Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2009
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
¨ 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.
Large accelerated filer ¨ | Accelerated filer ¨ | Non-accelerated filer x | 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 July 31, 2009, was 82,311,524.
Table of Contents
PART I. | FINANCIAL INFORMATION | 1 | ||
Item 1. | Financial Statements | 1 | ||
STATEMENTS OF CONDITION (Unaudited) | 1 | |||
STATEMENTS OF INCOME (Unaudited) | 2 | |||
STATEMENTS OF CAPITAL (Unaudited) | 3 | |||
STATEMENTS OF CASH FLOWS (Unaudited) | 4 | |||
NOTES TO FINANCIAL STATEMENTS | 6 | |||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 39 | ||
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 76 | ||
Item 4. | Controls and Procedures | 80 | ||
Item 4T. | Controls and Procedures | 80 | ||
PART II. | OTHER INFORMATION | 81 | ||
Item 1. | Legal Proceedings | 81 | ||
Item 1A. | Risk Factors | 81 | ||
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 81 | ||
Item 3. | Defaults Upon Senior Securities | 81 | ||
Item 4. | Submission of Matters to a Vote of Security Holders | 81 | ||
Item 5. | Other Information | 81 | ||
Item 6. | Exhibits | 82 | ||
SIGNATURES | 83 |
Table of Contents
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 | ||||||||
June 30, 2009 | December 31, 2008 | |||||||
ASSETS | ||||||||
Cash and due from banks | $ | 12,473 | $ | 27,841 | ||||
Deposit with other FHLBanks | 2,614 | 2,888 | ||||||
Federal funds sold | 8,202,000 | 10,769,000 | ||||||
Trading securities (includes $510,839 and $1,104,434 pledged as collateral as of June 30, 2009 and December 31, 2008, respectively, that may be repledged and includes other FHLBanks’ bonds of $154,885 and $300,135 as of June 30, 2009 and December 31, 2008, respectively) | 3,827,305 | 4,485,929 | ||||||
Available-for-sale securities | 1,536,608 | — | ||||||
Held-to-maturity securities, net (fair value of $16,636,699 and $19,593,615 as of June 30, 2009 and December 31, 2008, respectively) | 18,447,139 | 23,118,123 | ||||||
Mortgage loans held for portfolio, net of allowance for credit losses on mortgage loans of $877 and $856 as of June 30, 2009 and December 31, 2008, respectively | 2,833,348 | 3,251,074 | ||||||
Advances, net | 134,502,617 | 165,855,546 | ||||||
Accrued interest receivable | 600,554 | 775,083 | ||||||
Premises and equipment, net | 29,069 | 29,383 | ||||||
Derivative assets | 50,396 | 91,406 | ||||||
Other assets | 161,723 | 158,067 | ||||||
TOTAL ASSETS | $ | 170,205,846 | $ | 208,564,340 | ||||
LIABILITIES | ||||||||
Interest-bearing deposits | $ | 4,147,790 | $ | 3,572,709 | ||||
Consolidated obligations, net: | ||||||||
Discount notes | 38,672,030 | 55,194,777 | ||||||
Bonds | 117,755,528 | 138,181,334 | ||||||
Total consolidated obligations, net | 156,427,558 | 193,376,111 | ||||||
Mandatorily redeemable capital stock | 106,237 | 44,428 | ||||||
Accrued interest payable | 698,694 | 1,039,002 | ||||||
Affordable Housing Program | 137,856 | 139,300 | ||||||
Payable to REFCORP | 30,492 | — | ||||||
Derivative liabilities | 714,762 | 1,413,792 | ||||||
Other liabilities | 84,089 | 86,062 | ||||||
Total liabilities | 162,347,478 | 199,671,404 | ||||||
Commitments and contingencies (Note 14) | ||||||||
CAPITAL | ||||||||
Capital stock Class B putable ($100 par value) issued and outstanding shares: | ||||||||
Subclass B1 issued and outstanding shares: 15,398 and 14,671 June 30, 2009 and December 31, 2008 , respectively | 1,539,799 | 1,467,092 | ||||||
Subclass B2 issued and outstanding shares: 65,788 and 69,959 as of June 30, 2009 and December 31, 2008, respectively | 6,578,784 | 6,995,903 | ||||||
Total capital stock Class B putable | 8,118,583 | 8,462,995 | ||||||
Retained earnings | 803,577 | 434,883 | ||||||
Accumulated other comprehensive loss | (1,063,792 | ) | (4,942 | ) | ||||
Total capital | 7,858,368 | 8,892,936 | ||||||
TOTAL LIABILITIES AND CAPITAL | $ | 170,205,846 | $ | 208,564,340 | ||||
The accompanying notes are an integral part of these financial statements.
1
Table of Contents
FEDERAL HOME LOAN BANK OF ATLANTA
STATEMENTS OF INCOME
(Unaudited)
(In thousands)
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
INTEREST INCOME | ||||||||||||||||
Advances | $ | 270,728 | $ | 1,049,476 | $ | 702,839 | $ | 2,525,511 | ||||||||
Prepayment fees on advances, net | 7,657 | 1,762 | 10,269 | 2,714 | ||||||||||||
Interest-bearing deposits | 2,046 | 6,386 | 4,599 | 22,907 | ||||||||||||
Federal funds sold | 5,318 | 62,003 | 13,630 | 140,375 | ||||||||||||
Trading securities | 50,475 | 78,761 | 104,296 | 146,494 | ||||||||||||
Available-for-sale securities | 34,701 | — | 34,701 | — | ||||||||||||
Held-to-maturity securities | 224,774 | 300,016 | 500,229 | 574,094 | ||||||||||||
Mortgage loans held for portfolio | 39,278 | 46,382 | 81,728 | 93,209 | ||||||||||||
Loans to other FHLBanks | 1 | 21 | 2 | 50 | ||||||||||||
Total interest income | 634,978 | 1,544,807 | 1,452,293 | 3,505,354 | ||||||||||||
INTEREST EXPENSE | ||||||||||||||||
Consolidated obligations: | ||||||||||||||||
Discount notes | 74,756 | 178,814 | 238,203 | 449,745 | ||||||||||||
Bonds | 455,006 | 1,092,957 | 1,069,946 | 2,526,363 | ||||||||||||
Deposits | 1,148 | 31,836 | 2,628 | 79,643 | ||||||||||||
Loans from other FHLBanks | 1 | — | 4 | 12 | ||||||||||||
Mandatorily redeemable capital stock | 87 | 538 | 1,810 | 1,123 | ||||||||||||
Other borrowings | 17 | 39 | 17 | 129 | ||||||||||||
Total interest expense | 531,015 | 1,304,184 | 1,312,608 | 3,057,015 | ||||||||||||
NET INTEREST INCOME | 103,963 | 240,623 | 139,685 | 448,339 | ||||||||||||
(Reversal) provision for credit losses on mortgage loans held for portfolio | — | (5 | ) | 21 | 150 | |||||||||||
NET INTEREST INCOME AFTER (REVERSAL) PROVISION FOR CREDIT LOSSES | 103,963 | 240,628 | 139,664 | 448,189 | ||||||||||||
OTHER INCOME (LOSS) | ||||||||||||||||
Total other-than-temporary impairment losses | (403,584 | ) | — | (1,101,722 | ) | — | ||||||||||
Portion of impairment losses recognized in other comprehensive loss | 357,342 | — | 966,612 | — | ||||||||||||
Net impairment losses recognized in earnings | (46,242 | ) | — | (135,110 | ) | — | ||||||||||
Service fees | 429 | 588 | 1,036 | 1,260 | ||||||||||||
Net losses on trading securities | (74,019 | ) | (188,626 | ) | (107,650 | ) | (82,038 | ) | ||||||||
Net gains (losses) on derivatives and hedging activities | 304,958 | 123,122 | 417,250 | (5,920 | ) | |||||||||||
Other | 939 | 194 | 494 | 56 | ||||||||||||
Total other income (loss) | 186,065 | (64,722 | ) | 176,020 | (86,642 | ) | ||||||||||
OTHER EXPENSE | ||||||||||||||||
Compensation and benefits | 14,655 | 16,020 | 30,618 | 32,298 | ||||||||||||
Other operating expenses | 11,693 | 9,029 | 20,041 | 16,349 | ||||||||||||
Finance Agency | 1,385 | 1,480 | 2,913 | 3,185 | ||||||||||||
Office of Finance | 1,128 | 1,080 | 2,510 | 2,238 | ||||||||||||
Other | 262 | 325 | 553 | 679 | ||||||||||||
Total other expense | 29,123 | 27,934 | 56,635 | 54,749 | ||||||||||||
INCOME BEFORE ASSESSMENTS | 260,905 | 147,972 | 259,049 | 306,798 | ||||||||||||
Affordable Housing Program | 21,308 | 12,134 | 21,332 | 25,159 | ||||||||||||
REFCORP | 47,919 | 27,168 | 47,543 | 56,328 | ||||||||||||
Total assessments | 69,227 | 39,302 | 68,875 | 81,487 | ||||||||||||
NET INCOME | $ | 191,678 | $ | 108,670 | $ | 190,174 | $ | 225,311 | ||||||||
The accompanying notes are an integral part of these financial statements.
2
Table of Contents
FEDERAL HOME LOAN BANK OF ATLANTA
STATEMENTS OF CAPITAL
FOR THE SIX MONTHS ENDED JUNE 30, 2009 AND 2008
(Unaudited)
(In thousands)
Capital Stock Class B Putable | Retained Earnings | Accumulated Other Comprehensive Loss | Total Capital | ||||||||||||||||
Shares | Par Value | ||||||||||||||||||
BALANCE, DECEMBER 31, 2007 | 75,560 | $ | 7,556,016 | $ | 468,779 | $ | (2,559 | ) | $ | 8,022,236 | |||||||||
Issuance of capital stock | 25,262 | 2,526,119 | — | — | 2,526,119 | ||||||||||||||
Repurchase/redemption of capital stock | (22,282 | ) | (2,228,195 | ) | — | — | (2,228,195 | ) | |||||||||||
Net shares reclassified to mandatorily redeemable capital stock | (168 | ) | (16,785 | ) | — | — | (16,785 | ) | |||||||||||
Comprehensive income: | |||||||||||||||||||
Net income | — | — | 225,311 | — | 225,311 | ||||||||||||||
Other comprehensive income | — | — | — | 12 | 12 | ||||||||||||||
Total comprehensive income | — | — | — | — | 225,323 | ||||||||||||||
Cash dividends on capital stock | — | — | (228,731 | ) | — | (228,731 | ) | ||||||||||||
BALANCE, JUNE 30, 2008 | 78,372 | $ | 7,837,155 | $ | 465,359 | $ | (2,547 | ) | $ | 8,299,967 | |||||||||
BALANCE, DECEMBER 31, 2008 | 84,630 | $ | 8,462,995 | $ | 434,883 | $ | (4,942 | ) | $ | 8,892,936 | |||||||||
Cumulative effect of adjustment to opening balance relating to FSP FAS 115-2 and FAS 124-2 | — | — | 178,520 | (178,520 | ) | — | |||||||||||||
Issuance of capital stock | 8,385 | 838,488 | — | — | 838,488 | ||||||||||||||
Repurchase/redemption of capital stock | (8,511 | ) | (851,078 | ) | — | — | (851,078 | ) | |||||||||||
Net shares reclassified to mandatorily redeemable capital stock | (3,318 | ) | (331,822 | ) | — | — | (331,822 | ) | |||||||||||
Comprehensive loss: | |||||||||||||||||||
Net income | — | — | 190,174 | — | 190,174 | ||||||||||||||
Other comprehensive loss | — | — | — | (880,330 | ) | (880,330 | ) | ||||||||||||
Total comprehensive loss | — | — | — | — | (690,156 | ) | |||||||||||||
BALANCE, JUNE 30, 2009 | 81,186 | $ | 8,118,583 | $ | 803,577 | $ | (1,063,792 | ) | $ | 7,858,368 | |||||||||
The accompanying notes are an integral part of these financial statements.
3
Table of Contents
FEDERAL HOME LOAN BANK OF ATLANTA
STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
Six Months Ended June 30, | ||||||||
2009 | 2008 | |||||||
OPERATING ACTIVITIES | ||||||||
Net income | $ | 190,174 | $ | 225,311 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization: | ||||||||
Net premiums and discounts on consolidated obligations | (121,063 | ) | 125,192 | |||||
Net premiums and discounts on investments | (9,796 | ) | (6,140 | ) | ||||
Net premiums and discounts on mortgage loans | (843 | ) | 934 | |||||
Concessions on consolidated obligations | 21,296 | 29,590 | ||||||
Net deferred loss on derivatives | 158 | 162 | ||||||
Premises and equipment | 1,454 | 1,449 | ||||||
Capitalized software | 2,574 | 2,512 | ||||||
Other | (12,973 | ) | 8,086 | |||||
Provision for credit losses on mortgage loans held for the portfolio | 21 | 150 | ||||||
Net realized gains from redemption of held-to-maturity securities | — | (401 | ) | |||||
Loss on disposal of capitalized software | — | 322 | ||||||
Loss due to change in net fair value adjustment on derivative and hedging activities | 265,683 | 9,031 | ||||||
Fair value adjustment on trading securities | 133,682 | 125,804 | ||||||
Net impairment losses recognized in earnings | 135,110 | — | ||||||
Net change in: | ||||||||
Accrued interest receivable | 174,607 | 62,758 | ||||||
Other assets | (5,396 | ) | (17,863 | ) | ||||
Affordable Housing Program liability | (2,182 | ) | 2,233 | |||||
Accrued interest payable | (340,300 | ) | (254,332 | ) | ||||
Payable to REFCORP | 30,492 | (3,514 | ) | |||||
Other liabilities | (1,861 | ) | (1,045 | ) | ||||
Total adjustments | 270,663 | 84,928 | ||||||
Net cash provided by operating activities | 460,837 | 310,239 | ||||||
INVESTING ACTIVITIES | ||||||||
Net change in: | ||||||||
Interest-bearing deposits | 2,154,126 | 535,316 | ||||||
Federal funds sold | 2,567,000 | 3,432,000 | ||||||
Deposits with other FHLBanks | 274 | 247 | ||||||
Trading Securities: | ||||||||
Proceeds from sales | 300,000 | 850,000 | ||||||
Proceeds from maturities | 228,000 | 350,000 | ||||||
Purchases | — | (2,768,441 | ) | |||||
Held-to-maturity securities: | ||||||||
Net change in short-term | — | (800,000 | ) | |||||
Proceeds | 2,534,013 | 1,771,951 | ||||||
Purchases | (475,924 | ) | (5,239,208 | ) | ||||
Available-for-sale securities: | ||||||||
Proceeds | 66,978 | — | ||||||
Advances: | ||||||||
Proceeds from principal collected | 67,115,927 | 94,436,271 | ||||||
Made | (39,321,776 | ) | (96,788,727 | ) | ||||
Mortgage loans held for portfolio: | ||||||||
Proceeds from principal collected | 418,514 | 257,187 | ||||||
Purchases | — | (156,748 | ) | |||||
Capital expenditures: | ||||||||
Purchase of premises and equipment | (1,218 | ) | (220 | ) | ||||
Purchase of software | (3,607 | ) | (1,463 | ) | ||||
Net cash provided by (used in) investing activities | 35,582,307 | (4,121,835 | ) | |||||
The accompanying notes are an integral part of these financial statements.
4
Table of Contents
Six Months Ended June 30, | ||||||||
2009 | 2008 | |||||||
FINANCING ACTIVITIES | ||||||||
Net change in deposits | 600,761 | (2,116,359 | ) | |||||
Net (payments) proceeds from derivatives containing a financing element | (473,980 | ) | 102,607 | |||||
Proceeds from issuance of consolidated obligations: | ||||||||
Discount notes | 83,389,557 | 139,593,365 | ||||||
Bonds | 48,912,250 | 75,331,030 | ||||||
Bonds transferred from other FHLBanks | 517,689 | — | ||||||
Payments for debt issuance costs | (18,554 | ) | (21,740 | ) | ||||
Payments for maturing and retiring consolidated obligations: | ||||||||
Discount notes | (99,742,732 | ) | (139,397,318 | ) | ||||
Bonds | (68,960,900 | ) | (69,722,515 | ) | ||||
Proceeds from issuance of capital stock | 838,488 | 2,526,119 | ||||||
Payments for repurchase/redemption of capital stock | (851,078 | ) | (2,228,195 | ) | ||||
Payments for repurchase/redemption of mandatorily redeemable capital stock | (270,013 | ) | (36,941 | ) | ||||
Cash dividends paid | — | (228,367 | ) | |||||
Net cash (used in) provided by financing activities | (36,058,512 | ) | 3,801,686 | |||||
Net decrease in cash and cash equivalents | (15,368 | ) | (9,910 | ) | ||||
Cash and cash equivalents at beginning of the period | 27,841 | 18,927 | ||||||
Cash and cash equivalents at end of the period | $ | 12,473 | $ | 9,017 | ||||
Supplemental disclosures of cash flow information: | ||||||||
Cash paid for: | ||||||||
Interest paid | $ | 1,406,647 | $ | 2,846,082 | ||||
AHP assessments paid, net | $ | 22,776 | $ | 22,584 | ||||
REFCORP assessments paid | $ | 3,024 | $ | 59,841 | ||||
Noncash investing and financing activities: | ||||||||
Dividends declared but not paid | $ | — | $ | 114,923 | ||||
Net shares reclassified to mandatorily redeemable capital stock | $ | 331,822 | $ | 16,785 | ||||
Transfer of held-to-maturity securities to available-for-sale securities | $ | 1,760,477 | $ | — | ||||
The accompanying notes are an integral part of these financial statements.
5
Table of Contents
FEDERAL HOME LOAN BANK OF ATLANTA
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
Note 1—Basis of Presentation and Summary of Significant Accounting Policies
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 accounting principles generally accepted 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, 2009, 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, 2008, which are contained in the Bank’s 2008 Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March 30, 2009 (“Form 10-K”).
Subsequent events have been evaluated by Bank management through August 12, 2009, which is the date the Bank’s interim financial statements were issued.
Reclassifications.Certain amounts in the prior-year financial statements have been reclassified to conform to the current presentation.
During the third quarter of 2008, on a retrospective basis, the Bank reclassified its investments in certificates of deposit, previously reported as interest-bearing deposits, to present them appropriately as held-to-maturity securities in its statements of condition and income based on the definition of a security under Statement of Financial Accounting Standard (“SFAS”) No. 115,Accounting for Certain Investments in Debt and Equity Securities (“SFAS 115”). These financial instruments have been classified as held-to-maturity securities based on their short-term nature and the Bank’s history of holding them until maturity. This reclassification had no effect on total assets or net interest income and net income and was not material to the previously issued financial statements.
The effects of the above reclassifications on the Bank’s prior year financial statements were as follows (in thousands):
Statement of Income | ||||||||||
Three Months Ended June 30, 2008 | ||||||||||
As Originally Reported | Certificates of Deposit Adjustment | As Adjusted | ||||||||
Interest Income: | ||||||||||
Interest-bearing deposits | $ | 11,486 | $ | (5,100 | ) | $ | 6,386 | |||
Held-to-maturity securities | 294,916 | 5,100 | 300,016 |
6
Table of Contents
Statement of Income | ||||||||||||
Six Months Ended June 30, 2008 | ||||||||||||
As Originally Reported | Certificates of Deposit Adjustment | As Adjusted | ||||||||||
Interest Income: | ||||||||||||
Interest-bearing deposits | $ | 33,553 | $ | (10,646 | ) | $ | 22,907 | |||||
Held-to-maturity securities | 563,448 | 10,646 | 574,094 | |||||||||
Statement of Cash Flows | ||||||||||||
Six Months Ended June 30, 2008 | ||||||||||||
As Originally Reported | Certificates of Deposit Adjustment | As Adjusted | ||||||||||
Investing Activities: | ||||||||||||
Net change in interest-bearing deposits | $ | (264,684 | ) | $ | 800,000 | $ | 535,316 | |||||
Held-to-maturity securities: | ||||||||||||
Net change in short-term | — | (800,000 | ) | (800,000 | ) |
Summary of Significant Accounting Policies
Investment Securities.The Bank classifies certain investments acquired for purposes of liquidity and asset-liability management as trading investments and carries these securities at their estimated fair value. The Bank records changes in the fair value of these investments in other income (loss) as “Net losses on trading securities,” along with gains and losses on sales of investment securities using the specific identification method. The Bank does not participate in speculative trading practices in these investments and generally holds them until maturity, except to the extent management deems necessary to manage the Bank’s liquidity position.
The Bank classifies certain securities as available-for-sale and carries these securities at their estimated fair value. Unrealized gains and losses are reflected as an element of accumulated other comprehensive loss in the Statements of Capital. The Bank intends to hold its available-for-sale securities for an indefinite period of time, but may sell them prior to maturity in response to changes in interest rates, changes in prepayment risk, or other factors.
The Bank carries at cost, and classifies as held-to-maturity, investments for which it has both the ability and intent to hold to maturity, adjusted for periodic principal repayments, amortization of premiums and accretion of discounts. Amortization of premiums and accretion of discounts are computed using the level-yield method.
In accordance with SFAS 115, changes in circumstances may cause the Bank to change its intent to hold a certain security to maturity without calling into question its intent to hold other debt securities to maturity in the future. Thus, the sale or transfer of a held-to-maturity security due to certain changes in circumstances, such as evidence of significant deterioration in the issuer’s creditworthiness, is not considered to be inconsistent with its original classification. At March 31, 2009 and June 30, 2009, the Bank transferred certain private-label mortgage-backed securities (“MBS”) from its held-to-maturity portfolio to an available-for-sale portfolio. These securities represent private-label MBS
7
Table of Contents
in the Bank’s held-to-maturity portfolio for which the Bank has recorded an other-than-temporary impairment loss. The objective of the transfer was to recognize management’s intent to hold these securities for an indefinite period of time, but that management may choose to sell them prior to maturity in response to changes in interest rates, changes in prepayment risk, or other factors.
The Bank computes the amortization of premiums and accretion of discounts on investment securities using the contractual level-yield method (the “contractual method”), adjusted for actual prepayments. The contractual method recognizes the income effects of premiums and discounts in a manner that effectively is proportionate to the actual behavior of the underlying assets and reflects the contractual terms of the assets without regard to changes in estimated prepayments based on assumptions about future borrower behavior.
The Bank evaluates its individual available-for-sale and held-to-maturity investment securities for other-than-temporary impairment on at least a quarterly basis. The Bank recognizes an other-than-temporary impairment loss when the Bank determines it will not recover the entire amortized cost basis of a security.
To determine which individual securities are at risk for other-than-temporary impairment, the Bank considers various characteristics of each security including, but not limited to, the following: the credit rating and related outlook or status; the underlying type of collateral; the duration and amount of the unrealized loss; and any credit enhancements or insurance. The relative importance of this information varies based on the facts and circumstances surrounding each security, as well as the economic environment at the time of the assessment. As a result of the security-level review, the Bank identifies individual securities believed to be at risk for other-than-temporary impairment, which are evaluated by analyzing the performance of the security. At-risk securities are evaluated by estimating the projected cash flows using a model that incorporates projections and assumptions based on the structure of the security and certain economic environment assumptions such as delinquency and default rates, loss severity, home price appreciation, interest rates, and securities prepayment speeds while factoring in the underlying collateral and credit enhancement.
If, as a result of the projected cash flow analysis, the present value of the expected cash flows is less than the amortized cost basis, an impairment is considered to be other than temporary. The amount of the other-than-temporary impairment loss is separated into two components: (1) the amount of the total impairment related to credit loss; and (2) the amount of the total impairment related to all other factors. The portion of the other-than-temporary impairment loss that is attributable to the credit loss (that is, the difference between the present value of the cash flows expected to be collected and the amortized cost basis) is recognized in other income (loss). If the Bank does not intend to sell the security and it is not more likely than not that the Bank will be required to sell the debt security before the anticipated recovery of its remaining amortized cost basis, the portion of the impairment loss that is not attributable to the credit loss is recognized through other comprehensive loss.
If the Bank determines that an other-than-temporary impairment exists, the Bank accounts for the investment security as if it had been purchased on the measurement date of the other-than-temporary impairment loss at an amortized cost basis equal to the previous amortized cost basis less the other-than-temporary impairment recognized in income. The difference between the new amortized cost basis and the cash flows expected to be collected is accreted into interest income prospectively over the remaining life of the security.
8
Table of Contents
A description of the Bank’s other significant accounting policies is included in Note 1 to the 2008 audited financial statements contained in the Bank’s Form 10-K. There have been no material changes to these policies as of June 30, 2009, except as disclosed above.
Note 2—Recently Issued and Adopted Accounting Standards and Interpretations and Change in Accounting Principle
SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities an amendment of FASB Statement No. 133 (“SFAS 161”), issued in March 2008, required enhanced disclosures about an entity’s derivative and hedging activities. These enhanced disclosures must discuss (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133,Accounting for Derivatives Instruments and Hedging Activities (“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 adopted SFAS 161 as of January 1, 2009. The adoption of SFAS 161 did not have a material effect on the Bank’s financial condition or results of operations. The adoption of SFAS 161 resulted in increased financial statement disclosures.
FASB Staff Position (“FSP”)FAS 157-4,Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (“FSP FAS 157-4”), was issued in April 2009.FSP FAS 157-4 is intended to provide application guidance addressing the determination of when a market for a financial asset or a financial liability is not active and when a transaction is not distressed for fair value measurements under SFAS No. 157,Fair Value Measurements(“SFAS 157”). FSP FAS 157-4 is effective and should be applied prospectively for financial statements issued for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for reporting periods ending after March 15, 2009. Early adoption of FSP FAS 157-4 also requires early adoption of FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (“FSP FAS 115-2 and FAS 124-2”). The Bank adopted FSP FAS 157-4 as of January 1, 2009. The adoption of FSP FAS 157-4 did not have a material effect on the Bank’s financial condition or results of operations.
FSP FAS 115-2 and FAS 124-2was issued in April 2009. FSP FAS 115-2 and FAS 124-2 is intended to provide greater clarity to investors about the credit and noncredit component of an other-than-temporary impairment event and to communicate more effectively when an other-than-temporary impairment event has occurred. FSP FAS 115-2 and FAS 124-2 amends the other-than-temporary impairment guidance in GAAP for debt securities. The new guidance improves the presentation and disclosure of other-than-temporary impairment on investment securities and changes the calculation of the other-than-temporary impairment recognized in earnings in the financial statements. FSP FAS 115-2 and FAS 124-2 does not amend existing recognition and measurement guidance related to other-than-temporary impairment of equity securities.
For debt securities, FSP FAS 115-2 and FAS 124-2 requires an entity to assess whether (a) it has the intent to sell the debt security, or (b) it is more likely than not that it will be required to sell the debt security before its anticipated recovery. If either of these conditions is met, an other-than-temporary impairment on the security must be recognized.
9
Table of Contents
In instances in which a determination is made that a credit loss (defined by FSP FAS 115-2 and FAS 124-2 as the difference between the present value of the cash flows expected to be collected and the amortized cost basis) exists but the entity does not intend to sell the debt security and it is not more likely than not that the entity will be required to sell the debt security before the anticipated recovery of its remaining amortized cost basis (i.e., the amortized cost basis less any current-period credit loss), FSP FAS 115-2 and FAS 124-2 changes the presentation and amount of the other-than-temporary impairment recognized in the income statement. In these instances, the impairment is separated into (a) the amount of the total impairment related to the credit loss, and (b) the amount of the total impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total impairment related to all other factors is recognized in other comprehensive loss and will be amortized over the remaining life of the debt security as an increase in the carrying value of the security (with no effect on earnings unless the security subsequently is sold or additional other-than-temporary impairment losses are recognized). The total other-than-temporary impairment is presented in the income statement with an offset for the amount of the total other-than-temporary impairment that is recognized in other comprehensive loss. Previously, in all cases, if an impairment was determined to be other-than-temporary, an impairment loss was recognized in earnings in an amount equal to the entire difference between the security’s amortized cost basis and its fair value at the balance sheet date of the reporting period for which the assessment was made. The new presentation provides additional information about the amounts that the entity does not expect to collect related to a debt security.
FSP FAS 115-2 and FAS 124-2 is effective and is to be applied prospectively for financial statements issued for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for reporting periods ending after March 15, 2009. Early adoption of FSP FAS 115-2 and FAS 124-2 also requires early adoption of FSP FAS 157-4. When adopting FSP FAS 115-2 and FAS 124-2, an entity is required to record a cumulative-effect adjustment as of the beginning of the period of adoption to reclassify the noncredit component of a previously recognized other-than-temporary impairment from retained earnings to accumulated other comprehensive loss if the entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before the anticipated recovery of its amortized cost basis.
The Bank adopted FSP FAS 115-2 and FAS 124-2 as of January 1, 2009, and recognized the effects of applying FSP FAS 115-2 and FAS 124-2 as a change in accounting principle. The Bank recognized the $178.5 million cumulative effect of initially applying FSP FAS 115-2 and FAS 124-2 as an adjustment to retained earnings at January 1, 2009, with a corresponding adjustment to accumulated other comprehensive loss.
FSP FAS 107-1 and APB 28-1,Interim Disclosures about Fair Value of Financial Instruments (“FSP FAS 107-1 and APB 28-1”), was issued in April 2009.FSP FAS 107-1 and APB 28-1 amends the disclosure requirements in SFAS No. 107,Disclosures about Fair Value of Financial Instruments(“SFAS 107”), and APB Opinion No. 28,Interim Financial Reporting, to require disclosures about the fair value of financial instruments within the scope of SFAS 107, including disclosure of the method(s) and significant assumptions used to estimate the fair value of financial instruments, in interim financial statements as well as in annual financial statements. Previously, these disclosures were required only in annual financial statements. FSP FAS 107-1 and APB 28-1 is effective and should be applied prospectively for financial statements issued for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for reporting periods ending after March 15, 2009. Early adoption of FSP FAS 107-1 and APB 28-1 is permitted only if an election also is made to early adopt FSP FAS 115-2 and FAS 124-2 and FSP
10
Table of Contents
FAS 157-4. In periods after initial adoption, FSP FAS 107-1 and APB 28-1 requires comparative disclosures only for periods ending subsequent to initial adoption and does not require earlier periods to be disclosed for comparative purposes at initial adoption. The Bank adopted FSP FAS 107-1 and APB 28-1 as of January 1, 2009. The adoption of FSP FAS 107-1 and APB 28-1 did not have a material effect on the Bank’s financial condition or results of operations. The adoption of FSP FAS 107-1 and APB 28-1 resulted in increased financial statement disclosures.
SFAS No. 165, Subsequent Events (“SFAS 165”), issued in May 2009, is intended to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS 165 sets forth: (1) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; (2) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and (3) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date, including disclosure of the date through which an entity has evaluated subsequent events and whether that represents the date the financial statements were issued or were available to be issued. This disclosure should alert all users of financial statements that an entity has not evaluated subsequent events after the date disclosed in the financial statements being presented. SFAS 165 does not apply to subsequent events or transactions that are within the scope of other applicable GAAP that provide different guidance on the accounting treatment for subsequent events or transactions. SFAS 165 is effective for interim and annual financial periods ending after June 15, 2009 (June 30, 2009 for the Bank). The Bank adopted SFAS 165 as of June 30, 2009. The adoption of SFAS 165 did not have a material effect on the Bank’s financial condition or results of operations. The adoption of SFAS 165 resulted in increased financial statement disclosures.
SFAS No. 166,Accounting for Transfers of Financial Assets—an amendment of FASB Statement No. 140(“SFAS 166”), issued in June 2009, is intended to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement in transferred financial assets. SFAS 166 is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009 (January 1, 2010 for the Bank), for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. Earlier application is prohibited. The Bank does not believe that the adoption of SFAS 166 will have a material effect on its financial condition or results of operations.
SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (“SFAS 167”), issued in June 2009, is intended to amend certain requirements of FASB Interpretation No. 46 (revised December 2003),Consolidation of Variable Interest Entities, to improve financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. SFAS 167 is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009 (January 1, 2010 for the Bank), for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. Earlier application is prohibited. The Bank does not believe that the adoption of SFAS 167 will have a material effect on its financial condition or results of operations.
SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles(“SFAS 168”), issued in June 2009, designates the FASB Accounting Standards Codification (“ASC”) as the single source of authoritative nongovernmental GAAP. The ASC does not change current
11
Table of Contents
GAAP; rather, its intent is to organize all accounting literature by topic in one place in order to enable users to quickly identify appropriate GAAP. SFAS 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009 (September 30, 2009 for the Bank). The Bank does not believe that the adoption of SFAS 168 will have a material effect on its financial condition or results of operations.
Note 3—Trading Securities
Major Security Types.Trading securities were as follows (in thousands):
As of June 30, 2009 | As of December 31, 2008 | |||||
Government-sponsored enterprises debt obligations | $ | 3,658,337 | $ | 4,171,725 | ||
Other FHLBanks’ bonds | 154,885 | 300,135 | ||||
State or local housing agency obligations | 14,083 | 14,069 | ||||
Total | $ | 3,827,305 | $ | 4,485,929 | ||
Net losses on trading securities held on June 30, 2009 and 2008 consist of a change in net unrealized holding losses of $72.8 million and $102.5 million for the three-and six-month periods ended June 30, 2009, respectively, compared to $175.5 million and $83.3 million for the same periods ended June 30, 2008, respectively.
Other Federal Home Loan Banks’ (“FHLBanks”) Consolidated Obligation Bonds.The following table details the Bank’s investment in other FHLBanks’ consolidated obligation bonds by primary obligor (in thousands):
As of June 30, 2009 | As of December 31, 2008 | |||||
Other FHLBanks’ bonds: | ||||||
FHLBank Dallas | $ | 80,015 | $ | 82,300 | ||
FHLBank Chicago | 74,870 | 89,128 | ||||
154,885 | 171,428 | |||||
FHLBank TAP Program* | — | 128,707 | ||||
Total | $ | 154,885 | $ | 300,135 | ||
* | Under this program, the FHLBanks can offer debt obligations representing aggregations of smaller bond issues into larger bond issues that may have greater market liquidity. Because of the aggregation of smaller issues, there is more than one primary obligor. |
Note 4—Available-for-sale Securities
At March 31, 2009 and June 30, 2009, the Bank transferred certain private-label MBS from its held-to-maturity portfolio to an available-for-sale portfolio. These securities represent private-label MBS in the Bank’s held-to-maturity portfolio for which the Bank has recorded an other-than-temporary impairment loss. The amortized cost basis of the securities prior to transfer at March 31, 2009 and June 30, 2009 was $2.4 billion and $313.5 million, respectively. This amortized cost basis reflects the impact of the credit loss related to the other-than-temporary impairment loss. The carrying value established by the transfer at March 31, 2009 and June 30, 2009 was $1.6 billion and $156.0 million, respectively, which represents the fair value of the securities at the time of transfer.
12
Table of Contents
Major Security Types.Available-for-sale securities were as follows (in thousands):
As of June 30, 2009 | ||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses* | Estimated Fair Value | |||||||||
Mortgage-backed Securities: | ||||||||||||
Private label | $ | 2,595,579 | $ | — | $ | 1,058,971 | $ | 1,536,608 | ||||
Total | $ | 2,595,579 | $ | — | $ | 1,058,971 | $ | 1,536,608 | ||||
* | Represents total other-than-temporary impairment recognized in accumulated other comprehensive loss. |
The Bank did not have any available-for-sale securities as of December 31, 2008.
A summary of available-for-sale MBS issued by members or affiliates of members follows (in thousands):
As of June 30, 2009 | ||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses* | Estimated Fair Value | |||||||||
Bank of America Corporation, Charlotte, NC | $ | 228,262 | $ | — | $ | 78,855 | $ | 149,407 | ||||
Total | $ | 228,262 | $ | — | $ | 78,855 | $ | 149,407 | ||||
* | Represents total other-than-temporary impairment recognized in accumulated other comprehensive loss. |
The following table summarizes the available-for-sale securities with unrealized losses (dollar amounts 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.
As of June 30, 2009 | ||||||||||||||||||||||||
Less than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
Number of Positions | Fair Value | Unrealized Losses | Number of Positions | Fair Value | Unrealized Losses | Number of Positions | Fair Value | Unrealized Losses | ||||||||||||||||
Mortgage-backed securities: | ||||||||||||||||||||||||
Private label | — | $ | — | $ | — | 22 | $ | 1,536,608 | $ | 1,058,971 | 22 | $ | 1,536,608 | $ | 1,058,971 | |||||||||
Total | — | $ | — | $ | — | 22 | $ | 1,536,608 | $ | 1,058,971 | 22 | $ | 1,536,608 | $ | 1,058,971 | |||||||||
The amortized cost of the Bank’s MBS classified as available-for-sale includes $1.2 million in net premiums as of June 30, 2009.
13
Table of Contents
Note 5—Held-to-maturity Securities
Major Security Types.Held-to-maturity securities were as follows (in thousands):
As of June 30, 2009 | As of December 31, 2008 | |||||||||||||||||||||||
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 | $ | 136,756 | $ | 3,686 | $ | — | $ | 140,442 | $ | 101,105 | $ | 3,605 | $ | — | $ | 104,710 | ||||||||
Mortgage-backed securities: | ||||||||||||||||||||||||
U.S. agency obligations-guaranteed | 36,254 | 1,250 | 1 | 37,503 | 38,545 | 260 | 367 | 38,438 | ||||||||||||||||
Government-sponsored enterprises | 6,750,050 | 214,570 | 20,295 | 6,944,325 | 7,060,082 | 117,494 | 3,467 | 7,174,109 | ||||||||||||||||
Private label | 11,524,079 | 1,371 | 2,011,021 | 9,514,429 | 15,918,391 | 6,246 | 3,648,279 | 12,276,358 | ||||||||||||||||
Total | $ | 18,447,139 | $ | 220,877 | $ | 2,031,317 | $ | 16,636,699 | $ | 23,118,123 | $ | 127,605 | $ | 3,652,113 | $ | 19,593,615 | ||||||||
A summary of held-to-maturity MBS issued by members or affiliates of members follows (in thousands):
As of June 30, 2009 | As of December 31, 2008 | |||||||||||||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | |||||||||||||||||
Countrywide Financial Corporation, Calabasas, CA* | $ | — | $ | — | $ | — | $ | — | $ | 4,675,435 | $ | 6,062 | $ | 1,195,018 | $ | 3,486,479 | ||||||||
Bank of America Corporation, Charlotte, NC | 1,521,900 | 130 | 273,772 | 1,248,258 | 2,060,873 | — | 488,315 | 1,572,558 | ||||||||||||||||
Total | $ | 1,521,900 | $ | 130 | $ | 273,772 | $ | 1,248,258 | $ | 6,736,308 | $ | 6,062 | $ | 1,683,333 | $ | 5,059,037 | ||||||||
* | Effective April 27, 2009, Bank of America Corporation converted Countrywide into a national bank and merged it into Bank of America, N.A., a member of the Bank. |
The following tables summarize the held-to-maturity securities with unrealized losses (dollar amounts 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.
As of June 30, 2009 | ||||||||||||||||||||||||
Less than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
Number of Positions | Fair Value | Unrealized Losses | Number of Positions | Fair Value | Unrealized Losses | Number of Positions | Fair Value | Unrealized Losses | ||||||||||||||||
Mortgage-backed securities: | ||||||||||||||||||||||||
U.S. agency obligations, guaranteed | — | $ | — | $ | — | 1 | $ | 1,585 | $ | 1 | 1 | $ | 1,585 | $ | 1 | |||||||||
Government-sponsored enterprises | 8 | 648,075 | 20,030 | 1 | 47,271 | 265 | 9 | 695,346 | 20,295 | |||||||||||||||
Private label | 6 | 88,512 | 12,723 | 207 | 9,265,600 | 1,998,298 | 213 | 9,354,112 | 2,011,021 | |||||||||||||||
Total | 14 | $ | 736,587 | $ | 32,753 | 209 | $ | 9,314,456 | $ | 1,998,564 | 223 | $ | 10,051,043 | $ | 2,031,317 | |||||||||
14
Table of Contents
As of December 31, 2008 | ||||||||||||||||||||||||
Less than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
Number of Positions | Fair Value | Unrealized Losses | Number of Positions | Fair Value | Unrealized Losses | Number of Positions | Fair Value | Unrealized Losses | ||||||||||||||||
Mortgage-backed securities: | ||||||||||||||||||||||||
U.S. agency obligations, guaranteed | 32 | $ | 25,580 | $ | 367 | — | $ | — | $ | — | 32 | $ | 25,580 | $ | 367 | |||||||||
Government-sponsored enterprises | 4 | 557,822 | 3,467 | — | — | — | 4 | 557,822 | 3,467 | |||||||||||||||
Private label | 93 | 4,635,936 | 1,647,200 | 150 | 7,371,486 | 2,001,079 | 243 | 12,007,422 | 3,648,279 | |||||||||||||||
Total | 129 | $ | 5,219,338 | $ | 1,651,034 | 150 | $ | 7,371,486 | $ | 2,001,079 | 279 | $ | 12,590,824 | $ | 3,652,113 | |||||||||
Redemption Terms.The amortized cost and estimated fair value of held-to-maturity securities by contractual maturity are shown below (in thousands). Expected maturities of some securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment fees.
As of June 30, 2009 | As of December 31, 2008 | |||||||||||
Amortized Cost | Estimated Fair Value | Amortized Cost | Estimated Fair Value | |||||||||
Year of maturity: | ||||||||||||
Due in one year or less | $ | 1,635 | $ | 1,656 | $ | 1,705 | $ | 1,721 | ||||
Due after one year through five years | 108,730 | 111,452 | 71,465 | 74,197 | ||||||||
Due after 10 years | 26,391 | 27,334 | 27,935 | 28,792 | ||||||||
136,756 | 140,442 | 101,105 | 104,710 | |||||||||
Mortgage-backed securities | 18,310,383 | 16,496,257 | 23,017,018 | 19,488,905 | ||||||||
Total | $ | 18,447,139 | $ | 16,636,699 | $ | 23,118,123 | $ | 19,593,615 | ||||
The amortized cost of the Bank’s MBS classified as held-to-maturity includes net discounts of $56.0 million and $145.7 million as of June 30, 2009 and December 31, 2008, respectively.
Note 6—Other-than-temporary Impairment
Mortgage-backed Securities. The Bank’s investments in MBS consist of agency guaranteed securities and senior tranches of private-label MBS. The Bank has increased exposure to the risk of loss on its investments in MBS when the loans backing the MBS exhibit high rates of delinquency and foreclosures, as well as losses on the sale of foreclosed properties. The Bank regularly requires high levels of credit enhancements from the structure of the collateralized mortgage obligation to reduce its risk of loss on such securities. Credit enhancements are defined as the percentage of subordinate tranches, overcollateralization, or excess spread, or the support of monoline insurance, if any, in a security structure that will absorb the losses before the security the Bank purchased will take a loss. The Bank does not purchase credit enhancements for its MBS from monoline insurance companies.
The Bank’s investments in private-label MBS were rated “AAA” (or its equivalent) by a nationally recognized statistical rating organization (“NRSRO”), such as Moody’s Investors Service (“Moody’s”) and Standard & Poor’s Rating Services (“S&P”), at purchase date. The “AAA”-rated securities achieved their ratings through credit enhancement, over-collateralization and senior-subordinated shifting interest
15
Table of Contents
features; the latter results in subordination of payments by junior classes to ensure cash flows to the senior classes. Some of the ratings on the Bank’s private-label MBS have changed since their purchase date.
Non-Private-label MBS. The unrealized losses related to U.S. agency MBS and government-sponsored enterprises MBS are caused by interest rate changes and not credit quality. These securities are guaranteed by government agencies or government-sponsored enterprises and Bank management does not expect these securities to be settled at a price less than the amortized cost basis. In addition, the Bank does not intend to sell the investments and it is not more likely than not that the Bank will be required to sell the investments before recovery of their amortized cost basis, which may be at maturity. The Bank does not consider these investments to be other-than-temporarily impaired as of June 30, 2009.
Private-label MBS.The Bank evaluates its individual private-label MBS holdings for other-than-temporary impairment on a quarterly basis, or more frequently if events or changes in circumstances indicate that these investments may be other-than-temporarily impaired.
To assess whether the entire amortized cost bases of its private-label MBS will be recovered, the Bank performed a cash flow analysis for each of its private-label MBS that was determined to be other-than-temporarily impaired in a previous reporting period as well as those with adverse risk characteristics as of June 30, 2009. The adverse risk characteristics used to select securities for cash flow analysis included: the duration and magnitude of the unrealized loss, NRSRO credit ratings below investment grade, and criteria related to the credit performance of the underlying collateral, including the ratio of credit enhancement to expected collateral losses and the ratio of seriously delinquent loans to credit enhancement. For these purposes, expected collateral losses are those that are implied by current delinquencies taking into account a default probability based on the state of delinquency and a loss severity assumption based on product and vintage; seriously delinquent loans are those that are 60 or more days past due, including loans in foreclosure and real estate owned. In performing the cash flow analysis for each of these securities, the Bank used two third party models. The first model considers borrower characteristics and the particular attributes of the loans underlying the Bank’s securities, in conjunction with assumptions about future changes in home prices and interest rates, to project prepayments, defaults and loss severities. A significant input to the first model is the forecast of future housing price changes for the relevant states and core based statistical areas (“CBSAs”), which are based upon an assessment of the individual housing markets. (The term CBSA refers collectively to metropolitan and micropolitan statistical areas as defined by the United States Office of Management and Budget; as currently defined, a CBSA must contain at least one urban area of 10,000 or more people.) The Bank’s housing price forecast assumed current-to-trough home price declines ranging from zero percent to 20 percent over the next nine to 15 months (resulting in peak-to-trough home price declines of up to 51 percent). Thereafter, home prices are projected to increase one percent in the first year, three percent in the second year and four percent in each subsequent year. The month-by-month projections of future loan performance derived from the first model, which reflect projected prepayments, defaults and loss severities, are then input into a second model that allocates the projected loan level cash flows and losses to the various security classes in the securitization structure in accordance with its prescribed cash flow and loss allocation rules. The model classifies securities, as noted in the below table, based on current characteristics and performance, which may be different than the securities’ classification as determined by the originator at the time of origination. For those securities for which an other-than-temporary impairment was determined to have occurred as of June 30, 2009 (that is, a determination was made that less than all of the entire amortized cost bases will likely be recovered), the following table represents a summary of the significant inputs used to measure the amount of the credit loss recognized in earnings (dollar amounts in thousands):
16
Table of Contents
Significant Inputs | |||||||||||||||||||||||
Prepayment Rates | Default Rates | Loss Severities | |||||||||||||||||||||
Year of Securitization | Number of Securities | Unpaid Principal Balance | Weighted Average % | Range % | Weighted Average % | Range % | Weighted Average % | Range % | |||||||||||||||
Alt-A: | |||||||||||||||||||||||
2007 | 7 | $ | 1,072,539 | 13.8 | 10.8 to 17.0 | 43.4 | 40.4 to 51.6 | 40.0 | 36.7 to 41.8 | ||||||||||||||
2006 | 4 | 373,402 | 14.6 | 12.7 to 16.1 | 47.2 | 43.1 to 50.6 | 38.9 | 33.2 to 43.8 | |||||||||||||||
2005 | 6 | 732,600 | 14.4 | 8.3 to 19.4 | 49.2 | 30.9 to 76.7 | 41.5 | 34.3 to 48.0 | |||||||||||||||
Total | 17 | $ | 2,178,541 | 14.1 | 8.3 to 19.4 | 46.0 | 30.9 to 76.7 | 40.3 | 33.2 to 48.0 | ||||||||||||||
Based on the Bank’s impairment analysis for the three- and six-month periods ended June 30, 2009, the Bank recognized a total other-than-temporary impairment loss of $403.6 million and $1.1 billion, respectively. The credit related portion of $46.2 million and $135.1 million for the three- and six-month periods ended June 30, 2009, respectively, of this other-than-temporary impairment loss is reported in the Statements of Income as “Net impairment losses recognized in earnings,” while the noncredit related portion of $357.3 million and $966.6 million for the three- and six-month periods ended June 30, 2009, respectively, of the other-than-temporary impairment loss is reflected as a portion of other comprehensive loss. No other-than-temporary impairment loss was recognized during the six months ended June 30, 2008.
The following table presents a roll-forward of the amount of credit losses on the Bank’s investment securities recognized in earnings for which a portion of the other-than-temporary loss was recognized in accumulated other comprehensive loss (in thousands):
Three Months Ended June 30, 2009 | Six Months Ended June 30, 2009 | |||||
Beginning balance of credit losses previously recognized in earnings | $ | 93,754 | $ | 4,886 | ||
Amount related to credit loss for which an other-than-temporary impairment was not previously recognized | 9,282 | 83,182 | ||||
Amount related to credit loss for which an other-than-temporary impairment was previously recognized | 36,960 | 51,928 | ||||
Ending balance of cumulative credit losses recognized in earnings | $ | 139,996 | $ | 139,996 | ||
The remainder of the Bank’s private-label MBS that has not been designated as other-than-temporarily impaired has experienced unrealized losses and decreases in fair value due to interest rate volatility, illiquidity in the marketplace, and general disruption in the U.S. mortgage markets. This decline in fair value is considered temporary as the Bank expects to recover the amortized cost basis of the securities, the Bank does not intend to sell the securities and it is not more likely than not that the Bank will be required to sell the securities before the anticipated recovery of the securities’ remaining amortized cost basis, which may be at maturity. The assessment is based on the fact that the Bank has sufficient capital and liquidity to operate its business and has no need to sell these securities, nor has the Bank entered into any contractual constraints that would require the Bank to sell these securities.
17
Table of Contents
Note 7—Advances
Redemption Terms.The Bank had advances outstanding, as summarized below (in thousands):
As of June 30, 2009 | As of December 31, 2008 | |||||||
Year of contractual maturity: | ||||||||
Overdrawn demand deposit accounts | $ | 17,529 | $ | 550 | ||||
Due in one year or less | 34,670,058 | 39,739,223 | ||||||
Due after one year through two years | 28,392,212 | 34,187,680 | ||||||
Due after two years through three years | 16,328,091 | 23,761,810 | ||||||
Due after three years through four years | 12,452,948 | 17,692,714 | ||||||
Due after four years through five years | 7,906,705 | 10,566,914 | ||||||
Due after five years | 28,708,435 | 30,320,265 | ||||||
Total par value | 128,475,978 | 156,269,156 | ||||||
Discount on AHP* advances | (13,424 | ) | (14,028 | ) | ||||
Discount on EDGE** advances | (13,119 | ) | (13,253 | ) | ||||
SFAS 133 hedging adjustments | 6,058,036 | 9,617,925 | ||||||
Deferred commitment fees | (4,854 | ) | (4,254 | ) | ||||
Total | $ | 134,502,617 | $ | 165,855,546 | ||||
* | The Affordable Housing Program |
** | The Economic Development and Growth Enhancement Program |
The following table summarizes advances by year of contractual maturity or, for convertible advances, next conversion date (in thousands):
As of June 30, 2009 | |||
Year of contractual maturity or next convert date: | |||
Overdrawn demand deposit accounts | $ | 17,529 | |
Due or convertible in one year or less | 52,963,403 | ||
Due or convertible after one year through two years | 29,096,312 | ||
Due or convertible after two years through three years | 14,885,251 | ||
Due or convertible after three years through four years | 9,521,643 | ||
Due or convertible after four years through five years | 7,631,455 | ||
Due or convertible after five years | 14,360,385 | ||
Total par value | $ | 128,475,978 | |
Based on the collateral pledged as security for advances, management’s credit analysis of members’ financial condition, and prior repayment history, no allowance for credit losses on advances is deemed necessary by management, as of June 30, 2009 and December 31, 2008, respectively. No advance was past due as of June 30, 2009 or December 31, 2008.
The Bank’s potential credit risk from advances is concentrated in commercial banks, savings institutions and credit unions and further concentrated in certain larger borrowing relationships. As of June 30, 2009 and December 31, 2008, the concentration of the Bank’s advances was $86.0 billion and $102.7 billion, respectively, to its 10 largest borrowers, and this represented 67.0 percent and 65.7 percent, respectively, of total advances.
18
Table of Contents
Interest-rate Payment Terms.The following table details interest-rate payment terms for advances (in thousands):
As of June 30, 2009 | As of December 31, 2008 | |||||
Par value of advances: | ||||||
Fixed-rate | $ | 109,542,732 | $ | 127,322,930 | ||
Variable-rate | 18,933,246 | 28,946,226 | ||||
Total | $ | 128,475,978 | $ | 156,269,156 | ||
Note 8—Consolidated Obligations
Consolidated obligations, consisting of consolidated obligation bonds and discount notes, are the joint and several obligations of the FHLBanks and are backed only by the financial resources of the FHLBanks. The FHLBanks 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.
Interest-rate Payment Terms.The following table details consolidated obligation bonds by interest-rate payment type (in thousands):
As of June 30, 2009 | As of December 31, 2008 | |||||
Par value of consolidated bonds: | ||||||
Fixed-rate | $ | 88,415,530 | $ | 101,202,430 | ||
Simple variable-rate | 19,162,000 | 28,004,900 | ||||
Step | 8,340,000 | 6,023,000 | ||||
Variable-rate that converts to fixed-rate | 125,000 | 225,000 | ||||
Zero-coupon | 93,060 | 168,060 | ||||
Variable-rate capped floater | 25,000 | 100,000 | ||||
Fixed-rate that converts to variable-rate | — | 15,000 | ||||
Total | $ | 116,160,590 | $ | 135,738,390 | ||
19
Table of Contents
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 June 30, 2009 | As of December 31, 2008 | |||||||||||
Amount | Weighted- average Interest Rate (%) | Amount | Weighted- average Interest Rate (%) | |||||||||
Year of contractual maturity: | ||||||||||||
Due in one year or less | $ | 57,065,665 | 1.81 | $ | 73,667,975 | 2.63 | ||||||
Due after one year through two years | 25,517,160 | 1.99 | 22,242,000 | 3.40 | ||||||||
Due after two years through three years | 7,649,500 | 3.12 | 8,245,900 | 3.90 | ||||||||
Due after three years through four years | 7,012,765 | 3.92 | 5,402,015 | 4.57 | ||||||||
Due after four years through five years | 7,758,000 | 4.00 | 13,548,750 | 4.13 | ||||||||
Due after five years | 11,157,500 | 5.11 | 12,631,750 | 5.13 | ||||||||
Total par value | 116,160,590 | 2.54 | 135,738,390 | 3.30 | ||||||||
Premiums | 126,997 | 100,767 | ||||||||||
Discounts | (64,822 | ) | (109,228 | ) | ||||||||
SFAS 133 hedging adjustments | 1,533,333 | 2,452,134 | ||||||||||
Deferred net losses on terminated hedges | (570 | ) | (729 | ) | ||||||||
Total | $ | 117,755,528 | $ | 138,181,334 | ||||||||
The Bank’s consolidated obligation bonds outstanding included (in thousands):
As of June 30, 2009 | As of December 31, 2008 | |||||
Par value of consolidated bonds: | ||||||
Noncallable | $ | 91,468,840 | $ | 92,597,640 | ||
Callable | 24,691,750 | 43,140,750 | ||||
Total | $ | 116,160,590 | $ | 135,738,390 | ||
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 June 30, 2009 | |||
Year of contractual maturity or next call date: | |||
Due or callable in one year or less | $ | 69,503,665 | |
Due or callable after one year through two years | 23,577,160 | ||
Due or callable after two years through three years | 4,723,500 | ||
Due or callable after three years through four years | 4,277,765 | ||
Due or callable after four years through five years | 4,933,000 | ||
Due or callable after five years | 9,145,500 | ||
Total par value | $ | 116,160,590 | |
20
Table of Contents
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 | Average Interest Rate (%) | ||||||
As of June 30, 2009 | $ | 38,672,030 | $ | 38,734,238 | 0.69 | |||
As of December 31, 2008 | $ | 55,194,777 | $ | 55,393,546 | 1.73 | |||
Note 9—Capital and Mandatorily Redeemable Capital Stock
Capital.The Bank was in compliance with the Federal Housing Finance Agency (“Finance Agency”) regulatory capital rules and requirements, as shown in the following table (dollar amounts in thousands):
As of June 30, 2009 | As of December 31, 2008 | |||||||||||||||
Required | Actual | Required | Actual | |||||||||||||
Regulatory capital requirements: | ||||||||||||||||
Risk based capital | $ | 5,062,414 | $ | 9,028,397 | $ | 5,715,678 | $ | 8,942,306 | ||||||||
Total capital-to-assets ratio | 4.00 | % | 5.30 | % | 4.00 | % | 4.29 | % | ||||||||
Total regulatory capital* | $ | 6,808,234 | $ | 9,028,397 | $ | 8,342,574 | $ | 8,942,306 | ||||||||
Leverage ratio | 5.00 | % | 7.96 | % | 5.00 | % | 6.43 | % | ||||||||
Leverage capital | $ | 8,510,292 | $ | 13,542,596 | $ | 10,428,217 | $ | 13,413,459 |
* | Mandatorily redeemable capital stock is considered capital for regulatory purposes, and “total regulatory capital” includes the Bank’s $106.2 million and $44.4 million in mandatorily redeemable capital stock at June 30, 2009 and December 31, 2008, respectively. |
Mandatorily Redeemable Capital Stock.The following table provides the number of stockholders and the activity in mandatorily redeemable capital stock (dollar amounts in thousands):
Three Months Ended June 30, | ||||||||||||||
2009 | 2008 | |||||||||||||
Number of Stockholders | Amount | Number of Stockholders | Amount | |||||||||||
Balance, beginning of period | 21 | $ | 1,900,684 | 11 | $ | 36,881 | ||||||||
Capital stock subject to mandatory redemption reclassified from equity during the period due to: | ||||||||||||||
Attainment of nonmember status | 10 | 308,508 | 1 | 8,738 | ||||||||||
Withdrawal | 2 | 260 | — | — | ||||||||||
Other redemptions | 2 | 3,778 | — | — | ||||||||||
Repurchase/redemption of mandatorily redeemable capital stock | (5 | ) | (259,493 | ) | (2 | ) | (10,237 | ) | ||||||
Capital stock no longer subject to redemption due to a a nonmember becoming a member | (1 | ) | (1,847,500 | ) | — | — | ||||||||
Balance, end of period | 29 | $ | 106,237 | 10 | $ | 35,382 | ||||||||
21
Table of Contents
Six Months Ended June 30, | ||||||||||||||
2009 | 2008 | |||||||||||||
Number of Stockholders | Amount | Number of Stockholders | Amount | |||||||||||
Balance, beginning of period | 13 | $ | 44,428 | 11 | $ | 55,538 | ||||||||
Capital stock subject to mandatory redemption reclassified from equity during the period due to: | ||||||||||||||
Attainment of nonmember status | 19 | 2,173,981 | 2 | 17,353 | ||||||||||
Withdrawal | 5 | 1,398 | — | — | ||||||||||
Other redemptions | 4 | 3,943 | — | — | ||||||||||
Repurchase/redemption of mandatorily redeemable capital stock | (11 | ) | (270,013 | ) | (2 | ) | (36,941 | ) | ||||||
Capital stock no longer subject to redemption due to a a nonmember becoming a member | (1 | ) | (1,847,500 | ) | (1 | ) | (568 | ) | ||||||
Balance, end of period | 29 | $ | 106,237 | 10 | $ | 35,382 | ||||||||
The Bank reclassified $1.8 billion in capital stock held by Countrywide Bank, FSB (“Countrywide”), from capital to mandatorily redeemable capital stock upon termination of its membership with the Bank during the first quarter of 2009. Bank of America Corporation converted Countrywide into a national bank and merged it into Bank of America, N.A., a member of the Bank, on April 27, 2009. Upon the merger, the mandatorily redeemable capital stock of Countrywide became capital stock of Bank of America, N.A. under the Bank’s Capital Plan and was reclassified from mandatorily redeemable capital stock to capital stock.
The following table shows the amount of mandatorily redeemable capital stock by year of redemption (in thousands).
As of June 30, 2009 | As of December 31, 2008 | |||||
Contractual year of redemption: | ||||||
Due in one year or less | $ | — | $ | 3,764 | ||
Due after one year through two years | 416 | 3,578 | ||||
Due after two years through three years | 9,541 | 3,831 | ||||
Due after three years through four years | 4,223 | 8,948 | ||||
Due after four years through five years | 71,875 | 2,700 | ||||
Due after five years | 20,182 | 21,607 | ||||
Total | $ | 106,237 | $ | 44,428 | ||
The Bank is not required to redeem activity-based stock until the later of the expiration of the redemption period, which is five years after notification is received, or until the activity no longer remains outstanding. During 2008, it was the Bank’s practice, if, as a result of a member’s activity no longer remaining outstanding, a member’s activity-based stock became excess capital stock, the Bank would, in general, promptly repurchase the member’s excess stock, subject to certain limitations and thresholds in the Bank’s capital plan. During the first quarter of 2009, the Bank notified members of an increase in the excess stock threshold amount from $100 thousand to $2.5 billion and a change from the automatic daily repurchase of excess stock to a quarterly evaluation process.
22
Table of Contents
Note 10—Accumulated Other Comprehensive (Loss) Income
Components comprising other comprehensive (loss) income were as follows (in thousands):
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Benefit plans: | ||||||||||||||||
Amortization of net loss | $ | 213 | $ | 171 | $ | 425 | $ | 346 | ||||||||
Amortization of net prior service credit | (162 | ) | (182 | ) | (324 | ) | (357 | ) | ||||||||
Amortization of net transition obligation | 10 | 10 | 20 | 23 | ||||||||||||
Benefit plans, net | 61 | (1 | ) | 121 | 12 | |||||||||||
Noncredit portion of other-than-temporary losses on available-for-sale securities: | ||||||||||||||||
Change in unrealized losses on available-for-sale securities | (156,405 | ) | — | (150,553 | ) | — | ||||||||||
Reclassification adjustment of noncredit portion of impairment losses included in net income related to available-for-sale securities | 36,961 | — | 36,961 | — | ||||||||||||
Noncredit portion of other-than-temporary impairment losses on available-for-sale securities, net | (119,444 | ) | — | (113,592 | ) | — | ||||||||||
Noncredit portion of other-than-temporary impairment losses on held-to-maturity securities | (158,311 | ) | — | (766,859 | ) | — | ||||||||||
Other comprehensive (loss) income | $ | (277,694 | ) | $ | (1 | ) | $ | (880,330 | ) | $ | 12 | |||||
Components comprising accumulated other comprehensive (loss) income were as follows (in thousands):
Benefit Plans | Available-for-sale Noncredit Other- Than-Temporary- Impairment Losses | Held-to-maturity Noncredit Other- Than-Temporary- Impairment Losses | Total | |||||||||||||
Balance at December 31, 2008 | $ | (4,942 | ) | $ | — | $ | — | $ | (4,942 | ) | ||||||
Cumulative effect adjustment to opening balance relating to adoption of FSP FAS 115-2 and FAS 124-2 | — | — | (178,520 | ) | (178,520 | ) | ||||||||||
Net change during the period | 121 | (113,592 | ) | (766,859 | ) | (880,330 | ) | |||||||||
Reclassification of noncredit portion of other-than-temporary impairment losses on held-to-maturity securities to available-for-sale securities | — | (945,379 | ) | 945,379 | — | |||||||||||
Balance at June 30, 2009 | $ | (4,821 | ) | $ | (1,058,971 | ) | $ | — | $ | (1,063,792 | ) | |||||
Note 11—Employee Retirement Plans
Components of the net periodic benefit cost for the Bank’s supplemental defined benefit pension plan were as follows (in thousands):
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Service cost | $ | 142 | $ | 110 | $ | 284 | $ | 235 | ||||||||
Interest cost | 174 | 142 | 348 | 280 | ||||||||||||
Amortization of prior service credit | (11 | ) | (31 | ) | (22 | ) | (56 | ) | ||||||||
Amortization of net loss | 152 | 95 | 303 | 195 | ||||||||||||
Net periodic benefit cost | $ | 457 | $ | 316 | $ | 913 | $ | 654 | ||||||||
23
Table of Contents
Components of the net periodic benefit cost for the Bank’s postretirement health benefit plan were as follows (in thousands):
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Service cost | $ | 77 | $ | 68 | $ | 154 | $ | 143 | ||||||||
Interest cost | 104 | 95 | 208 | 195 | ||||||||||||
Amortization of net transition obligation | 10 | 10 | 20 | 23 | ||||||||||||
Amortization of prior service credit | (151 | ) | (151 | ) | (302 | ) | (301 | ) | ||||||||
Amortization of net loss | 61 | 76 | 122 | 151 | ||||||||||||
Net periodic benefit cost | $ | 101 | $ | 98 | $ | 202 | $ | 211 | ||||||||
Note 12—Derivatives and Hedging Activities
Nature of Business Activity
The Bank is exposed to interest rate risk primarily from the effect of interest rate changes on its interest-earning assets and funding sources which finance these assets.
The Bank enters into derivatives to manage the interest-rate risk exposures inherent in otherwise unhedged assets and funding positions, to achieve the Bank’s risk management objectives, and to act as an intermediary between its members and counterparties. Finance Agency regulations and the Bank’s risk management policy prohibit trading in or the speculative use of these derivative instruments and limit credit risk arising from these instruments. The Bank may use derivatives only to reduce funding costs for consolidated obligations and to manage its interest-rate risk, mortgage prepayment risk and foreign currency risk positions. Derivatives are an integral part of the Bank’s financial management strategy.
The most common ways in which the Bank use derivatives are to:
• | reduce the interest-rate sensitivity and repricing gaps of assets and liabilities; |
• | reduce funding costs by combining a derivative with a consolidated obligation as the cost of a combined funding structure can be lower than the cost of a comparable consolidated obligation bond; |
• | preserve a favorable interest-rate spread between the yield of an asset (e.g., an advance) and the cost of the related liability (e.g., the consolidated obligation bond used to fund the advance). Without the use of derivatives, this interest-rate spread could be reduced or eliminated when a change in the interest rate on the advance does not match a change in the interest rate on the bond; |
• | mitigate the adverse earnings effects of the shortening or extension of certain assets (e.g., mortgage assets); |
• | protect the value of existing asset or liability positions; |
• | manage embedded options in assets and liabilities; and |
• | as part of its overall asset/liability management. |
24
Table of Contents
Types of Derivatives
The Bank’s risk management policy establishes guidelines for its use of derivatives. The Bank may enter into interest-rate swaps, swaptions, interest-rate cap and floor agreements, calls, puts and forward contracts (collectively derivatives) to manage its exposure to changes in interest rates. The goal of the Bank’s interest rate risk management strategy is not to eliminate interest rate risk, but to manage it within appropriate limits. To mitigate the risk of loss, the Bank has established policies and procedures, which include guidelines on the amount of exposure to interest rate changes it is willing to accept. In addition, the Bank monitors the risk to its interest income, net interest margin and average maturity of interest-earning assets and funding sources.
One strategy the Bank uses to manage interest rate risk is to acquire and maintain a portfolio of assets and liabilities which, together with their associated interest rate derivatives, are reasonably matched with respect to the expected maturities or repricing of the assets and liabilities. The Bank also may use interest rate derivatives to adjust the effective maturity, repricing frequency, or option characteristics of financial instruments (such as advances, mortgage loans, MBS, and consolidated obligations) to achieve risk management objectives.
The Bank uses either derivative strategies or embedded options in its funding to minimize hedging costs. Swaps, swaptions, caps and floors are used to manage interest rate exposure.
Interest-Rate Swaps.An interest-rate swap is an agreement between two entities to exchange cash flows in the future. The agreement sets the dates on which the cash flows will be paid and the manner in which the cash flows will be calculated. One of the simplest forms of an interest-rate swap involves the promise by one party to pay cash flows equivalent to the interest on a notional principal amount at a predetermined fixed rate for a given period of time. In return for this promise, this party receives cash flows equivalent to the interest on the same notional principal amount at a variable-rate index for the same period of time. The variable rate received by the Bank in most interest-rate swap agreements is London Interbank Offered Rate (“LIBOR”).
Swaptions. A swaption is an option on a swap that gives the buyer the right to enter into a specified interest-rate swap at a certain time in the future. When used as a hedge, a swaption can protect the Bank when it is planning to lend or borrow funds in the future against future interest rate changes. The Bank purchases both payer swaptions and receiver swaptions. A payer swaption is the option to make fixed interest payments at a later date and a receiver swaption is the option to receive fixed interest payments at a later date.
Interest-Rate Caps and Floors.In a cap agreement, a cash flow is generated if the price or rate of an underlying variable rises above a certain threshold (or “cap”) price. In a floor agreement, a cash flow is generated if the price or rate of an underlying variable falls below a certain threshold (or “floor”) price. Caps and floors are designed as protection against the interest rate on a variable-rate asset or liability rising above or falling below a certain level.
Foreign Currencies. At times, the Bank has issued some consolidated obligations denominated in currencies other than U.S. dollars. The Bank uses forward exchange contracts to hedge currency risk on such consolidated obligations. These contracts exchange different currencies at specified rates on specified dates in the future. These contracts effectively simulate the conversion of consolidated obligations denominated in foreign currencies into ones denominated in U.S. dollars. As of June 30, 2009 and December 31, 2008, there were no outstanding consolidated obligations denominated in foreign currencies.
25
Table of Contents
Application of Derivatives
General. The Bank may use these derivatives to, in effect, adjust the maturity, repricing frequency, or option characteristics of financial instruments to achieve risk management objectives. The Bank uses derivatives in three ways: (1) as a fair value hedge of an underlying financial instrument or a firm commitment; (2) as an intermediary transaction; or (3) as a SFAS 133 non-qualifying hedge for purposes of asset/liability management. In addition to using derivatives to manage mismatches of interest rates between assets and liabilities, the Bank also uses derivatives to manage embedded options in assets and liabilities, to hedge the market value of existing assets and liabilities, to hedge the duration risk of prepayable instruments, to offset exactly other derivatives executed with members (when the Bank serves as an intermediary) and to reduce funding costs.
The Bank reevaluates its hedging strategies from time to time and may change the hedging techniques it uses or adopt new strategies.
Bank management uses derivatives when they are considered to be the most cost-effective alternative to achieve the Bank’s financial and risk management objectives. Accordingly, the Bank may enter into derivatives that do not qualify for hedge accounting (SFAS 133 non-qualifying hedge).
Types of Assets and Liabilities Hedged
The Bank documents at inception all relationships between derivatives designated as hedging instruments and hedged items, its risk management objectives and strategies for undertaking various hedge transactions, and its method of assessing effectiveness. This process includes linking all derivatives that are designated as fair value hedges to (1) assets and liabilities on the Statements of Condition, or (2) firm commitments. The Bank also formally assesses (both at the hedge’s inception and at least quarterly on an ongoing basis) whether the derivatives that it uses in hedging relationships have been effective in offsetting changes in the fair value of hedged items attributable to the risk being hedged and whether those derivatives may be expected to remain effective in future periods. The Bank uses regression analyses to assess the effectiveness of its hedges.
Consolidated Obligations. While consolidated obligations are the joint and several obligations of the FHLBanks, each FHLBank has consolidated obligations for which it is the primary obligor. The Bank enters into derivatives to hedge the interest rate risk associated with its specific debt issuances. The Bank manages the risk arising from changing market prices and volatility of a consolidated obligation by matching the cash inflow on the derivative with the cash outflow on the consolidated obligation. In addition, the Bank requires collateral on derivatives at specified levels correlated to counterparty credit ratings. For instance, in a typical transaction, fixed-rate consolidated obligations are issued for the Bank, and the Bank simultaneously enters into a matching derivative in which the counterparty pays fixed cash flows to the Bank designed to mirror in timing and amount the cash outflows the Bank pays on the consolidated obligation. The Bank pays a variable cash flow that closely matches the interest payments it receives on short-term or variable-rate advances (typically one- or three-month LIBOR). These transactions are treated as fair-value hedges under SFAS 133. This intermediation between the capital and swap markets permits the Bank to raise funds at lower costs than otherwise would be available through the issuance of simple fixed-rate consolidated obligations in the capital markets.
26
Table of Contents
Advances. The Bank offers a variety of advance structures to meet members’ funding needs. These advances may have maturities of up to 30 years with variable or fixed rates and may include early termination features or options. The Bank may use derivatives to adjust the repricing and/or options characteristics of advances in order to more closely match the characteristics of the Bank’s funding liabilities. In general, whenever a member executes a fixed-rate advance or a variable-rate advance with embedded options, the Bank simultaneously will execute a derivative with terms that offset the terms and embedded options in the advance. For example, the Bank may hedge a fixed-rate advance with an interest-rate swap where the Bank pays a fixed-rate coupon and receives a variable-rate coupon, effectively converting the fixed-rate advance to a variable-rate advance.
Mortgage Assets.The Bank has invested in fixed-rate mortgage assets. The prepayment options embedded in mortgage assets may result in extensions or contractions in the expected repayment of these investments, depending on changes in estimated prepayment speeds. Finance Agency regulation limits this source of interest-rate risk by restricting the types of mortgage assets the Bank may own to those with limited average life changes under certain interest-rate shock scenarios and by establishing limitations on duration of equity and change in market value of equity. The Bank manages prepayment and duration risk by funding some mortgage assets with consolidated obligations that have call features. In addition, the Bank may use derivatives to manage the prepayment and duration variability of mortgage assets. Net income could be reduced if the Bank replaces the mortgages with lower-yielding assets and if the Bank’s higher funding costs are not reduced concomitantly.
The Bank manages the interest-rate and prepayment risk associated with mortgages through a combination of debt issuance and derivatives. The Bank issues both callable and non-callable debt to achieve cash flow patterns and liability durations similar to those expected on the mortgage loans. The Bank may use derivatives to match the expected prepayment characteristics of the mortgages.
Options (interest-rate caps, interest-rate floors and/or options) also may be used to hedge prepayment risk on the mortgages, many of which are not identified to specific mortgages and, therefore, do not receive fair-value or cash-flow hedge accounting treatment. The options are marked-to-market through current-period earnings and presented in the Statements of Income as “Net gains (losses) on derivatives and hedging activities.” The Bank also may purchase interest-rate caps and floors, swaptions, callable swaps, calls, and puts to minimize the prepayment risk embedded in the mortgage loans. Although these derivatives are valid SFAS 133 non-qualifying hedges against the prepayment risk of the loans, they do not receive either fair-value or cash-flow hedge accounting.
The Bank analyzes the duration, convexity, and earnings risk of the mortgage portfolio on a regular basis under various rate scenarios.
Firm Commitment Strategies. In accordance with SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (“SFAS 149”), certain mortgage purchase commitments are considered derivatives. Mortgage purchase commitments are recorded on the balance sheet at fair value, with changes in fair value recognized in current-period earnings. When the mortgage purchase commitment derivative settles, the current market value of the commitment is included with the basis of the mortgage loan and amortized accordingly.
The Bank also may enter into a fair value hedge of a firm commitment for a forward starting advance through the use of an interest-rate swap. In this case, the swap will function as the hedging instrument for
27
Table of Contents
both the firm commitment and the subsequent advance. The basis movement associated with the firm commitment will be rolled into the basis of the advance at the time the commitment is terminated and the advance is issued. The basis adjustment will then be amortized into interest income over the life of the advance using the level-yield method.
Investments. The Bank invests in U.S. agency obligations, MBS, and the taxable portion of state or local housing finance agency obligations. The interest-rate and prepayment risks associated with these investment securities is managed through a combination of debt issuance and derivatives. The Bank may manage the prepayment and interest rate risks by funding investment securities with consolidated obligations that have call features, or by hedging the prepayment risk with caps or floors, or by adjusting the duration of the securities by using derivatives to modify the cash flows of the securities. Investment securities may be classified as trading, available-for-sale or held-to-maturity.
The Bank also may manage the risk arising from changing market prices and volatility of investment securities classified as trading by entering into derivatives (SFAS 133 non-qualifying hedges) that offset the changes in fair value of the securities. The market value changes of both the trading securities and the associated derivatives are included in “Other Income (Loss)” in the Statements of Income and presented as part of the “Net losses on trading securities” and “Net gains (losses) on derivatives and hedging activities.”
The Bank is not a derivative dealer and thus does not trade derivatives for short-term profit.
Managing Credit Risk on Derivatives
The Bank is subject to credit risk due to nonperformance by counterparties to the derivative agreements. The amount of counterparty risk depends on the extent to which master netting arrangements are included in such contracts to mitigate the risk. The Bank manages counterparty credit risk through credit analysis, collateral requirements and adherence to the requirements set forth in Bank policies and regulations. Based on credit analyses and collateral requirements, Bank management presently does not anticipate any credit losses on its existing derivative agreements with counterparties as of June 30, 2009.
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 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. As of June 30, 2009, the Bank has not sold or repledged any such collateral.
As of June 30, 2009 and December 31, 2008, the Bank’s maximum credit risk, as defined above, was approximately $120.1 million and $117.7 million, respectively. These totals include $38.4 million and $12.0 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 held by the Bank as collateral for derivatives was $95.4 million and $69.7 million as of June 30, 2009 and December 31, 2008, 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.
28
Table of Contents
Certain of the Bank’s derivative instruments contain provisions that require the Bank to post additional collateral with its counterparties if there is deterioration in the Bank’s credit rating. If the Bank’s credit rating is lowered by a major credit rating agency, the Bank would be required to deliver additional collateral on derivative instruments in net liability positions. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a net liability position at June 30, 2009 was $4.9 billion for which the Bank has posted collateral of $4.7 billion in the normal course of business. If the Bank’s credit ratings had been lowered from its current rating to the next lower rating that would have triggered additional collateral to be delivered and the Bank would have been required to deliver up to an additional $170.0 million of collateral (at fair value) to its derivatives counterparties at June 30, 2009. However, the Bank’s credit rating has not changed during the previous 12 months.
The Bank transacts most of its derivatives with large banks and major broker-dealers. Some of these banks and broker-dealers or their affiliates buy, sell, and distribute consolidated obligations. Note 14 discusses assets pledged by the Bank to these counterparties.
Intermediation.To assist its members in meeting their hedging needs, the Bank acts as an intermediary between the members and other counterparties by entering into offsetting derivatives. This intermediation allows smaller members indirect access to the derivatives market.
Derivatives in which the Bank is an intermediary may arise when the Bank: (1) enters into derivatives with members and offsetting derivatives with other counterparties to meet the needs of its members, and (2) enters into derivatives to offset the economic effect of other derivatives that are no longer designated to either advances, investments, or consolidated obligations.
Total notional principal of derivatives for the Bank as an intermediary was $2.3 billion and $2.5 billion at June 30, 2009 and December 31, 2008, respectively.
Financial Statement Effect and Additional Financial Information
Derivative Notional Amounts.The notional amount of derivatives serves as a factor in determining periodic interest payments or cash flows received and paid.
29
Table of Contents
The following table summarizes fair value of derivative instruments without effect of netting arrangements or collateral as of June 30, 2009 (in thousands). For purposes of this disclosure, the derivative values include fair value of derivatives and related accrued interest.
As of June 30, 2009 | |||||||||||
Notional Amount of Derivatives | Derivative Assets | Derivative Liabilities | |||||||||
Derivatives in SFAS 133 hedging relationships under SFAS 133: | |||||||||||
Interest rate swaps | $ | 198,936,481 | $ | 1,955,043 | $ | (6,256,487 | ) | ||||
Total derivatives in SFAS 133 hedging relationships | 198,936,481 | 1,955,043 | (6,256,487 | ) | |||||||
Derivatives not designated as hedging instruments under SFAS 133: | |||||||||||
Interest rate swaps | 11,767,071 | 33,131 | (522,331 | ) | |||||||
Interest rate caps or floors | 4,300,000 | 56,182 | (18,677 | ) | |||||||
Total derivatives not designated as hedging instruments under SFAS 133 | 16,067,071 | 89,313 | (541,008 | ) | |||||||
Total derivatives before netting and collateral adjustments | $ | 215,003,552 | 2,044,356 | (6,797,495 | ) | ||||||
Netting adjustments | (1,898,517 | ) | 1,898,517 | ||||||||
Cash collateral and related accrued interest | (95,443 | ) | 4,184,216 | ||||||||
Total collateral and netting adjustments * | (1,993,960 | ) | 6,082,733 | ||||||||
Derivative assets and derivative liabilities | $ | 50,396 | $ | (714,762 | ) | ||||||
* | Amounts represent the effect of legally enforceable master netting agreements that allow the Bank to settle positive and negative positions and also cash collateral held or placed with the same counterparties. |
The following table presents the components of net gains (losses) on derivatives and hedging activities as presented in the Statements of Income (in thousands).
Three Months Ended June 30, 2009 | Six Months Ended June 30, 2009 | ||||||
Amount of Gain Recognized in Net Gains (Losses) on Derivatives and Hedging Activities | Amount of Gain (Loss) Recognized in Net Gains (Losses) on Derivatives and Hedging Activities | ||||||
Derivatives and hedged items in SFAS 133 fair value hedging relationships: | |||||||
Interest rate swaps | $ | 196,929 | $ | 297,099 | |||
Total net gain related to fair value hedge ineffectiveness | 196,929 | 297,099 | |||||
Derivatives not designated as hedging instruments under SFAS 133: | |||||||
Economic hedges: | |||||||
Interest rate swaps | 106,282 | 117,133 | |||||
Interest rate caps or floors | 1,742 | 3,164 | |||||
Interest rate futures/forwards | — | (146 | ) | ||||
Intermediary transactions: | |||||||
Interest rate swaps | — | (10 | ) | ||||
Interest rate caps or floors | 5 | 10 | |||||
Total net gain related to derivatives not designated as hedging instruments under SFAS 133 | 108,029 | 120,151 | |||||
Net gains on derivatives and hedging activities | $ | 304,958 | $ | 417,250 | |||
30
Table of Contents
The following table presents, by type of hedged item, the gains (losses) on derivatives and the related hedged items in fair value hedging relationships and the impact of those derivatives on the Bank’s net interest income (in thousands).
Three Months Ended June 30, 2009 | ||||||||||||||||
Hedged Item Type | Gain/(Loss) on Derivative | Gain/(Loss) on Hedged Item | Net Fair Value Hedge Ineffectiveness | Effect of Derivatives on Net Interest Income * | ||||||||||||
Advances | $ | 2,187,642 | $ | (1,995,060 | ) | $ | 192,582 | $ | (868,098 | ) | ||||||
Consolidated Obligations | ||||||||||||||||
Bonds | (559,620 | ) | 556,346 | (3,274 | ) | 339,698 | ||||||||||
Discount notes | 10,697 | (3,076 | ) | 7,621 | 30,993 | |||||||||||
Total | $ | 1,638,719 | $ | (1,441,790 | ) | $ | 196,929 | $ | (497,407 | ) | ||||||
* | The net interest income on derivatives in fair value hedge relationships is presented in the interest income/expense line item of the respective hedged item. |
Six Months Ended June 30, 2009 | |||||||||||||||
Hedged Item Type | Gain/(Loss) on Derivative | Gain/(Loss) on Hedged Item | Net Fair Value Hedge Ineffectiveness | Effect of Derivatives on Net Interest Income * | |||||||||||
Advances | $ | 3,434,135 | $ | (3,157,848 | ) | $ | 276,287 | $ | (1,634,748 | ) | |||||
Consolidated Obligations | |||||||||||||||
Bonds | (868,660 | ) | 884,400 | 15,740 | 705,087 | ||||||||||
Discount notes | (15,118 | ) | 20,190 | 5,072 | 38,103 | ||||||||||
Total | $ | 2,550,357 | $ | (2,253,258 | ) | $ | 297,099 | $ | (891,558 | ) | |||||
* | The net interest income on derivatives in fair value hedge relationships is presented in the interest income/expense line item of the respective hedged item. |
Note 13—Estimated Fair Values
The Bank records trading securities, available-for-sale 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 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
31
Table of Contents
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 June 30, 2009, the Bank did not carry any financial assets or 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 June 30, 2009, the types of financial assets and liabilities the Bank 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 June 30, 2009, the Bank carried available-for-sale securities 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.
Fair Value on a Recurring Basis.The following tables present 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 June 30, 2009 | ||||||||||||||||||
Fair Value Measurements Using | ||||||||||||||||||
Level 1 | Level 2 | Level 3 | Netting Adjustment* | Total | ||||||||||||||
Assets | ||||||||||||||||||
Trading securities: | ||||||||||||||||||
Government-sponsored enterprises debt obligations | $ | — | $ | 3,658,337 | $ | — | $ | — | $ | 3,658,337 | ||||||||
Other FHLBanks’ bonds | — | 154,885 | — | — | 154,885 | |||||||||||||
State or local housing agency obligations | — | 14,083 | — | — | 14,083 | |||||||||||||
Available-for-sale: | ||||||||||||||||||
Private-label MBS | — | — | 1,536,608 | — | 1,536,608 | |||||||||||||
Derivative assets | — | 2,044,356 | — | (1,993,960 | ) | 50,396 | ||||||||||||
Total assets at fair value | $ | — | $ | 5,871,661 | $ | 1,536,608 | $ | (1,993,960 | ) | $ | 5,414,309 | |||||||
Liabilities | ||||||||||||||||||
Derivative liabilities | $ | — | $ | (6,797,495 | ) | $ | — | $ | 6,082,733 | $ | (714,762 | ) | ||||||
Total liabilities at fair value | $ | — | $ | (6,797,495 | ) | $ | — | $ | 6,082,733 | $ | (714,762 | ) | ||||||
* | Amounts represent the effect of legally enforceable master netting agreements that allow the Bank to settle positive and negative positions and also cash collateral held or placed with the same counterparties. |
32
Table of Contents
As of December 31, 2008 | ||||||||||||||||||
Fair Value Measurements Using | ||||||||||||||||||
Level 1 | Level 2 | Level 3 | Netting Adjustment* | Total | ||||||||||||||
Assets | ||||||||||||||||||
Trading securities | $ | — | $ | 4,485,929 | $ | — | $ | — | $ | 4,485,929 | ||||||||
Derivative assets | — | 2,813,328 | — | (2,721,922 | ) | 91,406 | ||||||||||||
Total assets at fair value | $ | — | $ | 7,299,257 | $ | — | $ | (2,721,922 | ) | $ | 4,577,335 | |||||||
Liabilities | ||||||||||||||||||
Derivative liabilities | $ | — | $ | (10,404,378 | ) | $ | — | $ | 8,990,586 | $ | (1,413,792 | ) | ||||||
Total liabilities at fair value | $ | — | $ | (10,404,378 | ) | $ | — | $ | 8,990,586 | $ | (1,413,792 | ) | ||||||
* | Amounts represent the effect of legally enforceable master netting agreements that allow the Bank to settle positive and negative positions and also cash collateral held or placed with the same counterparties. |
For financial instruments carried at fair value, the Bank reviews the fair value hierarchy classification of financial assets and liabilities on a quarterly basis. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets or liabilities. Such reclassifications are reported as transfers in and/or out of Level 3 at fair value in the quarter in which the changes occur.
The following table presents a reconciliation of available-for-sale securities that are measured at fair value using significant unobservable inputs (Level 3) (in thousands):
Six Months Ended June 30, 2009 | ||||
Balance, beginning of the period | $ | — | ||
Transfer of private-label MBS from held-to-maturity to available-for-sale | 1,760,477 | |||
Total net realized losses during the period | (36,961 | ) | ||
Total net unrealized losses during the period | (186,908 | ) | ||
Balance, end of the period | $ | 1,536,608 | ||
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 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 based on market observable inputs obtained from an outside source that are input into the Bank’s valuation model.
33
Table of Contents
Private-label MBS.The fair value of the Bank’s private-label MBS is determined by reference to prices from third-party broker/dealers or pricing services and by a discounted cash flow approach. The significant reduction in transaction volumes and widening credit spreads led the Bank to conclude that the prices received from pricing services, which were derived from the third-party’s proprietary models, were reflective of significant unobservable inputs. Because of the significant unobservable inputs used by the pricing services, the Bank considered these to be Level 3 inputs.
Due to the reduced market activity for the Bank’s private-label MBS, the Bank also determined prices for certain securities using a discounted cash flow approach. This discounted cash flow model used cash flows adjusted for credit factors calculated by a third-party model and discounted at a rate incorporating interest-rate and market liquidity factors. Other significant inputs include loan default rates, prepayment speeds, and loss severity rates. Due to the unobservable nature of the inputs, the discounted cash flow model is classified as Level 3.
The Bank evaluated the reasonableness of the two above Level 3 indicators of prices for its private-label MBS and determined that multiple inputs from different pricing sources would collectively provide the best evidence of fair value as of June 30, 2009. Generally, the Bank used prices obtained from multiple third-party pricing services to determine the fair value of its private-label MBS. When the Bank was unable to obtain a sufficient number of prices from third-party vendors (generally less than two third-party prices), the Bank utilized prices determined by a discounted cash flow model to determine the fair value of the private-label MBS.
Agency MBS and Other Held-to-maturity Securities.The estimated fair value of agency MBS and other held-to-maturity securities is generally determined based on market-based prices received from third party pricing services, excluding accrued interest. The prices received from third-party pricing services are generally non-binding. 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. In obtaining such valuation information from third parties, the Bank generally evaluates the prices for reasonableness in order to determine whether such valuations are representative of an exit price in the Bank’s principal markets.
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 observable LIBOR curve for advances with similar terms as of June 30, 2009 and December 31, 2008, respectively. In accordance with the 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.
34
Table of Contents
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.
Derivative instruments are primarily transacted in the institutional dealer market and priced with observable market assumptions at a mid-market valuation point. The Bank does not provide a credit valuation adjustment based on aggregate exposure by derivative counterparty when measuring the fair value of its derivatives. This is because the collateral provisions pertaining to the Bank’s derivatives obviate the need to provide such a credit valuation adjustment. The fair values of the Bank’s derivatives take into consideration the effects of legally enforceable master netting agreements that allow the Bank to settle positive and negative positions and offset cash collateral with the same counterparty on a net basis. The Bank and each derivative counterparty have bilateral collateral thresholds that take into account both the Bank’s and the counterparty’s credit ratings. As a result of these practices and agreements, the Bank has concluded that the impact of the credit differential between it and its derivative counterparties was mitigated to an immaterial level and no further adjustments were deemed necessary to the recorded fair values of derivative assets and liabilities on the Statements of Condition at June 30, 2009 and December 31, 2008.
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 and to some extent on the Office of Finance cost of funds curve, which 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 June 30, 2009 and December 31, 2008. 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.
35
Table of Contents
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, although they do reflect the Bank’s judgment of how a market participant would estimate the fair value. 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.
The carrying values and estimated fair values of the Bank’s financial instruments as of June 30, 2009 were as follows (in thousands):
2009 FAIR VALUE SUMMARY
Financial Instruments | Carrying Value | Estimated Fair Value | ||||||
Assets: | ||||||||
Cash and due from banks | $ | 12,473 | $ | 12,473 | ||||
Deposits with other FHLBanks | 2,614 | 2,614 | ||||||
Federal funds sold | 8,202,000 | 8,202,000 | ||||||
Trading securities | 3,827,305 | 3,827,305 | ||||||
Available-for-sale securities | 1,536,608 | 1,536,608 | ||||||
Held-to-maturity securities | 18,447,139 | 16,636,699 | ||||||
Mortgage loans held for portfolio, net | 2,833,348 | 2,918,912 | ||||||
Advances, net | 134,502,617 | 134,155,381 | ||||||
Accrued interest receivable | 600,554 | 600,554 | ||||||
Derivative assets | 50,396 | 50,396 | ||||||
Liabilities: | ||||||||
Deposits | (4,147,790 | ) | (4,148,653 | ) | ||||
Consolidated obligations, net: | ||||||||
Discount notes | (38,672,030 | ) | (38,706,282 | ) | ||||
Bonds | (117,755,528 | ) | (118,273,533 | ) | ||||
Mandatorily redeemable capital stock | (106,237 | ) | (106,237 | ) | ||||
Accrued interest payable | (698,694 | ) | (698,694 | ) | ||||
Derivative liabilities | (714,762 | ) | (714,762 | ) |
36
Table of Contents
The carrying values and estimated fair values of the Bank’s financial instruments as of December 31, 2008 were as follows (in thousands):
2008 FAIR VALUE SUMMARY
Financial Instruments | Carrying Value | Estimated Fair Value | ||||||
Assets: | ||||||||
Cash and due from banks | $ | 27,841 | $ | 27,841 | ||||
Deposits with other FHLBanks | 2,888 | 2,888 | ||||||
Federal funds sold | 10,769,000 | 10,768,763 | ||||||
Trading securities | 4,485,929 | 4,485,929 | ||||||
Held-to-maturity securities | 23,118,123 | 19,593,615 | ||||||
Mortgage loans held for portfolio, net | 3,251,074 | 3,348,375 | ||||||
Advances, net | 165,855,546 | 165,772,958 | ||||||
Accrued interest receivable | 775,083 | 775,083 | ||||||
Derivative assets | 91,406 | 91,406 | ||||||
Liabilities: | ||||||||
Deposits | (3,572,709 | ) | (3,572,475 | ) | ||||
Consolidated obligations, net: | ||||||||
Discount notes | (55,194,777 | ) | (55,365,686 | ) | ||||
Bonds | (138,181,334 | ) | (138,740,905 | ) | ||||
Mandatorily redeemable capital stock | (44,428 | ) | (44,428 | ) | ||||
Accrued interest payable | (1,039,002 | ) | (1,039,002 | ) | ||||
Derivative liabilities | (1,413,792 | ) | (1,413,792 | ) |
Note 14—Commitments and Contingencies
As described in Note 8, consolidated obligations are backed only by the financial resources of the 12 FHLBanks. The Finance Agency, 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 $901.0 billion and $1.1 trillion as of June 30, 2009 and December 31, 2008, respectively, exclusive of the outstanding consolidated obligations for which the Bank is the primary obligor.
During the third quarter of 2008, each FHLBank entered into a Lending Agreement with the U.S. Treasury in connection with the U.S. Treasury’s establishment of the Government Sponsored Enterprise Credit Facility (“GSECF”), as authorized by the Housing and Economic Recovery Act of 2008 (“Housing Act”). The GSECF is designed to serve as a contingent source of liquidity for the housing government-sponsored enterprises, including each of the 12 FHLBanks. Any borrowings by one or more of the FHLBanks under the GSECF are considered consolidated obligations with the same joint and several liability as all other consolidated obligations. The terms of any borrowings are agreed to at the time of issuance. Loans under the Lending Agreement are to be secured by collateral acceptable to the U.S. Treasury, which consists of FHLBank advances to members that have been collateralized in accordance
37
Table of Contents
with regulatory standards and MBS issued by Fannie Mae or Freddie Mac. Each FHLBank is required to submit to the Federal Reserve Bank of New York, acting as fiscal agent of the U.S. Treasury, a list of eligible collateral, updated on a weekly basis. As of June 30, 2009, the Bank has provided the U.S. Treasury with a listing of collateral amounting to $10.5 billion, which provides for maximum borrowings of $9.1 billion. The amount of collateral available can be increased or decreased (subject to the approval of the U.S. Treasury) at any time through the delivery of an updated listing of collateral. As of June 30, 2009 the Bank has not drawn on this available source of liquidity.
The Bank’s outstanding standby letters of credit were as follows:
As of June 30, 2009 | As of December 31, 2008 | |||
Outstanding notional (in thousands) | $ 11,837,285 | $ 10,231,656 | ||
Original terms | Less than three months to 16 years | Less than three months to 15 years | ||
Final expiration year | 2025 | 2023 |
The value of the guarantees related to standby letters of credit is recorded in other liabilities and amounted to $36.4 million and $35.0 million as of June 30, 2009 and December 31, 2008, 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.
The Bank monitors the creditworthiness of its standby letters of credit based on an evaluation of the guaranteed entity. The Bank has established parameters for the measurement, review, classification, and monitoring of credit risk related to these standby letters of credit that results in an internal credit rating, which focuses primarily on an institution’s overall financial health and takes into account quality of assets, earnings, and capital position. In general, borrowers categorized into the higher risk rating categories have more restrictions on the types of collateral they may use to secure standby letters of credit, may be required to maintain higher collateral maintenance levels and deliver loan collateral, and may face more stringent collateral reporting requirements.
The Bank did not have any commitments that unconditionally obligate the Bank to purchase closed mortgage loans as of June 30, 2009 and December 31, 2008. Commitments are generally for periods not to exceed 45 days. Such commitments are recorded as derivatives at their fair values under SFAS 149.
The Bank executes derivatives with major banks and broker-dealers and generally enters into bilateral collateral agreements. As of June 30, 2009 and December 31, 2008, 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 $510.8 million and $1.1 billion, respectively, which can be sold or repledged by those counterparties.
At June 30, 2009, the Bank had committed to the issuance of $1.0 billion (par value) in consolidated obligation bonds, of which $1.0 billion were hedged with associated interest rate swaps, and $209.9 million (par value) in consolidated obligation discount notes, none of which were hedged to associated interest rate swaps. At December 31, 2008, the Bank had committed to the issuance of $3.0 billion (par value) in consolidated obligation bonds of which $2.8 million were hedged with associated interest rate swaps, and $100.2 million (par value) in consolidated obligation discount notes of which $99.2 million were hedged with associated interest rate swaps that had traded but not yet settled.
38
Table of Contents
The Bank is subject to legal proceedings arising in the normal course of business. After consultation with legal counsel, management does not anticipate, as of the date of the financial statements, 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 15—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, Bank of America, N.A., which held 23.3 percent of the Bank’s total regulatory capital stock as of June 30, 2009, was considered a related party. Total advances outstanding to Bank of America, N.A. were $39.1 billion and $3.8 billion as of June 30, 2009 and December 31, 2008, respectively. The total advance balance at June 30, 2009 includes the assumption of Countrywide’s advances by Bank of America, N.A. Total deposits held in the name of Bank of America were $100 thousand as of June 30, 2009 and December 31, 2008. No mortgage loans were acquired from Bank of America, N.A. during the six-month periods ended June 30, 2009 and 2008. No mortgage-backed securities were acquired from Bank of America, N.A. during the six-month periods ended June 30, 2009 and June 30, 2008.
Note 16—Subsequent Events
On August 10, 2009, the Bank’s board of directors declared a cash dividend for the second quarter of 2009 in the amount of $15.8 million. The Bank expects to pay the second quarter 2009 dividend on August 14, 2009.
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:
39
Table of Contents
• | 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 second quarter and the first six months ended June 30, 2009 and 2008. 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, 2008.
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 makes grants and subsidized advances under the 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 FHLBanks are the principal funding source for Bank assets. The Bank is primarily liable for repayment of COs issued on its behalf and is jointly and severally liable for the COs 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 competitively-priced credit to help its members meet the credit needs of their communities.
Financial Condition
As of June 30, 2009, total assets were $170.2 billion, a decrease of $38.4 billion, or 18.4 percent, from December 31, 2008. This decrease was due primarily to a $31.4 billion, or 18.9 percent, decrease in advances and a $4.7 billion, or 20.2 percent, decrease in held-to-maturity securities during the period. Advances, the largest asset on the Bank’s balance sheet, decreased during the period due to maturing advances and decreased demand for advances by the Bank’s members. The decrease in held-to-maturity securities during the period was due primarily to $2.5 billion in proceeds received for principal repayments and maturities, the Bank’s continued decline in its purchase of MBS, and total other-than-temporary impairment losses of $865.0 million recorded on held-to-maturity securities which were subsequently
40
Table of Contents
transferred to the Bank’s available-for-sale portfolio. Available-for-sale securities were $1.5 billion as of June 30, 2009 compared to $0 as of December 31, 2008. These securities represent private-label MBS previously held in the Bank’s held-to-maturity portfolio for which the Bank has recorded an other-than-temporary impairment loss and subsequently transferred to the Bank’s available-for-sale portfolio.
As of June 30, 2009, total liabilities were $162.3 billion, a decrease of $37.3 billion, or 18.7 percent, from December 31, 2008. This decrease was due primarily to a $36.9 billion, or 19.1 percent, decrease in COs during the period. The decrease in COs corresponds to the decrease in demand for advances by the Bank’s members during the period.
As of June 30, 2009, total capital was $7.9 billion, a decrease of $1.0 billion, or 11.6 percent, from December 31, 2008. This decrease was due primarily to a $1.1 billion increase in accumulated other comprehensive loss during the period. The increase in accumulated other comprehensive loss was due primarily to the adoption of FSP FAS 115-2 and FAS 124-2 as of January 1, 2009. This adoption resulted in a $178.5 million cumulative effect adjustment to retained earnings (increase) and other comprehensive loss (increase) as of the date of adoption and the recording of $966.6 million related to the noncredit portion of other-than-temporary impairment losses in other comprehensive loss during the first six months of 2009. The Bank’s retained earnings were $803.6 million as of June 30, 2009, an increase of $368.7 million, or 84.8 percent, from December 31, 2008. The increase in retained earnings was due to the adoption of FSP FAS 115-2 and FAS 124-2, as previously discussed, and the recording of $190.2 million in net income for the first six months of 2009.
Results of Operations
The Bank recorded net income of $191.7 million for the second quarter of 2009, an increase of $83.0 million, or 76.4 percent, from net income of $108.7 million for the second quarter of 2008. The increase in net income during the period was due primarily to a $181.8 million increase in net gains on derivatives and hedging activities and a $114.6 million decrease in net losses on trading securities, offset by a $136.7 million decrease in net interest income, the recording of net impairment losses in earnings of $46.2 million, and a $29.9 million increase in total assessments. The increase in net gains on derivatives and hedging activities resulted from a decrease in LIBOR during the period and mark-to-market gains on swaps in discontinued hedging relationships. The decrease in net losses on trading securities was due primarily to the impact of changes in interest rates on trading securities during the period. The decrease in net interest income during the period was due primarily to the write-off of SFAS 133-related basis adjustments on advances that were prepaid during the second quarter of 2009 and amortization related to discontinued hedging activities.
The Bank recorded net income of $190.2 million for the first six months of 2009, a decrease of $35.1 million, or 15.6 percent, from net income of $225.3 million for the same period in 2008. The decrease in net income during the period was due primarily to a $308.7 million decrease in net interest income, the recording of net impairment losses on private-label MBS recognized in earnings of $135.1 million, and a $25.6 million increase on net losses on trading securities, offset by a $423.2 million increase in net gains on derivatives and hedging activities and a $12.6 million decrease in total assessments. The increase in net gains on derivatives and hedging activities resulted from a decrease in LIBOR during the period and mark-to-market gains on swaps in discontinued hedging relationships. The increase in net losses on trading securities is due primarily to the impact of changes in interest rates on trading securities during the period. As discussed above, net interest income decreased as a result of the write-off of SFAS 133-related basis
41
Table of Contents
adjustments on advances that were prepaid during the second quarter of 2009 and amortization related to discontinued hedging activities.
One way in which the Bank analyzes its performance is by comparing its annualized return on equity (“ROE”) to three-month average LIBOR. The Bank’s ROE was 10.3 percent for the second quarter of 2009, compared to 5.13 percent for the second quarter of 2008. ROE increased between the periods primarily as a result of increased net income and decreased capital as discussed above. ROE spread to three-month average LIBOR increased between the periods, equaling 9.50 percent for the second quarter of 2009 as compared to 2.38 percent for the second quarter of 2008. The increase in this spread was due primarily to the increased ROE during the period.
The Bank’s annualized ROE was 4.97 percent for the first six months of 2009, compared to 5.42 percent for the same period in 2008. ROE spread to three-month average LIBOR increased between the periods, equaling 3.93 percent for the first six months of 2009 as compared to 2.40 percent for the same period in 2008. The increase in this spread was due primarily to a 198 basis point decrease in three-month average LIBOR during the first six months of 2009 compared to a 45 basis point decrease in ROE during the first six months of 2008.
The Bank’s interest rate spread decreased by 19 basis points and 23 basis points for the second quarter and the first six months of 2009, respectively, compared to the same periods in 2008. The decrease in interest rate spread during these periods was due primarily to advances repricing faster than corresponding liabilities in the lower rate environment. In addition, lower yields on advances due to the write-off of SFAS 133-related basis adjustments on advances that were prepaid during the second quarter of 2009 contributed to the decrease in interest rate spread.
Credit Risk and Capital Management
As a result of recent market conditions, delinquency and foreclosure rates have increased significantly nationwide. Additionally, home prices have fallen in many areas, increasing the likelihood and magnitude of potential losses to lenders of foreclosed real estate. These trends may continue throughout 2009 and into the foreseeable future. The uncertainty as to the depth and duration of these trends has led to a significant reduction in the market values of MBS. During the second quarter and first six months of 2009, the Bank recorded net impairment losses recognized in earnings of $46.2 million and $135.1 million, respectively, related to private-label MBS in the Bank’s held-to-maturity and available-for-sale securities portfolios. Given the current market conditions and the significant judgments involved, there is a continuing risk that further declines in fair value may occur and that the Bank may record additional material other-than-temporary impairment losses in future periods, which could affect the Bank’s financial condition and results of operations.
According to the Federal Deposit Insurance Corporation (the “FDIC”), during the second quarter of 2009, 24 FDIC-insured institutions were closed and the FDIC was named receiver, compared to 21 institutions that were closed during the first quarter of 2009. Seven of the FDIC-insured institutions that were closed during the second quarter of 2009 were members of the Bank. Additionally, a state-chartered life insurance company member was placed under the receivership for rehabilitation by its state regulator, a status similar to an FDIC conservatorship. Between July 1, 2009 and July 31, 2009, eight FDIC-insured member institutions were closed and the FDIC was named receiver. All outstanding advances to those institutions placed into FDIC receivership were either paid in full or assumed by another member
42
Table of Contents
institution under purchase and assumption agreements between the assuming institution and the FDIC. As of July 31, 2009, all advances to the institution under receivership for rehabilitation continued to be outstanding and interest payments were being made in accordance with their terms, pending resolution of the receivership for rehabilitation. There has been no material effect to the Bank’s financial condition or results of operations as a result of these closures or of the receivership for rehabilitation.
At the time of their closure or receivership for rehabilitation, these institutions were assigned a credit risk rating of 10 by the Bank (10 being the greatest amount of credit risk). As of June 30, 2009, 103 borrowers were assigned a credit risk rating of 10 by the Bank, compared to 50 at December 31, 2008. As of July 31, 2009, 126 borrowers were assigned a credit risk rating of 10 by the Bank. Credit risk ratings are assigned and updated based in part on financial information available only on a trailing basis. The failure of a material number of the Bank’s members could have a material negative effect on the Bank’s financial condition and results of operations.
The Bank has never experienced a credit loss on an advance. The FHLBank Act affords any security interest granted to the Bank by any member of the Bank, or any affiliate of any such member, priority over the claims and rights of any party (including any receiver, conservator, trustee, or similar party having rights of a lien creditor), other than claims and rights that (1) would be entitled to priority under otherwise applicable law and (2) are held by actual bona fide purchasers for value or by actual secured parties that are secured by actual perfected security interests.
On March 25, 2009, the Bank announced that due to the ongoing uncertainty in financial markets, the Bank no longer would provide dividend guidance prior to the end of each quarter. The Bank expects to make any dividend determination after the end of each quarter and after quarterly results are known. For the second quarter of 2009, the Bank’s board of directors approved an annualized dividend rate of 0.84 percent. The Bank did not pay a dividend for the first quarter of 2009. Given the continued volatility in the financial markets and the Bank’s conservative financial management approach in light of these conditions, future dividends, if any, may continue to be affected, which may adversely affect member demand for advances or reduce the attractiveness of Bank membership, which could negatively affect the Bank’s financial condition and results of operations.
On February 27, 2009 the Bank announced certain capital management changes that the Bank believes will facilitate capital management. These changes included an increase in the Subclass B1 membership stock requirement cap from $25 million to $26 million and a change in the process for evaluating and approving excess activity-based stock repurchases from a daily to a quarterly review cycle. While the Bank took these steps to manage capital until markets improve, these changes could affect demand for member advances or reduce the attractiveness of Bank membership, which could negatively affect the Bank’s financial condition and results of operations.
Business Outlook
The continued instability of the markets, along with a number of responsive actions by the government, could continue to impact negatively the Bank’s funding costs, ability to issue long-term debt, and advance demand.
43
Table of Contents
Advance Demand
On November 21, 2008, the FDIC adopted the final rule implementing the Temporary Liquidity Guarantee Program (“TLGP”), which was announced on October 14, 2008. The TLGP is a program pursuant to which the FDIC guarantees new senior unsecured debt issued prior to October 31, 2009 by domestic banks and thrift institutions. This program has affected, and may continue to affect, member demand for advances, by providing members with alternative sources of funding. On March 17, 2009, the FDIC announced that in order to gradually phase out the program, it would impose a surcharge on debt issued on or after April 1, 2009 with a maturity of one year or more.
On February 27, 2009, the FDIC approved a final rule to raise an insured institution’s base assessment rate based upon its ratio of secured liabilities to domestic deposits. Under the rule, an institution’s ratio of secured liabilities to domestic deposits (if greater than 25 percent) would increase its assessment rate, but the resulting base assessment rate after any such increase could be no more than 50 percent greater than it was before the adjustment. The rule became effective on April 1, 2009. Because all of the Bank’s advances are secured liabilities, the rule may affect member demand for advances.
While advance demand increased significantly during the year ended December 31, 2008 as a result of the general illiquidity of markets, outstanding advances decreased during the second quarter of 2009 and the Bank expects that outstanding advances will continue to decrease during 2009 in light of maturing advances, prepayments as a result of member closures, an anticipated reduced need for funding by the Bank’s members in light of their increased deposits, slower loan growth and the government programs discussed above. Further, to the extent that the Bank does not pay dividends or pays dividends at less than historical spreads, such action may adversely affect member demand for advances.
Debt Issuance
On October 7, 2008, federal bank and thrift regulatory agencies announced that they would request public comment on proposed regulatory action to lower the risk weight for select obligations of Fannie Mae and Freddie Mac from 20 percent to 10 percent (the “Risk Weighting Proposal”). The agencies also requested comment on whether to reduce the risk weight for FHLBank debt in the same manner. This regulation, if adopted without a corresponding change in the risk weight for FHLBank debt, could result in higher investor demand for Fannie Mae and Freddie Mac debt securities relative to similar FHLBank debt securities.
To the extent that the FHLBanks’ cost of funds increase, member institutions, in turn, experience higher costs for advance borrowings. During the second half of 2008 and the first quarter of 2009, the Bank experienced difficulty in issuing attractively-priced long-term debt. The continuation of this trend could have a material adverse effect on the Bank’s results of operations. However, the Bank expects that its funding needs in 2009 will be less than its funding needs in 2008 due to its anticipated decrease in advance demand. Additionally, during the second quarter of 2009, the Bank experienced a slight improvement in its funding costs and ability to issue longer-term and structured debt, as the decrease in LIBOR rates during the period caused investors to seek this type of debt, as compared to discount notes, for additional yields. Nonetheless, to the extent that the Bank’s cost of funds or liquidity is affected negatively for an extended period of time, the Bank’s business and ability to offer advances could be materially adversely affected.
44
Table of Contents
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.
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 June 30, 2009 | As of December 31, 2008 | Increase/(Decrease) | |||||||||||||||||||
Amount | Percent of Total | Amount | Percent of Total | Amount | Percent | ||||||||||||||||
Advances, net | $ | 134,502,617 | 79.02 | $ | 165,855,546 | 79.52 | $ | (31,352,929 | ) | (18.90 | ) | ||||||||||
Long-term investments | 23,811,052 | 14.00 | 27,604,052 | 13.24 | (3,793,000 | ) | (13.74 | ) | |||||||||||||
Federal funds sold | 8,202,000 | 4.82 | 10,769,000 | 5.16 | (2,567,000 | ) | (23.84 | ) | |||||||||||||
Mortgage loans, net | 2,833,348 | 1.66 | 3,251,074 | 1.56 | (417,726 | ) | (12.85 | ) | |||||||||||||
Deposits with other FHLBanks | 2,614 | — | 2,888 | — | (274 | ) | (9.49 | ) | |||||||||||||
Other assets | 854,215 | 0.50 | 1,081,780 | 0.52 | (227,565 | ) | (21.04 | ) | |||||||||||||
Total assets | $ | 170,205,846 | 100.00 | $ | 208,564,340 | 100.00 | $ | (38,358,494 | ) | (18.39 | ) | ||||||||||
Consolidated obligations, net: | |||||||||||||||||||||
Bonds | $ | 117,755,528 | 72.54 | $ | 138,181,334 | 69.20 | $ | (20,425,806 | ) | (14.78 | ) | ||||||||||
Discount notes | 38,672,030 | 23.82 | 55,194,777 | 27.64 | (16,522,747 | ) | (29.94 | ) | |||||||||||||
Deposits | 4,147,790 | 2.55 | 3,572,709 | 1.79 | 575,081 | 16.10 | |||||||||||||||
Other liabilities | 1,772,130 | 1.09 | 2,722,584 | 1.37 | (950,454 | ) | (34.91 | ) | |||||||||||||
Total liabilities | $ | 162,347,478 | 100.00 | $ | 199,671,404 | 100.00 | $ | (37,323,926 | ) | (18.69 | ) | ||||||||||
Capital stock | $ | 8,118,583 | 103.31 | $ | 8,462,995 | 95.17 | $ | (344,412 | ) | (4.07 | ) | ||||||||||
Retained earnings | 803,577 | 10.23 | 434,883 | 4.89 | 368,694 | 84.78 | |||||||||||||||
Accumulated other comprehensive loss | (1,063,792 | ) | (13.54 | ) | (4,942 | ) | (0.06 | ) | (1,058,850 | ) | (21,425.54 | ) | |||||||||
Total capital | $ | 7,858,368 | 100.00 | $ | 8,892,936 | 100.00 | $ | (1,034,568 | ) | (11.63 | ) | ||||||||||
Advances
Advances were $134.5 billion at June 30, 2009, a decrease of $31.4 billion, or 18.9 percent, from December 31, 2008. This decrease was due to maturing advances, prepayments as a result of member failures and decreased demand for advances by the Bank’s members. The decreased demand for advances by the Bank’s members was primarily a result of their increased deposits, slower loan growth and
45
Table of Contents
government programs that provide them with alternative sources of funding. At June 30, 2009, 85.3 percent of the Bank’s advances were fixed-rate. However, the Bank often simultaneously enters into derivatives with the issuance of advances to convert the rates on them, in effect, into a short-term interest rate, usually based on LIBOR. Of the par value of $128.5 billion of advances outstanding as of June 30, 2009, $102.6 billion, or 79.9 percent, had their terms reconfigured through the use of interest rate exchange agreements. The comparable notional amount of such outstanding derivatives at December 31, 2008 was $118.9 billion, or 76.1 percent, of the par value of advances. The majority of the Bank’s variable-rate advances were indexed 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 institutions was as follows (dollar amounts in billions):
Advances to 10 Largest Borrowing Institutions | Percent of Total Advances Outstanding (%) | ||||
June 30, 2009 | $ | 86.0 | 67.0 | ||
December 31, 2008 | 102.7 | 65.7 |
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 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, at purchase, carried the highest rating from Moody’s or S&P, 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):
46
Table of Contents
Increase/ (Decrease) | |||||||||||||
As of June 30, 2009 | As of December 31, 2008 | Amount | Percent | ||||||||||
Short-term investments: | |||||||||||||
Deposits with other FHLBanks | $ | 2,614 | $ | 2,888 | $ | (274 | ) | (9.49 | ) | ||||
Federal funds sold | 8,202,000 | 10,769,000 | (2,567,000 | ) | (23.84 | ) | |||||||
Total short-term investments | $ | 8,204,614 | $ | 10,771,888 | $ | (2,567,274 | ) | (23.83 | ) | ||||
Long-term investments: | |||||||||||||
Trading securities: | |||||||||||||
Government-sponsored enterprises debt obligations | $ | 3,658,337 | $ | 4,171,725 | $ | (513,388 | ) | (12.31 | ) | ||||
Other FHLBanks’ bonds | 154,885 | 300,135 | (145,250 | ) | (48.39 | ) | |||||||
State or local housing agency obligations | 14,083 | 14,069 | 14 | 0.10 | |||||||||
Available-for-sale securities: | |||||||||||||
Mortgage-backed securities: | |||||||||||||
Private label | 1,536,608 | — | 1,536,608 | 100.00 | |||||||||
Held-to-maturity securities: | |||||||||||||
State or local housing agency obligations | 136,756 | 101,105 | 35,651 | 35.26 | |||||||||
Mortgage-backed securities: | |||||||||||||
U.S. agency obligations-guaranteed | 36,254 | 38,545 | (2,291 | ) | (5.94 | ) | |||||||
Government-sponsored enterprises | 6,750,050 | 7,060,082 | (310,032 | ) | (4.39 | ) | |||||||
Private label | 11,524,079 | 15,918,391 | (4,394,312 | ) | (27.61 | ) | |||||||
Total long-term investments | $ | 23,811,052 | $ | 27,604,052 | $ | (3,793,000 | ) | (13.74 | ) | ||||
Short-term investments were $8.2 billion at June 30, 2009, a decrease of $2.6 million, or 23.8 percent, from December 31, 2008. The decrease in short-term investments was due to the decrease in overnight federal funds during the period as market conditions improved and the Bank’s need for this source of liquidity eased. Currently, the Bank expects its federal funds holdings to stabilize at this level for the near-term.
Long-term investments were $23.8 billion at June 30, 2009, a decrease of $3.8 billion, or 13.7 percent, from December 31, 2008. The decrease in long-term investments was due primarily to principal prepayments and maturities and the Bank’s continued decline in its purchase of MBS during this same period. In addition, during the second quarter and first six months of 2009, the Bank recorded total other-than-temporary impairment losses of $403.6 million and $1.1 billion, respectively, related to its private-label MBS.
The Finance Agency limits an FHLBank’s investment in MBS and asset-backed securities by requiring that the total book value of MBS owned by the FHLBank generally may not exceed 300 percent or, in certain circumstances 600 percent, of the FHLBank’s previous month-end capital plus its mandatorily redeemable capital stock on the day it purchases the securities. In light of current market conditions, the Bank attempts to maintain this ratio at 250 percent to 275 percent to help to maximize and stabilize earnings. These investments amounted to 249 percent and 258 percent of total capital plus mandatorily redeemable capital stock at June 30, 2009 and December 31, 2008, respectively.
The Bank had a total of 22 securities classified as available-for-sale in an unrealized loss position, with total gross unrealized losses of $1.1 billion as of June 30, 2009. The Bank had a total of 223 securities classified as held-to-maturity in an unrealized loss position, with total gross unrealized losses of $2.0 billion as of June 30, 2009. As of December 31, 2008, the Bank had a total of 279 securities classified as held-to-maturity in an unrealized loss position, with total gross unrealized losses of $3.7 billion. The Bank evaluates its individual held-to-maturity investment securities holdings for other-than-temporary impairment on a quarterly basis, or more frequently if events or changes in circumstances indicate that
47
Table of Contents
these investments may be other-than-temporarily impaired. The Bank recognizes an other-than-temporary impairment loss when the Bank determines it will not recover the entire amortized cost basis of a security.
To determine which individual securities are at risk for other-than-temporary impairment, the Bank considers various characteristics of each security including, but not limited to, the following: the credit rating; the duration and amount of the unrealized loss; and any credit enhancements. The relative importance of this information varies based on the facts and circumstances surrounding each security, as well as the economic environment at the time of assessment. As a result of this security-level review, for the period ending June 30, 2009, the Bank identified 76 individual securities believed to be at risk for other-than-temporary impairment. These securities are evaluated by estimating the present value of cash flows the Bank expects to collect based on the structure of the security and certain economic environment assumptions, such as delinquency and default rates, loss severity, home price appreciation, interest rates, and securities prepayment speeds, while factoring in underlying collateral and credit enhancement.
On April 28, 2009 and May 7, 2009, the FHFA provided the FHLBanks with guidance on the process for determining other-than-temporary impairment with respect to private-label MBS and the Bank’s adoption of recent FASB guidance governing the accounting for other-than-temporary impairment in the first quarter of 2009. The goal of the FHFA guidance is to promote consistency in the determination of other-than-temporary impairment for private-label MBS among all FHLBanks. Recognizing that many of the FHLBanks desired to early adopt the FASB other-than-temporary impairment guidance, the FHFA guidance also required that all FHLBanks early adopt the FASB other-than-temporary impairment guidance in order to achieve consistency among the 12 FHLBanks and to follow certain guidelines for determining other-than-temporary impairment. The Bank adopted the FASB other-than-temporary impairment guidance, applied in accordance with the FHFA guidance as further described below, effective January 1, 2009.
Beginning with the second quarter of 2009, consistent with the objectives in the FHFA guidance, the FHLBanks formed an Other-than-Temporary Impairment Governance Committee (the “OTTI Committee”) with the responsibility for reviewing and approving the key modeling assumptions, inputs and methodologies to be used by the FHLBanks to generate cash flow projections used in analyzing credit losses and determining other-than-temporary impairment for private-label MBS. The OTTI Committee charter was approved on June 11, 2009 and provides a formal process by which the FHLBanks can provide input on and approve the assumptions.
In accordance with FHFA guidance, the Bank engaged FHLBank Dallas to perform the cash flow analysis underlying its other-than-temporary impairment determination. Each FHLBank is responsible for making its own determination of impairment and the reasonableness of assumptions, inputs, and methodologies used and performing the required present value calculations using appropriate historical cost bases and yields. FHLBanks that hold common private-label MBS are required to consult with one another to ensure that any decision that a commonly held private-label MBS is other-than-temporarily impaired, including the determination of fair value and the credit loss component of the unrealized loss, is consistent among those FHLBanks. With respect to such commonly-owned securities (of which there were 20 at June 30, 2009), FHLBank San Francisco performed the cash flow analysis underlying the Bank’s other-than-temporary impairment determination.
In order to promote consistency in the application of the assumptions and implementation of the other-than-temporary impairment methodology, the FHLBanks have established control procedures whereby the FHLBanks performing cash flow analysis select a sample group of private-label MBS and each
48
Table of Contents
performs cash flow analyses on all such test MBS, using the assumptions approved by the OTTI Committee. These FHLBanks exchange and discuss the results and make any adjustments necessary to achieve consistency among their respective cash flow models.
For the period ending June 30, 2009, the Bank completed its other-than-temporary impairment analysis and made its other-than-temporary impairment determination utilizing the key modeling assumptions approved by the OTTI Committee (on which the Bank had representation). Based on the impairment analysis described above, the Bank recognized an other-than-temporary impairment loss of $403.6 million and $1.1 billion related to 22 private-label MBS in its held-to-maturity securities portfolio for the second quarter and first six months of 2009, respectively. The total amount of other-than-temporary impairment is calculated as the difference between the security’s amortized cost basis and its fair value. The credit related portion of this other-than-temporary impairment loss of $46.2 million and $135.1 million for the second quarter and first six months of 2009, respectively, is reported in the Statements of Income as “Net impairment losses recognized in earnings,” while the noncredit portion of $357.3 million and $966.6 million for the second quarter and first six months of 2009, respectively, is reflected as a component of other comprehensive loss. The remainder of the Bank’s held-to-maturity securities portfolio that has not been designated as other-than-temporarily impaired has experienced unrealized losses and decreases in fair value due to interest rate volatility, illiquidity in the marketplace, and credit deterioration in the U.S. mortgage markets. This decline in fair value is considered temporary as the Bank presently expects to collect all contractual cash flows and the Bank does not intend to sell the securities and it is not more likely than not that the Bank will be required to sell the security before the anticipated recovery of its remaining amortized cost basis. This assessment is based on the determination that the Bank has sufficient capital and liquidity to operate its business and has no need to sell these securities, nor has the Bank entered into any contractual constraints that would require the Bank to sell these securities.
Mortgage Loans Held for Portfolio
Mortgage loans held for portfolio were $2.8 billion at June 30, 2009, a decrease of $417.7 million, or 12.9 percent, from December 31, 2008. The decrease in mortgage loans held was due to the maturity of these assets during the period. In 2006, the Bank ceased purchasing assets under the Affordable Multifamily Participation Program, and in 2008 the Bank ceased purchasing assets under the Mortgage Partnership Finance® Program (“MPF® Program”). Early in the third quarter of 2008, the Bank suspended acquisitions of mortgage loans under the Mortgage Purchase Program (“MPP”).
As of June 30, 2009 and December 31, 2008, the Bank’s mortgage loan portfolio was concentrated in the southeastern United States because those members selling loans to the Bank were located primarily in that region.
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 91.9 percent of the $170.2 billion in total assets at June 30, 2009, remaining relatively stable from the financing ratio of 92.7 percent as of December 31, 2008.
Consolidated obligation bonds were $117.8 billion at June 30, 2009, a decrease of $20.4 billion, or 14.8 percent, from December 31, 2008. Consolidated obligation discount notes were $38.7 billion at June 30, 2009, a decrease of $16.5 billion, or 29.9 percent, from December 31, 2008. The decrease in consolidated
49
Table of Contents
obligations corresponds to the decrease in demand for advances by the Bank’s members during the period. Also reflected is a slight shift in investor demand towards consolidated obligation bonds from consolidated obligation discount notes. Consolidated obligation bonds outstanding at June 30, 2009 and December 31, 2008 were primarily fixed-rate. However, the Bank often simultaneously enters into derivatives with the issuance of consolidated obligation bonds to convert the rates on them, in effect, into short-term interest rates, usually based on LIBOR. Of the par value of $116.2 billion of consolidated obligation bonds outstanding as of June 30, 2009, $75.3 billion, or 64.8 percent, had their terms reconfigured through the use of interest rate exchange agreements. The comparable notional amount of such outstanding derivatives at December 31, 2008 was $92.7 billion, or 68.3 percent, of the par value of consolidated obligation bonds.
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 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 $4.1 billion as of June 30, 2009, compared to $3.6 billion as of December 31, 2008.
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 June 30, 2009.
Other Liabilities
Other liabilities were $1.8 billion at June 30, 2009, a decrease of $950.5 million, or 34.9 percent, from December 31, 2008. This decrease during the period was due primarily to a $699.0 million decrease in derivative liabilities due to the interaction of interest rates on associated derivatives and a $340.3 million decrease in accrued interest payable related to the decrease in consolidated obligations.
Capital and Retained Earnings
Total capital was $7.9 billion at June 30, 2009, a decrease of $1.0 billion, or 11.6 percent, from December 31, 2008. This decrease was due primarily to a $1.1 billion increase in accumulated other comprehensive loss during the period. The increase in accumulated other comprehensive loss was due primarily to the adoption of FSP FAS 115-2 and FAS 124-2 as of January 1, 2009, which resulted in a $178.5 million cumulative effect adjustment to retained earnings (increase) and other comprehensive loss (increase) as of the date of adoption and the recording of $966.6 million related to the noncredit portion of other-than-temporary impairment losses in other comprehensive loss during the first six months of 2009.
The Bank’s retained earnings were $803.6 million as of June 30, 2009, an increase of $368.7 million, or 84.8 percent, from December 31, 2008. The increase in retained earnings was due to the adoption of FSP
50
Table of Contents
FAS 115-2 and FAS 124-2 as discussed above and the recording of $190.2 million in net income for the first six months of 2009.
The FHLBank Act and Finance Agency regulations specify that each FHLBank must meet certain minimum regulatory capital standards. The Bank was in compliance with these regulatory capital rules and requirements as shown in the following table (dollar amounts in thousands):
As of June 30, 2009 | As of December 31, 2008 | |||||||||||||||
Required | Actual | Required | Actual | |||||||||||||
Regulatory capital requirements: | ||||||||||||||||
Risk based capital | $ | 5,062,414 | $ | 9,028,397 | $ | 5,715,678 | $ | 8,942,306 | ||||||||
Total capital-to-assets ratio | 4.00 | % | 5.30 | % | 4.00 | % | 4.29 | % | ||||||||
Total regulatory capital* | $ | 6,808,234 | $ | 9,028,397 | $ | 8,342,574 | $ | 8,942,306 | ||||||||
Leverage ratio | 5.00 | % | 7.96 | % | 5.00 | % | 6.43 | % | ||||||||
Leverage capital | $ | 8,510,292 | $ | 13,542,596 | $ | 10,428,217 | $ | 13,413,459 |
* | Mandatorily redeemable capital stock is considered capital for regulatory purposes, and “total regulatory capital” includes the Bank’s $106.2 million and $44.4 million in mandatorily redeemable capital stock at June 30, 2009 and December 31, 2008, respectively. |
As required by the Housing Act, effective on January 30, 2009, the Director of the Finance Agency issued an interim final rule that established criteria based on the amount and type of capital held by a FHLBank for four capital classifications as follows:
• | Adequately Capitalized - FHLBank meets both risk-based and minimum capital requirements |
• | Undercapitalized - FHLBank does not meet one or both of its risk-based or minimum capital requirements |
• | Significantly Undercapitalized - FHLBank has less than 75 percent of one or both of its risk-based or minimum capital requirements |
• | Critically Undercapitalized - FHLBank total capital is two percent or less of total assets |
The regulation also requested comment on whether to establish a fifth classification, “Well Capitalized”, and generally defined this as meeting 110 percent of the adequately capitalized classification.
Under the regulation, the Director will make a capital classification for each FHLBank at least quarterly and notify the FHLBank in writing of any proposed action and provide an opportunity for the FHLBank to submit information relevant to such action. The Director is permitted to make discretionary classifications. An FHLBank must provide written notice to the Finance Agency within 10 days of any event or development that has caused or is likely to cause its permanent or total capital to fall below the level required to maintain its most recent capital classification or reclassification. The regulation delineates the types of prompt corrective actions the Director may order in the event an FHLBank is not adequately capitalized, including submission of a capital restoration plan by the FHLBank and restrictions on its dividends, stock redemptions, executive compensation, new business activities, or any other actions the Director determines will ensure safe and sound operations and capital compliance by the FHLBank. On July 29, 2009, the Bank received notification from the Director that, based on March 31, 2009 data, the Bank meets the definition of “adequately capitalized.”
As of June 30, 2009, the Bank had capital stock subject to mandatory redemption from 29 members and former members, consisting of B1 membership stock and B2 activity-based stock, compared to 13
51
Table of Contents
members and former members as of December 31, 2008. 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, until the later of the expiration of the five-year redemption period or the activity no longer remains outstanding. During 2008, if activity-based stock became excess stock as a result of an activity no longer remaining outstanding, the Bank generally repurchased the excess activity-based stock if the dollar amount of excess stock exceeded the threshold specified by the Bank, which in 2008 was $100 thousand. As of June 30, 2009 and December 31, 2008, the Bank’s activity-based stock included $929.2 million and $13.2 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. On February 27, 2009, the Bank notified members of an increase in the excess stock threshold amount to $2.5 billion and a change from the automatic daily repurchase of excess stock to a quarterly evaluation process.
Results of Operations
Net Income
The following table sets forth the Bank’s significant income items for the second quarter and first six months of 2009 and 2008, and provides information regarding the changes during the periods (dollar amounts in thousands):
Three Months Ended June 30, | Increase/ (Decrease) | Increase/ (Decrease) % | Six Months Ended June 30, | Increase/ (Decrease) | Increase/ (Decrease) % | |||||||||||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||||||||||||||
Net interest income | $ | 103,963 | $ | 240,623 | $ | (136,660 | ) | (56.79 | ) | $ | 139,685 | $ | 448,339 | $ | (308,654 | ) | (68.84 | ) | ||||||||||
Other income (loss) | 186,065 | (64,722 | ) | 250,787 | 387.48 | 176,020 | (86,642 | ) | 262,662 | 303.16 | ||||||||||||||||||
Other expense | 29,123 | 27,934 | 1,189 | 4.26 | 56,635 | 54,749 | 1,886 | 3.44 | ||||||||||||||||||||
Total assessments | 69,227 | 39,302 | 29,925 | 76.14 | 68,875 | 81,487 | (12,612 | ) | (15.48 | ) | ||||||||||||||||||
Net income | 191,678 | 108,670 | 83,008 | 76.39 | 190,174 | 225,311 | (35,137 | ) | (15.59 | ) |
The Bank recorded net income of $191.7 million for the second quarter of 2009, an increase of $83.0 million, or 76.4 percent, from net income of $108.7 million for the second quarter of 2008. The increase in net income during the period was due primarily to a $181.8 million increase in net gains on derivatives and hedging activities and a $114.6 million decrease in net losses on trading securities, offset by a $136.7 million decrease in net interest income, the recording of net impairment losses in earnings of $46.2 million, and a $29.9 million increase in total assessments. The increase in net gains on derivatives and hedging activities resulted from a decrease in LIBOR during the period and mark-to-market gains on swaps in discontinued hedging relationships. The decrease in net losses on trading securities was due primarily to the impact of changes in interest rates on trading securities during the period. The decrease in net interest income during the period was due primarily to the write-off of SFAS 133-related basis adjustments on advances that were prepaid during the second quarter of 2009 and amortization related to discontinued hedging activities.
The Bank recorded net income of $190.2 million for the first six months of 2009, a decrease of $35.1 million, or 15.6 percent, from net income of $225.3 million for the same period in 2008. The decrease in net income during the period was due primarily to a $308.7 million decrease in net interest income, the recording of net impairment losses recognized in earnings of $135.1 million, and a $25.6 million increase
52
Table of Contents
on net losses on trading securities, offset by a $423.2 million increase in net gains on derivatives and hedging activities and a $12.6 million decrease in total assessments. The increase in net gains on derivatives and hedging activities resulted from a decrease in LIBOR during the period and mark-to-market gains on swaps in discontinued hedging relationships. The increase in net losses on trading securities is due primarily to the impact of changes in interest rates on trading securities during the period. As discussed above, net interest income decreased as a result of the write-off of SFAS 133-related basis adjustments on advances that were prepaid during the second quarter of 2009 and amortization related to discontinued hedging activities.
Net Interest Income
A 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 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.
Net interest income was $104.0 million for the second quarter of 2009, a decrease of $136.7 million, or 56.8 percent, from the second quarter of 2008. The Bank’s net interest income for the first six months of 2009 was $139.7 million, a decrease of $308.7 million, or 68.8 percent, from net interest income of $448.3 million for the same period in 2008. The decline in net interest income resulted from:
• | holding higher average balances of short-term investments for liquidity purposes at lower earning interest rates; |
• | rates on interest-earning assets repricing faster than rates on interest-bearing liabilities; |
• | write-offs of large SFAS 133-related basis adjustments on advances that were prepaid during the second quarter of 2009; and |
• | amortization related to discontinued hedging activities. |
The following tables present spreads between the average yield on total interest-earning assets and the average cost of interest-bearing liabilities for the second quarter and first six months of 2009 and 2008 (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. Amortization associated with SFAS 133 basis adjustments also are reflected in net interest income, which affect interest rate spread. As noted in the tables below, during the second quarter and first six months of 2009, compared to the same periods in 2008, the interest rate spread decreased by 19 basis points and 23 basis points, respectively. The decrease in interest rate spread during the periods is due primarily to large write-offs of basis adjustments associated with hedging on prepaid advances reducing interest income as well as increased amortization of the basis adjustment.
53
Table of Contents
Spread and Yield Analysis
Three Months Ended June 30, | ||||||||||||||||||
2009 | 2008 | |||||||||||||||||
Average Balance | Interest | Yield/ Rate (%) | Average Balance | Interest | Yield/ Rate (%) | |||||||||||||
Assets | ||||||||||||||||||
Federal funds sold | $ | 10,672,797 | $ | 5,318 | 0.20 | $ | 10,843,097 | $ | 62,003 | 2.30 | ||||||||
Interest-bearing deposits (1) | 4,474,937 | 2,046 | 0.18 | 1,143,846 | 6,386 | 2.25 | ||||||||||||
Certificate of deposits | — | — | — | 720,330 | 5,100 | 2.85 | ||||||||||||
Long-term investments (2) | 25,359,272 | 309,950 | 4.90 | 29,644,269 | 373,677 | 5.07 | ||||||||||||
Advances | 141,841,130 | 278,385 | 0.79 | 150,528,183 | 1,051,238 | 2.81 | ||||||||||||
Mortgage loans held for portfolio (3) | 2,953,044 | �� | 39,278 | 5.33 | 3,475,992 | 46,382 | 5.37 | |||||||||||
Loans to other FHLBanks | 1,846 | 1 | 0.19 | 3,791 | 21 | 2.23 | ||||||||||||
Total interest-earning assets | 185,303,026 | 634,978 | 1.37 | 196,359,508 | 1,544,807 | 3.16 | ||||||||||||
Allowance for credit losses on mortgage loans | (877 | ) | (1,000 | ) | ||||||||||||||
Other assets | 1,396,232 | 2,619,228 | ||||||||||||||||
Total assets | $ | 186,698,381 | $ | 198,977,736 | ||||||||||||||
Liabilities and Capital | ||||||||||||||||||
Demand and overnight deposits | $ | 4,541,033 | 1,108 | 0.10 | $ | 6,455,743 | 31,675 | 1.97 | ||||||||||
Other interest-bearing deposits (4) | 86,195 | 40 | 0.19 | 29,020 | 161 | 2.23 | ||||||||||||
Short-term borrowings | 45,171,675 | 74,774 | 0.66 | 30,359,663 | 178,853 | 2.37 | ||||||||||||
Long-term debt | 121,197,105 | 455,006 | 1.51 | 147,490,616 | 1,092,957 | 2.98 | ||||||||||||
Other borrowings | 622,070 | 87 | 0.06 | 37,637 | 538 | 5.75 | ||||||||||||
Total interest-bearing liabilities | 171,618,078 | 531,015 | 1.24 | 184,372,679 | 1,304,184 | 2.84 | ||||||||||||
Noninterest-bearing deposits | — | 3,392 | ||||||||||||||||
Other liabilities | 7,643,005 | 6,084,794 | ||||||||||||||||
Total capital | 7,437,298 | 8,516,871 | ||||||||||||||||
Total liabilities and capital | $ | 186,698,381 | $ | 198,977,736 | ||||||||||||||
Net interest income and net yield on interest-earning assets | $ | 103,963 | 0.23 | $ | 240,623 | 0.49 | ||||||||||||
Interest rate spread | 0.13 | 0.32 | ||||||||||||||||
Average interest-earning assets to interest-bearing liabilities | 107.97 | 106.50 | ||||||||||||||||
Notes
(1) | Includes amounts recognized for the right to reclaim cash collateral paid under master netting agreements with derivative counterparties. |
(2) | Includes trading securities at fair value and available-for-sale securities at amortized cost. |
(3) | Nonperforming loans are included in average balances used to determine average rate. |
(4) | Includes amounts recognized for the right to return cash collateral received under master netting agreements with derivative counterparties. |
54
Table of Contents
Spread and Yield Analysis
Six Months Ended June 30, | ||||||||||||||||||
2009 | 2008 | |||||||||||||||||
Average Balance | Interest | Yield/ Rate (%) | Average Balance | Interest | Yield/ Rate (%) | |||||||||||||
Assets | ||||||||||||||||||
Federal funds sold | $ | 13,238,465 | $ | 13,630 | 0.21 | $ | 9,860,137 | $ | 140,375 | 2.86 | ||||||||
Interest-bearing deposits (1) | 4,938,735 | 4,599 | 0.19 | 1,597,668 | 22,907 | 2.88 | ||||||||||||
Certificate of deposits | — | — | — | 627,335 | 10,646 | 3.41 | ||||||||||||
Long-term investments (2) | 26,188,723 | 639,226 | 4.92 | 28,008,266 | 709,942 | 5.10 | ||||||||||||
Advances | 148,584,340 | 713,108 | 0.97 | 148,512,554 | 2,528,225 | 3.42 | ||||||||||||
Mortgage loans held for portfolio (3) | 3,066,478 | 81,728 | 5.37 | 3,503,854 | 93,209 | 5.35 | ||||||||||||
Loans to other FHLBanks | 1,619 | 2 | 0.22 | 3,929 | 50 | 2.56 | ||||||||||||
Total interest-earning assets | 196,018,360 | 1,452,293 | 1.49 | 192,113,743 | 3,505,354 | 3.67 | ||||||||||||
Allowance for credit losses on mortgage loans | (870 | ) | (975 | ) | ||||||||||||||
Other assets | 1,773,287 | 2,759,599 | ||||||||||||||||
Total assets | $ | 197,790,777 | $ | 194,872,367 | ||||||||||||||
Liabilities and Capital | ||||||||||||||||||
Demand and overnight deposits | $ | 4,443,466 | 2,556 | 0.12 | $ | 6,269,643 | 79,281 | 2.54 | ||||||||||
Other interest-bearing deposits (4) | 76,411 | 72 | 0.19 | 27,421 | 362 | 2.65 | ||||||||||||
Short-term borrowings | 49,131,637 | 238,224 | 0.98 | 29,966,635 | 449,886 | 3.02 | ||||||||||||
Long-term debt | 127,592,920 | 1,069,946 | 1.69 | 143,850,262 | 2,526,363 | 3.53 | ||||||||||||
Other borrowings | 611,384 | 1,810 | 0.60 | 38,438 | 1,123 | 5.88 | ||||||||||||
Total interest-bearing liabilities | 181,855,818 | 1,312,608 | 1.46 | 180,152,399 | 3,057,015 | 3.41 | ||||||||||||
Noninterest-bearing deposits | — | 11,996 | ||||||||||||||||
Other liabilities | 8,222,728 | 6,346,529 | ||||||||||||||||
Total capital | 7,712,231 | 8,361,443 | ||||||||||||||||
Total liabilities and capital | $ | 197,790,777 | $ | 194,872,367 | ||||||||||||||
Net interest income and net yield on interest-earning assets | $ | 139,685 | 0.14 | $ | 448,339 | 0.47 | ||||||||||||
Interest rate spread | 0.03 | 0.26 | ||||||||||||||||
Average interest-earning assets to interest-bearing liabilities | 107.79 | 106.64 | ||||||||||||||||
Notes
(1) | Includes amounts recognized for the right to reclaim cash collateral paid under master netting agreements with derivative counterparties. |
(2) | Includes trading securities at fair value and available-for-sale securities at amortized cost. |
(3) | Nonperforming loans are included in average balances used to determine average rate. |
(4) | 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 second quarter and first six months of 2009, compared to the same periods in 2008, was primarily rate related.
55
Table of Contents
Volume and Rate Table*
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||
2009 vs. 2008 | 2009 vs. 2008 | |||||||||||||||||||||||
Volume | Rate | Increase (Decrease) | Volume | Rate | Increase (Decrease) | |||||||||||||||||||
Increase (decrease) in interest income: |
| |||||||||||||||||||||||
Federal funds sold | $ | (959 | ) | $ | (55,726 | ) | $ | (56,685 | ) | $ | 36,062 | $ | (162,807 | ) | $ | (126,745 | ) | |||||||
Interest-bearing deposits | 5,616 | (9,956 | ) | (4,340 | ) | 16,951 | (35,259 | ) | (18,308 | ) | ||||||||||||||
Certificate of deposits | (2,550 | ) | (2,550 | ) | (5,100 | ) | (5,323 | ) | (5,323 | ) | (10,646 | ) | ||||||||||||
Long-term investments | (52,658 | ) | (11,069 | ) | (63,727 | ) | (45,033 | ) | (25,683 | ) | (70,716 | ) | ||||||||||||
Advances | (57,426 | ) | (715,427 | ) | (772,853 | ) | 1,221 | (1,816,338 | ) | (1,815,117 | ) | |||||||||||||
Mortgage loans held for portfolio | (6,955 | ) | (149 | ) | (7,104 | ) | (11,657 | ) | 176 | (11,481 | ) | |||||||||||||
Loans to other FHLBanks | (7 | ) | (13 | ) | (20 | ) | (18 | ) | (30 | ) | (48 | ) | ||||||||||||
Total | (114,939 | ) | (794,890 | ) | (909,829 | ) | (7,797 | ) | (2,045,264 | ) | (2,053,061 | ) | ||||||||||||
Increase (decrease) in interest expense: | ||||||||||||||||||||||||
Demand and overnight deposits | (7,271 | ) | (23,296 | ) | (30,567 | ) | (17,939 | ) | (58,786 | ) | (76,725 | ) | ||||||||||||
Other interest-bearing deposits | 119 | (240 | ) | (121 | ) | 251 | (541 | ) | (290 | ) | ||||||||||||||
Short-term borrowings | 61,897 | (165,976 | ) | (104,079 | ) | 193,098 | (404,760 | ) | (211,662 | ) | ||||||||||||||
Long-term debt | (169,328 | ) | (468,623 | ) | (637,951 | ) | (258,989 | ) | (1,197,428 | ) | (1,456,417 | ) | ||||||||||||
Other borrowings | 578 | (1,029 | ) | (451 | ) | 2,552 | (1,865 | ) | 687 | |||||||||||||||
Total | (114,005 | ) | (659,164 | ) | (773,169 | ) | (81,027 | ) | (1,663,380 | ) | (1,744,407 | ) | ||||||||||||
(Decrease) increase in net interest income | $ | (934 | ) | $ | (135,726 | ) | $ | (136,660 | ) | $ | 73,230 | $ | (381,884 | ) | $ | (308,654 | ) | |||||||
* | 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 (loss) related results (in thousands). For a description regarding the individual interest components discussed below, see the Bank’s Form 10-K.
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Net interest income | $ | 103,963 | $ | 240,623 | $ | 139,685 | $ | 448,339 | ||||||||
Interest components of hedging activities included in net interest income: | ||||||||||||||||
Hedging advances | $ | (868,098 | ) | $ | (438,978 | ) | $ | (1,634,748 | ) | $ | (535,661 | ) | ||||
Hedging consolidated obligations | 370,690 | 287,957 | 743,190 | 409,072 | ||||||||||||
Hedging related amortization | (136,931 | ) | 16,076 | (296,061 | ) | 13,097 | ||||||||||
Net decrease in net interest income | $ | (634,339 | ) | $ | (134,945 | ) | $ | (1,187,619 | ) | $ | (113,492 | ) | ||||
Interest components of derivative activity included in other income (loss): | ||||||||||||||||
Purchased options | $ | 11,563 | $ | 8,037 | $ | 20,569 | $ | 9,588 | ||||||||
Synthetic macro funding | (8,247 | ) | (8,130 | ) | (19,215 | ) | (13,820 | ) | ||||||||
Trading securities | (36,844 | ) | (37,756 | ) | (70,165 | ) | (52,014 | ) | ||||||||
Other | 11 | 18 | 25 | 41 | ||||||||||||
Net decrease in other income (loss) | $ | (33,517 | ) | $ | (37,831 | ) | $ | (68,786 | ) | $ | (56,205 | ) | ||||
56
Table of Contents
Other Income (Loss)
The Bank’s other income (loss) is composed primarily of net impairment losses recognized in earnings, net losses on trading securities and net gains (losses) on derivatives and hedging activities. The following table presents the components of other income (loss) (in thousands):
Three Months Ended June 30, | Increase (Decrease) | Six Months Ended June 30, | Increase (Decrease) | |||||||||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||||||||||
Other Income (Loss): | ||||||||||||||||||||||||
Net impairment losses recognized in earnings | $ | (46,242 | ) | $ | — | $ | (46,242 | ) | $ | (135,110 | ) | $ | — | $ | (135,110 | ) | ||||||||
Service fees | 429 | 588 | (159 | ) | 1,036 | 1,260 | (224 | ) | ||||||||||||||||
Net losses on trading securities | (74,019 | ) | (188,626 | ) | 114,607 | (107,650 | ) | (82,038 | ) | (25,612 | ) | |||||||||||||
Net gains (losses) on derivatives and hedging activities | 304,958 | 123,122 | 181,836 | 417,250 | (5,920 | ) | 423,170 | |||||||||||||||||
Other | 939 | 194 | 745 | 494 | 56 | 438 | ||||||||||||||||||
Total other income (loss) | $ | 186,065 | $ | (64,722 | ) | $ | 250,787 | $ | 176,020 | $ | (86,642 | ) | $ | 262,662 | ||||||||||
The overall changes in other income (loss) for the second quarter and first six months of 2009, compared to the same periods in 2008, was due primarily to 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 hedges trading securities with derivative transactions, and the income effect of the market-value change for these securities under SFAS 115 was offset by market-value changes in the related derivatives. In addition, during the second quarter and first six months of 2009, the Bank recorded $46.2 million and $135.1 million, respectively, of net impairment losses as part of other income (loss).
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 gains (losses) on derivatives and hedging activities classification. The following tables detail each of the components of net gains (losses) on derivatives and hedging activities (in thousands):
Net Gains (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 | |||||||||||||||||||||||||
For the Three Months Ended June 30, 2009 | ||||||||||||||||||||||||||||||||
Interest-related | $ | — | $ | 3,316 | $ | (36,844 | ) | $ | — | $ | — | $ | — | $ | 11 | $ | (33,517 | ) | ||||||||||||||
SFAS 133 qualifying fair value hedges | 192,582 | — | — | — | (3,274 | ) | 7,621 | — | 196,929 | |||||||||||||||||||||||
SFAS 133 non-qualifying hedges | — | 10,558 | 130,994 | — | — | — | (6 | ) | 141,546 | |||||||||||||||||||||||
Total gains (losses) | $ | 192,582 | $ | 13,874 | $ | 94,150 | $ | — | $ | (3,274 | ) | $ | 7,621 | $ | 5 | $ | 304,958 | |||||||||||||||
For the Three Months Ended June 30, 2008 | ||||||||||||||||||||||||||||||||
Interest-related | $ | — | $ | (93 | ) | $ | (37,756 | ) | $ | — | $ | — | $ | — | $ | 18 | $ | (37,831 | ) | |||||||||||||
SFAS 133 qualifying fair value hedges | (22,353 | ) | — | — | — | 11,236 | (784 | ) | — | (11,901 | ) | |||||||||||||||||||||
SFAS 133 non-qualifying hedges | — | (20,267 | ) | 193,499 | (238 | ) | — | — | (140 | ) | 172,854 | |||||||||||||||||||||
Total (losses) gains | $ | (22,353 | ) | $ | (20,360 | ) | $ | 155,743 | $ | (238 | ) | $ | 11,236 | $ | (784 | ) | $ | (122 | ) | $ | 123,122 | |||||||||||
57
Table of Contents
Advances | Purchased Options, Macro Hedging and Synthetic Macro Funding | Investments | MPF/MPP Loans | Consolidated Obligations Bonds | Consolidated Obligations Discount Notes | Intermediary Positions | Total | |||||||||||||||||||||||
For the Six Months Ended June 30, 2009 | ||||||||||||||||||||||||||||||
Interest-related | $ | — | $ | 1,354 | $ | (70,165 | ) | $ | — | $ | — | $ | — | $ | 25 | $ | (68,786 | ) | ||||||||||||
SFAS 133 qualifying fair value hedges | 276,287 | — | — | — | 15,740 | 5,072 | — | 297,099 | ||||||||||||||||||||||
SFAS 133 non-qualifying hedges | — | 15,358 | 173,604 | — | — | — | (25 | ) | 188,937 | |||||||||||||||||||||
Total gains (losses) | $ | 276,287 | $ | 16,712 | $ | 103,439 | $ | — | $ | 15,740 | $ | 5,072 | $ | — | $ | 417,250 | ||||||||||||||
For the Six Months Ended June 30, 2008 | ||||||||||||||||||||||||||||||
Interest-related | $ | — | $ | (4,232 | ) | $ | (52,014 | ) | $ | — | $ | — | $ | — | $ | 41 | $ | (56,205 | ) | |||||||||||
SFAS 133 qualifying fair value hedges | (10,163) | — | — | — | 4,311 | (1,230 | ) | — | (7,082 | ) | ||||||||||||||||||||
SFAS 133 non-qualifying hedges | — | (5,058 | ) | 62,558 | (146 | ) | — | — | 13 | 57,367 | ||||||||||||||||||||
Total gains (losses) | $ | (10,163) | $ | (9,290 | ) | $ | 10,544 | $ | (146 | ) | $ | 4,311 | $ | (1,230 | ) | $ | 54 | $ | (5,920 | ) | ||||||||||
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 during the second quarter of 2009, compared to the same period in 2008, due primarily to a $29.9 million increase in total assessments due to an increase in income during the period. Non-interest expense decreased during the first six months of 2009, compared to the same period in 2008, due primarily to a $12.6 million decrease in total assessments due to a decrease in income during the period.
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.
Finance Agency 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. In addition, the Bank attempts to maintain sufficient liquidity to service debt obligations for at least 90 days, assuming restricted debt market access. At times during the second quarter of 2009, the Bank did not meet its 90-day debt service goal due to continued reliance on consolidated obligation discount notes and other short-term debt because of their attractive pricing and the lack of availability of long-term debt.
In light of stress and instability in domestic and international credit markets, the Finance Agency in September 2008 provided liquidity guidance to each FHLBank. In March 2009, the Finance Agency updated this guidance, generally to provide ranges of days within which each FHLBank should maintain positive cash balances based upon different assumptions and scenarios. The Bank has operated within these ranges since the Finance Agency issued this guidance.
58
Table of Contents
The Bank’s principal source of liquidity is consolidated obligation debt instruments, which carry government-sponsored enterprise (“GSE”) 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 an extended period. Historically, the FHLBanks have had excellent capital market access, although the FHLBanks experienced a decrease in investor demand for consolidated obligation bonds beginning in mid-July 2008. However, during this time, the Bank increased its issuance of short-term discount notes as an alternative source of funding. During the second quarter of 2009, the Bank experienced a slight improvement in its funding costs and ability to issue longer-term and structured debt, as the decrease in LIBOR rates during the period caused investors to seek this type of debt, as compared to discount notes, for additional yields.
During the third quarter of 2008, each FHLBank entered into a Lending Agreement with the U.S. Treasury in connection with the U.S. Treasury’s establishment of the GSECF, as authorized by the Housing Act. The GSECF is designed to serve as a contingent source of liquidity for the housing government-sponsored enterprises, including each of the 12 FHLBanks. Any borrowings by one or more of the FHLBanks under the GSECF are considered consolidated obligations with the same joint and several liability as all other consolidated obligations. The terms of any borrowings are agreed to at the time of issuance. Loans under the Lending Agreement are to be secured by collateral acceptable to the U.S. Treasury, which consists of FHLBank advances to members that have been collateralized in accordance with regulatory standards and MBS issued by Fannie Mae or Freddie Mac. The maximum borrowings under the Lending Agreement are subject to the federal debt ceiling limits and are based upon eligible collateral. Each FHLBank is required to submit to the Federal Reserve Bank of New York, acting as fiscal agent of the U.S. Treasury, a list of eligible collateral, updated on a weekly basis. As of June 30, 2009, the Bank has provided the U.S. Treasury with a listing of advance collateral amounting to $10.5 billion, which provides for maximum borrowings of $9.1 billion. The amount of collateral can be increased or decreased (subject to the approval of the U.S. Treasury) at any time through the delivery of an updated listing of collateral. As of June 30, 2009, the Bank has not drawn on this available source of liquidity.
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. Under the Housing Act, the Secretary of Treasury has the authority, at his or her discretion, to purchase consolidated obligations, subject to the general federal debt ceiling limits. Previously, the FHLBank Act had authorized 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 latter authority have been outstanding since 1977 and the Bank has no immediate plans to request the Treasury to exercise the authority under the Housing Act.
59
Table of Contents
Off-balance Sheet Commitments
The Bank’s primary off-balance sheet commitments are as follows:
• | The Bank has joint and several liability for all FHLBank consolidated obligations |
• | 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 Agency. 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 June 30, 2009 or December 31, 2008. As of June 30, 2009, the FHLBanks had $1.1 trillion in aggregate par value of consolidated obligations issued and outstanding, $154.9 billion of which was attributable to the Bank.
As of June 30, 2009, the Bank had outstanding standby letters of credit of approximately $11.8 billion with original terms of less than three months to 16 years, with the longest final expiration in 2025.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 does not deem it necessary to have an allowance for credit losses for these unfunded letters of credit as of June 30, 2009.
Contractual Obligations
As of June 30, 2009, there has been no a material change outside the ordinary course of business in the Bank’s contractual obligations as 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 |
60
Table of Contents
• | 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. |
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
The Bank faces credit risk primarily with respect to its advances, investments, derivatives and mortgage loans.
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 the quality and value of the assets members pledge as eligible collateral.
The Bank utilizes a credit risk rating system for its members, which focuses primarily on an institution’s overall financial health and takes into account quality of assets, earnings, and capital position. The Bank assigns each borrower that is an insured depository institution a credit risk rating from one to 10 according to the relative amount of credit risk such borrower poses to the Bank (one being the least amount of credit risk and 10 the greatest amount of credit risk). In general, borrowers in categories nine and 10 may have more restrictions on the types of collateral they may use to secure advances, may be required to maintain higher collateral maintenance levels and deliver loan collateral, may be restricted from obtaining convertible advances and may face more stringent collateral reporting requirements. At times, the Bank may place more restrictive requirements on a borrower than those generally applicable to borrowers with the same rating based upon management’s assessment of the borrower and its collateral.
The following table sets forth the number of borrowers and the par amount of advances outstanding to borrowers with the specified ratings as of the specified dates (dollar amounts in thousands).
As of June 30, 2009 | As of December 31, 2008 | |||||||||
Rating | Number of Borrowers | Outstanding Advances | Number of Borrowers | Outstanding Advances | ||||||
1-4 | 114 | $ | 4,311,042 | 207 | $ | 7,786,864 | ||||
5-7 | 297 | 28,607,130 | 436 | 70,081,172 | ||||||
8 | 179 | 76,623,044 | 134 | 22,064,197 | ||||||
9 | 190 | 11,444,305 | 101 | 46,662,050 | ||||||
10 | 103 | 6,376,712 | 50 | 7,612,959 |
The Bank establishes a credit limit for each borrower. The credit limit is not a committed line of credit, but rather an indication of the borrower’s general borrowing capacity with the Bank. The Bank determines
61
Table of Contents
the credit limit in its sole and absolute discretion, by evaluating a wide variety of factors indicating the borrower’s overall creditworthiness. The credit limit is expressed as a percentage equal to the ratio of the borrower’s total liabilities to the Bank, including the face amount of outstanding letters of credit, the principal amount of outstanding advances and the total exposure of the Bank to the borrower under any derivative contract, to the borrower’s total assets. Generally, borrowers are held to a credit limit of no more than 30.0 percent. However, the Bank’s board of directors, or a relevant committee thereof, may approve a higher limit at its discretion. Prior to 2009, credit limits in excess of 30.0 percent required approval of the Bank’s Credit and Collateral Committee. Beginning in 2009, the board of directors, or a relevant committee thereof, is required to approve credit limits in excess of 30.0 percent.
Each borrower must maintain an amount of qualifying collateral that, when discounted to the lendable collateral value (“LCV”), is equal to at least 100 percent of the outstanding principal amount of all advances and other liabilities of the borrower to the Bank. Borrowers with a credit risk rating of nine or 10 currently must maintain higher collateral balances. The LCV is the value that the Bank assigns to each type of qualifying collateral for purposes of determining the amount of credit that such qualifying collateral will support. For each type of qualifying collateral, the Bank discounts the unpaid principal balance, market value, or other value of the qualifying collateral, to calculate the LCV. The following table provides information about the types of collateral held for the Bank’s advances (dollar amounts in thousands):
Total Par Value of Outstanding Advances | LCV of Collateral Pledged by members | First Mortgage Collateral (%) | Securities Collateral (%) | Other Real Estate Related Collateral (%) | ||||||||
As of June 30, 2009 | $ | 128,475,978 | $ | 228,406,858 | 60.6 | 15.2 | 24.2 | |||||
As of December 31, 2008 | 156,269,156 | 272,879,687 | 58.2 | 14.9 | 26.9 |
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 an allowance for credit losses on advances as of June 30, 2009.
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 and MBS.
The Bank follows guidelines approved by its board of directors regarding unsecured extensions of credit, in addition to Finance Agency regulations with respect to term limits and eligible counterparties.
Finance Agency regulations prohibit the Bank from investing in any of the following securities:
• | Instruments such as common stock that represent an ownership interest in an entity, other than stock in small business investment companies or certain investments targeted to low-income people or communities |
• | Instruments issued by non-United States entities, other than those issued by United States branches and agency offices of foreign commercial banks |
62
Table of Contents
• | Non-investment grade debt instruments, other than certain investments targeted to low-income people or communities and instruments that were downgraded to below an investment grade rating after purchase by the Bank |
• | Whole mortgages or other whole loans, other than (1) those acquired under the Bank’s mortgage purchase programs; (2) certain investments targeted to low-income people or communities; (3) certain marketable direct obligations of state, local, or tribal government units or agencies having at least the second highest credit rating from an NRSRO; (4) MBS or asset-backed securities backed by manufactured housing loans or home equity loans; and (5) certain foreign housing loans authorized under section 12(b) of the FHLBank Act |
• | Non-U.S. dollar denominated securities. |
In addition, Finance Agency regulations prohibit the Bank from taking a position in any commodity or foreign currency, other than participating in consolidated obligations denominated in a foreign currency or linked to equity or commodity prices. Further, the Finance Agency prohibits the Bank from purchasing any of the following:
• | Interest-only or principal-only stripped MBS, collateralized mortgage obligations (“CMOs”), and real estate mortgage-investment conduits (“REMICS”) |
• | Residual-interest or interest-accrual classes of CMOs and REMICs |
• | Fixed-rate or variable-rate MBS, CMOs, and REMICs that on the trade date are at rates equal to their contractual cap and that have average lives that vary by more than six years under an assumed instantaneous interest-rate change of 300 basis points. |
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 Risk Management Policy (“RMP”) and Finance Agency 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.
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 $11.4 billion at December 31, 2008 to $8.8 billion as of June 30, 2009. As of June 30, 2009, the Bank had unsecured credit exposure to three non-U.S. government counterparties that was greater than 10 percent of total unsecured credit exposure. The Bank did not have any unsecured credit exposure to any counterparties in excess of five percent but less than 10 percent of total unsecured credit exposure.
Mortgage–backed Securities
The Bank’s RMP permits the Bank to invest in agency (Fannie Mae, Freddie Mac and Ginnie Mae) obligations, including CMOs and REMICS backed by such securities, and other MBS, CMOs and REMICS rated AAA by S&P or Aaa by Moody’s at the time of purchase. The MBS purchased by the Bank attain their triple-A ratings through credit enhancements, which primarily consist of the subordination of the claims of the other tranches of these securities. The Bank’s long-term investment
63
Table of Contents
portfolio as of June 30, 2009 included $13.1 billion of private-label MBS, which represented a substantial portion, or 54.9 percent of the carrying value, of the Bank’s long-term investment portfolio.
The tables below provide information on the credit ratings of the Bank’s private-label MBS held at June 30, 2009, based on their credit ratings as of June 30, 2009 and August 7, 2009 (in thousands). The credit ratings reflect the lowest rating as reported by a NRSRO.
As of June 30, 2009 | ||||||
Investment Ratings: | Amortized Cost | Estimated Fair Value | ||||
AAA | $ | 7,273,201 | $ | 6,374,340 | ||
AA | 660,943 | 520,698 | ||||
A | 1,362,106 | 1,077,856 | ||||
BBB | 368,939 | 247,581 | ||||
BB | 873,857 | 623,998 | ||||
B | 2,146,701 | 1,368,202 | ||||
CCC | 1,433,911 | 838,362 | ||||
Total | $ | 14,119,658 | $ | 11,051,037 | ||
As of August 7, 2009 | ||||||
Investment Ratings: | Amortized Cost | Estimated Fair Value | ||||
AAA | $ | 5,937,651 | $ | 5,308,932 | ||
AA | 1,263,038 | 1,006,996 | ||||
A | 1,907,829 | 1,514,093 | ||||
BBB | 152,529 | 117,317 | ||||
BB | 518,911 | 419,586 | ||||
B | 2,193,648 | 1,438,516 | ||||
CCC | 1,861,336 | 1,063,534 | ||||
CC | 78,018 | 57,624 | ||||
C | 206,698 | 124,439 | ||||
Total | $ | 14,119,658 | $ | 11,051,037 | ||
The table below provides information on the credit ratings of the Bank’s private-label MBS held at December 31, 2008 (in thousands). The credit ratings reflect the lowest rating as reported by a NRSRO.
As of December 31, 2008 | ||||||
Investment Ratings: | Amortized Cost | Estimated Fair Value | ||||
AAA | $ | 13,823,733 | $ | 10,845,358 | ||
AA | 915,440 | 594,561 | ||||
A | 582,658 | 381,914 | ||||
BBB | 432,153 | 294,703 | ||||
BB | 24,539 | 14,063 | ||||
B | 72,246 | 72,246 | ||||
CCC | 67,622 | 73,513 | ||||
Total | $ | 15,918,391 | $ | 12,276,358 | ||
A portion of the Bank’s private-label MBS, or 42.1 percent, was rated AAA as of August 7, 2009 and 23.5 percent were rated AA to BBB as of August 7, 2009. Subsequent to June 30, 2009, approximately $2.6 billion, or 18.5 percent of the Bank’s private-label MBS have been downgraded as of August 7, 2009 as outlined in the below table (in thousands):
64
Table of Contents
Rating Agency Actions as of August 7, 2009 | |||||||||
Downgraded and Stable | |||||||||
To Double A | To Single A | To Below Investment Grade | |||||||
Private-label MBS | $ | 666,090 | $ | 615,994 | $ | 1,335,498 | |||
Total amortized cost | $ | 666,090 | $ | 615,994 | $ | 1,335,498 | |||
For disclosure purposes, the Bank classifies private-label MBS as either prime or Alt-A based upon the overall credit quality of the underlying loans as determined by the originator at the time of origination. Although there is no universal accepted definition of Alt-A, generally, loans with credit characteristics that range between prime and subprime are classified as Alt-A. Participants in the mortgage market have used the Alt-A classification principally to describe loans for which the underwriting process has been streamlined in order to reduce the documentation requirements of the borrower or allow alternative documentation. At June 30, 2009, based on the classification by the originator at the time of origination, approximately 90 percent of the underlying mortgages collateralizing the Bank’s private-label MBS were considered prime and the remaining underlying mortgages collateralizing these securities were considered Alt-A. None of the underlying mortgages collateralizing the private-label MBS portfolio is considered subprime.
The tables below provide additional information on the credit rating of the Bank’s private-label MBS backed by prime and Alt-A loans (dollar amounts in thousands).
Credit Ratings of Private-label MBS Backed by Prime Loans June 30, 2009 | ||||||||||||
Unpaid Principal Balance | Amortized Cost | Gross Unrealized Losses | Collateral Delinquency (%) | |||||||||
Investment grade: | ||||||||||||
AAA-rated | $ | 6,488,579 | $ | 6,447,249 | $ | (790,340 | ) | 1.93 | ||||
AA-rated | 530,486 | 526,235 | (127,336 | ) | 4.36 | |||||||
A-rated | 1,328,489 | 1,325,281 | (282,674 | ) | 4.85 | |||||||
BBB-rated | 381,443 | 368,939 | (121,357 | ) | 9.34 | |||||||
Below Investment Grade | 4,087,698 | 3,960,058 | (1,368,437 | ) | 13.70 | |||||||
Total | $ | 12,816,695 | $ | 12,627,762 | $ | (2,690,144 | ) | 6.31 | ||||
65
Table of Contents
Credit Ratings of Private-label MBS Backed by Alt-A Loans June 30, 2009 | ||||||||||||
Unpaid Principal Balance | Amortized Cost | Gross Unrealized Losses | Collateral Delinquency (%) | |||||||||
Investment grade: | ||||||||||||
AAA-rated | $ | 823,187 | $ | 825,952 | $ | (109,892 | ) | 3.66 | ||||
AA-rated | 135,011 | 134,707 | (12,908 | ) | 3.32 | |||||||
A-rated | 36,903 | 36,825 | (1,576 | ) | 4.17 | |||||||
Below Investment Grade | 506,484 | 494,412 | (255,472 | ) | 28.14 | |||||||
Total | $ | 1,501,585 | $ | 1,491,896 | $ | (379,848 | ) | 11.90 | ||||
The tables below provide additional information on the Bank’s private-label MBS by year of issuance (dollar amounts in thousands).
As of June 30, 2009 | ||||||||||||||||||||||||||||
AAA | AA | A | BBB | |||||||||||||||||||||||||
Unpaid Principal Balance | Gross Unrealized Losses | Unpaid Principal Balance | Gross Unrealized Losses | Unpaid Principal Balance | Gross Unrealized Losses | Unpaid Principal Balance | Gross Unrealized Losses | |||||||||||||||||||||
Prime - Year of Issuance: | ||||||||||||||||||||||||||||
2004 and prior | $ | 5,211,923 | $ | (480,360 | ) | $ | 15,671 | $ | (4,914 | ) | $ | 361,886 | $ | (88,118 | ) | $ | 73,042 | $ | (18,865 | ) | ||||||||
2005 | 797,776 | (201,682 | ) | 145,444 | (31,582 | ) | 834,611 | (171,222 | ) | 42,194 | (7,945 | ) | ||||||||||||||||
2006 | — | — | 192,827 | (47,505 | ) | — | — | 141,697 | (50,159 | ) | ||||||||||||||||||
2007 | 478,880 | (108,298 | ) | 77,475 | (11,829 | ) | 131,992 | (23,334 | ) | 124,510 | (44,388 | ) | ||||||||||||||||
2008 | — | — | 99,069 | (31,506 | ) | — | — | — | — | |||||||||||||||||||
Total Prime | 6,488,579 | (790,340 | ) | 530,486 | (127,336 | ) | 1,328,489 | (282,674 | ) | 381,443 | (121,357 | ) | ||||||||||||||||
Alt-A- Year of Issuance: | ||||||||||||||||||||||||||||
2004 and prior | 823,187 | (109,892 | ) | 135,011 | (12,908 | ) | 36,903 | (1,576 | ) | — | — | |||||||||||||||||
2005 | — | — | — | — | — | — | — | — | ||||||||||||||||||||
2007 | — | — | — | — | — | — | — | — | ||||||||||||||||||||
Total Alt-A | 823,187 | (109,892 | ) | 135,011 | (12,908 | ) | 36,903 | (1,576 | ) | — | — | |||||||||||||||||
Total | $ | 7,311,766 | $ | (900,232 | ) | $ | 665,497 | $ | (140,244 | ) | $ | 1,365,392 | $ | (284,250 | ) | $ | 381,443 | $ | (121,357 | ) | ||||||||
66
Table of Contents
As of June 30, 2009 | |||||||||||||||
Below Investment Grade | Total | ||||||||||||||
Unpaid Principal Balance | Gross Unrealized Losses | Gross Unrealized Losses | Original Credit Enhancement (%) | Weighted Average Credit Support Percentage (%) | |||||||||||
Prime-Year of Issuance: | |||||||||||||||
2004 and prior | $ | 28,177 | $ | (8,606 | ) | $ | (600,863 | ) | 2.9 | 5.9 | |||||
2005 | 1,231,630 | (349,514 | ) | (761,945 | ) | 6.3 | 8.3 | ||||||||
2006 | 1,169,847 | (420,836 | ) | (518,500 | ) | 9.4 | 9.9 | ||||||||
2007 | 1,422,145 | (544,999 | ) | (732,848 | ) | 12.0 | 12.1 | ||||||||
2008 | 235,899 | (44,482 | ) | (75,988 | ) | 15.7 | 16.4 | ||||||||
Total Prime | 4,087,698 | (1,368,437 | ) | (2,690,144 | ) | 6.4 | 8.3 | ||||||||
Alt-A-Year of Issuance: | |||||||||||||||
2004 and prior | — | — | (124,376 | ) | 6.6 | 10.7 | |||||||||
2005 | 415,605 | (226,875 | ) | (226,875 | ) | 26.6 | 27.5 | ||||||||
2007 | 90,879 | (28,597 | ) | (28,597 | ) | 12.3 | 10.5 | ||||||||
Total Alt-A | 506,484 | (255,472 | ) | (379,848 | ) | 12.5 | 15.3 | ||||||||
Total | $ | 4,594,182 | $ | (1,623,909 | ) | $ | (3,069,992 | ) | 7.0 | 9.0 | |||||
Fair Value as a Percentage of Unpaid Principal Balance (%)
By Year of Issuance
June 30, 2009 | March 31, 2009 | December 31, 2008 | September 30, 2008 | June 30, 2008 | ||||||
Private-label MBS by Year of Issuance | ||||||||||
Prime: | ||||||||||
2009 | — | — | �� | — | — | — | ||||
2008 | 77 | 54 | 66 | 86 | 96 | |||||
2007 | 64 | 73 | 72 | 78 | 94 | |||||
2006 | 63 | 57 | 64 | 80 | 95 | |||||
2005 | 74 | 66 | 70 | 83 | 95 | |||||
2004 and earlier | 89 | 86 | 83 | 88 | 94 | |||||
Weighted-average of all Prime | 78 | 75 | 76 | 84 | 95 | |||||
Alt-A: | ||||||||||
2009 | — | — | — | — | — | |||||
2008 | — | — | — | — | — | |||||
2007 | 63 | 72 | 74 | 68 | 88 | |||||
2006 | — | — | — | — | — | |||||
2005 | 44 | 44 | 51 | 69 | 72 | |||||
2004 and earlier | 88 | 89 | 89 | 81 | 83 | |||||
Weighted-average of all Alt-A | 74 | 76 | 78 | 77 | 80 | |||||
Weighted-average of all private-label MBS | 77 | 75 | 76 | 83 | 93 | |||||
67
Table of Contents
The table below provides information on the interest-rate payment terms of the Bank’s MBS backed by prime and Alt-A loans (in thousands).
As of June 30, 2009 | As of December 31, 2008 | |||||||||||||||||
Fixed-Rate | Variable-Rate | Total | Fixed-Rate | Variable-Rate | Total | |||||||||||||
Private-label MBS: | ||||||||||||||||||
Prime | $ | 2,964,285 | $ | 9,852,410 | $ | 12,816,695 | $ | 3,536,058 | $ | 10,997,724 | $ | 14,533,782 | ||||||
Alt-A | 807,407 | 694,178 | 1,501,585 | 1,116,874 | 517,784 | 1,634,658 | ||||||||||||
Total unpaid principal balance | 3,771,692 | 10,546,588 | 14,318,280 | 4,652,932 | 11,515,508 | 16,168,440 | ||||||||||||
To assess whether the entire amortized cost bases of its private-label MBS will be recovered, the Bank performed a cash flow analysis for each of its private-label MBS that was determined to be other-than-temporarily impaired in a previous reporting period as well as those with adverse risk characteristics as of June 30, 2009. The adverse risk characteristics used to select securities for cash flow analysis included: the duration and magnitude of the unrealized loss, NRSRO credit ratings below investment grade, and criteria related to the credit performance of the underlying collateral, including the ratio of credit enhancement to expected collateral losses and the ratio of seriously delinquent loans to credit enhancement. For these purposes, expected collateral losses are those that are implied by current delinquencies taking into account a default probability based on the state of delinquency and a loss severity assumption based on product and vintage; seriously delinquent loans are those that are 60 or more days past due, including loans in foreclosure and real estate owned. In performing the cash flow analysis for each of these securities, the Bank used two third party models. The first model considers borrower characteristics and the particular attributes of the loans underlying the Bank’s securities, in conjunction with assumptions about future changes in home prices and interest rates, to project prepayments, defaults and loss severities. A significant input to the first model is the forecast of future housing price changes for the relevant states and core based statistical areas (“CBSAs”), which are based upon an assessment of the individual housing markets. (The term CBSA refers collectively to metropolitan and micropolitan statistical areas as defined by the United States Office of Management and Budget; as currently defined, a CBSA must contain at least one urban area of 10,000 or more people.) The Bank’s housing price forecast assumed current-to-trough home price declines ranging from zero percent to 20 percent over the next nine to 15 months (resulting in peak-to-trough home price declines of up to 51 percent). Thereafter, home prices are projected to increase one percent in the first year, three percent in the second year and four percent in each subsequent year. The month-by-month projections of future loan performance derived from the first model, which reflect projected prepayments, defaults and loss severities, are then input into a second model that allocates the projected loan level cash flows and losses to the various security classes in the securitization structure in accordance with its prescribed cash flow and loss allocation rules. The model classifies securities, as noted in the below table, based on current characteristics and performance, which may be different than the securities’ classification as determined by the originator at the time of origination. For those securities for which an other-than-temporary impairment was determined to have occurred as of June 30, 2009 (that is, a determination was made that the entire amortized cost bases will not likely be recovered), the following table represents a summary of the significant inputs used to measure the amount of the credit loss recognized in earnings (dollar amounts in thousands):
68
Table of Contents
Year of Securitization | Number of Securities | Unpaid Principal Balance | Significant Inputs | ||||||||||||||||||||
Prepayment Rates | Default Rates | Loss Severities | |||||||||||||||||||||
Weighted Average % | Range % | Weighted Average % | Range % | Weighted Average % | Range % | ||||||||||||||||||
Alt-A: | |||||||||||||||||||||||
2007 | 7 | $ | 1,072,539 | 13.8 | 10.8 to 17.0 | 43.4 | 40.4 to 51.6 | 40.0 | 36.7 to 41.8 | ||||||||||||||
2006 | 4 | 373,402 | 14.6 | 12.7 to 16.1 | 47.2 | 43.1 to 50.6 | 38.9 | 33.2 to 43.8 | |||||||||||||||
2005 | 6 | 732,600 | 14.4 | 8.3 to 19.4 | 49.2 | 30.9 to 76.7 | 41.5 | 34.3 to 48.0 | |||||||||||||||
Total | 17 | $ | 2,178,541 | 14.1 | 8.3 to 19.4 | 46.0 | 30.9 to 76.7 | 40.3 | 33.2 to 48.0 | ||||||||||||||
As previously discussed, the Bank recognized an other-than-temporary impairment loss of $403.6 million and $1.1 billion related to its private-label MBS for the second quarter and first six months of 2009, respectively. The total amount of other-than-temporary impairment is calculated as the difference between the security’s amortized cost basis and its fair value. The credit related portion of this other-than-temporary impairment loss of $46.2 million and $135.1 million for the second quarter and first six months of 2009, respectively, is reported in the Statements of Income as “Net impairment losses recognized in earnings,” while the noncredit portion of $357.3 million and $966.6 million for the second quarter and first six months of 2009, respectively, is reflected as a component of other comprehensive loss. The table below summarizes the total other-than-temporary impairment loss recorded during the period by classification and by the duration of the unrealized loss prior to impairment (in thousands):
Three Months Ended June 30, 2009 | |||||||||
Gross Unrealized Loss Position | |||||||||
Less than 12 Months | 12 Months or more | Total | |||||||
Private-label MBS backed by: | |||||||||
Prime loans | $ | — | $ | 273,010 | $ | 273,010 | |||
Alt-A | — | 130,574 | 130,574 | ||||||
Total securities impairments | $ | — | $ | 403,584 | $ | 403,584 | |||
Six Months Ended June 30, 2009 | |||||||||
Gross Unrealized Loss Position | |||||||||
Less than 12 Months | 12 Months or more | Total | |||||||
Private-label MBS backed by: | |||||||||
Prime loans | $ | — | $ | 971,148 | $ | 971,148 | |||
Alt-A | — | 130,574 | 130,574 | ||||||
Total securities impairments | $ | — | $ | 1,101,722 | $ | 1,101,722 | |||
The remainder of the Bank’s private-label MBS that has not been designated as other-than-temporarily impaired has experienced significant unrealized losses and decreases in fair value due to interest rate volatility, illiquidity in the marketplace, and credit deterioration in the U.S. mortgage markets. This decline in fair value is considered temporary as the Bank expects to recover the amortized cost basis of these securities, the Bank does not intend to sell the securities, and it is not more likely than not that the Bank will be required to sell the securities before the anticipated recovery of the securities’ remaining amortized cost basis, which may be at maturity.
69
Table of Contents
Non-Private-label MBS.The unrealized losses related to U.S. agency MBS, and government-sponsored enterprises MBS are caused by interest rate changes. Because these securities are guaranteed by government agencies or government-sponsored enterprises, it is expected that these securities would not be settled at a price less than the amortized cost basis. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Bank does not intend to sell the investments and it is not more likely than not that the Bank will be required to sell the investments before recovery of their amortized cost basis, which may be at maturity, the Bank does not consider these investments to be other-than-temporarily impaired as of June 30, 2009.
Given the current market conditions and the significant judgments involved, there is a continuing risk that further declines in fair value may occur and that the Bank may record material other-than-temporary impairment losses in future periods, which could affect the Bank’s financial condition and results of operations.
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 applicable regulatory requirements, which set forth the eligibility criteria for counterparties (i.e., minimum capital requirements, an NRSRO, 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 June 30, 2009, the Bank had $215.0 billion in total notional amount of derivatives outstanding compared to $240.2 billion at December 31, 2008. 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 June 30, 2009, 99.4 percent of the total notional amount of outstanding derivative transactions was represented by 20 counterparties with a credit rating of A or better. Of these counterparties, there were three, JP Morgan Chase Bank N.A., Deutsche Bank AG, Goldman Sachs Group, Inc, that represented more than 10 percent of the Bank’s total notional amount, and three counterparties, Bank of America N.A., Rabobank Nederland and Royal Bank of Canada, that represented more than 10 percent of the Bank’s net exposure. As of December 31, 2008, 99.5 percent of the total notional amount of outstanding derivative transactions was represented by 27 counterparties with a credit rating of A or better. Of these counterparties, there were five, Barclays Bank Plc, JP Morgan Chase Bank N.A., Deutsche Bank AG, Goldman Sachs Group, Inc and Merrill Lynch & Co. Inc., that represented more than 10 percent of the Bank’s total notional amount, and three counterparties, Bank of America N.A., Rabobank Nederland and Royal Bank of Canada, that represented more than 10 percent of the Bank’s net exposure.
70
Table of Contents
The following tables represent the credit ratings of the Bank’s derivative counterparties (in thousands):
Derivative Counterparty Credit Exposure
As of June 30, 2009
Credit Rating: | Notional Amount | Total Net Exposure at Fair Value | Collateral Held | Net Exposure After Collateral | ||||||||
AAA | $ | 4,170,211 | $ | — | $ | — | $ | — | ||||
AA | 65,995,160 | 14,244 | — | 14,244 | ||||||||
A | 143,626,304 | 101,291 | 95,427 | 5,864 | ||||||||
BBB | 40,000 | 321 | — | 321 | ||||||||
Member institutions* | 1,171,877 | 4,269 | — | — | ||||||||
Total derivatives | $ | 215,003,552 | $ | 120,125 | $ | 95,427 | $ | 20,429 | ||||
* | 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, 2008
Credit Rating: | Notional Amount | Total Net Exposure at Fair Value | Collateral Held | Net Exposure After Collateral | ||||||||
AAA | $ | 4,487,365 | $ | — | $ | — | $ | — | ||||
AA | 86,833,819 | 108,627 | 69,747 | 38,880 | ||||||||
A | 147,626,848 | 2,382 | — | 2,382 | ||||||||
Member institutions* | 1,266,126 | 6,692 | — | — | ||||||||
Total derivatives | $ | 240,214,158 | $ | 117,701 | $ | 69,747 | $ | 41,262 | ||||
* | 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 cost of replacing 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 pledged to the Bank, if any, is of no value to the Bank.
The net exposure after collateral is treated as unsecured credit consistent with the Bank’s RMP and the Finance Agency 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.
71
Table of Contents
Mortgage Loan Programs
The Bank stopped accepting additional MPF Program master commitments as of February 4, 2008, and as of June 30, 2008, ceased purchasing assets under the MPF Program. Early in the third quarter of 2008, the Bank suspended new acquisitions of mortgage loans under MPP.
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 participating financial institution (“PFI”). These risk management practices are described in detail in the Bank’s Form 10-K. In some cases, a portion of the credit support for MPP and MPF loans is provided under a primary and/or supplemental mortgage insurance policy. Currently, eight mortgage insurance companies provide primary and/or supplemental mortgage insurance for loans in which the Bank has a retained interest. As of June 30, 2009, several of the Bank’s mortgage insurance providers have had their ratings for claims paying ability or insurer financial strength downgraded below AA by one or more NRSROs. Ratings downgrades imply an increased risk that these mortgage insurers may be unable to fulfill their obligations to pay claims that may be made under the insurance policies. Given the amount of loans covered by this insurance, the other credit enhancements and the historical performance of those loans, the Bank believes its credit exposure to these companies, both individually and in the aggregate, was not significant as of June 30, 2009.
Critical Accounting Policies and Estimates
Other-Than-Temporary Impairment Analysis
The Bank applies SFAS 115, as amended by FSP FAS 115-1 and FAS 124-1,The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, and FSP FAS 115-2 and 124-2, to determine whether the Bank’s investment securities have incurred other-than-temporary impairment. The Bank recognizes an other-than-temporary impairment loss when the Bank determines it will not recover the entire amortized cost basis of a security.
To assess whether the entire amortized cost bases of its private-label MBS will be recovered, the Bank performed a cash flow analysis for each of its private-label MBS that was determined to be other-than-temporarily impaired in a previous reporting period as well as those with adverse risk characteristics as of June 30, 2009. The adverse risk characteristics used to select securities for cash flow analysis included: the duration and magnitude of the unrealized loss, NRSRO credit ratings below investment grade, and criteria related to the credit performance of the underlying collateral, including the ratio of credit enhancement to expected collateral losses and the ratio of seriously delinquent loans to credit enhancement. As a result of this security-level review, the Bank identifies individual securities believed to be at risk for other-than-temporary impairment, which are evaluated further by analyzing the performance of the security. These at risk securities are evaluated by estimating the present value of cash flows the Bank expects to collect based on the structure of the security and certain assumptions, such as future changes in home prices, prepayments, default rates and loss severity. If the present value of the expected cash flows of a particular security is less than the security’s amortized cost basis, the security is considered to be other-than temporarily impaired.
The amount of the other-than-temporary impairment is separated into two components: (1) the amount of the total impairment related to credit loss; and (2) the amount of the total impairment related to all
72
Table of Contents
other factors. The portion of the other-than-temporary impairment loss that is attributable to the credit loss (that is, the difference between the present value of the cash flows expected to be collected and the amortized cost basis) is recognized in other income (loss). If the Bank does not intend to sell the security and it is not more likely than not that the Bank will be required to sell the debt security before the anticipated recovery of its remaining amortized cost basis, the portion of the impairment loss that is not attributable to the credit loss is recognized through other comprehensive loss.
If the Bank determines that an other-than-temporary impairment exists, the Bank accounts for the investment security as if it had been purchased on the measurement date of the other-than-temporary impairment loss at an amortized cost basis equal to the previous amortized cost basis less the other-than-temporary impairment recognized in income. The difference between the new amortized cost basis and the cash flows expected to be collected is accreted into interest income prospectively over the remaining life of the security.
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 Issued and Adopted Accounting Standards
SFAS 161, issued in March 2008, required enhanced disclosures about an entity’s derivative and hedging activities. These enhanced disclosures must discuss (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133,Accounting for Derivatives Instruments and Hedging Activities (“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 adopted SFAS 161 as of January 1, 2009. The adoption of SFAS 161 did not have a material effect on the Bank’s financial condition or results of operations. The adoption of SFAS 161 resulted in increased financial statement disclosures.
FSP FAS 157-4,issued in April 2009, is intended to provide application guidance addressing the determination of when a market for a financial asset or a financial liability is not active and when a transaction is not distressed for fair value measurements under SFAS No. 157,Fair Value Measurements. FSP FAS 157-4 is effective and should be applied prospectively for financial statements issued for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for reporting periods ending after March 15, 2009. Early adoption of FSP FAS 157-4 also requires early adoption of FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (“FSP FAS 115-2 and FAS 124-2”). The Bank adopted FSP FAS 157-4 as of January 1, 2009. The adoption of FSP FAS 157-4 did not have a material effect on the Bank’s financial condition or results of operations.
FSP FAS 115-2 and FAS 124-2,issued in April 2009, is intended to provide greater clarity to investors about the credit and noncredit component of an other-than-temporary impairment event and to communicate more effectively when an other-than-temporary impairment event has occurred. FSP FAS 115-2 and FAS 124-2 amends the other-than-temporary impairment guidance in GAAP for debt securities. The new guidance improves the presentation and disclosure of other-than-temporary impairment on investment securities and changes the calculation of the other-than-temporary impairment
73
Table of Contents
recognized in earnings in the financial statements. FSP FAS 115-2 and FAS 124-2 does not amend existing recognition and measurement guidance related to other-than-temporary impairment of equity securities.
For debt securities, FSP FAS 115-2 and FAS 124-2 requires an entity to assess whether (a) it has the intent to sell the debt security, or (b) it is more likely than not that it will be required to sell the debt security before its anticipated recovery. If either of these conditions is met, an other-than-temporary impairment on the security must be recognized.
In instances in which a determination is made that a credit loss (defined by FSP FAS 115-2 and FAS 124-2 as the difference between the present value of the cash flows expected to be collected and the amortized cost basis) exists but the entity does not intend to sell the debt security and it is not more likely than not that the entity will be required to sell the debt security before the anticipated recovery of its remaining amortized cost basis (i.e., the amortized cost basis less any current-period credit loss), FSP FAS 115-2 and FAS 124-2 changes the presentation and amount of the other-than-temporary impairment recognized in the income statement. In these instances, the impairment is separated into (a) the amount of the total impairment related to the credit loss, and (b) the amount of the total impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total impairment related to all other factors is recognized in other comprehensive loss and will be amortized over the remaining life of the debt security as an increase in the carrying value of the security (with no effect on earnings unless the security subsequently is sold or additional other-than-temporary impairment losses are recognized). The total other-than-temporary impairment is presented in the income statement with an offset for the amount of the total other-than-temporary impairment that is recognized in other comprehensive loss. Previously, in all cases, if an impairment was determined to be other-than-temporary, an impairment loss was recognized in earnings in an amount equal to the entire difference between the security’s amortized cost basis and its fair value at the balance sheet date of the reporting period for which the assessment was made. The new presentation provides additional information about the amounts that the entity does not expect to collect related to a debt security.
FSP FAS 115-2 and FAS 124-2 is effective and is to be applied prospectively for financial statements issued for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for reporting periods ending after March 15, 2009. Early adoption of FSP FAS 115-2 and FAS 124-2 also requires early adoption of FSP FAS 157-4. When adopting FSP FAS 115-2 and FAS 124-2, an entity is required to record a cumulative-effect adjustment as of the beginning of the period of adoption to reclassify the noncredit component of a previously recognized other-than-temporary impairment from retained earnings to accumulated other comprehensive loss if the entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before the anticipated recovery of its amortized cost basis.
The Bank adopted FSP FAS 115-2 and FAS 124-2 as of January 1, 2009, and recognized the effects of applying FSP FAS 115-2 and FAS 124-2 as a change in accounting principle. The Bank recognized the $178.5 million cumulative effect of initially applying FSP FAS 115-2 and FAS 124-2 as an adjustment to retained earnings at January 1, 2009, with a corresponding adjustment to accumulated other comprehensive loss.
FSP FAS 107-1 and APB 28-1, issued in April 2009, amends the disclosure requirements in SFAS No. 107,Disclosures about Fair Value of Financial Instruments(“SFAS 107”), and APB Opinion No. 28,Interim Financial Reporting, to require disclosures about the fair value of financial instruments within the scope of SFAS 107,
74
Table of Contents
including disclosure of the method(s) and significant assumptions used to estimate the fair value of financial instruments, in interim financial statements as well as in annual financial statements. Previously, these disclosures were required only in annual financial statements. FSP FAS 107-1 and APB 28-1 is effective and should be applied prospectively for financial statements issued for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for reporting periods ending after March 15, 2009. Early adoption of FSP FAS 107-1 and APB 28-1 is permitted only if an election also is made to early adopt FSP FAS 115-2 and FAS 124-2 and FSP FAS 157-4. In periods after initial adoption, FSP FAS 107-1 and APB 28-1 requires comparative disclosures only for periods ending subsequent to initial adoption and does not require earlier periods to be disclosed for comparative purposes at initial adoption. The Bank adopted FSP FAS 107-1 and APB 28-1 on January 1, 2009. The adoption of FSP FAS 107-1 and APB 28-1 did not have a material effect on the Bank’s financial condition or results of operations. The adoption of FSP FAS 107-1 and APB 28-1 resulted in increased financial statement disclosures.
SFAS 165, issued in May 2009, is intended to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS 165 sets forth: (a) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; (b) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and (c) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date, including disclosure of the date through which an entity has evaluated subsequent events and whether that represents the date the financial statements were issued or were available to be issued. This disclosure should alert all users of financial statements that an entity has not evaluated subsequent events after that date in the set of financial statements being presented. SFAS 165 does not apply to subsequent events or transactions that are within the scope of other applicable GAAP that provide different guidance on the accounting treatment for subsequent events or transactions. SFAS 165 is effective for interim and annual financial periods ending after June 15, 2009 (June 30, 2009 for the Bank). The Bank adopted SFAS 165 as of June 30, 2009. The adoption of SFAS 165 did not have a material effect on the Bank’s financial condition or results of operations. The adoption of SFAS 165 resulted in increased financial statement disclosures.
SFAS 166, issued in June 2009, is intended to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement in transferred financial assets. SFAS 166 is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009 (January 1, 2010 for the Bank), for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. Earlier application is prohibited. The Bank does not believe that the adoption of SFAS 166 will have a material effect on its financial condition or results of operations.
SFAS 167, issued in June 2009, is intended to amend certain requirements of FASB Interpretation No. 46 (revised December 2003),Consolidation of Variable Interest Entities, to improve financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. SFAS 167 is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009 (January 1, 2010 for the Bank), for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter.
75
Table of Contents
Earlier application is prohibited. The Bank does not believe that the adoption of SFAS 167 will have a material effect on its financial condition or results of operations.
SFAS 168, issued in June 2009, designates the FASB Accounting Standards Codification (“ASC”) as the single source of authoritative nongovernmental GAAP. The ASC does not change current GAAP; rather, its intent is to organize all accounting literature by topic in one place in order to enable users to quickly identify appropriate GAAP. SFAS 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009 (September 30, 2009 for the Bank). The Bank does not believe that the adoption of SFAS 168 will have a material effect on its financial condition or results of operations.
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.
76
Table of Contents
The following table summarizes the fair-value amounts of derivative financial instruments, excluding accrued interest, by product type (in thousands). The category “Fair value hedges” represents 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.
Derivative Financial Instruments Excluding Accrued Interest/By Product
As of June 30, 2009 | As of December 31, 2008 | |||||||||||||
Total Notional | Estimated Fair Value Gain /(Loss) (excludes accrued interest) | Total Notional | Estimated Fair Value Gain /(Loss) (excludes accrued interest) | |||||||||||
Advances: | ||||||||||||||
Fair value hedges | $ | 100,162,084 | $ | (5,917,018 | ) | $ | 116,095,763 | $ | (9,392,889 | ) | ||||
SFAS 133 non-qualifying hedges | 2,451,900 | (92,369 | ) | 2,768,400 | (162,994 | ) | ||||||||
Total | 102,613,984 | (6,009,387 | ) | 118,864,163 | (9,555,883 | ) | ||||||||
Investments: | ||||||||||||||
SFAS 133 non-qualifying hedges | 3,487,855 | (313,416 | ) | 4,015,855 | (512,160 | ) | ||||||||
Total | 3,487,855 | (313,416 | ) | 4,015,855 | (512,160 | ) | ||||||||
Consolidated obligation bonds: | ||||||||||||||
Fair value hedges | 72,292,382 | 1,458,179 | 83,307,558 | 2,358,057 | ||||||||||
SFAS 133 non-qualifying hedges | 2,969,000 | 12,680 | 9,430,000 | (10,418 | ) | |||||||||
Total | 75,261,382 | 1,470,859 | 92,737,558 | 2,347,639 | ||||||||||
Consolidated obligation discount notes: | ||||||||||||||
Fair value hedges | 26,482,015 | 42,245 | 18,623,263 | 54,753 | ||||||||||
SFAS 133 non-qualifying hedges | 1,968,064 | 1,768 | 243,030 | 1,903 | ||||||||||
Total | 28,450,079 | 44,013 | 18,866,293 | 56,656 | ||||||||||
Balance Sheet: | ||||||||||||||
SFAS 133 non-qualifying hedges | 2,846,499 | 7,201 | 3,198,038 | 15,827 | ||||||||||
Total | 2,846,499 | 7,201 | 3,198,038 | 15,827 | ||||||||||
Intermediary positions: | ||||||||||||||
Intermediaries | 2,343,753 | 68 | 2,532,251 | 108 | ||||||||||
Total | 2,343,753 | 68 | 2,532,251 | 108 | ||||||||||
Total notional and fair value | $ | 215,003,552 | $ | (4,800,662 | ) | $ | 240,214,158 | $ | (7,647,813 | ) | ||||
Total derivatives excluding accrued interest | $ | (4,800,662 | ) | $ | (7,647,813 | ) | ||||||||
Accrued interest | 47,523 | 56,762 | ||||||||||||
Cash collateral held by counterparty - assets | 4,184,216 | 6,338,420 | ||||||||||||
Cash collateral held from counterparty- liabilities | (95,443 | ) | (69,755 | ) | ||||||||||
Net derivative balance | $ | (664,366 | ) | $ | (1,322,386 | ) | ||||||||
Net derivative assets balance | $ | 50,396 | $ | 91,406 | ||||||||||
Net derivative liabilities balance | (714,762 | ) | (1,413,792 | ) | ||||||||||
Net derivative balance | $ | (664,366 | ) | $ | (1,322,386 | ) | ||||||||
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
77
Table of Contents
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.
Effective Duration Exposure | ||||||||||||||||
(In months) | ||||||||||||||||
As of June 30, 2009 | As of December 31, 2008 | |||||||||||||||
Up 200 Basis Points | Current | Down 200 Basis Points* | Up 200 Basis Points | Current | Down 200 Basis Points* | |||||||||||
Assets | 7.8 | 7.7 | 4.6 | 6.9 | 5.2 | 2.8 | ||||||||||
Liabilities | 6.4 | 6.6 | 6.6 | 5.3 | 4.7 | 4.8 | ||||||||||
Equity | 43.2 | 32.4 | (40.3 | ) | 48.8 | 19.0 | (51.5 | ) | ||||||||
Effective duration gap | 1.4 | 1.1 | (2.0 | ) | 1.6 | 0.5 | (2.0 | ) |
* | The “down 200 basis points” scenarios shown above are considered to be “constrained shocks”; to prevent the possibility of negative interest rates when a designated low rate environment exists. |
The Bank uses both sophisticated computer models and an experienced professional staff to measure the amount of interest rate risk in the balance sheet, thus allowing management to monitor the risk against policy and regulatory limits. Management regularly reviews the major assumptions and methodologies used in the Bank’s models, and may be required to make adjustments to the Bank’s models in response to rapid changes in economic conditions. Management believes that the use of market spreads calculated from estimates of current market prices (which include large embedded liquidity spreads), as opposed to valuation spreads that existed at the time the Bank acquired the MBS and mortgage loans (acquisition spreads), results in a disconnect between measured risk and the actual risks faced by the Bank. Because the Bank intends to and is able to hold its MBS and mortgage loans to maturity, the risks of value loss implied by current market prices of MBS and mortgage loans are not likely to affect the Bank’s duration of equity. As a result, management does not believe that the increased sensitivity indicates a fundamental change in interest-rate risk. In light of these conditions, in the third quarter of 2008, management refined its duration model to reflect mortgage asset spreads closer to the historical average and price assets closer to book value. The changes between the Bank’s effective duration of equity and duration gap between June 30, 2009 and December 31, 2008 in the table above are based on this difference in calculation method. If these changes had not been made to the model, management estimates that the Bank’s effective duration of equity would have been calculated at 111.8 months and the effective duration gap would have been calculated at 3.4 months at June 30, 2009.
78
Table of Contents
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 June 30, 2009, under the refined assets spreads and prices discussed above.
Additional Duration Exposure Scenarios* | |||||||||||||||||
(In months) | |||||||||||||||||
As of June 30, 2009 | |||||||||||||||||
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 | 8.0 | 8.2 | 8.0 | 7.7 | 5.9 | 6.5 | 5.4 | ||||||||||
Liabilities | 6.4 | 6.5 | 6.5 | 6.6 | 6.4 | 6.6 | 6.6 | ||||||||||
Equity | 46.0 | 44.4 | 41.3 | 32.4 | (3.2 | ) | 4.0 | (19.1 | ) | ||||||||
Effective duration gap | 1.6 | 1.7 | 1.5 | 1.1 | (0.5 | ) | (0.1 | ) | (1.2 | ) |
* | The “down” scenarios shown above are considered to be “constrained shocks”; to prevent the possibility of negative interest rates when a designated low rate environment exists. |
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. The Bank’s total capital decreased by $1.0 billion and the market value of equity decreased by $703.0 million from December 31, 2008 to June 30, 2009, respectively. The market value of equity decreased due to continued declines in private-label MBS prices and total capital decreased due to a decline in advances and capital stock.
Market Value Equity | ||||||||||||||||||
(In millions) | ||||||||||||||||||
As of June 30, 2009 | As of December 31, 2008 | |||||||||||||||||
Up 200 Basis Points | Current | Down 200 Basis Points* | Up 200 Basis Points | Current | Down 200 Basis Points* | |||||||||||||
Assets | $ | 159,195 | $ | 161,646 | $ | 161,646 | $ | 198,937 | $ | 202,397 | $ | 202,397 | ||||||
Liabilities | 154,675 | 156,347 | 156,347 | 196,076 | 197,801 | 197,801 | ||||||||||||
Equity | 4,520 | 5,299 | 5,299 | 2,861 | 4,596 | 4,596 |
* | The “down 200 basis points” scenarios shown above are considered to be “constrained shocks”; to prevent the possibility of negative interest rates when a designated low rate environment exists. |
79
Table of Contents
Item 4. | Controls and Procedures |
Not applicable.
Item 4T. | Controls and Procedures |
Disclosure Controls and Procedures
The Bank’s senior management is responsible for establishing and maintaining a system of disclosure controls and procedures designed to ensure that information required to be disclosed by the Bank in the reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. The Bank’s disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Bank in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to the Bank’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the Bank’s disclosure controls and procedures, the Bank’s management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and the Bank’s management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of controls and procedures.
Management of the Bank has evaluated the effectiveness of the design and operation of its disclosure controls and procedures with the participation of the president and chief executive officer, and chief financial officer as of the end of the period covered by this report. Based on that evaluation, the Bank’s president and chief executive officer and chief financial officer have concluded that the Bank’s disclosure controls and procedures were effective at a reasonable assurance level as of the end of the fiscal quarter covered by this report.
Changes in Internal Control Over Financial Reporting
For the second quarter of 2009, there has been a significant change in the Bank’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Bank’s internal control over financial reporting. The Bank participates in an FHLBank System OTTI Committee which reviews and approves key modeling assumptions, inputs and methodologies used in making the Bank’s determination of other-than-temporary impairment for its private-label MBS and has implemented a testing process with the other FHLBanks to establish consistency within the other-than-temporary impairment cash flow models utilized. These modeling assumptions, inputs and methodologies are material to the determination of other-than-temporary impairment and, in turn, material to the Bank’s internal control over financial reporting. Accordingly, management reviewed the assumptions approved by the OTTI Committee and determined that they were reasonable and utilized the assumptions in connection with the Bank’s risk model to produce the cash flow analysis used in analyzing credit losses and determining other-than-temporary impairment. There were no other changes in the Bank’s internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Bank’s internal control over financial reporting.
80
Table of Contents
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 |
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in the Bank’s Annual Report on Form 10-K for the year ended December 31, 2008, and in the Bank’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2009, which could materially affect the Bank’s business, financial condition or future results. The results described in the Bank’s Form 10-K are not the only risks facing the Bank. The capital and credit markets have been experiencing volatility and disruption for more than 12 months. In the past several months, volatility and disruptions have increased and recently reached unprecedented levels. Additional risks and uncertainties not currently known to the Bank or that the Bank currently deems to be immaterial also may materially adversely affect the Bank’s business, financial condition and/or operating results.
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.
81
Table of Contents
Item 6. | Exhibits |
3.1 | Restated Organization Certificate of the Federal Home Loan Bank of Atlanta (1) | |
3.2 | Bylaws of the Federal Home Loan Bank of Atlanta (Revised and Restated) (2) | |
4.1 | Capital Plan of the Federal Home Loan Bank of Atlanta (3) | |
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. |
(1) | Filed on March 17, 2006 with the Securities and Exchange Commission in the Bank’s Form 10 Registration Statement and incorporated herein by reference. |
(2) | Filed on January 29, 2008 with the Securities and Exchange Commission in the Bank’s Form 8-K and incorporated herein by reference. |
(3) | Filed on March 30, 2009 with the Securities and Exchange Commission in the Bank’s Form 10-K and incorporated herein by reference. |
82
Table of Contents
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: August 12, 2009 | 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 |
83