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, 2011
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 000-51404
FEDERAL HOME LOAN BANK OF INDIANAPOLIS
(Exact name of registrant as specified in its charter)
Federally chartered corporation (State or other jurisdiction of incorporation or organization) | 35-6001443 (I.R.S. employer identification number) | |
8250 Woodfield Crossing Boulevard Indianapolis, IN (Address of principal executive offices) | 46240 (Zip code) |
(317) 465-0200
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing for the past 90 days.
x Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
x Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
o Large accelerated filer | o Accelerated filer |
x Non-accelerated filer (Do not check if a smaller reporting company) | o Smaller reporting company |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes x No
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Shares outstanding as of July 31, 2011 | ||
Class B Stock, par value $100 | 20,152,531 |
Table of Contents | Page | |
Number | ||
PART I. | ||
Item 1. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
PART II. | ||
Item 1. | ||
Item 1A. | ||
Item 6. | ||
Glossary | ||
Exhibit 31.1 | ||
Exhibit 31.2 | ||
Exhibit 31.3 | ||
Exhibit 32 |
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Federal Home Loan Bank of Indianapolis
Statements of Condition
(Unaudited, $ amounts and shares in thousands, except par value)
June 30, 2011 | December 31, 2010 | ||||||
Assets: | |||||||
Cash and Due from Banks | $ | 1,539,157 | $ | 11,676 | |||
Interest-Bearing Deposits | 59 | 3 | |||||
Securities Purchased Under Agreements to Resell | — | 750,000 | |||||
Federal Funds Sold | 2,905,000 | 7,325,000 | |||||
Available-for-Sale Securities (1) (Note 3) | 3,084,813 | 3,237,916 | |||||
Held-to-Maturity Securities (2) (Note 4) | 8,633,802 | 8,471,827 | |||||
Advances (Notes 6 and 8) | 17,475,572 | 18,275,364 | |||||
Mortgage Loans Held for Portfolio, net (Notes 7 and 8) | 6,281,450 | 6,702,576 | |||||
Accrued Interest Receivable | 89,876 | 98,924 | |||||
Premises, Software, and Equipment, net | 10,937 | 10,830 | |||||
Derivative Assets, net (Note 9) | 177 | 6,173 | |||||
Other Assets | 37,666 | 39,584 | |||||
Total Assets | $ | 40,058,509 | $ | 44,929,873 | |||
Liabilities: | |||||||
Deposits (Note 10): | |||||||
Interest-Bearing | $ | 695,749 | $ | 574,894 | |||
Non-Interest-Bearing | 10,850 | 10,034 | |||||
Total Deposits | 706,599 | 584,928 | |||||
Consolidated Obligations (Note 11): | |||||||
Discount Notes | 9,992,689 | 8,924,687 | |||||
Bonds | 26,068,239 | 31,875,237 | |||||
Total Consolidated Obligations, net | 36,060,928 | 40,799,924 | |||||
Accrued Interest Payable | 123,686 | 133,862 | |||||
Affordable Housing Program Payable | 32,689 | 35,648 | |||||
Payable to Resolution Funding Corporation | 5,930 | 10,325 | |||||
Derivative Liabilities, net (Note 9) | 679,000 | 657,030 | |||||
Mandatorily Redeemable Capital Stock (Note 13) | 515,130 | 658,363 | |||||
Other Liabilities | 50,988 | 102,422 | |||||
Total Liabilities | 38,174,950 | 42,982,502 | |||||
Commitments and Contingencies (Note 17) | |||||||
Capital (Notes 13 and 14): | |||||||
Capital Stock Putable (at par value of $100 per share): | |||||||
Class B-1 issued and outstanding shares: 14,866 and 16,072, respectively | 1,486,534 | 1,607,116 | |||||
Class B-2 issued and outstanding shares: 33 and 29, respectively | 3,341 | 2,944 | |||||
Total Capital Stock Putable | 1,489,875 | 1,610,060 | |||||
Retained Earnings | 451,314 | 427,557 | |||||
Accumulated Other Comprehensive Income (Loss) (Note 14): | |||||||
Net Unrealized Gains (Losses) on Available-for-Sale Securities (Note 3) | 5,534 | (4,615 | ) | ||||
Net Non-Credit Portion of Other-Than-Temporary Impairment Losses: | |||||||
Available-for-Sale Securities (Note 3) | (49,889 | ) | (68,806 | ) | |||
Held-to-Maturity Securities (Note 4) | (5,154 | ) | (7,056 | ) | |||
Pension and Postretirement Benefits | (8,121 | ) | (9,769 | ) | |||
Total Accumulated Other Comprehensive Income (Loss) | (57,630 | ) | (90,246 | ) | |||
Total Capital | 1,883,559 | 1,947,371 | |||||
Total Liabilities and Capital | $ | 40,058,509 | $ | 44,929,873 |
(1) Amortized cost: $2,944,213 and $3,146,617 at June 30, 2011, and December 31, 2010, respectively.
(2) Estimated fair values: $8,701,206 and $8,513,391 at June 30, 2011, and December 31, 2010, respectively.
The accompanying notes are an integral part of these financial statements.
1
Federal Home Loan Bank of Indianapolis
Statements of Income
(Unaudited, $ amounts in thousands)
Three Months Ended | Six Months Ended | ||||||||||||||
June 30, | June 30, | ||||||||||||||
2011 | 2010 | 2011 | 2010 | ||||||||||||
Interest Income: | |||||||||||||||
Advances | $ | 39,465 | $ | 49,526 | $ | 80,613 | $ | 99,960 | |||||||
Prepayment Fees on Advances, net | 280 | 2,845 | 1,414 | 3,538 | |||||||||||
Interest-Bearing Deposits | 8 | 59 | 18 | 95 | |||||||||||
Securities Purchased Under Agreements to Resell | 94 | 762 | 683 | 931 | |||||||||||
Federal Funds Sold | 1,973 | 4,490 | 4,914 | 7,023 | |||||||||||
Available-for-Sale Securities | 13,113 | 1,862 | 27,990 | 3,483 | |||||||||||
Held-to-Maturity Securities | 45,458 | 63,120 | 90,971 | 126,551 | |||||||||||
Mortgage Loans Held for Portfolio, net | 76,532 | 83,396 | 156,661 | 174,051 | |||||||||||
Other, net | 71 | (524 | ) | 592 | (165 | ) | |||||||||
Total Interest Income | 176,994 | 205,536 | 363,856 | 415,467 | |||||||||||
Interest Expense: | |||||||||||||||
Consolidated Obligation Discount Notes | 2,082 | 4,736 | 5,281 | 7,201 | |||||||||||
Consolidated Obligation Bonds | 115,130 | 141,038 | 233,650 | 283,200 | |||||||||||
Deposits | 60 | 83 | 133 | 161 | |||||||||||
Mandatorily Redeemable Capital Stock | 3,737 | 3,612 | 8,562 | 7,191 | |||||||||||
Total Interest Expense | 121,009 | 149,469 | 247,626 | 297,753 | |||||||||||
Net Interest Income | 55,985 | 56,067 | 116,230 | 117,714 | |||||||||||
Provision for Credit Losses | 1,183 | — | 2,159 | — | |||||||||||
Net Interest Income After Provision for Credit Losses | 54,802 | 56,067 | 114,071 | 117,714 | |||||||||||
Other Income (Loss): | |||||||||||||||
Total Other-Than-Temporary Impairment Losses | — | (7,826 | ) | (2,972 | ) | (22,279 | ) | ||||||||
Portion of Impairment Losses Reclassified to (from) Other Comprehensive Income (Loss), net | (3,336 | ) | (53,868 | ) | (18,745 | ) | (45,481 | ) | |||||||
Net Other-Than-Temporary Impairment Losses | (3,336 | ) | (61,694 | ) | (21,717 | ) | (67,760 | ) | |||||||
Net Realized Losses from Sale of Available-for-Sale Securities | (1,943 | ) | — | (1,943 | ) | — | |||||||||
Net Gains (Losses) on Derivatives and Hedging Activities | (3,406 | ) | (893 | ) | (3,533 | ) | (2,068 | ) | |||||||
Service Fees | 265 | 314 | 528 | 615 | |||||||||||
Standby Letters of Credit Fees | 462 | 396 | 800 | 759 | |||||||||||
Loss on Extinguishment of Debt | — | — | (397 | ) | — | ||||||||||
Other, net | 239 | 120 | 421 | 382 | |||||||||||
Total Other Income (Loss) | (7,719 | ) | (61,757 | ) | (25,841 | ) | (68,072 | ) | |||||||
Other Expenses: | |||||||||||||||
Compensation and Benefits | 8,320 | 6,821 | 17,063 | 13,525 | |||||||||||
Other Operating Expenses | 3,686 | 3,446 | 6,516 | 6,380 | |||||||||||
Federal Housing Finance Agency | 860 | 533 | 1,776 | 1,132 | |||||||||||
Office of Finance | 523 | 445 | 1,344 | 910 | |||||||||||
Other | 259 | 278 | 514 | 562 | |||||||||||
Total Other Expenses | 13,648 | 11,523 | 27,213 | 22,509 | |||||||||||
Income (Loss) Before Assessments | 33,435 | (17,213 | ) | 61,017 | 27,133 | ||||||||||
Assessments: | |||||||||||||||
Affordable Housing Program | 3,111 | (1,036 | ) | 5,855 | 2,949 | ||||||||||
Resolution Funding Corporation | 5,939 | (3,235 | ) | 10,907 | 4,837 | ||||||||||
Total Assessments, net | 9,050 | (4,271 | ) | 16,762 | 7,786 | ||||||||||
Net Income (Loss) | $ | 24,385 | $ | (12,942 | ) | $ | 44,255 | $ | 19,347 |
The accompanying notes are an integral part of these financial statements.
2
Federal Home Loan Bank of Indianapolis
Statements of Capital
(Unaudited, $ amounts and shares in thousands)
Capital Stock Class B-1 Putable | Capital Stock Class B-2 Putable | Retained Earnings | Accumulated Other Comprehensive Income (Loss) | Total Capital | ||||||||||||||||||||||
Shares | Par Value | Shares | Par Value | |||||||||||||||||||||||
Balance, December 31, 2009 | 17,260 | $ | 1,726,000 | — | $ | — | $ | 349,013 | $ | (328,602 | ) | $ | 1,746,411 | |||||||||||||
Proceeds from Sale of Capital Stock | 339 | 33,882 | — | — | 33,882 | |||||||||||||||||||||
Transfers of Capital Stock | (46 | ) | (4,567 | ) | 46 | 4,567 | — | |||||||||||||||||||
Net Shares Reclassified to Mandatorily Redeemable Capital Stock | (291 | ) | (29,061 | ) | — | — | (29,061 | ) | ||||||||||||||||||
Comprehensive Income: | ||||||||||||||||||||||||||
Net Income | 19,347 | 19,347 | ||||||||||||||||||||||||
Other Comprehensive Income (Loss) (Note 14) | 65,128 | 65,128 | ||||||||||||||||||||||||
Total Comprehensive Income (Loss) | 19,347 | 65,128 | 84,475 | |||||||||||||||||||||||
Distributions on Mandatorily Redeemable Capital Stock | (53 | ) | (53 | ) | ||||||||||||||||||||||
Cash Dividends on Capital Stock (2.00% annualized) | (17,207 | ) | (17,207 | ) | ||||||||||||||||||||||
Balance, June 30, 2010 | 17,262 | $ | 1,726,254 | 46 | $ | 4,567 | $ | 351,100 | $ | (263,474 | ) | $ | 1,818,447 | |||||||||||||
Balance, December 31, 2010 | 16,072 | $ | 1,607,116 | 29 | $ | 2,944 | $ | 427,557 | $ | (90,246 | ) | $ | 1,947,371 | |||||||||||||
Proceeds from Sale of Capital Stock | 349 | 34,898 | — | — | 34,898 | |||||||||||||||||||||
Repurchase/Redemption of Capital Stock | (1,497 | ) | (149,694 | ) | — | — | (149,694 | ) | ||||||||||||||||||
Transfers of Capital Stock | (4 | ) | (397 | ) | 4 | 397 | — | |||||||||||||||||||
Net Shares Reclassified to Mandatorily Redeemable Capital Stock | (54 | ) | (5,389 | ) | — | — | (5,389 | ) | ||||||||||||||||||
Comprehensive Income: | ||||||||||||||||||||||||||
Net Income | 44,255 | 44,255 | ||||||||||||||||||||||||
Other Comprehensive Income (Loss) (Note 14) | 32,616 | 32,616 | ||||||||||||||||||||||||
Total Comprehensive Income (Loss) | 44,255 | 32,616 | 76,871 | |||||||||||||||||||||||
Distributions on Mandatorily Redeemable Capital Stock | (11 | ) | (11 | ) | ||||||||||||||||||||||
Cash Dividends on Capital Stock (2.50% annualized) | (20,487 | ) | (20,487 | ) | ||||||||||||||||||||||
Balance, June 30, 2011 | 14,866 | $ | 1,486,534 | 33 | $ | 3,341 | $ | 451,314 | $ | (57,630 | ) | $ | 1,883,559 |
The accompanying notes are an integral part of these financial statements.
3
Federal Home Loan Bank of Indianapolis
Statements of Cash Flows
(Unaudited, $ amounts in thousands)
Six Months Ended | |||||||
June 30, | |||||||
2011 | 2010 | ||||||
Operating Activities: | |||||||
Net Income | $ | 44,255 | $ | 19,347 | |||
Adjustments to Reconcile Net Income to Net Cash provided by (used in) Operating Activities: | |||||||
Depreciation and Amortization | 13,423 | (18,210 | ) | ||||
Net Other-Than-Temporary Impairment Losses | 21,717 | 67,760 | |||||
Loss on Extinguishment of Debt | 397 | — | |||||
Provision for Credit Losses | 2,159 | — | |||||
(Gain) Loss on Sale of Available-for-Sale Securities | 1,943 | — | |||||
(Gain) Loss on Derivative and Hedging Activities | (776 | ) | 2,744 | ||||
Net Change in: | |||||||
Accrued Interest Receivable | 9,051 | 9,139 | |||||
Net Accrued Interest on Derivatives | 51,780 | 106,939 | |||||
Other Assets | (138 | ) | 326 | ||||
Affordable Housing Program Payable, including discount on Advances | (2,959 | ) | (3,174 | ) | |||
Accrued Interest Payable | (10,176 | ) | (51,870 | ) | |||
Payable to Resolution Funding Corporation | (4,395 | ) | (8,691 | ) | |||
Other Liabilities | (1,457 | ) | (543 | ) | |||
Total Adjustments, net | 80,569 | 104,420 | |||||
Net Cash provided by (used in) Operating Activities | 124,824 | 123,767 | |||||
Investing Activities: | |||||||
Net Change in: | |||||||
Interest-Bearing Deposits | (10,956 | ) | (87,532 | ) | |||
Securities Purchased Under Agreements to Resell | 750,000 | — | |||||
Federal Funds Sold | 4,420,000 | (2,817,000 | ) | ||||
Premises, Software, and Equipment | (894 | ) | (260 | ) | |||
Available-for-Sale Securities: | |||||||
Proceeds from Maturities | 107,740 | — | |||||
Proceeds from Sales | 66,520 | — | |||||
Held-to-Maturity Securities: | |||||||
Net (Increase) Decrease in Short-Term | — | (105,000 | ) | ||||
Proceeds from Maturities of Long-Term | 764,381 | 958,802 | |||||
Purchases of Long-Term | (975,136 | ) | (1,490,976 | ) | |||
Advances: | |||||||
Principal Collected | 7,954,850 | 10,336,792 | |||||
Made to Members | (7,142,745 | ) | (7,773,621 | ) | |||
Mortgage Loans Held for Portfolio: | |||||||
Principal Collected | 664,708 | 673,585 | |||||
Purchases | (248,416 | ) | (158,107 | ) | |||
Proceeds from Sales of Foreclosed Properties | — | (162 | ) | ||||
Other Federal Home Loan Banks: | |||||||
Principal Collected on Loans | 50,000 | 60,735 | |||||
Loans Made | (50,000 | ) | (60,735 | ) | |||
Net Cash provided by (used in) Investing Activities | 6,350,052 | (463,479 | ) |
The accompanying notes are an integral part of these financial statements.
4
Federal Home Loan Bank of Indianapolis
Statements of Cash Flows, continued
(Unaudited, $ amounts in thousands)
Six Months Ended | |||||||
June 30, | |||||||
2011 | 2010 | ||||||
Financing Activities: | |||||||
Net Change in Deposits | 121,672 | (196,661 | ) | ||||
Net Proceeds (Payments) on Derivative Contracts with Financing Elements | (54,171 | ) | (81,799 | ) | |||
Net Proceeds from Issuance of Consolidated Obligations: | |||||||
Discount Notes | 259,944,888 | 333,468,395 | |||||
Bonds | 9,923,131 | 19,678,279 | |||||
Payments for Matured and Retired Consolidated Obligations: | |||||||
Discount Notes | (258,875,922 | ) | (332,285,441 | ) | |||
Bonds | (15,723,077 | ) | (21,971,100 | ) | |||
Proceeds from Sale of Capital Stock | 34,898 | 33,882 | |||||
Payments for Redemption of Mandatorily Redeemable Capital Stock | (148,633 | ) | (3,333 | ) | |||
Payments for Repurchase/Redemption of Capital Stock | (149,694 | ) | — | ||||
Cash Dividends Paid | (20,487 | ) | (17,207 | ) | |||
Net Cash provided by (used in) Financing Activities | (4,947,395 | ) | (1,374,985 | ) | |||
Net Increase (Decrease) in Cash and Cash Equivalents | 1,527,481 | (1,714,697 | ) | ||||
Cash and Cash Equivalents at Beginning of the Period | 11,676 | 1,722,077 | |||||
Cash and Cash Equivalents at End of the Period | $ | 1,539,157 | $ | 7,380 | |||
Supplemental Disclosures: | |||||||
Interest Paid | $ | 259,993 | $ | 348,541 | |||
Affordable Housing Program Payments, net | 8,813 | 6,122 | |||||
Resolution Funding Corporation Assessments Paid | 15,302 | 13,529 |
The accompanying notes are an integral part of these financial statements.
5
Federal Home Loan Bank of Indianapolis
Notes to Financial Statements
(Unaudited, $ amounts in thousands unless otherwise indicated)
Note 1 - Summary of Significant Accounting Policies
Basis of Presentation. The accompanying interim financial statements of the Federal Home Loan Bank of Indianapolis are unaudited and have been prepared in accordance with GAAP for interim financial information and with the instructions provided by Article 10, Rule 10-01 of Regulation S-X promulgated by the SEC. Accordingly, they do not include all of the information and disclosures required by GAAP for complete financial statements. The interim financial statements presented herein should be read in conjunction with our audited financial statements and notes thereto, which are included in our 2010 Form 10-K.
The financial statements contain all adjustments which are, in the opinion of management, necessary for a fair statement of our financial position, results of operations and cash flows for the interim periods presented. All such adjustments were of a normal recurring nature. The results of operations for the periods presented are not necessarily indicative of the results to be expected for the full fiscal year or any other interim period.
Our significant accounting policies and certain other disclosures are set forth in the notes to the audited financial statements in Note 1 - Summary of Significant Accounting Policies in the 2010 Form 10-K. There have been no significant changes to these policies as of June 30, 2011.
All dollar amounts included in the notes are presented in thousands, unless otherwise indicated. We use certain acronyms and terms throughout this Form 10-Q which are defined in the Glossary of Terms located after Item 6. Exhibits. Unless the context otherwise requires, the terms "we," "us," and "our" refer to the Federal Home Loan Bank of Indianapolis.
Reclassifications. We have reclassified certain amounts from the prior periods to conform to the current period presentation. These reclassifications had no effect on Net Income, Total Assets, or Total Capital.
Use of Estimates. The preparation of financial statements in accordance with GAAP requires us to make subjective assumptions and estimates that may affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of income and expense. Actual results could differ significantly from these estimates.
Variable Interest Entities. We have investments in VIEs that include, but are not limited to, senior interests in private-label MBS and ABS. The carrying amounts of the investments are included in HTM and AFS securities on the Statement of Condition. We have no liabilities related to these VIEs. The maximum loss exposure to these VIEs is limited to the carrying value of our investments in the VIEs.
If we were to determine that we are the primary beneficiary of a VIE, we would be required to consolidate that VIE. On an ongoing basis, we perform a quarterly evaluation to determine whether we are the primary beneficiary in any VIE. To perform this evaluation, we consider whether we possess both of the following characteristics:
• | the power to direct the VIE's activities that most significantly affect the VIE's economic performance; and |
• | the obligation to absorb the VIE's losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. |
Based on an evaluation of the above characteristics, we have determined that consolidation is not required for our VIEs as of June 30, 2011. In addition, we have not provided financial or other support (explicitly or implicitly) to any VIE during the three or six months ended June 30, 2011. Furthermore, we were not previously contractually required to provide, nor do we intend to provide, such support to any VIE in the future.
Office of Finance Expenses. Effective January 1, 2011, our proportionate share of the Office of Finance operating and capital expenditures is calculated using a formula that is based upon two components as follows: (i) two-thirds based on our share of Consolidated Obligations outstanding and (ii) one-third based on equal pro-rata share among the 12 FHLBanks. These regular assessments are determined on a monthly basis. In addition, we are apportioned special assessments using the same calculation for specific system-wide expenditures related to audit fees and rating agency annual relationship fees. Any ratings agency subscription fees are assessed as incurred on a per user basis and directly to the applicable FHLBank(s).
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
Prior to January 1, 2011, we were assessed for the costs of operating the Office of Finance based equally on each FHLBank's percentage of capital stock, percentage of Consolidated Obligations issued and percentage of Consolidated Obligations outstanding.
Subsequent Events. In preparing this Form 10-Q, we have evaluated events and considered transactions through the time of filing our second quarter 2011 Form 10-Q with the SEC.
Note 2 - Recently Adopted and Issued Accounting Guidance
Fair Value Measurements and Disclosures. On January 21, 2010, the FASB issued amended guidance for fair value measurements and disclosures. We adopted this amended guidance as of January 1, 2010, except for required disclosures about purchases, sales, issuances, and settlements in the rollforward of activity for Level 3 fair value measurements, which we adopted as of January 1, 2011. The adoption of this amended guidance resulted in increased annual and interim financial statement disclosures, but did not have a material effect on our financial condition, results of operations or cash flows. See Note 16 - Estimated Fair Values for additional disclosures required under this amended guidance.
On May 12, 2011, the FASB and the International Accounting Standards Board issued substantially converged guidance on fair value measurement and disclosure requirements. This guidance clarifies how fair value accounting should be applied where its use is already required or permitted by other standards within GAAP or International Financial Reporting Standards; these amendments do not require additional fair value measurements. This guidance generally represents clarifications to the application of existing fair value measurement and disclosure requirements, as well as some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This guidance is effective for interim and annual periods beginning on January 1, 2012, and should be applied prospectively. Early application by public entities is not permitted. The adoption of this guidance may result in increased annual and interim financial statement disclosures, but is not expected to have a material effect on our financial condition, results of operations or cash flows.
Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. On July 21, 2010, the FASB issued amended guidance to enhance disclosures about the credit quality of an entity's financing receivables and the allowance for credit losses. The required disclosures as of the end of a reporting period became effective for interim and annual reporting periods as of December 31, 2010. The required disclosures about activity that occurs during a reporting period became effective for interim and annual reporting periods as of January 1, 2011. The adoption of this amended guidance resulted in increased annual and interim financial statement disclosures, but did not have a material effect on our financial condition, results of operations or cash flows. See Note 8 - Allowance for Credit Losses for additional disclosures required under this amended guidance.
A Creditor's Determination of Whether a Restructuring Is a Troubled Debt Restructuring. On January 19, 2011, the FASB issued guidance to defer temporarily the effective date of disclosures about troubled debt restructurings required by the amended guidance on disclosures about the credit quality of financing receivables and the allowance for credit losses. The effective date for these new disclosures will be coordinated with the effective date of the guidance for determining what constitutes a troubled debt restructuring.
On April 5, 2011, the FASB issued guidance to clarify which debt modifications constitute troubled debt restructurings. This guidance is intended to help creditors determine whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for presenting previously deferred disclosures related to troubled debt restructurings. This guidance is effective for interim and annual periods beginning on or after July 1, 2011, and applies to troubled debt restructurings occurring on or after the beginning of the annual period of adoption. Early adoption is permitted. The adoption of this amended guidance may result in increased annual and interim financial statement disclosures but is not expected to have a material effect on our financial condition, results of operations or cash flows.
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
Reconsideration of Effective Control for Repurchase Agreements. On April 29, 2011, the FASB issued guidance to improve the accounting for repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. The new guidance removes from the assessment of effective control: (i) the criterion requiring the transferor to have the ability to repurchase or redeem financial assets before their maturity on substantially the agreed terms, even in the event of the transferee's default, and (ii) the collateral maintenance implementation guidance related to that criterion. This guidance is effective for interim and annual periods beginning on or after January 1, 2012. This guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. We are currently evaluating the effect of the adoption of this amended guidance on our financial condition, results of operations and cash flows.
Presentation of Comprehensive Income. On June 16, 2011, the FASB issued guidance to increase the prominence of other comprehensive income in financial statements. This guidance requires an entity that reports items of other comprehensive income to present comprehensive income in either a single financial statement or in two consecutive financial statements. In a single continuous statement, an entity is required to present the components and amount of net income, the components of other comprehensive income and a total for other comprehensive income, as well as a total for comprehensive income. In a two-statement approach, an entity is required to present the components and amount of net income in its statement of net income. The statement of other comprehensive income should follow immediately and include the components of other comprehensive income as well as totals for both other comprehensive income and comprehensive income. This guidance eliminates the option to present other comprehensive income in the statement of changes in stockholders' equity. This guidance is effective for interim and annual periods beginning on January 1, 2012, and should be applied retrospectively for all periods presented. Early adoption is permitted. We plan to elect the two-statement approach noted above. The adoption of this guidance is expected to be limited to increased annual and interim financial statement disclosures and not affect our financial condition, results of operations or cash flows.
Note 3 - Available-for-Sale Securities
Major Security Types. AFS securities consist primarily of GSE debentures and RMBS. Our AFS securities were as follows:
OTTI | Gross | Gross | ||||||||||||||||||
Amortized | Recognized | Unrealized | Unrealized | Estimated | ||||||||||||||||
June 30, 2011 | Cost (1) | in AOCI | Gains | Losses | Fair Value | |||||||||||||||
GSE debentures | $ | 1,766,230 | $ | — | $ | 190,025 | $ | (1,023 | ) | $ | 1,955,232 | |||||||||
TLGP debentures | 322,524 | — | 1,486 | — | 324,010 | |||||||||||||||
Private-label RMBS | 855,459 | (169,323 | ) | 119,606 | (171 | ) | 805,571 | |||||||||||||
Total AFS securities | $ | 2,944,213 | $ | (169,323 | ) | $ | 311,117 | $ | (1,194 | ) | $ | 3,084,813 | ||||||||
December 31, 2010 | ||||||||||||||||||||
GSE debentures | $ | 1,771,077 | $ | — | $ | 163,110 | $ | (3,929 | ) | $ | 1,930,258 | |||||||||
TLGP debentures | 324,193 | — | 924 | — | 325,117 | |||||||||||||||
Private-label RMBS | 1,051,347 | (203,839 | ) | 135,501 | (468 | ) | 982,541 | |||||||||||||
Total AFS securities | $ | 3,146,617 | $ | (203,839 | ) | $ | 299,535 | $ | (4,397 | ) | $ | 3,237,916 |
(1) Amortized cost of AFS securities includes adjustments made to the cost basis of an investment for accretion, amortization, collection of cash, and, if applicable, OTTI recognized in earnings (credit losses).
At June 30, 2011, and December 31, 2010, 91% and 85%, respectively, of our fixed-rate AFS securities at amortized cost were swapped to a variable rate and none of our variable-rate AFS securities were swapped.
Premiums and Discounts. At June 30, 2011, and December 31, 2010, the amortized cost of our MBS classified as AFS securities included OTTI credit losses, OTTI-related accretion adjustments, and net discounts on OTTI securities totaling $125,106 and $122,173, respectively.
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
Reconciliations of Amounts in AOCI. Subsequent increases and decreases in the fair value of previously OTTI AFS securities are netted against the non-credit component of OTTI in AOCI in the Statement of Condition. The following tables reconcile the amounts in the AFS major security types table above to the Statement of Condition and AOCI rollforward presentation:
Net Unrealized Gains (Losses) on AFS Securities | June 30, 2011 | December 31, 2010 | ||||||
Net unrealized gains | $ | 309,923 | $ | 295,138 | ||||
Less: | ||||||||
Subsequent net unrealized gains on previously OTTI securities | 119,434 | 135,033 | ||||||
Unrealized gains on hedged items recognized in Other Income (Loss) | 184,955 | 164,720 | ||||||
Net unrealized gains (losses) on AFS securities recognized in AOCI | $ | 5,534 | $ | (4,615 | ) |
Net Non-Credit Portion of OTTI Losses on AFS Securities | June 30, 2011 | December 31, 2010 | ||||||
OTTI Recognized in AOCI | $ | (169,323 | ) | $ | (203,839 | ) | ||
Subsequent net unrealized gains on previously OTTI securities | 119,434 | 135,033 | ||||||
Net non-credit portion of OTTI losses on AFS securities | $ | (49,889 | ) | $ | (68,806 | ) |
Unrealized Loss Positions. The following table presents impaired AFS securities, which are aggregated by major security type and length of time that individual securities have been in a continuous unrealized loss position.
Less than 12 months | 12 months or more | Total | ||||||||||||||||||||||
Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
June 30, 2011 | Value | Losses | Value | Losses | Value | Losses (1) | ||||||||||||||||||
Non-MBS: | ||||||||||||||||||||||||
GSE debentures | $ | 106,543 | $ | (1,023 | ) | $ | — | $ | — | $ | 106,543 | $ | (1,023 | ) | ||||||||||
TLGP debentures | — | — | — | — | — | — | ||||||||||||||||||
Total Non-MBS | 106,543 | (1,023 | ) | — | — | 106,543 | (1,023 | ) | ||||||||||||||||
Private-label RMBS | 107,805 | (1,769 | ) | 585,815 | (54,432 | ) | 693,620 | (56,201 | ) | |||||||||||||||
Total impaired AFS securities | $ | 214,348 | $ | (2,792 | ) | $ | 585,815 | $ | (54,432 | ) | $ | 800,163 | $ | (57,224 | ) | |||||||||
December 31, 2010 | ||||||||||||||||||||||||
Non-MBS: | ||||||||||||||||||||||||
GSE debentures | $ | 103,652 | $ | (3,929 | ) | $ | — | $ | — | $ | 103,652 | $ | (3,929 | ) | ||||||||||
TLGP debentures | — | — | — | — | — | — | ||||||||||||||||||
Total Non-MBS | 103,652 | (3,929 | ) | — | — | 103,652 | (3,929 | ) | ||||||||||||||||
Private-label RMBS | — | — | 777,955 | (75,825 | ) | 777,955 | (75,825 | ) | ||||||||||||||||
Total impaired AFS securities | $ | 103,652 | $ | (3,929 | ) | $ | 777,955 | $ | (75,825 | ) | $ | 881,607 | $ | (79,754 | ) |
(1) As a result of OTTI accounting guidance, the total unrealized losses on private-label RMBS will not agree to the gross unrealized losses on private-label RMBS in the major security types table above.
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
Redemption Terms. The amortized cost and estimated fair value of non-MBS AFS securities by contractual maturity are presented below. MBS are not presented by contractual maturity because their expected maturities will likely differ from contractual maturities as borrowers may have the right to prepay obligations with or without prepayment fees.
June 30, 2011 | December 31, 2010 | |||||||||||||||
Amortized | Estimated | Amortized | Estimated | |||||||||||||
Year of Contractual Maturity | Cost | Fair Value | Cost | Fair Value | ||||||||||||
Due in one year or less | $ | — | $ | — | $ | — | $ | — | ||||||||
Due after one year through five years | 533,150 | 554,710 | 324,193 | 325,117 | ||||||||||||
Due after five years through ten years | 1,555,604 | 1,724,532 | 1,771,077 | 1,930,258 | ||||||||||||
Due after ten years | — | — | — | — | ||||||||||||
Total Non-MBS | 2,088,754 | 2,279,242 | 2,095,270 | 2,255,375 | ||||||||||||
Total MBS | 855,459 | 805,571 | 1,051,347 | 982,541 | ||||||||||||
Total AFS securities | $ | 2,944,213 | $ | 3,084,813 | $ | 3,146,617 | $ | 3,237,916 |
Realized Gains and Losses. The following table presents the proceeds, gross gains and losses, and previously recognized OTTI credit losses including accretion related to the sale of two AFS securities. We compute gains and losses on sales of investment securities using the specific identification method.
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
Sales of AFS Securities | 2011 | 2010 | 2011 | 2010 | ||||||||||||
Proceeds from sale | $ | 66,520 | $ | — | $ | 66,520 | $ | — | ||||||||
Previously recognized OTTI credit losses including accretion | 16,585 | — | 16,585 | — | ||||||||||||
Gross gains | $ | 904 | $ | — | $ | 904 | $ | — | ||||||||
Gross losses | (2,847 | ) | — | (2,847 | ) | — | ||||||||||
Net Realized Losses from Sale of Available-for-Sale Securities | $ | (1,943 | ) | $ | — | $ | (1,943 | ) | $ | — |
As of June 30, 2011, we had no intention to sell the remaining OTTI AFS securities, nor did we consider it more likely than not that we will be required to sell these securities before our anticipated recovery of each security's remaining amortized cost basis.
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
Note 4 - Held-to-Maturity Securities
Major Security Types. HTM securities consist primarily of MBS and TLGP debentures. Our HTM securities were as follows:
Gross | Gross | |||||||||||||||||||||||
OTTI | Unrecognized | Unrecognized | Estimated | |||||||||||||||||||||
Amortized | Recognized | Carrying | Holding | Holding | Fair | |||||||||||||||||||
June 30, 2011 | Cost (1) | In AOCI | Value (2) | Gains (3) | Losses (3) | Value | ||||||||||||||||||
Non-MBS and ABS: | ||||||||||||||||||||||||
GSE debentures | $ | 293,738 | $ | — | $ | 293,738 | $ | 644 | $ | — | $ | 294,382 | ||||||||||||
TLGP debentures | 1,980,332 | — | 1,980,332 | 3,608 | — | 1,983,940 | ||||||||||||||||||
Total Non-MBS and ABS | 2,274,070 | — | 2,274,070 | 4,252 | — | 2,278,322 | ||||||||||||||||||
MBS and ABS: | ||||||||||||||||||||||||
Other U.S. obligations -guaranteed RMBS | 2,569,690 | — | 2,569,690 | 36,608 | (9,205 | ) | 2,597,093 | |||||||||||||||||
GSE RMBS | 3,245,341 | — | 3,245,341 | 57,368 | (12,458 | ) | 3,290,251 | |||||||||||||||||
Private-label RMBS | 528,990 | (5,154 | ) | 523,836 | 5,199 | (10,846 | ) | 518,189 | ||||||||||||||||
Private-label ABS | 20,865 | — | 20,865 | — | (3,514 | ) | 17,351 | |||||||||||||||||
Total MBS and ABS | 6,364,886 | (5,154 | ) | 6,359,732 | 99,175 | (36,023 | ) | 6,422,884 | ||||||||||||||||
Total HTM securities | $ | 8,638,956 | $ | (5,154 | ) | $ | 8,633,802 | $ | 103,427 | $ | (36,023 | ) | $ | 8,701,206 | ||||||||||
December 31, 2010 | ||||||||||||||||||||||||
Non-MBS and ABS: | ||||||||||||||||||||||||
GSE debentures | $ | 294,121 | $ | — | $ | 294,121 | $ | 300 | $ | (214 | ) | $ | 294,207 | |||||||||||
TLGP debentures | 2,065,994 | — | 2,065,994 | 4,530 | (3 | ) | 2,070,521 | |||||||||||||||||
Total Non-MBS and ABS | 2,360,115 | — | 2,360,115 | 4,830 | (217 | ) | 2,364,728 | |||||||||||||||||
MBS and ABS: | ||||||||||||||||||||||||
Other U.S. obligations -guaranteed RMBS | 2,326,958 | — | 2,326,958 | 31,773 | (7,849 | ) | 2,350,882 | |||||||||||||||||
GSE RMBS | 3,044,129 | — | 3,044,129 | 53,049 | (24,933 | ) | 3,072,245 | |||||||||||||||||
Private-label RMBS | 725,493 | (7,056 | ) | 718,437 | 5,665 | (18,277 | ) | 705,825 | ||||||||||||||||
Private-label ABS | 22,188 | — | 22,188 | — | (2,477 | ) | 19,711 | |||||||||||||||||
Total MBS and ABS | 6,118,768 | (7,056 | ) | 6,111,712 | 90,487 | (53,536 | ) | 6,148,663 | ||||||||||||||||
Total HTM securities | $ | 8,478,883 | $ | (7,056 | ) | $ | 8,471,827 | $ | 95,317 | $ | (53,753 | ) | $ | 8,513,391 |
(1) Amortized cost includes adjustments made to the cost basis of an investment for accretion, amortization, collection of cash, and, if applicable, OTTI recognized in earnings (credit losses).
(2) Carrying value of HTM securities represents amortized cost after adjustment for non-credit OTTI recognized in AOCI.
(3) Gross unrecognized holding gains (losses) represents the difference between estimated fair value and carrying value.
Premiums and Discounts. The following table presents the net (discounts) premiums included in the amortized cost of our HTM securities:
Net (Discounts) Premiums | June 30, 2011 | December 31, 2010 | ||||||
Non-MBS and ABS: | ||||||||
Net purchased premiums | $ | 1,105 | $ | 2,150 | ||||
Total Non-MBS and ABS | 1,105 | 2,150 | ||||||
MBS and ABS: | ||||||||
Net purchased premiums | 59,105 | 62,503 | ||||||
OTTI related credit losses | (1,143 | ) | (1,143 | ) | ||||
OTTI related accretion adjustments | (1 | ) | 34 | |||||
Other - net discounts on OTTI securities | (393 | ) | (393 | ) | ||||
Total MBS and ABS | 57,568 | 61,001 | ||||||
Total HTM securities, net (discounts) premiums included in amortized cost | $ | 58,673 | $ | 63,151 |
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
Unrealized Loss Positions. The following table presents impaired HTM securities, which are aggregated by major security type and length of time that individual securities have been in a continuous unrealized loss position.
Less than 12 months | 12 months or more | Total | ||||||||||||||||||||||
Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
June 30, 2011 | Value | Losses | Value | Losses | Value | Losses (1) | ||||||||||||||||||
Non-MBS and ABS: | ||||||||||||||||||||||||
GSE debentures | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||||
TLGP debentures | — | — | — | — | — | — | ||||||||||||||||||
Total Non-MBS and ABS | — | — | — | — | — | — | ||||||||||||||||||
MBS and ABS: | ||||||||||||||||||||||||
Other U.S. obligations - guaranteed RMBS | 1,049,345 | (9,205 | ) | — | — | 1,049,345 | (9,205 | ) | ||||||||||||||||
GSE RMBS | 1,090,928 | (12,458 | ) | — | — | 1,090,928 | (12,458 | ) | ||||||||||||||||
Private-label RMBS | 98,961 | (1,069 | ) | 346,562 | (10,635 | ) | 445,523 | (11,704 | ) | |||||||||||||||
Private-label ABS | — | — | 17,350 | (3,514 | ) | 17,350 | (3,514 | ) | ||||||||||||||||
Total MBS and ABS | 2,239,234 | (22,732 | ) | 363,912 | (14,149 | ) | 2,603,146 | (36,881 | ) | |||||||||||||||
Total impaired HTM securities | $ | 2,239,234 | $ | (22,732 | ) | $ | 363,912 | $ | (14,149 | ) | $ | 2,603,146 | $ | (36,881 | ) | |||||||||
December 31, 2010 | ||||||||||||||||||||||||
Non-MBS and ABS: | ||||||||||||||||||||||||
GSE debentures | $ | 168,779 | $ | (214 | ) | $ | — | $ | — | $ | 168,779 | $ | (214 | ) | ||||||||||
TLGP debentures | 68,764 | (3 | ) | — | — | 68,764 | (3 | ) | ||||||||||||||||
Total Non-MBS and ABS | 237,543 | (217 | ) | — | — | 237,543 | (217 | ) | ||||||||||||||||
MBS and ABS: | ||||||||||||||||||||||||
Other U.S. obligations - guaranteed RMBS | 994,667 | (7,849 | ) | — | — | 994,667 | (7,849 | ) | ||||||||||||||||
GSE RMBS | 1,034,990 | (24,933 | ) | — | — | 1,034,990 | (24,933 | ) | ||||||||||||||||
Private-label RMBS | 51,012 | (223 | ) | 546,135 | (20,466 | ) | 597,147 | (20,689 | ) | |||||||||||||||
Private-label ABS | — | — | 19,711 | (2,477 | ) | 19,711 | (2,477 | ) | ||||||||||||||||
Total MBS and ABS | 2,080,669 | (33,005 | ) | 565,846 | (22,943 | ) | 2,646,515 | (55,948 | ) | |||||||||||||||
Total impaired HTM securities | $ | 2,318,212 | $ | (33,222 | ) | $ | 565,846 | $ | (22,943 | ) | $ | 2,884,058 | $ | (56,165 | ) |
(1) As a result of OTTI accounting guidance, the total unrealized losses on private-label RMBS will not agree to the gross unrecognized holding losses on private-label RMBS in the major security types table above.
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
Redemption Terms. The amortized cost, carrying value and estimated fair value of non-MBS and ABS HTM securities by contractual maturity are presented below. MBS and ABS are not presented by contractual maturity because their expected maturities will likely differ from contractual maturities as borrowers may have the right to prepay obligations with or without prepayment fees.
June 30, 2011 | December 31, 2010 | |||||||||||||||||||||||
Estimated | Estimated | |||||||||||||||||||||||
Amortized | Carrying | Fair | Amortized | Carrying | Fair | |||||||||||||||||||
Year of Contractual Maturity | Cost (1) | Value (2) | Value | Cost (1) | Value (2) | Value | ||||||||||||||||||
Non-MBS and ABS: | ||||||||||||||||||||||||
Due in one year or less | $ | 1,786,310 | $ | 1,786,310 | $ | 1,789,857 | $ | 306,826 | $ | 306,826 | $ | 307,306 | ||||||||||||
Due after one year through five years | 487,760 | 487,760 | 488,465 | 2,053,289 | 2,053,289 | 2,057,422 | ||||||||||||||||||
Due after five years through ten years | — | — | — | — | — | — | ||||||||||||||||||
Due after ten years | — | — | — | — | — | — | ||||||||||||||||||
Total Non-MBS and ABS | 2,274,070 | 2,274,070 | 2,278,322 | 2,360,115 | 2,360,115 | 2,364,728 | ||||||||||||||||||
Total MBS and ABS | 6,364,886 | 6,359,732 | 6,422,884 | 6,118,768 | 6,111,712 | 6,148,663 | ||||||||||||||||||
Total HTM securities | $ | 8,638,956 | $ | 8,633,802 | $ | 8,701,206 | $ | 8,478,883 | $ | 8,471,827 | $ | 8,513,391 |
(1) Amortized cost includes adjustments made to the cost basis of an investment for accretion, amortization, collection of cash, and, if applicable, OTTI recognized in earnings (credit losses).
(2) Carrying value of HTM securities represents amortized cost after adjustment for non-credit OTTI recognized in AOCI.
Realized Gains and Losses. There were no sales of HTM securities during the three or six months ended June 30, 2011, or 2010.
Note 5 - Other-Than-Temporary Impairment Analysis
We evaluate our individual AFS and HTM securities that have been previously OTTI or are in an unrealized loss position for OTTI on a quarterly basis. As part of our evaluation, we consider our intent to sell each of these securities and whether it is more likely than not that we will be required to sell the security before its anticipated recovery. If either of these conditions is met, we recognize an OTTI equal to the entire difference between the security's amortized cost basis and its fair value at the Statement of Condition date. For those securities that meet neither of these conditions, we perform an analysis to determine whether we expect to recover the entire amortized cost basis of the security as described in Note 7 - Other-Than-Temporary Impairment Analysis in our 2010 Form 10-K.
OTTI Evaluation Process and Results - Private-label RMBS and ABS
Our evaluation includes an estimation of the cash flows that we are likely to collect based on an assessment of the structure of each security and certain assumptions such as:
• | the remaining payment terms for the security; |
• | prepayment speeds; |
• | default rates; |
• | loss severity on the collateral supporting our security based on underlying loan-level borrower and loan characteristics; |
• | expected housing price changes; and |
• | interest-rates. |
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
A significant modeling assumption is the forecast of future housing price changes for the relevant states and core-based statistical areas, which are based upon an assessment of the individual housing markets. Our housing price forecast assumes core-based statistical areas current-to-trough home price declines ranging from 0% (for those housing markets that are believed to have reached their trough) to 8%. For those markets for which further home price declines are anticipated, such declines were projected to occur over the 3- to 9-month period beginning April 1, 2011, followed in each case by a 3-month period of flat prices. From the trough, home prices were projected to recover using one of five different recovery paths that vary by housing market. Under those recovery paths, home prices were projected to increase from the trough within a range of 0% to 2.8% in the first year, 0% to 3.0% in the second year, 1.5% to 4.0% in the third year, 2.0% to 5.0% in the fourth year, 2.0% to 6.0% in each of the fifth and sixth years, and 2.3% to 5.6% in each subsequent year.
For those securities which were determined to be OTTI during the three months ended June 30, 2011, the following table presents the significant modeling assumptions used to determine the amount of credit loss recognized in earnings during this period as well as the related current credit enhancement. Credit enhancement is defined as the percentage of subordinated tranches and over-collateralization, if any, in a security structure that will generally absorb losses before we will experience a loss on the security. The calculated averages represent the dollar-weighted averages of the private-label RMBS in each category shown. The classification (prime or Alt-A) is based on the model used to estimate the cash flows for the security, which may not be the same as the classification at the time of origination.
Significant Modeling Assumptions for OTTI private-label RMBS | Current Credit | |||||||||||||||||||
Prepayment Rates | Default Rates | Loss Severities | Enhancement | |||||||||||||||||
Weighted | Weighted | Weighted | Weighted | |||||||||||||||||
Average | Range | Average | Range | Average | Range | Average | Range | |||||||||||||
Year of Securitization | % | % | % | % | % | % | % | % | ||||||||||||
Prime: | ||||||||||||||||||||
2007 | 8.3 | 7.6 - 8.5 | 53.1 | 35.4 - 56.2 | 47.6 | 43.4 - 48.4 | 4.7 | 4.1 - 4.8 | ||||||||||||
2006 | 7.3 | 7.3 - 7.3 | 21.9 | 21.9 - 21.9 | 37.2 | 37.2 - 37.2 | 2.4 | 2.4 - 2.4 | ||||||||||||
2005 | 9.5 | 9.2 - 10.3 | 37.8 | 33.3 - 39.6 | 39.3 | 37.7 - 43.4 | 9.2 | 7.3 - 9.9 | ||||||||||||
Total Prime | 9.0 | 7.3 - 10.3 | 40.2 | 21.9 - 56.2 | 41.2 | 37.2 - 48.4 | 7.4 | 2.4 - 9.9 | ||||||||||||
Alt-A: | ||||||||||||||||||||
2005 | 8.6 | 7.3 - 13.2 | 39.8 | 29.5 - 42.7 | 44.0 | 37.4 - 45.8 | 2.3 | 2.1 - 3.0 | ||||||||||||
Total Alt-A | 8.6 | 7.3 - 13.2 | 39.8 | 29.5 - 42.7 | 44.0 | 37.4 - 45.8 | 2.3 | 2.1 - 3.0 | ||||||||||||
Total OTTI private-label RMBS | 9.0 | 7.3 - 13.2 | 40.1 | 21.9 - 56.2 | 41.6 | 37.2 - 48.4 | 6.7 | 2.1 - 9.9 |
Results of OTTI Evaluation Process - Private-label RMBS and ABS. As a result of our evaluations, for the three months ended June 30, 2011, and 2010, we recognized OTTI losses after we determined that it was likely that we would not recover the entire amortized cost of each of these securities.
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
The table below presents the credit losses and net OTTI reclassified (to) from OCI for the three and six months ended June 30, 2011, and 2010. Securities are listed based on the originator's classification at the time of origination or based on the classification by the NRSROs upon issuance.
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
OTTI | Net OTTI | Total | OTTI | Net OTTI | Total | |||||||||||||||||||
Related to | Reclassified | OTTI | Related to | Reclassified | OTTI | |||||||||||||||||||
June 30, 2011 | Credit Loss | (to) from OCI | Losses | Credit Loss | (to) from OCI | Losses | ||||||||||||||||||
Private-label RMBS: | ||||||||||||||||||||||||
Prime | $ | (2,334 | ) | $ | 2,334 | $ | — | $ | (20,074 | ) | $ | 20,074 | $ | — | ||||||||||
Alt-A | (1,002 | ) | 1,002 | — | (1,643 | ) | (1,329 | ) | (2,972 | ) | ||||||||||||||
Total OTTI securities | $ | (3,336 | ) | $ | 3,336 | $ | — | $ | (21,717 | ) | $ | 18,745 | $ | (2,972 | ) | |||||||||
June 30, 2010 | ||||||||||||||||||||||||
Private-label RMBS: | ||||||||||||||||||||||||
Prime | $ | (60,177 | ) | $ | 53,219 | $ | (6,958 | ) | $ | (65,967 | ) | $ | 44,556 | $ | (21,411 | ) | ||||||||
Alt-A | (1,517 | ) | 649 | (868 | ) | (1,793 | ) | 925 | (868 | ) | ||||||||||||||
Total OTTI securities | $ | (61,694 | ) | $ | 53,868 | $ | (7,826 | ) | $ | (67,760 | ) | $ | 45,481 | $ | (22,279 | ) |
For the three and six months ended June 30, 2011, we accreted $832 and $1,902, respectively, of non-credit OTTI from AOCI to the carrying value of HTM securities, compared to $14,744 and $28,520 for the three and six months ended June 30, 2010, respectively.
For the three and six months ended June 30, 2011, we accreted (i.e., increased income) $793 and $1,997, respectively, of credit OTTI included in the amortized cost of private-label RMBS to Net Interest Income, compared to amortization (i.e., decreased income) of $1,308 and $2,565 for the three and six months ended June 30, 2010, respectively.
The following table presents a reconciliation of the non-credit losses reclassified to (from) OCI:
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
Reconciliation of Non-credit Losses | 2011 | 2010 | 2011 | 2010 | ||||||||||||
Reclassification of non-credit losses to Other Income (Loss) | $ | (3,336 | ) | $ | (60,987 | ) | $ | (21,076 | ) | $ | (66,769 | ) | ||||
Non-credit losses recognized in OCI | — | 7,119 | 2,331 | 21,288 | ||||||||||||
Portion of Impairment Losses Reclassified to (from) Other Comprehensive Income (Loss) | $ | (3,336 | ) | $ | (53,868 | ) | $ | (18,745 | ) | $ | (45,481 | ) |
The following table presents a rollforward of the cumulative credit losses. The rollforward excludes accretion of credit losses for securities that have not experienced a significant increase in cash flows.
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
Credit Loss Rollforward | 2011 | 2010 | 2011 | 2010 | ||||||||||||
Balance at Beginning of Period | $ | 128,238 | $ | 66,357 | $ | 110,747 | $ | 60,291 | ||||||||
Additions: | ||||||||||||||||
Credit losses for which OTTI was not previously recognized | — | 514 | — | 694 | ||||||||||||
Additional credit losses for which OTTI was previously recognized | 3,336 | 61,180 | 21,717 | 67,066 | ||||||||||||
Reductions: | ||||||||||||||||
Credit losses on securities sold, matured, paid down or prepaid | (16,585 | ) | — | (16,585 | ) | — | ||||||||||
Significant increases in cash flows expected to be collected, recognized over the remaining life of the securities | (218 | ) | — | (1,108 | ) | — | ||||||||||
Balance at End of Period | $ | 114,771 | $ | 128,051 | $ | 114,771 | $ | 128,051 |
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
The following table presents the June 30, 2011, balances and classifications of the securities with OTTI losses during the three months ended June 30, 2011. The table also presents the balances and classifications of our securities for which an OTTI loss has been recognized during the life of the securities, which represents securities impaired prior to 2011, as well as during 2011. We classify private-label MBS as prime, Alt-A or subprime based on the originator's classification at the time of origination or based on the classification by the NRSROs upon issuance of the MBS.
June 30, 2011 | ||||||||||||||||||||||||||||
HTM Securities | AFS Securities | |||||||||||||||||||||||||||
Estimated | Estimated | |||||||||||||||||||||||||||
OTTI Three Months Ended | UPB | Amortized Cost | Carrying Value | Fair Value | UPB | Amortized Cost | Fair Value | |||||||||||||||||||||
Private-label RMBS - prime | $ | — | $ | — | $ | — | $ | — | $ | 303,715 | $ | 267,584 | $ | 250,485 | ||||||||||||||
Private-label RMBS - Alt-A | — | — | — | — | 47,220 | 39,521 | 31,708 | |||||||||||||||||||||
Total OTTI securities | $ | — | $ | — | $ | — | $ | — | $ | 350,935 | $ | 307,105 | $ | 282,193 | ||||||||||||||
OTTI Life-to-Date | ||||||||||||||||||||||||||||
Private-label RMBS - prime | $ | 30,126 | $ | 28,589 | $ | 23,435 | $ | 28,203 | $ | 933,345 | $ | 815,939 | $ | 773,863 | ||||||||||||||
Private-label RMBS - Alt-A | — | — | — | — | 47,220 | 39,521 | 31,708 | |||||||||||||||||||||
Total OTTI securities | $ | 30,126 | $ | 28,589 | $ | 23,435 | $ | 28,203 | $ | 980,565 | $ | 855,460 | $ | 805,571 | ||||||||||||||
Total MBS and ABS | $ | 6,364,886 | $ | 6,359,732 | $ | 6,422,884 | $ | 855,459 | $ | 805,571 | ||||||||||||||||||
Total securities | $ | 8,638,956 | $ | 8,633,802 | $ | 8,701,206 | $ | 2,944,213 | $ | 3,084,813 |
OTTI Evaluation Process and Results - All Other AFS and HTM Securities
Other U.S. Obligations and GSE Securities. For other U.S. obligations and GSEs, we determined that the strength of the issuers' guarantees through direct obligations or support from the United States government is sufficient to protect us from any losses based on current expectations. As a result, we have determined that, as of June 30, 2011, all of the gross unrealized losses are temporary.
Note 6 - Advances
We had Advances outstanding, with interest rates ranging from 0.14% to 8.34%, as presented below.
June 30, 2011 | December 31, 2010 | |||||||||||||
Year of Contractual Maturity | Amount | WAIR % | Amount | WAIR % | ||||||||||
Overdrawn demand and overnight deposit accounts | $ | 200 | 2.50 | $ | 1,394 | 2.50 | ||||||||
Due in 1 year or less | 1,683,766 | 2.47 | 2,850,291 | 2.81 | ||||||||||
Due after 1 year through 2 years | 3,557,977 | 2.85 | 1,784,681 | 3.29 | ||||||||||
Due after 2 years through 3 years | 1,379,594 | 3.19 | 2,646,696 | 3.52 | ||||||||||
Due after 3 years through 4 years | 1,444,275 | 3.19 | 1,394,515 | 3.09 | ||||||||||
Due after 4 years through 5 years | 2,879,001 | 3.50 | 2,565,321 | 3.66 | ||||||||||
Thereafter | 5,880,919 | 2.37 | 6,394,940 | 2.44 | ||||||||||
Total Advances, par value | 16,825,732 | 2.82 | 17,637,838 | 2.98 | ||||||||||
Unamortized discount on AHP Advances | (79 | ) | (104 | ) | ||||||||||
Unamortized discount on Advances | (756 | ) | (880 | ) | ||||||||||
Hedging adjustments | 509,436 | 489,180 | ||||||||||||
Unamortized deferred prepayment fees | 141,239 | 149,330 | ||||||||||||
Total Advances | $ | 17,475,572 | $ | 18,275,364 |
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
We offer Advances to members that provide a right, based upon predetermined option exercise dates, to call the Advance prior to maturity without incurring prepayment or termination fees (callable Advances). At June 30, 2011, and December 31, 2010, we had callable Advances outstanding of $3,114,775 and $3,610,325, respectively. All other Advances may only be prepaid by paying a fee (prepayment fee) that makes us financially indifferent to the prepayment of the Advance.
We offer putable and convertible Advances that contain embedded options. Under the terms of a putable Advance, we may put or extinguish the fixed-rate Advance on predetermined exercise dates, and offer, subject to certain conditions, replacement funding at prevailing market rates. At June 30, 2011, and December 31, 2010, we had putable Advances outstanding totaling $917,250 and $1,018,750, respectively. Under the terms of a convertible Advance, we may convert an Advance from one interest-payment term structure to another. We had no convertible Advances outstanding at June 30, 2011, or December 31, 2010.
The following table presents Advances by the earlier of the year of contractual maturity or next call date and next put date:
Year of Contractual Maturity or Next Call Date | Year of Contractual Maturity or Next Put Date | |||||||||||||||
June 30, 2011 | December 31, 2010 | June 30, 2011 | December 31, 2010 | |||||||||||||
Overdrawn demand and overnight deposit accounts | $ | 200 | $ | 1,394 | $ | 200 | $ | 1,394 | ||||||||
Due in 1 year or less | 3,688,116 | 4,301,641 | 2,383,016 | 3,725,041 | ||||||||||||
Due after 1 year through 2 years | 3,788,977 | 2,684,681 | 3,365,727 | 1,561,681 | ||||||||||||
Due after 2 years through 3 years | 1,404,594 | 2,606,696 | 1,365,594 | 2,513,946 | ||||||||||||
Due after 3 years through 4 years | 1,444,275 | 1,347,515 | 1,412,275 | 1,341,515 | ||||||||||||
Due after 4 years through 5 years | 2,713,001 | 2,480,321 | 2,652,501 | 2,343,821 | ||||||||||||
Thereafter | 3,786,569 | 4,215,590 | 5,646,419 | 6,150,440 | ||||||||||||
Total Advances, par value | $ | 16,825,732 | $ | 17,637,838 | $ | 16,825,732 | $ | 17,637,838 |
The following table presents interest-rate payment terms for Advances:
June 30, 2011 | December 31, 2010 | |||||||||||||||||||||
Interest-Rate Payment Terms | Total Outstanding | Amount Swapped | % Swapped | Total Outstanding | Amount Swapped | % Swapped | ||||||||||||||||
Total Fixed-rate | $ | 13,498,487 | $ | 10,776,166 | 80 | % | $ | 13,763,437 | $ | 10,845,833 | 79 | % | ||||||||||
Total Variable-rate | 3,327,245 | 10,000 | — | % | 3,874,401 | 10,000 | — | % | ||||||||||||||
Total Advances, par value | $ | 16,825,732 | $ | 10,786,166 | 64 | % | $ | 17,637,838 | $ | 10,855,833 | 62 | % |
Prepayment Fees. When a borrower prepays an Advance, we could suffer lower future income if the principal portion of the prepaid Advance is reinvested in lower-yielding assets that continue to be funded by higher-costing debt. To protect against this risk, we generally charge a prepayment fee that makes us financially indifferent to a borrower's decision to prepay an Advance. For the three and six months ended June 30, 2011, gross Advance prepayment fees (i.e., excluding any associated hedging basis adjustments) received from borrowers were $409 and $1,584, respectively, compared to $17,733 and $21,242 for the three and six months ended June 30, 2010, respectively. In cases in which we fund a new Advance concurrent with or within a short period of time before or after the prepayment of an existing Advance and the Advance meets the accounting criteria to qualify as a modification of the prepaid Advance, the net prepayment fee on the prepaid Advance is deferred, recorded in the basis of the modified Advance, and amortized into Interest Income over the life of the modified Advance using the level-yield method. For the three and six months ended June 30, 2011, we deferred $6,108 and $6,702, respectively, of the gross Advance prepayment fees, compared to $0 for both the three and six months ended June 30, 2010, to be recognized in Interest Income in the future.
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
Credit Risk Exposure and Security Terms. We lend to financial institutions involved in housing finance within our district according to Federal statutes, including the Bank Act. The Bank Act requires each FHLBank to hold, or have access to, collateral to secure its Advances.
At June 30, 2011, and December 31, 2010, we had a total of $5.2 billion and $5.5 billion, respectively, of Advances outstanding, at par, to single borrowers with Advances that were greater than or equal to $1 billion. These Advances, representing 31% of total Advances at par outstanding on those dates, were made to two borrowers. At June 30, 2011, and December 31, 2010, we held $10.5 billion and $10.9 billion, respectively, of UPB of collateral to cover the Advances to these institutions.
We have the policies and procedures in place to appropriately manage credit risk. Such policies and procedures include requirements for physical possession or control of pledged collateral, restrictions on borrowing, verifications of collateral and continuous monitoring of borrowings and the borrower's financial condition and creditworthiness. We expect to collect all amounts due according to the contractual terms of our Advances, based on the collateral pledged to us as security for Advances, our credit analyses of our members' financial condition and our credit extension and collateral policies. For information related to our credit risk on Advances and allowance for credit losses, see Note 8 – Allowance for Credit Losses.
Note 7 - Mortgage Loans Held for Portfolio
The following tables present information on Mortgage Loans Held for Portfolio:
By Term | June 30, 2011 | December 31, 2010 | ||||||
Fixed-rate medium-term (1) mortgages | $ | 853,964 | $ | 928,797 | ||||
Fixed-rate long-term (2) mortgages | 5,389,167 | 5,735,744 | ||||||
Total Mortgage Loans Held for Portfolio, UPB | 6,243,131 | 6,664,541 | ||||||
Unamortized premiums | 60,676 | 61,181 | ||||||
Unamortized discounts | (27,911 | ) | (30,592 | ) | ||||
Hedging adjustments | 7,454 | 7,946 | ||||||
Allowance for loan losses, net | (1,900 | ) | (500 | ) | ||||
Total Mortgage Loans Held for Portfolio | $ | 6,281,450 | $ | 6,702,576 |
(1) Medium-term is defined as an original term of 15 years or less.
(2) Long-term is defined as an original term greater than 15 years.
By Type | June 30, 2011 | December 31, 2010 | ||||||
Conventional | $ | 5,181,000 | $ | 5,653,969 | ||||
FHA | 1,062,131 | 1,010,572 | ||||||
Total Mortgage Loans Held for Portfolio, UPB | $ | 6,243,131 | $ | 6,664,541 |
For information related to our credit risk on mortgage loans and allowance for credit losses, see Note 8 – Allowance for Credit Losses.
Note 8 - Allowance for Credit Losses
We have established an allowance methodology for each of our portfolio segments: credit products; government-guaranteed or insured Mortgage Loans Held for Portfolio; conventional Mortgage Loans Held for Portfolio; term securities purchased under agreements to resell; and term federal funds sold. A description of the allowance methodologies related to our portfolio segments is disclosed in Note 10 - Allowance for Credit Losses in our 2010 Form 10-K.
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
Credit Products. Using a risk-based approach and taking into consideration each borrower's financial strength, we consider the types and level of collateral to be the primary tool for managing credit products. At June 30, 2011, and December 31, 2010, we had rights to collateral on a borrower-by-borrower basis with an estimated value in excess of our outstanding extensions of credit.
At June 30, 2011, and December 31, 2010, we did not have any credit products that were past due, on non-accrual status, or considered impaired. In addition, there were no troubled debt restructurings related to credit products during the three and six months ended June 30, 2011, or June 30, 2010.
Based upon the collateral held as security, our credit extension and collateral policies, our credit analysis and the repayment history on credit products, we did not record any allowance for credit losses on credit products or any liability to reflect an allowance for credit losses for off-balance sheet credit exposures at June 30, 2011, or December 31, 2010. For additional information about off-balance sheet credit exposure, see Note 17 – Commitments and Contingencies.
Mortgage Loans – Government-Guaranteed or Insured. Based upon our assessment of our servicers, we did not establish an allowance for credit losses for government-guaranteed or insured mortgage loans at June 30, 2011, or December 31, 2010. Further, due to the government guarantee or insurance, these mortgage loans are not placed on non-accrual status.
Mortgage Loans – Conventional.
Collectively Evaluated Mortgage Loans. Our credit risk analysis includes collectively evaluating conventional loans for impairment within each pool purchased under the MPP. This credit risk analysis considers MPP pool-specific attribute data, estimated liquidation value of real estate collateral held, estimated costs associated with maintaining and disposing of the collateral, and credit enhancements. The measurement of our allowance for loan losses consists of evaluating (i) homogeneous pools of delinquent residential mortgage loans; (ii) any remaining exposure to loans paid in full by the servicers; and (iii) the current portion of the loan portfolio.
Rollforward of Allowance for Loan Losses on Mortgage Loans. The table below presents a rollforward of our allowance for loan losses on conventional mortgage loans and the recorded investment in mortgage loans collectively evaluated for impairment. We did not have any allowance for loan losses as of June 30, 2010. We did not have any loans individually assessed for impairment at June 30, 2011. The recorded investment in a loan is the UPB of the loan, adjusted for accrued interest, net deferred loan fees or costs, unamortized premiums or discounts (which may include the basis adjustment related to any gain or loss on a delivery commitment prior to being funded) and direct write-downs. The recorded investment is not net of any valuation allowance.
Rollforward of Allowance | Six Months Ended June 30, 2011 | |||
Allowance for loan losses on mortgage loans, beginning of the period | $ | 500 | ||
Charge-offs | (759 | ) | ||
Provision (reversal) for loan losses | 2,159 | |||
Allowance for loan losses on mortgage loans, end of the period | $ | 1,900 | ||
Recorded Investment | ||||
Conventional loans collectively evaluated for impairment | $ | 5,216,947 | ||
Total recorded investment | $ | 5,216,947 |
Credit Enhancements. Our allowance for loan losses considers the credit enhancements associated with conventional mortgage loans under the MPP. Specifically, the determination of the allowance generally factors in PMI, SMI, and LRA, including pooled LRA for those members participating in an aggregate MPP pool. Any incurred losses that would be recovered from the credit enhancements are not reserved as part of our allowance for loan losses. The LRA is recorded in Other Liabilities in the Statement of Condition.
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
The following table presents the changes in the LRA:
Six Months Ended | ||||
LRA Activity | June 30, 2011 | |||
Balance of LRA, beginning of the period | $ | 21,141 | ||
Additions | 3,602 | |||
Claims paid | (5,184 | ) | ||
Distributions | (544 | ) | ||
Balance of LRA, end of the period | $ | 19,015 |
Credit Quality Indicators. Key credit quality indicators for mortgage loans include the migration of past due loans (movement of loans through the various stages of delinquency), non-accrual loans, loans in process of foreclosure, and impaired loans. The table below presents our key credit quality indicators for mortgage loans at June 30, 2011, and December 31, 2010:
Mortgage Loans Held for Portfolio as of June 30, 2011 | Conventional Loans | FHA Loans | Total | |||||||||
Past due 30-59 days delinquent | $ | 69,001 | $ | 34,233 | $ | 103,234 | ||||||
Past due 60-89 days delinquent | 31,011 | 5,394 | 36,405 | |||||||||
Past due 90 days or more delinquent | 115,379 | 2,585 | 117,964 | |||||||||
Total past due | 215,391 | 42,212 | 257,603 | |||||||||
Total current loans | 5,001,556 | 1,050,470 | 6,052,026 | |||||||||
Total mortgage loans, recorded investment | 5,216,947 | 1,092,682 | 6,309,629 | |||||||||
Net unamortized premiums | (7,911 | ) | (24,854 | ) | (32,765 | ) | ||||||
Hedging adjustments | (5,897 | ) | (1,557 | ) | (7,454 | ) | ||||||
Accrued interest receivable | (22,139 | ) | (4,140 | ) | (26,279 | ) | ||||||
Total Mortgage Loans Held for Portfolio, UPB | $ | 5,181,000 | $ | 1,062,131 | $ | 6,243,131 | ||||||
Other delinquency statistics as of June 30, 2011 | ||||||||||||
In process of foreclosure, included above (1) | $ | 89,876 | $ | — | $ | 89,876 | ||||||
Serious delinquency rate (2) | 2.21 | % | 0.24 | % | 1.87 | % | ||||||
Past due 90 days or more still accruing interest | $ | 115,379 | $ | 2,585 | $ | 117,964 | ||||||
Mortgage Loans Held for Portfolio as of December 31, 2010 | ||||||||||||
Past due 30-59 days delinquent | $ | 87,520 | $ | 39,155 | $ | 126,675 | ||||||
Past due 60-89 days delinquent | 30,568 | 5,819 | 36,387 | |||||||||
Past due 90 days or more delinquent | 127,449 | 914 | 128,363 | |||||||||
Total past due | 245,537 | 45,888 | 291,425 | |||||||||
Total current loans | 5,445,115 | 994,744 | 6,439,859 | |||||||||
Total mortgage loans, recorded investment | 5,690,652 | 1,040,632 | 6,731,284 | |||||||||
Net unamortized premiums | (5,732 | ) | (24,857 | ) | (30,589 | ) | ||||||
Hedging adjustments | (6,701 | ) | (1,245 | ) | (7,946 | ) | ||||||
Accrued interest receivable | (24,250 | ) | (3,958 | ) | (28,208 | ) | ||||||
Total Mortgage Loans Held for Portfolio, UPB | $ | 5,653,969 | $ | 1,010,572 | $ | 6,664,541 | ||||||
Other delinquency statistics as of December 31, 2010 | ||||||||||||
In process of foreclosure, included above (1) | $ | 85,803 | $ | — | $ | 85,803 | ||||||
Serious delinquency rate (2) | 2.24 | % | 0.09 | % | 1.91 | % | ||||||
Past due 90 days or more still accruing interest | $ | 127,449 | $ | 914 | $ | 128,363 |
(1) Includes loans where the decision of foreclosure or similar alternative such as pursuit of deed-in-lieu of foreclosure has been reported. Loans in process of foreclosure are included in past due categories depending on their delinquency status.
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
(2) Represents loans 90 days or more past due (including loans in process of foreclosure) expressed as a percentage of the total recorded investment in mortgage loans.
We did not have any MPP loans classified as real estate owned at June 30, 2011, or December 31, 2010, as the servicers foreclose in their name and then generally pay off the delinquent loans at the completion of the foreclosure or liquidate the foreclosed properties. Subsequently, the servicers may submit claims to us for any losses. There were no troubled debt restructurings related to mortgage loans during the three and six months ended June 30, 2011, or 2010.
Term Securities Purchased Under Agreements to Resell and Term Federal Funds Sold. We held no term securities purchased under agreements to resell at June 30, 2011, or December 31, 2010. All investments in term federal funds sold as of June 30, 2011, and December 31, 2010, were repaid according to the contractual terms.
Note 9 - Derivative and Hedging Activities
Managing Credit Risk on Derivatives. We are subject to credit risk due to potential nonperformance by counterparties to the derivative agreements. The degree of counterparty risk depends on the extent to which master netting arrangements are included in such contracts to mitigate the risk. We manage counterparty credit risk through credit analysis, collateral requirements and adherence to the requirements set forth in our policies and Finance Agency regulations. Collateral delivery thresholds are established in the collateral agreements that we require for all LIBOR based derivatives. Based on credit analyses and collateral requirements, our management does not anticipate any credit losses on our derivative agreements.
The following table presents our credit risk exposure on derivative instruments, excluding circumstances where a counterparty's pledged collateral to us exceeds our net position. Amounts represent the effect of legally enforceable master netting agreements that allow us to settle positive and negative positions and also cash collateral held or placed with the same counterparties.
Credit Risk Exposure | June 30, 2011 | December 31, 2010 | ||||||
Total net exposure at fair value | $ | 177 | $ | 6,173 | ||||
Cash collateral held | — | — | ||||||
Net positive exposure after cash collateral | 177 | 6,173 | ||||||
Other collateral | — | — | ||||||
Net exposure after collateral | $ | 177 | $ | 6,173 |
The net exposure at fair value includes accrued interest payable of $0 and $249 at June 30, 2011, and December 31, 2010, respectively.
We have credit support agreements that contain provisions requiring us to post additional collateral with our counterparties if there is deterioration in our credit rating. If our credit rating is lowered by a major credit rating agency, we could 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 (before cash collateral and related accrued interest on cash collateral) at June 30, 2011, was $715,154 for which we have posted collateral, including accrued interest, of $36,275 in the normal course of business. In addition, we held other derivative instruments in a net liability position of $121 that are not subject to credit support agreements containing credit-risk related contingent features. If our credit rating had been lowered by a major credit rating agency (from AAA to AA+) we could have been required to deliver up to an additional $558,756 of collateral (at fair value) to our derivative counterparties at June 30, 2011.
On August 2, 2011, Moody's confirmed the Aaa rating on the FHLBank System's Consolidated Obligations and changed the rating outlook to negative at the same time that Moody's confirmed the Aaa bond rating of the United States government and changed the rating outlook to negative. On August 5, 2011, S&P lowered its long-term sovereign rating on the United States government from AAA to AA+ and affirmed its A-1+ short-term credit rating on the United States government. On August 8, 2011, S&P announced that it had lowered the issuer credit ratings of 10 of 12 FHLBanks (including us) and the rating on the FHLBank System's Consolidated Obligations from AAA to AA+. All 12 of the FHLBanks are currently rated AA+ with negative outlook.
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
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.
The following table presents the fair value of derivative instruments. For purposes of this disclosure, the derivative values include the fair values of derivatives and the related accrued interest.
Notional | Fair Value | Fair Value | ||||||||||
Amount of | of Derivative | of Derivative | ||||||||||
June 30, 2011 | Derivatives | Assets | Liabilities | |||||||||
Derivatives designated as hedging instruments: | ||||||||||||
Interest-rate swaps | $ | 26,959,016 | $ | 122,701 | $ | 841,653 | ||||||
Total derivatives designated as hedging instruments | 26,959,016 | 122,701 | 841,653 | |||||||||
Derivatives not designated as hedging instruments: | ||||||||||||
Interest-rate swaps | 1,425,396 | 1,108 | 851 | |||||||||
Interest-rate caps/floors | 245,000 | 3,541 | — | |||||||||
Interest-rate futures/forwards | 27,600 | 174 | — | |||||||||
Mortgage delivery commitments | 28,667 | 3 | 121 | |||||||||
Total derivatives not designated as hedging instruments | 1,726,663 | 4,826 | 972 | |||||||||
Total derivatives before adjustments | $ | 28,685,679 | 127,527 | 842,625 | ||||||||
Netting adjustments | (127,350 | ) | (127,350 | ) | ||||||||
Cash collateral and related accrued interest | — | (36,275 | ) | |||||||||
Total adjustments (1) | (127,350 | ) | (163,625 | ) | ||||||||
Total derivatives, net | $ | 177 | $ | 679,000 | ||||||||
December 31, 2010 | ||||||||||||
Derivatives designated as hedging instruments: | ||||||||||||
Interest-rate swaps | $ | 32,667,683 | $ | 197,382 | $ | 873,504 | ||||||
Total derivatives designated as hedging instruments | 32,667,683 | 197,382 | 873,504 | |||||||||
Derivatives not designated as hedging instruments: | ||||||||||||
Interest-rate swaps | 497,596 | 364 | 1,350 | |||||||||
Interest-rate caps/floors | 75,000 | 1,369 | — | |||||||||
Interest-rate futures/forwards | 126,085 | 241 | 542 | |||||||||
Mortgage delivery commitments | 57,063 | 275 | 469 | |||||||||
Total derivatives not designated as hedging instruments | 755,744 | 2,249 | 2,361 | |||||||||
Total derivatives before adjustments | $ | 33,423,427 | 199,631 | 875,865 | ||||||||
Netting adjustments | (193,458 | ) | (193,458 | ) | ||||||||
Cash collateral and related accrued interest | — | (25,377 | ) | |||||||||
Total adjustments (1) | (193,458 | ) | (218,835 | ) | ||||||||
Total derivatives, net | $ | 6,173 | $ | 657,030 |
(1) Amounts represent the effect of legally enforceable master netting agreements that allow us to settle positive and negative positions and also cash collateral held or placed with the same counterparties.
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
The following table presents the components of Net Gains (Losses) on Derivatives and Hedging Activities reported in Other Income (Loss):
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
Net Gains (Losses) by Type | 2011 | 2010 | 2011 | 2010 | ||||||||||||
Net gain (loss) related to fair-value hedge ineffectiveness: | ||||||||||||||||
Interest-rate swaps | $ | (2,915 | ) | $ | 7 | $ | (2,830 | ) | $ | (1,401 | ) | |||||
Interest-rate futures/forwards | — | — | (45 | ) | — | |||||||||||
Total net gain (loss) related to fair-value hedge ineffectiveness | (2,915 | ) | 7 | (2,875 | ) | (1,401 | ) | |||||||||
Net gain (loss) for derivatives not designated as hedging instruments: | ||||||||||||||||
Economic hedges: | ||||||||||||||||
Interest-rate swaps | 239 | (655 | ) | 407 | (1,061 | ) | ||||||||||
Interest-rate caps/floors | (713 | ) | — | (1,046 | ) | — | ||||||||||
Interest-rate futures/forwards | (666 | ) | (1,315 | ) | (597 | ) | (1,858 | ) | ||||||||
Net interest settlements | 380 | 160 | 403 | 1,095 | ||||||||||||
Mortgage delivery commitments | 269 | 910 | 175 | 1,157 | ||||||||||||
Total net gain (loss) for derivatives not designated as hedging instruments | (491 | ) | (900 | ) | (658 | ) | (667 | ) | ||||||||
Net Gains (Losses) on Derivatives and Hedging Activities | $ | (3,406 | ) | $ | (893 | ) | $ | (3,533 | ) | $ | (2,068 | ) |
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 effect of those derivatives on Net Interest Income:
Gain (Loss) | Gain (Loss) | Net Fair- | Effect on | ||||||||||||||
on | on Hedged | Value Hedge | Net Interest | ||||||||||||||
Three Months Ended June 30, 2011 | Derivative | Item | Ineffectiveness | Income (1) | |||||||||||||
Advances | $ | (92,518 | ) | $ | 88,697 | $ | (3,821 | ) | $ | (76,214 | ) | ||||||
CO Bonds | 15,147 | (14,036 | ) | 1,111 | 31,406 | ||||||||||||
MPP (2) | — | — | — | (685 | ) | ||||||||||||
AFS securities | (40,437 | ) | 40,232 | (205 | ) | (17,752 | ) | ||||||||||
Total | $ | (117,808 | ) | $ | 114,893 | $ | (2,915 | ) | $ | (63,245 | ) | ||||||
Three Months Ended June 30, 2010 | |||||||||||||||||
Advances | $ | (53,621 | ) | $ | 52,861 | $ | (760 | ) | $ | (126,585 | ) | ||||||
CO Bonds | 2,110 | (893 | ) | 1,217 | 50,755 | ||||||||||||
MPP (2) | — | — | — | — | |||||||||||||
AFS securities | (76,976 | ) | 76,526 | (450 | ) | (16,764 | ) | ||||||||||
Total | $ | (128,487 | ) | $ | 128,494 | $ | 7 | $ | (92,594 | ) | |||||||
Six Months Ended June 30, 2011 | |||||||||||||||||
Advances | $ | (30,271 | ) | $ | 27,086 | $ | (3,185 | ) | $ | (157,608 | ) | ||||||
CO Bonds | (6,682 | ) | 7,074 | 392 | 63,580 | ||||||||||||
MPP (2) | (422 | ) | 377 | (45 | ) | (966 | ) | ||||||||||
AFS securities | (20,273 | ) | 20,236 | (37 | ) | (35,516 | ) | ||||||||||
Total | $ | (57,648 | ) | $ | 54,773 | $ | (2,875 | ) | $ | (130,510 | ) | ||||||
Six Months Ended June 30, 2010 | |||||||||||||||||
Advances | $ | (78,297 | ) | $ | 76,293 | $ | (2,004 | ) | $ | (262,638 | ) | ||||||
CO Bonds | 2,357 | (1,093 | ) | 1,264 | 115,407 | ||||||||||||
MPP (2) | — | — | — | — | |||||||||||||
AFS securities | (103,688 | ) | 103,027 | (661 | ) | (33,817 | ) | ||||||||||
Total | $ | (179,628 | ) | $ | 178,227 | $ | (1,401 | ) | $ | (181,048 | ) |
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
(1) The net interest on derivatives in fair-value hedging relationships is presented in the Interest Income / Interest Expense line item of the respective hedged item.
(2) The effect of MPP hedges on Net Interest Income includes derivatives and the related hedged items in both fair-value and economic hedging relationships.
Note 10 - Deposits
Demand, overnight, and other deposits pay interest based on a daily interest rate. Time deposits pay interest based on a fixed rate determined at the origination of the deposit.
The following table presents Interest-Bearing and Non-Interest-Bearing Deposits:
Type of Deposits | June 30, 2011 | December 31, 2010 | ||||||
Interest-Bearing: | ||||||||
Demand and overnight | $ | 695,727 | $ | 559,872 | ||||
Time | — | 15,000 | ||||||
Other | 22 | 22 | ||||||
Total Interest-Bearing | 695,749 | 574,894 | ||||||
Non-Interest-Bearing: (1) | ||||||||
Other | 10,850 | 10,034 | ||||||
Total Non-Interest Bearing | 10,850 | 10,034 | ||||||
Total Deposits | $ | 706,599 | $ | 584,928 |
(1) Non-Interest-Bearing includes pass-through deposit reserves from members.
Note 11 - Consolidated Obligations
Consolidated Obligations are backed only by the financial resources of the FHLBanks. The joint and several liability regulation of the Finance Agency authorizes it to require any FHLBank to repay all or a portion of the principal and interest on Consolidated Obligations for which another FHLBank is the primary obligor. No FHLBank has ever been asked or required to repay the principal or interest on any Consolidated Obligation on behalf of another FHLBank, and as of June 30, 2011, or through the filing date of this report, we do not believe that it is probable that we will be asked to do so. The par values of the 12 FHLBanks' outstanding Consolidated Obligations, including Consolidated Obligations held by other FHLBanks, were approximately $727.5 billion and $796.4 billion at June 30, 2011, and December 31, 2010, respectively.
The following table presents our participation in CO Bonds outstanding:
June 30, 2011 | December 31, 2010 | |||||||||||||
Year of Contractual Maturity | Amount | WAIR% | Amount | WAIR% | ||||||||||
Due in 1 year or less | $ | 10,330,770 | 0.80 | $ | 15,976,170 | 0.72 | ||||||||
Due after 1 year through 2 years | 2,932,000 | 2.02 | 2,967,550 | 2.14 | ||||||||||
Due after 2 years through 3 years | 1,960,125 | 2.10 | 2,520,405 | 2.25 | ||||||||||
Due after 3 years through 4 years | 1,973,800 | 2.53 | 1,586,900 | 2.81 | ||||||||||
Due after 4 years through 5 years | 1,834,100 | 2.26 | 1,771,350 | 2.24 | ||||||||||
Thereafter | 6,949,950 | 3.99 | 6,957,350 | 4.08 | ||||||||||
Total CO Bonds, par value | 25,980,745 | 2.12 | 31,779,725 | 1.90 | ||||||||||
Unamortized bond premiums | 46,047 | 48,504 | ||||||||||||
Unamortized bond discounts | (21,688 | ) | (23,421 | ) | ||||||||||
Hedging adjustments | 63,135 | 70,429 | ||||||||||||
Total CO Bonds | $ | 26,068,239 | $ | 31,875,237 |
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
Consolidated Obligations are issued with either fixed-rate coupon payment terms or variable-rate coupon payment terms that use a variety of indices for interest-rate resets including LIBOR, treasury bills, prime, and others. At June 30, 2011, and December 31, 2010, 54% and 62%, respectively, of our fixed-rate CO Bonds at par were swapped to a variable rate. At both period ends, 100% of our variable-rate CO Bonds were swapped.
The following tables present our participation in CO Bonds outstanding by redemption feature and contractual maturity or next call date:
Redemption Feature | June 30, 2011 | December 31, 2010 | ||||||
Non-callable | $ | 17,371,745 | $ | 23,801,725 | ||||
Callable | 8,609,000 | 7,978,000 | ||||||
Total CO Bonds, par value | $ | 25,980,745 | $ | 31,779,725 |
Year of Contractual Maturity or Next Call Date | June 30, 2011 | December 31, 2010 | ||||||
Due in 1 year or less | $ | 17,938,770 | $ | 23,217,170 | ||||
Due after 1 year through 2 years | 2,311,000 | 2,357,550 | ||||||
Due after 2 years through 3 years | 1,177,125 | 1,737,405 | ||||||
Due after 3 years through 4 years | 1,028,800 | 946,900 | ||||||
Due after 4 years through 5 years | 545,100 | 469,350 | ||||||
Thereafter | 2,979,950 | 3,051,350 | ||||||
Total CO Bonds, par value | $ | 25,980,745 | $ | 31,779,725 |
Discount Notes. Our participation in Discount Notes, all of which are due within one year of issuance, was as follows:
Discount Notes | June 30, 2011 | December 31, 2010 | ||||||
Book value | $ | 9,992,689 | $ | 8,924,687 | ||||
Par value | 9,993,921 | 8,926,179 | ||||||
Weighted average effective interest rate | 0.10 | % | 0.15 | % |
At June 30, 2011, and December 31, 2010, 9% and 5%, respectively, of our fixed-rate Discount Notes at par were swapped to a variable rate.
Note 12 - Resolution Funding Corporation
Each FHLBank was required to pay to REFCORP 20% of net income calculated in accordance with GAAP after the assessment for AHP, but before the assessment for REFCORP. The AHP and REFCORP assessments were calculated simultaneously because of their interdependence on each other. Based upon this calculation and amounts reported by the FHLBanks through June 30, 2011, the aggregate amounts actually assessed through that date, and payments made in July 2011, by all 12 FHLBanks, the REFCORP obligation is fully satisfied. Consequently, no additional payments to REFCORP will be required. This was confirmed by the Finance Agency through a notice issued on August 5, 2011, certifying that the FHLBanks' payments to the United States Department of the Treasury resulted in full satisfaction of the FHLBanks' REFCORP obligation.
In accordance with the JCE Agreement, starting in the third quarter of 2011, each FHLBank is required to allocate 20% of its net income to a separate restricted retained earnings account. See Note 13 - Capital for further information regarding the JCE Agreement.
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
Note 13 - Capital
We are subject to capital requirements under our capital plan and the Finance Agency rules and regulations as further disclosed in Note 16 - Capital in our 2010 Form 10-K. As presented in the following table, we were in compliance with the Finance Agency's capital requirements at June 30, 2011, and December 31, 2010. For regulatory purposes, AOCI is not considered capital; MRCS, however, is considered capital.
June 30, 2011 | December 31, 2010 | |||||||||||||||
Regulatory Capital Requirements | Required | Actual | Required | Actual | ||||||||||||
Risk-based capital | $ | 796,941 | $ | 2,456,319 | $ | 927,965 | $ | 2,695,980 | ||||||||
Regulatory permanent capital-to-asset ratio | 4.00 | % | 6.13 | % | 4.00 | % | 6.00 | % | ||||||||
Regulatory permanent capital | $ | 1,602,340 | $ | 2,456,319 | $ | 1,797,195 | $ | 2,695,980 | ||||||||
Leverage ratio | 5.00 | % | 9.20 | % | 5.00 | % | 9.00 | % | ||||||||
Leverage capital | $ | 2,002,925 | $ | 3,684,478 | $ | 2,246,494 | $ | 4,043,970 |
Mandatorily Redeemable Capital Stock. At June 30, 2011, and December 31, 2010, we had $515,130 and $658,363, respectively, in capital stock subject to mandatory redemption, which is classified as a liability in the Statement of Condition.
The following table presents distributions on MRCS:
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
Distributions | 2011 | 2010 | 2011 | 2010 | ||||||||||||
Charged to Interest Expense | $ | 3,737 | $ | 3,612 | $ | 8,562 | $ | 7,191 | ||||||||
From Retained Earnings | 11 | 53 | 11 | 53 | ||||||||||||
Total Distributions | $ | 3,748 | $ | 3,665 | $ | 8,573 | $ | 7,244 |
The distributions from Retained Earnings represent dividends paid to former members for the portion of the previous quarterly period that they were members. The amounts charged to Interest Expense represent distributions to former members for the portion of the period they were not members.
There were 31 former members holding MRCS at both June 30, 2011, and December 31, 2010, which includes nine and eight institutions, respectively, acquired by the FDIC in its capacity as receiver. As of June 30, 2011, there was $76,467 of MRCS contractually due within the following 12-month period.
Excess Capital Stock. Excess stock is defined as the amount of stock held by a member or former member in excess of that institution's minimum stock requirement. During the second quarter of 2011, we repurchased excess stock as part of an announced repurchase program in accordance with our capital plan. A total of $247,993 of excess stock was repurchased, consisting of MRCS of $122,097 and Capital Stock of $125,896.
Finance Agency rules limit the ability of an FHLBank to create member excess stock under certain circumstances, including if excess stock exceeds 1% of Total Assets or if the issuance of excess stock would cause excess stock to exceed 1% of Total Assets. Our excess stock totaled $0.9 billion and $1.1 billion at June 30, 2011, and December 31, 2010, respectively, which exceeded 1% of our Total Assets. Therefore, we are currently not permitted to issue new excess stock to members or distribute stock dividends.
Stock Redemption Requests. At June 30, 2011, there was $5,650 of stock not considered MRCS that is subject to a redemption request within the next 12 months.
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
Joint Capital Enhancement Agreement. The 12 FHLBanks entered into a JCE Agreement, as amended, which is intended to enhance the capital position of each FHLBank. Each FHLBank has been required to contribute 20% of its net earnings toward payment of the interest on the REFCORP bonds until the REFCORP obligation was satisfied. The JCE Agreement provides that, upon full satisfaction of the REFCORP obligation, each FHLBank will allocate 20% of its net income each quarter to a restricted retained earnings account until the balance of that account equals at least 1% of that FHLBank's average balance of outstanding Consolidated Obligations for the previous quarter. These restricted retained earnings will not be available from which to pay dividends until the balance exceeds 1.5% of an FHLBank's average balance of outstanding Consolidated Obligations for the previous quarter.
The FHLBanks subsequently amended their capital plans or capital plan submissions, as applicable, to implement the provisions of the JCE Agreement, and the Finance Agency approved the capital plan amendments on August 5, 2011.
Note 14 - Accumulated Other Comprehensive Income (Loss)
The following table presents the changes in AOCI for the six months ended June 30, 2010, and 2011:
Unrealized Gains (Losses) on AFS Securities | Non-Credit OTTI on AFS Securities | Non-Credit OTTI on HTM Securities | Pension and Post-retirement Benefits | Total AOCI | |||||||||||||||||
Balance, December 31, 2009 | $ | 2,140 | $ | — | $ | (324,041 | ) | $ | (6,701 | ) | $ | (328,602 | ) | ||||||||
Net unrealized gains (losses) on AFS securities | (9,423 | ) | — | — | — | (9,423 | ) | ||||||||||||||
Non-credit portion of OTTI losses | — | — | (21,288 | ) | — | (21,288 | ) | ||||||||||||||
Reclassification of non-credit losses to Other Income (Loss) | — | — | 66,769 | — | 66,769 | ||||||||||||||||
Accretion of non-credit portion of OTTI losses | — | — | 28,520 | — | 28,520 | ||||||||||||||||
Subsequent unrealized changes in fair value | — | — | — | — | — | ||||||||||||||||
Net change in non-credit OTTI | — | — | 74,001 | — | 74,001 | ||||||||||||||||
Pension and postretirement benefits | — | — | — | 550 | 550 | ||||||||||||||||
Other Comprehensive Income (Loss) | (9,423 | ) | — | 74,001 | 550 | 65,128 | |||||||||||||||
Balance, June 30, 2010 | $ | (7,283 | ) | $ | — | $ | (250,040 | ) | $ | (6,151 | ) | $ | (263,474 | ) | |||||||
Balance, December 31, 2010 | $ | (4,615 | ) | $ | (68,806 | ) | $ | (7,056 | ) | $ | (9,769 | ) | $ | (90,246 | ) | ||||||
Net unrealized gains (losses) on AFS securities | 10,149 | — | — | — | 10,149 | ||||||||||||||||
Non-credit portion of OTTI losses | — | (2,331 | ) | — | — | (2,331 | ) | ||||||||||||||
Reclassification of net realized losses to Other Income (Loss) | — | 1,943 | — | — | 1,943 | ||||||||||||||||
Reclassification of non-credit losses to Other Income (Loss) | — | 21,076 | — | — | 21,076 | ||||||||||||||||
Accretion of non-credit portion of OTTI losses | — | — | 1,902 | — | 1,902 | ||||||||||||||||
Subsequent unrealized changes in fair value | — | (1,771 | ) | — | — | (1,771 | ) | ||||||||||||||
Net change in non-credit OTTI | — | 18,917 | 1,902 | — | 20,819 | ||||||||||||||||
Pension and postretirement benefits | — | — | — | — | 1,648 | 1,648 | |||||||||||||||
Other Comprehensive Income (Loss) | 10,149 | 18,917 | 1,902 | 1,648 | 32,616 | ||||||||||||||||
Balance, June 30, 2011 | $ | 5,534 | $ | (49,889 | ) | $ | (5,154 | ) | $ | (8,121 | ) | $ | (57,630 | ) |
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
Note 15 - Segment Information
We have identified two primary operating segments:
• | Traditional, which includes credit services (such as Advances, letters of credit, and lines of credit), investments (including Federal Funds Sold, Securities Purchased Under Agreements to Resell, AFS securities, and HTM securities), and deposits; and |
• | MPP, which consists of mortgage loans purchased from our members. |
We have not symmetrically allocated assets to each segment based upon financial results as it is impracticable to measure the performance of our segments from a total assets perspective. As a result, there is asymmetrical information presented in the tables below including, among other items, the allocation of depreciation without an allocation of the depreciable assets, derivatives and hedging earnings adjustments with no corresponding allocation to derivative assets, if any, and the recording of interest income with no allocation to accrued interest receivable.
The following table presents our financial performance by operating segment:
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
June 30, 2011 | Traditional | MPP | Total | Traditional | MPP | Total | ||||||||||||||||||
Net Interest Income | $ | 32,661 | $ | 23,324 | $ | 55,985 | $ | 67,340 | $ | 48,890 | $ | 116,230 | ||||||||||||
Provision for Credit Losses | — | (1,183 | ) | (1,183 | ) | — | (2,159 | ) | (2,159 | ) | ||||||||||||||
Other Income (Loss) | (7,322 | ) | (397 | ) | (7,719 | ) | (25,374 | ) | (467 | ) | (25,841 | ) | ||||||||||||
Other Expenses | 13,080 | 568 | 13,648 | 26,036 | 1,177 | 27,213 | ||||||||||||||||||
Income Before Assessments | 12,259 | 21,176 | 33,435 | 15,930 | 45,087 | 61,017 | ||||||||||||||||||
Total Assessments | 3,432 | 5,618 | 9,050 | 4,800 | 11,962 | 16,762 | ||||||||||||||||||
Net Income | $ | 8,827 | $ | 15,558 | $ | 24,385 | $ | 11,130 | $ | 33,125 | $ | 44,255 | ||||||||||||
June 30, 2010 | ||||||||||||||||||||||||
Net Interest Income | $ | 40,460 | $ | 15,607 | $ | 56,067 | $ | 79,757 | $ | 37,957 | $ | 117,714 | ||||||||||||
Provision for Credit Losses | — | — | — | — | — | — | ||||||||||||||||||
Other Income (Loss) | (61,353 | ) | (404 | ) | (61,757 | ) | (67,372 | ) | (700 | ) | (68,072 | ) | ||||||||||||
Other Expenses | 10,894 | 629 | 11,523 | 21,289 | 1,220 | 22,509 | ||||||||||||||||||
Income (Loss) Before Assessments | (31,787 | ) | 14,574 | (17,213 | ) | (8,904 | ) | 36,037 | 27,133 | |||||||||||||||
Total Assessments, net | (8,138 | ) | 3,867 | (4,271 | ) | (1,775 | ) | 9,561 | 7,786 | |||||||||||||||
Net Income (Loss) | $ | (23,649 | ) | $ | 10,707 | $ | (12,942 | ) | $ | (7,129 | ) | $ | 26,476 | $ | 19,347 |
The following table presents asset balances by segment:
Asset Balances by Segment | Traditional | MPP | Total | |||||||||
June 30, 2011 | $ | 33,777,059 | $ | 6,281,450 | $ | 40,058,509 | ||||||
December 31, 2010 | 38,227,297 | 6,702,576 | 44,929,873 |
Note 16 - Estimated Fair Values
The fair value amounts, recorded on the Statement of Condition and presented in the note disclosures, have been determined by using available market information and our best judgment of appropriate valuation methods. These estimates are based on pertinent information available to us at June 30, 2011, and December 31, 2010. Although we use our best judgment in estimating the fair values of these financial instruments, there are inherent limitations in any valuation technique. Therefore, these fair values may not be indicative of the amounts that would have been realized in market transactions at the reporting dates.
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
The following fair value summary table does not represent an estimate of our overall market value as a going concern, which would take into account future business opportunities and the net profitability of assets and liabilities:
June 30, 2011 | December 31, 2010 | |||||||||||||||
Carrying | Estimated | Carrying | Estimated | |||||||||||||
Financial Instruments | Value | Fair Value | Value | Fair Value | ||||||||||||
Assets: | ||||||||||||||||
Cash and Due from Banks | $ | 1,539,157 | $ | 1,539,157 | $ | 11,676 | $ | 11,676 | ||||||||
Interest-Bearing Deposits | 59 | 59 | 3 | 3 | ||||||||||||
Securities Purchased Under Agreements to Resell | — | — | 750,000 | 750,000 | ||||||||||||
Federal Funds Sold | 2,905,000 | 2,905,023 | 7,325,000 | 7,325,100 | ||||||||||||
AFS securities | 3,084,813 | 3,084,813 | 3,237,916 | 3,237,916 | ||||||||||||
HTM securities | 8,633,802 | 8,701,206 | 8,471,827 | 8,513,391 | ||||||||||||
Advances | 17,475,572 | 17,610,700 | 18,275,364 | 18,354,184 | ||||||||||||
Mortgage Loans Held for Portfolio, net | 6,281,450 | 6,620,669 | 6,702,576 | 7,017,784 | ||||||||||||
Accrued Interest Receivable | 89,876 | 89,876 | 98,924 | 98,924 | ||||||||||||
Derivative Assets | 177 | 177 | 6,173 | 6,173 | ||||||||||||
Rabbi trust assets (included in Other Assets) | 13,485 | 13,485 | 12,893 | 12,893 | ||||||||||||
Liabilities: | ||||||||||||||||
Deposits | 706,599 | 706,599 | 584,928 | 584,928 | ||||||||||||
Consolidated Obligations: | ||||||||||||||||
Discount Notes | 9,992,689 | 9,992,870 | 8,924,687 | 8,924,782 | ||||||||||||
CO Bonds | 26,068,239 | 26,429,577 | 31,875,237 | 32,147,040 | ||||||||||||
Accrued Interest Payable | 123,686 | 123,686 | 133,862 | 133,862 | ||||||||||||
Derivative Liabilities | 679,000 | 679,000 | 657,030 | 657,030 | ||||||||||||
MRCS | 515,130 | 515,130 | 658,363 | 658,363 |
Fair Value Hierarchy. We record AFS securities, Derivative Assets, rabbi trust assets (publicly-traded mutual funds), and Derivative Liabilities at fair value. The fair value hierarchy is used to prioritize the inputs of valuation techniques used to measure fair value for assets and liabilities that are carried at fair value, both on a recurring and non-recurring basis, on the Statement of Condition. The inputs are evaluated, and an overall level for the fair value measurement is determined. This overall level is an indication of market observability of the fair value measurement for the asset or liability.
A description of the application of the fair value hierarchy is disclosed in Note 19 - Estimated Fair Values in our 2010 Form 10-K, and no changes have been made in the current year.
For financial instruments carried at fair value, we review the fair value hierarchy classifications on a quarterly basis. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets or liabilities. Such reclassifications are reported as transfers in/out at fair value at the beginning of the quarter in which the changes occur.
Valuation Techniques and Significant Inputs. A description of the valuation techniques and significant inputs is disclosed in Note 19 - Estimated Fair Values in our 2010 Form 10-K, and no changes have been made in the current year, except as disclosed below.
Investment securities – non-MBS. The estimated fair value is determined using market-observable price quotes from dealers or third-party pricing services, such as the composite Bloomberg bond trade screen, thus falling under the market approach. This price represents executable prices for identical assets.
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
Fair Value on a Recurring Basis. The following tables present the fair value of financial assets and liabilities by level within the fair value hierarchy which are recorded on a recurring basis on our Statement of Condition:
Netting | ||||||||||||||||||||
June 30, 2011 | Total | Level 1 | Level 2 | Level 3 | Adjustment (1) | |||||||||||||||
AFS securities: | ||||||||||||||||||||
GSE debentures | $ | 1,955,232 | $ | — | $ | 1,955,232 | $ | — | $ | — | ||||||||||
TLGP debentures | 324,010 | — | 324,010 | — | — | |||||||||||||||
Private-label RMBS | 805,571 | — | — | 805,571 | — | |||||||||||||||
Total AFS securities | 3,084,813 | — | 2,279,242 | 805,571 | — | |||||||||||||||
Derivative Assets: | ||||||||||||||||||||
Interest-rate related | — | — | 127,350 | — | (127,350 | ) | ||||||||||||||
Interest-rate futures/forwards | 174 | — | 174 | — | — | |||||||||||||||
Mortgage delivery commitments | 3 | — | 3 | — | — | |||||||||||||||
Total Derivative Assets | 177 | — | 127,527 | — | (127,350 | ) | ||||||||||||||
Rabbi Trust (included in Other Assets) | 13,485 | 13,485 | — | — | — | |||||||||||||||
Total assets at fair value | $ | 3,098,475 | $ | 13,485 | $ | 2,406,769 | $ | 805,571 | $ | (127,350 | ) | |||||||||
Derivative Liabilities: | ||||||||||||||||||||
Interest-rate related | $ | 678,879 | $ | — | $ | 842,504 | $ | — | $ | (163,625 | ) | |||||||||
Interest-rate futures/forwards | — | — | — | — | — | |||||||||||||||
Mortgage delivery commitments | 121 | — | 121 | — | — | |||||||||||||||
Total Derivative Liabilities | 679,000 | — | 842,625 | — | (163,625 | ) | ||||||||||||||
Total liabilities at fair value | $ | 679,000 | $ | — | $ | 842,625 | $ | — | $ | (163,625 | ) | |||||||||
December 31, 2010 | ||||||||||||||||||||
AFS securities: | ||||||||||||||||||||
GSE debentures | $ | 1,930,258 | $ | — | $ | 1,930,258 | $ | — | $ | — | ||||||||||
TLGP debentures | 325,117 | — | 325,117 | — | — | |||||||||||||||
Private-label RMBS | 982,541 | — | — | 982,541 | — | |||||||||||||||
Total AFS securities | 3,237,916 | — | 2,255,375 | 982,541 | — | |||||||||||||||
Derivative Assets: | ||||||||||||||||||||
Interest-rate related | 5,657 | — | 199,115 | — | (193,458 | ) | ||||||||||||||
Interest-rate futures/forwards | 241 | — | 241 | — | — | |||||||||||||||
Mortgage delivery commitments | 275 | — | 275 | — | — | |||||||||||||||
Total Derivative Assets | 6,173 | — | 199,631 | — | (193,458 | ) | ||||||||||||||
Rabbi Trust (included in Other Assets) | 12,893 | 12,893 | — | — | — | |||||||||||||||
Total assets at fair value | $ | 3,256,982 | $ | 12,893 | $ | 2,455,006 | $ | 982,541 | $ | (193,458 | ) | |||||||||
Derivative Liabilities: | ||||||||||||||||||||
Interest-rate related | $ | 656,018 | $ | — | $ | 874,854 | $ | — | $ | (218,836 | ) | |||||||||
Interest-rate futures/forwards | 543 | — | 543 | — | — | |||||||||||||||
Mortgage delivery commitments | 469 | — | 469 | — | — | |||||||||||||||
Total Derivative Liabilities | 657,030 | — | 875,866 | — | (218,836 | ) | ||||||||||||||
Total liabilities at fair value | $ | 657,030 | $ | — | $ | 875,866 | $ | — | $ | (218,836 | ) |
(1) Amounts represent the effect of legally enforceable master netting agreements that allow us to settle positive and negative positions and also cash collateral and related accrued interest held or placed with the same counterparties.
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
The table below presents a reconciliation of our AFS private-label RMBS measured at fair value on a recurring basis by using Level 3 significant inputs. We did not measure our AFS private-label RMBS at fair value on a recurring basis during the three or six months ended June 30, 2010.
Three Months Ended | Six Months Ended | |||||||
Fair Value Measurements Using Significant Unobservable Inputs (Level 3) | June 30, 2011 | June 30, 2011 | ||||||
Balance, beginning of period | $ | 932,839 | $ | 982,541 | ||||
Total realized and unrealized gains (losses): | ||||||||
Included in net losses on sale of AFS securities | (1,943 | ) | (1,943 | ) | ||||
Included in net gains (losses) on changes in fair value included in Other Income (Loss) | (2,356 | ) | (19,517 | ) | ||||
Included in AOCI | (8,415 | ) | 16,097 | |||||
Purchases, issuances, sales and settlements: | ||||||||
Sales | (63,700 | ) | (63,700 | ) | ||||
Settlements | (50,854 | ) | (107,907 | ) | ||||
Balance, end of period | $ | 805,571 | $ | 805,571 | ||||
Net gains (losses) included in Other Income (Loss) attributable to changes in fair value relating to assets still held at June 30, 2011 | $ | (2,519 | ) | $ | (18,199 | ) |
Fair Value on a Nonrecurring Basis. We measure certain HTM securities at fair value on a nonrecurring basis. These assets are not carried at fair value on an ongoing basis, but are subject to fair value adjustments only in certain circumstances (e.g., when there is evidence of OTTI). These amounts fall under Level 3 in the fair value hierarchy.
As of June 30, 2011, and December 31, 2010, none of our HTM securities were carried at fair value.
Note 17 - Commitments and Contingencies
The following table presents our off-balance-sheet commitments at their notional amounts:
June 30, 2011 | December 31, 2010 | |||||||||||||||||||||||
By Commitment | Expire within one year | Expire after one year | Total | Expire within one year | Expire after one year | Total | ||||||||||||||||||
Standby letters of credit outstanding (1) | $ | 339,171 | $ | 435,675 | $ | 774,846 | $ | 41,616 | $ | 485,220 | $ | 526,836 | ||||||||||||
Unused lines of credit | 784,829 | — | 784,829 | 762,418 | — | 762,418 | ||||||||||||||||||
Commitments to fund additional Advances (2) | 29,500 | — | 29,500 | 15,633 | — | 15,633 | ||||||||||||||||||
Commitment to fund or purchase mortgage loans | 28,667 | — | 28,667 | 57,063 | — | 57,063 | ||||||||||||||||||
Unsettled CO Bonds, at par (3) | 572,000 | — | 572,000 | 412,000 | — | 412,000 | ||||||||||||||||||
Unsettled Discount Notes, at par | 200,000 | — | 200,000 | — | — | — |
(1) We had no outstanding commitments to issue standby letters of credit at June 30, 2011, or December 31, 2010.
(2) Commitments to fund additional Advances are generally for periods up to 6 months.
(3) Unsettled CO Bonds of $475,000 and $250,000, at June 30, 2011, and December 31, 2010, respectively, were hedged with associated interest-rate swaps.
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
Commitments to Extend Credit. Standby letters of credit are executed for members for a fee. A standby letter of credit is a financing arrangement between us and one of our members. Commitments to extend credit are fully collateralized at the time of issuance. If we are required to make payment for a beneficiary's draw, the payment amount is converted into a collateralized Advance to the member. The original terms of these standby letters of credit, including related commitments, range from less than three months to 20 years, including standby letters of credit with a final expiration in 2029. The carrying value of guarantees related to standby letters of credit is recorded in Other Liabilities and was $6,406 and $5,859 at June 30, 2011, and December 31, 2010, respectively.
We monitor the creditworthiness of our standby letters of credit based on an evaluation of the financial condition of our members. We have established parameters for the measurement, review, classification, and monitoring of credit risk related to these standby letters of credit. Based on credit analyses performed by us as well as collateral requirements, we have not deemed it necessary to record any additional liability on these commitments. See Note 6 – Advances for more information.
Commitments to Fund or Purchase Mortgage Loans. Commitments that unconditionally obligate us to purchase mortgage loans are generally for periods not to exceed 91 days. Such commitments are reported as Derivative Assets or Derivative Liabilities at their fair value.
Pledged Collateral. We generally execute derivatives with large banks and major broker-dealers and generally enter into bilateral pledge (collateral) agreements. We had pledged $42,100 and $31,200 of cash collateral, at par, at June 30, 2011, and December 31, 2010, respectively. At June 30, 2011, and December 31, 2010, we had not pledged any securities as collateral.
Legal Proceedings. Lehman Brothers Holding Company, the guarantor for one of our former derivatives counterparties, Lehman Brothers Special Financing (Lehman), declared bankruptcy on September 15, 2008. We provided notice of default based on the bankruptcy to Lehman Brothers Holding Company on September 22, 2008, and designated September 25, 2008, as the early termination date under the International Swaps and Derivatives Association Master Agreement. On the early termination date, we had $5.4 billion notional amount of derivatives transactions outstanding with Lehman and no collateral posted to Lehman. The close-out provisions of the International Swaps and Derivatives Master Agreement required us to pay Lehman a termination fee of approximately $95.6 million, which we remitted to Lehman on September 25, 2008. Lehman's bankruptcy remains pending in the United States Bankruptcy Court Southern District of New York as Chapter 11 Case No. 08-13555(JMP).
On May 9, 2011, we received a Derivatives Alternative Dispute Resolution notice from the Lehman bankruptcy estate with a settlement demand of $1.471 million, which is the difference between the termination fee we previously paid Lehman and the market value fee we received on the replacement swaps, plus interest accruing since the early termination date, at Lehman's cost of funds plus 1%. Lehman asserts such accrued interest, as of May 9, 2011, amounts to approximately $650 thousand. On June 8, 2011, we filed a response in which we rejected Lehman's settlement demand. On June 23, 2011, Lehman served a reply, effectively reiterating its demand. We expect this matter to be scheduled for mediation with a court-appointed mediator.
While we believe that we fully satisfied our obligation to Lehman and intend to vigorously defend this matter, we are unable to predict the timing or ultimate outcome of this matter.
We are also subject to other legal proceedings arising in the normal course of business. After consultation with legal counsel, management does not anticipate that the ultimate liability, if any, arising out of these matters will have a material effect on our financial condition or results of operations.
Additional discussion of other commitments and contingencies is provided in Note 6 – Advances; Note 7 – Mortgage Loans Held for Portfolio; Note 9 – Derivative and Hedging Activities; Note 11 – Consolidated Obligations; Note 13 – Capital; and Note 16 – Estimated Fair Values.
Notes to Financial Statements, continued
(Unaudited, $ amounts in thousands unless otherwise indicated)
Note 18 - Transactions with Related Parties
For purposes of these financial statements, we define related parties as those members and former members and their affiliates with capital stock outstanding in excess of 10% of our total outstanding Capital Stock and MRCS. Transactions with such members are entered into in the normal course of business and are subject to the same eligibility and credit criteria, as well as the same terms and conditions as other similar transactions, and do not involve more than the normal risk of collectability.
The following table presents significant outstanding balances with respect to transactions with related parties.
Balances with Related Parties | June 30, 2011 | December 31, 2010 | ||||||
Advances, par value | $ | 3,806,571 | $ | 4,626,477 | ||||
% of Total Advances, par value | 23 | % | 26 | % | ||||
Mortgage Loans Held for Portfolio, UPB | $ | 2,656,178 | $ | 2,863,456 | ||||
% of Total Mortgage Loans Held for Portfolio, UPB | 43 | % | 43 | % | ||||
Capital Stock, including MRCS | $ | 526,658 | $ | 618,807 | ||||
% of Total Capital Stock, including MRCS | 26 | % | 27 | % |
Transactions with Directors' Financial Institutions. We provide, in the ordinary course of business, products and services to members whose officers or directors serve on our board of directors. Finance Agency regulations require that transactions with directors' financial institutions be made on the same terms as those with any other member. We had Advances, Mortgage Loans Held for Portfolio, and Capital Stock outstanding (including MRCS) to directors' financial institutions as follows:
Balances with directors' financial institutions | June 30, 2011 | December 31, 2010 | ||||||
Advances, par value | $ | 714,768 | $ | 4,408,276 | ||||
% of Total Advances, par value | 4 | % | 25 | % | ||||
Mortgage Loans Held for Portfolio, UPB | $ | 41,414 | $ | 758,879 | ||||
% of Total Mortgage Loans Held for Portfolio, UPB | 1 | % | 11 | % | ||||
Capital Stock, including MRCS | $ | 64,223 | $ | 406,555 | ||||
% of Total Capital Stock, including MRCS | 3 | % | 18 | % |
During the three and six months ended June 30, 2011, and 2010, we acquired mortgage loans from directors' financial institutions, presented as of the date of the directors' appointments and resignations, as follows:
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Mortgage loans purchased from directors' financial institutions | $ | 1,787 | $ | 2,941 | $ | 4,041 | $ | 5,133 |
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Presentation
This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our 2010 Form 10-K and the financial statements and related footnotes contained in Item 1. Financial Statements.
As used in this Form 10-Q, unless the context otherwise requires, the terms "we," "us," and "our" refer to the Federal Home Loan Bank of Indianapolis. We use certain acronyms and terms throughout this Form 10-Q which are defined in the Glossary of Terms located after Item 6. Exhibits.
Dollar amounts less than one million may not be reflected in this report and may not appear to agree to the Financial Statements due to rounding in previous quarters. Amounts used to calculate changes are based on numbers in the thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results.
Special Note Regarding Forward-looking Statements
Statements in this Form 10-Q, including statements describing our objectives, projections, estimates or future predictions, may be "forward-looking statements." These statements may use forward-looking terminology, such as "anticipates," "believes," "could," "estimates," "may," "should," "expects," "will," or their negatives or other variations on these terms. We caution that, by their nature, forward-looking statements involve risk or uncertainty and that actual results either could differ materially from those expressed or implied in these forward-looking statements or could affect the extent to which a particular objective, projection, estimate, or prediction is realized. These forward-looking statements involve risks and uncertainties including, but not limited to, the following:
• | economic and market conditions, including the timing and volume of market activity, inflation or deflation, changes in the value of global currencies, and changes in the financial condition of market participants; |
• | volatility of market prices, rates, and indices that could affect the value of collateral we hold as security for the obligations of our members and counterparties; |
• | demand for our Advances and purchases of mortgage loans resulting from: |
◦ | changes in our members' deposit flows and credit demands; |
◦ | membership changes, including, but not limited to, mergers, acquisitions and consolidations of charters; |
◦ | changes in the general level of housing activity in the United States, the level of refinancing activity and consumer product preferences; and |
◦ | competitive forces, including, without limitation, other sources of funding available to our members; |
• | our ability to introduce new products and services and successfully manage the risks associated with our products and services, including new types of collateral securing Advances; |
• | changes in mortgage asset prepayment patterns, delinquency rates and housing values; |
• | political events, including legislative, regulatory, or other developments, and judicial rulings that affect us, our status as a secured creditor, our members, counterparties, one or more of the FHLBanks and/or investors in the Consolidated Obligations of the 12 FHLBanks; |
• | changes in our ability to raise capital market funding, including changes in credit ratings and the level of government guarantees provided to other United States and international financial institutions; and competition from other entities borrowing funds in the capital markets; |
• | negative adjustments in the FHLBanks' credit ratings that could adversely impact the pricing and marketability of our Consolidated Obligations, products, or services; |
• | risk of loss should one or more of the FHLBanks be unable to repay its participation in the Consolidated Obligations, or otherwise be unable to meet its financial obligations; |
• | ability to attract and retain skilled individuals in order to fulfill an anticipated increase in staffing needs due to the evolving regulatory environment; |
• | ability to develop and support technology and information systems sufficient to effectively manage the risks of our business; |
• | changes in terms of interest-rate exchange agreements and similar agreements; |
• | risk of loss arising from natural disasters, acts of war or acts of terrorism; and |
• | changes in or differing interpretations of accounting guidance. |
Although we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, you are advised to consult any additional disclosures that we may make through reports filed with the SEC in the future, including our Form 10-K's, Form 10-Q's and Form 8-K's.
Executive Summary
Overview. We are a regional wholesale bank that makes Advances, purchases mortgages and other investments, and provides other financial services to our member financial institutions. These member financial institutions can consist of federally-insured depository institutions (including commercial banks, thrifts, and credit unions), community development financial institutions and insurance companies. All member financial institutions are required to purchase shares of our Class B Capital Stock as a condition of membership. Our public policy mission is to facilitate and expand the availability of financing for housing and community development. We seek to achieve our mission by providing products and services to our members in a safe, sound, and profitable manner, and by generating a competitive return on their capital investment. See Item 1. Business - Background Information in our 2010 Form 10-K for more information.
We group our products and services within two business segments:
• | Traditional, which includes credit services (such as Advances, letters of credit, and lines of credit), investments (including Federal Funds Sold, Securities Purchased Under Agreements to Resell, AFS securities, and HTM securities), and deposits; and |
• | MPP, which consists of mortgage loans purchased from our members. |
Our principal source of funding is the proceeds from the sale to the public of FHLBank debt instruments, called Consolidated Obligations, which are the joint and several obligation of all 12 FHLBanks. We obtain additional funds from deposits, other borrowings, and the sale of capital stock to our members.
Our primary source of revenue is interest earned on Advances, long- and short-term investments, and mortgage loans purchased from our members.
Our Net Interest Income is primarily determined by the interest-rate spread between the interest rate earned on our assets and the interest rate paid on our share of the Consolidated Obligations. We use funding and hedging strategies to mitigate the related interest-rate risk.
The Economy and the Financial Services Industry. Our financial condition and results of operations are influenced by the general state of the global and national economies; the prevailing level of interest rates; the local economies in our district states of Indiana and Michigan and their impact on our member financial institutions; and the conditions in the financial, credit and mortgage markets.
The United States economy entered a recession in December 2007, which ended in June 2009. Many of the effects of this recession and the world-wide financial crisis continued through the first six months of 2011, including serious pressures on earnings and capital at many financial institutions, high unemployment rates, high levels of mortgage delinquencies and foreclosures, and the depressed housing market. Delays in processing problem loans contributed to the backlog of distressed properties that has been building up, putting ongoing downward pressure on home prices.
According to the FOMC of the Federal Reserve Board, there are signs that the economic recovery is proceeding at a moderate pace, though somewhat more slowly than expected. Also, recent labor market indicators have been weaker than anticipated. The FOMC indicated that it will maintain the target range for the federal funds rate at 0.00-0.25%, as it continues to anticipate that economic conditions, including low rates of resource utilization, and subdued inflation trends, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.
Economic data for Michigan continues to generally compare unfavorably to national data, while Indiana presents a mixed picture. The Bureau of Labor Statistics reported that Michigan's preliminary unemployment rate equaled 10.5% for June 2011, while Indiana's preliminary rate was 8.3%, compared to the United States rate of 9.2%. Lender Processing Services reported that Indiana had a non-current mortgage rate (loans past due 30 days or more) of 13.5%, and Michigan had a non-current mortgage rate of 12.0% for April 2011, compared to the national rate of 12.1%.
In its most recent forecast, the Center for Econometric Research at Indiana University stated that its current forecast for the Indiana economy has turned more optimistic for both employment and the growth rate of personal income. The most recent forecast published by the Research Seminar in Quantitative Economics at the University of Michigan states that Michigan recorded a stronger recovery in jobs than the nation from the low point in the third quarter of 2009 until now. However, University of Michigan economists expect state job growth to to be less than national job growth through 2012. We believe the overall economic outlook for our district is showing some signs of improvement but will continue to trail the overall United States economy.
Financial Trends in the Capital Markets. The Office of Finance, our fiscal agent, issues debt in the global capital markets on behalf of the 12 FHLBanks in the form of Consolidated Obligations, which include CO Bonds and Discount Notes. Our funding operations depend on debt issued by the Office of Finance, and the issuance of our debt is affected by events in the capital markets.
The FOMC completed its purchases of $600 billion of longer-term Treasury securities at the end of the second quarter of 2011 and is maintaining its existing policy of reinvesting principal payments from its securities holdings. The FOMC will regularly review the size and composition of its securities holdings in light of incoming information and is prepared to adjust those holdings as needed to best foster maximum employment and price stability.
Taxable money market fund assets declined during the first six months of 2011. As a subset of those assets, taxable money market fund investments allocated to the "U.S. Other Agency" category also declined during the first six months of 2011. The SEC's final rule on money market fund reform, which included amendments to SEC Rule 2a-7, became effective on May 5, 2010, with certain aspects of the rule phased in over the remainder of 2010. This rule, combined with reduced yields in the money market sector, has driven investors to seek riskier investment categories that offer a higher rate of return. Our Discount Notes with remaining maturities of 60 days or less are included in the definition of weekly liquid assets, which has helped maintain investor demand for shorter-term Discount Notes.
On August 2, 2011, Moody's confirmed the Aaa rating on the FHLBank System's Consolidated Obligations and changed the rating outlook to negative at the same time that Moody's confirmed the Aaa bond rating of the United States government and changed the rating outlook to negative. On August 5, 2011, S&P lowered its long-term sovereign rating on the United States government to AA+ from AAA and affirmed its A-1+ short-term credit rating on the United States government. S&P removed both ratings from CreditWatch, where they were placed on July 15, 2011, with negative implications. Due to our status as a GSE and the application of S&P's government-related entity criteria, our issuer rating is constrained by the long-term sovereign credit rating of the United States government. On August 8, 2011, S&P announced that it had lowered the issuer credit ratings of 10 of 12 FHLBanks (including us) and the rating on the FHLBank System's Consolidated Obligations to AA+ from AAA. All 12 of the FHLBanks are currently rated AA+ with outlook negative. S&P affirmed the FHLBanks' short-term issuer ratings at A-1+ and removed all of the ratings from CreditWatch. These changes have not had a material impact on our funding costs.
Summary of Operating Results. Our overall results are dependent on the market environment, as well as our members' demand for wholesale funding and their sales of mortgage loans to us. As part of their overall business strategy, our members typically use wholesale funding, in the form of Advances, along with other sources of funding, such as retail deposits and excess liquidity. In addition, certain members may also sell mortgage loans to us.
Periods of economic growth have led to significant use of wholesale funds by our members because businesses typically fund expansion by using either wholesale or retail borrowing. Conversely, slow economic growth has tended to decrease our members' wholesale borrowing activity. Member demand for Advances and the MPP is also influenced by the steepness of the yield curve, as well as the availability and cost of other sources of wholesale or government funding. Advances declined during the first six months of 2011 due to repayments and decreased demand related to various economic factors such as growth in our members' deposits and low loan demand at our members' institutions. Mortgage Loans Held for Portfolio also decreased as purchases of mortgage loans were not large enough to fully offset the reduction due to repayments.
The market turmoil in 2008 and 2009 created opportunities to generate spreads well above historic levels on certain types of transactions. The frequency and level of higher-spread investment opportunities diminished during 2010, and spreads on our Advances and short-term investments began to normalize. We expect Net Interest Income to continue to decline in 2011 as spreads on our mortgage-related assets revert to normal levels. However, these spreads could be influenced by unexpected changes in the market environment.
Summary of Selected Financial Data
The following table presents a summary of certain financial information as of and for the periods indicated ($ amounts in millions):
As of and for the Three Months Ended | |||||||||||||||||||||
June 30, 2011 | March 31, 2011 | December 31, 2010 | September 30, 2010 | June 30, 2010 | |||||||||||||||||
Statement of Condition: | |||||||||||||||||||||
Total Assets | $ | 40,059 | $ | 43,901 | $ | 44,930 | $ | 44,862 | $ | 45,639 | |||||||||||
Advances | 17,476 | 17,679 | 18,275 | 18,914 | 19,989 | ||||||||||||||||
Investments (1) | 14,624 | 19,274 | 19,785 | 19,294 | 18,734 | ||||||||||||||||
Mortgage Loans Held for Portfolio | 6,283 | 6,469 | 6,703 | 6,487 | 6,749 | ||||||||||||||||
Allowance for loan losses | (2 | ) | (1 | ) | (1 | ) | — | — | |||||||||||||
Discount Notes | 9,993 | 8,489 | 8,925 | 9,728 | 7,434 | ||||||||||||||||
CO Bonds | 26,068 | 31,287 | 31,875 | 30,548 | 33,616 | ||||||||||||||||
Total Consolidated Obligations | 36,061 | 39,776 | 40,800 | 40,276 | 41,050 | ||||||||||||||||
MRCS | 515 | 658 | 658 | 782 | 781 | ||||||||||||||||
Capital Stock, Class B Putable | 1,490 | 1,614 | 1,610 | 1,733 | 1,731 | ||||||||||||||||
Retained Earnings | 451 | 437 | 427 | 396 | 351 | ||||||||||||||||
AOCI | (57 | ) | (60 | ) | (90 | ) | (255 | ) | (264 | ) | |||||||||||
Total Capital | 1,884 | 1,991 | 1,947 | 1,874 | 1,818 | ||||||||||||||||
Statement of Income: | |||||||||||||||||||||
Net Interest Income | 56 | 60 | 67 | 82 | 56 | ||||||||||||||||
Provision for Credit Losses | 1 | 1 | 1 | — | — | ||||||||||||||||
Net OTTI losses | (3 | ) | (18 | ) | (2 | ) | — (a) | (62 | ) | ||||||||||||
Other Income (Loss), excluding net OTTI losses | (5 | ) | — | 11 | 1 | — | |||||||||||||||
Other Expenses | 14 | 13 | 8 | 19 | 14 | 11 | |||||||||||||||
Total Assessments, net | 9 | 8 | 15 | 18 | (4 | ) | |||||||||||||||
Net Income (Loss) | 24 | 20 | 41 | 51 | (13 | ) | |||||||||||||||
Selected Financial Ratios: | |||||||||||||||||||||
Return on average equity (2) | 4.96 | % | 4.08 | % | 8.76 | % | 10.96 | % | (2.90 | %) | |||||||||||
Return on average assets | 0.23 | % | 0.18 | % | 0.35 | % | 0.45 | % | (0.11 | %) | |||||||||||
Dividend payout ratio (3) | 40.72 | % | 53.14 | % | 21.40 | % | 12.67 | % | NM | ||||||||||||
Net interest margin (4) | 0.53 | % | 0.55 | % | 0.58 | % | 0.73 | % | 0.47 | % | |||||||||||
Total capital ratio (5) | 4.70 | % | 4.54 | % | 4.33 | % | 4.18 | % | 3.98 | % | |||||||||||
Total regulatory capital ratio (6) | 6.13 | % | 6.17 | % | 6.00 | % | 6.49 | % | 6.27 | % | |||||||||||
Average equity to average assets | 4.63 | % | 4.43 | % | 4.03 | % | 4.09 | % | 3.77 | % | |||||||||||
Weighted average dividend rate, Class B stock (7) | 2.50 | % | 2.50 | % | 2.00 | % | 1.50 | % | 2.00 | % | |||||||||||
Par amount of outstanding Consolidated Obligations for all 12 FHLBanks | $ | 727,475 | $ | 765,980 | $ | 796,374 | $ | 806,006 | $ | 846,481 |
(1) Investments consist of Interest-Bearing Deposits, Securities Purchased Under Agreements to Resell, Federal Funds Sold, AFS securities, HTM securities, and loans to other FHLBanks.
(2) Return on average equity is Net Income (Loss) expressed as a percentage of average total capital.
(3) The dividend payout ratio is calculated by dividing dividends paid in cash during the period by Net Income (Loss) for the period.
(4) Net interest margin is Net Interest Income expressed as a percentage of average earning assets.
(5) Total capital ratio is Capital Stock plus Retained Earnings and AOCI expressed as a percentage of period-end Total Assets.
(6) Total regulatory capital ratio is Capital Stock plus Retained Earnings and MRCS expressed as a percentage of period-end Total Assets.
(7) The weighted average dividend rate is calculated by dividing dividends paid in cash during the period by the average of Capital Stock eligible for dividends (i.e., excludes MRCS).
(a) Due to the rounding of quarterly and year-to-date amounts, the actual amount of $0.6 million is shown as zero for the three months ended September 30, 2010.
Results of Operations for the Three and Six Months Ended June 30, 2011, and 2010
Net Income. Net Income was $24.4 million for the three months ended June 30, 2011, an improvement of $37.3 million compared to a net loss of $12.9 million for the same period in 2010. The improvement was primarily due to lower OTTI credit losses on our private-label MBS recognized in Other Income (Loss) that totaled $3.3 million for the three months ended June 30, 2011, compared to $61.7 million for the same period in 2010. Related OTTI non-credit losses of $3.3 million and $53.9 million for the three months ended June 30, 2011, and 2010, respectively, were reclassified from AOCI to Other Income (Loss), which offset the impact of the credit losses on Total Capital. Net Interest Income After Provision for Credit Losses decreased by $1.3 million or 2% for the three months ended June 30, 2011, compared to the same period in 2010.
Net Income was $44.3 million for the six months ended June 30, 2011, an increase of $24.9 million or 129% compared to the same period in 2010. The increase was primarily due to lower OTTI credit losses on our private-label MBS recognized in Other Income (Loss) that totaled $21.7 million for the six months ended June 30, 2011, compared to $67.8 million for the same period in 2010. Related OTTI non-credit losses of $18.7 million and $45.5 million for the six months ended June 30, 2011, and 2010, respectively, were reclassified from AOCI to Other Income (Loss), which offset the impact of the credit losses on Total Capital. Net Interest Income After Provision for Credit Losses decreased by $3.6 million or 3% for the six months ended June 30, 2011, compared to the same period in 2010.
The following table presents the comparative highlights of our results of operations ($ amounts in millions):
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
Comparative Highlights | 2011 | 2010 | Change | Change | 2011 | 2010 | Change | Change | ||||||||||||||||||||||
Net Interest Income After Provision for Credit Losses | $ | 55 | $ | 56 | $ | (1 | ) | (2 | %) | $ | 114 | $ | 118 | $ | (4 | ) | (3 | %) | ||||||||||||
Other Income (Loss) | (8 | ) | (62 | ) | 54 | 88 | % | (26 | ) | (68 | ) | 42 | 62 | % | ||||||||||||||||
Other Expenses | 14 | 11 | 3 | 18 | % | 27 | 23 | 4 | 21 | % | ||||||||||||||||||||
Income (Loss) Before Assessments | 33 | (17 | ) | 50 | NM | 61 | 27 | 34 | 125 | % | ||||||||||||||||||||
Total Assessments, net | 9 | (4 | ) | 13 | NM | 17 | 8 | 9 | 115 | % | ||||||||||||||||||||
Net Income (Loss) | $ | 24 | $ | (13 | ) | $ | 37 | NM | $ | 44 | $ | 19 | $ | 25 | 129 | % |
Analysis of Results of Operations for the Three and Six Months Ended June 30, 2011, and 2010
Net Interest Income After Provision for Credit Losses. Net Interest Income is our primary source of earnings. We generate Net Interest Income from two components: (i) the net interest-rate spread, and (ii) the amount earned on the excess of interest-earning assets over interest-bearing liabilities. The sum of these two components, when expressed as a percentage of the average balance of interest-earning assets, equals the net interest margin.
See Net Gains (Losses) on Derivatives and Hedging Activities herein for information on the net effect of derivatives on our Net Interest Income.
Items that increased Net Interest Income After Provision for Credit Losses for the three and six months ended June 30, 2011, compared to the same period in 2010, included:
• | higher average balances of investment securities, as shown in the table below; and |
• | wider spreads on mortgage-related assets, primarily due to the replacement of higher-costing debt with lower-costing debt reflecting the current low interest-rate environment. |
These increases were partially offset by:
• | lower prepayment fee income on Advances; |
• | lower average balances of Advances and Mortgage Loans Held for Portfolio, as shown in the table below; |
• | narrower spreads on short-term investments; |
• | higher interest expense on MRCS; and |
• | the provision for losses on Mortgage Loans Held for Portfolio. |
The following tables present average balances, interest income and expense, and average yields of our major categories of interest-earning assets and the sources funding those interest-earning assets ($ amounts in millions):
Three Months Ended June 30, | |||||||||||||||||||||
2011 | 2010 | ||||||||||||||||||||
Average Balance | Interest Income/ Expense | Average Yield | Average Balance | Interest Income/ Expense | Average Yield | ||||||||||||||||
Assets: | |||||||||||||||||||||
Federal Funds Sold and Securities Purchased Under Agreements to Resell | $ | 6,639 | $ | 1 | 0.12 | % | $ | 9,281 | $ | 4 | 0.23 | % | |||||||||
Investment securities (1) | 11,837 | 59 | 1.98 | % | 10,345 | 65 | 2.52 | % | |||||||||||||
Advances (2) | 17,346 | 40 | 0.92 | % | 20,934 | 52 | 1.00 | % | |||||||||||||
Mortgage Loans Held for Portfolio (2) | 6,373 | 77 | 4.82 | % | 6,870 | 84 | 4.87 | % | |||||||||||||
Other Assets (interest-earning) (3) | 47 | — | 0.67 | % | 138 | — | (1.35 | %) | |||||||||||||
Total interest-earning assets | 42,242 | 177 | 1.68 | % | 47,568 | 205 | 1.73 | % | |||||||||||||
Other Assets (4) | 325 | (63 | ) | ||||||||||||||||||
Total Assets | $ | 42,567 | $ | 47,505 | |||||||||||||||||
Liabilities and Capital: | |||||||||||||||||||||
Interest-Bearing Deposits | $ | 834 | — | 0.03 | % | $ | 669 | — | 0.05 | % | |||||||||||
Discount Notes | 8,786 | 2 | 0.10 | % | 11,236 | 5 | 0.17 | % | |||||||||||||
CO Bonds (2) | 29,315 | 115 | 1.58 | % | 31,554 | 141 | 1.79 | % | |||||||||||||
MRCS | 614 | 4 | 2.44 | % | 771 | 3 | 1.88 | % | |||||||||||||
Other borrowings | — | — | — | % | — | — | — | % | |||||||||||||
Total interest-bearing liabilities | 39,549 | 121 | 1.23 | % | 44,230 | 149 | 1.36 | % | |||||||||||||
Other Liabilities | 1,046 | 1,484 | |||||||||||||||||||
Total Capital | 1,972 | 1,791 | |||||||||||||||||||
Total Liabilities and Capital | $ | 42,567 | $ | 47,505 | |||||||||||||||||
Net Interest Income and net spread on interest-earning assets less interest-bearing liabilities | $ | 56 | 0.45 | % | $ | 56 | 0.37 | % | |||||||||||||
Net interest margin | 0.53 | % | 0.47 | % | |||||||||||||||||
Average interest-earning assets to interest-bearing liabilities | 1.07 | 1.08 |
Six Months Ended June 30, | |||||||||||||||||||||
2011 | 2010 | ||||||||||||||||||||
Average Balance | Interest Income/ Expense | Average Yield | Average Balance | Interest Income/ Expense | Average Yield | ||||||||||||||||
Assets: | |||||||||||||||||||||
Federal Funds Sold and Securities Purchased Under Agreements to Resell | $ | 7,265 | $ | 5 | 0.16 | % | $ | 8,633 | $ | 8 | 0.19 | % | |||||||||
Investment securities (1) | 11,801 | 119 | 2.03 | % | 10,149 | 130 | 2.58 | % | |||||||||||||
Advances (2) | 17,633 | 82 | 0.94 | % | 21,484 | 103 | 0.97 | % | |||||||||||||
Mortgage Loans Held for Portfolio (2) | 6,484 | 157 | 4.87 | % | 7,005 | 174 | 5.01 | % | |||||||||||||
Other Assets (interest-earning) (3) | 43 | 1 | 2.84 | % | 129 | — | (0.11 | %) | |||||||||||||
Total interest-earning assets | 43,226 | 364 | 1.70 | % | 47,400 | 415 | 1.77 | % | |||||||||||||
Other Assets (4) | 327 | (33 | ) | ||||||||||||||||||
Total Assets | $ | 43,553 | $ | 47,367 | |||||||||||||||||
Liabilities and Capital: | |||||||||||||||||||||
Interest-Bearing Deposits | $ | 767 | — | 0.03 | % | $ | 791 | — | 0.04 | % | |||||||||||
Discount Notes | 8,699 | 5 | 0.12 | % | 9,656 | 7 | 0.15 | % | |||||||||||||
CO Bonds (2) | 30,406 | 234 | 1.55 | % | 32,944 | 283 | 1.73 | % | |||||||||||||
MRCS | 636 | 9 | 2.72 | % | 763 | 7 | 1.90 | % | |||||||||||||
Other borrowings | — | — | — | % | — | — | — | % | |||||||||||||
Total interest-bearing liabilities | 40,508 | 248 | 1.23 | % | 44,154 | 297 | 1.36 | % | |||||||||||||
Other Liabilities | 1,071 | 1,435 | |||||||||||||||||||
Total Capital | 1,974 | 1,778 | |||||||||||||||||||
Total Liabilities and Capital | $ | 43,553 | $ | 47,367 | |||||||||||||||||
Net Interest Income and net spread on interest-earning assets less interest-bearing liabilities | $ | 116 | 0.47 | % | $ | 118 | 0.41 | % | |||||||||||||
Net interest margin | 0.54 | % | 0.50 | % | |||||||||||||||||
Average interest-earning assets to interest-bearing liabilities | 1.07 | 1.07 |
(1) The average balances of investment securities are reflected at amortized cost; therefore, the resulting yields do not reflect changes in fair value that are reflected as a component of AOCI, nor do they include the effect of OTTI-related to non-credit losses. Interest income/expense includes the effect of associated interest-rate exchange agreements.
(2) Interest income/expense and average yield includes all other components of interest, including the impact of net interest payments or receipts on derivatives, hedge accounting amortization, and Advance prepayment fees.
(3) Other Assets (interest-earning) consists of Interest-Bearing Deposits, loans to other FHLBanks, and rabbi trust assets.
(4) Includes the non-credit portion of OTTI losses on AFS and HTM securities for purposes of the table.
The following table presents changes in Interest Income and Interest Expense ($ amounts in millions):
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
2011 vs. 2010 | 2011 vs. 2010 | ||||||||||||||||||||||
Volume | Rate | Total | Volume | Rate | Total | ||||||||||||||||||
Increase (Decrease) in Interest Income: | |||||||||||||||||||||||
Federal Funds Sold and Securities Purchased Under Agreements to Resell | $ | (1 | ) | $ | (3 | ) | $ | (4 | ) | $ | (1 | ) | $ | (2 | ) | $ | (3 | ) | |||||
Investment securities | 8 | (14 | ) | (6 | ) | 19 | (30 | ) | (11 | ) | |||||||||||||
Advances | (8 | ) | (4 | ) | (12 | ) | (18 | ) | (3 | ) | (21 | ) | |||||||||||
Mortgage Loans Held for Portfolio | (5 | ) | (1 | ) | (6 | ) | (12 | ) | (5 | ) | (17 | ) | |||||||||||
Other Assets, net | — | — | — | — | 1 | 1 | |||||||||||||||||
Total | (6 | ) | (22 | ) | (28 | ) | (12 | ) | (39 | ) | (51 | ) | |||||||||||
Increase (Decrease) in Interest Expense: | |||||||||||||||||||||||
Interest-Bearing Deposits | — | — | — | — | — | — | |||||||||||||||||
Discount Notes | (1 | ) | (2 | ) | (3 | ) | (1 | ) | (1 | ) | (2 | ) | |||||||||||
CO Bonds | (10 | ) | (16 | ) | (26 | ) | (21 | ) | (28 | ) | (49 | ) | |||||||||||
MRCS | (1 | ) | 2 | 1 | (1 | ) | 3 | 2 | |||||||||||||||
Other borrowings | — | — | — | — | — | — | |||||||||||||||||
Total | (12 | ) | (16 | ) | (28 | ) | (23 | ) | (26 | ) | (49 | ) | |||||||||||
Increase (Decrease) in Net Interest Income Before Provision for Credit Losses | $ | 6 | $ | (6 | ) | $ | — | $ | 11 | $ | (13 | ) | $ | (2 | ) |
Changes in both volume and interest rates influence changes in Net Interest Income and net interest margin. Changes in Interest Income and Interest Expense that are not identifiable as either volume-related or rate-related, but are attributable to both volume and rate changes, have been allocated to the volume and rate categories based upon the proportion of the volume and rate changes.
Other Income (Loss). The following table presents the components of Other Income (Loss) ($ amounts in millions):
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
Components | 2011 | 2010 | 2011 | 2010 | ||||||||||||
Total OTTI losses | $ | — | $ | (8 | ) | $ | (3 | ) | $ | (22 | ) | |||||
Portion of Impairment Losses Reclassified to (from) Other Comprehensive Income (Loss) | (3 | ) | (54 | ) | (18 | ) | (46 | ) | ||||||||
Net OTTI losses | (3 | ) | (62 | ) | (21 | ) | (68 | ) | ||||||||
Net Realized Losses from Sale of Available-for-Sale Securities | (2 | ) | — | (2 | ) | — | ||||||||||
Net Gains (Losses) on Derivatives and Hedging Activities | (4 | ) | — | (4 | ) | (2 | ) | |||||||||
Service Fees | — | — | — | 1 | ||||||||||||
Standby Letters of Credit Fees | 1 | — | 1 | 1 | ||||||||||||
Loss on Extinguishment of Debt | — | — | — | — | ||||||||||||
Other, net | — | — | — | — | ||||||||||||
Total Other Income (Loss) | $ | (8 | ) | $ | (62 | ) | $ | (26 | ) | $ | (68 | ) |
The favorable change in Other Income (Loss) for the three and six months ended June 30, 2011, compared to the same period in 2010, was primarily due to the lower credit losses on certain private-label RMBS described in Results of OTTI Evaluation Process below. The net effect of derivatives on our Net Interest Income and Other Income (Loss) is presented in Net Gains (Losses) on Derivatives and Hedging Activities below.
Results of OTTI Evaluation Process. As a result of our evaluations, during the three and six months ended June 30, 2011, and 2010, we recognized OTTI on private-label RMBS as shown in the table below ($ amounts in millions):
Impairment | ||||||||||||
Impairment Related to | Related to All Other | Total | ||||||||||
Three Months Ended June 30, 2011 | Credit Loss | Factors | Impairment | |||||||||
Impairment on securities for which OTTI was not previously recognized | $ | — | $ | — | $ | — | ||||||
Additional impairment on securities for which OTTI was previously recognized | (3 | ) | 3 | — | ||||||||
Total | $ | (3 | ) | $ | 3 | $ | — | |||||
Three Months Ended June 30, 2010 | ||||||||||||
Impairment on securities for which OTTI was not previously recognized | $ | (1 | ) | $ | (6 | ) | $ | (7 | ) | |||
Additional impairment on securities for which OTTI was previously recognized | (61 | ) | 60 | (1 | ) | |||||||
Total | $ | (62 | ) | $ | 54 | $ | (8 | ) | ||||
Six Months Ended June 30, 2011 | ||||||||||||
Impairment on securities for which OTTI was not previously recognized | $ | — | $ | — | $ | — | ||||||
Additional impairment on securities for which OTTI was previously recognized | (21 | ) | 18 | (3 | ) | |||||||
Total | $ | (21 | ) | $ | 18 | $ | (3 | ) | ||||
Six Months Ended June 30, 2010 | ||||||||||||
Impairment on securities for which OTTI was not previously recognized | $ | (4 | ) | $ | (17 | ) | $ | (21 | ) | |||
Additional impairment on securities for which OTTI was previously recognized | (64 | ) | 63 | (1 | ) | |||||||
Total | $ | (68 | ) | $ | 46 | $ | (22 | ) |
Net Gains (Losses) on Derivatives and Hedging Activities. Our Net Gains (Losses) on Derivatives and Hedging Activities fluctuate with volatility in the overall interest rate environment, as we hedge our asset risk exposures. In general, we hold derivatives and associated hedged instruments, and certain assets and liabilities that are carried at fair value, to the maturity, call, or put date. Therefore, due to timing, nearly all of the cumulative net gains and losses for these financial instruments will generally reverse over the remaining contractual terms of the hedged financial instruments. The increases in gains (losses) on fair-value hedges for three and six months ended June 30, 2011, compared to the same periods in 2010, were primarily due to changes in benchmark interest rates. The tables below present the net effect of derivatives on Net Interest Income and Other Income (Loss), within the line Net Gains (Losses) on Derivatives and Hedging Activities, by type of hedge and hedged item
($ amounts in millions):
Three Months Ended June 30, 2011 | Advances | Investments | Mortgage Loans | CO Bonds | Discount Notes | Total | ||||||||||||||||||
Net Interest Income: | ||||||||||||||||||||||||
Amortization/accretion of hedging activities in net interest income (1) | $ | — | $ | 4 | $ | (1 | ) | $ | 1 | $ | — | $ | 4 | |||||||||||
Net interest settlements included in net interest income (2) | (76 | ) | (21 | ) | — | 30 | — | (67 | ) | |||||||||||||||
Total Net Interest Income | (76 | ) | (17 | ) | (1 | ) | 31 | — | (63 | ) | ||||||||||||||
Net Gains (Losses) on Derivatives and Hedging Activities: | ||||||||||||||||||||||||
Gains (losses) on fair-value hedges | (4 | ) | — | — | 1 | — | (3 | ) | ||||||||||||||||
Gains (losses) on derivatives not receiving hedge accounting | — | (1 | ) | — | — | — | (1 | ) | ||||||||||||||||
Net Gains (Losses) on Derivatives and Hedging Activities | (4 | ) | (1 | ) | — | 1 | — | (4 | ) | |||||||||||||||
Total net effect of derivatives and hedging activities | $ | (80 | ) | $ | (18 | ) | $ | (1 | ) | $ | 32 | $ | — | $ | (67 | ) | ||||||||
Three Months Ended June 30, 2010 | ||||||||||||||||||||||||
Net Interest Income: | ||||||||||||||||||||||||
Amortization/accretion of hedging activities in net interest income (1) | $ | — | $ | 3 | $ | (4 | ) | $ | 2 | $ | — | $ | 1 | |||||||||||
Net interest settlements included in net interest income (2) | (127 | ) | (19 | ) | — | 49 | — | (97 | ) | |||||||||||||||
Total Net Interest Income | (127 | ) | (16 | ) | (4 | ) | 51 | — | (96 | ) | ||||||||||||||
Net Gains (Losses) on Derivatives and Hedging Activities: | ||||||||||||||||||||||||
Gains (losses) on fair-value hedges | (1 | ) | — | — | 1 | — | — | |||||||||||||||||
Gains (losses) on derivatives not receiving hedge accounting | (1 | ) | — | (1 | ) | 1 | — | (1 | ) | |||||||||||||||
Net Gains (Losses) on Derivatives and Hedging Activities | (2 | ) | — | (1 | ) | 2 | — | (1 | ) | |||||||||||||||
Total net effect of derivatives and hedging activities | $ | (129 | ) | $ | (16 | ) | $ | (5 | ) | $ | 53 | $ | — | $ | (97 | ) | ||||||||
Six Months Ended June 30, 2011 | Advances | Investments | Mortgage Loans | CO Bonds | Discount Notes | Total | ||||||||||||||||||
Net Interest Income: | ||||||||||||||||||||||||
Amortization/accretion of hedging activities in net interest income (1) | $ | — | $ | 7 | $ | (1 | ) | $ | 1 | $ | — | $ | 7 | |||||||||||
Net interest settlements included in net interest income (2) | (157 | ) | (42 | ) | — | 62 | — | (137 | ) | |||||||||||||||
Total Net Interest Income | (157 | ) | (35 | ) | (1 | ) | 63 | — | (130 | ) | ||||||||||||||
Net Gains (Losses) on Derivatives and Hedging Activities: | ||||||||||||||||||||||||
Gains (losses) on fair-value hedges | (3 | ) | — | — | — | — | (3 | ) | ||||||||||||||||
Gains (losses) on derivatives not receiving hedge accounting | — | (1 | ) | — | — | — | (1 | ) | ||||||||||||||||
Net Gains (Losses) on Derivatives and Hedging Activities | (3 | ) | (1 | ) | — | — | — | (4 | ) | |||||||||||||||
Total net effect of derivatives and hedging activities | $ | (160 | ) | $ | (36 | ) | $ | (1 | ) | $ | 63 | $ | — | $ | (134 | ) | ||||||||
Six Months Ended June 30, 2010 | ||||||||||||||||||||||||
Net Interest Income: | ||||||||||||||||||||||||
Amortization/accretion of hedging activities in net interest income (1) | $ | — | $ | 5 | $ | (4 | ) | $ | 3 | $ | — | $ | 4 | |||||||||||
Net interest settlements included in net interest income (2) | (263 | ) | (38 | ) | — | 112 | — | (189 | ) | |||||||||||||||
Total Net Interest Income | (263 | ) | (33 | ) | (4 | ) | 115 | — | (185 | ) | ||||||||||||||
Net Gains (Losses) on Derivatives and Hedging Activities: | ||||||||||||||||||||||||
Gains (losses) on fair-value hedges | (2 | ) | — | — | 1 | — | (1 | ) | ||||||||||||||||
Gains (losses) on derivatives not receiving hedge accounting | (1 | ) | — | (1 | ) | 1 | — | (1 | ) | |||||||||||||||
Net Gains (Losses) on Derivatives and Hedging Activities | (3 | ) | — | (1 | ) | 2 | — | (2 | ) | |||||||||||||||
Total net effect of derivatives and hedging activities | $ | (266 | ) | $ | (33 | ) | $ | (5 | ) | $ | 117 | $ | — | $ | (187 | ) |
(1) Represents the amortization/accretion of hedging fair value adjustments for both open and closed hedge positions.
(2) Represents interest income/expense on derivatives included in Net Interest Income.
Other Expenses. The following table presents the components of Other Expenses ($ amounts in millions):
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
Components | 2011 | 2010 | 2011 | 2010 | ||||||||||||
Compensation and Benefits | $ | 8 | $ | 7 | $ | 17 | $ | 14 | ||||||||
Other Operating Expenses | 4 | 3 | 6 | 6 | ||||||||||||
Finance Agency and Office of Finance Expenses | 2 | 1 | 4 | 2 | ||||||||||||
Other | — | — | — | 1 | ||||||||||||
Total Other Expenses | $ | 14 | $ | 11 | $ | 27 | $ | 23 |
The increase in Other Expenses for the three and six months ended June 30, 2011, compared to the same periods in 2010, was primarily due to increased compensation and benefit expenses, which were mainly attributable to additional staff needed to support operating systems enhancements and compliance-related initiatives, as well as increased retirement plan costs due to a lower discount rate used to calculate the benefit obligation.
Total Assessments. AHP and REFCORP contributions are statutorily required and are calculated simultaneously because of their interdependence.
AHP. The FHLBanks are required to set aside annually, in the aggregate, the greater of $100 million or 10% of their net earnings before Interest Expense on MRCS and after the REFCORP assessments, to fund the AHP. Each FHLBank's required annual AHP contribution is limited to its annual net earnings. Our AHP expense for the three months ended June 30, 2011, was $3.1 million, compared to a credit of $1.0 million for the same period in 2010. Our AHP expense for the six months ended June 30, 2011, was $5.9 million, compared to $2.9 million for the same period in 2010.
REFCORP. Each FHLBank was required to pay to REFCORP 20% of net income calculated in accordance with GAAP after the assessment for AHP, but before the assessment for REFCORP. Our REFCORP expense for the three months ended June 30, 2011, was $5.9 million, compared to a credit of $3.2 million for the same period in 2010. Our REFCORP expense for the six months ended June 30, 2011, was $10.9 million, compared to $4.8 million for the same period in 2010.
The increases in both AHP and REFCORP expense for the three and six months ended June 30, 2011, are directly attributable to the higher level of Income (Loss) Before Assessments for the three and six months ended June 30, 2011, compared to the same periods in 2010.
The FHLBanks were obligated to pay the REFCORP assessment until the aggregate amounts actually paid by all 12 FHLBanks were equivalent to a $300 million annual annuity (or a scheduled payment of $75 million per quarter) with a final maturity date of April 15, 2030, at which point the required payment of each FHLBank to REFCORP would be fully satisfied.
However, the aggregate payments made by the FHLBanks have exceeded the scheduled payments, effectively accelerating payment of the REFCORP obligation and shortening the remaining term to June 30, 2011. On August 5, 2011, the Finance Agency certified that the FHLBanks have fully satisfied their REFCORP obligation. See Liquidity and Capital Resources - Joint Capital Enhancement Agreement for information about the amended JCE Agreement that becomes operational now that our REFCORP obligation has been satisfied.
Business Segments
Our products and services are grouped within two business segments: Traditional and MPP.
The Traditional business segment includes credit services (such as Advances, letters of credit, and lines of credit), investments (including Federal Funds Sold, Securities Purchased Under Agreement to Resell, AFS securities, and HTM securities) and deposits. The following table presents our financial performance for this operating segment ($ amounts in millions):
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
Traditional Segment | 2011 | 2010 | 2011 | 2010 | ||||||||||||
Net Interest Income | $ | 33 | $ | 41 | $ | 68 | $ | 80 | ||||||||
Provision for Credit Losses | — | — | — | — | ||||||||||||
Other Income (Loss) | (8 | ) | (62 | ) | (26 | ) | (67 | ) | ||||||||
Other Expenses | 14 | 11 | 26 | 22 | ||||||||||||
Income (Loss) Before Assessments | 11 | (32 | ) | 16 | (9 | ) | ||||||||||
Total Assessments, net | 3 | (8 | ) | 5 | (2 | ) | ||||||||||
Net Income (Loss) | $ | 8 | $ | (24 | ) | $ | 11 | $ | (7 | ) |
The improvements in Net Income for the Traditional segment for the three and six months ended June 30, 2011, compared to the same periods in 2010, were primarily due to improvements in Other Income (Loss) that substantially resulted from the lower credit losses on certain private-label RMBS, as described in Results of Operations for the Three and Six Months Ended June 30, 2011, and 2010 - Other Income - Results of OTTI Evaluation Process herein. These improvements in Other Income (Loss) were partially offset by decreases in Net Interest Income primarily resulting from lower average balances of Advances and higher Total Assessments, which were directly attributable to the higher Income Before Assessments.
The MPP business segment consists of mortgage loans purchased from our members. The following table presents our financial performance for this operating segment ($ amounts in millions):
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
MPP Segment | 2011 | 2010 | 2011 | 2010 | ||||||||||||
Net Interest Income | $ | 23 | $ | 15 | $ | 48 | $ | 38 | ||||||||
Provision for Credit Losses | (1 | ) | — | (2 | ) | — | ||||||||||
Other Income (Loss) | — | — | — | (1 | ) | |||||||||||
Other Expenses | — | — | 1 | 1 | ||||||||||||
Income Before Assessments | 22 | 15 | 45 | 36 | ||||||||||||
Total Assessments | 6 | 4 | 12 | 10 | ||||||||||||
Net Income | $ | 16 | $ | 11 | $ | 33 | $ | 26 |
The increases in Net Income for the MPP segment for the three and six months ended June 30, 2011, compared to the same periods in 2010, were primarily due to higher Net Interest Income resulting from higher spreads attributable to the replacement of higher-costing debt with lower-costing debt reflecting the current low interest-rate environment, partially offset by the lower average balance of MPP loans.
Analysis of Financial Condition
Total Assets. Total Assets were $40.1 billion as of June 30, 2011, a decrease of 11% compared to December 31, 2010. This decrease of $4.9 billion was primarily due to net decreases of $3.6 billion in cash and short-term investments, $0.8 billion in Advances and $0.4 billion in Mortgage Loans Held for Portfolio.
Advances. Advances totaled $17.5 billion at June 30, 2011, a decrease of 4% compared to December 31, 2010. This decrease was primarily due to repayments and our members' reduced need for liquidity in the current economic environment, partially offset by a 14% increase in Advances to insurance company members, which totaled $6.0 billion at June 30, 2011. In general, Advances fluctuate in accordance with our members' funding needs related to their deposit levels, mortgage pipelines, investment opportunities, available collateral, other balance sheet strategies, and the cost of alternative funding opportunities.
A breakdown of Advances by primary product line is presented below ($ amounts in millions):
June 30, 2011 | December 31, 2010 | |||||||||||||
% of | % of | |||||||||||||
By Primary Product Line | Amount | Total | Amount | Total | ||||||||||
Fixed-rate | ||||||||||||||
Fixed-rate (1) | $ | 11,498 | 68 | % | $ | 11,959 | 68 | % | ||||||
Amortizing/mortgage matched (2) | 1,956 | 12 | % | 1,789 | 10 | % | ||||||||
Other | 45 | — | % | 15 | — | % | ||||||||
Total fixed-rate | 13,499 | 80 | % | 13,763 | 78 | % | ||||||||
Adjustable/variable-rate indexed (3) | 3,327 | 20 | % | 3,875 | 22 | % | ||||||||
Total Advances, par value | 16,826 | 100 | % | 17,638 | 100 | % | ||||||||
Total Adjustments (unamortized discounts, hedging and other) | 650 | 637 | ||||||||||||
Total Advances | $ | 17,476 | $ | 18,275 |
(1) Includes fixed-rate bullet and putable Advances
(2) Includes fixed-rate amortizing Advances
(3) Includes adjustable-rate and variable-rate Advances
Mortgage Loans Held for Portfolio. We purchase mortgage loans from our members through our MPP. At June 30, 2011, we held $6.3 billion of MPP loans, a decrease of 6% compared to December 31, 2010. The decrease was primarily due to repayments of outstanding mortgage loans exceeding the purchases of new loans. In general, the volume of mortgage loans purchased through the MPP is affected by several factors, including the general level of housing activity in the United States, the level of refinancing activity, and consumer product preferences.
Cash and Investments. The following table presents the components of our cash and investments at carrying value ($ amounts in millions):
Components of Cash and Investments | June 30, 2011 | December 31, 2010 | ||||||
Cash and Due from Banks | $ | 1,539 | $ | 12 | ||||
Interest-Bearing Deposits | — | — | ||||||
Securities Purchased Under Agreements to Resell | — | 750 | ||||||
Federal Funds Sold | 2,905 | 7,325 | ||||||
Total cash and short-term investments | 4,444 | 8,087 | ||||||
AFS securities: | ||||||||
GSE debentures | 1,955 | 1,930 | ||||||
TLGP debentures | 324 | 325 | ||||||
Private-label MBS | 806 | 983 | ||||||
Total AFS securities | 3,085 | 3,238 | ||||||
HTM securities: | ||||||||
GSE debentures | 294 | 294 | ||||||
TLGP debentures | 1,980 | 2,066 | ||||||
Other U.S. obligations - guaranteed RMBS | 2,570 | 2,327 | ||||||
GSE RMBS | 3,245 | 3,044 | ||||||
Private-label MBS | 524 | 719 | ||||||
Private-label ABS | 21 | 22 | ||||||
Total HTM securities | 8,634 | 8,472 | ||||||
Total investment securities | 11,719 | 11,710 | ||||||
Total Cash and Investments, carrying value | $ | 16,163 | $ | 19,797 |
Cash and Short-Term Investments. Cash and short-term investments totaled $4.4 billion at June 30, 2011, a decrease of 45% compared to December 31, 2010. However, we remain in compliance with all liquidity requirements. The decrease was primarily due to decreases of $4.4 billion in Federal Funds Sold and $0.8 billion in Securities Purchased Under Agreements to Resell resulting from a managed reduction in short-term investments. The decrease in short-term investments was partially offset by an increase of $1.5 billion in cash due to a lack of attractive investment opportunities at June 30, 2011. The composition of our short-term investment portfolio is influenced by our liquidity needs and the availability of short-term investments at attractive interest rates, relative to our cost of funds. See Liquidity and Capital Resources below for more information.
Available-for-Sale Securities. AFS securities totaled $3.1 billion at June 30, 2011, a decrease of 5% compared to December 31, 2010. The decrease was primarily due to paydowns and the sale of two private-label MBS. As a result of previously recognizing OTTI credit losses of $16.6 million, we realized a net loss on the sale of those securities of $1.9 million. Even though these two securities were sold, as of June 30, 2011, we had no intention to sell the remaining OTTI AFS securities, nor did we consider it more likely than not that we will be required to sell these securities before our anticipated recovery of each security's remaining amortized cost basis. However, in the future we may decide to sell these securities if conditions, strategies, risk tolerances or other factors change.
Held-to-Maturity Securities. HTM securities totaled $8.6 billion at June 30, 2011, an increase of 2% compared to December 31, 2010, due to purchases of agency MBS.
Total Liabilities. Total Liabilities were $38.2 billion at June 30, 2011, a decrease of 11% compared to December 31, 2010. This decrease of $4.8 billion was primarily due to a decrease of $4.7 billion in Consolidated Obligations.
Deposits (Liabilities). Total Deposits were $0.7 billion at June 30, 2011, an increase of 21% compared to December 31, 2010. These deposits represent a relatively small portion of our funding, and they vary depending upon market factors, such as the attractiveness of our deposit pricing relative to the rates available on alternative money market instruments, members' investment preferences with respect to the maturity of their investments, and member liquidity.
Consolidated Obligations. At June 30, 2011, the carrying values of our Discount Notes and CO Bonds totaled $10.0 billion and $26.1 billion, respectively, compared to $8.9 billion and $31.9 billion, respectively, at December 31, 2010. The overall balance of our Consolidated Obligations fluctuates in relation to our Total Assets. This overall decrease was due to our lower funding needs that primarily resulted from the decline in Advances. The carrying value of our Discount Notes was 28% of total Consolidated Obligations at June 30, 2011, compared to 22% at December 31, 2010. Discount Notes are issued primarily to provide short-term funds while CO Bonds are issued to provide longer-term funding. The composition of our Consolidated Obligations can fluctuate significantly based on comparative changes in their cost levels, supply and demand conditions, Advance demand, money market investment balances, and our balance sheet management strategy.
Derivatives. As of June 30, 2011, and December 31, 2010, we had Derivative Assets, net of collateral held or posted including accrued interest, with fair values of $0.2 million and $6.2 million, respectively, and Derivative Liabilities, net of collateral held or posted including accrued interest, with fair values of $679.0 million and $657.0 million, respectively. We classify interest-rate swaps as derivative assets or liabilities according to the net fair value of the interest-rate swaps with each counterparty. Increases and decreases in fair value are primarily caused by market changes in the derivative's underlying interest rate index. Therefore, these fair values reflect the impact of interest-rate changes.
Total Capital. Total Capital was $1.9 billion at June 30, 2011, a decrease of 3% compared to December 31, 2010. This decrease was primarily due to a repurchase of the excess capital stock included in Capital Stock of $125.9 million, partially offset by an increase due to proceeds from the sale of Capital Stock of $34.9 million and increases in Retained Earnings of $23.8 million and AOCI of $32.6 million. The improvement in AOCI was mainly attributable to OCI, which included unrealized gains of $10.1 million on AFS securities and the reclassification of OTTI non-credit losses of $21.1 million from AOCI to Other Income (Loss).
Liquidity and Capital Resources
Liquidity. Our cash and short-term investments portfolio totaled $4.4 billion at June 30, 2011. We manage our short-term investment portfolio in response to economic conditions and market events and uncertainties. As a result, the overall level of our short-term investment portfolio may fluctuate accordingly. The maturities of the short-term investments provide sufficient cash flows to support our ongoing liquidity needs. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources in our 2010 Form 10-K for more detailed information.
On July 15, 2011, the FHLBanks satisfied their obligation to REFCORP, which will result in an increase in net cash provided by operating activities. On August 8, 2011, S&P lowered our issuer credit rating and the rating on the FHLBank System's Consolidated Obligations from AAA to AA+. As a result, we could be required to deliver additional collateral (at fair value) to certain of our derivative counterparties. Such amount was approximately $650 million as of July 31, 2011. However, our liquidity position can satisfy this additional funding requirement with no material impact to our financial position. We have not identified any other known trends, demands, commitments, events or uncertainties that are likely to materially increase or decrease our liquidity.
Capital Resources.
Capital Adequacy. We are required by Finance Agency regulations to maintain sufficient "permanent capital" (defined as Class B Stock, MRCS, and Retained Earnings) to meet the combined credit risk, market risk and operational risk components of the risk-based capital requirement. The Finance Agency may mandate us to maintain a greater amount of permanent capital than is required by the risk-based capital requirements as defined. As of June 30, 2011, our risk-based capital requirement was $0.8 billion, compared to permanent capital of $2.5 billion. As of December 31, 2010, our risk-based capital requirement was $0.9 billion, compared to permanent capital of $2.7 billion.
In addition, the Gramm-Leach-Bliley Act of 1999 and Finance Agency regulations require us to maintain at all times a regulatory capital ratio of at least 4.00% and a leverage ratio of at least 5.00%. Our total regulatory capital consists of Retained Earnings and total regulatory capital stock, which includes Class B Capital Stock and MRCS. At June 30, 2011, our regulatory capital ratio was 6.13%, and our leverage ratio was 9.20%.
Capital Distributions. Our capital plan divides our Class B stock into two sub-series: Class B-1 and Class B-2. The difference between the two sub-series is that Class B-2 is required stock that is subject to a redemption request and pays a lower dividend. The Class B-2 stock dividend is presently calculated at 80% of the amount of the Class B-1 dividend and can only be changed by amendment of our capital plan by our board of directors with approval of the Finance Agency. On July 28, 2011, our board of directors declared a cash dividend of 2.50% (annualized) on our Capital Stock Putable - Class B-1 and of 2.00% (annualized) on our Capital Stock Putable - Class B-2.
Joint Capital Enhancement Agreement. Effective February 28, 2011, the 12 FHLBanks entered into a JCE Agreement intending to enhance the capital position of each FHLBank. The purpose of the JCE Agreement is to allocate that portion of each FHLBank's earnings historically paid to satisfy its REFCORP obligation to a separate restricted retained earnings account at that FHLBank.
Each FHLBank has been required to contribute 20% of its net earnings toward payment of the interest on the REFCORP bonds until the REFCORP obligation was satisfied. The JCE Agreement provides that, upon full satisfaction of the REFCORP obligation, each FHLBank will allocate 20% of its Net Income each quarter to a restricted retained earnings account until the balance of that account equals at least 1% of that FHLBank's average balance of outstanding Consolidated Obligations for the previous quarter. These restricted retained earnings will not be available from which to pay dividends except to the extent the restricted retained earnings balance exceeds 1.5% of an FHLBank's average balance of outstanding Consolidated Obligations for the previous quarter. We do not expect that level to be reached for several years. For more information on the JCE Agreement, please refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation - Liquidity and Capital Resources - Joint Capital Enhancement Agreement in our 2010 Form 10-K.
On August 5, 2011, the Finance Agency certified that the FHLBanks have fully satisfied their REFCORP obligation and approved the FHLBanks' capital plan amendments to implement the provisions of the JCE Agreement. Subsequently, on August 5, 2011, the FHLBanks entered into an amended JCE Agreement to address differences between the original JCE Agreement and the approved capital plan amendments, including changes to the definition of an automatic termination event, provisions for determining whether an automatic termination event has occurred, and modifications to the provisions regarding the release of restricted retained earnings if the agreement is terminated. In particular, an FHLBank's obligation to make allocations to the restricted retained earnings account terminates on the Automatic Termination Event Declaration Date (as defined in the amended JCE Agreement), and restrictions on paying dividends out of the restricted retained earnings account or otherwise reallocating funds from the restricted retained earnings account are terminated one year later. For more information on the amendments to the JCE Agreement, see our Form 8-K filed on August 5, 2011. The amended capital plans of the FHLBanks, including our amended capital plan, will become effective on September 5, 2011.
Mandatorily Redeemable Capital Stock. At June 30, 2011, we had $515.1 million in capital stock subject to mandatory redemption, compared to $658.4 million at December 31, 2010. This decrease was primarily due to the repurchase of $122.1 million of excess MRCS. See Note 13 - Capital - Notes to Financial Statements for additional information.
Excess Stock. Excess stock is capital stock that is not required as a condition of membership or to support services to members or former members. In general, the level of excess stock fluctuates with our members' demand for Advances. Finance Agency regulations prohibit an FHLBank from issuing new excess stock if the amount of excess stock outstanding exceeds 1% of our Total Assets. At June 30, 2011, our outstanding excess stock of $0.9 billion was equal to 2% of our Total Assets. Therefore, we are currently not permitted to distribute stock dividends.
Off-Balance Sheet Arrangements
See Note 17 - Commitments and Contingencies - Notes to Financial Statements for information on our off-balance sheet arrangements.
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with GAAP requires management to make a number of judgments, estimates, and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities (if applicable), and the reported amounts of income and expenses during the reporting period. We review these estimates and assumptions based on historical experience, changes in business conditions and other relevant factors we believe to be reasonable under the circumstances. Changes in estimates and assumptions have the potential to significantly affect our financial position and results of operations. In any given reporting period, our actual results may differ from the estimates and assumptions used in preparing our financial statements.
We have identified five accounting policies that we believe are critical because they require management to make particularly difficult, subjective, and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts could be reported under different conditions or using different assumptions. These accounting policies relate to:
• | OTTI; |
• | Credit losses; |
• | Derivatives and hedging activities; |
• | Fair value estimates; and |
• | Premiums and discounts and other costs associated with originating or acquiring mortgage loans, MBS, and ABS. |
We believe the application of our accounting policies on a consistent basis enables us to provide financial statement users with useful, reliable and timely information about our results of operations, financial position and cash flows.
A full discussion of these critical accounting policies and estimates can be found in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations section under the caption Critical Accounting Policies and Estimates in our 2010 Form 10-K. See below for additional information regarding certain of these policies.
Other-Than-Temporary Impairment Analysis. In addition to evaluating our private-label MBS and ABS under a base case (or best estimate) scenario, we also performed a cash-flow analysis for each of these securities under a more adverse housing price scenario.
This more stressful scenario was based on a housing price forecast that was five percentage points lower at the trough than the base case scenario, followed by a flatter recovery path. Under this scenario, for those markets for which further home price declines are anticipated, current-to-trough home price declines were projected to range from 5% to 13% over the three- to nine-month period beginning April 1, 2011, followed in each case by a three-month period of flat prices. Thereafter, home prices were projected to increase from the trough within a range of 0% to 1.9% in the first year, 0% to 2% in the second year, 1% to 2.7% in the third year, 1.3% to 3.4% in the fourth year, 1.3% to 4% in each of the fifth and sixth years, and 1.5% to 3.8% in each subsequent year.
The adverse scenario and associated results do not represent our current expectations, and therefore should not be construed as a prediction of our future results, market conditions or the performance of these securities. Rather, the results from this hypothetical stress test scenario provide a measure of the credit losses that we might incur if home price declines (and subsequent recoveries) are more adverse than those projected in our OTTI evaluation.
The following table presents the base case scenario and what the impact on OTTI would have been under the more adverse home price scenario ($ amounts in millions). The classification (prime or Alt-A) is based on the model used to estimate the cash flows for the security, which may not be the same as the classification at the time of origination.
Three Months Ended June 30, 2011 | ||||||||||||||||||||||
As Reported | Using Adverse Housing Price Scenario | |||||||||||||||||||||
Number of | Impairment | Number of | Impairment | |||||||||||||||||||
Securities | Related to | Securities | Related to | |||||||||||||||||||
NRSRO Classification | Impaired | UPB | Credit Loss | Impaired | UPB | Credit Loss | ||||||||||||||||
Prime | 5 | $ | 304 | $ | (2 | ) | 15 | $ | 877 | $ | (24 | ) | ||||||||||
Alt-A | 2 | 47 | (1 | ) | 2 | 47 | (2 | ) | ||||||||||||||
Total | 7 | $ | 351 | $ | (3 | ) | 17 | $ | 924 | $ | (26 | ) |
Additional information about OTTI of our private-label MBS and ABS is provided in Risk Management - Credit Risk Management - Investments herein, and in Note 5 - Other-Than-Temporary Impairment Analysis - Notes to Financial Statements.
Provision for Credit Losses.
Advances. At June 30, 2011, based on the collateral held as security for Advances, management's credit analyses and prior repayment history, no allowance for losses on Advances is deemed necessary by management.
Mortgage Loans Acquired under MPP. Based on our analysis, using the most recent 12 months weighted-average recovery rate through June 30, 2011, of approximately 55% of the original appraised value, further reduced by estimated liquidation costs, and after consideration of PMI, LRA, and SMI, we recorded $1.9 million of allowance for loan losses on our conventional mortgage loans at June 30, 2011. We have also performed our loan loss reserve analysis under multiple scenarios whereby we changed various assumptions and have concluded that a worsening of those assumptions down to a 50% recovery rate would have increased our allowance to approximately $4.5 million at June 30, 2011.
Recent Accounting and Regulatory Developments
Accounting Developments. See Note 2 - Recently Adopted and Issued Accounting Guidance - Notes to Financial Statements for a description of how recent accounting developments may impact our results of operations or financial condition.
Legislative and Regulatory Developments. The legislative and regulatory environment continues to change as financial regulators issue proposed and/or final rules to implement the Dodd-Frank Act and Congress begins to debate proposals for housing finance and GSE reform.
As discussed under Legislative and Regulatory Developments in our 2010 Form 10-K, the Dodd-Frank Act will likely impact our business operations, funding costs, rights, obligations, and/or the environment in which we carry out our mission. Certain regulatory actions during the period covered by this report resulting from the Dodd-Frank Act that may have an important impact on us are summarized below, although the full effect of the Dodd-Frank Act will become known only after all of the required regulations, studies and reports are finalized and issued. The Dodd-Frank Act, among other things: (i) creates an inter-agency oversight council that is charged with identifying and regulating systemically important financial institutions; (ii) regulates the over-the-counter derivatives market; (iii) imposes new executive compensation proxy and disclosure requirements; (iv) establishes new requirements for MBS, including a risk-retention requirement; (v) reforms the credit rating agencies; (vi) makes a number of changes to the federal deposit insurance system; and (vii) creates a consumer financial protection bureau.
New Requirements for Our Derivatives Transactions. The Dodd-Frank Act provides for new statutory and regulatory requirements for derivative transactions, including those utilized by us to hedge interest rate and other risks. As a result of these requirements, certain derivative transactions will be required to be cleared through a third-party central clearinghouse and traded on regulated exchanges or new swap execution facilities. The CFTC has issued a final rule regarding the process pursuant to which it will determine which types of swaps will be subject to mandatory clearing, but has not yet made any such determinations. Based on the effective date of this rule and the time periods set forth in the rule for CFTC determinations regarding mandatory clearing, it is not expected that any of our swaps will be required to be cleared until the last week of 2011, at the very earliest, and it is possible that such date will be some time in 2012.
Cleared swaps will be subject to initial and variation margin requirements established by the clearinghouse and its clearing members. While clearing swaps may reduce counterparty credit risk, the margin requirements for cleared trades have the potential of making derivative transactions more costly. In addition, mandatory swap clearing will require us to enter into new relationships and accompanying agreements with clearing members and additional agreements with swap counterparties.
The Dodd-Frank Act also changes the regulatory landscape for derivative transactions that are not subject to mandatory clearing requirements (uncleared trades). While we expect to continue to enter into uncleared trades on a bilateral basis, such trades will be subject to new regulatory requirements, including new mandatory reporting requirements, new documentation requirements and new minimum margin and capital requirements. Under the proposed CFTC margin rules, we will have to post both initial margin and variation margin to our swap dealer counterparties, but may be eligible in both instances for modest unsecured thresholds as "low-risk financial end users." Pursuant to additional rules proposed by the Finance Agency, we will be required to collect both initial margin and variation margin from our swap dealer counterparties, without any unsecured thresholds. These margin requirements and any related capital requirements could adversely impact the liquidity and pricing of certain uncleared derivative transactions we may enter into, thus making uncleared trades more costly.
The CFTC has issued a proposed rule requiring that collateral posted by swap customers to a clearinghouse in connection with cleared swaps be legally segregated on a customer-by-customer basis. However, in connection with this proposed rule the CFTC has left open the possibility that customer collateral would not have to be legally segregated but could instead be commingled with all collateral posted by other customers of our clearing member. Such commingling would put our collateral at risk in the event of a default by another customer of our clearing member. To the extent the CFTC's final rule places our posted collateral at greater risk of loss in the clearing structure than under the current over-the-counter market structure, we may be adversely impacted.
The Dodd-Frank Act will require swap dealers and certain other large users of derivatives to register as "swap dealers" or "major swap participants," as the case may be, with the CFTC and/or the SEC. Based on the definitions in the proposed rules jointly issued by the CFTC and SEC, it does not appear likely that we will be required to register as a "major swap participant," although this remains a possibility. Also, based on the definitions in the proposed rules, it does not appear likely that an FHLBank will be required to register as a "swap dealer" for the derivative transactions that it enters into with dealer counterparties for the purpose of hedging and managing our interest rate risk, which constitute the majority of our derivative transactions. However, based on the proposed rules, it is possible that an FHLBank could be required to register with the CFTC as a swap dealer based on intermediated "swaps" that it enters into with its members. Although our policies permit us to enter into intermediated swaps with our members, we have no such swaps outstanding as of August 10, 2011.
It is also unclear how the final rule will treat certain Advance products with FHLBank members that may contain features that operate in a similar manner to certain derivatives, such as interest-rate caps, floors and options. The CFTC and SEC have issued joint proposed rules further defining the term "swap" under the Dodd-Frank Act. These proposed rules and accompanying interpretive guidance attempt to clarify that certain products will or will not be regulated as "swaps." While it is unlikely that Advances transactions between us and our members will be treated as "swaps," the proposed rules and accompanying interpretive guidance are not entirely clear on this issue.
Depending on how the terms "swap" and "swap dealer" are defined in the final regulations, we may be faced with the business decision of whether to continue to offer Advances to members that have features that cause the Advances to be deemed to be "swaps," if those transactions would require us to register as a swap dealer. Designation as a swap dealer would subject us to significant additional regulation and cost including, without limitation, registration with the CFTC, new internal and external business conduct standards, additional reporting requirements and additional swap-based capital and margin requirements. Even if we are designated as a swap dealer, however, the proposed regulations would permit us to apply to the CFTC to limit such designation to those specified activities for which we are acting as a swap dealer. Upon such designation, our hedging activities would not be subject to the full requirements that will generally be imposed on traditional swap dealers.
While certain provisions of the Dodd-Frank Act took effect on July 16, 2011, the CFTC has issued an order temporarily exempting persons or entities with respect to provisions of Title VII of the Dodd-Frank Act that reference "swap dealer," "major swap participant," "eligible contract participant" and "swap." These exemptions will expire upon the earlier of: (1) the effective date of the applicable final rule further defining the relevant terms; or (2) December 31, 2011. In addition, the provisions of the Dodd-Frank Act that are expected to have the most effect on us did not take effect on July 16, 2011, but will take effect no less than 60 days after the CFTC publishes final regulations implementing such provisions. The CFTC is expected to publish such final regulations by the end of 2011, but it is not expected that such final regulations will become effective until the end of 2011, and delays beyond that time are possible.
We, together with the other FHLBanks, are actively participating in the regulatory process regarding the Dodd-Frank Act by formally commenting to the regulators regarding a variety of rulemakings that could impact us. We and the other FHLBanks are also working to implement the processes and documentation necessary to comply with the Dodd-Frank Act's new requirements for derivatives.
Other Banking Regulatory Actions
Banking Agency Revisions to Regulations to Permit Payment of Interest on Demand Deposit Accounts. The Dodd-Frank Act repealed the statutory prohibition against the payment of interest on demand deposits, effective July 21, 2011. To conform to this provision, the FDIC and other applicable banking regulators rescinded their regulations prohibiting paying interest on demand deposits effective July 21, 2011. FHLBanks members' ability to pay interest on their customers' demand deposit accounts may increase their ability to attract or retain customer deposits, which could reduce their funding needs from the FHLBanks.
Joint Regulatory Actions
Proposed Rule on Credit Risk Retention for Asset-Backed Securities. As discussed under Legislative and Regulatory Developments in our Form 10-Q for the quarter ended March 31, 2011, the Federal banking agencies, the Finance Agency, the Department of Housing and Urban Development and the SEC jointly issued a notice of proposed rulemaking on April 29, 2011, which proposes regulations requiring sponsors of ABS to retain a minimum of a 5% economic interest in a portion of the credit risk of the assets collateralizing ABS, unless all the assets securitized satisfy specified qualifications. The proposed rule outlines the permissible forms of retention of economic interests (either in the form of retained interests in specified classes of the issued ABS or in randomly selected assets from the potential pool of underlying assets). The proposed rule also specifies criteria for qualified residential mortgage loans that would make them exempt from the risk retention requirements. The final rule that results from this process is likely to have a significant impact on the structure, operation and financial health of the mortgage finance sector and if adopted as proposed could significantly reduce the overall amount of financing available to creditworthy borrowers. A contraction in mortgage lending in turn could reduce members' need for FHLBank Advances, decrease the amount of collateral available to secure such Advances and result in lower values for available collateral. The final rule may also have implications for FHLBank AMA programs (including our MPP) if such programs are determined to be subject to the final rule and required to be restructured to replace the existing credit risk-sharing methodology with an across-the-board 5% risk retention by the seller of the mortgages to the FHLBanks. Comments on this proposed rule were due August 1, 2011.
Proposed Rule on Incentive-Based Compensation Arrangements. As discussed under Legislative and Regulatory Developments in our Form 10-Q for the quarter ended on March 31, 2011, seven federal financial regulators, including the Finance Agency, published a proposed rule on April 14, 2011, that would implement Section 956 of the Dodd-Frank Act. Section 956 requires these agencies to issue joint regulations that prohibit "covered financial institutions" from entering into incentive-based compensation arrangements that encourage inappropriate risks and requiring deferral of the payment of incentive-based compensation. If adopted as proposed, the rule would impact the design of our compensation policies and practices, including our incentive compensation policies and practices. Comments on the proposed rule were due on May 31, 2011.
Finance Agency Regulatory Actions
Regulatory Waiver of SMI Rating Requirement for MPP Purchases. The Finance Agency's AMA regulations require FHLBank members that sell loans to FHLBanks through an AMA program (such as our MPP) to be legally obligated at all times to maintain SMI with an insurer rated not lower than the second highest rating category when SMI is used as a form of credit enhancement in the AMA program. With prolonged deteriorations in the mortgage markets, it has remained difficult for us to meet this requirement because no mortgage insurers that currently underwrite SMI are currently rated in the second highest rating category or better by any NRSRO. On August 6, 2009, the Director of the Finance Agency granted a temporary waiver of this NRSRO rating requirement for SMI providers, subject to certain limitations and conditions.
On April 8, 2010, in accordance with its temporary waiver, we submitted to the Finance Agency a written analysis of credit enhancement alternatives that would no longer rely on SMI for our existing pools of loans. On July 29, 2010, the Acting Director of the Finance Agency issued an order extending the waiver relating to our existing MPP pools that utilize SMI until such time as the Finance Agency amends the subject AMA regulation, or for an additional year, whichever comes sooner. On August 5, 2011, the Finance Agency extended this waiver until the subject regulation is amended. Under this extended waiver, we are required to continue evaluating the claims-paying ability of SMI providers, hold additional retained earnings, and take any other steps necessary to mitigate any attendant risk associated with using an SMI provider having a rating below the standard established by the AMA regulation.
Final Conservatorship/Receivership Regulation. On June 20, 2011, the Finance Agency issued a final conservatorship and receivership regulation for the FHLBanks effective July 20, 2011. The final regulation addresses the nature of a conservatorship or receivership and provides greater specificity on their operations, in line with procedures set forth in similar regulatory regimes (for example, the FDIC receivership authorities). The regulation clarifies the relationship among various classes of creditors and equity holders of an FHLBank under a conservatorship or receivership and the priorities for contract parties and other claimants in receivership. The Finance Agency explained that its general approach in adopting the final regulation was to set out the basic general framework for conservatorships and receiverships.
The Finance Agency's comments to the final regulation state:
• | Claims of FHLBank members arising from the members' deposit accounts, service agreements, Advances, and other transactions with their FHLBanks are distinct from such members' equity claims as holders of FHLBank stock. The lowest priority position for equity claims only applies to members' claims in regard to their FHLBank stock and does not apply to claims arising from other member transactions with an FHLBank. |
• | An FHLBank's claim for repayment/reimbursement for making payments on any Consolidated Obligations of another FHLBank in conservatorship or receivership following its default in making such payment would be treated as a general creditor claim against the defaulting FHLBank. The Finance Agency may also address these reimbursement matters in policy statements or discretionary decisions. |
• | With respect to property held by an FHLBank in trust or in custodial arrangements, the Finance Agency stated that it expects to follow FDIC and bankruptcy practice; such property would not be considered part of a receivership estate and would not be available to satisfy general creditor claims. |
Final Investment Regulation. On May 20, 2011, the Finance Agency issued a final investment regulation effective June 20, 2011. The final regulation is narrowly focused and codifies the existing 300% of capital and other existing policy limitations on the FHLBanks' MBS purchases and use of derivatives. The Finance Agency stated in the preamble to the final regulation that it continues to have concerns about FHLBank investments, including investments in MBS, and will likely issue a future rulemaking addressing all aspects of the FHLBanks' investment authority.
Final Rule on FHLBank Liabilities. As discussed under Legislative and Regulatory Developments in our Form 10-Q
for the quarter ended on March 31, 2011, on April 4, 2011, the Finance Agency issued a final rule regarding FHLBank liabilities effective May 4, 2011. This rule is not expected to have any adverse impact on the FHLBanks' joint and several liability for the principal and interest payments on Consolidated Obligations.
Proposed Rule on Prudential Management Standards. On June 20, 2011, the Finance Agency issued a proposed rule, as required by the Housing and Economic Recovery Act of 2008, to establish prudential standards with respect to ten categories of operation and management of the FHLBanks and the GSEs, including internal controls, interest rate risk exposure, market risk, and others. The Finance Agency has proposed to adopt the standards as guidelines, which generally provide principles and leave to the regulated entities the obligation to organize and manage themselves to ensure that the standards are met, subject to agency oversight. The proposed rule also includes procedural provisions relating to the consequences of failing to meet applicable standards, such as requirements regarding submission of a corrective action plan to the Finance Agency. Comments on the proposal are due August 19, 2011.
Housing Finance and GSE Reform
On February 11, 2011, the Department of the Treasury and the United States Department of Housing and Urban Development issued a white paper report to Congress entitled "Reforming America's Housing Finance Market: A Report to Congress." The report's primary focus is to provide options for Congressional consideration regarding the long-term structure of housing finance, including reforms specific to Fannie Mae and Freddie Mac. In addition, the Obama Administration noted it would work, in consultation with the Finance Agency and Congress, to restrict the areas of mortgage finance in which Fannie Mae, Freddie Mac and the FHLBanks operate so that overall government support of the mortgage market will be substantially reduced over time.
Although the FHLBanks are not the primary focus of this report, they are recognized as playing a vital role in helping smaller financial institutions access liquidity and capital to compete in an increasingly competitive marketplace. The report suggests the following possible reforms for the FHLBank System:
• | focus the FHLBanks on small- and medium-sized financial institutions; |
• | restrict membership by allowing each institution eligible for membership to be an active member in only a single FHLBank; |
• | limit the level of outstanding Advances to larger members; and |
• | reduce FHLBank investment portfolios and their composition, focusing FHLBanks on providing liquidity for insured depository institutions. |
The report also supports exploring additional means to provide funding to housing lenders, including potentially the development of a covered bond market. Covered bonds are debt instruments issued by banks and collateralized by specific pools of assets (home mortgages or, in the United States, AAA-rated MBS).
Partially in response to the report, a number of bills, including covered bond legislation, have been introduced in Congress in both the first and second quarters of 2011. It is expected that GSE legislative activity will continue. While none proposes specific changes to the FHLBanks, we could nonetheless be affected in numerous ways by changes to the United States housing finance structure, to Fannie Mae and Freddie Mac, and to the Finance Agency. For example, the FHLBanks traditionally have allocated a significant portion of their investment portfolio to investments in Fannie Mae and Freddie Mac debt securities. Accordingly, the FHLBanks' investment strategies would likely be affected by winding down those entities. Winding down these two GSEs, or limiting the amount of mortgages they purchase, also could increase demand for FHLBank Advances if FHLBank members respond by retaining more of their mortgage loans in portfolio and using Advances to fund the loans. Additionally, the Finance Agency may consider regulatory actions consistent with the report, including restricting membership by allowing each eligible institution to be an active member of a single FHLBank or limiting the level of Advances outstanding to larger members. It is also possible that Congress will consider any or all of the specific changes to the FHLBanks suggested by the Obama Administration's proposal. If regulation or legislation is enacted incorporating these changes, the FHLBanks could be significantly limited in their ability to make Advances to their members and subject to additional limitations on their investment authority. Additionally, if Congress enacts legislation encouraging the development of a covered bond market, FHLBank Advances could be reduced in time as larger members use covered bonds as an alternative form of wholesale mortgage financing.
The ultimate effects on the FHLBanks of housing finance and GSE reform or any other legislation, including any legislation to address the federal deficit, are unknown at this time and will depend on the legislation or regulations, if any, that are finally enacted or adopted.
See the Legislative and Regulatory Developments section in our 2010 Form 10-K for additional discussion on pending legislative and regulatory developments.
Risk Management
We have exposure to a number of risks in pursuing our business objectives. These risks may be broadly classified as market, credit, liquidity, operations, and business. Market risk is discussed in detail in Item 3. Quantitative and Qualitative Disclosures about Market Risk.
Active risk management is an integral part of our operations because these risks are an inherent part of our business activities. We manage these risks by setting and enforcing appropriate limits and developing and maintaining internal policies and processes to ensure an appropriate risk profile. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management in our 2010 Form 10-K for more detailed information.
Credit Risk Management. Credit risk is the risk that members or other counterparties may be unable to meet their contractual obligations to us, or that the values of those obligations will decline as a result of deterioration in the members' or other counterparties' creditworthiness. Credit risk arises when our funds are extended, committed, invested or otherwise exposed through actual or implied contractual agreements. We face credit risk on Advances and other credit products, investments, mortgage loans, derivative financial instruments, and AHP grants.
The most important step in the management of credit risk is the initial decision to extend credit. We also manage credit risk by following established policies, evaluating the creditworthiness of our members and counterparties, and utilizing collateral agreements and settlement netting. Periodic monitoring of members and other counterparties is performed for wherever we are exposed to credit risk.
Advances. We manage our exposure to credit risk on Advances through a combination of our security interest in assets pledged by the borrowing member and ongoing reviews of each borrower's financial condition. However, our credit risk is magnified due to the concentration of Advances in a few borrowers. As of June 30, 2011, our top three borrowers held 36% of total Advances outstanding, at par. Because of this concentration in Advances, we perform frequent credit and collateral reviews on our largest borrowers. In addition, we analyze the implications to our financial management and profitability if we were to lose the business of one or more of these borrowers.
Investments. We are also exposed to credit risk through our investment portfolios. The risk management policy approved by our board of directors restricts the acquisition of investments to high-quality, short-term money market instruments and highly-rated long-term securities.
Short-Term Investments. We place funds with large, high-quality financial institutions with investment-grade long-term credit ratings on an unsecured basis for terms of up to 275 days; most such placements typically mature within 90 days. At June 30, 2011, our unsecured credit exposure, including accrued interest related to short-term money-market instruments, was $2.9 billion to 13 counterparties and issuers, of which $1.7 billion was for Federal Funds Sold that mature overnight. We actively monitor counterparty creditworthiness, ratings, performance, and capital adequacy in an effort to mitigate unsecured credit risk on the short-term investments, with emphasis on the potential impacts from global economic conditions. Unsecured transactions can only be conducted with counterparties that are domiciled in countries that maintain a long-term sovereign rating from S&P of AA or higher.
Long-Term Investments. Our long-term investments include RMBS guaranteed by the housing GSEs (Fannie Mae and Freddie Mac), other U.S. obligations - guaranteed RMBS (Ginnie Mae), corporate debentures guaranteed by the FDIC and backed by the full faith and credit of the United States government under the TLGP, and corporate debentures issued by GSEs.
Our long-term investments also include private-label MBS and ABS. We are subject to secured credit risk related to private-label MBS and ABS that are directly or indirectly supported by underlying mortgage loans. Each of the securities contains one or more forms of credit protection, including subordination, excess spread, over-collateralization and/or an insurance wrap. Investments in private-label MBS and ABS may be purchased as long as the investments are rated AAA.
Finance Agency policy provides that the total value of our investments in MBS and ABS, calculated using amortized historical cost, must not exceed 300% of our total regulatory capital, consisting of Retained Earnings, Class B Capital Stock, and MRCS, based on the amount most recently reported to the Finance Agency as of the day we purchase the securities. These investments, as a percentage of total regulatory capital, were 294% at June 30, 2011. Generally, our goal is to maintain these investments near the 300% limit.
Applicable rating levels are determined using the lowest relevant long-term rating from S&P, Moody's and Fitch. Rating modifiers are ignored when determining the applicable rating level for a given counterparty or investment.
The following tables present the carrying value by credit ratings of our investments, grouped by category ($ amounts in millions):
Below | ||||||||||||||||||||||||
Investment | ||||||||||||||||||||||||
June 30, 2011 | AAA | AA | A | BBB | Grade | Total | ||||||||||||||||||
Short-term investments: | ||||||||||||||||||||||||
Interest-Bearing Deposits | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||||
Securities Purchased Under Agreements to Resell | — | — | — | — | — | — | ||||||||||||||||||
Federal Funds Sold | — | 1,630 | 1,275 | — | — | 2,905 | ||||||||||||||||||
Total short-term investments | — | 1,630 | 1,275 | — | — | 2,905 | ||||||||||||||||||
AFS securities: | ||||||||||||||||||||||||
GSE debentures | 1,955 | — | — | — | — | 1,955 | ||||||||||||||||||
TLGP debentures | 324 | — | — | — | — | 324 | ||||||||||||||||||
Private-label MBS | — | — | — | — | 806 | 806 | ||||||||||||||||||
Total AFS securities | 2,279 | — | — | — | 806 | 3,085 | ||||||||||||||||||
HTM securities: | ||||||||||||||||||||||||
GSE debentures | 269 | 25 | — | — | — | 294 | ||||||||||||||||||
TLGP debentures | 1,980 | — | — | — | — | 1,980 | ||||||||||||||||||
Other U.S. obligations - guaranteed RMBS | 2,570 | — | — | — | — | 2,570 | ||||||||||||||||||
GSE RMBS | 3,245 | — | — | — | — | 3,245 | ||||||||||||||||||
Private-label MBS | 276 | 62 | 15 | 57 | 114 | 524 | ||||||||||||||||||
Private-label ABS | — | 18 | — | — | 3 | 21 | ||||||||||||||||||
Total HTM securities | 8,340 | 105 | 15 | 57 | 117 | 8,634 | ||||||||||||||||||
Total investments, carrying value | $ | 10,619 | $ | 1,735 | $ | 1,290 | $ | 57 | $ | 923 | $ | 14,624 | ||||||||||||
Percentage of total | 73 | % | 12 | % | 9 | % | — | % | 6 | % | 100 | % | ||||||||||||
December 31, 2010 | ||||||||||||||||||||||||
Short-term investments: | ||||||||||||||||||||||||
Interest-Bearing Deposits | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||||
Securities Purchased Under Agreements to Resell | 750 | — | — | — | — | 750 | ||||||||||||||||||
Federal Funds Sold | — | 5,343 | 1,982 | — | — | 7,325 | ||||||||||||||||||
Total short-term investments | 750 | 5,343 | 1,982 | — | — | 8,075 | ||||||||||||||||||
AFS securities: | ||||||||||||||||||||||||
GSE debentures | 1,930 | — | — | — | — | 1,930 | ||||||||||||||||||
TLGP debentures | 325 | — | — | — | — | 325 | ||||||||||||||||||
Private-label MBS | — | — | — | — | 983 | 983 | ||||||||||||||||||
Total AFS securities | 2,255 | — | — | — | 983 | 3,238 | ||||||||||||||||||
HTM securities: | ||||||||||||||||||||||||
GSE debentures | 269 | 25 | — | — | — | 294 | ||||||||||||||||||
TLGP debentures | 2,066 | — | — | — | — | 2,066 | ||||||||||||||||||
Other U.S. obligations - guaranteed RMBS | 2,327 | — | — | — | — | 2,327 | ||||||||||||||||||
GSE RMBS | 3,044 | — | — | — | — | 3,044 | ||||||||||||||||||
Private-label MBS | 479 | 82 | 35 | 16 | 107 | 719 | ||||||||||||||||||
Private-label ABS | — | 19 | — | — | 3 | 22 | ||||||||||||||||||
Total HTM securities | 8,185 | 126 | 35 | 16 | 110 | 8,472 | ||||||||||||||||||
Total investments, carrying value | $ | 11,190 | $ | 5,469 | $ | 2,017 | $ | 16 | $ | 1,093 | $ | 19,785 | ||||||||||||
Percentage of total | 57 | % | 28 | % | 10 | % | — | % | 5 | % | 100 | % |
The following table presents the carrying values and fair values at June 30, 2011, of seven private-label RMBS and other securities downgraded during the period from July 1, 2011, to August 8, 2011, from the lowest NRSRO rating previously reported. There were no other downgrades of MBS and ABS or unsecured counterparties during this period ($ amounts in millions):
To AA | To BB | To B | To CCC | To CC | ||||||||||||||||||||||||||||||||||||
Carrying Value | Fair Value | Carrying Value | Fair Value | Carrying Value | Fair Value | Carrying Value | Fair Value | Carrying Value | Fair Value | |||||||||||||||||||||||||||||||
Downgraded from AAA: | ||||||||||||||||||||||||||||||||||||||||
GSE debentures | $ | 2,224 | $ | 2,225 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||||||||||||
TLGP debentures | 2,304 | 2,308 | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
Other U.S. obligations - guaranteed RMBS | 2,570 | 2,597 | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
GSE RMBS | 3,245 | 3,290 | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
Private-label RMBS: | ||||||||||||||||||||||||||||||||||||||||
Downgraded from AAA | 37 | 35 | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
Downgraded from AA | — | — | — | — | 26 | 26 | — | — | — | — | ||||||||||||||||||||||||||||||
Downgraded from B | — | — | — | — | — | — | 45 | 45 | 69 | 69 | ||||||||||||||||||||||||||||||
Downgraded from CCC | — | — | — | — | — | — | — | — | 48 | 48 | ||||||||||||||||||||||||||||||
Total | $ | 10,380 | $ | 10,455 | $ | — | $ | — | $ | 26 | $ | 26 | $ | 45 | $ | 45 | $ | 117 | $ | 117 |
On August 5, 2011, S&P lowered its long-term United States sovereign credit rating from AAA to AA+ with a negative outlook. On August 8, 2011, S&P lowered the long-term issuer credit ratings and related issue ratings of the GSEs from AAA to AA+ with a negative outlook. In S&P's application of its government-related entities criteria, the ratings of the GSEs, including Fannie Mae, Freddie Mac, and Federal Farm Credit, are constrained by the long-term sovereign credit rating of the United States. The TLGP debentures are guaranteed by the FDIC and backed by the full faith and credit of the United States government. Ginnie Mae guarantees the timely payment of principal and interest on all of its RMBS, which are included in the above table in other U.S. obligations - guaranteed RMBS, and its guarantee is backed by the full faith and credit of the United States government. Although these individual securities are not rated, we consider these investments to have been downgraded based on S&P's action. We expect to recover all contractual cash flows on these securities because we determined that the strength of the issuers' guarantees and the direct or indirect support from the United States government are sufficient to protect us from losses based on current expectations.
The following table presents the carrying values and fair values at June 30, 2011, of three private-label RMBS whose investment ratings were on negative watch as of August 8, 2011. No other private-label MBS and ABS or unsecured counterparties were placed on negative watch ($ amounts in millions):
Private-label RMBS | ||||||||
Investment ratings | Carrying Value | Fair Value | ||||||
AAA | $ | 4 | $ | 4 | ||||
AA | 21 | 21 | ||||||
B | 122 | 122 | ||||||
Total | $ | 147 | $ | 147 |
Private-Label MBS and ABS. While there is no universally accepted definition of prime, Alt-A or subprime underwriting standards, MBS and ABS are classified as prime, Alt-A or subprime based on the originator's classification at the time of origination or based on classification by an NRSRO upon issuance. We do not hold any collateralized debt obligations. All MBS and ABS were rated AAA at the date of purchase.
Our private-label MBS and ABS are backed by collateral located in the United States. The top five states, by percentage of collateral located in those states, were California (54%), New York (6%), Florida (5%), Virginia (3%), and New Jersey (3%).
The tables below present for our prime, Alt-A and subprime securities the UPB by credit ratings, based on the lowest of Moody's, S&P, or comparable Fitch ratings, as well as amortized cost, fair value, and other collateral information by year of securitization as of June 30, 2011 ($ amounts in millions):
2004 | ||||||||||||||||||||
and | ||||||||||||||||||||
Prime | prior | 2005 | 2006 | 2007 | Total | |||||||||||||||
Private-label RMBS: | ||||||||||||||||||||
AAA-rated | $ | 263 | $ | — | $ | — | $ | — | $ | 263 | ||||||||||
AA-rated | 1 | 47 | — | — | 48 | |||||||||||||||
A-rated | — | — | — | — | — | |||||||||||||||
BBB-rated | 26 | 31 | — | — | 57 | |||||||||||||||
Below investment grade: | ||||||||||||||||||||
BB-rated | 44 | 11 | — | — | 55 | |||||||||||||||
B-rated | — | 231 | 87 | — | 318 | |||||||||||||||
CCC-rated | — | 200 | 53 | 92 | 345 | |||||||||||||||
CC-rated | — | 42 | 30 | 115 | 187 | |||||||||||||||
C-rated | — | — | — | 146 | 146 | |||||||||||||||
Total UPB | $ | 334 | $ | 562 | $ | 170 | $ | 353 | $ | 1,419 | ||||||||||
Amortized cost | $ | 333 | $ | 520 | $ | 162 | $ | 284 | $ | 1,299 | ||||||||||
Gross unrealized losses (1) | (6 | ) | (37 | ) | (8 | ) | (7 | ) | (58 | ) | ||||||||||
Fair value | 327 | 483 | 154 | 283 | 1,247 | |||||||||||||||
OTTI: | ||||||||||||||||||||
Related to credit losses | $ | — | $ | (13 | ) | $ | — | $ | (6 | ) | $ | (19 | ) | |||||||
Related to non-credit losses | — | 13 | — | 6 | 19 | |||||||||||||||
Total OTTI losses | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||
Weighted average percentage of fair value to UPB | 98 | % | 86 | % | 91 | % | 80 | % | 88 | % | ||||||||||
Original weighted average credit support | 3 | % | 7 | % | 5 | % | 8 | % | 6 | % | ||||||||||
Current weighted average credit support | 10 | % | 8 | % | 4 | % | 5 | % | 7 | % | ||||||||||
Weighted average collateral delinquency (2) | 6 | % | 16 | % | 16 | % | 21 | % | 15 | % |
(1) Gross unrealized losses represent the difference between estimated fair value and amortized cost where fair value is less than amortized cost. These amounts exclude gross unrealized gains.
(2) Includes delinquencies of 60 days or more, foreclosures, real estate owned and bankruptcies, weighted by the UPB of the individual securities in the category based on their respective collateral delinquency.
2004 | ||||||||||||||||||||
and | ||||||||||||||||||||
Alt-A | prior | 2005 | 2006 | 2007 | Total | |||||||||||||||
Private-label RMBS: | ||||||||||||||||||||
AAA-rated | $ | 13 | $ | — | $ | — | $ | — | $ | 13 | ||||||||||
AA-rated | 15 | — | — | — | 15 | |||||||||||||||
A-rated | 16 | — | — | — | 16 | |||||||||||||||
BBB-rated | — | — | — | — | — | |||||||||||||||
Below investment grade: | ||||||||||||||||||||
BB-rated | — | 2 | — | — | 2 | |||||||||||||||
B-rated | — | — | — | — | — | |||||||||||||||
CCC-rated | — | 47 | — | — | 47 | |||||||||||||||
CC-rated | — | — | — | — | — | |||||||||||||||
C-rated | — | — | — | — | — | |||||||||||||||
Total UPB | $ | 44 | $ | 49 | $ | — | $ | — | $ | 93 | ||||||||||
Amortized cost | $ | 43 | $ | 42 | $ | — | $ | — | $ | 85 | ||||||||||
Gross unrealized losses (1) | (1 | ) | (8 | ) | — | — | (9 | ) | ||||||||||||
Fair value | 42 | 34 | — | — | 76 | |||||||||||||||
OTTI: | ||||||||||||||||||||
Related to credit losses | $ | — | $ | (2 | ) | $ | — | $ | — | $ | (2 | ) | ||||||||
Related to non-credit losses | — | (1 | ) | — | — | (1 | ) | |||||||||||||
Total OTTI losses | $ | — | $ | (3 | ) | $ | — | $ | — | $ | (3 | ) | ||||||||
Weighted average percentage of fair value to UPB | 96 | % | 69 | % | — | % | — | % | 81 | % | ||||||||||
Original weighted average credit support | 3 | % | 6 | % | — | % | — | % | 5 | % | ||||||||||
Current weighted average credit support | 10 | % | 2 | % | — | % | — | % | 6 | % | ||||||||||
Weighted average collateral delinquency (2) | 7 | % | 17 | % | — | % | — | % | 12 | % |
(1) Gross unrealized losses represent the difference between estimated fair value and amortized cost where fair value is less than amortized cost. These amounts exclude gross unrealized gains.
(2) Includes delinquencies of 60 days or more, foreclosures, real estate owned and bankruptcies, weighted by the UPB of the individual securities in the category based on their respective collateral delinquency.
2004 | ||||||||||||||||||||
and | ||||||||||||||||||||
Subprime | prior | 2005 | 2006 | 2007 | Total | |||||||||||||||
Home equity loan investments: | ||||||||||||||||||||
Below investment grade: | ||||||||||||||||||||
B-rated | $ | 3 | $ | — | $ | — | $ | — | $ | 3 | ||||||||||
Total UPB | $ | 3 | $ | — | $ | — | $ | — | $ | 3 | ||||||||||
Amortized cost | $ | 3 | $ | — | $ | — | $ | — | $ | 3 | ||||||||||
Gross unrealized losses (1) | (1 | ) | — | — | — | (1 | ) | |||||||||||||
Fair value | 2 | — | — | — | 2 | |||||||||||||||
OTTI: | ||||||||||||||||||||
Related to credit losses | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||
Related to non-credit losses | — | — | — | — | — | |||||||||||||||
Total OTTI losses | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||
Weighted average percentage of fair value to UPB | 56 | % | — | % | — | % | — | % | 56 | % | ||||||||||
Original weighted average credit support | 100 | % | — | % | — | % | — | % | 100 | % | ||||||||||
Current weighted average credit support | 100 | % | — | % | — | % | — | % | 100 | % | ||||||||||
Weighted average collateral delinquency (2) | 27 | % | — | % | — | % | — | % | 27 | % | ||||||||||
Manufactured housing loan investments: | ||||||||||||||||||||
AA-rated | $ | 18 | $ | — | $ | — | $ | — | $ | 18 | ||||||||||
Total UPB | $ | 18 | $ | — | $ | — | $ | — | $ | 18 | ||||||||||
Amortized cost | $ | 18 | $ | — | $ | — | $ | — | $ | 18 | ||||||||||
Gross unrealized losses (1) | (2 | ) | — | — | — | (2 | ) | |||||||||||||
Fair value | 16 | — | — | — | 16 | |||||||||||||||
OTTI: | ||||||||||||||||||||
Related to credit losses | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||
Related to non-credit losses | — | — | — | — | — | |||||||||||||||
Total OTTI losses | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||
Weighted average percentage of fair value to UPB | 87 | % | — | % | — | % | — | % | 87 | % | ||||||||||
Original weighted average credit support | 28 | % | — | % | — | % | — | % | 28 | % | ||||||||||
Current weighted average credit support | 29 | % | — | % | — | % | — | % | 29 | % | ||||||||||
Weighted average collateral delinquency (2) | 2 | % | — | % | — | % | — | % | 2 | % |
(1) Gross unrealized losses represent the difference between estimated fair value and amortized cost where fair value is less than amortized cost. These amounts exclude gross unrealized gains.
(2) Includes delinquencies of 60 days or more, foreclosures, real estate owned and bankruptcies, weighted by the UPB of the individual securities in the category based on their respective collateral delinquency.
The following table presents the UPB of our private-label MBS and ABS by collateral type ($ amounts in millions):
June 30, 2011 | December 31, 2010 | |||||||||||||||||||||||
Fixed | Variable | Fixed | Variable | |||||||||||||||||||||
Collateral Type | Rate | Rate (1)(2) | Total | Rate | Rate (1)(2) | Total | ||||||||||||||||||
RMBS: | ||||||||||||||||||||||||
Prime loans | $ | 643 | $ | 776 | $ | 1,419 | $ | 985 | $ | 800 | $ | 1,785 | ||||||||||||
Alt-A loans | 93 | — | 93 | 118 | — | 118 | ||||||||||||||||||
Total RMBS | 736 | 776 | 1,512 | 1,103 | 800 | 1,903 | ||||||||||||||||||
Home equity loans ABS: | ||||||||||||||||||||||||
Subprime loans | — | 3 | 3 | — | 3 | 3 | ||||||||||||||||||
Total home equity loans ABS | — | 3 | 3 | — | 3 | 3 | ||||||||||||||||||
Manufactured housing ABS: | ||||||||||||||||||||||||
Subprime Loans | 18 | — | 18 | 19 | — | 19 | ||||||||||||||||||
Total manufactured housing ABS | 18 | — | 18 | 19 | — | 19 | ||||||||||||||||||
Total private-label MBS and ABS, at UPB | $ | 754 | $ | 779 | $ | 1,533 | $ | 1,122 | $ | 803 | $ | 1,925 |
(1) Variable-rate private-label MBS and ABS include those with a contractual coupon rate that, prior to contractual maturity, is either scheduled to change or is subject to change.
(2) All variable-rate RMBS prime loans are hybrid adjustable-rate mortgage securities.
The table below presents, by loan type, certain characteristics of private-label RMBS, manufactured housing loans and home equity loans in a gross unrealized loss position at June 30, 2011. The lowest ratings available for each security are reported as of August 8, 2011, based on the security's UPB at June 30, 2011 ($ amounts in millions):
August 8, 2011 Ratings Based on | |||||||||||||||||||||||||||||||
June 30, 2011 | June 30, 2011 UPB (3) (4) | ||||||||||||||||||||||||||||||
Gross | Collateral | Other | Below | ||||||||||||||||||||||||||||
Amortized | Unrealized | Delinquency | Investment | Investment | |||||||||||||||||||||||||||
By Loan Type (1) | UPB | Cost | Losses | Rate (2) | AAA (3) | AAA | Grade | Grade | Watchlist | ||||||||||||||||||||||
Private-label RMBS backed by: | |||||||||||||||||||||||||||||||
Prime - 1st lien | $ | 1,230 | $ | 1,125 | $ | (58 | ) | 16 | % | 16 | % | 13 | % | 10 | % | 77 | % | 14 | % | ||||||||||||
Alt-A other - 1st lien | 90 | 82 | (9 | ) | 13 | % | 15 | % | 15 | % | 30 | % | 55 | % | — | % | |||||||||||||||
Total private-label RMBS | 1,320 | 1,207 | (67 | ) | 16 | % | 16 | % | 13 | % | 11 | % | 76 | % | 13 | % | |||||||||||||||
Subprime manufactured housing ABS loans backed by: | |||||||||||||||||||||||||||||||
1st lien | 18 | 18 | (2 | ) | 2 | % | — | % | — | % | 100 | % | — | % | — | % | |||||||||||||||
Total subprime manufactured housing ABS loans | 18 | 18 | (2 | ) | 2 | % | — | % | — | % | 100 | % | — | % | — | % | |||||||||||||||
Subprime home equity ABS loans backed by: (5) | |||||||||||||||||||||||||||||||
2nd lien | 3 | 3 | (1 | ) | 27 | % | — | % | — | % | — | % | 100 | % | — | % | |||||||||||||||
Total subprime home equity ABS loans | 3 | 3 | (1 | ) | 27 | % | — | % | — | % | — | % | 100 | % | — | % | |||||||||||||||
Total private-label MBS and ABS | $ | 1,341 | $ | 1,228 | $ | (70 | ) | 15 | % | 16 | % | 13 | % | 12 | % | 75 | % | 13 | % |
(1) We classify our private-label RMBS, manufactured housing loans and home equity loan investments as prime, Alt-A and subprime based on the originator's classification at the time of origination or based on classification by an NRSRO upon issuance of the MBS.
(2) Includes delinquencies of 60 days or more, foreclosures, real estate owned and bankruptcies, weighted by the UPB of the individual securities in the category based on their respective collateral delinquency.
(3) Represents the lowest ratings available for each security based on the lowest of Moody's, S&P or comparable Fitch ratings.
(4) Excludes paydowns in full subsequent to June 30, 2011.
(5) The credit support for the home equity loans is provided by MBIA Insurance Corporation. This insurance company had a credit rating of B as of August 8, 2011, based on the lower of Moody's and S&P ratings.
OTTI Evaluation Process. In addition to all previously OTTI securities, we evaluate our individual AFS and HTM securities that are in an unrealized loss position for OTTI on a quarterly basis as described in Note 7 - Other-Than-Temporary Impairment Analysis - Notes to Financial Statements contained in our 2010 Form 10-K.
OTTI calculations are performed on an individual security basis where the projected losses of each security vary according to the changes in assumptions. These changes were based on current and forecasted economic trends affecting the underlying loans. Such trends include continued high unemployment, ongoing downward pressure on housing prices, and limited refinancing opportunities for many borrowers whose houses are now worth less than the balance of their mortgages.
The following table presents the significant modeling assumptions used to determine whether a security was OTTI during the second quarter of 2011, as well as the related current credit enhancement, for all private-label RMBS (i.e., excludes ABS) outstanding as of June 30, 2011. Credit enhancement is defined as the percentage of subordinated tranches and over-collateralization, if any, in a security structure that will generally absorb losses before we will experience a loss on the security. The calculated averages represent the dollar-weighted averages of all the private-label RMBS in each category shown. While there is no universally accepted definition of prime, Alt-A or subprime, the classification in the table below is based on the model used to estimate the cash flows for the security, which may not be the same as the classification at the time of origination.
Significant Modeling Assumptions for all Private-label RMBS | Current Credit | |||||||||||||||||||
Prepayment Rates | Default Rates | Loss Severities | Enhancement | |||||||||||||||||
Weighted | Weighted | Weighted | Weighted | |||||||||||||||||
Average | Range | Average | Range | Average | Range | Average | Range | |||||||||||||
Year of Securitization | % | % | % | % | % | % | % | % | ||||||||||||
Prime: | ||||||||||||||||||||
2007 | 7.9 | 7.2 - 9.1 | 43.8 | 29.2 - 57.1 | 44.5 | 41.0 - 48.4 | 5.7 | 1.9 - 10.5 | ||||||||||||
2006 | 8.5 | 3.1 - 10.5 | 20.4 | 12.9 - 23.4 | 42.7 | 37.2 - 58.7 | 4.4 | 2.4 - 6.5 | ||||||||||||
2005 | 9.7 | 7.3 - 14.5 | 33.5 | 0.4 - 43.9 | 37.7 | 19.7 - 47.5 | 8.1 | 4.0 - 11.6 | ||||||||||||
2004 and prior | 20.7 | 1.9 - 45.8 | 7.4 | 0.0 - 21.2 | 26.3 | 0.0 - 57.3 | 10.2 | 2.5 - 60.8 | ||||||||||||
Total Prime | 11.7 | 1.9 - 45.8 | 28.5 | 0.0 - 57.1 | 37.2 | 0.0 - 58.7 | 7.6 | 1.9 - 60.8 | ||||||||||||
Alt-A: | ||||||||||||||||||||
2006 | 12.3 | 12.3 - 12.3 | 27.2 | 27.2 - 27.2 | 45.3 | 45.3 - 45.3 | 4.2 | 4.2 - 4.2 | ||||||||||||
2005 | 8.6 | 7.3 - 13.2 | 39.8 | 29.5 - 42.7 | 44.0 | 37.4 - 45.8 | 2.3 | 2.1 - 3.0 | ||||||||||||
2004 and prior | 15.0 | 11.9 - 17.9 | 6.4 | 0.5 - 9.2 | 25.6 | 19.3 - 37.7 | 9.5 | 4.4 - 15.7 | ||||||||||||
Total Alt-A | 11.8 | 7.3 - 17.9 | 24.5 | 0.5 - 42.7 | 37.2 | 19.3 - 45.8 | 5.5 | 2.1 - 15.7 | ||||||||||||
Total private-label RMBS | 11.7 | 1.9 - 45.8 | 28.2 | 0.0 - 57.1 | 37.2 | 0.0 - 58.7 | 7.4 | 1.9 - 60.8 |
The following table presents the significant modeling assumptions used to determine whether a security was OTTI during the second quarter of 2011 for all home equity loans. Disclosures on current credit enhancements are not considered meaningful for home equity loans as these investments are third-party insured. The calculated averages represent the dollar-weighted averages in each category shown. While there is no universally accepted definition of prime, Alt-A or subprime, the classification in the table below is based on the model used to estimate the cash flows for the security, which may not be the same as the classification at the time of origination.
Significant Modeling Assumptions for all Home Equity Loans | ||||||||||||
Prepayment Rates | Default Rates | Loss Severities | ||||||||||
Weighted | Weighted | Weighted | ||||||||||
Average | Range | Average | Range | Average | Range | |||||||
Year of Securitization | % | % | % | % | % | % | ||||||
Subprime 2004 and prior | 15.4 | 14.0 - 16.1 | 27.0 | 24.6 - 31.5 | 47.5 | 28.1 - 58.1 | ||||||
Total home equity loans | 15.4 | 14.0 - 16.1 | 27.0 | 24.6 - 31.5 | 47.5 | 28.1 - 58.1 |
We continue to actively monitor the credit quality of our private-label MBS and ABS, which depends on the actual performance of the underlying loan collateral as well as our future modeling assumptions. Many factors could influence our future modeling assumptions including economic, financial market and housing market conditions. If performance of the underlying loan collateral deteriorates and/or our modeling assumptions become more pessimistic, we could record additional losses on our portfolio.
MPP. We are exposed to credit risk on loans purchased from members through the MPP. Each loan we purchase must meet guidelines for our MPP or be specifically approved as an exception based on compensating factors. For example, the maximum loan-to-value for any conventional mortgage loan purchased is 95%, and the borrowers must meet certain minimum credit scores depending upon the type of property or loan.
Credit Enhancements. FHA loans comprise 17% of our outstanding MPP loans, at par. These loans are backed by insurance provided by the FHA; therefore, we do not require either LRA or SMI coverage for these loans.
Credit enhancements for conventional loans include (in order of priority):
• | PMI (when applicable for the purchase of mortgages with an initial loan-to-value ratio of over 80% at the time of purchase); |
• | LRA; and |
• | SMI (as applicable) purchased by the seller from a third-party provider naming us as the beneficiary. |
Primary Mortgage Insurance. For a conventional loan, PMI, if applicable, covers losses or exposure down to approximately a loan-to-value ratio of between 65% and 80% based upon the original appraisal, original loan-to-value ratio, term, amount of PMI coverage, and characteristics of the loan. We are exposed to credit risk if a PMI provider fails to fulfill its claims payment obligations to us. As of June 30, 2011, we were the beneficiary of PMI coverage on $649.5 million or 13% of conventional mortgage loans. We have analyzed our potential loss exposure to all of the mortgage insurance companies and do not expect incremental losses due to the lower mortgage insurance company ratings. This expectation is based on the credit-enhancement features of our master commitments (exclusive of PMI), the underwriting characteristics of the loans that back our master commitments, the seasoning of the loans that back these master commitments, and the strong performance of the loans to date. We closely monitor the financial conditions of these mortgage insurance companies.
The following table presents the mortgage insurance companies and related PMI coverage amount on seriously delinquent loans held in our portfolio as of June 30, 2011, and the mortgage insurance company credit ratings as of August 8, 2011
($ amounts in millions):
Seriously Delinquent Loans with Primary Mortgage Insurance (2) | ||||||||||||
Credit | ||||||||||||
Credit | Rating | PMI Coverage | ||||||||||
Mortgage Insurance Company | Rating (1) | Outlook (1) | UPB | Outstanding | ||||||||
Mortgage Guaranty Insurance Corporation | B | Negative | $ | 7 | $ | 2 | ||||||
Republic Mortgage Insurance Corporation (3) | B | Negative | 5 | 1 | ||||||||
Radian Guaranty, Inc. | B | Negative | 5 | 1 | ||||||||
Genworth Mortgage Insurance Corporation Corporation | BB | Negative | 3 | 1 | ||||||||
United Guaranty Residential Insurance Corporation | BBB | Stable | 3 | 1 | ||||||||
All Others | NR,BBB,CCC | N/A | 2 | 1 | ||||||||
Total | $ | 25 | $ | 7 |
(1) Represents the lowest credit rating and outlook of S&P, Moody's or Fitch stated in terms of the S&P equivalent as of August 8, 2011.
(2) Seriously delinquent loans includes loans that are 90 days or more past due or in the process of foreclosure.
(3) On August 3, 2011, we announced that we would no longer accept Republic Mortgage Insurance Corporation as a provider of PMI, effective with mandatory delivery contracts committed on or after August 1, 2011.
Lender Risk Account. We use either a "spread LRA" or a "fixed LRA" for credit enhancement. For each pool of conventional loans acquired prior to December 2010, we established a spread LRA in combination with SMI. The spread LRA is funded through a reduction to our net yield earned on the loans, and the corresponding purchase price paid to the PFI reflects the reduced net yield to us. The fixed LRA is funded through an adjustment to the corresponding price paid to the PFI. As these funds are collected, either from the remittances or a reduction in purchase price, they are held by us and used to reimburse losses incurred by us or the SMI provider, if applicable, within each pool. If any LRA funds are not used to cover losses, the remaining funds in the LRA are returned to the member in accordance with the Master Commitment Contracts. The LRA for each Master Commitment Contract is segregated. These funds are available to cover losses in excess of the borrower's equity and PMI, if any, on the conventional loans we have purchased.
The LRA is recorded in Other Liabilities in the Statement of Condition and totaled $19.0 million at June 30, 2011, and $21.1 million at December 31, 2010. See Note 8 - Allowance for Credit Losses - Notes to Financial Statements for more information.
Supplemental Mortgage Insurance. For pools of loans acquired prior to December 6, 2010, we have credit protection from loss on each loan, where eligible, through SMI, which provides sufficient insurance to cover credit losses to approximately 50% of the property's original value, subject, in certain cases, to an aggregate stop-loss provision in the SMI policy. Master Commitment Contracts that equal or exceed $35 million include an aggregate loss/benefit limit or "stop-loss" that is equal to the total initial principal balance of loans under the Master Commitment Contract multiplied by the stop-loss percentage, as is then in effect, and represents the maximum aggregate amount payable by the SMI provider under the SMI policy for that pool. We do not have SMI coverage on loans purchased on or after December 6, 2010.
Even with the stop-loss provision, the aggregate of the LRA and the amount payable by the SMI provider under an SMI stop-loss contract will be equal to or greater than the amount of credit enhancement required for the pool to have an implied credit rating of at least AA at the time of purchase.
Non-credit losses, such as uninsured property damage losses that are not covered by the SMI, can be recovered from the LRA to the extent that there are available funds prior to a disbursement to the PFI. We will absorb any non-credit losses greater than the available LRA.
Credit Risk Exposure to Supplemental Mortgage Insurance Providers. As of June 30, 2011, we were the beneficiary of SMI coverage on mortgage pools with a total UPB of $5.2 billion. Two mortgage insurance companies provide all of the SMI coverage. The following table presents the SMI exposure ($ amounts in millions):
Mortgage Insurance Company | June 30, 2011 | December 31, 2010 | ||||||
Mortgage Guaranty Insurance Corporation | $ | 29 | $ | 22 | ||||
Genworth Mortgage Insurance Corporation | 22 | 17 | ||||||
Total | $ | 51 | $ | 39 |
Finance Agency credit-risk-sharing regulations require us to use SMI providers that are rated at least AA- at the time the loans are purchased. With the deterioration in the mortgage markets, we have been unable to meet the Finance Agency regulation's rating requirement because no mortgage insurers that underwrite SMI are currently rated in the second highest rating category or better by any NRSRO. In fact, none of the mortgage insurance companies providing SMI coverage to us at this time were rated higher than BB as of August 8, 2011. On November 29, 2010, we began offering MPP Advantage, which utilizes an enhanced fixed LRA account for additional credit enhancement for new MPP business consistent with Finance Agency regulations, instead of utilizing coverage from an SMI provider. Additional information is provided in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation - Recent Accounting and Regulatory Developments - Legislative and Regulatory Developments - Other Legislative and Regulatory Developments in our 2010 Form 10-K.
Loan Characteristics. The mortgage loans purchased through the MPP are currently dispersed across 50 states and the District of Columbia. No single zip code represented more than 1% of MPP loans outstanding at June 30, 2011, or December 31, 2010. It is likely that the concentration of MPP loans in our district states of Indiana and Michigan will increase in the future, due to the loss of the three largest sellers in 2006 - 2007 that were our primary sources of nationwide mortgages. The median outstanding balance of our MPP loans was approximately $133 thousand and $134 thousand at June 30, 2011, and December 31, 2010, respectively.
Credit Performance. The UPB of our conventional and FHA loans 90 days or more past due and accruing interest and the allowance for loan losses are presented in the table below ($ amounts in millions):
June 30, 2011 | December 31, 2010 | |||||||
Real estate mortgages past due 90 days or more and still accruing interest | $ | 117 | $ | 127 | ||||
Allowance for loan losses | 2 | 1 |
The allowance for loan losses includes our best estimate of probable losses over the next 12 months that would not be recovered from the credit enhancements. This estimate incorporates potential claims by servicers for any losses on approximately $27.3 million of principal that has been paid in full by the servicers through June 30, 2011.
There were no troubled debt restructurings related to mortgage loans during the three or six months ended June 30, 2011, or 2010.
The serious delinquency rate for our FHA mortgages was 0.24% at June 30, 2011, compared to 0.09% at December 31, 2010. We rely on insurance provided by the FHA, which generally provides coverage for 100% of the principal balance of the underlying mortgage loan and defaulted interest at the debenture rate. However, we would receive defaulted interest at the contractual rate from the servicer.
The serious delinquency rate for conventional mortgages was 2.21% at June 30, 2011, compared to 2.24% at December 31, 2010. Both rates were below the national serious delinquency rate. See Note 8 - Allowance for Credit Losses - Notes to Financial Statements for more information.
Derivatives. A primary credit risk posed by derivative transactions is the risk that a counterparty will fail to meet its related contractual obligations, forcing us to replace the derivatives at market prices. The notional amount of interest-rate exchange agreements does not represent our true credit risk exposure. Rather, when the net fair value of our interest-rate exchange agreements with a counterparty is positive, this generally indicates that the counterparty owes us. When the net fair value of the interest-rate exchange agreements is negative, this generally indicates that we owe the counterparty. If a counterparty fails to perform, our credit risk is approximately equal to the aggregate fair value gain, if any, on the interest-rate exchange agreements.
The following table presents key information on derivative counterparties on a settlement date basis using credit ratings based on the lower of S&P or Moody's ($ amounts in millions):
Credit Exposure | Other | |||||||||||||||
Total | Net of Cash | Collateral | Net Credit | |||||||||||||
June 30, 2011 | Notional | Collateral | Held | Exposure | ||||||||||||
AA | $ | 11,227 | $ | — | $ | — | $ | — | ||||||||
A | 17,403 | — | — | — | ||||||||||||
Unrated | 28 | — | — | — | ||||||||||||
Subtotal | 28,658 | — | — | — | ||||||||||||
Member institutions (1) | 29 | — | — | — | ||||||||||||
Total | $ | 28,687 | $ | — | $ | — | $ | — | ||||||||
December 31, 2010 | ||||||||||||||||
AA | $ | 14,691 | $ | 6 | $ | — | $ | 6 | ||||||||
A | 18,549 | — | — | — | ||||||||||||
Unrated | 126 | — | — | — | ||||||||||||
Subtotal | 33,366 | 6 | — | 6 | ||||||||||||
Member institutions (1) | 57 | — | — | — | ||||||||||||
Total | $ | 33,423 | $ | 6 | $ | — | $ | 6 |
(1) Includes mortgage delivery commitments.
AHP. Our AHP requires members and project sponsors to make commitments with respect to the usage of the AHP grants to assist very low-, low-, and moderate-income families, as defined by regulation. If these commitments are not met, we may have an obligation to recapture these funds from the member or project sponsor to replenish the AHP fund. This credit exposure is addressed in part by evaluating project feasibility at the time of an award and the member’s ongoing monitoring of AHP projects.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk that the market value or estimated fair value of our overall portfolio of assets and liabilities, including derivatives, or our net earnings will decline as a result of changes in interest rates or financial market volatility. The goal of market risk management is to preserve our financial strength at all times, including during periods of significant market volatility and across a wide range of possible interest-rate changes. We regularly assess our exposure to changes in interest rates using a diverse set of analyses and measures. As appropriate, we may rebalance our portfolio to help attain risk management objectives.
Measuring Market Risks
We utilize multiple risk measurements, including duration of equity, duration gap, convexity, VaR, earnings at risk, and changes in market value of equity, to calculate market risk. Periodically, stress tests are conducted to measure and analyze the effects that extreme movements in the level of interest rates and the shape of the yield curve would have on our risk position. Detailed information about some of these market risk measurements is provided below.
Duration of Equity. Duration of equity is a measure of interest-rate risk and a primary metric used to manage our market risk exposure. It is an estimate of the percentage change (expressed in years) in our market value of equity that could be caused by a 100 basis point parallel upward or downward shift in the interest-rate curves. We value our portfolios using two main interest-rate curves, the LIBOR curve and the CO curve. The market value and interest-rate sensitivity of each asset, liability, and off balance sheet position is computed to determine our duration of equity. We calculate duration of equity using the interest-rate curves as of the date of calculation and for scenarios where interest-rate curves are 200 bps higher or lower than the initial level. Our board of directors determines acceptable ranges for duration of equity. A negative duration of equity suggests adverse exposure to falling rates and a favorable response to rising rates, while a positive duration suggests adverse exposure to rising rates and a favorable response to falling rates.
The following table presents the effective duration of equity levels for our total position which are subject to internal policy guidelines:
-200 basis points* | 0 basis points | +200 basis points | ||||
June 30, 2011 | (0.5) years | 0.1 years | 2.0 years | |||
December 31, 2010 | (1.0) years | 0.6 years | 2.9 years |
* Our internal policy guidelines provide for the calculation of the duration of equity in a low-rate environment to be based on the Finance Agency Advisory Bulletin 03-09, as modified September 3, 2008. Under these guidelines, our duration of equity was 0.1 years at June 30, 2011, and 0.6 years at December 31, 2010.
We were in compliance with the duration of equity limits established at both dates.
Duration Gap. The duration gap is the difference between the effective duration of total assets and the effective duration of total liabilities, adjusted for the effect of derivatives. A positive duration gap signals an exposure to rising interest rates because it indicates that the duration of assets exceeds the duration of liabilities. A negative duration gap signals an exposure to declining interest rates because the duration of assets is less than the duration of liabilities. The duration gap was (1.1) months at June 30, 2011, compared to (0.6) months at December 31, 2010.
Convexity. Convexity measures how fast duration changes as a function of interest-rate changes. Measurement of convexity is important because of the optionality embedded in the mortgage and callable debt portfolios. The mortgage portfolios exhibit negative convexity due to the embedded prepayment options. Management routinely reviews convexity and considers it when developing funding and hedging strategies for the acquisition of mortgage-based assets. A primary strategy for managing convexity risk arising from our mortgage portfolio is the issuance of callable debt. At June 30, 2011, callable debt funding mortgage assets as a percentage of the net mortgage portfolio equaled 35%, compared to 34% at the end of 2010. The negative convexity of the mortgage assets is partially offset by the negative convexity of underlying callable debt.
Market Risk-Based Capital Requirement. We are subject to the Finance Agency's risk-based capital regulations. This regulatory framework requires the maintenance of sufficient permanent capital to meet the combined credit risk, market risk, and operations risk components. Our permanent capital is defined by the Finance Agency as Class B Stock (including MRCS) and Retained Earnings. The market risk-based capital component is the sum of two factors. The first factor is the market value of the portfolio at risk from movements in interest rates that could occur during times of market stress. This estimation is accomplished through an internal VaR-based modeling approach that was approved by the Federal Housing Finance Board (predecessor to the Finance Agency) before the implementation of our capital plan. The second factor is the amount, if any, by which the current market value of total regulatory capital is less than 85% of the book value of total regulatory capital.
The VaR approach used for calculating the first factor is primarily based upon historical simulation methodology. The estimation incorporates scenarios that reflect interest-rate shifts, interest-rate volatility, and changes in the shape of the yield curve. These observations are based on historical information from 1978 to the present. When calculating the risk-based capital requirement, the VaR comprising the first factor of the market risk component is defined as the potential dollar loss from adverse market movements, for a holding period of 120 business days, with a 99% confidence interval, based on these historical prices and market rates. Market risk-based capital estimates are presented below ($ amounts in millions):
VaR | ||||
June 30, 2011 | $ | 263 | ||
December 31, 2010 | 286 |
Changes in the Ratio of Market Value to Book Value of Equity between Base Rates and Shift Scenarios. We measure potential changes in the market value to book value of equity based on the current month-end level of rates versus the ratio of market value to book value of equity under large parallel rate shifts. This measurement provides information related to the sensitivity of our interest-rate position. The table below presents changes in the ratio of market value to book value of equity from the base rates:
-200 bps | +200 bps | ||||
June 30, 2011 | 1.6 | % | (2.0 | )% | |
December 31, 2010 | 0.1 | % | (4.0 | )% |
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We are responsible for establishing and maintaining disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in our reports filed under the Exchange Act is: (a) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms; and (b) accumulated and communicated to our management, including our principal executive officer, principal financial officer, and principal accounting officer, to allow timely decisions regarding required disclosures. As of June 30, 2011, we conducted an evaluation, under the supervision, and with the participation, of our management, including our Chief Executive Officer (the principal executive officer), Chief Operating Officer-Chief Financial Officer (the principal financial officer) and Chief Accounting Officer (the principal accounting officer), of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based on that evaluation, our Chief Executive Officer, Chief Operating Officer-Chief Financial Officer and Chief Accounting Officer concluded that our disclosure controls and procedures were effective as of June 30, 2011.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting, as defined in rules 13a-15(f) and 15(d)-15(f) of the Exchange Act, that occurred during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Limitations on the Effectiveness of Controls
We do not expect that our disclosure controls and procedures and other internal controls will prevent all error and fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can only be reasonable assurance that any design will succeed in achieving its stated goals under all potential future conditions. Additionally, over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost effective control system, misstatements due to error or fraud may occur and not be detected.
Part II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
Except as described in the following paragraphs, we are unaware of any potential claims that could be material.
Lehman Brothers Bankruptcy
As previously disclosed in our Form 10-Q for the quarter ended September 30, 2008, Lehman Brothers Holding Company, the guarantor for one of our former derivatives counterparties, Lehman Brothers Special Financing (Lehman), declared bankruptcy on September 15, 2008. We provided notice of default based on the bankruptcy to Lehman Brothers Holding Company on September 22, 2008, and designated September 25, 2008, as the early termination date under the International Swaps and Derivatives Association Master Agreement. On the early termination date, we had $5.4 billion notional amount of derivatives transactions outstanding with Lehman and no collateral posted to Lehman. The close-out provisions of the International Swaps and Derivatives Master Agreement required us to pay Lehman a termination fee of approximately $95.6 million, which we remitted to Lehman on September 25, 2008. Lehman's bankruptcy remains pending in the United States Bankruptcy Court Southern District of New York as Chapter 11 Case No. 08-13555(JMP).
On May 9, 2011, we received a Derivatives Alternative Dispute Resolution notice from the Lehman bankruptcy estate with a settlement demand of $1.471 million, which is the difference between the termination fee we previously paid Lehman and the market value fee we received on the replacement swaps, plus interest accruing since the early termination date, at Lehman's cost of funds plus 1%. Lehman asserts such accrued interest, as of May 9, 2011, amounts to approximately $650 thousand. On June 8, 2011, we filed a response in which we rejected Lehman's settlement demand. On June 23, 2011, Lehman served a reply, effectively reiterating its demand. We expect this matter to be scheduled for mediation with a court-appointed mediator. While we believe that we fully satisfied our obligation to Lehman and intend to vigorously defend this matter, we are unable to predict the timing or ultimate outcome of this matter.
Private-Label MBS Litigation
On July 14, 2011, we filed an amended complaint in the Superior Court of Marion County, Indiana, relating to 30 private-label MBS we purchased in the aggregate original principal amount of approximately $2.7 billion. Our amended complaint, like our original complaint filed on October 15, 2010, is an action for rescission and damages and continues to assert claims for negligent misrepresentation and violations of state and federal securities law occurring in connection with the sale of these private-label MBS. Our amended complaint includes additional legal and factual allegations in support of our claims and makes other technical corrections.
The table below provides additional information concerning the private-label MBS at issue in our amended complaint, the original principal amount of each security, the defendants named in the amended complaint, and their alleged capacities with respect to each security.
Number | Original Face Amount | Defendants | Capacities | |||
1 | $ | 70,000,000 | Banc of America Mortgage Securities, Inc. | Depositor | ||
Bank of America Securities LLC | Underwriter / Seller | |||||
Bank of America Corporation | Controlling Person | |||||
2 | 96,221,210 | Banc of America Securities LLC | Seller | |||
Bank of America Corporation | Controlling Person | |||||
Structured Asset Mortgage Investments II Inc. | Depositor | |||||
The Bear Stearns Companies, Inc. n/k/a The Bear Stearns Companies, LLC | Controlling Person | |||||
Bear, Stearns & Co. Inc. | Underwriter | |||||
3 | 100,306,000 | Countrywide Financial Corporation | Controlling Person | |||
CWMBS, Inc. | Depositor | |||||
Credit Suisse (USA), Inc. | Controlling Person | |||||
Credit Suisse First Boston LLC | Underwriter / Seller | |||||
Credit Suisse Holdings (USA), Inc. | Controlling Person | |||||
4 | 100,000,000 | Countrywide Financial Corporation | Controlling Person | |||
CWMBS, Inc. | Depositor | |||||
Goldman, Sachs & Co. | Underwriter / Seller | |||||
The Goldman Sachs Group Inc. | Controlling Person |
Number | Original Face Amount | Defendants | Capacities | |||
5 | 42,330,700 | Chase Mortgage Finance Corporation | Depositor | |||
J.P. Morgan Securities Inc. | Underwriter / Seller | |||||
JPMorgan Chase & Co. | Controlling Person | |||||
JPMorgan Securities Holdings LLC | Controlling Person | |||||
6 | 54,755,000 | Bear, Stearns & Co. Inc. | Underwriter / Seller | |||
Countrywide Financial Corporation | Controlling Person | |||||
CWMBS, Inc. | Depositor | |||||
The Bear Stearns Companies, Inc. n/k/a The Bear Stearns Companies, LLC | Controlling Person | |||||
7 | 64,454,000 | Credit Suisse (USA), Inc. | Controlling Person | |||
Credit Suisse First Boston LLC | Underwriter / Seller | |||||
Credit Suisse First Boston Mortgage Securities Corp. | Depositor | |||||
Credit Suisse Holdings (USA), Inc. | Controlling Person | |||||
9 | 86,000,000 | The Goldman Sachs Group Inc. | Controlling Person | |||
GS Mortgage Securities Corp. | Depositor | |||||
Goldman, Sachs & Co. | Underwriter / Seller | |||||
Goldman Sachs Mortgage Company | Controlling Person | |||||
10 | 56,658,000 | The Goldman Sachs Group Inc. | Controlling Person | |||
GS Mortgage Securities Corp. | Depositor | |||||
Goldman, Sachs & Co. | Underwriter / Seller | |||||
Goldman Sachs Mortgage Company | Controlling Person | |||||
11 | 100,000,000 | The Goldman Sachs Group Inc. | Controlling Person | |||
GS Mortgage Securities Corp. | Depositor | |||||
Goldman, Sachs & Co. | Underwriter / Seller | |||||
Goldman Sachs Mortgage Company | Controlling Person | |||||
12 | 105,000,000 | The Goldman Sachs Group Inc. | Controlling Person | |||
GS Mortgage Securities Corp. | Depositor | |||||
Goldman, Sachs & Co. | Underwriter / Seller | |||||
Goldman Sachs Mortgage Company | Controlling Person | |||||
13 | 53,899,000 | The Goldman Sachs Group Inc. | Controlling Person | |||
GS Mortgage Securities Corp. | Depositor | |||||
Goldman, Sachs & Co. | Underwriter / Seller | |||||
Goldman Sachs Mortgage Company | Controlling Person | |||||
14 | 143,000,000 | The Goldman Sachs Group Inc. | Controlling Person | |||
GS Mortgage Securities Corp. | Depositor | |||||
Goldman, Sachs & Co. | Underwriter / Seller | |||||
Goldman Sachs Mortgage Company | Controlling Person | |||||
15 | 105,000,000 | The Goldman Sachs Group Inc. | Controlling Person | |||
GS Mortgage Securities Corp. | Depositor | |||||
Goldman, Sachs & Co. | Underwriter / Seller | |||||
Goldman Sachs Mortgage Company | Controlling Person | |||||
16 | 103,000,000 | The Goldman Sachs Group Inc. | Controlling Person | |||
GS Mortgage Securities Corp. | Depositor | |||||
Goldman, Sachs & Co. | Underwriter / Seller | |||||
Goldman Sachs Mortgage Company | Controlling Person | |||||
17 | 82,019,000 | IndyMac MBS, Inc. | Depositor | |||
UBS Securities LLC | Underwriter / Seller | |||||
18 | 54,125,700 | J.P. Morgan Acceptance Corporation I | Depositor | |||
J.P. Morgan Securities Inc. | Underwriter / Seller | |||||
JPMorgan Chase & Co. | Controlling Person | |||||
JPMorgan Securities Holdings LLC | Controlling Person | |||||
19 | 90,360,000 | GMAC, Inc. n/k/a Ally Financial, Inc. | Controlling Person | |||
GMAC Mortgage Group, Inc. | Controlling Person | |||||
Greenwich Capital Markets, Inc. | Underwriter / Seller | |||||
Residential Funding Mortgage Securities I, Inc. | Depositor | |||||
Number | Original Face Amount | Defendants | Capacities | |||
20 | 99,160,206 | Credit Suisse (USA), Inc. | Controlling Person | |||
Credit Suisse First Boston LLC | Seller | |||||
Credit Suisse Holdings (USA), Inc. | Controlling Person | |||||
GMAC, Inc. n/k/a Ally Financial, Inc. | Controlling Person | |||||
GMAC Mortgage Group, Inc. | Controlling Person | |||||
Residential Funding Mortgage Securities I, Inc. | Depositor | |||||
Residential Funding Securities, LLC | Underwriter | |||||
21 | 94,464,000 | GMAC, Inc. n/k/a Ally Financial, Inc. | Controlling Person | |||
GMAC Mortgage Group, Inc. | Controlling Person | |||||
Greenwich Capital Markets, Inc. | Underwriter / Seller | |||||
Residential Funding Mortgage Securities I, Inc. | Depositor | |||||
22 | 95,418,000 | GS Mortgage Securities Corp. | Depositor | |||
Goldman, Sachs & Co. | Underwriter / Seller | |||||
The Goldman Sachs Group Inc. | Controlling Person | |||||
23 | 143,860,000 | WaMu Asset Acceptance Corp. | Depositor | |||
WaMu Capital Corp. | Underwritter | |||||
24 | 93,831,000 | J.P. Morgan Securities Inc. | Underwriter / Seller | |||
JPMorgan Chase & Co. | Controlling Person | |||||
JPMorgan Securities Holdings LLC | Controlling Person | |||||
WaMu Asset Acceptance Corp. | Depositor | |||||
WaMu Capital Corp. | Underwritter | |||||
25 | 106,000,000 | Goldman, Sachs & Co. | Underwriter / Seller | |||
The Goldman Sachs Group Inc. | Controlling Person | |||||
WaMu Asset Acceptance Corp. | Depositor | |||||
WaMu Capital Corp. | Underwritter | |||||
26 | 59,874,246 | Credit Suisse (USA), Inc. | Controlling Person | |||
Credit Suisse Holdings (USA), Inc. | Controlling Person | |||||
Credit Suisse First Boston LLC | Seller | |||||
WaMu Asset Acceptance Corp. | Depositor | |||||
WaMu Capital Corp. | Underwritter | |||||
27 | 112,889,185 | Banc of America Securities LLC | Seller | |||
Bank of America Corporation | Controlling Person | |||||
WaMu Asset Acceptance Corp. | Depositor | |||||
WaMu Capital Corp. | Underwritter | |||||
28 | 100,000,000 | UBS Securities LLC | Underwriter / Seller | |||
Wells Fargo & Company | Controlling Person | |||||
Wells Fargo Asset Securities Corporation | Depositor | |||||
Wells Fargo Bank, National Association | Controlling Person | |||||
30 | 165,000,000 | Wells Fargo & Company | Controlling Person | |||
Wells Fargo Asset Securities Corporation | Depositor | |||||
Wells Fargo Bank, National Association | Controlling Person | |||||
Credit Suisse First Boston LLC | Underwriter / Seller | |||||
Credit Suisse (USA), Inc. | Controlling Person | |||||
Credit Suisse Holdings (USA), Inc. | Controlling Person | |||||
31 | 59,618,990 | Wells Fargo & Company | Controlling Person | |||
Wells Fargo Asset Securities Corporation | Depositor | |||||
Wells Fargo Bank, National Association | Controlling Person | |||||
Greenwich Capital Markets, Inc. | Underwriter / Seller | |||||
32 | 100,000,000 | Wells Fargo & Company | Controlling Person | |||
Wells Fargo Asset Securities Corporation | Depositor | |||||
Wells Fargo Bank, National Association | Controlling Person | |||||
Goldman, Sachs & Co. | Underwriter / Seller | |||||
The Goldman Sachs Group Inc. | Controlling Person | |||||
Total | $ | 2,737,244,237 |
Item 1A. RISK FACTORS
Except for an update to the following risk factor, there have been no material changes in the risk factors described in Item 1A of our 2010 Form 10-K.
Our Credit Rating, the Credit Rating of One or More of the Other FHLBanks, or the Credit Rating of the Consolidated Obligations Could be Lowered, Which Could Adversely Impact Our Cost of Funds, Our Ability to Access the Capital Markets, and/or Our Ability to Enter Into Derivative Instrument Transactions on Acceptable Terms
S&P and Moody's have each taken various actions regarding credit ratings on the FHLBanks and the FHLBank System's Consolidated Obligations, based on the implied linkage between the FHLBanks, and the FHLBank System's Consolidated Obligations, to the United States government. On August 2, 2011, Moody's confirmed the Aaa rating on the FHLBank System's Consolidated Obligations and changed the rating outlook to negative at the same time that Moody's confirmed the Aaa bond rating of the United States government and changed the rating outlook to negative.
On August 5, 2011, S&P lowered its long-term sovereign rating on the United States government from AAA to AA+ and affirmed its A-1+ short-term credit rating on the United States government. S&P removed both ratings from CreditWatch, where they had been placed on July 15, 2011, with negative implications. On August 8, 2011, S&P lowered the issuer credit ratings of 10 of 12 FHLBanks (including us) and the rating on the FHLBank System's Consolidated Obligations from AAA to AA+. All 12 of the FHLBanks are currently rated AA+ with negative outlook. S&P affirmed the short-term issuer ratings of the FHLBanks and the short-term rating of the FHLBank System's debt at A-1+ and removed all of the ratings from CreditWatch. As a result of S&P lowering our credit rating, we could be required to deliver additional collateral (at fair value) to certain of our derivative counterparties. Such amount was approximately $650 million as of July 31, 2011.
While at this time the recent rating actions have not had a material impact on our funding costs, we cannot predict what the longer-term impacts will be.
However, if our credit rating, the credit ratings of one or more of the other FHLBanks or the credit rating of the Consolidated Obligations are lowered again, our cost of issuing debt, our ability to access the capital markets, and/or our ability to enter into derivative instrument transactions on acceptable terms could be adversely affected.
ITEM 6. EXHIBITS
EXHIBIT INDEX
Exhibit Number | Description | |
3.1* | Organization Certificate of the Federal Home Loan Bank of Indianapolis, incorporated by reference to our Registration Statement on Form 10 filed on February 14, 2006 | |
3.2* | Bylaws of the Federal Home Loan Bank of Indianapolis, incorporated by reference to Exhibit 3.2 of our Current Report on Form 8-K filed on May 21, 2010 | |
4* | Capital Plan of the Federal Home Loan Bank of Indianapolis, effective September 5, 2011, incorporated by reference to Exhibit 99.1 of our Current Report on Form 8-K filed on August 5, 2011 | |
10.1*+ | Federal Home Loan Bank of Indianapolis 2009 Executive Incentive Compensation Plan, incorporated by reference to Exhibit 99.1 of our Current Report on Form 8-K filed on August 13, 2009 | |
10.2*+ | Form of Key Employee Severance Agreement for Executive Officers, incorporated by reference to our Current Report on Form 8-K, filed on November 20, 2007 | |
10.3*+ | Directors' Compensation and Travel Expense Reimbursement Policy effective January 1, 2011, incorporated by reference to Exhibit 99.3 of our Current Report on Form 8-K filed on December 17, 2010 | |
10.4*+ | Federal Home Loan Bank of Indianapolis 2011 Long Term Incentive Plan, effective January 1, 2011, incorporated by reference to Exhibit 10.12 of our Annual Report on Form 10-K filed on March 18, 2011 | |
10.5*+ | Federal Home Loan Banks P&I Funding and Contingency Plan Agreement, incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K filed on June 27, 2006 | |
10.6*+ | Federal Home Loan Bank 2009 Long Term Incentive Plan, incorporated by reference to our Annual Report on Form 10-K filed on March 16, 2009 | |
10.7*+ | Federal Home Loan Bank of Indianapolis 2011 Executive Incentive Compensation Plan (STI), effective January 1, 2011, incorporated by reference to Exhibit 10.15 of our Annual Report on Form 10-K filed on March 18, 2011 | |
10.8*+ | Form of Key Employee Severance Agreement for Principal Executive Officer, incorporated by reference to Exhibit 99.1 of our Current Report on Form 8-K filed on May 24, 2010 | |
10.9*+ | Form of Key Employee Severance Agreement for Executive Officers, incorporated by reference to Exhibit 99.1 of our Current Report on Form 8-K filed on February 4, 2011 | |
10.10* | Joint Capital Enhancement Agreement dated August 5, 2011, incorporated by reference to Exhibit 99.1 of our Current Report on Form 8-K filed on August 5, 2011 | |
31.1 | Certification of the President - Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
Exhibit Number | Description | |
31.2 | Certification of the Executive Vice President - Chief Operating Officer - Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.3 | Certification of the Senior Vice President - Chief Accounting Officer pursuant to Section 302 of the Sarbanes - Oxley Act of 2002 | |
32 | Certification of the President - Chief Executive Officer, Executive Vice President - Chief Operating Officer - Chief Financial Officer, and Senior Vice President - Chief Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
101.INS | XBRL Instance Document | |
101.SCH | XBRL Taxonomy Extension Schema Document | |
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | |
101.LAB | XBRL Taxonomy Extension Label Linkbase Document | |
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document | |
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document |
* These documents are incorporated by reference.
+ Management contract or compensatory plan or arrangement.
GLOSSARY OF TERMS
ABS: Asset-backed securities
Advances: Secured loans to members
AFS: Available-for-sale
AHP: Affordable Housing Program
AMA: Acquired Member Assets
AOCI: Accumulated Other Comprehensive Income (Loss)
Bank Act: Federal Home Loan Bank Act of 1932, as amended
CFTC: Commodity Futures Trading Commission
Consolidated Obligations: CO Bonds and Discount Notes
Dodd-Frank Act: Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted July 21, 2010
Exchange Act: Securities Exchange Act of 1934, as amended
Fannie Mae: Federal National Mortgage Association
FASB: Financial Accounting Standards Board
FDIC: Federal Deposit Insurance Corporation
FOMC: Federal Open Market Committee
FHA: Federal Housing Administration
FHLBank: A Federal Home Loan Bank
FHLBanks: The 12 Federal Home Loan Banks or subset thereof
FHLBank System: The 12 FHLBanks and the Office of Finance
Finance Agency: Federal Housing Finance Agency
Fitch: Fitch Ratings, Inc.
Form 8-K: Current Report on Form 8-K as filed with the SEC under the Securities Exchange Act of 1934
Form 10-K: Annual Report on Form 10-K as filed with the SEC under the Securities Exchange Act of 1934
Form 10-Q: Quarterly Report on Form 10-Q as filed with the SEC under the Securities Exchange Act of 1934
Freddie Mac: Federal Home Loan Mortgage Corporation
GAAP: Generally accepted accounting principles in the United States of America
Ginnie Mae: Government National Mortgage Association
GSE: Government-sponsored enterprise
HTM: Held-to-maturity
JCE Agreement: Joint Capital Enhancement Agreement
LIBOR: London Interbank Offered Rate
LRA: Lender risk account
MBS: Mortgage-backed securities
Moody's: Moody's Investor Service
MPP: Mortgage Purchase Program
MRCS: Mandatorily Redeemable Capital Stock
NRSRO: Nationally Recognized Statistical Rating Organization
NM: The ratio or percentage is not meaningful
OCI: Other Comprehensive Income
OTTI: Other-Than-Temporary-Impairment (or other-than-temporarily impaired as the context indicates)
PFI: Participating Financial Institution
PMI: Primary mortgage insurance
REFCORP: Resolution Funding Corporation
RMBS: Residential mortgage-backed securities
S&P: Standard & Poor's Rating Service
SEC: Securities and Exchange Commission
SMI: Supplemental mortgage insurance
TLGP: The FDIC's Temporary Liquidity Guarantee Program
UPB: Unpaid principal balance
VaR: Value at risk
VIE: Variable Interest Entity
WAIR: Weighted average interest rate
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
FEDERAL HOME LOAN BANK OF INDIANAPOLIS | ||
August 10, 2011 | By: | /s/ MILTON J. MILLER II |
Name: | Milton J. Miller II | |
Title: | President - Chief Executive Officer | |
August 10, 2011 | By: | /s/ CINDY L. KONICH |
Name: | Cindy L. Konich | |
Title: | Executive Vice President - Chief Operating Officer - Chief Financial Officer | |
August 10, 2011 | By: | /s/ K. LOWELL SHORT, JR. |
Name: | K. Lowell Short, Jr. | |
Title: | Senior Vice President - Chief Accounting Officer |