attributable to the Bank.
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As of March 31, 2008, the Bank had outstanding standby letters of credit of approximately $7.6 billion with original terms of less than three months to 15 years, with the longest final expiration in 2022. Commitments to extend credit, including standby letters of credit, are agreements to lend. The Bank issues a standby letter of credit for the account of a member in exchange for a fee. A member may use these standby letters of credit to facilitate a financing arrangement. The Bank requires its borrowers, upon the effective date of the letter of credit through its expiration, to collateralize fully the face amount of any letter of credit issued by the Bank, as if such face amount were an advance to the borrower. If the Bank is required to make payment for a beneficiary’s draw, the Bank converts such paid amount to an advance to the member. The Bank’s underwriting and collateral requirements for standby letters of credit are the same as those requirements for advances. Based on management’s credit analyses and collateral requirements, the Bank presently does not deem it necessary to have an allowance for these unfunded letters of credit.
Contractual Obligations
There has not been a material change in the Bank’s contractual obligations reported in the Bank’s Form 10-K.
Risk Management
The Bank’s lending, investment, and funding activities and the use of derivative hedge instruments expose the Bank to a number of risks, including any one or more of the following:
• | Market risk, which is the risk that the market value, or estimated fair value, of the Bank’s portfolio will decline as a result of changes in interest rates |
• | Liquidity risk, which is the risk that the Bank will be unable to meet its obligations as they come due or meet the credit needs of its members and associates in a timely and cost-efficient manner |
• | Credit risk, which is the risk that the market value of an obligation will decline as a result of deterioration in creditworthiness, or that the amount will not be realized |
• | Operational risk, which is the risk of loss resulting from inadequate or failed internal processes, people or systems, or from external events, as well as reputation and legal risks associated with business practices or market conduct that the Bank may undertake |
• | Business risk, which is the risk of an adverse effect on the Bank’s profitability resulting from external factors that may occur in both the short term and long term. |
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A detailed discussion of the Bank’s management of these risks is contained in the Bank’s Form 10-K and under “Item 3. Quantitative and Qualitative Disclosure About Market Risk” below.
Credit Risk
Credit risk is defined as the risk of loss due to defaults on principal and interest payments on advances, mortgage-backed securities and other investments, derivatives, mortgage loans and unsecured extensions of credit.
Management does not expect that the problems in the residential loan market involving subprime loans will affect the Bank’s financial condition or results of operation. The Bank believes that it has minimal exposure to subprime loans due to its business model and its credit risk policies pertaining to advances, investments, and mortgage loan programs.
Advances
Secured advances to member financial institutions account for the largest category of Bank assets; thus, advances are the Bank’s principal source of credit risk exposure. The Bank uses a risk-focused approach to credit and collateral underwriting. The Bank attempts to reduce credit risk on advances by monitoring the financial condition of borrowers and counterparties and the quality and value of the assets members pledge as eligible collateral.
The Bank categorizes each borrowing member utilizing a proprietary credit score model according to the relative amount of credit and/or collateral risk it poses to the Bank. In general, borrowers in categories three and four, the lower-rated categories (more credit/collateral risk), have more restrictions on the types of collateral they may use to secure advances, are subject to higher collateral discounts for residential first-mortgage collateral, and face more stringent collateral reporting requirements. At times, the Bank may place more restrictive requirements on a borrower than those generally applicable to borrowers in the same matrix category based upon management’s assessment of the borrower and its collateral. The following table sets forth the number of borrowers in each category and the par amount of advances outstanding to all borrowers in each category:
As of March 31, 2008 | As of December 31, 2007 | |||||||||
Category | Number of Borrowers | Outstanding Advances | Number of Borrowers | Outstanding Advances | ||||||
1 | 302 | $ | 26.3 billion | 347 | $ | 29.4 billion | ||||
2 | 494 | 117.6 billion | 436 | 108.1 billion | ||||||
3 | 34 | 911.4 million | 21 | 770.4 million | ||||||
4 | 45 | 1.5 billion | 24 | 653.3 million |
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The following table provides information about the types of collateral held for the Bank’s advances (dollar amount in thousands):
Total Par Value of Outstanding Advances | Discounted Value of Collateral Pledged by Members | Residential First | Commercial Real Estate | Multifamily and | ||||||||
As of March 31, 2008 | $ | 146,380,718 | $ | 243,948,320 | 77.4 | 7.1 | 15.5 | |||||
As of December 31, 2007 | 140,229,705 | 227,230,433 | 79.2 | 6.4 | 14.4 |
In its history, the Bank has never experienced a credit loss on an advance. In consideration of this, and the Bank’s policies and practices detailed above, the Bank has not established a loan loss allowance for advances.
Investments
While the Bank faces what it believes to be minimal credit risk on advances to members, it is subject to credit risk on certain unsecured investments, including federal funds sold, Eurodollar inter-bank deposit markets and MBS. However, the Bank has never suffered a credit loss in its investment portfolio and does not anticipate any such losses in the future.
The Bank follows guidelines approved by its board of directors regarding unsecured extensions of credit, in addition to Finance Board regulations with respect to term limits and eligible counterparties. The Bank’s Risk Management Policy (“RMP”) permits the Bank to invest in agency (Fannie Mae, Freddie Mac and Ginnie Mae) and private label MBS, including collateralized mortgage obligations and real estate mortgage-investment conduits, rated AAA by S&P or Aaa by Moody’s at the time of purchase. As of March 31, 2008 and December 31, 2007, each MBS owned by the Bank held one of these ratings. As of March 31, 2008, a substantial portion of the Bank’s MBS portfolio consisted of private label MBS. The MBS securities purchased by the Bank attain triple-A ratings through credit enhancements, which generally consists of over-collateralization and the subordination of the claims of the other tranches of these securities. As of April 29, 2008, while each MBS owned by the Bank continued to hold a triple-A rating, six private label MBS totaling approximately $628.3 million at March 31, 2008 were on rating watch negative by Fitch. Due to the high level of credit protection associated with these investments, the Bank does not expect any material credit losses on its MBS at this time.
Consistent with its practice with respect to members, the Bank monitors the financial condition of investment counterparties to ensure that they are in compliance with the Bank’s RMP and the Finance Board’s regulations. Unsecured credit exposure to any counterparty is limited by the credit quality and capital of the counterparty and by the capital of the Bank. On a monthly basis, management produces financial monitoring reports detailing the financial condition of the Bank’s counterparties. These reports are reviewed by the Bank’s board of directors.
The Bank experienced a decrease in unsecured credit exposure in its investment portfolio related to counterparties other than the U.S. government or U.S. government agencies and instrumentalities from $10.6 billion at December 31, 2007 to $8.0 billion as of March 31, 2008. As of March 31, 2008, the
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Bank had unsecured credit exposure to four non-U.S. government counterparties that was greater than 10 percent of total unsecured credit exposure. The Bank had unsecured credit exposure to one counterparty in excess of five percent but less than 10 percent of total unsecured credit exposure.
Derivatives
Derivative transactions may subject the Bank to credit risk due to potential nonperformance by counterparties to the agreements. The Bank seeks to limit counterparty risk by collateral requirements and netting procedures that establish collateral requirement thresholds. The Bank also manages counterparty credit risk through credit analysis, collateral management, and other credit enhancements. Additionally, the Bank follows the regulatory requirements of the Finance Board, which set forth the eligibility criteria for counterparties (i.e., minimum capital requirements, NRSRO ratings, dollar and term limits, etc.). The Bank requires collateral agreements with counterparties that establish maximum allowable net unsecured credit exposure before collateral requirements are triggered. Limits are based on the credit rating of the counterparty. Uncollateralized exposures result when credit exposures to specific counterparties fall below collateralization trigger levels.
As of March 31, 2008, the Bank had $231.8 billion in total notional amount of derivatives outstanding compared to $222.9 billion at December 31, 2007. The notional amount serves as a factor in determining periodic interest payments or cash flows received and paid. It does not represent actual amounts exchanged or the Bank’s exposure to credit and market risk. The amount potentially subject to credit loss is based upon the counterparty’s net payment obligations. The credit risk of derivatives is measured on a portfolio basis by netting the market values of all outstanding transactions for each counterparty.
As of March 31, 2008, 100 percent of the total notional amount of outstanding derivative transactions was represented by 32 counterparties. Of these counterparties, there were four, Goldman Sachs Group, Inc., JP Morgan Chase Bank N.A., Deutsche Bank AG and Lehman Brothers Holdings Inc., that represented more than 10 percent of the Bank’s total notional amount, and four counterparties, Bank of America N.A., Rabobank Netherland, Royal Bank of Canada, and Salomon Swapco that represented more than 10 percent of the Bank’s net exposure.Each of these named counterparties had a credit rating of A or better at March 31, 2008.
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The following tables represent the credit ratings of the Bank’s derivative counterparties (in thousands):
Derivative Counterparty Credit Exposure
As of March 31, 2008
Credit Rating | Notional Amount | Total Net Exposure at Fair Value | Collateral Held | Net Exposure After Collateral | ||||||||
AAA | $ | 985,635 | $ | 14,705 | $ | — | $ | 14,705 | ||||
AA | 170,278,762 | 82,448 | 37,180 | 45,268 | ||||||||
A | 58,856,227 | 2,788 | — | 2,788 | ||||||||
BBB | 1,424,437 | — | — | — | ||||||||
Member institutions * | 232,258 | 2,482 | — | — | ||||||||
Delivery commitments* | 25,762 | 37 | — | — | ||||||||
Total derivatives | $ | 231,803,081 | $ | 102,460 | $ | 37,180 | $ | 62,761 | ||||
* Collateral held with respect to derivative financial instruments with member institutions represents either collateral physically held by or on behalf of the Bank or collateral assigned to the Bank, as evidenced by a written security agreement, and held by the member institution for the benefit of the Bank.
Derivative Counterparty Credit Exposure
As of December 31, 2007
Credit Rating | Notional Amount | Total Net Exposure at Fair Value | Collateral Held | Net Exposure After Collateral | ||||||||
AAA | $ | 2,043,635 | $ | 38 | $ | — | $ | 38 | ||||
AA | 161,453,653 | 39,859 | — | 39,859 | ||||||||
A | 58,771,087 | 355 | — | 355 | ||||||||
Member institutions * | 589,833 | 2,755 | — | — | ||||||||
Delivery commitments* | 9,309 | 41 | — | — | ||||||||
Total derivatives | $ | 222,867,517 | $ | 43,048 | $ | — | $ | 40,252 | ||||
* Collateral held with respect to derivative financial instruments with member institutions represents either collateral physically held by or on behalf of the Bank or 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 maximum credit risk is the estimated net cost of replacing all interest-rate exchange agreements if the counterparty defaults, net of the value of related collateral.
The net exposure after collateral is treated as unsecured credit consistent with the Bank’s RMP and Finance Board regulations if the counterparty has an NRSRO rating. If the counterparty does not have an NRSRO rating, the Bank requires collateral for the full amount of the exposure.
Mortgage Loan Programs
The Bank seeks to manage the credit risk associated with MPP and the MPF Program by maintaining underwriting and eligibility standards and structuring possible losses into several layers to be shared with the PFI. These risk management practices are described in detail in the Bank’s Form 10-K.
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Critical Accounting Policies and Estimates
Fair Values
The Bank carries certain assets and liabilities, including investments classified as trading, and all derivatives on the balance sheet at fair value. The Bank adopted SFAS 157 effective January 1, 2008. SFAS 157 defines fair value, establishes a framework for measuring fair value, establishes fair value hierarchy based on the inputs used to measure fair value and requires additional disclosures for instruments carried at fair value on the balance sheet. SFAS 157 defines “fair value” as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date, or an exit price.
Fair values play an important role in the valuation of certain of the assets, liabilities and hedging transactions of the Bank. Fair values are based on quoted market prices or market-based prices, if such prices are available, even in situations where trading volume may be low when compared with prior periods as has been the case during the current market disruption. If quoted market prices or market-based prices are not available, the Bank determines fair values based on valuation models that use discounted cash flows, using market estimates of interest rates and volatility.
Valuation models and their underlying assumptions are based on the best estimates of management of the Bank with respect to:
• | market indices (primarily LIBOR) |
• | discount rates; |
• | prepayments; |
• | market volatility; and |
• | other factors. |
These assumptions, particularly estimates of market indices and discount rates, may have a significant effect on the reported fair values of assets and liabilities, including derivatives, and the income and expense related thereto. The use of different assumptions, as well as changes in market conditions, could result in materially different net income and retained earnings. The assumptions used in the model are corroborated by and independently verified against market observable data where possible.
The Bank categorizes its financial instruments carried at fair value into a three-level classification in accordance with SFAS 157. The valuation hierarchy is based upon the transparency (observable or unobservable) of inputs to the valuation of an asset or liability as of the measurement date. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Bank’s market assumptions. The Bank utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs.
As of March 31, 2008, the Bank does not carry any financial assets or liabilities at fair value based on unobservable inputs.
For further discussion regarding how the Bank measure financial assets and financial liabilities at fair value, see Note 9 to the financial statements.
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A description of the Bank’s other critical accounting policies and estimates is contained in detail in the Bank’s Form 10-K. There have been no material changes to these policies and estimates during the period reported.
Recently Adopted and Issued Accounting Standards
SFAS 157 was issued in September 2006. In defining fair value, SFAS 157 retains the exchange price notion in earlier definitions of fair value. However, the definition of fair value under SFAS 157 focuses on the price that would be received to sell an asset or paid to transfer a liability (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price). SFAS 157 applies whenever other accounting pronouncements require or permit assets or liabilities to be measured at fair value. Accordingly, SFAS 157 does not expand the use of fair value in any new circumstances. SFAS 157 also establishes a fair value hierarchy that prioritizes the information used to develop assumptions used to determine the exit price. Under this standard, fair value measurements would be disclosed separately by level within the fair value hierarchy. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years, with early adoption permitted. The Bank adopted SFAS 157 effective January 1, 2008. The adoption of SFAS 157 had no effect on the Bank’s financial condition or results of operations. For additional information on the fair value of certain financial assets and liabilities, see Note 9 to the financial statements.
SFAS 159, issued in February 2007, creates a fair value option allowing 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 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. SFAS 159 also 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, with early adoption permitted. The Bank adopted SFAS 159 effective January 1, 2008. As of March 31, 2008, the Bank elected not to measure any financial assets or liabilities using the fair value option under SFAS 159; therefore the adoption of SFAS 159 had no effect on the Bank’s financial condition or results of operations.
FSPFIN 39-1, issued in April 2007, 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. 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. FSP FIN 39-1 is effective for fiscal years beginning after
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November 15, 2007, with earlier application permitted. The Bank adopted FSP FIN 39-1 effective January 1, 2008 and retroactively applied its requirements to all prior periods. The Bank has not changed its accounting policy of offsetting fair value amounts recognized for derivative instruments under the same master netting arrangement. As of March 31, 2008 and December 31, 2007, the fair value of derivative assets reported were reduced by $35.8 million and $9 thousand, respectively, for amounts recognized for the right to return cash collateral received under master netting agreements with derivative counterparties. As of March 31, 2008 and December 31, 2007, the fair value of derivative liabilities reported were reduced by $2.5 billion and $808.4 million, respectively, for amounts recognized for the right to reclaim cash collateral paid under master netting agreements with derivative counterparties.
Issue 23, issued in January 2008 amends SFAS 133 explicitly to permit use of the shortcut method for those hedging relationships in which (1) the interest rate swap has a nonzero fair value at the inception of the hedging relationship, attributable solely to differing prices within the bid-ask spread; and/or (2) the hedged item has a trade date that differs from its settlement date because of generally established conventions in the marketplace in which the transaction to acquire or issue the hedged item is executed. Issue E23 is effective for hedging relationships designated on or after January 1, 2008. At adoption, preexisting hedging relationships utilizing the shortcut method that did not meet the requirements of Issue E23 as of the inception of the hedging relationship must be dedesignated prospectively. The effects of applying hedge accounting prior to the effective date may not be reversed. A hedging relationship that does not qualify for the shortcut method based on Issue E23 could be redesignated without the application of the shortcut method if that hedging relationship meets the applicable requirements of SFAS 133. The Bank adopted Issue E23 effective January 1, 2008. The Bank concluded that no dedesignations were required as a result of the adoption of Issue E23. In addition, since May 31, 2005, the Bank no longer applies the short-cut method to new hedging relationships. Therefore, the adoption of Issue E23 had no effect on the Bank’s financial condition or results of operations.
SFAS 161, issued in March 2008, requires enhanced disclosures about an entity’s derivative and hedging activities. These enhanced disclosures will discuss (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedged items are accounted for under SFAS 133, and its related interpretations; and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS 161 is effective for financial statements issued for fiscal years beginning after November 15, 2008 with earlier adoption allowed. The Bank does not believe that the adoption of SFAS 161 will have a material effect on its financial condition or results of operations.
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Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Changes in interest rates and spreads can have a direct effect on the value of the Bank’s assets and liabilities. As a result of the volume of its interest-earning assets and interest-bearing liabilities, the component of market risk having the greatest effect on the Bank’s financial condition and results of operations is interest-rate risk. A description of the Bank’s management of interest-rate risk is contained in the Bank’s Form 10-K.
The Bank uses derivative financial instruments to reduce the interest-rate risk exposure inherent in otherwise unhedged assets and funding positions. These derivatives are used to adjust the effective maturity, repricing frequency, or option characteristics of financial instruments to achieve risk management objectives.
The following table summarizes the fair-value amounts of derivative financial instruments, excluding accrued interest, by product type (in thousands). The categories “Fair value hedges” represent hedge strategies for which hedge accounting is achieved. The category “SFAS 133 non-qualifying hedges” represents hedge strategies for which the derivatives are not in designated hedge relationships that formally meet the hedge accounting requirements under GAAP. The table also includes mandatory delivery commitments for purchased loans under both the MPF Program and MPP, which are accounted for as derivatives in accordance with SFAS 133.
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As of March 31, 2008 | As of December 31, 2007 | |||||||||||
Total Notional | Estimated Fair Value Gain / (Loss) (excludes accrued interest) | Total Notional | Estimated Fair Value Gain / (Loss) (excludes accrued interest) | |||||||||
Advances: | ||||||||||||
Fair value hedges | $ | 113,838,056 | $ | (5,759,269) | $ | 108,404,411 | $ | (2,687,295) | ||||
SFAS 133 non-qualifying hedges | 2,426,850 | (20,037) | 789,150 | (7,861) | ||||||||
Total | 116,264,906 | (5,779,306) | 109,193,561 | (2,695,156) | ||||||||
Investments: | ||||||||||||
SFAS 133 non-qualifying hedges | 10,665,605 | (345,624) | 8,281,248 | (216,207) | ||||||||
Total | 10,665,605 | (345,624) | 8,281,248 | (216,207) | ||||||||
MPF/MPP loans: | ||||||||||||
Stand alone delivery commitments | 25,762 | 37 | 9,309 | 41 | ||||||||
Total | 25,762 | 37 | 9,309 | 41 | ||||||||
Consolidated obligation bonds: | ||||||||||||
Fair value hedges | 91,382,467 | 1,553,850 | 97,244,433 | 651,605 | ||||||||
SFAS 133 non-qualifying hedges | 11,159,500 | (5,578) | 5,464,500 | (2,552) | ||||||||
Total | 102,541,967 | 1,548,272 | 102,708,933 | 649,053 | ||||||||
Consolidated obligation discount notes: | ||||||||||||
Fair value hedges | 1,840,324 | 11,195 | 1,494,799 | 3,789 | ||||||||
Total | 1,840,324 | 11,195 | 1,494,799 | 3,789 | ||||||||
Intermediary positions: | ||||||||||||
Intermediaries | 464,517 | 76 | 1,179,667 | 103 | ||||||||
Total | 464,517 | 76 | 1,179,667 | 103 | ||||||||
Total notional and fair value | $ | 231,803,081 | $ | (4,565,350) | $ | 222,867,517 | $ | (2,258,377) | ||||
Total derivatives excluding accrued interest | $ | (4,565,350) | $ | (2,258,377) | ||||||||
Accrued interest | 269,830 | 187,934 | ||||||||||
Cash collateral held by counterparty—assets | 2,535,056 | 808,360 | ||||||||||
Cash collateral held from counterparty—liabilities | (35,755) | (9) | ||||||||||
Net derivative balance | $ | (1,796,219) | $ | (1,262,092) | ||||||||
Net derivative assets balance | $ | 66,705 | $ | 43,039 | ||||||||
Net derivative liabilities balance | (1,862,924) | (1,305,131) | ||||||||||
Net derivative balance | $ | (1,796,219) | $ | (1,262,092) | ||||||||
The Bank measures interest-rate risk exposure by various methods, including calculating the effective duration of assets, liabilities, and equity under various scenarios and calculating the theoretical market value of equity. Effective duration, normally expressed in years or months, measures the price sensitivity of the Bank’s interest bearing assets and liabilities to changes in interest rates. As effective duration lengthens, market-value changes become more sensitive to interest-rate changes. The Bank employs sophisticated modeling systems to measure effective duration.
Bank policy requires the Bank to maintain its effective duration of equity within a range of +60 months to – 60 months, assuming current interest rates, and within a range of +84 months to – 84 months, assuming an instantaneous parallel increase or decrease in market interest rates of 200 basis points. The table below reflects the Bank’s effective duration exposure measurements as calculated in accordance with Bank policy.
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Effective Duration Exposure
(In months)
As of March 31, 2008 | As of December 31, 2007 | |||||||||||
Up 200 Basis Points | Current | Down 200 Basis Points* | Up 200 Basis Points | Current | Down 200 Basis Points | |||||||
Assets | 9.3 | 5.5 | 3.8 | 5.3 | 5.6 | 3.4 | ||||||
Liabilities | 6.0 | 5.6 | 5.3 | 5.3 | 5.2 | 5.0 | ||||||
Equity | 97.2 | 2.4 | (35.6) | 4.1 | 14.6 | (36.9) | ||||||
Effective duration gap | 3.3 | (0.1) | (1.5) | 0.0 | 0.4 | (1.6) |
* | The “down 200 basis points” scenario shown above as of March 31, 2008 is considered to be a “constrained shock” to prevent the possibility of negative interest rates when a designated low-rate environment exists, shocked rates are limited to the largest parallel down shock that produces post-shock Treasury rates no lower than 35 basis points. |
Although the Bank has presented its effective duration exposure calculation results as of March 31, 2008 above, it believes that the information may be misleading and should not be relied upon. The Bank uses a mortgage prepayment model to help calculate its effective duration exposure. However, the mortgage prepayment model is significantly impacted by the ongoing disruptions in the mortgage market. Management believes that in light of current market conditions, the model is underestimating prepayment speeds in an upward shock environment due to assumptions about a continued widened spread on MBS rates, and the model is overestimating prepayment speeds in a downward shock environment due to home price stagnation and depreciation, credit quality issues of mortgage borrowers, and tighter underwriting standards. As a result, the prepayment estimates calculated by the model are, in management’s estimation, misleading given management’s estimation of current and long-term economic conditions as they relate to the mortgage market. Management believes that a more realistic estimate of its effective duration as of March 31, 2008 is in the following ranges:
Up 200 basis points: 50-55 months
Current: 30-35 months
Down 200 basis points: 0-10 months
Management believes that the Bank’s effective duration of equity has lengthened since December 31, 2007 because of the liquidity difficulties in the mortgage market and the unprecedented relationship between prepayment speeds and interest rates. As noted in the table above, the Bank’s duration of equity at March 31, 2008 in an up 200 basis points rate shock of 97.2 months exceeded Bank policy. Because management believes that this number has been adversely impacted by the aforementioned mortgage market disruption, it does not believe that the policy has been effectively exceeded. Management has discussed the matter with the board of directors and will continue to monitor the duration of equity carefully and to evaluate modeling alternatives to better represent the expected economic impact in the extreme up and down interest rate scenarios.
Management also considers interest-rate movements of a lesser magnitude than +/-200 basis point shifts. The table below shows effective duration exposure to increases and decreases in interest rates in 50 basis-point increments as of March 31, 2008. Because of the reasons discussed above, the Bank believes that these calculations are misleading and should not be relied upon.
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Additional Effective Duration Exposure Scenarios
(In months)
As of March 31, 2008 | ||||||||||||||
Up 150 Basis Points | Up 100 Basis Points | Up 50 Basis Points | Current | Down 50 Basis Points | Down 100 Basis Points | Down 150 Basis Points | ||||||||
Assets | 8.8 | 7.8 | 6.6 | 5.5 | 4.7 | 4.2 | 3.6 | |||||||
Liabilities | 6.0 | 5.9 | 5.8 | 5.6 | 5.4 | 5.3 | 5.3 | |||||||
Equity | 81.5 | 56.8 | 27.4 | 2.4 | (12.8) | (24.9) | (40.3) | |||||||
Effective duration gap | 2.8 | 1.9 | 0.8 | (0.1) | (0.7) | (1.1) | (1.7) |
Another way the Bank analyzes its interest-rate risk and market exposure is by evaluating the theoretical market value of equity. The market value of equity represents the net result of the present value of future cash flows discounted to arrive at the theoretical market value of each balance sheet item. By using the discounted present value of future cash flows, the Bank is able to factor in the various maturities of assets and liabilities, similar to the effective duration analysis discussed above. The difference between the market value of total assets and the market value of total liabilities is the market value of equity. A more volatile market value of equity under different shock scenarios tends to result in a higher effective duration of equity, indicating increased sensitivity to interest rate changes. Although the Bank’s total capital increased by $407.4 million from December 31, 2007 to March 31, 2008, the market value of equity increased $92.0 million during this same period. The difference is attributable to the decline in MBS prices relative to other fixed income securities.
Market Value of Equity
(In millions)
As of March 31, 2008 | As of December 31, 2007 | |||||||||||||||||
Up 200 Basis Points | Current | Down 200 Basis Points | Up 200 Basis Points | Current | Down 200 Basis Points | |||||||||||||
Assets | $ | 190,354 | $ | 192,814 | $ | 193,859 | $ | 186,394 | $ | 188,114 | $ | 189,524 | ||||||
Liabilities | 183,510 | 185,308 | 186,480 | 179,075 | 180,700 | 182,212 | ||||||||||||
Equity | 6,844 | 7,506 | 7,379 | 7,319 | 7,414 | 7,312 |
Item 4. | Controls and Procedures |
Not applicable.
Item 4T. | Controls and Procedures |
Disclosure Controls and Procedures
The Bank’s President and Chief Executive Officer and the Bank’s Executive Vice President and Chief Financial Officer (the “Certifying Officers”) are 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 (the “Exchange Act”), is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms.
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As of March 31, 2008, the Bank’s Certifying Officers have evaluated the effectiveness of the design and operation of the Bank’s disclosure controls and procedures. Based on that evaluation, they have concluded that the Bank’s disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by the Bank in the reports that it files or submits under the Exchange Act (1) is accumulated and communicated to the Certifying Officers, as appropriate, to allow timely decisions regarding required disclosure; and (2) is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms.
In designing and evaluating the Bank’s disclosure controls and procedures, the Bank’s Certifying Officers recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.
Internal Control Over Financial Reporting
During the first quarter of 2008, there were no changes in the Bank’s internal control over financial reporting that have affected materially, or are reasonably likely to affect materially, the Bank’s internal control over financial reporting.
Item 1. | Legal Proceedings |
The Bank may be subject to various legal proceedings arising in the normal course of business. After consultation with legal counsel, management is not aware of any such proceedings that might result in the Bank’s ultimate liability in an amount that will have a material effect on the Bank’s financial condition or results of operations.
Item 1A. | Risk Factors |
The Bank is jointly and severally liable for payment of principal and interest on the consolidated obligations issued by the other 11 FHLBanks.
Each of the FHLBanks relies upon the issuance of COs as a primary source of funds. COs are the joint and several obligations of all of the FHLBanks, backed only by the financial resources of the FHLBanks. Accordingly, the Bank is jointly and severally liable with the other FHLBanks for the COs issued by the FHLBanks through the Office of Finance, regardless of whether the Bank receives all or any portion of the proceeds from any particular issuance of COs.
The Finance Board may by regulation require any FHLBank to make principal or interest payments due on any COs at any time, whether or not the FHLBank who was the primary obligor has defaulted on the payment of that obligation. The Finance Board may allocate the liability among one or more FHLBanks on a pro rata basis or on any other basis the Finance Board may determine. Accordingly, the Bank could incur significant liability beyond its primary obligation under COs due to the failure of other FHLBanks to meet their obligations, which could affect negatively the Bank’s financial condition and results of operations.
On April 10, 2008, S&P announced that it had placed FHLBank Chicago on credit watch with negative implications. Additionally, on April 8, 2008, Moody’s announced that it had revised its outlook on the FHLBank of Chicago’s subordinated notes to negative from stable. On April 28, 2008, FHLBank Chicago
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furnished a Current Report on Form 8-K with the SEC stating that it expected to record a $78 million net loss for the first quarter of 2008 and that it believed that it will continue to experience losses in subsequent quarters. FHLBank Chicago noted that although the first quarter loss is significant, it has retained earnings of $581 million at the end of the first quarter. The Bank is monitoring these developments.
To date, no FHLBank has defaulted on its principal or interest payments under any consolidated obligation, and the Bank has never been required to make payments under any consolidated obligation as a result of the failure of another FHLBank to meet its obligations.
For a further discussion of the Bank’s risk factors, see “Item 1A. Risk Factors” in the Bank’s Form 10-K.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
Not applicable.
Item 3. | Defaults Upon Senior Securities |
None.
Item 4. | Submission of Matters to a Vote of Security Holders |
None.
Item 5. | Other Information |
None.
Item 6. | Exhibits |
3.1 | Restated Organization Certificate of the Federal Home Loan Bank of Atlanta, incorporated by reference to Exhibit 3.1 to the Bank’s Registration Statement on Form 10 filed with the Securities and Exchange Commission on March 17, 2006. | |
3.2 | Revised and Restated Bylaws of the Federal Home Loan Bank of Atlanta, incorporated by reference to Exhibit 3.2 to the Bank’s Form 8-K filed with the Securities and Exchange Commission on January 29, 2008. | |
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 Executive Vice President and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | Certification of the President and Chief Executive Officer and the Executive Vice President and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized.
Federal Home Loan Bank of Atlanta | ||||||
Date: May 12, 2008 | By: | /s/ Richard A. Dorfman | ||||
Name: | Richard A. Dorfman | |||||
Title: | President and Chief Executive Officer | |||||
By: | /s/ Steven J. Goldstein | |||||
Name: | Steven J. Goldstein | |||||
Title: | Executive Vice President and Chief Financial Officer |
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