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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2011
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number 000-51405
FEDERAL HOME LOAN BANK OF DALLAS
(Exact name of registrant as specified in its charter)
Federally chartered corporation (State or other jurisdiction of incorporation or organization) | 71-6013989 (I.R.S. Employer Identification Number) | |
8500 Freeport Parkway South, Suite 600 Irving, TX (Address of principal executive offices) | 75063-2547 (Zip code) |
(214) 441-8500
(Registrant’s telephone number, including area code)
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant [1] has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and [2] has been subject to such filing requirements for the past 90 days.
Yesþ Noo
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (17 C.F.R. §232.405) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yeso Noo
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filero | Accelerated filero | Non-accelerated filerþ | Smaller reporting companyo | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yeso Noþ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
At April 30, 2011 the registrant had outstanding 12,934,979 shares of its Class B Capital Stock, $100 par value per share.
FEDERAL HOME LOAN BANK OF DALLAS
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FEDERAL HOME LOAN BANK OF DALLAS
STATEMENTS OF CONDITION
(Unaudited; in thousands, except share data)
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
ASSETS | ||||||||
Cash and due from banks | $ | 511,713 | $ | 1,631,899 | ||||
Interest-bearing deposits | 252 | 208 | ||||||
Security purchased under agreement to resell | 375,000 | — | ||||||
Federal funds sold | 2,326,000 | 3,767,000 | ||||||
Trading securities (Note 11) | 5,956 | 5,317 | ||||||
Held-to-maturity securities (a) (Note 3) | 7,838,641 | 8,496,429 | ||||||
Advances (Notes 4 and 5) | 21,804,806 | 25,455,656 | ||||||
Mortgage loans held for portfolio, net of allowance for credit losses of $225 at both March 31, 2011 and December 31, 2010 (Note 5) | 194,478 | 207,168 | ||||||
Accrued interest receivable | 40,678 | 43,248 | ||||||
Premises and equipment, net | 24,477 | 24,660 | ||||||
Derivative assets (Notes 8 and 11) | 29,106 | 38,671 | ||||||
Other assets | 18,602 | 19,814 | ||||||
TOTAL ASSETS | $ | 33,169,709 | $ | 39,690,070 | ||||
LIABILITIES AND CAPITAL | ||||||||
Deposits | ||||||||
Interest-bearing | $ | 1,322,804 | $ | 1,070,028 | ||||
Non-interest bearing | 24 | 24 | ||||||
Total deposits | 1,322,828 | 1,070,052 | ||||||
Consolidated obligations, net (Note 6) | ||||||||
Discount notes | 500,000 | 5,131,978 | ||||||
Bonds | 29,302,425 | 31,315,605 | ||||||
Total consolidated obligations, net | 29,802,425 | 36,447,583 | ||||||
Mandatorily redeemable capital stock | 18,131 | 8,076 | ||||||
Accrued interest payable | 117,504 | 94,417 | ||||||
Affordable Housing Program (Note 7) | 38,853 | 41,044 | ||||||
Payable to REFCORP | 3,049 | 5,593 | ||||||
Derivative liabilities (Notes 8 and 11) | 511 | 1,310 | ||||||
Other liabilities, including $15,390 and $11,156 of optional advance commitments carried at fair value under the fair value option at March 31, 2011 and December 31, 2010, respectively (Note 11) | 33,153 | 31,583 | ||||||
Total liabilities | 31,336,454 | 37,699,658 | ||||||
Commitments and contingencies (Notes 5 and 12) | ||||||||
CAPITAL (Note 9) | ||||||||
Capital stock — Class B putable ($100 par value) issued and outstanding shares: | ||||||||
14,278,103 and 16,009,091 shares at March 31, 2011 and December 31, 2010, respectively | 1,427,810 | 1,600,909 | ||||||
Retained earnings | 462,188 | 452,205 | ||||||
Accumulated other comprehensive income (loss) (Note 15) | ||||||||
Non-credit portion of other-than-temporary impairment losses on held-to-maturity securities (Note 3) | (57,289 | ) | (63,263 | ) | ||||
Postretirement benefits | 546 | 561 | ||||||
Total accumulated other comprehensive income (loss) | (56,743 | ) | (62,702 | ) | ||||
Total capital | 1,833,255 | 1,990,412 | ||||||
TOTAL LIABILITIES AND CAPITAL | $ | 33,169,709 | $ | 39,690,070 | ||||
(a) | Fair values: $7,924,731 and $8,602,589 at March 31, 2011 and December 31, 2010, respectively. |
The accompanying notes are an integral part of these financial statements.
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FEDERAL HOME LOAN BANK OF DALLAS
STATEMENTS OF INCOME
(Unaudited, in thousands)
For the Three Months Ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
INTEREST INCOME | ||||||||
Advances | $ | 59,405 | $ | 81,537 | ||||
Prepayment fees on advances, net | 1,266 | 2,673 | ||||||
Interest-bearing deposits | 72 | 42 | ||||||
Securities purchased under agreements to resell | 104 | — | ||||||
Federal funds sold | 1,205 | 1,143 | ||||||
Held-to-maturity securities | 24,132 | 38,217 | ||||||
Mortgage loans held for portfolio | 2,780 | 3,523 | ||||||
Other | 6 | 3 | ||||||
Total interest income | 88,970 | 127,138 | ||||||
INTEREST EXPENSE | ||||||||
Consolidated obligations | ||||||||
Bonds | 45,468 | 59,104 | ||||||
Discount notes | 1,244 | 3,679 | ||||||
Deposits | 117 | 156 | ||||||
Mandatorily redeemable capital stock | 18 | 13 | ||||||
Other borrowings | — | 1 | ||||||
Total interest expense | 46,847 | 62,953 | ||||||
NET INTEREST INCOME | 42,123 | 64,185 | ||||||
OTHER INCOME (LOSS) | ||||||||
Total other-than-temporary impairment losses on held-to-maturity securities | — | (7,031 | ) | |||||
Net non-credit impairment losses recognized in other comprehensive income | (1,378 | ) | 6,463 | |||||
Credit component of other-than-temporary impairment losses on held-to-maturity securities | (1,378 | ) | (568 | ) | ||||
Service fees | 570 | 563 | ||||||
Net gain on trading securities | 129 | 119 | ||||||
Net losses on derivatives and hedging activities | (6,515 | ) | (26,706 | ) | ||||
Losses on other liabilities carried at fair value under the fair value option | (861 | ) | — | |||||
Gains on early extinguishment of debt | 369 | — | ||||||
Letter of credit fees | 1,429 | 1,432 | ||||||
Other, net | (10 | ) | 27 | |||||
Total other loss | (6,267 | ) | (25,133 | ) | ||||
OTHER EXPENSE | ||||||||
Compensation and benefits | 11,585 | 9,997 | ||||||
Other operating expenses | 6,694 | 6,591 | ||||||
Finance Agency | 1,145 | 706 | ||||||
Office of Finance | 733 | 538 | ||||||
Total other expense | 20,157 | 17,832 | ||||||
INCOME BEFORE ASSESSMENTS | 15,699 | 21,220 | ||||||
Affordable Housing Program | 1,283 | 1,734 | ||||||
REFCORP | 2,883 | 3,897 | ||||||
Total assessments | 4,166 | 5,631 | ||||||
NET INCOME | $ | 11,533 | $ | 15,589 | ||||
The accompanying notes are an integral part of these financial statements.
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FEDERAL HOME LOAN BANK OF DALLAS
STATEMENTS OF CAPITAL
FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010
(Unaudited, in thousands)
Accumulated | ||||||||||||||||||||
Capital Stock | Other | |||||||||||||||||||
Class B - Putable | Retained | Comprehensive | Total | |||||||||||||||||
Shares | Par Value | Earnings | Income (Loss) | Capital | ||||||||||||||||
BALANCE, JANUARY 1, 2011 | 16,009 | $ | 1,600,909 | $ | 452,205 | $ | (62,702 | ) | $ | 1,990,412 | ||||||||||
Proceeds from sale of capital stock | 750 | 74,976 | — | — | 74,976 | |||||||||||||||
Repurchase/redemption of capital stock | (1,883 | ) | (188,255 | ) | — | — | (188,255 | ) | ||||||||||||
Shares reclassified to mandatorily redeemable capital stock | (613 | ) | (61,268 | ) | — | — | (61,268 | ) | ||||||||||||
Comprehensive income | ||||||||||||||||||||
Net income | — | — | 11,533 | — | 11,533 | |||||||||||||||
Other comprehensive income (a) | — | — | — | 5,959 | 5,959 | |||||||||||||||
Total comprehensive income | — | — | — | — | 17,492 | |||||||||||||||
Dividends on capital stock (at 0.375 percent annualized rate) | ||||||||||||||||||||
Cash | — | — | (46 | ) | — | (46 | ) | |||||||||||||
Mandatorily redeemable capital stock | — | — | (56 | ) | — | (56 | ) | |||||||||||||
Stock | 15 | 1,448 | (1,448 | ) | — | — | ||||||||||||||
BALANCE, MARCH 31, 2011 | 14,278 | $ | 1,427,810 | $ | 462,188 | $ | (56,743 | ) | $ | 1,833,255 | ||||||||||
BALANCE, JANUARY 1, 2010 | 25,317 | $ | 2,531,715 | $ | 356,282 | $ | (65,965 | ) | $ | 2,822,032 | ||||||||||
Proceeds from sale of capital stock | 993 | 99,291 | — | — | 99,291 | |||||||||||||||
Repurchase/redemption of capital stock | (3,221 | ) | (322,132 | ) | — | — | (322,132 | ) | ||||||||||||
Comprehensive income | ||||||||||||||||||||
Net income | — | — | 15,589 | — | 15,589 | |||||||||||||||
Other comprehensive income (loss)(a) | — | — | — | (2,212 | ) | (2,212 | ) | |||||||||||||
Total comprehensive income | — | — | — | — | 13,377 | |||||||||||||||
Dividends on capital stock (at 0.375 percent annualized rate) | ||||||||||||||||||||
Cash | — | — | (46 | ) | — | (46 | ) | |||||||||||||
Mandatorily redeemable capital stock | — | — | (2 | ) | — | (2 | ) | |||||||||||||
Stock | 23 | 2,338 | (2,338 | ) | — | — | ||||||||||||||
BALANCE, MARCH 31, 2010 | 23,112 | $ | 2,311,212 | $ | 369,485 | $ | (68,177 | ) | $ | 2,612,520 | ||||||||||
(a) | For the components of other comprehensive income (loss) for the three months ended March 31, 2011 and 2010, see Note 15. |
The accompanying notes are an integral part of these financial statements.
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FEDERAL HOME LOAN BANK OF DALLAS
STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
For the Three Months Ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
OPERATING ACTIVITIES | ||||||||
Net income | $ | 11,533 | $ | 15,589 | ||||
Adjustments to reconcile net income to net cash provided by operating activities | ||||||||
Depreciation and amortization | ||||||||
Net premiums and discounts on advances, consolidated obligations, investments and mortgage loans | (19,149 | ) | (33,358 | ) | ||||
Concessions on consolidated obligation bonds | 984 | 2,400 | ||||||
Premises, equipment and computer software costs | 1,605 | 1,473 | ||||||
Non-cash interest on mandatorily redeemable capital stock | 5 | 8 | ||||||
Credit component of other-than-temporary impairment losses on held-to-maturity securities | 1,378 | 568 | ||||||
Gains on early extinguishment of debt | (369 | ) | — | |||||
Losses on other liabilities carried at fair value under the fair value option | 861 | — | ||||||
Net increase in trading securities | (639 | ) | (135 | ) | ||||
Loss due to change in net fair value adjustment on derivative and hedging activities | 14,329 | 49,421 | ||||||
Decrease in accrued interest receivable | 2,583 | 5,069 | ||||||
Decrease (increase) in other assets | 1,683 | (1,630 | ) | |||||
Decrease in Affordable Housing Program (AHP) liability | (2,191 | ) | (1,970 | ) | ||||
Increase in accrued interest payable | 23,081 | 11,905 | ||||||
Decrease in payable to REFCORP | (2,544 | ) | (5,980 | ) | ||||
Increase (decrease) in other liabilities | 695 | (821 | ) | |||||
Total adjustments | 22,312 | 26,950 | ||||||
Net cash provided by operating activities | 33,845 | 42,539 | ||||||
INVESTING ACTIVITIES | ||||||||
Net decrease in interest-bearing deposits | 26,847 | 6,921 | ||||||
Net increase in securities purchased under agreements to resell | (375,000 | ) | — | |||||
Net decrease (increase) in federal funds sold | 1,441,000 | (1,439,000 | ) | |||||
Proceeds from maturities of long-term held-to-maturity securities | 670,196 | 1,167,308 | ||||||
Purchases of long-term held-to-maturity securities | — | (953,810 | ) | |||||
Principal collected on advances | 59,401,324 | 67,226,627 | ||||||
Advances made | (55,826,927 | ) | (62,571,465 | ) | ||||
Principal collected on mortgage loans held for portfolio | 12,365 | 10,790 | ||||||
Purchases of premises, equipment and computer software | (2,183 | ) | (1,207 | ) | ||||
Net cash provided by investing activities | 5,347,622 | 3,446,164 | ||||||
FINANCING ACTIVITIES | ||||||||
Net increase in deposits | 237,495 | 50,807 | ||||||
Net payments on derivative contracts with financing elements | (5,130 | ) | (5,054 | ) | ||||
Net proceeds from issuance of consolidated obligations | ||||||||
Discount notes | 89,715,189 | 29,212,208 | ||||||
Bonds | 1,182,862 | 11,581,406 | ||||||
Proceeds from assumption of debt from other FHLBank | 167,381 | — | ||||||
Debt issuance costs | (464 | ) | (2,053 | ) | ||||
Payments for maturing and retiring consolidated obligations | ||||||||
Discount notes | (94,344,690 | ) | (32,337,577 | ) | ||||
Bonds | (3,289,696 | ) | (14,837,155 | ) | ||||
Proceeds from issuance of capital stock | 74,976 | 99,291 | ||||||
Payments for redemption of mandatorily redeemable capital stock | (51,275 | ) | (1,595 | ) | ||||
Payments for repurchase/redemption of capital stock | (188,255 | ) | (322,132 | ) | ||||
Cash dividends paid | (46 | ) | (46 | ) | ||||
Net cash used in financing activities | (6,501,653 | ) | (6,561,900 | ) | ||||
Net decrease in cash and cash equivalents | (1,120,186 | ) | (3,073,197 | ) | ||||
Cash and cash equivalents at beginning of the period | 1,631,899 | 3,908,242 | ||||||
Cash and cash equivalents at end of the period | $ | 511,713 | $ | 835,045 | ||||
Supplemental Disclosures: | ||||||||
Interest paid | $ | 29,226 | $ | 65,883 | ||||
AHP payments, net | $ | 3,474 | $ | 3,704 | ||||
REFCORP payments | $ | 5,427 | $ | 9,877 | ||||
Stock dividends issued | $ | 1,448 | $ | 2,338 | ||||
Dividends paid through issuance of mandatorily redeemable capital stock | $ | 56 | $ | 2 | ||||
Capital stock reclassified to mandatorily redeemable capital stock | $ | 61,268 | $ | — | ||||
The accompanying notes are an integral part of these financial statements.
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FEDERAL HOME LOAN BANK OF DALLAS
NOTES TO INTERIM UNAUDITED FINANCIAL STATEMENTS
Note 1—Basis of Presentation
The accompanying interim financial statements of the Federal Home Loan Bank of Dallas (the “Bank”) are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions provided by Article 10, Rule 10-01 of Regulation S-X promulgated by the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and disclosures required by generally accepted accounting principles for complete financial statements. The financial statements contain all adjustments that are, in the opinion of management, necessary for a fair statement of the Bank’s 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.
The Bank’s significant accounting policies and certain other disclosures are set forth in the notes to the audited financial statements for the year ended December 31, 2010. The interim financial statements presented herein should be read in conjunction with the Bank’s audited financial statements and notes thereto, which are included in the Bank’s Annual Report on Form 10-K for the year ended December 31, 2010 filed with the SEC on March 25, 2011 (the “2010 10-K”). The notes to the interim financial statements update and/or highlight significant changes to the notes included in the 2010 10-K.
The Bank is one of 12 district Federal Home Loan Banks, each individually a “FHLBank” and collectively the “FHLBanks,” and, together with the Office of Finance, a joint office of the FHLBanks, the “FHLBank System.” The Office of Finance manages the sale and servicing of the FHLBanks’ consolidated obligations. The Federal Housing Finance Agency (“Finance Agency”), an independent agency in the executive branch of the United States Government, supervises and regulates the FHLBanks and the Office of Finance.
Use of Estimates.The preparation of financial statements in conformity with GAAP requires management to make assumptions and estimates. These assumptions and estimates may affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of income and expenses. Significant assumptions include those that are used by the Bank in its periodic evaluation of its holdings of non-agency residential mortgage-backed securities for other-than-temporary impairment (“OTTI”). Significant estimates include the valuations of the Bank’s investment securities, as well as its derivative instruments and any associated hedged items. Actual results could differ from these estimates.
Note 2—Recently Issued Accounting Guidance
Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.On July 21, 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-20“Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”(“ASU 2010-20”), which amends the existing disclosure requirements to require a greater level of disaggregated information about the credit quality of financing receivables and the allowance for credit losses. The requirements are intended to enhance transparency regarding the nature of an entity’s credit risk associated with its financing receivables and an entity’s assessment of that risk in estimating its allowance for credit losses as well as changes in the allowance and the reasons for those changes. The disclosures that relate to information as of the end of a reporting period were effective for interim and annual reporting periods ending on or after December 15, 2010 (December 31, 2010 for the Bank). Except for disclosures related to troubled debt restructurings, which have been deferred until interim and annual reporting periods beginning on or after June 15, 2011, the disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010 (January 1, 2011 for the Bank). The required disclosures are presented in Note 5. The adoption of this guidance did not have any impact on the Bank’s results of operations or financial condition.
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A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring.On April 5, 2011, the FASB issued ASU 2011-02“A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring”(“ASU 2011-02”),which clarifies when a loan modification or restructuring constitutes a troubled debt restructuring. A restructuring is considered a troubled debt restructuring if both of the following conditions exist: (1) the restructuring constitutes a concession and (2) the borrower is experiencing financial difficulties. The guidance in ASU 2011-02 also requires presentation of the disclosures related to troubled debt restructurings that are required by the provisions of ASU 2010-20. The provisions of ASU 2011-02 are effective for interim and annual reporting periods beginning on or after June 15, 2011 (July 1, 2011 for the Bank) and are to be applied retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption (January 1, 2011 for the Bank). The adoption of this guidance is not expected to have a significant impact on the Bank’s results of operations or financial condition, nor is it expected to significantly expand the Bank’s footnote disclosures.
Reconsideration of Effective Control for Repurchase Agreements.On April 29, 2011, the FASB issued ASU 2011-03 “Reconsideration of Effective Control for Repurchase Agreements”(“ASU 2011-03”), which eliminates from U.S. GAAP the requirement for entities to consider whether a transferor has the ability to repurchase the financial assets in a repurchase agreement. The guidance is intended to focus the assessment of effective control over financial assets on a transferor’s contractual rights and obligations with respect to transferred financial assets and not on whether the transferor has the practical ability to exercise those rights or honor those obligations. In addition to removing the criterion for entities to consider a transferor’s ability to repurchase the financial assets, ASU 2011-03 also removes the collateral maintenance implementation guidance related to that criterion. The guidance is effective prospectively for transactions, or modifications of existing transactions, that occur during or after the first interim or annual reporting period beginning on or after December 15, 2011 (January 1, 2012 for the Bank). Early adoption is not permitted. The adoption of this guidance is not expected to have a significant impact on the Bank’s results of operations or financial condition.
Note 3—Held-to-Maturity Securities
Major Security Types.Held-to-maturity securities as of March 31, 2011 were as follows (in thousands):
OTTI Recorded in | Gross | Gross | ||||||||||||||||||||||
Accumulated Other | Unrecognized | Unrecognized | Estimated | |||||||||||||||||||||
Amortized | Comprehensive | Carrying | Holding | Holding | Fair | |||||||||||||||||||
Cost | Income (Loss) | Value | Gains | Losses | Value | |||||||||||||||||||
Debentures | ||||||||||||||||||||||||
U.S. government guaranteed obligations | $ | 49,840 | $ | — | $ | 49,840 | $ | 285 | $ | 53 | $ | 50,072 | ||||||||||||
Mortgage-backed securities | ||||||||||||||||||||||||
U.S. government guaranteed obligations | 19,118 | — | 19,118 | 18 | 11 | 19,125 | ||||||||||||||||||
Government-sponsored enterprises | 7,463,953 | — | 7,463,953 | 108,166 | 5,098 | 7,567,021 | ||||||||||||||||||
Non-agency residential mortgage-backed securities | 363,019 | 57,289 | 305,730 | — | 17,217 | 288,513 | ||||||||||||||||||
7,846,090 | 57,289 | 7,788,801 | 108,184 | 22,326 | 7,874,659 | |||||||||||||||||||
Total | $ | 7,895,930 | $ | 57,289 | $ | 7,838,641 | $ | 108,469 | $ | 22,379 | $ | 7,924,731 | ||||||||||||
Held-to-maturity securities as of December 31, 2010 were as follows (in thousands):
OTTI Recorded in | Gross | Gross | ||||||||||||||||||||||
Accumulated Other | Unrecognized | Unrecognized | Estimated | |||||||||||||||||||||
Amortized | Comprehensive | Carrying | Holding | Holding | Fair | |||||||||||||||||||
Cost | Income (Loss) | Value | Gains | Losses | Value | |||||||||||||||||||
Debentures | ||||||||||||||||||||||||
U.S. government guaranteed obligations | $ | 51,946 | $ | — | $ | 51,946 | $ | 331 | $ | 217 | $ | 52,060 | ||||||||||||
Mortgage-backed securities | ||||||||||||||||||||||||
U.S. government guaranteed obligations | 20,038 | — | 20,038 | 70 | — | 20,108 | ||||||||||||||||||
Government-sponsored enterprises | 8,096,361 | — | 8,096,361 | 128,732 | 2,068 | 8,223,025 | ||||||||||||||||||
Non-agency residential mortgage-backed securities | 391,347 | 63,263 | 328,084 | — | 20,688 | 307,396 | ||||||||||||||||||
8,507,746 | 63,263 | 8,444,483 | 128,802 | 22,756 | 8,550,529 | |||||||||||||||||||
Total | $ | 8,559,692 | $ | 63,263 | $ | 8,496,429 | $ | 129,133 | $ | 22,973 | $ | 8,602,589 | ||||||||||||
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The following table summarizes (in thousands, except number of positions) the held-to-maturity securities with unrealized losses as of March 31, 2011. The unrealized losses include other-than-temporary impairments recognized in accumulated other comprehensive income (loss) and gross unrecognized holding losses and are aggregated by major security type and length of time that individual securities have been in a continuous loss position.
Less than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||||||||||||||
Estimated | Gross | Estimated | Gross | Estimated | Gross | |||||||||||||||||||||||||||||||
Number of | Fair | Unrealized | Number of | Fair | Unrealized | Number of | Fair | Unrealized | ||||||||||||||||||||||||||||
Positions | Value | Losses | Positions | Value | Losses | Positions | Value | Losses | ||||||||||||||||||||||||||||
Debentures | ||||||||||||||||||||||||||||||||||||
U.S. government guaranteed obligations | 2 | $ | 20,970 | $ | 53 | — | $ | — | $ | — | 2 | $ | 20,970 | $ | 53 | |||||||||||||||||||||
Mortgage-backed securities | ||||||||||||||||||||||||||||||||||||
U.S. government guaranteed obligations | 5 | 6,750 | 11 | — | — | — | 5 | 6,750 | 11 | |||||||||||||||||||||||||||
Government-sponsored enterprises | 67 | 909,521 | 1,769 | 33 | 744,301 | 3,329 | 100 | 1,653,822 | 5,098 | |||||||||||||||||||||||||||
Non-agency residential mortgage-backed securities | — | — | — | 37 | 288,513 | 74,506 | 37 | 288,513 | 74,506 | |||||||||||||||||||||||||||
72 | 916,271 | 1,780 | 70 | 1,032,814 | 77,835 | 142 | 1,949,085 | 79,615 | ||||||||||||||||||||||||||||
Total | 74 | $ | 937,241 | $ | 1,833 | 70 | $ | 1,032,814 | $ | 77,835 | 144 | $ | 1,970,055 | $ | 79,668 | |||||||||||||||||||||
The following table summarizes (in thousands, except number of positions) the held-to-maturity securities with unrealized losses as of December 31, 2010.
Less than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||||||||||||||
Estimated | Gross | Estimated | Gross | Estimated | Gross | |||||||||||||||||||||||||||||||
Number of | Fair | Unrealized | Number of | Fair | Unrealized | Number of | Fair | Unrealized | ||||||||||||||||||||||||||||
Positions | Value | Losses | Positions | Value | Losses | Positions | Value | Losses | ||||||||||||||||||||||||||||
Debentures | ||||||||||||||||||||||||||||||||||||
U.S. government guaranteed obligations | 2 | $ | 21,303 | $ | 217 | — | $ | — | $ | — | 2 | $ | 21,303 | $ | 217 | |||||||||||||||||||||
Mortgage-backed securities | ||||||||||||||||||||||||||||||||||||
Government-sponsored enterprises | 23 | 398,522 | 434 | 34 | 792,031 | 1,634 | 57 | 1,190,553 | 2,068 | |||||||||||||||||||||||||||
Non-agency residential mortgage-backed securities | — | — | — | 39 | 307,396 | 83,951 | 39 | 307,396 | 83,951 | |||||||||||||||||||||||||||
23 | 398,522 | 434 | 73 | 1,099,427 | 85,585 | 96 | 1,497,949 | 86,019 | ||||||||||||||||||||||||||||
Total | 25 | $ | 419,825 | $ | 651 | 73 | $ | 1,099,427 | $ | 85,585 | 98 | $ | 1,519,252 | $ | 86,236 | |||||||||||||||||||||
At March 31, 2011, the gross unrealized losses on the Bank’s held-to-maturity securities were $79,668,000, of which $74,506,000 was attributable to its holdings of non-agency (i.e., private label) residential mortgage-backed securities and $5,162,000 was attributable to other securities. All of the Bank’s held-to-maturity securities are rated by one or more of the following nationally recognized statistical ratings organizations (“NRSROs”): Moody’s Investors Service (“Moody’s”), Standard and Poor’s (“S&P”) and/or Fitch Ratings, Ltd. (“Fitch”). With the exception of 24 non-agency residential mortgage-backed securities with an aggregate carrying value of $220,400,000, all of the securities held by the Bank carried the highest investment grade credit rating by each of the NRSROs that rated the respective securities at March 31, 2011. Based upon the Bank’s assessment of the strength of the government guarantees of the debentures and government guaranteed mortgage-backed securities (“MBS”) held by the Bank, the credit ratings assigned by the NRSROs and the strength of the government-sponsored enterprises’ guarantees of the Bank’s holdings of agency MBS, the Bank expects that its holdings of U.S. government guaranteed debentures, U.S. government guaranteed MBS and government-sponsored enterprise MBS that were in an unrealized loss position at March 31, 2011 would not be settled at an amount less than the Bank’s amortized cost bases in these investments. Because the current market value deficits associated with these securities are not attributable to credit quality, and because the Bank does not intend to sell the investments and it is not more likely than not that the Bank will be required to sell the investments before recovery of their amortized cost bases, the Bank does not consider any of these investments to be other-than-temporarily impaired at March 31, 2011.
The deterioration in the U.S. housing markets that began in 2007, as reflected by declines in the values of residential real estate and higher levels of delinquencies, defaults and losses on residential mortgages, including the mortgages underlying the Bank’s non-agency residential MBS (“RMBS”), generally increased the risk that the Bank may not ultimately recover the entire cost bases of some of its non-agency RMBS. Based on its analysis of the securities in this portfolio, however, the Bank believes that the unrealized losses as of March 31, 2011 were principally the result of liquidity risk related discounts in the non-agency RMBS market and do not accurately reflect the actual historical or currently likely future credit performance of the securities.
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Because the ultimate receipt of contractual payments on the Bank’s non-agency RMBS will depend upon the credit and prepayment performance of the underlying loans and the credit enhancements for the senior securities owned by the Bank, the Bank closely monitors these investments in an effort to determine whether the credit enhancement associated with each security is sufficient to protect against potential losses of principal and interest on the underlying mortgage loans. The credit enhancement for each of the Bank’s non-agency RMBS is provided by a senior/subordinate structure, and none of the securities owned by the Bank are insured by third party bond insurers. More specifically, each of the Bank’s non-agency RMBS represents a single security class within a securitization that has multiple classes of securities. Each security class has a distinct claim on the cash flows from the underlying mortgage loans, with the subordinate securities having a junior claim relative to the more senior securities. The Bank’s non-agency RMBS have a senior claim on the cash flows from the underlying mortgage loans.
To assess whether the entire amortized cost bases of its non-agency RMBS will be recovered, the Bank performed a cash flow analysis for each security as of March 31, 2011 using two third-party models. The first model considers borrower characteristics and the particular attributes of the loans underlying the Bank’s securities, in conjunction with assumptions about future changes in home prices and interest rates, to project prepayments, defaults and loss severities. A significant input to the first model is the forecast of future housing price changes for the relevant states and core based statistical areas (“CBSAs”), which are based upon an assessment of the individual housing markets. (The term “CBSA” refers collectively to metropolitan and micropolitan statistical areas as defined by the United States Office of Management and Budget; as currently defined, a CBSA must contain at least one urban area of 10,000 or more people.) The Bank’s housing price forecast as of March 31, 2011 assumed current-to-trough home price declines ranging from 0 percent (for those housing markets that are believed to have reached their trough) to 10.0 percent. 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 January 1, 2011. 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 within a range of 0 percent to 2.8 percent in the first year, 0 percent to 3.0 percent in the second year, 1.5 percent to 4.0 percent in the third year, 2.0 percent to 5.0 percent in the fourth year, 2.0 percent to 6.0 percent in each of the fifth and sixth years, and 2.3 percent to 5.6 percent in each subsequent year. The month-by-month projections of future loan performance derived from the first model, which reflect projected prepayments, defaults and loss severities, are then input into a second model that allocates the projected loan level cash flows and losses to the various security classes in the securitization structure in accordance with its prescribed cash flow and loss allocation rules. In a securitization in which the credit enhancement for the senior securities is derived from the presence of subordinate securities, losses are generally allocated first to the subordinate securities until their principal balance is reduced to zero.
Based on the results of its cash flow analyses, the Bank determined that it is likely that it will not fully recover the amortized cost bases of eight of its non-agency RMBS and, accordingly, these securities were deemed to be other-than-temporarily impaired as of March 31, 2011. All of these securities had previously been deemed to be other-than-temporarily impaired in 2009 and/or 2010. The difference between the present value of the cash flows expected to be collected from these eight securities and their amortized cost bases (i.e., the credit losses) totaled $1,378,000 as of March 31, 2011. Because the Bank does not intend to sell the investments and it is not more likely than not that the Bank will be required to sell the investments before recovery of their remaining amortized cost bases (that is, their previous amortized cost bases less the current-period credit losses), only the amounts related to the credit losses were recognized in earnings. The credit losses associated with the eight securities were reclassified from accumulated other comprehensive income (loss) to earnings during the three months ended March 31, 2011 as the estimated fair values of these securities were greater than their carrying values at that date.
In addition to the eight securities that were determined to be other-than-temporarily impaired at March 31, 2011, five other securities were previously deemed to be other-than-temporarily impaired. The following tables set forth additional information for each of the securities that were other-than-temporarily impaired as of March 31, 2011, including those securities that were deemed to be other-than-temporarily impaired in a prior period but which were not further impaired as of March 31, 2011 (in thousands). The credit ratings presented in the first table represent the lowest rating assigned to the security by Moody’s, S&P or Fitch as of March 31, 2011.
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For the Three Months Ended March 31, 2011 | ||||||||||||||||
Period of | Credit | Non-Credit | ||||||||||||||
Initial | Credit | Component | Component | Total | ||||||||||||
Impairment | Rating | of OTTI | of OTTI | OTTI | ||||||||||||
Security #1 | Q1 2009 | Triple-C | $ | 278 | $ | (278 | ) | $ | — | |||||||
Security #2 | Q1 2009 | Triple-C | 309 | (309 | ) | — | ||||||||||
Security #3 | Q2 2009 | Double-C | — | — | — | |||||||||||
Security #4 | Q2 2009 | Triple-C | 104 | (104 | ) | — | ||||||||||
Security #5 | Q3 2009 | Triple-C | 594 | (594 | ) | — | ||||||||||
Security #6 | Q3 2009 | Triple-C | — | — | — | |||||||||||
Security #7 | Q3 2009 | Single-B | — | — | — | |||||||||||
Security #8 | Q1 2010 | Triple-C | 9 | (9 | ) | — | ||||||||||
Security #9 | Q1 2010 | Single-B | 6 | (6 | ) | — | ||||||||||
Security #10 | Q4 2010 | Triple-C | 7 | (7 | ) | — | ||||||||||
Security #11 | Q4 2010 | Triple-C | — | — | — | |||||||||||
Security #12 | Q4 2010 | Triple-C | 71 | (71 | ) | — | ||||||||||
Security #13 | Q4 2010 | Triple-C | — | — | — | |||||||||||
Totals | $ | 1,378 | $ | (1,378 | ) | $ | — | |||||||||
Cumulative from Period of Initial | ||||||||||||||||||||||||
March 31, 2011 | Impairment Through March 31, 2011 | March 31, 2011 | ||||||||||||||||||||||
Unpaid | Non-Credit | Accretion of | Estimated | |||||||||||||||||||||
Principal | Amortized | Component of | Non-Credit | Carrying | Fair | |||||||||||||||||||
Balance | Cost | OTTI | Component | Value | Value | |||||||||||||||||||
Security #1 | $ | 16,321 | $ | 14,230 | $ | 11,064 | $ | 5,017 | $ | 8,183 | $ | 9,706 | ||||||||||||
Security #2 | 17,855 | 17,484 | 12,705 | 5,237 | 10,016 | 12,349 | ||||||||||||||||||
Security #3 | 35,818 | 32,322 | 15,888 | 6,817 | 23,251 | 28,751 | ||||||||||||||||||
Security #4 | 12,354 | 12,148 | 8,380 | 3,287 | 7,055 | 7,823 | ||||||||||||||||||
Security #5 | 20,569 | 19,395 | 10,569 | 4,095 | 12,921 | 13,738 | ||||||||||||||||||
Security #6 | 17,578 | 17,126 | 10,054 | 3,700 | 10,772 | 10,465 | ||||||||||||||||||
Security #7 | 6,733 | 6,658 | 3,575 | 1,155 | 4,238 | 4,616 | ||||||||||||||||||
Security #8 | 10,060 | 10,039 | 4,968 | 1,326 | 6,397 | 6,576 | ||||||||||||||||||
Security #9 | 4,380 | 4,368 | 1,916 | 520 | 2,972 | 3,108 | ||||||||||||||||||
Security #10 | 7,907 | 7,899 | 3,038 | 201 | 5,062 | 5,189 | ||||||||||||||||||
Security #11 | 9,961 | 9,960 | 3,061 | 256 | 7,155 | 7,080 | ||||||||||||||||||
Security #12 | 5,189 | 5,107 | 1,820 | 116 | 3,403 | 3,508 | ||||||||||||||||||
Security #13 | 6,460 | 6,451 | 2,152 | 174 | 4,473 | 4,349 | ||||||||||||||||||
Totals | $ | 171,185 | $ | 163,187 | $ | 89,190 | $ | 31,901 | $ | 105,898 | $ | 117,258 | ||||||||||||
For those securities for which an other-than-temporary impairment was determined to have occurred as of March 31, 2011, the following table presents a summary of the significant inputs used to measure the amount of the credit loss recognized in earnings during the three months ended March 31, 2011 (dollars in thousands).
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Significant Inputs(2) | Current Credit | |||||||||||||||||||||||
Unpaid Principal | Projected | Projected | Projected | Enhancement | ||||||||||||||||||||
Year of | Collateral | Balance as of | Prepayment | Default | Loss | as of | ||||||||||||||||||
Securitization | Type(1) | March 31, 2011 | Rate | Rate | Severity | March 31, 2011(3) | ||||||||||||||||||
Security #1 | 2005 | Alt-A/Option ARM | $ | 16,321 | 7.7% | 72.0% | 52.0% | 33.4% | ||||||||||||||||
Security #2 | 2005 | Alt-A/Option ARM | 17,855 | 9.6% | 67.2% | 57.2% | 48.9% | |||||||||||||||||
Security #4 | 2005 | Alt-A/Option ARM | 12,354 | 8.6% | 65.0% | 41.7% | 45.8% | |||||||||||||||||
Security #5 | 2005 | Alt-A/Option ARM | 20,569 | 8.3% | 74.6% | 51.1% | 44.6% | |||||||||||||||||
Security #8 | 2005 | Alt-A/Option ARM | 10,060 | 7.0% | 65.8% | 33.9% | 43.5% | |||||||||||||||||
Security #9 | 2005 | Alt-A/Option ARM | 4,380 | 11.4% | 43.2% | 39.5% | 43.3% | |||||||||||||||||
Security #10 | 2005 | Alt-A/Option ARM | 7,907 | 9.0% | 64.0% | 45.2% | 43.6% | |||||||||||||||||
Security #12 | 2004 | Alt-A/Option ARM | 5,189 | 7.4% | 60.9% | 42.5% | 35.4% | |||||||||||||||||
Total | $ | 94,635 | ||||||||||||||||||||||
(1) | Security #1 and Security #5 are the only securities presented in the table above that were labeled as Alt-A at the time of issuance; however, based upon their current collateral or performance characteristics, all of the other-than-temporarily impaired securities presented in the table above were analyzed using Alt-A assumptions. | |
(2) | Prepayment rates reflect the weighted average of projected future voluntary prepayments. Default rates reflect the total balance of loans projected to default as a percentage of the current unpaid principal balance of the underlying loan pool. Loss severities reflect the total projected loan losses as a percentage of the total balance of loans that are projected to default. | |
(3) | Current credit enhancement percentages reflect the ability of subordinated classes of securities to absorb principal losses and interest shortfalls before the senior class held by the Bank is impacted (i.e., the losses, expressed as a percentage of the outstanding principal balances, that could be incurred in the underlying loan pool before the security held by the Bank would be impacted, assuming that all of those losses occurred on the measurement date). Depending upon the timing and amount of losses in the underlying loan pool, it is possible that the senior classes held by the Bank could bear losses in scenarios where the cumulative loan losses do not exceed the current credit enhancement percentage. |
The following table presents a rollforward for the three months ended March 31, 2011 and 2010 of the amount related to credit losses on the Bank’s non-agency RMBS holdings for which a portion of an other-than-temporary impairment has been recognized in other comprehensive income (in thousands).
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Balance of credit losses, beginning of period | $ | 6,576 | $ | 4,022 | ||||
Credit losses on securities for which an other-than-temporary impairment was not previously recognized | — | 13 | ||||||
Credit losses on securities for which an other-than-temporary impairment was previously recognized | 1,378 | 555 | ||||||
Balance of credit losses, end of period | $ | 7,954 | $ | 4,590 | ||||
Because the Bank currently expects to recover the entire amortized cost basis of each of its other non-agency RMBS holdings, and because the Bank does not intend to sell the investments and it is not more likely than not that the Bank will be required to sell the investments before recovery of their amortized cost bases, the Bank does not consider any of its other non-agency RMBS to be other-than-temporarily impaired at March 31, 2011.
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Redemption Terms.The amortized cost, carrying value and estimated fair value of held-to-maturity securities by contractual maturity at March 31, 2011 and December 31, 2010 are presented below (in thousands). The expected maturities of some debentures could differ from the contractual maturities presented because issuers may have the right to call such debentures prior to their final stated maturities.
March 31, 2011 | December 31, 2010 | |||||||||||||||||||||||
Estimated | Estimated | |||||||||||||||||||||||
Amortized | Carrying | Fair | Amortized | Carrying | Fair | |||||||||||||||||||
Maturity | Cost | Value | Value | Cost | Value | Value | ||||||||||||||||||
Debentures | ||||||||||||||||||||||||
Due after one year through five years | $ | 2,550 | $ | 2,550 | $ | 2,579 | $ | 2,555 | $ | 2,555 | $ | 2,598 | ||||||||||||
Due after five years through ten years | 26,267 | 26,267 | 26,523 | 27,871 | 27,871 | 28,159 | ||||||||||||||||||
Due after ten years | 21,023 | 21,023 | 20,970 | 21,520 | 21,520 | 21,303 | ||||||||||||||||||
49,840 | 49,840 | 50,072 | 51,946 | 51,946 | 52,060 | |||||||||||||||||||
Mortgage-backed securities | 7,846,090 | 7,788,801 | 7,874,659 | 8,507,746 | 8,444,483 | 8,550,529 | ||||||||||||||||||
Total | $ | 7,895,930 | $ | 7,838,641 | $ | 7,924,731 | $ | 8,559,692 | $ | 8,496,429 | $ | 8,602,589 | ||||||||||||
The amortized cost of the Bank’s mortgage-backed securities classified as held-to-maturity includes net purchase discounts of $97,222,000 and $105,046,000 at March 31, 2011 and December 31, 2010, respectively.
Interest Rate Payment Terms.The following table provides interest rate payment terms for investment securities classified as held-to-maturity at March 31, 2011 and December 31, 2010 (in thousands):
March 31, 2011 | December 31, 2010 | |||||||
Amortized cost of variable-rate held-to-maturity securities other than mortgage-backed securities | $ | 49,840 | $ | 51,946 | ||||
Amortized cost of held-to-maturity mortgage-backed securities | ||||||||
Fixed-rate pass-through securities | 798 | 821 | ||||||
Collateralized mortgage obligations | ||||||||
Fixed-rate | 1,534 | 1,620 | ||||||
Variable-rate | 7,843,758 | 8,505,305 | ||||||
7,846,090 | 8,507,746 | |||||||
Total | $ | 7,895,930 | $ | 8,559,692 | ||||
All of the Bank’s variable-rate collateralized mortgage obligations classified as held-to-maturity securities have coupon rates that are subject to interest rate caps, none of which were reached during 2010 or the three months ended March 31, 2011.
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Note 4—Advances
Redemption Terms.At March 31, 2011 and December 31, 2010, the Bank had advances outstanding at interest rates ranging from 0.03 percent to 8.61 percent and 0.05 percent to 8.61 percent, respectively, as summarized below (in thousands).
March 31, 2011 | December 31, 2010 | |||||||||||||||
Weighted | Weighted | |||||||||||||||
Average | Average | |||||||||||||||
Interest | Interest | |||||||||||||||
Contractual Maturity | Amount | Rate | Amount | Rate | ||||||||||||
Overdrawn demand deposit accounts | $ | 83 | 4.10 | % | $ | 171 | 4.10 | % | ||||||||
Due in one year or less | 9,057,348 | 0.77 | 12,362,781 | 0.70 | ||||||||||||
Due after one year through two years | 1,868,025 | 3.14 | 1,511,311 | 3.15 | ||||||||||||
Due after two years through three years | 2,446,386 | 1.93 | 2,927,555 | 2.17 | ||||||||||||
Due after three years through four years | 1,515,079 | 1.23 | 1,419,491 | 1.11 | ||||||||||||
Due after four years through five years | 602,541 | 2.89 | 736,210 | 2.97 | ||||||||||||
Due after five years | 3,367,330 | 3.78 | 3,389,605 | 3.78 | ||||||||||||
Amortizing advances | 2,629,617 | 4.37 | 2,713,632 | 4.40 | ||||||||||||
Total par value | 21,486,409 | 2.11 | % | 25,060,756 | 1.93 | % | ||||||||||
Deferred prepayment fees | (29,014 | ) | (31,290 | ) | ||||||||||||
Commitment fees | (103 | ) | (105 | ) | ||||||||||||
Hedging adjustments | 347,514 | 426,295 | ||||||||||||||
Total | $ | 21,804,806 | $ | 25,455,656 | ||||||||||||
Amortizing advances require repayment according to predetermined amortization schedules.
The Bank offers advances to members that may be prepaid on specified dates without the member incurring prepayment or termination fees (prepayable and callable advances). The prepayment of other advances requires the payment of a fee to the Bank (prepayment fee) if necessary to make the Bank financially indifferent to the prepayment of the advance. At March 31, 2011 and December 31, 2010, the Bank had aggregate prepayable and callable advances totaling $165,956,000 and $170,349,000, respectively.
The following table summarizes advances at March 31, 2011 and December 31, 2010, by the earliest of contractual maturity, next call date, or the first date on which prepayable advances can be repaid without a prepayment fee (in thousands):
Contractual Maturity or Next Call Date | March 31, 2011 | December 31, 2010 | ||||||
Overdrawn demand deposit accounts | $ | 83 | $ | 171 | ||||
Due in one year or less | 9,132,823 | 12,437,799 | ||||||
Due after one year through two years | 1,887,600 | 1,534,056 | ||||||
Due after two years through three years | 2,470,495 | 2,953,639 | ||||||
Due after three years through four years | 1,525,633 | 1,433,491 | ||||||
Due after four years through five years | 621,324 | 750,082 | ||||||
Due after five years | 3,218,834 | 3,237,886 | ||||||
Amortizing advances | 2,629,617 | 2,713,632 | ||||||
Total par value | $ | 21,486,409 | $ | 25,060,756 | ||||
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The Bank also offers putable advances. With a putable advance, the Bank purchases a put option from the member that allows the Bank to terminate the fixed-rate advance on specified dates and offer, subject to certain conditions, replacement funding at prevailing market rates. At March 31, 2011 and December 31, 2010, the Bank had putable advances outstanding totaling $3,364,321,000 and $3,486,421,000, respectively.
The following table summarizes advances at March 31, 2011 and December 31, 2010, by the earlier of contractual maturity or next possible put date (in thousands):
Contractual Maturity or Next Put Date | March 31, 2011 | December 31, 2010 | ||||||
Overdrawn demand deposit accounts | $ | 83 | $ | 171 | ||||
Due in one year or less | 12,028,668 | 15,288,601 | ||||||
Due after one year through two years | 1,574,175 | 1,494,561 | ||||||
Due after two years through three years | 2,242,386 | 2,476,955 | ||||||
Due after three years through four years | 1,422,679 | 1,409,091 | ||||||
Due after four years through five years | 481,041 | 565,210 | ||||||
Due after five years | 1,107,760 | 1,112,535 | ||||||
Amortizing advances | 2,629,617 | 2,713,632 | ||||||
Total par value | $ | 21,486,409 | $ | 25,060,756 | ||||
Interest Rate Payment Terms.The following table provides interest rate payment terms for advances at March 31, 2011 and December 31, 2010 (in thousands, based upon par amount):
March 31, 2011 | December 31, 2010 | |||||||
Fixed-rate | ||||||||
Due in one year or less | $ | 5,378,275 | $ | 7,688,427 | ||||
Due after one year | 10,346,509 | 10,607,136 | ||||||
Total fixed-rate | 15,724,784 | 18,295,563 | ||||||
Variable-rate | ||||||||
Due in one year or less | 3,691,283 | 4,690,851 | ||||||
Due after one year | 2,070,342 | 2,074,342 | ||||||
Total variable-rate | 5,761,625 | 6,765,193 | ||||||
Total par value | $ | 21,486,409 | $ | 25,060,756 | ||||
At March 31, 2011 and December 31, 2010, 52 percent and 47 percent, respectively, of the Bank’s fixed-rate advances were swapped to a variable rate.
Prepayment Fees.When a member/borrower prepays an advance, the Bank 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-cost debt. To protect against this risk, the Bank generally charges a prepayment fee that makes it financially indifferent to a borrower’s decision to prepay an advance. The Bank records prepayment fees received from members/borrowers on prepaid advances net of any associated hedging adjustments on those advances. These fees are reflected as interest income in the statements of income either immediately (as prepayment fees on advances) or over time (as interest income on advances) as further described below. In cases in which the Bank funds 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. Gross advance prepayment fees received from members/borrowers during the three months ended March 31, 2011 and 2010 were $2,391,000 and $5,135,000, respectively. The Bank deferred $51,000 and $1,615,000 of these gross advance prepayment fees during the three months ended March 31, 2011 and 2010, respectively.
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Note 5—Allowance for Credit Losses
An allowance for credit losses is separately established for each of the Bank’s identified portfolio segments, if necessary, to provide for probable losses inherent in its financing receivables portfolio and other off-balance sheet credit exposures as of the balance sheet date. To the extent necessary, an allowance for credit losses for off-balance sheet credit exposures is recorded as a liability.
A portfolio segment is defined as the level at which an entity develops and documents a systematic method for determining its allowance for credit losses. The Bank has developed and documented a systematic methodology for determining an allowance for credit losses for the following portfolio segments: (1) advances and other extensions of credit to members, collectively referred to as “extensions of credit to members;” (2) government-guaranteed/insured mortgage loans held for portfolio; and (3) conventional mortgage loans held for portfolio.
Classes of financing receivables are generally a disaggregation of a portfolio segment and are determined on the basis of their initial measurement attribute, the risk characteristics of the financing receivable and an entity’s method for monitoring and assessing credit risk. Because the credit risk arising from the Bank’s financing receivables is assessed and measured at the portfolio segment level, the Bank does not have separate classes of financing receivables within each of its portfolio segments.
During the three months ended March 31, 2011, there were no purchases or sales of financing receivables, nor were any financing receivables reclassified to held for sale.
Advances and Other Extensions of Credit to Members.In accordance with federal statutes, including the Federal Home Loan Bank Act of 1932, as amended (the “FHLB Act”), the Bank lends to financial institutions within its five-state district that are involved in housing finance. The FHLB Act requires the Bank to obtain and maintain sufficient collateral for advances and other extensions of credit to protect against losses. The Bank makes advances and otherwise extends credit only against eligible collateral, as defined by regulation. To ensure the value of collateral pledged to the Bank is sufficient to secure its advances and other extensions of credit, the Bank applies various haircuts, or discounts, to determine the value of the collateral against which borrowers may borrow. As additional security, the Bank has a statutory lien on each borrower’s capital stock in the Bank.
On at least a quarterly basis, the Bank evaluates all outstanding extensions of credit to members/borrowers for potential credit losses. These evaluations include a review of: (1) the amount, type and performance of collateral available to secure the outstanding obligations; (2) metrics that may be indicative of changes in the financial condition and general creditworthiness of the member/borrower; and (3) the payment status of the obligations. Any outstanding extensions of credit that exhibit a potential credit weakness that could jeopardize the full collection of the outstanding obligations would be classified as substandard, doubtful or loss. The Bank did not have any advances or other extensions of credit to members/borrowers that were classified as substandard, doubtful or loss at March 31, 2011 or December 31, 2010.
The Bank considers the amount, type and performance of collateral to be the primary indicator of credit quality with respect to its extensions of credit to members/borrowers. At March 31, 2011 and December 31, 2010, the Bank had rights to collateral on a borrower-by-borrower basis with an estimated value in excess of each borrower’s outstanding extensions of credit.
The Bank continues to evaluate and, as necessary, modify its credit extension and collateral policies based on market conditions. At March 31, 2011 and December 31, 2010, the Bank did not have any advances that were past due, on non-accrual status, or considered impaired. There have been no troubled debt restructurings related to advances.
The Bank has never experienced a credit loss on an advance or any other extension of credit to a member/borrower and, based on its credit extension and collateral policies, management currently does not anticipate any credit losses on its extensions of credit to members/borrowers. Accordingly, the Bank has not provided any allowance for credit losses on advances, nor has it recorded any liabilities to reflect an allowance for credit losses related to its off-balance sheet credit exposures.
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Mortgage Loans — Government-guaranteed/Insured.The Bank’s government-guaranteed/insured fixed-rate mortgage loans are insured or guaranteed by the Federal Housing Administration or the Department of Veterans Affairs. Any losses from such loans are expected to be recovered from those entities. Any losses from such loans that are not recovered from those entities are absorbed by the servicers. Therefore, the Bank has not established an allowance for credit losses on government-guaranteed/insured mortgage loans. Government-guaranteed/insured loans are not placed on non-accrual status.
Mortgage Loans — Conventional Mortgage Loans.The Bank’s conventional mortgage loans were acquired through the Mortgage Partnership Finance (“MPF”) Program, as more fully described in the Bank’s 2010 10-K. The allowance for losses on conventional mortgage loans is determined by an analysis that includes consideration of various data such as past performance, current performance, loan portfolio characteristics, collateral-related characteristics, industry data, and prevailing economic conditions. The allowance for losses on conventional mortgage loans also factors in the credit enhancement under the MPF Program. Any incurred losses that are expected to be recovered from the credit enhancements are not reserved as part of the Bank’s allowance for loan losses.
The Bank places a conventional mortgage loan on non-accrual status when the collection of the contractual principal or interest is 90 days or more past due. When a mortgage loan is placed on non-accrual status, accrued but uncollected interest is reversed against interest income. The Bank records cash payments received on non-accrual loans first as interest income until it recovers all interest, and then as a reduction of principal. A loan on non-accrual status may be restored to accrual status when (1) none of its contractual principal and interest is due and unpaid, and the Bank expects repayment of the remaining contractual interest and principal, or (2) the loan otherwise becomes well secured and in the process of collection.
A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. Collateral-dependent loans that are on non-accrual status are measured for impairment based on the fair value of the underlying property less estimated selling costs. Loans are considered collateral-dependent if repayment is expected to be provided solely by the sale of the underlying property; that is, there is no other available and reliable source of repayment. A collateral-dependent loan is impaired if the fair value of the underlying collateral is insufficient to recover the unpaid principal and interest on the loan. Interest income on impaired loans is recognized in the same manner as it is for non-accrual loans noted above.
The Bank evaluates whether to record a charge-off on a conventional mortgage loan upon the occurrence of a confirming event. Confirming events include, but are not limited to, the occurrence of foreclosure or notification of a claim against any of the credit enhancements. A charge-off is recorded if the recorded investment in the loan will not be recovered.
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The Bank considers the key credit quality indicator for conventional mortgage loans to be the payment status of each loan. The table below summarizes the unpaid principal balance by payment status for mortgage loans at March 31, 2011 and December 31, 2010 (dollar amounts in thousands). The unpaid principal balance approximates the recorded investment in the loans.
March 31, 2011 | December 31, 2010 | |||||||||||||||||||||||
Government- | Government- | |||||||||||||||||||||||
Guaranteed/ | Guaranteed/ | |||||||||||||||||||||||
Conventional | Insured | Conventional | Insured | |||||||||||||||||||||
Loans | Loans | Total | Loans | Loans | Total | |||||||||||||||||||
Mortgage loans: | ||||||||||||||||||||||||
30-59 days delinquent | $ | 1,969 | $ | 4,644 | $ | 6,613 | $ | 2,092 | $ | 4,993 | $ | 7,085 | ||||||||||||
60-89 days delinquent | 710 | 1,021 | 1,731 | 919 | 1,406 | 2,325 | ||||||||||||||||||
90 days or more delinquent | 1,404 | 732 | 2,136 | 1,254 | 857 | 2,111 | ||||||||||||||||||
Total past due | 4,083 | 6,397 | 10,480 | 4,265 | 7,256 | 11,521 | ||||||||||||||||||
Total current loans | 96,486 | 86,439 | 182,925 | 103,866 | 90,611 | 194,477 | ||||||||||||||||||
Total mortgage loans | $ | 100,569 | $ | 92,836 | $ | 193,405 | $ | 108,131 | $ | 97,867 | $ | 205,998 | ||||||||||||
Other delinquency statistics: | ||||||||||||||||||||||||
In process of foreclosure(1) | $ | 746 | $ | 162 | $ | 908 | $ | 678 | $ | 73 | $ | 751 | ||||||||||||
Serious delinquency rate(2) | 1.4 | % | 0.8 | % | 1.1 | % | 1.2 | % | 0.9 | % | 1.0 | % | ||||||||||||
Past due 90 days or more and still accruing interest(3) | $ | — | $ | 732 | $ | 732 | $ | — | $ | 857 | $ | 857 | ||||||||||||
Non-accrual loans | $ | 1,404 | $ | — | $ | 1,404 | $ | 1,254 | $ | — | $ | 1,254 | ||||||||||||
Troubled debt restructurings | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||||
(1) | Includes loans where the decision of foreclosure or similar alternative such as pursuit of deed-in-lieu has been made. | |
(2) | Loans that are 90 days or more past due or in the process of foreclosure expressed as a percentage of the total loan portfolio. | |
(3) | Only government-guaranteed/insured mortgage loans continue to accrue interest after they become 90 days past due. |
At March 31, 2011 and December 31, 2010, the Bank’s other assets included $355,000 and $126,000, respectively, of real estate owned.
Mortgage loans, other than those included in large groups of smaller-balance homogeneous loans, are considered impaired when, based upon current information and events, it is probable that the Bank will be unable to collect all principal and interest amounts due according to the contractual terms of the mortgage loan agreement. Each non-accrual mortgage loan is specifically reviewed for impairment. At March 31, 2011 and December 31, 2010, the estimated value of the collateral securing each of these loans was in excess of the outstanding loan amount. Therefore, none of these loans were considered impaired and no specific reserve was established for any of these mortgage loans. The remaining conventional mortgage loans were evaluated for impairment on a pool basis. Based upon the current and past performance of these loans, the underwriting standards in place at the time the loans were acquired, and current economic conditions, the Bank determined that an allowance for loan losses of $225,000 was adequate to reserve for credit losses in its conventional mortgage loan portfolio at March 31, 2011. The following table presents the activity in the allowance for credit losses on conventional mortgage loans held for portfolio during the three months ended March 31, 2011 and 2010 (in thousands):
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Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Balance, beginning of period | $ | 225 | $ | 240 | ||||
Chargeoffs | — | (6 | ) | |||||
Balance, end of period | $ | 225 | $ | 234 | ||||
March 31, 2011 | ||||
Ending balance of reserve related to loans collectively evaluated for impairment | $ | 225 | ||
Unpaid principal balance | ||||
Individually evaluated for impairment | $ | 1,404 | ||
Collectively evaluated for impairment | $ | 99,165 | ||
Note 6—Consolidated Obligations
Consolidated obligations are the joint and several obligations of the FHLBanks and consist of consolidated obligation bonds and discount notes. Consolidated obligations are backed only by the financial resources of the 12 FHLBanks. Consolidated obligations are not obligations of, nor are they guaranteed by, the United States Government. The FHLBanks issue consolidated obligations through the Office of Finance as their agent. In connection with each debt issuance, one or more of the FHLBanks specifies the amount of debt it wants issued on its behalf; the Bank receives the proceeds only of the debt issued on its behalf and is the primary obligor only for the portion of bonds and discount notes for which it has received the proceeds. The Bank records on its balance sheet only that portion of the consolidated obligations for which it is the primary obligor. Consolidated obligation bonds are issued primarily to raise intermediate- and long-term funds for the FHLBanks and are not subject to any statutory or regulatory limits on maturity. Consolidated obligation discount notes are issued to raise short-term funds and have maturities of one year or less. These notes are issued at a price that is less than their face amount and are redeemed at par value when they mature. For additional information regarding the FHLBanks’ joint and several liability on consolidated obligations, see Note 12.
The par amounts of the 12 FHLBanks’ outstanding consolidated obligations, including consolidated obligations held as investments by other FHLBanks, were approximately $766 billion and $796 billion at March 31, 2011 and December 31, 2010, respectively. The Bank was the primary obligor on $29.6 billion and $36.2 billion (at par value), respectively, of these consolidated obligations.
Interest Rate Payment Terms.The following table summarizes the Bank’s consolidated obligation bonds outstanding by interest rate payment terms at March 31, 2011 and December 31, 2010 (in thousands, at par value).
March 31, 2011 | December 31, 2010 | |||||||
Fixed-rate | $ | 14,253,565 | $ | 14,582,605 | ||||
Simple variable-rate | 11,139,700 | 13,411,000 | ||||||
Step-up | 3,441,500 | 3,001,500 | ||||||
Variable that converts to fixed | 184,000 | 83,000 | ||||||
Step-down | 100,000 | — | ||||||
Total par value | $ | 29,118,765 | $ | 31,078,105 | ||||
At March 31, 2011 and December 31, 2010, 80 percent and 82 percent, respectively, of the Bank’s fixed-rate consolidated obligation bonds were swapped to a variable rate and 17 percent and 14 percent, respectively, of the Bank’s variable-rate consolidated obligation bonds were swapped to a different variable-rate index.
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Redemption Terms.The following is a summary of the Bank’s consolidated obligation bonds outstanding at March 31, 2011 and December 31, 2010, by contractual maturity (in thousands):
March 31, 2011 | December 31, 2010 | |||||||||||||||
Weighted | Weighted | |||||||||||||||
Average | Average | |||||||||||||||
Interest | Interest | |||||||||||||||
Contractual Maturity | Amount | Rate | Amount | Rate | ||||||||||||
Due in one year or less | $ | 15,754,825 | 0.96 | % | $ | 18,269,685 | 0.86 | % | ||||||||
Due after one year through two years | 6,129,465 | 2.17 | 6,107,905 | 2.17 | ||||||||||||
Due after two years through three years | 1,424,000 | 2.66 | 1,465,000 | 2.59 | ||||||||||||
Due after three years through four years | 1,494,400 | 3.01 | 1,400,440 | 2.65 | ||||||||||||
Due after four years through five years | 1,035,255 | 3.11 | 883,255 | 2.69 | ||||||||||||
Thereafter | 3,280,820 | 3.18 | 2,951,820 | 3.28 | ||||||||||||
Total par value | 29,118,765 | 1.73 | % | 31,078,105 | 1.56 | % | ||||||||||
Premiums | 61,971 | 51,349 | ||||||||||||||
Discounts | (11,095 | ) | (11,977 | ) | ||||||||||||
Hedging adjustments | 132,784 | 198,128 | ||||||||||||||
Total | $ | 29,302,425 | $ | 31,315,605 | ||||||||||||
At March 31, 2011 and December 31, 2010, the Bank’s consolidated obligation bonds outstanding included the following (in thousands, at par value):
March 31, 2011 | December 31, 2010 | |||||||
Non-callable bonds | $ | 24,488,550 | $ | 26,278,890 | ||||
Callable bonds | 4,630,215 | 4,799,215 | ||||||
Total par value | $ | 29,118,765 | $ | 31,078,105 | ||||
The following table summarizes the Bank’s consolidated obligation bonds outstanding at March 31, 2011 and December 31, 2010, by the earlier of contractual maturity or next possible call date (in thousands, at par value):
Contractual Maturity or Next Call Date | March 31, 2011 | December 31, 2010 | ||||||
Due in one year or less | $ | 19,395,645 | $ | 21,479,505 | ||||
Due after one year through two years | 6,561,465 | 6,594,905 | ||||||
Due after two years through three years | 1,354,000 | 1,545,000 | ||||||
Due after three years through four years | 714,400 | 440,440 | ||||||
Due after four years through five years | 411,255 | 336,255 | ||||||
Thereafter | 682,000 | 682,000 | ||||||
Total par value | $ | 29,118,765 | $ | 31,078,105 | ||||
Discount Notes.At March 31, 2011 and December 31, 2010, the Bank’s consolidated obligation discount notes, all of which are due within one year, were as follows (in thousands):
Weighted | ||||||||||||
Average | ||||||||||||
Implied | ||||||||||||
Book Value | Par Value | Interest Rate | ||||||||||
March 31, 2011 | $ | 500,000 | $ | 500,000 | 0.10 | % | ||||||
December 31, 2010 | $ | 5,131,978 | $ | 5,132,613 | 0.15 | % | ||||||
At December 31, 2010, 18 percent of the Bank’s consolidated obligation discount notes were swapped to a variable rate. None of the Bank’s discount notes were swapped at March 31, 2011.
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Note 7—Affordable Housing Program (“AHP”)
The following table summarizes the changes in the Bank’s AHP liability during the three months ended March 31, 2011 and 2010 (in thousands):
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Balance, beginning of period | $ | 41,044 | $ | 43,714 | ||||
AHP assessment | 1,283 | 1,734 | ||||||
Grants funded, net of recaptured amounts | (3,474 | ) | (3,704 | ) | ||||
Balance, end of period | $ | 38,853 | $ | 41,744 | ||||
Note 8—Derivatives and Hedging Activities
Hedging Activities.As a financial intermediary, the Bank is exposed to interest rate risk. This risk arises from a variety of financial instruments that the Bank enters into on a regular basis in the normal course of its business. The Bank enters into interest rate swap, swaption, cap and forward rate agreements (collectively, interest rate exchange agreements) to manage its exposure to changes in interest rates. The Bank may use these instruments to adjust the effective maturity, repricing frequency, or option characteristics of financial instruments to achieve risk management objectives. The Bank has not entered into any credit default swaps or foreign exchange-related derivatives.
The Bank uses interest rate exchange agreements in two ways: either by designating the agreement as a fair value hedge of a specific financial instrument or firm commitment or by designating the agreement as a hedge of some defined risk in the course of its balance sheet management (referred to as an “economic hedge”). For example, the Bank uses interest rate exchange agreements in its overall interest rate risk management activities to adjust the interest rate sensitivity of consolidated obligations to approximate more closely the interest rate sensitivity of its assets (both advances and investments), and/or to adjust the interest rate sensitivity of advances or investments to approximate more closely the interest rate sensitivity of its liabilities. In addition to using interest rate exchange agreements to manage mismatches between the coupon features of its assets and liabilities, the Bank also uses interest rate exchange agreements to manage embedded options in assets and liabilities, to preserve the market value of existing assets and liabilities, to hedge the duration risk of prepayable instruments, to offset interest rate exchange agreements entered into with members (the Bank serves as an intermediary in these transactions), and to reduce funding costs.
The Bank, consistent with Finance Agency regulations, enters into interest rate exchange agreements only to reduce potential market risk exposures inherent in otherwise unhedged assets and liabilities or to act as an intermediary between its members and the Bank’s derivative counterparties. The Bank is not a derivatives dealer and it does not trade derivatives for short-term profit.
At inception, the Bank formally documents the relationships between derivatives designated as hedging instruments and their hedged items, its risk management objectives and strategies for undertaking the hedge transactions, and its method for assessing the effectiveness of the hedging relationships. This process includes linking all derivatives that are designated as fair value hedges to: (1) specific assets and liabilities on the statement of condition or (2) firm commitments. The Bank also formally assesses (both at the inception of the hedging relationship and on a monthly basis thereafter) whether the derivatives that are used in hedging transactions have been effective in offsetting changes in the fair value of hedged items and whether those derivatives may be expected to remain effective in future periods. The Bank uses regression analyses to assess the effectiveness of its hedges.
Investments— The Bank has invested in agency and non-agency mortgage-backed securities. The interest rate and prepayment risk associated with these investment securities is managed through consolidated obligations and/or derivatives. The Bank may manage prepayment and duration risk presented by some investment securities with either callable or non-callable consolidated obligations or interest rate exchange agreements, including caps and interest rate swaps.
A substantial portion of the Bank’s held-to-maturity securities are variable-rate mortgage-backed securities that include caps that would limit the variable-rate coupons if short-term interest rates rise dramatically. To hedge a
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portion of the potential cap risk embedded in these securities, the Bank enters into interest rate cap agreements. These derivatives are treated as economic hedges.
Advances— The Bank issues both fixed-rate and variable-rate advances. When appropriate, the Bank uses interest rate exchange agreements to adjust the interest rate sensitivity of its fixed-rate advances to approximate more closely the interest rate sensitivity of its liabilities. With issuances of putable advances, the Bank purchases from the member a put option that enables the Bank to terminate a fixed-rate advance on specified future dates. This embedded option is clearly and closely related to the host advance contract. The Bank typically hedges a putable advance by entering into a cancelable interest rate exchange agreement where the Bank pays a fixed coupon and receives a variable coupon, and sells an option to cancel the swap to the swap counterparty. This type of hedge is treated as a fair value hedge. The swap counterparty can cancel the interest rate exchange agreement on the call date and the Bank can cancel the putable advance and offer, subject to certain conditions, replacement funding at prevailing market rates.
A small portion of the Bank’s variable-rate advances are subject to interest rate caps that would limit the variable-rate coupons if short-term interest rates rise above a predetermined level. To hedge the cap risk embedded in these advances, the Bank generally enters into interest rate cap agreements. This type of hedge is treated as a fair value hedge.
The Bank may hedge a firm commitment for a forward-starting advance through the use of an interest rate swap. In this case, the swap will function as the hedging instrument for both the firm commitment and the subsequent advance. The carrying value of the firm commitment will be included in the basis of the advance at the time the commitment is terminated and the advance is issued. The basis adjustment will then be amortized into interest income over the life of the advance.
The Bank enters into optional advance commitments with its members. In an optional advance commitment, the Bank sells an option to the member that provides the member with the right to enter into an advance at a specified fixed rate and term on a specified future date, provided the member has satisfied all of the customary requirements for such advance. Optional advance commitments involving Community Investment Program (“CIP”) and Economic Development Program (“EDP”) advances with a commitment period of three months or less are currently provided at no cost to members. The Bank may hedge an optional advance commitment through the use of an interest rate swaption. In this case, the swaption will function as the hedging instrument for both the commitment and, if the option is exercised by the member, the subsequent advance. These swaptions are treated as economic hedges.
Consolidated Obligations- While consolidated obligations are the joint and several obligations of the FHLBanks, each FHLBank is the primary obligor for the consolidated obligations it has issued or assumed from another FHLBank. The Bank generally enters into derivative contracts to hedge the interest rate risk associated with its specific debt issuances.
To manage the interest rate risk of certain of its consolidated obligations, the Bank will match the cash outflow on a consolidated obligation with the cash inflow of an interest rate exchange agreement. With issuances of fixed-rate consolidated obligation bonds, the Bank typically enters into a matching interest rate exchange agreement in which the counterparty pays fixed cash flows to the Bank that are designed to mirror in timing and amount the cash outflows the Bank pays on the consolidated obligation. In this transaction, the Bank pays a variable cash flow that closely matches the interest payments it receives on short-term or variable-rate assets, typically one-month or three-month LIBOR. Such transactions are treated as fair value hedges. On occasion, the Bank may enter into fixed-for-floating interest rate exchange agreements to hedge the interest rate risk associated with certain of its consolidated obligation discount notes. The derivatives associated with the Bank’s discount note hedging are treated as economic hedges. The Bank may also use interest rate exchange agreements to convert variable-rate consolidated obligation bonds from one index rate (e.g., the daily federal funds rate) to another index rate (e.g., one- or three-month LIBOR); these transactions are treated as economic hedges.
The Bank has not issued consolidated obligations denominated in currencies other than U.S. dollars.
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Balance Sheet Management —From time to time, the Bank may enter into interest rate basis swaps to reduce its exposure to changing spreads between one-month and three-month LIBOR. In addition, to reduce its exposure to reset risk, the Bank may occasionally enter into forward rate agreements. These derivatives are treated as economic hedges.
Intermediation —The Bank offers interest rate swaps, caps and floors to its members to assist them in meeting their hedging needs. In these transactions, the Bank acts as an intermediary for its members by entering into an interest rate exchange agreement with a member and then entering into an offsetting interest rate exchange agreement with one of the Bank’s approved derivative counterparties. All interest rate exchange agreements related to the Bank’s intermediary activities with its members are accounted for as economic hedges.
Accounting for Derivatives and Hedging Activities.The Bank accounts for derivatives and hedging activities in accordance with the guidance in Topic 815 of the FASB’s Accounting Standards Codification (“ASC”) entitled “Derivatives and Hedging”(“ASC 815”). All derivatives are recognized on the statements of condition at their fair values, including accrued interest receivable and payable. For purposes of reporting derivative assets and derivative liabilities, the Bank offsets the fair value amounts recognized for derivative instruments executed with the same counterparty under a master netting arrangement (including any cash collateral remitted to or received from the counterparty).
Changes in the fair value of a derivative that is effective as — and that is designated and qualifies as — a fair value hedge, along with changes in the fair value of the hedged asset or liability that are attributable to the hedged risk (including changes that reflect gains or losses on firm commitments), are recorded in current period earnings. Any hedge ineffectiveness (which represents the amount by which the change in the fair value of the derivative differs from the change in the fair value of the hedged item) is recorded in other income (loss) as “net gains (losses) on derivatives and hedging activities.” Net interest income/expense associated with derivatives that qualify for fair value hedge accounting under ASC 815 is recorded as a component of net interest income. An economic hedge is defined as a derivative hedging specific or non-specific assets or liabilities that does not qualify or was not designated for hedge accounting under ASC 815, but is an acceptable hedging strategy under the Bank’s Risk Management Policy. These hedging strategies also comply with Finance Agency regulatory requirements prohibiting speculative hedge transactions. An economic hedge by definition introduces the potential for earnings variability as changes in the fair value of a derivative designated as an economic hedge are recorded in current period earnings with no offsetting fair value adjustment to an asset or liability. Both the net interest income/expense and the fair value adjustments associated with derivatives in economic hedging relationships are recorded in other income (loss) as “net gains (losses) on derivatives and hedging activities.” Cash flows associated with derivatives are reported as cash flows from operating activities in the statements of cash flows, unless the derivatives contain an other-than-insignificant financing element, in which case the cash flows are reported as cash flows from financing activities.
If hedging relationships meet certain criteria specified in ASC 815, they are eligible for hedge accounting and the offsetting changes in fair value of the hedged items may be recorded in earnings. The application of hedge accounting generally requires the Bank to evaluate the effectiveness of the hedging relationships on an ongoing basis and to calculate the changes in fair value of the derivatives and related hedged items independently. This is commonly known as the “long-haul” method of accounting. Transactions that meet more stringent criteria qualify for the “short-cut” method of hedge accounting in which an assumption can be made that the change in fair value of a hedged item exactly offsets the change in value of the related derivative. The Bank considers hedges of committed advances to be eligible for the short-cut method of accounting as long as the settlement of the committed advance occurs within the shortest period possible for that type of instrument based on market settlement conventions, the fair value of the swap is zero at the inception of the hedging relationship, and the transaction meets all of the other criteria for short-cut accounting specified in ASC 815. The Bank has defined the market settlement convention to be 5 business days or less for advances. The Bank records the changes in fair value of the derivative and the hedged item beginning on the trade date.
The Bank may issue debt, make advances, or purchase financial instruments in which a derivative instrument is “embedded” and the financial instrument that embodies the embedded derivative instrument is not remeasured at fair value with changes in fair value reported in earnings as they occur. Upon execution of these transactions, the Bank assesses whether the economic characteristics of the embedded derivative are clearly and closely related to the
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economic characteristics of the remaining component of the financial instrument (i.e., the host contract) and whether a separate, non-embedded instrument with the same terms as the embedded instrument would meet the definition of a derivative instrument. When it is determined that (1) the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract and (2) a separate, stand-alone instrument with the same terms would qualify as a derivative instrument, the embedded derivative is separated from the host contract, carried at fair value, and designated as either (1) a hedging instrument in a fair value hedge or (2) a stand-alone derivative instrument pursuant to an economic hedge. However, if the entire contract were to be measured at fair value, with changes in fair value reported in current earnings, or if the Bank could not reliably identify and measure the embedded derivative for purposes of separating that derivative from its host contract, the entire contract would be carried on the statement of condition at fair value and no portion of the contract would be separately accounted for as a derivative.
The Bank discontinues hedge accounting prospectively when: (1) management determines that the derivative is no longer effective in offsetting changes in the fair value of a hedged item; (2) the derivative and/or the hedged item expires or is sold, terminated, or exercised; (3) a hedged firm commitment no longer meets the definition of a firm commitment; or (4) management determines that designating the derivative as a hedging instrument in accordance with ASC 815 is no longer appropriate.
When fair value hedge accounting for a specific derivative is discontinued due to the Bank’s determination that such derivative no longer qualifies for hedge accounting treatment, the Bank will continue to carry the derivative on the statement of condition at its fair value, cease to adjust the hedged asset or liability for changes in fair value, and amortize the cumulative basis adjustment on the formerly hedged item into earnings over its remaining term using the level-yield method. In all cases in which hedge accounting is discontinued and the derivative remains outstanding, the Bank will carry the derivative at its fair value on the statement of condition, recognizing changes in the fair value of the derivative in current period earnings.
When hedge accounting is discontinued because the hedged item no longer meets the definition of a firm commitment, the Bank continues to carry the derivative on the statement of condition at its fair value, removing from the statement of condition any asset or liability that was recorded to recognize the firm commitment and recording it as a gain or loss in current period earnings.
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Impact of Derivatives and Hedging Activities.The following table summarizes the notional balances and estimated fair values of the Bank’s outstanding derivatives at March 31, 2011 and December 31, 2010 (in thousands).
March 31, 2011 | December 31, 2010 | |||||||||||||||||||||||
Notional | Estimated Fair Value | Notional | Estimated Fair Value | |||||||||||||||||||||
Amount of | Derivative | Derivative | Amount of | Derivative | Derivative | |||||||||||||||||||
Derivatives | Assets | Liabilities | Derivatives | Assets | Liabilities | |||||||||||||||||||
Derivatives designated as hedging instruments under ASC 815 | ||||||||||||||||||||||||
Interest rate swaps | ||||||||||||||||||||||||
Advances | $ | 8,141,870 | $ | 35,782 | $ | 426,753 | $ | 8,538,084 | $ | 29,201 | $ | 501,545 | ||||||||||||
Consolidated obligation bonds | 14,572,080 | 288,394 | 59,610 | 14,650,120 | 352,710 | 53,502 | ||||||||||||||||||
Interest rate caps related to advances | 83,000 | 654 | — | 83,000 | 632 | — | ||||||||||||||||||
Total derivatives designated as hedging instruments under ASC 815 | 22,796,950 | 324,830 | 486,363 | 23,271,204 | 382,543 | 555,047 | ||||||||||||||||||
Derivatives not designated as hedging instruments under ASC 815 | ||||||||||||||||||||||||
Interest rate swaps | ||||||||||||||||||||||||
Advances | 10,000 | — | 112 | 6,000 | — | 59 | ||||||||||||||||||
Consolidated obligation bonds | 1,600,000 | 1,081 | — | 1,600,000 | 2,262 | — | ||||||||||||||||||
Consolidated obligation discount notes | — | — | — | 912,722 | 2,825 | — | ||||||||||||||||||
Basis swaps(1) | 5,700,000 | 10,730 | — | 6,700,000 | 14,886 | — | ||||||||||||||||||
Intermediary transactions | 86,758 | 663 | 486 | 44,200 | 508 | 426 | ||||||||||||||||||
Interest rate swaptions related to optional advance commitments | 200,000 | 14,735 | — | 150,000 | 10,409 | — | ||||||||||||||||||
Interest rate caps related to advances | 13,000 | — | — | 13,000 | — | — | ||||||||||||||||||
Interest rate caps related to held-to-maturity securities | 3,700,000 | 15,259 | — | 3,700,000 | 19,585 | — | ||||||||||||||||||
Total derivatives not designated as hedging instruments under ASC 815 | 11,309,758 | 42,468 | 598 | 13,125,922 | 50,475 | 485 | ||||||||||||||||||
Total derivatives before netting and collateral adjustments | $ | 34,106,708 | 367,298 | 486,961 | $ | 36,397,126 | 433,018 | 555,532 | ||||||||||||||||
Cash collateral and related accrued interest | (40,193 | ) | (188,451 | ) | (55,481 | ) | (215,356 | ) | ||||||||||||||||
Netting adjustments | (297,999 | ) | (297,999 | ) | (338,866 | ) | (338,866 | ) | ||||||||||||||||
Total collateral and netting adjustments(2) | (338,192 | ) | (486,450 | ) | (394,347 | ) | (554,222 | ) | ||||||||||||||||
Net derivative balances reported in statements of condition | $ | 29,106 | $ | 511 | $ | 38,671 | $ | 1,310 | ||||||||||||||||
(1) | The Bank’s basis swaps are used to reduce its exposure to changing spreads between one-month and three-month LIBOR. | |
(2) | Amounts represent the effect of legally enforceable master netting agreements between the Bank and its derivative counterparties that allow the Bank to offset positive and negative positions as well as the cash collateral held or placed with those same counterparties. |
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The following table presents the components of net gains (losses) on derivatives and hedging activities as presented in the statements of income for the three months ended March 31, 2011 and 2010 (in thousands).
Gain (Loss) Recognized in Earnings | ||||||||
for the Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Derivatives and hedged items in ASC 815 fair value hedging relationships | ||||||||
Interest rate swaps | $ | 379 | $ | 2,508 | ||||
Interest rate caps | 22 | (54 | ) | |||||
Total net gain related to fair value hedge ineffectiveness | 401 | 2,454 | ||||||
Derivatives not designated as hedging instruments under ASC 815 | ||||||||
Net interest income on interest rate swaps | 1,668 | 8,495 | ||||||
Interest rate swaps | ||||||||
Advances | 60 | (1 | ) | |||||
Consolidated obligation bonds | (1,109 | ) | (6,520 | ) | ||||
Consolidated obligation discount notes | (497 | ) | (1,622 | ) | ||||
Basis swaps(1) | (3,909 | ) | (554 | ) | ||||
Intermediary transactions | 95 | — | ||||||
Interest rate swaptions related to optional advance commitments | 1,102 | — | ||||||
Interest rate caps | ||||||||
Advances | — | (5 | ) | |||||
Held-to-maturity securities | (4,326 | ) | (28,953 | ) | ||||
Total net loss related to derivatives not designated as hedging instruments under ASC 815 | (6,916 | ) | (29,160 | ) | ||||
Net losses on derivatives and hedging activities reported in the statements of income | $ | (6,515 | ) | $ | (26,706 | ) | ||
(1) | The Bank’s basis swaps are used to reduce its exposure to changing spreads between one-month and three-month LIBOR. |
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The following table presents, by type of hedged item, the gains (losses) on derivatives and the related hedged items in ASC 815 fair value hedging relationships and the impact of those derivatives on the Bank’s net interest income for the three months ended March 31, 2011 and 2010 (in thousands).
Derivative | ||||||||||||||||
Gain (Loss) | Gain (Loss) | Net Fair Value | Net Interest | |||||||||||||
on | on | Hedge | Income | |||||||||||||
Hedged Item | Derivatives | Hedged Items | Ineffectiveness(1) | (Expense)(2) | ||||||||||||
Three months ended March 31, 2011 | ||||||||||||||||
Advances | $ | 75,336 | $ | (74,933 | ) | $ | 403 | $ | (57,178 | ) | ||||||
Consolidated obligation bonds | (63,958 | ) | 63,956 | (2 | ) | 69,673 | ||||||||||
Total | $ | 11,378 | $ | (10,977 | ) | $ | 401 | $ | 12,495 | |||||||
Three months ended March 31, 2010 | ||||||||||||||||
Advances | $ | (23,849 | ) | $ | 24,073 | $ | 224 | $ | (78,614 | ) | ||||||
Consolidated obligation bonds | 21,570 | (19,340 | ) | 2,230 | 132,597 | |||||||||||
Total | $ | (2,279 | ) | $ | 4,733 | $ | 2,454 | $ | 53,983 | |||||||
(1) | Reported as net gains (losses) on derivatives and hedging activities in the statements of income. | |
(2) | The net interest income (expense) associated with derivatives in ASC 815 fair value hedging relationships is reported in the statements of income in the interest income/expense line item for the indicated hedged item. |
Credit Risk Related to Derivatives.The Bank is subject to credit risk due to the risk of nonperformance by counterparties to its derivative agreements. To mitigate this risk, the Bank has entered into master swap and credit support agreements with all of its derivative counterparties. These agreements provide for the netting of all transactions with a derivative counterparty and the delivery of collateral when certain thresholds (generally ranging from $100,000 to $500,000) are met. The Bank manages derivative counterparty credit risk through the use of these agreements, credit analysis, and adherence to the requirements set forth in the Bank’s Risk Management Policy and Finance Agency regulations. Based on the netting provisions and collateral requirements of its master swap and credit support agreements and the creditworthiness of its derivative counterparties, Bank management does not currently anticipate any credit losses on its derivative agreements.
The notional amount of its interest rate exchange agreements does not measure the Bank’s credit risk exposure, and the maximum credit exposure for the Bank is substantially less than the notional amount. The maximum credit risk exposure is the estimated cost, on a present value basis, of replacing at current market rates all interest rate exchange agreements with a counterparty with whom the Bank is in a net gain position, if the counterparty were to default. In determining its maximum credit exposure to a counterparty, the Bank, as permitted under master netting provisions of its interest rate exchange agreements, nets its obligations to the counterparty (i.e., derivative liabilities) against the counterparty’s obligations to the Bank (i.e., derivative assets). Maximum credit risk also considers the impact of cash collateral held or remitted by the Bank. As of March 31, 2011 and December 31, 2010, the Bank held as collateral cash balances of $40,189,000 and $55,471,000, respectively. The cash collateral held is included in derivative assets/liabilities in the statements of condition.
At March 31, 2011 and December 31, 2010, the Bank’s maximum credit risk, as defined above, was approximately $22,678,000 and $34,183,000, respectively. In early April 2011 and early January 2011, additional/excess cash collateral of $20,801,000 and $33,006,000, respectively, was delivered/returned to the Bank pursuant to counterparty credit arrangements.
The Bank transacts most of its interest rate exchange agreements with large financial institutions. Some of these institutions (or their affiliates) buy, sell, and distribute consolidated obligations. Assets pledged by the Bank to these counterparties are further described in Note 12.
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When entering into interest rate exchange agreements with its members, the Bank requires the member to post eligible collateral in an amount equal to the sum of the net market value of the member’s derivative transactions with the Bank (if the value is positive to the Bank) plus a percentage of the notional amount of any interest rate swaps, with market values determined on at least a monthly basis. At March 31, 2011 and December 31, 2010, the net market value of the Bank’s derivatives with its members totaled ($93,000) and ($53,000), respectively.
The Bank has an agreement with one of its derivative counterparties that contains provisions that may require the Bank to deliver collateral to the counterparty if there is a deterioration in the Bank’s long-term credit rating to AA+ or below by S&P or Aa1 or below by Moody’s and the Bank loses its status as a government-sponsored enterprise. If this were to occur, the counterparty to the agreement would be entitled to collateral equal to its exposure to the extent such exposure exceeded $1,000,000. However, the Bank would not be required to deliver collateral unless the amount to be delivered is at least $500,000. The derivative instruments subject to this agreement were in a net asset position for the Bank on March 31, 2011.
Note 9—Capital
At all times during the three months ended March 31, 2011, the Bank was in compliance with all applicable statutory and regulatory capital requirements. The following table summarizes the Bank’s compliance with those capital requirements as of March 31, 2011 and December 31, 2010 (dollars in thousands):
March 31, 2011 | December 31, 2010 | |||||||||||||||
Required | Actual | Required | Actual | |||||||||||||
Regulatory capital requirements: | ||||||||||||||||
Risk-based capital | $ | 404,486 | $ | 1,908,129 | $ | 402,820 | $ | 2,061,190 | ||||||||
Total capital | $ | 1,326,788 | $ | 1,908,129 | $ | 1,587,603 | $ | 2,061,190 | ||||||||
Total capital-to-assets ratio | 4.00 | % | 5.75 | % | 4.00 | % | 5.19 | % | ||||||||
Leverage capital | $ | 1,658,485 | $ | 2,862,193 | $ | 1,984,503 | $ | 3,091,785 | ||||||||
Leverage capital-to-assets ratio | 5.00 | % | 8.63 | % | 5.00 | % | 7.79 | % |
Shareholders are required to maintain an investment in Class B stock equal to the sum of a membership investment requirement and an activity-based investment requirement. Effective April 18, 2011, the membership investment requirement was reduced from 0.06 percent to 0.05 percent of each member’s total assets as of the previous calendar year-end, subject to a minimum of $1,000 and a maximum of $10,000,000. The activity-based investment requirement is currently 4.10 percent of outstanding advances.
The Bank generally repurchases surplus stock at the end of the month following the end of each calendar quarter (e.g., January 31, April 30, July 31 and October 31). For the repurchases that occurred on January 31, 2011 and April 29, 2011, surplus stock was defined as the amount of stock held by a member in excess of 105 percent of the member’s minimum investment requirement. The Bank’s practice has been that a member’s surplus stock will not be repurchased if the amount of that member’s surplus stock is $250,000 or less or if, subject to certain exceptions, the member is on restricted collateral status. On January 31, 2011 and April 29, 2011, the Bank repurchased surplus stock totaling $102,459,000 and $147,036,000, respectively, of which $0 and $119,000, respectively, was classified as mandatorily redeemable capital stock at those dates.
Effective February 28, 2011, the Bank entered into a Joint Capital Enhancement Agreement (the “JCE Agreement”) with the other 11 FHLBanks. The JCE Agreement provides that upon satisfaction of the FHLBanks’ obligations to REFCORP, which is currently expected to occur in 2011, the Bank (and each of the other FHLBanks) will, on a quarterly basis, allocate at least 20 percent of its net income to a restricted retained earnings account. Pursuant to the provisions of the JCE Agreement, the Bank will be required to build its restricted retained earnings account to an amount equal to one percent of its total outstanding consolidated obligations, which for this purpose is based on the most recent quarter’s average carrying value of all outstanding consolidated obligations, excluding hedging adjustments. The JCE Agreement provides that during periods in which the Bank’s restricted retained earnings account is less than the amount prescribed in the preceding sentence, it may pay dividends only from
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unrestricted retained earnings or from the portion of its quarterly net income that exceeds the amount required to be allocated to its restricted retained earnings account.
Note 10—Employee Retirement Plans
The Bank sponsors a retirement benefits program that includes health care and life insurance benefits for eligible retirees. Components of net periodic benefit cost related to this program for the three months ended March 31, 2011 and 2010 were as follows (in thousands):
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Service cost | $ | 4 | $ | 3 | ||||
Interest cost | 28 | 29 | ||||||
Amortization of prior service credit | (9 | ) | (9 | ) | ||||
Amortization of net actuarial gain | (6 | ) | (6 | ) | ||||
Net periodic benefit cost | $ | 17 | $ | 17 | ||||
Note 11—Estimated Fair Values
Fair value is defined under GAAP as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. GAAP establishes a fair value hierarchy and requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. GAAP also requires an entity to disclose the level within the fair value hierarchy in which the measurements fall for assets and liabilities that are carried at fair value (that is, those assets and liabilities that are measured at fair value on a recurring basis) and for assets and liabilities that are measured at fair value on a nonrecurring basis in periods subsequent to initial recognition (for example, impaired assets). The fair value hierarchy prioritizes the inputs used to measure fair value into three broad levels:
Level 1 Inputs— Quoted prices (unadjusted) in active markets for identical assets and liabilities.
Level 2 Inputs— Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the asset or liability. Level 2 inputs include the following: (1) quoted prices for similar assets or liabilities in active markets; (2) quoted prices for identical or similar assets or liabilities in markets that are not active or in which little information is released publicly; (3) inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates and yield curves that are observable at commonly quoted intervals, volatilities and prepayment speeds); and (4) inputs that are derived principally from or corroborated by observable market data (e.g., implied spreads).
Level 3 Inputs— Unobservable inputs for the asset or liability that are supported by little or no market activity and that are significant to the fair value measurement of such asset or liability. None of the Bank’s assets or liabilities that are recorded at fair value on a recurring basis were measured using Level 3 inputs.
The following estimated fair value amounts have been determined by the Bank using available market information and the Bank’s best judgment of appropriate valuation methods. These estimates are based on pertinent information available to the Bank as of March 31, 2011 and December 31, 2010. Although the Bank uses its best judgment in estimating the fair value of these financial instruments, there are inherent limitations in any estimation technique or valuation methodology. For example, because an active secondary market does not exist for many of the Bank’s financial instruments (e.g., advances, non-agency RMBS and mortgage loans held for portfolio), in certain cases, their fair values are not subject to precise quantification or verification. Therefore, the estimated fair values presented below in the Fair Value Summary Table may not be indicative of the amounts that would have been realized in market transactions at the reporting dates. Further, the fair values do not represent an estimate of
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the overall market value of the Bank as a going concern, which would take into account future business opportunities.
The valuation techniques used to measure the fair values of the Bank’s financial instruments are described below.
Cash and due from banks.The estimated fair value equals the carrying value.
Interest-bearing deposit assets.Interest-bearing deposit assets earn interest at floating market rates; therefore, the estimated fair value of the deposits approximates their carrying value.
Securities purchased under agreements to resell and federal funds sold.All federal funds sold and securities purchased under agreements to resell represent overnight balances and are carried at cost. The estimated fair value approximates the carrying value.
Trading securities.The Bank obtains quoted prices for identical securities.
Held-to-maturity securities.To value its MBS holdings, the Bank obtains prices from up to four designated third-party pricing vendors when available. These pricing vendors use methods that generally employ, but are not limited to, benchmark yields, recent trades, dealer estimates, valuation models, benchmarking of like securities, sector groupings, and/or matrix pricing. A price is established for each MBS using a formula that is based upon the number of prices received. If four prices are received, the average of the middle two prices is used; if three prices are received, the middle price is used; if two prices are received, the average of the two prices is used; and if one price is received, it is used subject to some type of validation as described below. The computed prices are tested for reasonableness using specified tolerance thresholds. Computed prices within these thresholds are generally accepted unless strong evidence suggests that using the formula-driven price would not be appropriate. Preliminary estimated fair values that are outside the tolerance thresholds, or that management believes may not be appropriate based on all available information (including those limited instances in which only one price is received), are subject to further analysis including, but not limited to, comparison to the prices for similar securities and/or to non-binding dealer estimates. As of March 31, 2011, four vendor prices were received for substantially all of the Bank’s MBS holdings and all of the computed prices fell within the specified tolerance thresholds. The relative lack of dispersion among the vendor prices received for each of the securities supports the Bank’s conclusion that the final computed prices are reasonable estimates of fair value. The Bank estimates the fair values of debentures using a pricing model.
Advances.The Bank determines the estimated fair value of advances by calculating the present value of expected future cash flows from the advances and reducing this amount for accrued interest receivable. The discount rates used in these calculations are the replacement advance rates for advances with similar terms.
Mortgage loans held for portfolio.The Bank estimates the fair values of mortgage loans held for portfolio based on observed market prices for agency mortgage-backed securities. Individual mortgage loans are pooled based on certain criteria such as loan type, weighted average coupon, and origination year and matched to reference securities with a similar collateral composition to derive benchmark pricing. The prices for agency mortgage-backed securities used as a benchmark are subject to certain market conditions including, but not limited to, the market’s expectations of future prepayments, the current and expected level of interest rates, and investor demand.
Accrued interest receivable and payable.The estimated fair value approximates the carrying value due to their short-term nature.
Derivative assets/liabilities. With the exception of its interest rate basis swaps, the fair values of the Bank’s interest rate swap and swaption agreements are estimated using a pricing model with inputs that are observable in the market (e.g., the relevant interest rate swap curve and, for agreements containing options, swaption volatility). As the provisions of the Bank’s master netting and collateral exchange agreements with its derivative counterparties significantly reduce the risk from nonperformance (see Note 8), the Bank does not consider its own nonperformance risk or the nonperformance risk associated with each of its counterparties to be a significant factor in the valuation of its derivative assets and liabilities. The Bank compares the fair values obtained from its pricing model to non-
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binding dealer estimates and may also compare its fair values to those of similar instruments to ensure that such fair values are reasonable. For the Bank’s interest rate basis swaps, fair values are obtained from dealers (for each basis swap, one dealer estimate is received); these non-binding fair value estimates are corroborated using a pricing model and observable market data (i.e., the interest rate swap curve).
For the Bank’s interest rate caps, fair values are obtained from dealers (for each interest rate cap, one dealer estimate is received). These non-binding fair value estimates are corroborated using a pricing model and observable market data (e.g., the interest rate swap curve and cap volatility).
The fair values of the Bank’s derivative assets and liabilities include accrued interest receivable/payable and cash collateral remitted to/received from counterparties; the estimated fair values of the accrued interest receivable/payable and cash collateral approximate their carrying values due to their short-term nature. The fair values of derivatives are netted by counterparty pursuant to the provisions of the Bank’s master swap and credit support agreements. If these netted amounts are positive, they are classified as an asset and, if negative, as a liability.
Deposit liabilities.The Bank determines the estimated fair values of its deposit liabilities with fixed rates and more than three months to maturity by calculating the present value of expected future cash flows from the deposits and reducing this amount for accrued interest payable. The discount rates used in these calculations are based on replacement funding rates for liabilities with similar terms. The estimated fair value approximates the carrying value for deposits with floating rates and fixed rates with three months or less to their maturity or repricing date.
Consolidated obligations.The Bank estimates the fair values of consolidated obligations by calculating the present value of expected future cash flows using discount rates that are based on replacement funding rates for liabilities with similar terms and reducing this amount for accrued interest payable.
Mandatorily redeemable capital stock.The fair value of capital stock subject to mandatory redemption is generally equal to its par value ($100 per share), as adjusted for any estimated dividend earned but unpaid at the time of reclassification from equity to liabilities. The Bank’s capital stock cannot, by statute or implementing regulation, be purchased, redeemed, repurchased or transferred at any amount other than its par value.
Commitments.The Bank determines the estimated fair values of optional commitments to fund advances by calculating the present value of expected future cash flows from the instruments using replacement advance rates for advances with similar terms and swaption volatility. The estimated fair value of the Bank’s other commitments to extend credit, including advances and letters of credit, was not material at March 31, 2011 or December 31, 2010.
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The carrying values and estimated fair values of the Bank’s financial instruments at March 31, 2011 and December 31, 2010, were as follows (in thousands):
FAIR VALUE SUMMARY TABLE
March 31, 2011 | December 31, 2010 | |||||||||||||||
Carrying | Estimated | Carrying | Estimated | |||||||||||||
Financial Instruments | Value | Fair Value | Value | Fair Value | ||||||||||||
Assets: | ||||||||||||||||
Cash and due from banks | $ | 511,713 | $ | 511,713 | $ | 1,631,899 | $ | 1,631,899 | ||||||||
Interest-bearing deposits | 252 | 252 | 208 | 208 | ||||||||||||
Security purchased under agreement to resell | 375,000 | 375,000 | — | — | ||||||||||||
Federal funds sold | 2,326,000 | 2,326,000 | 3,767,000 | 3,767,000 | ||||||||||||
Trading securities | 5,956 | 5,956 | 5,317 | 5,317 | ||||||||||||
Held-to-maturity securities | 7,838,641 | 7,924,731 | 8,496,429 | 8,602,589 | ||||||||||||
Advances | 21,804,806 | 21,994,210 | 25,455,656 | 25,672,203 | ||||||||||||
Mortgage loans held for portfolio, net | 194,478 | 211,883 | 207,168 | 225,336 | ||||||||||||
Accrued interest receivable | 40,678 | 40,678 | 43,248 | 43,248 | ||||||||||||
Derivative assets | 29,106 | 29,106 | 38,671 | 38,671 | ||||||||||||
Liabilities: | ||||||||||||||||
Deposits | 1,322,828 | 1,322,828 | 1,070,052 | 1,070,044 | ||||||||||||
Consolidated obligations: | ||||||||||||||||
Discount notes | 500,000 | 500,000 | 5,131,978 | 5,132,290 | ||||||||||||
Bonds | 29,302,425 | 29,441,339 | 31,315,605 | 31,444,058 | ||||||||||||
Mandatorily redeemable capital stock | 18,131 | 18,131 | 8,076 | 8,076 | ||||||||||||
Accrued interest payable | 117,504 | 117,504 | 94,417 | 94,417 | ||||||||||||
Derivative liabilities | 511 | 511 | 1,310 | 1,310 | ||||||||||||
Optional advance commitments (other liabilities) | 15,390 | 15,390 | 11,156 | 11,156 |
The following table summarizes the Bank’s assets and liabilities that were measured at fair value on a recurring basis as of March 31, 2011 by their level within the fair value hierarchy (in thousands). Financial assets and liabilities are classified in their entirety based on the lowest level input that is significant to the fair value measurement.
Netting | ||||||||||||||||||||
Level 1 | Level 2 | Level 3 | Adjustment(1) | Total | ||||||||||||||||
Assets | ||||||||||||||||||||
Trading securities | $ | 5,956 | $ | — | $ | — | $ | — | $ | 5,956 | ||||||||||
Derivative assets | — | 367,298 | — | (338,192 | ) | 29,106 | ||||||||||||||
Total assets at fair value | $ | 5,956 | $ | 367,298 | $ | — | $ | (338,192 | ) | $ | 35,062 | |||||||||
Liabilities | ||||||||||||||||||||
Derivative liabilities | $ | — | $ | 486,961 | $ | — | $ | (486,450 | ) | $ | 511 | |||||||||
Optional advance commitments | ||||||||||||||||||||
(other liabilities) | — | 15,390 | — | — | 15,390 | |||||||||||||||
Total liabilities at fair value | $ | — | $ | 502,351 | $ | — | $ | (486,450 | ) | $ | 15,901 | |||||||||
(1) | Amounts represent the impact of legally enforceable master netting agreements between the Bank and its derivative counterparties that allow the Bank to offset positive and negative positions as well as the cash collateral held or placed with those same counterparties. |
The Bank did not have any assets recorded at fair value on a non-recurring basis at March 31, 2011.
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The following table summarizes the Bank’s assets and liabilities that were measured at fair value on a recurring basis as of December 31, 2010 by their level within the fair value hierarchy (in thousands).
Netting | ||||||||||||||||||||
Level 1 | Level 2 | Level 3 | Adjustment(1) | Total | ||||||||||||||||
Assets | ||||||||||||||||||||
Trading securities | $ | 5,317 | $ | — | $ | — | $ | — | $ | 5,317 | ||||||||||
Derivative assets | — | 433,018 | — | (394,347 | ) | 38,671 | ||||||||||||||
Total assets at fair value | $ | 5,317 | $ | 433,018 | $ | — | $ | (394,347 | ) | $ | 43,988 | |||||||||
Liabilities | ||||||||||||||||||||
Derivative liabilities | $ | — | $ | 555,532 | $ | — | $ | (554,222 | ) | $ | 1,310 | |||||||||
Optional advance commitments | ||||||||||||||||||||
(other liabilities) | — | 11,156 | — | — | 11,156 | |||||||||||||||
Total liabilities at fair value | $ | — | $ | 566,688 | $ | — | $ | (554,222 | ) | $ | 12,466 | |||||||||
(1) | Amounts represent the impact of legally enforceable master netting agreements between the Bank and its derivative counterparties that allow the Bank to offset positive and negative positions as well as the cash collateral held or placed with those same counterparties. |
As of March 31, 2011 and December 31, 2010, the Bank had entered into optional advance commitments with par values totaling $200,000,000 and $150,000,000, respectively, excluding commitments to fund CIP/EDP advances. Under each of these commitments, the Bank sold an option to a member that provides the member with the right to enter into an advance at a specified fixed rate and term on a specified future date, provided the member has satisfied all of the customary requirements for such advance. The Bank hedged these commitments through the use of interest rate swaptions, which are treated as economic hedges. The Bank has irrevocably elected to carry these optional advance commitments at fair value under the fair value option in an effort to mitigate the potential income statement volatility that can arise from economic hedging relationships. Gains and losses on optional advance commitments carried at fair value under the fair value option are reported in other income (loss) in the statements of income. The optional advance commitments are reported in other liabilities in the statements of condition. At March 31, 2011 and December 31, 2010, other liabilities included items with an aggregate carrying value of $17,763,000 and $20,427,000, respectively, that were not eligible for the fair value option.
Note 12—Commitments and Contingencies
Joint and several liability.The Bank is jointly and severally liable with the other 11 FHLBanks for the payment of principal and interest on all of the consolidated obligations issued by the 12 FHLBanks. At March 31, 2011, the par amount of the other 11 FHLBanks’ outstanding consolidated obligations was approximately $736 billion. The Finance Agency, in its discretion, may require any FHLBank to make principal or interest payments due on any consolidated obligation, regardless of whether there has been a default by a FHLBank having primary liability. To the extent that a FHLBank makes any consolidated obligation payment on behalf of another FHLBank, the paying FHLBank is entitled to reimbursement from the FHLBank with primary liability. However, if the Finance Agency determines that the primary obligor is unable to satisfy its obligations, then the Finance Agency may allocate the outstanding liability among the remaining FHLBanks on a pro rata basis in proportion to each FHLBank’s participation in all consolidated obligations outstanding, or on any other basis that the Finance Agency may determine. No FHLBank has ever failed to make any payment on a consolidated obligation for which it was the primary obligor; as a result, the regulatory provisions for directing other FHLBanks to make payments on behalf of another FHLBank or allocating the liability among other FHLBanks have never been invoked. If the Bank were to determine that a loss was probable under its joint and several liability and the amount of such loss could be reasonably estimated, the Bank would charge to income the amount of the expected loss. Based upon the creditworthiness of the other FHLBanks, the Bank currently believes that the likelihood of a loss arising from its joint and several liability is remote.
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Other commitments and contingencies.At March 31, 2011 and December 31, 2010, the Bank had commitments to make additional advances totaling approximately $282,742,000 and $199,773,000, respectively. In addition, outstanding standby letters of credit totaled $4,267,681,000 and $4,595,290,000 at March 31, 2011 and December 31, 2010, respectively. Based on management’s credit analyses and collateral requirements, the Bank does not deem it necessary to have any provision for credit losses on these letters of credit (see Note 5).
At March 31, 2011 and December 31, 2010, the Bank had commitments to issue $15,000,000 and $115,000,000, respectively, of consolidated obligation bonds, all of which were hedged with associated interest rate swaps.
The Bank executes interest rate exchange agreements with large financial institutions with which it has bilateral collateral exchange agreements. As of March 31, 2011 and December 31, 2010, the Bank had pledged cash collateral of $188,430,000 and $215,322,000, respectively, to institutions that had credit risk exposure to the Bank related to interest rate exchange agreements; at those dates, the Bank had not pledged any securities as collateral. The pledged cash collateral (i.e., interest-bearing deposit asset) is netted against derivative assets and liabilities in the statements of condition.
In the ordinary course of its business, the Bank is subject to the risk that litigation may arise. Currently, the Bank is not a party to any material pending legal proceedings.
Note 13— Transactions with Shareholders
Affiliates of two of the Bank’s derivative counterparties (Citigroup and Wells Fargo) acquired member institutions on March 31, 2005 and October 1, 2006, respectively. Since the acquisitions were completed, the Bank has continued to enter into interest rate exchange agreements with Citigroup and Wells Fargo in the normal course of business and under the same terms and conditions as before. Effective October 1, 2006, Citigroup terminated the Ninth District charter of the affiliate that acquired the member institution and, as a result, an affiliate of Citigroup became a non-member shareholder of the Bank.
Note 14 — Transactions with Other FHLBanks
Occasionally, the Bank loans (or borrows) short-term federal funds to (from) other FHLBanks. During the three months ended March 31, 2011, interest income from loans to other FHLBanks totaled $1,000. The following table summarizes the Bank’s loans to other FHLBanks during the three months ended March 31, 2011 (in thousands).
Three Months Ended | ||||
March 31, 2011 | ||||
Balance at January 1, 2011 | $ | — | ||
Loan made to FHLBank of San Francisco | 200,000 | |||
Collection from FHLBank of San Francisco | (200,000 | ) | ||
Balance at March 31, 2011 | $ | — | ||
During the three months ended March 31, 2011, interest expense on borrowings from other FHLBanks totaled $278. The following table summarizes the Bank’s borrowings from other FHLBanks during the three months ended March 31, 2011 (in thousands).
Three Months Ended | ||||
March 31, 2011 | ||||
Balance at January 1, 2011 | $ | — | ||
Borrowing from FHLBank of Indianapolis | 50,000 | |||
Repayment to FHLBank of Indianapolis | (50,000 | ) | ||
Balance at March 31, 2011 | $ | — | ||
There were no loans to or borrowings from other FHLBanks during the three months ended March 31, 2010.
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The Bank has, from time to time, assumed the outstanding debt of another FHLBank rather than issue new debt. In connection with these transactions, the Bank becomes the primary obligor for the transferred debt. During the three months ended March 31, 2011, the Bank assumed consolidated obligations from the FHLBank of New York with par amounts totaling $150,000,000. The net premium associated with these transactions totaled $17,381,000. The Bank did not assume any other debt from other FHLBanks during the three months ended March 31, 2011 or 2010.
Note 15 — Other Comprehensive Income (Loss)
The following table presents the components of other comprehensive income (loss) for the three months ended March 31, 2011 and 2010 (in thousands).
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Non-credit portion of other-than-temporary impairment losses on held-to-maturity securities | $ | — | $ | (6,958 | ) | |||
Reclassification adjustment for non-credit portion of other-than-temporary impairment losses recognized as credit losses in net income | 1,378 | 495 | ||||||
Accretion of non-credit portion of other-than-temporary impairment losses to the carrying value of held-to-maturity securities | 4,596 | 4,266 | ||||||
Postretirement benefit plan | ||||||||
Amortization of prior service credit included in net periodic benefit cost | (9 | ) | (9 | ) | ||||
Amortization of net actuarial gain included in net periodic benefit cost | (6 | ) | (6 | ) | ||||
Total other comprehensive income (loss) | $ | 5,959 | $ | (2,212 | ) | |||
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ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion and analysis of financial condition and results of operations should be read in conjunction with the financial statements and notes thereto included in “Item 1. Financial Statements.”
Forward-Looking Information
This quarterly report contains forward-looking statements that reflect current beliefs and expectations of the Federal Home Loan Bank of Dallas (the “Bank”) about its future results, performance, liquidity, financial condition, prospects and opportunities, including the prospects for the payment of dividends. These statements are identified by the use of forward-looking terminology, such as “anticipates,” “plans,” “believes,” “could,” “estimates,” “may,” “should,” “would,” “will,” “might,” “expects,” “intends” or their negatives or other similar terms. The Bank cautions that forward-looking statements involve risks or uncertainties that could cause the Bank’s actual future results to 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. As a result, undue reliance should not be placed on such statements.
These risks and uncertainties include, without limitation, evolving economic and market conditions, political events, and the impact of competitive business forces. The risks and uncertainties related to evolving economic and market conditions include, but are not limited to, changes in interest rates, changes in the Bank’s access to the capital markets, changes in the cost of the Bank’s debt, adverse consequences resulting from a significant regional or national economic downturn, credit and prepayment risks, or changes in the financial health of the Bank’s members or non-member borrowers. Among other things, political events could possibly lead to changes in the Bank’s regulatory environment or its status as a government-sponsored enterprise (“GSE”), or to changes in the regulatory environment for the Bank’s members or non-member borrowers. Risks and uncertainties related to competitive business forces include, but are not limited to, the potential loss of large members or large borrowers through acquisitions or other means or changes in the relative competitiveness of the Bank’s products and services for member institutions. For a more detailed discussion of the risk factors applicable to the Bank, see “Item 1A — Risk Factors” in the Bank’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 25, 2011 (the “2010 10-K”). The Bank undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances, or any other reason.
Overview
Business
The Bank is one of 12 district Federal Home Loan Banks (each individually a “FHLBank” and collectively the “FHLBanks” and, together with the Office of Finance, a joint office of the FHLBanks, the “FHLBank System”) that were created by the Federal Home Loan Bank Act of 1932, as amended. The FHLBanks serve the public by enhancing the availability of credit for residential mortgages, community lending, and targeted community development. As independent, member-owned cooperatives, the FHLBanks seek to maintain a balance between their public purpose and their ability to provide adequate returns on the capital supplied by their members. The Federal Housing Finance Agency (“Finance Agency”), an independent agency in the executive branch of the United States Government, is responsible for supervising and regulating the FHLBanks and the Office of Finance. The Finance Agency’s stated mission is to provide effective supervision, regulation and housing mission oversight of the FHLBanks to promote their safety and soundness, support housing finance and affordable housing, and support a stable and liquid mortgage market. Consistent with this mission, the Finance Agency establishes policies and regulations covering the operations of the FHLBanks.
The Bank serves eligible financial institutions in Arkansas, Louisiana, Mississippi, New Mexico and Texas (collectively, the Ninth District of the FHLBank System). The Bank’s primary business is lending relatively low cost funds (known as advances) to its member institutions, which include commercial banks, thrifts, insurance companies and credit unions. Community Development Financial Institutions that are certified under the Community Development Banking and Financial Institutions Act of 1994 are also eligible for membership in the Bank. While not members of the Bank, state and local housing authorities that meet certain statutory criteria may
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also borrow from the Bank. The Bank also maintains a portfolio of highly rated investments for liquidity purposes and to provide additional earnings. Additionally, the Bank holds interests in a portfolio of government-guaranteed/insured and conventional mortgage loans that were acquired through the Mortgage Partnership Finance® (“MPF”®) Program offered by the FHLBank of Chicago. Shareholders’ return on their investment includes dividends (which are typically paid quarterly in the form of capital stock) and the value derived from access to the Bank’s products and services. Historically, the Bank has balanced the financial rewards to shareholders by seeking to pay a dividend that meets or exceeds the return on alternative short-term money market investments available to shareholders, while lending funds at the lowest rates expected to be compatible with that objective and its objective to build retained earnings over time.
The Bank’s capital stock is not publicly traded and can be held only by members of the Bank, by non-member institutions that acquire stock by virtue of acquiring member institutions, by a federal or state agency or insurer acting as a receiver of a closed institution, or by former members of the Bank that retain capital stock to support advances or other activity that remains outstanding or until any applicable stock redemption or withdrawal notice period expires. All members must purchase stock in the Bank. The Bank’s capital stock has a par value of $100 per share and is purchased, redeemed, repurchased and transferred only at its par value. Members may redeem excess stock, or withdraw from membership and redeem all outstanding capital stock, with five years’ written notice to the Bank.
The FHLBanks’ debt instruments (known as consolidated obligations) are their primary source of funds and are the joint and several obligations of all 12 FHLBanks. Consolidated obligations are issued through the Office of Finance acting as agent for the FHLBanks and generally are publicly traded in the over-the-counter market. The Bank records on its balance sheet only those consolidated obligations for which it is the primary obligor. Consolidated obligations are not obligations of the United States Government and the United States Government does not guarantee them. Consolidated obligations are rated Aaa/P-1 by Moody’s Investors Service (“Moody’s”) and AAA/A-1+ by Standard & Poor’s (“S&P”), which are the highest ratings available from these nationally recognized statistical rating organizations (“NRSROs”). These ratings indicate that Moody’s and S&P have concluded that the FHLBanks have an extremely strong capacity to meet their commitments to pay principal and interest on consolidated obligations, and that consolidated obligations are judged to be of the highest quality, with minimal credit risk. The ratings also reflect the FHLBank System’s status as a GSE. Historically, the FHLBanks’ GSE status and highest available credit ratings on consolidated obligations have provided the FHLBanks with excellent capital markets access. Deposits, other borrowings and the proceeds from capital stock issued to members are also sources of funds for the Bank.
In addition to ratings on the FHLBanks’ consolidated obligations, each FHLBank is rated individually by both S&P and Moody’s. These individual FHLBank ratings apply to obligations of the respective FHLBanks, such as interest rate derivatives, deposits, and letters of credit. As of May 1, 2011, Moody’s had assigned a deposit rating of Aaa/P-1 to each of the FHLBanks.
On April 20, 2011, S&P affirmed its AAA long-term rating on the FHLBank System’s consolidated obligations while revising its outlook on the consolidated obligations from stable to negative. Concurrently, S&P affirmed the AAA long-term counterparty credit ratings of 10 of the FHLBanks, including the Bank, while revising its outlook for each of those FHLBanks from stable to negative. In its announcement, S&P indicated that these changes reflect its revision of the outlook on the United States of America from stable to negative. The outlooks for the other 2 FHLBanks, both of which have long-term counterparty credit ratings of AA+, were not affected by these changes. Further, S&P indicated that it will not raise its outlooks and ratings relating to the FHLBanks above those on the U.S. Government as long as the ratings and outlook on the United States remain unchanged. Conversely, S&P indicated that if it were to lower the ratings on the United States, it would also likely lower the ratings on the FHLBank System’s consolidated obligations as well as its counterparty credit ratings on relevant individual FHLBanks.
Shareholders, bondholders and prospective shareholders and bondholders should understand that these ratings are not a recommendation to buy, hold or sell securities and they may be subject to revision or withdrawal at any time by the NRSRO. The ratings from each of the NRSROs should be evaluated independently.
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The Bank conducts its business and fulfills its public purpose primarily by acting as a financial intermediary between its members and the capital markets. The intermediation of the timing, structure, and amount of its members’ credit needs with the investment requirements of the Bank’s creditors is made possible by the extensive use of interest rate exchange agreements, including interest rate swaps, caps and swaptions. The Bank’s interest rate exchange agreements are accounted for in accordance with the provisions of Topic 815 of the Financial Accounting Standards Board Accounting Standards Codification entitled “Derivatives and Hedging”(“ASC 815”).
The Bank considers its “core earnings” to be net earnings exclusive of: (1) gains or losses on the sales of investment securities, if any; (2) gains or losses on the retirement or transfer of debt, if any; (3) prepayment fees on advances; (4) fair value adjustments (except for net interest payments) associated with derivatives and hedging activities and assets and liabilities carried at fair value; and (5) realized gains and losses associated with early terminations of derivative transactions. The Bank’s core earnings are generated primarily from net interest income and typically tend to rise and fall with the overall level of interest rates, particularly short-term money market rates. Because the Bank is a cooperatively owned wholesale institution, the spread component of its net interest income is much smaller than a typical commercial bank, and a relatively larger portion of its net interest income is derived from the investment of its capital. The Bank endeavors to maintain a fairly neutral interest rate risk profile. As a result, the Bank’s capital is effectively invested in shorter-term assets and its core earnings and returns on capital stock (based on core earnings) generally tend to follow short-term interest rates.
The Bank’s profitability objective is to achieve a rate of return on members’ capital stock investment sufficient to allow the Bank to meet its retained earnings growth objectives and pay dividends on capital stock at rates that equal or exceed the average federal funds rate. The Bank’s quarterly dividends are based upon its operating results, shareholders’ average capital stock holdings and the average federal funds rate for the immediately preceding quarter. While the Bank has had a long-standing practice of paying quarterly dividends, future dividend payments cannot be assured.
The Bank operates in only one reportable segment. All of the Bank’s revenues are derived from U.S. operations.
The following table summarizes the Bank’s membership, by type of institution, as of March 31, 2011 and December 31, 2010.
MEMBERSHIP SUMMARY
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
Commercial banks | 737 | 741 | ||||||
Thrifts | 82 | 83 | ||||||
Credit unions | 73 | 73 | ||||||
Insurance companies | 21 | 21 | ||||||
Total members | 913 | 918 | ||||||
Housing associates | 8 | 8 | ||||||
Non-member borrowers | 12 | 12 | ||||||
Total | 933 | 938 | ||||||
Community Financial Institutions (“CFIs”)(1) | 768 | 768 | ||||||
(1) | The figures presented above reflect the number of members that were CFIs as of March 31, 2011 and December 31, 2010 based upon the definitions of CFIs that applied as of those dates. |
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For 2011, Community Financial Institutions (“CFIs”) are defined to include all institutions insured by the Federal Deposit Insurance Corporation (“FDIC”) with average total assets as of December 31, 2010, 2009 and 2008 of less than $1.040 billion. For 2010, CFIs were defined as FDIC-insured institutions with average total assets as of December 31, 2009, 2008 and 2007 of less than $1.029 billion.
Financial Market Conditions
Credit market conditions during the first three months of 2011 continued the trend of noticeable improvement observed during 2010.
During the first quarter of 2011, the Federal Reserve continued a $600 billion bond purchase program that was announced in November 2010. Under this program, the Federal Reserve will continue to purchase longer-term U.S. Government bonds at a pace of about $75 billion per month until the end of the second quarter of 2011 in an effort to promote a stronger pace of economic recovery and foster maximum employment and price stability.
Short-term interest rates remained relatively stable during the first three months of 2011, while long-term rates increased somewhat. The Federal Open Market Committee maintained its target for the federal funds rate at a range between 0 and 0.25 percent throughout 2009, 2010 and the first quarter of 2011. During these periods, the Federal Reserve paid interest on required and excess reserves held by depository institutions at a rate of 0.25 percent, equivalent to the upper boundary of the target range for federal funds. A significant and sustained increase in bank reserves during the past few years combined with the rate of interest being paid on those reserves has contributed to a decline in the volume of transactions taking place in the overnight federal funds market and an effective federal funds rate that has generally been below the upper end of the targeted range for most of 2010 and the first quarter of 2011.
One- and three-month LIBOR rates remained relatively stable during the first three months of 2011, with one- and three-month LIBOR ending the quarter at 0.24 percent and 0.30 percent, respectively, as compared to 0.26 percent and 0.30 percent, respectively, at the end of 2010. Stable one- and three-month LIBOR rates, combined with the small spreads between those two indices and between those indices and overnight lending rates, suggest the inter-bank lending markets are relatively stable.
The following table presents information on various market interest rates at March 31, 2011 and December 31, 2010 and various average market interest rates for the quarters ended March 31, 2011 and 2010.
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Ending Rate | Average Rate | |||||||||||||||
March 31, | December 31, | First Quarter | First Quarter | |||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Federal Funds Target(1) | 0.25 | % | 0.25 | % | 0.25 | % | 0.25 | % | ||||||||
Average Effective Federal Funds Rate(2) | 0.10 | % | 0.13 | % | 0.15 | % | 0.13 | % | ||||||||
1-month LIBOR(1) | 0.24 | % | 0.26 | % | 0.26 | % | 0.23 | % | ||||||||
3-month LIBOR (1) | 0.30 | % | 0.30 | % | 0.31 | % | 0.26 | % | ||||||||
2-year LIBOR (1) | 1.00 | % | 0.80 | % | 0.89 | % | 1.15 | % | ||||||||
5-year LIBOR (1) | 2.47 | % | 2.17 | % | 2.32 | % | 2.70 | % | ||||||||
10-year LIBOR (1) | 3.57 | % | 3.38 | % | 3.54 | % | 3.78 | % | ||||||||
3-month U.S. Treasury (1) | 0.09 | % | 0.12 | % | 0.13 | % | 0.11 | % | ||||||||
2-year U.S. Treasury (1) | 0.80 | % | 0.61 | % | 0.69 | % | 0.92 | % | ||||||||
5-year U.S. Treasury (1) | 2.24 | % | 2.01 | % | 2.12 | % | 2.43 | % | ||||||||
10-year U.S. Treasury (1) | 3.47 | % | 3.30 | % | 3.46 | % | 3.72 | % |
(1) | Source: Bloomberg | |
(2) | Source: Federal Reserve Statistical Release |
Economic conditions continued to show moderate signs of improvement during the first quarter of 2011. The gross domestic product increased 1.8 percent during the period. The nationwide unemployment rate fell from 9.4 percent at the end of 2010 to 8.8 percent at March 31, 2011. While housing prices improved in some areas, the national trend in housing prices during the period was downward, and many housing markets remain depressed. Policy makers have interpreted recent data to indicate that certain aspects of the economy are improving. Despite continued signs of economic improvement, the sustainability and extent of the improved economic conditions, and the prospects for and potential timing of further improvements (in particular, employment growth and housing market conditions), remain uncertain.
First Quarter 2011 Summary
• | The Bank ended the first quarter of 2011 with total assets of $33.2 billion and total advances of $21.8 billion, a decrease from $39.7 billion and $25.5 billion, respectively, at the end of 2010. Advances to the Bank’s top five borrowers decreased by $1.4 billion, including the maturity of $1.0 billion in advances to the Bank’s largest borrower. In addition, $0.8 billion of maturing advances were repaid following the consolidation of several members’ charters into the charter of an out-of-district institution. The remaining decline in advances during the quarter was attributable to a general decline in member demand that the Bank believes was due largely to members’ higher liquidity levels and reduced lending activity due to weak economic conditions. | ||
• | The Bank’s net income for the first quarter of 2011 was $11.5 million, including net interest income of $42.1 million and $6.5 million of net losses on derivatives and hedging activities. The $6.5 million in net losses on derivatives and hedging activities for the quarter included $8.6 million of net losses on economic hedge derivatives (excluding net interest settlements), $1.7 million of net interest income on interest rate swaps accounted for as economic hedge derivatives and $0.4 million of net ineffectiveness-related gains on fair value hedges. The net losses on the Bank’s economic hedge derivatives were due largely to losses on its stand-alone interest rate caps and interest rate basis swaps of $4.3 million and $3.9 million, respectively. | ||
• | The Bank held $7.6 billion (notional) of interest rate swaps and swaptions recorded as economic hedge derivatives with a net positive fair value of $25.4 million (excluding accrued interest) at March 31, 2011, including $14.7 million related to the Bank’s swaptions. If these derivatives are held to maturity, their |
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values will ultimately decline to zero and be recorded as losses in future periods. The timing of these losses will depend upon a number of factors including the relative level and volatility of short-term interest rates. In the case of the Bank’s swaptions, the largely offsetting fair value of the hedged items (i.e., the optional advance commitments) would also decline to zero in this scenario. At March 31, 2011, the carrying value of the optional advance commitments totaled $15.4 million. In addition, as of March 31, 2011, the Bank held $3.7 billion (notional) of stand-alone interest rate cap agreements with a fair value of $15.3 million that hedge a portion of the interest rate risk posed by interest rate caps embedded in its collateralized mortgage obligation (“CMO”) LIBOR floaters. If these agreements are held to maturity, the value of the caps will ultimately decline to zero and be recorded as a loss in net gains (losses) on derivatives and hedging activities in future periods. | |||
• | Unrealized fair value losses on the Bank’s holdings of non-agency residential mortgage-backed securities classified as held-to-maturity totaled $74.5 million (21 percent of amortized cost) at March 31, 2011, as compared to $84.0 million (22 percent of amortized cost) at December 31, 2010. Based on its quarter-end analysis of the 37 securities in this portfolio, the Bank believes that the unrealized losses were principally the result of liquidity risk related discounts in the non-agency residential mortgage-backed securities market and do not accurately reflect the actual historical or currently expected future credit performance of the securities. In assessing the expected credit performance of these securities as of March 31, 2011, the Bank determined it is likely that it will not fully recover the amortized cost basis of eight of its non-agency residential mortgage-backed securities and, accordingly, these securities were deemed to be other-than-temporarily impaired at that date. These eight securities had also been identified as other-than-temporarily impaired in prior periods. The credit components of the impairment losses (an aggregate amount of $1.4 million) were reclassified from accumulated other comprehensive income (loss) to earnings during the quarter ended March 31, 2011 as the fair values of these securities were greater than their carrying amounts at that date. For a discussion of the Bank’s analysis, see “Item 1. Financial Statements” (specifically, Note 3 beginning on page 6 of this report). If the actual and/or projected performance of the loans underlying the Bank’s holdings of non-agency residential mortgage-backed securities deteriorates beyond its current expectations, the Bank could recognize further losses on the securities that it has already determined to be other-than-temporarily impaired and/or losses on its other investments in non-agency residential mortgage-backed securities. | ||
• | At all times during the first quarter of 2011, the Bank was in compliance with all of its regulatory capital requirements. In addition, the Bank’s retained earnings increased to $462.2 million at March 31, 2011 from $452.2 million at December 31, 2010. | ||
• | During the first quarter of 2011, the Bank paid dividends totaling $1.5 million; the dividend was paid at an annualized rate of 0.375 percent, which exceeded the upper end of the Federal Reserve’s target for the federal funds rate of 0.25 percent for the preceding quarter by 12.5 basis points. | ||
• | While the Bank cannot predict how long the current economic conditions will continue, it expects that its lending activities may be reduced for some period of time. As advances are reduced, the Bank’s general practice is to repurchase capital stock in proportion to the reduction in the advances. As a result of the decrease in the Bank’s advances, total assets and capital stock, its future core earnings will likely be lower than they would have been otherwise. However, the Bank expects that its ability to adjust its capital levels in response to reductions in advances outstanding and the accumulation of retained earnings in recent years will help to mitigate the negative impact that these reductions would otherwise have on the Bank’s shareholders. While there can be no assurances, based on its current expectations the Bank anticipates that its earnings will be sufficient both to continue paying dividends at a rate equal to or slightly above the upper end of the Federal Reserve’s target for the federal funds rate for the applicable quarterly periods of 2011 and to continue building retained earnings. In addition, the Bank currently expects to continue its quarterly repurchases of surplus stock. |
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Selected Financial Data
SELECTED FINANCIAL DATA
(dollars in thousands)
(dollars in thousands)
First Quarter | 2010 | |||||||||||||||||||
2011 | Fourth Quarter | Third Quarter | Second Quarter | First Quarter | ||||||||||||||||
Balance sheet(at quarter end) | ||||||||||||||||||||
Advances | $ | 21,804,806 | $ | 25,455,656 | $ | 27,341,487 | $ | 41,453,540 | $ | 42,627,506 | ||||||||||
Investments(1) | 10,545,849 | 12,268,954 | 19,385,091 | 12,813,354 | 14,854,980 | |||||||||||||||
Mortgage loans | 194,703 | 207,393 | 222,365 | 235,469 | 248,721 | |||||||||||||||
Allowance for credit losses on mortgage loans | 225 | 225 | 234 | 234 | 234 | |||||||||||||||
Total assets | 33,169,709 | 39,690,070 | 51,644,281 | 57,063,342 | 58,696,797 | |||||||||||||||
Consolidated obligations — discount notes | 500,000 | 5,131,978 | 3,301,048 | 6,070,294 | 5,626,659 | |||||||||||||||
Consolidated obligations — bonds | 29,302,425 | 31,315,605 | 41,919,784 | 46,956,288 | 48,269,095 | |||||||||||||||
Total consolidated obligations(2) | 29,802,425 | 36,447,583 | 45,220,832 | 53,026,582 | 53,895,754 | |||||||||||||||
Mandatorily redeemable capital stock(3) | 18,131 | 8,076 | 6,894 | 7,787 | 7,579 | |||||||||||||||
Capital stock — putable | 1,427,810 | 1,600,909 | 1,835,532 | 2,260,945 | 2,311,212 | |||||||||||||||
Retained earnings | 462,188 | 452,205 | 431,890 | 406,608 | 369,485 | |||||||||||||||
Accumulated other comprehensive loss | (56,743 | ) | (62,702 | ) | (57,213 | ) | (62,207 | ) | (68,177 | ) | ||||||||||
Total capital | 1,833,255 | 1,990,412 | 2,210,209 | 2,605,346 | 2,612,520 | |||||||||||||||
Dividends paid(3) | 1,550 | 2,057 | 2,109 | 2,264 | 2,386 | |||||||||||||||
Income statement(for the quarter) | ||||||||||||||||||||
Net interest income(4) | $ | 42,123 | $ | 47,086 | $ | 54,686 | $ | 68,409 | $ | 64,185 | ||||||||||
Other income (loss) | (6,267 | ) | 8,824 | (174 | ) | 2,224 | (25,133 | ) | ||||||||||||
Other expense | 20,157 | 25,458 | 17,229 | 17,023 | 17,832 | |||||||||||||||
Assessments | 4,166 | 8,080 | 9,892 | 14,223 | 5,631 | |||||||||||||||
Net income | 11,533 | 22,372 | 27,391 | 39,387 | 15,589 | |||||||||||||||
Performance ratios | ||||||||||||||||||||
Net interest margin(5) | 0.46 | % | 0.46 | % | 0.42 | % | 0.48 | % | 0.41 | % | ||||||||||
Return on average assets | 0.13 | 0.22 | 0.21 | 0.28 | 0.10 | |||||||||||||||
Return on average equity | 2.45 | 4.37 | 4.28 | 6.11 | 2.30 | |||||||||||||||
Return on average capital stock(6) | 3.10 | 5.41 | 4.99 | 7.00 | 2.58 | |||||||||||||||
Total average equity to average assets | 5.27 | 4.93 | 4.80 | 4.57 | 4.42 | |||||||||||||||
Regulatory capital ratio(7) | 5.75 | 5.19 | 4.40 | 4.69 | 4.58 | |||||||||||||||
Dividend payout ratio(3)(8) | 13.44 | 9.19 | 7.70 | 5.75 | 15.31 | |||||||||||||||
Average effective federal funds rate(9) | 0.15 | % | 0.19 | % | 0.19 | % | 0.19 | % | 0.13 | % |
(1) | Investments consist of federal funds sold, interest-bearing deposits, securities purchased under agreements to resell and securities classified as held-to-maturity and trading. | |
(2) | The Bank is jointly and severally liable with the other FHLBanks for the payment of principal and interest on the consolidated obligations of all of the FHLBanks. At March 31, 2011, December 31, 2010, September 30, 2010, June 30, 2010, and March 31, 2010, the outstanding consolidated obligations (at par value) of all 12 FHLBanks totaled approximately $766 billion, $796 billion, $806 billion, $846 billion, and $871 billion, respectively. As of those dates, the Bank’s outstanding consolidated obligations (at par value) were $29.6 billion, $36.2 billion, $44.8 billion, $52.7 billion, and $53.5 billion, respectively. | |
(3) | Mandatorily redeemable capital stock represents capital stock that is classified as a liability under generally accepted accounting principles. Dividends on mandatorily redeemable capital stock are recorded as interest expense and excluded from dividends paid. Dividends paid on mandatorily redeemable capital stock totaled $6 thousand, $9 thousand, $7 thousand, $6 thousand, and $8 thousand for the quarters ended March 31, 2011, December 31, 2010, September 30, 2010, June 30, 2010, and March 31, 2010, respectively. | |
(4) | Net interest income excludes the net interest income/expense associated with interest rate exchange agreements that do not qualify for hedge accounting. The net interest income associated with such agreements totaled $1.7 million, $3.2 million, $4.9 million, $2.1 million and $8.5 million for the quarters ended March 31, 2011, December 31, 2010, September 30, 2010, June 30, 2010 and March 31, 2010, respectively. | |
(5) | Net interest margin is net interest income as a percentage of average earning assets. | |
(6) | Return on average capital stock is derived by dividing net income by average capital stock balances excluding mandatorily redeemable capital stock. | |
(7) | The regulatory capital ratio is computed by dividing regulatory capital (the sum of capital stock — putable, mandatorily redeemable capital stock and retained earnings) by total assets at each quarter-end. | |
(8) | Dividend payout ratio is computed by dividing dividends paid by net income for each quarter. | |
(9) | Rates obtained from the Federal Reserve Statistical Release. |
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Legislative and Regulatory Developments
On July 21, 2010, the President of the United States signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Dodd Frank-Act makes significant changes to a number of aspects of the regulation of financial institutions. Although the FHLBanks were exempted from several provisions of the Dodd-Frank Act, the Bank’s business operations, funding costs, rights, obligations, and/or the environment in which it carries out its housing finance mission are likely to be affected by the Dodd-Frank Act. Certain regulatory actions resulting from the Dodd-Frank Act that may have a significant impact on the Bank are summarized in the Bank’s 2010 10-K (see “Business — Legislative and Regulatory Developments” beginning on page 20 of that report). Because the Dodd-Frank Act requires the issuance of numerous regulations, orders, determinations and reports, the full effect of this legislation on the Bank and its activities will become known only after the required regulations, orders, determinations and reports have been issued and implemented.
In the wake of the financial crisis and related housing problems, both Congress and the Obama Administration are considering potential changes to the housing finance system that could impact the role and structure of the housing GSEs, including the FHLBanks. For additional discussion regarding potential housing GSE reform and other recent legislative and regulatory developments, see “Business — Legislative and Regulatory Developments” in the Bank’s 2010 10-K.
Financial Condition
The following table provides selected period-end balances as of March 31, 2011 and December 31, 2010, as well as selected average balances for the three-month period ended March 31, 2011 and the year ended December 31, 2010. As shown in the table, the Bank’s total assets decreased by 16.4 percent (or $6.5 billion) during the three months ended March 31, 2011, due primarily to a $3.7 billion decrease in advances, a $2.2 billion decrease in its short-term liquidity holdings, and a $0.6 billion decrease in held-to-maturity securities. As the Bank’s assets decreased, the funding for those assets also decreased. During the three months ended March 31, 2011, total consolidated obligations decreased by $6.6 billion as consolidated obligation bonds decreased by $2.0 billion and consolidated obligation discount notes decreased by $4.6 billion.
The activity in each of the major balance sheet captions is discussed in the sections following the table.
SUMMARY OF CHANGES IN FINANCIAL CONDITION
(dollars in millions)
(dollars in millions)
March 31, 2011 | Balance at | |||||||||||||||
Increase (Decrease) | December 31, | |||||||||||||||
Balance | Amount | Percentage | 2010 | |||||||||||||
Advances | $ | 21,805 | $ | (3,651 | ) | (14.3 | )% | $ | 25,456 | |||||||
Short-term liquidity holdings | ||||||||||||||||
Non-interest bearing excess cash balances(1) | 500 | (1,100 | ) | (68.8 | ) | 1,600 | ||||||||||
Security purchased under agreement to resell | 375 | 375 | * | — | ||||||||||||
Federal funds sold | 2,326 | (1,441 | ) | (38.3 | ) | 3,767 | ||||||||||
Held-to-maturity securities | 7,839 | (657 | ) | (7.7 | ) | 8,496 | ||||||||||
Mortgage loans, net | 194 | (13 | ) | (6.3 | ) | 207 | ||||||||||
Total assets | 33,170 | (6,520 | ) | (16.4 | ) | 39,690 | ||||||||||
Consolidated obligations — bonds | 29,302 | (2,014 | ) | (6.4 | ) | 31,316 | ||||||||||
Consolidated obligations — discount notes | 500 | (4,632 | ) | (90.3 | ) | 5,132 | ||||||||||
Total consolidated obligations | 29,802 | (6,646 | ) | (18.2 | ) | 36,448 | ||||||||||
Mandatorily redeemable capital stock | 18 | 10 | 125.0 | 8 | ||||||||||||
Capital stock | 1,428 | (173 | ) | (10.8 | ) | 1,601 | ||||||||||
Retained earnings | 462 | 10 | 2.2 | 452 | ||||||||||||
Average total assets | 36,265 | (16,878 | ) | (31.8 | ) | 53,143 | ||||||||||
Average capital stock | 1,508 | (620 | ) | (29.1 | ) | 2,128 | ||||||||||
Average mandatorily redeemable capital stock | 17 | 10 | 142.9 | 7 |
* | The percentage increase is not meaningful. | |
(1) | Represents excess cash held at the Federal Reserve Bank of Dallas. These amounts are classified as “Cash and Due From Banks” in the Bank’s statement of condition. |
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Advances
The following table presents advances outstanding, by type of institution, as of March 31, 2011 and December 31, 2010.
ADVANCES OUTSTANDING BY BORROWER TYPE
(par value, dollars in millions)
(par value, dollars in millions)
March 31, 2011 | December 31, 2010 | |||||||||||||||
Amount | Percent | Amount | Percent | |||||||||||||
Commercial banks | $ | 16,163 | 75 | % | $ | 19,708 | 79 | % | ||||||||
Thrift institutions | 3,614 | 17 | 3,686 | 15 | ||||||||||||
Credit unions | 1,153 | 5 | 1,215 | 5 | ||||||||||||
Insurance companies | 346 | 2 | 336 | 1 | ||||||||||||
Total member advances | 21,276 | 99 | 24,945 | 100 | ||||||||||||
Housing associates | 48 | — | 60 | — | ||||||||||||
Non-member borrowers | 162 | 1 | 56 | — | ||||||||||||
Total par value of advances | $ | 21,486 | 100 | % | $ | 25,061 | 100 | % | ||||||||
Total par value of advances outstanding to CFIs(1) | $ | 6,509 | 30 | % | $ | 6,908 | 28 | % | ||||||||
(1) | The figures presented above reflect the advances outstanding to CFIs as of March 31, 2011 and December 31, 2010 based upon the definitions of CFIs that applied as of those dates. |
At March 31, 2011 and December 31, 2010, the carrying value of the Bank’s advances portfolio totaled $21.8 billion and $25.5 billion, respectively. The par value of outstanding advances at those dates was $21.5 billion and $25.1 billion, respectively.
During the first three months of 2011, advances outstanding to the Bank’s five largest borrowers decreased by $1.4 billion, including the maturity of $1.0 billion in advances to Wells Fargo Bank South Central, National Association (the Bank’s largest borrower). In addition, $0.8 billion of maturing advances were repaid following the consolidation of several members’ charters into the charter of an out-of-district institution. The remaining decline in outstanding advances of $1.4 billion during the first quarter of 2011 was spread broadly across the Bank’s members. The Bank believes the decline in advances was due largely to members’ higher liquidity levels, which were primarily the result of higher deposit levels and reduced lending activity due to weak economic conditions.
At March 31, 2011, advances outstanding to the Bank’s five largest borrowers totaled $8.1 billion, representing 37.6 percent of the Bank’s total outstanding advances as of that date. In comparison, advances outstanding to the Bank’s five largest borrowers totaled $9.5 billion at December 31, 2010, representing 37.8 percent of the total outstanding balances at that date. The following table presents the Bank’s five largest borrowers as of March 31, 2011.
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FIVE LARGEST BORROWERS AS OF MARCH 31, 2011
(Par value, dollars in millions)
(Par value, dollars in millions)
Percent of | ||||||||
Par Value of | Total Par Value | |||||||
Name | Advances | of Advances | ||||||
Wells Fargo Bank South Central, National Association | $ | 3,000 | 14.0 | % | ||||
Comerica Bank | 2,500 | 11.6 | ||||||
Beal Bank Nevada(1) | 1,375 | 6.4 | ||||||
International Bank of Commerce | 620 | 2.9 | ||||||
First National Bank (Edinburg, Texas) | 582 | 2.7 | ||||||
$ | 8,077 | 37.6 | % | |||||
(1) | Beal Bank Nevada is chartered in Nevada, but maintains its home office in Plano, TX. |
The following table presents information regarding the composition of the Bank’s advances by product type as of March 31, 2011 and December 31, 2010.
ADVANCES OUTSTANDING BY PRODUCT TYPE
(dollars in millions)
(dollars in millions)
March 31, 2011 | December 31, 2010 | |||||||||||||||
Percentage | Percentage | |||||||||||||||
Balance | of Total | Balance | of Total | |||||||||||||
Fixed rate | $ | 13,095 | 61.0 | % | $ | 15,582 | 62.2 | % | ||||||||
Adjustable/variable rate indexed | 5,761 | 26.8 | 6,765 | 27.0 | ||||||||||||
Amortizing | 2,630 | 12.2 | 2,714 | 10.8 | ||||||||||||
Total par value | $ | 21,486 | 100.0 | % | $ | 25,061 | 100.0 | % | ||||||||
The Bank is required by statute and regulation to obtain sufficient collateral from members/borrowers to fully secure all advances and other extensions of credit. The Bank’s collateral arrangements with its members/borrowers and the types of collateral it accepts to secure advances are described in the 2010 10-K. To ensure the value of collateral pledged to the Bank is sufficient to secure its advances, the Bank applies various haircuts, or discounts, to determine the value of the collateral against which borrowers may borrow. From time to time, the Bank reevaluates the adequacy of its collateral haircuts under a range of stress scenarios to ensure that its collateral haircuts are sufficient to protect the Bank from credit losses on advances. In addition, as described in the 2010 10-K, the Bank reviews the financial condition of its depository institution borrowers on at least a quarterly basis to identify any borrowers whose financial condition indicates they might pose an increased credit risk and, as needed, takes appropriate action. The Bank has not experienced any credit losses on advances since it was founded in 1932 and, based on its credit extension and collateral policies, management currently does not anticipate any credit losses on advances. Accordingly, the Bank has not provided any allowance for losses on advances.
Short-Term Liquidity Portfolio
At March 31, 2011, the Bank’s short-term liquidity portfolio was comprised of $2.3 billion of overnight federal funds sold to domestic bank counterparties, $0.5 billion of non-interest bearing excess cash balances held at the Federal Reserve Bank of Dallas, and $0.4 billion of an overnight reverse repurchase agreement (i.e., security purchased under an agreement to resell). At December 31, 2010, the Bank’s short-term liquidity portfolio was
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comprised of $3.8 billion of overnight federal funds sold to domestic bank counterparties and $1.6 billion of non-interest bearing excess cash balances held at the Federal Reserve Bank of Dallas. As of March 31, 2011, the Bank’s overnight federal funds sold consisted of $0.5 billion sold to counterparties rated double-A, $1.5 billion sold to counterparties rated single-A and $0.3 billion sold to counterparties rated triple-B. The credit ratings presented in the preceding sentence represent the lowest long-term rating assigned to the counterparty by Moody’s, S&P or Fitch Ratings, Ltd. (“Fitch”). The amount of the Bank’s short-term liquidity portfolio fluctuates in response to several factors, including the anticipated demand for advances, the timing and extent of advance prepayments, changes in the Bank’s deposit balances, the Bank’s pre-funding activities, changes in the returns provided by short-term investment alternatives relative to the Bank’s discount note funding costs, and the level of liquidity needed to satisfy Finance Agency requirements. (For a discussion of the Finance Agency’s liquidity requirements, see the section below entitled “Liquidity and Capital Resources.”) The Bank entered into reverse repurchase agreements during the three months ended March 31, 2011 because those investments generally provided higher returns than those that were available in the overnight federal funds market.
Long-Term Investments
At March 31, 2011 and December 31, 2010, the Bank’s long-term investment portfolio (at carrying value) was comprised of approximately $7.8 billion and $8.4 billion, respectively, of MBS, substantially all of which were LIBOR-indexed floating rate CMOs, and approximately $50 million of U.S. agency debentures. All of the Bank’s long-term investments were classified as held-to-maturity at both of these dates.
The Bank did not acquire or sell any long-term investments during the three months ended March 31, 2011. During this same period, the proceeds from maturities and paydowns of long-term securities totaled approximately $670 million.
The Bank is currently precluded from purchasing additional MBS if such purchase would cause the aggregate book value of its MBS holdings to exceed 300 percent of the Bank’s total regulatory capital (an amount equal to the Bank’s retained earnings plus amounts paid in for Class B stock, regardless of its classification as equity or liabilities for financial reporting purposes). At March 31, 2011, the Bank held $7.8 billion of MBS, which represented 408 percent of its total regulatory capital. The Bank is not required to sell any previously purchased mortgage securities as it was in compliance with the applicable limit at the time of purchase. Due to the shrinkage of its capital base due to reductions in member borrowings, the Bank does not currently anticipate that it will have the capacity to purchase additional MBS throughout the remainder of 2011. Currently, the Bank has capacity under applicable policies and regulations to purchase certain other types of highly rated long-term investments and it may elect to purchase such securities if attractive opportunities to do so are available.
The following table provides the unpaid principal balances of the Bank’s MBS portfolio, by coupon type, as of March 31, 2011 and December 31, 2010.
UNPAID PRINCIPAL BALANCE OF MORTGAGE-BACKED SECURITIES BY COUPON TYPE
(In millions of dollars)
(In millions of dollars)
March 31, 2011 | December 31, 2010 | |||||||||||||||||||||||
Fixed | Variable | Fixed | Variable | |||||||||||||||||||||
Rate | Rate | Total | Rate | Rate | Total | |||||||||||||||||||
U.S. government guaranteed obligations | $ | — | $ | 19 | $ | 19 | $ | — | $ | 20 | $ | 20 | ||||||||||||
Government-sponsored enterprises | 2 | 7,559 | 7,561 | 2 | 8,199 | 8,201 | ||||||||||||||||||
Non-agency residential MBS | ||||||||||||||||||||||||
Prime(1) | — | 299 | 299 | — | 323 | 323 | ||||||||||||||||||
Alt-A(1) | — | 72 | 72 | — | 75 | 75 | ||||||||||||||||||
Total MBS | $ | 2 | $ | 7,949 | $ | 7,951 | $ | 2 | $ | 8,617 | $ | 8,619 | ||||||||||||
(1) | Reflects the label assigned to the securities at the time of issuance. |
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Gross unrealized losses on the Bank’s MBS investments decreased from $86 million at December 31, 2010 to $80 million at March 31, 2011. As of March 31, 2011, $75 million (or 94 percent) of the unrealized losses related to the Bank’s holdings of non-agency residential MBS (“RMBS”).
The Bank evaluates outstanding held-to-maturity securities in an unrealized loss position as of the end of each quarter for other-than-temporary impairment (“OTTI”). An investment security is impaired if the fair value of the investment is less than its amortized cost. For a summary of the Bank’s OTTI evaluation, see “Item 1. Financial Statements” (specifically, Note 3 beginning on page 6 of this report).
The deterioration in the U.S. housing markets that began in 2007, as reflected by declines in the values of residential real estate and higher levels of delinquencies, defaults and losses on residential mortgages, including the mortgages underlying the Bank’s non-agency RMBS, generally increased the risk that the Bank may not ultimately recover the entire cost bases of some of its non-agency RMBS. Based on its analysis of the securities in this portfolio, however, the Bank believes that the unrealized losses as of March 31, 2011 were principally the result of liquidity risk related discounts in the non-agency RMBS market and do not accurately reflect the actual historical or currently likely future credit performance of the securities.
All of the Bank’s held-to-maturity securities are rated by one or more of the following NRSROs: Moody’s, S&P and/or Fitch. With the exception of 24 non-agency RMBS, all of these securities carried the highest investment grade credit rating by each of the NRSROs that rated the respective securities as of March 31, 2011. The following table presents the credit ratings assigned to the Bank’s non-agency RMBS holdings as of March 31, 2011. The credit ratings presented in the table represent the lowest rating assigned to the security by Moody’s, S&P or Fitch.
NON-AGENCY RMBS BY CREDIT RATING
(dollars in thousands)
(dollars in thousands)
Number | Unpaid | Estimated | ||||||||||||||||||||||
Credit | of | Principal | Amortized | Carrying | Fair | Unrealized | ||||||||||||||||||
Rating | Securities | Balance | Cost | Value | Value | Losses | ||||||||||||||||||
Triple-A | 13 | $ | 85,319 | $ | 85,330 | $ | 85,330 | $ | 81,169 | $ | 4,161 | |||||||||||||
Double-A | 1 | 5,624 | 5,626 | 5,626 | 5,295 | 331 | ||||||||||||||||||
Triple-B | 1 | 2,211 | 2,211 | 2,211 | 2,105 | 106 | ||||||||||||||||||
Double-B | 1 | 205 | 205 | 205 | 195 | 10 | ||||||||||||||||||
Single-B | 9 | 99,237 | 99,154 | 95,338 | 74,647 | 24,507 | ||||||||||||||||||
Triple-C | 11 | 142,586 | 138,171 | 93,769 | 96,351 | 41,820 | ||||||||||||||||||
Double-C | 1 | 35,818 | 32,322 | 23,251 | 28,751 | 3,571 | ||||||||||||||||||
Total | 37 | $ | 371,000 | $ | 363,019 | $ | 305,730 | $ | 288,513 | $ | 74,506 | |||||||||||||
During the period from April 1, 2011 through May 5, 2011, two securities rated triple-A in the table above had their credit ratings lowered to double-A by one of the NRSROs; as of March 31, 2011, the amortized cost and estimated fair value of these securities totaled $6.0 million and $5.8 million, respectively. None of the Bank’s other non-agency RMBS holdings were downgraded during this period.
As of March 31, 2011, five of the securities rated triple-A in the table above, including the two securities that were downgraded in April 2011, were on negative watch. The five securities had carrying values and estimated fair values totaling $14.1 million and $13.6 million, respectively, at March 31, 2011. None of the Bank’s non-agency RMBS holdings were placed on negative watch during the period from April 1, 2011 through May 5, 2011; during that period, two of the securities that were on negative watch at March 31, 2011 were removed from the NRSRO’s watch list. The carrying values and estimated fair values of these two securities each totaled $2.2 million at March 31, 2011.
At March 31, 2011, the Bank’s portfolio of non-agency RMBS was comprised of 18 securities with an aggregate unpaid principal balance of $154 million that are backed by first lien fixed-rate loans and 19 securities with an
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aggregate unpaid principal balance of $217 million that are backed by first lien option adjustable-rate mortgage (“option ARM”) loans. In comparison, as of December 31, 2010, the Bank’s non-agency RMBS portfolio was comprised of 20 securities backed by fixed-rate loans that had an aggregate unpaid principal balance of $177 million and 19 securities backed by option ARM loans that had an aggregate unpaid principal balance of $221 million. The following table provides a summary of the Bank’s non-agency RMBS as of March 31, 2011 by classification at the time of issuance, collateral type and year of securitization (the Bank does not hold any MBS that were labeled as subprime at the time of issuance).
NON-AGENCY RMBS BY UNDERLYING COLLATERAL TYPE
(dollars in millions)
(dollars in millions)
Credit Enhancement Statistics | ||||||||||||||||||||||||||||||||||||
Unpaid | Weighted Average | Current | Original | |||||||||||||||||||||||||||||||||
Number of | Principal | Amortized | Estimated | Unrealized | Collateral | Weighted | Weighted | Minimum | ||||||||||||||||||||||||||||
Classification and year of securitization | Securities | Balance | Cost | Fair Value | Losses | Delinquency(1)(2) | Average (1)(3) | Average(1) | Current(4) | |||||||||||||||||||||||||||
Prime(5) | ||||||||||||||||||||||||||||||||||||
Fixed rate collateral | ||||||||||||||||||||||||||||||||||||
2006 | 1 | $ | 36 | $ | 32 | $ | 29 | $ | 3 | 15.88 | % | 6.28 | % | 8.89 | % | 6.28 | % | |||||||||||||||||||
2004 | 3 | 7 | 7 | 7 | — | 6.38 | % | 32.32 | % | 5.82 | % | 28.43 | % | |||||||||||||||||||||||
2003 | 9 | 76 | 76 | 72 | 4 | 1.55 | % | 6.87 | % | 3.89 | % | 5.34 | % | |||||||||||||||||||||||
2000 | 1 | — | — | — | — | 0.00 | % | 39.17 | % | 2.00 | % | 39.17 | % | |||||||||||||||||||||||
Total fixed rate prime collateral | 14 | 119 | 115 | 108 | 7 | 6.16 | % | 8.34 | % | 5.52 | % | 5.34 | % | |||||||||||||||||||||||
Option ARM collateral | ||||||||||||||||||||||||||||||||||||
2005 | 15 | 168 | 167 | 120 | 47 | 35.20 | % | 45.74 | % | 43.14 | % | 25.14 | % | |||||||||||||||||||||||
2004 | 2 | 12 | 12 | 8 | 4 | 33.02 | % | 32.84 | % | 29.87 | % | 30.91 | % | |||||||||||||||||||||||
Total option ARM prime collateral | 17 | 180 | 179 | 128 | 51 | 35.05 | % | 44.89 | % | 42.26 | % | 25.14 | % | |||||||||||||||||||||||
Total prime collateral | 31 | 299 | 294 | 236 | 58 | 23.56 | % | 30.35 | % | 27.64 | % | 5.34 | % | |||||||||||||||||||||||
Alt-A(5) | ||||||||||||||||||||||||||||||||||||
Fixed rate collateral | ||||||||||||||||||||||||||||||||||||
2005 | 1 | 25 | 25 | 20 | 5 | 13.65 | % | 9.80 | % | 6.84 | % | 9.80 | % | |||||||||||||||||||||||
2004 | 1 | 2 | 2 | 2 | — | 12.95 | % | 45.90 | % | 6.85 | % | 45.90 | % | |||||||||||||||||||||||
2002 | 2 | 8 | 8 | 7 | 1 | 7.71 | % | 20.35 | % | 4.54 | % | 17.09 | % | |||||||||||||||||||||||
Total fixed rate Alt-A collateral | 4 | 35 | 35 | 29 | 6 | 12.26 | % | 14.48 | % | 6.32 | % | 9.80 | % | |||||||||||||||||||||||
Option ARM collateral | ||||||||||||||||||||||||||||||||||||
2005 | 2 | 37 | 34 | 23 | 11 | 52.92 | % | 39.65 | % | 39.56 | % | 33.45 | % | |||||||||||||||||||||||
Total Alt-A collateral | 6 | 72 | 69 | 52 | 17 | 33.13 | % | 27.40 | % | 23.38 | % | 9.80 | % | |||||||||||||||||||||||
Total non-agency RMBS | 37 | $ | 371 | $ | 363 | $ | 288 | $ | 75 | 25.41 | % | 29.78 | % | 26.81 | % | 5.34 | % | |||||||||||||||||||
Total fixed rate collateral | 18 | $ | 154 | $ | 150 | $ | 137 | $ | 13 | 7.54 | % | 9.73 | % | 5.70 | % | 5.34 | % | |||||||||||||||||||
Total option ARM collateral | 19 | 217 | 213 | 151 | 62 | 38.09 | % | 44.00 | % | 41.80 | % | 25.14 | % | |||||||||||||||||||||||
Total non-agency RMBS | 37 | $ | 371 | $ | 363 | $ | 288 | $ | 75 | 25.41 | % | 29.78 | % | 26.81 | % | 5.34 | % | |||||||||||||||||||
(1) | Weighted average percentages are computed based upon unpaid principal balances. | |
(2) | Collateral delinquency reflects the percentage of underlying loans that are 60 or more days past due, including loans in foreclosure and real estate owned; as of March 31, 2011, actual cumulative loan losses in the pools of loans underlying the Bank’s non-agency RMBS portfolio ranged from 0 percent to 13.56 percent. | |
(3) | Current credit enhancement percentages reflect the ability of subordinated classes of securities to absorb principal losses and interest shortfalls before the senior classes held by the Bank are impacted (i.e., the losses, expressed as a percentage of the outstanding principal balances, that could be incurred in the underlying loan pools before the securities held by the Bank would be impacted, assuming that all of those losses occurred on the measurement date). Depending upon the timing and amount of losses in the underlying loan pools, it is possible that the senior classes held by the Bank could bear losses in scenarios where the cumulative loan losses do not exceed the current credit enhancement percentage. | |
(4) | Minimum credit enhancement reflects the security in each vintage year with the lowest current credit enhancement. | |
(5) | Reflects the label assigned to the securities at the time of issuance. |
The geographic concentration by state of the loans underlying the Bank’s non-agency RMBS as of December 31, 2010 is provided in the Bank’s 2010 10-K. There were no substantial changes in these concentrations during the three months ended March 31, 2011.
To assess whether the entire amortized cost bases of its non-agency RMBS will be recovered, the Bank performed a cash flow analysis for each of its non-agency RMBS holdings as of March 31, 2011 under a base case (or best estimate) scenario. The procedures used in this analysis, together with the results thereof, are summarized in “Item
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1. Financial Statements” (specifically, Note 3 beginning on page 6 of this report). A summary of the significant inputs that were used in the Bank’s analysis of its entire non-agency RMBS portfolio as of March 31, 2011 is set forth in the table below.
SUMMARY OF SIGNIFICANT INPUTS FOR ALL NON-AGENCY RMBS
(dollars in thousands)
(dollars in thousands)
Projected | Projected | Projected | ||||||||||||||||||||||||||||||||||||||
Unpaid Principal | Prepayment Rates(2) | Default Rates(2) | Loss Severities(2) | |||||||||||||||||||||||||||||||||||||
Balance at | Weighted | Range | Weighted | Range | Weighted | Range | ||||||||||||||||||||||||||||||||||
Year of Securitization | March 31, 2011 | Average | Low | High | Average | Low | High | Average | Low | High | ||||||||||||||||||||||||||||||
Prime(1) | ||||||||||||||||||||||||||||||||||||||||
2004 | $ | 7,463 | 9.31 | % | 8.45 | % | 9.81 | % | 7.46 | % | 6.63 | % | 10.56 | % | 24.48 | % | 21.38 | % | 27.63 | % | ||||||||||||||||||||
2003 | 75,536 | 29.07 | % | 13.49 | % | 34.29 | % | 0.92 | % | 0.00 | % | 3.52 | % | 14.11 | % | 0.00 | % | 29.73 | % | |||||||||||||||||||||
2000 | 205 | 13.65 | % | 13.65 | % | 13.65 | % | 0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % | |||||||||||||||||||||
Total prime collateral | 83,204 | 27.26 | % | 8.45 | % | 34.29 | % | 1.50 | % | 0.00 | % | 10.56 | % | 15.01 | % | 0.00 | % | 29.73 | % | |||||||||||||||||||||
Alt-A(1) | ||||||||||||||||||||||||||||||||||||||||
2006 | 35,818 | 13.21 | % | 13.21 | % | 13.21 | % | 30.32 | % | 30.32 | % | 30.32 | % | 49.17 | % | 49.17 | % | 49.17 | % | |||||||||||||||||||||
2005 | 229,901 | 9.86 | % | 6.96 | % | 13.18 | % | 54.66 | % | 17.98 | % | 74.56 | % | 41.51 | % | 30.41 | % | 57.18 | % | |||||||||||||||||||||
2004 | 14,133 | 8.32 | % | 7.42 | % | 10.32 | % | 51.01 | % | 17.13 | % | 60.89 | % | 41.83 | % | 39.38 | % | 42.46 | % | |||||||||||||||||||||
2002 | 7,944 | 14.00 | % | 12.91 | % | 16.63 | % | 5.51 | % | 4.29 | % | 8.47 | % | 22.92 | % | 18.71 | % | 33.11 | % | |||||||||||||||||||||
Total Alt-A collateral | 287,796 | 10.31 | % | 6.96 | % | 16.63 | % | 50.09 | % | 4.29 | % | 74.56 | % | 41.97 | % | 18.71 | % | 57.18 | % | |||||||||||||||||||||
Total non-agency RMBS | $ | 371,000 | 14.11 | % | 6.96 | % | 34.29 | % | 39.20 | % | 0.00 | % | 74.56 | % | 35.92 | % | 0.00 | % | 57.18 | % | ||||||||||||||||||||
(1) | The Bank’s non-agency RMBS holdings are classified as prime or Alt-A in the table above based upon the assumptions that were used to analyze the securities. | |
(2) | Prepayment rates reflect the weighted average of projected future voluntary prepayments. Default rates reflect the total balance of loans projected to default as a percentage of the current unpaid principal balance of each of the underlying loan pools. Loss severities reflect the total projected loan losses as a percentage of the total balance of loans that are projected to default. |
In addition to evaluating its non-agency RMBS under a best estimate scenario, the Bank also performed a cash flow analysis for each of these securities as of March 31, 2011 under a more stressful housing price scenario. The more stressful scenario was based on a housing price forecast that was 5 percentage points lower at the trough than the base case scenario followed by a flatter recovery path. Under the more stressful scenario, current-to-trough home price declines were projected to range from 5.0 percent to 15.0 percent over the 3- to 9-month period beginning January 1, 2011. Thereafter, home prices were projected to increase within a range of 0 percent to 1.9 percent in the first year, 0 percent to 2.0 percent in the second year, 1.0 percent to 2.7 percent in the third year, 1.3 percent to 3.4 percent in the fourth year, 1.3 percent to 4.0 percent in each of the fifth and sixth years, and 1.5 percent to 3.8 percent in each subsequent year.
As set forth in the table below, under the more stressful housing price scenario, 12 of the Bank’s non-agency RMBS would have been deemed to be other-than-temporarily impaired as of March 31, 2011 (including 7 of the 8 securities that were determined to be other-than-temporarily impaired as of March 31, 2011). The stress test scenario and associated results do not represent the Bank’s current expectations and therefore should not be construed as a prediction of the actual performance of these securities. Rather, the results from this hypothetical stress test scenario provide a measure of the credit losses that the Bank might incur if home price declines (and subsequent recoveries) are more adverse than those projected in its OTTI assessment.
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NON-AGENCY RMBS STRESS-TEST SCENARIO
(dollars in thousands)
(dollars in thousands)
Credit Losses | Hypothetical | |||||||||||||||||||||||||||||||||
Recorded | Credit | |||||||||||||||||||||||||||||||||
Unpaid | in Earnings | Losses Under | Current | |||||||||||||||||||||||||||||||
Year of | Collateral | Principal | Carrying | Fair | During the | Stress-Test | Collateral | Credit | ||||||||||||||||||||||||||
Securitization | Type | Balance | Value | Value | First Quarter | Scenario(2) | Delinquency(3) | Enhancement(4) | ||||||||||||||||||||||||||
Prime | ||||||||||||||||||||||||||||||||||
Security #2 | 2005 | Option ARM | $ | 17,855 | $ | 10,016 | $ | 12,349 | $ | 309 | $ | 1,101 | 52.9% | 48.9% | ||||||||||||||||||||
Security #3 | 2006 | Fixed Rate | 35,818 | 23,251 | 28,751 | — | 603 | 15.9% | 6.3% | |||||||||||||||||||||||||
Security #4 | 2005 | Option ARM | 12,354 | 7,055 | 7,823 | 104 | 468 | 26.6% | 45.8% | |||||||||||||||||||||||||
Security #6 | 2005 | Option ARM | 17,578 | 10,772 | 10,465 | — | 443 | 26.9% | 25.1% | |||||||||||||||||||||||||
Security #7 | 2004 | Option ARM | 6,733 | 4,238 | 4,616 | — | 76 | 25.5% | 30.9% | |||||||||||||||||||||||||
Security #8 | 2005 | Option ARM | 10,060 | 6,397 | 6,576 | 9 | 168 | 27.8% | 43.5% | |||||||||||||||||||||||||
Security #9 | 2005 | Option ARM | 4,380 | 2,972 | 3,108 | 6 | — | 31.7% | 43.3% | |||||||||||||||||||||||||
Security #10 | 2005 | Option ARM | 7,907 | 5,062 | 5,189 | 7 | 111 | 45.7% | 43.6% | |||||||||||||||||||||||||
Security #11 | 2005 | Option ARM | 9,961 | 7,155 | 7,080 | — | 67 | 49.3% | 49.1% | |||||||||||||||||||||||||
Security #12 | 2004 | Option ARM | 5,189 | 3,403 | 3,508 | 71 | 85 | 42.8% | 35.4% | |||||||||||||||||||||||||
Security #13 | 2005 | Option ARM | 6,460 | 4,473 | 4,349 | — | — | 39.5% | 46.2% | |||||||||||||||||||||||||
Total Prime | 134,295 | 84,794 | 93,814 | 506 | 3,122 | |||||||||||||||||||||||||||||
Alt-A(1) | ||||||||||||||||||||||||||||||||||
Security #1 | 2005 | Option ARM | 16,321 | 8,183 | 9,706 | 278 | 1,284 | 51.6% | 33.4% | |||||||||||||||||||||||||
Security #5 | 2005 | Option ARM | 20,569 | 12,921 | 13,738 | 594 | 1,551 | 53.9% | 44.6% | |||||||||||||||||||||||||
Security #14 | 2005 | Fixed Rate | 24,817 | 24,822 | 19,586 | — | 11 | 13.7% | 9.8% | |||||||||||||||||||||||||
Total Alt-A | 61,707 | 45,926 | 43,030 | 872 | 2,846 | |||||||||||||||||||||||||||||
$ | 196,002 | $ | 130,720 | $ | 136,844 | $ | 1,378 | $ | 5,968 | |||||||||||||||||||||||||
(1) | Security #1, Security #5 and Security #14 are the only securities presented in the table above that were labeled as Alt-A at the time of issuance; however, based upon their current collateral or performance characteristics, all of the securities presented in the table above were analyzed using Alt-A assumptions. | |
(2) | Represents the credit losses that would have been recorded in earnings during the quarter ended March 31, 2011 if the more stressful housing price scenario had been used in the Bank’s OTTI assessment as of March 31, 2011. | |
(3) | Collateral delinquency reflects the percentage of underlying loans that are 60 or more days past due, including loans in foreclosure and real estate owned; as of March 31, 2011, actual cumulative loan losses in the pools of loans underlying the securities presented in the table ranged from 0.03 percent to 19.93 percent. | |
(4) | Current credit enhancement percentages reflect the ability of subordinated classes of securities to absorb principal losses and interest shortfalls before the senior classes held by the Bank are impacted (i.e., the losses, expressed as a percentage of the outstanding principal balances, that could be incurred in the underlying loan pools before the securities held by the Bank would be impacted, assuming that all of those losses occurred on the measurement date). Depending upon the timing and amount of losses in the underlying loan pools, it is possible that the senior classes held by the Bank could bear losses in scenarios where the cumulative loan losses do not exceed the current credit enhancement percentage. |
While substantially all of its MBS portfolio is comprised of CMOs with floating rate coupons ($7.9 billion par value at March 31, 2011) that do not expose the Bank to interest rate risk if interest rates rise moderately, such securities include caps that would limit increases in the floating rate coupons if short-term interest rates rise above the caps. In addition, if interest rates rise, prepayments on the mortgage loans underlying the securities would likely decline, thus lengthening the time that the securities would remain outstanding with their coupon rates capped. As of March 31, 2011, one-month LIBOR was 0.24 percent and the effective interest rate caps on one-month LIBOR (the interest cap rate minus the stated spread on the coupon) embedded in the CMO floaters ranged from 6.0 percent to 15.3 percent. The largest concentration of embedded effective caps ($6.6 billion) was between 6.0 percent and 7.0 percent. As of March 31, 2011, one-month LIBOR rates were approximately 576 basis points below the lowest effective interest rate cap embedded in the CMO floaters. To hedge a portion of the potential cap risk embedded in these securities, the Bank held (i) $2.7 billion of interest rate caps with remaining maturities ranging from 33 months to 54 months as of March 31, 2011, and strike rates ranging from 6.00 percent to 6.75 percent and (ii) four forward-starting interest rate caps, each of which has a notional amount of $250 million. Two of the forward-starting caps have terms that commence in June 2012; these forward-starting caps mature in June 2015 and June 2016 and have strike rates of 6.50 percent and 7.00 percent, respectively. The other two forward-starting caps have terms that commence in October 2012; these forward-starting caps mature in October 2014 and October 2015 and have strike rates of 6.50 percent and 7.00 percent, respectively. If interest rates rise above the strike rates specified in these interest rate cap agreements, the Bank will be entitled to receive interest payments according to the terms and conditions of such agreements. Such payments would be based upon the notional amounts of those agreements and the difference between the specified strike rate and either one-month or three-month LIBOR.
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The following table provides a summary of the notional amounts, strike rates and expiration periods of the Bank’s current portfolio of stand-alone CMO-related interest rate cap agreements.
SUMMARY OF CMO-RELATED INTEREST RATE CAP AGREEMENTS
(dollars in millions)
(dollars in millions)
Expiration | Notional Amount | Strike Rate | ||||||
First quarter 2014 | $ | 500 | 6.00 | % | ||||
First quarter 2014 | 500 | 6.50 | % | |||||
Third quarter 2014 | 700 | 6.50 | % | |||||
Fourth quarter 2014 | 250 | 6.00 | % | |||||
Fourth quarter 2014(1) | 250 | 6.50 | % | |||||
First quarter 2015 | 150 | 6.75 | % | |||||
Second quarter 2015(2) | 250 | 6.50 | % | |||||
Third quarter 2015 | 150 | 6.75 | % | |||||
Third quarter 2015 | 200 | 6.50 | % | |||||
Fourth quarter 2015 | 250 | 6.00 | % | |||||
Fourth quarter 2015(1) | 250 | 7.00 | % | |||||
Second quarter 2016(2) | 250 | 7.00 | % | |||||
$ | 3,700 | |||||||
(1) | These caps are effective beginning in October 2012. | |
(2) | These caps are effective beginning in June 2012. |
Consolidated Obligations and Deposits
As of March 31, 2011, the carrying values of consolidated obligation bonds and discount notes totaled $29.3 billion and $0.5 billion, respectively. At that date, the par value of the Bank’s outstanding bonds was $29.1 billion and the par value of the Bank’s outstanding discount notes was $0.5 billion. In comparison, at December 31, 2010, the carrying values of consolidated obligation bonds and discount notes totaled $31.3 billion and $5.1 billion, respectively, and the par values of the Bank’s outstanding bonds and discount notes totaled $31.1 billion and $5.1 billion, respectively.
During the three months ended March 31, 2011, the Bank’s outstanding consolidated obligation bonds (at par value) decreased by $2.0 billion due primarily to decreases in the Bank’s outstanding advances. The following table presents the composition of the Bank’s outstanding bonds at March 31, 2011 and December 31, 2010.
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COMPOSITION OF CONSOLIDATED OBLIGATION BONDS OUTSTANDING
(Par value, dollars in millions)
(Par value, dollars in millions)
March 31, 2011 | December 31, 2010 | |||||||||||||||
Percentage | Percentage | |||||||||||||||
Balance | of Total | Balance | of Total | |||||||||||||
Fixed rate | ||||||||||||||||
Non-callable | $ | 13,513 | 46.4 | % | $ | 13,023 | 41.9 | % | ||||||||
Callable | 740 | 2.6 | 1,560 | 5.0 | ||||||||||||
Single-index variable rate | 11,140 | 38.3 | 13,411 | 43.2 | ||||||||||||
Callable step-up | 3,442 | 11.8 | 3,001 | 9.6 | ||||||||||||
Variable that converts to fixed | 184 | 0.6 | 83 | 0.3 | ||||||||||||
Callable step-down | 100 | 0.3 | — | — | ||||||||||||
Total par value | $ | 29,119 | 100.0 | % | $ | 31,078 | 100.0 | % | ||||||||
Due to the decrease in outstanding advances, the Bank’s funding needs remained relatively low during the first quarter of 2011, with only $1.2 billion of consolidated obligation bonds issued during this period. The proceeds of these issuances were generally used to replace maturing or called consolidated obligations. The consolidated obligations issued by the Bank during the quarter were primarily swapped fixed rate callable bonds, including step-up bonds, and unswapped non-callable bonds.
The average LIBOR cost of the consolidated obligation bonds issued during the first quarter was lower than the average LIBOR cost of consolidated obligation bonds issued during 2010. The weighted average cost of consolidated obligation bonds issued by the Bank decreased from approximately LIBOR minus 17 basis points during the year ended December 31, 2010 to approximately LIBOR minus 25 basis points in the first quarter of 2011. The lower cost of consolidated obligation bonds was primarily due to the decrease in the Bank’s need for funding; because of its liquidity position, the Bank was able to issue debt only when costs were very favorable. In addition, the reduced issuance of floating rate bonds, which typically bear a higher LIBOR cost than the LIBOR cost that results from converting structured debt such as callable bonds to LIBOR, also contributed to the Bank’s more favorable funding costs during the quarter.
The Bank’s discount note balance decreased substantially during the first quarter of 2011, with only one overnight discount note outstanding at March 31, 2011. Due to a sufficient supply of short-term liquidity, the Bank did not replace its discount notes as they matured during the first quarter of 2011.
Demand and term deposits were $1.3 billion and $1.1 billion at March 31, 2011 and December 31, 2010, respectively. The size of the Bank’s deposit base varies as market factors change, including the attractiveness of the Bank’s deposit pricing relative to the rates available to members on alternative money market investments, members’ investment preferences with respect to the maturity of their investments, and member liquidity.
Capital
The Bank’s outstanding capital stock (excluding mandatorily redeemable capital stock) was approximately $1.4 billion and $1.6 billion at March 31, 2011 and December 31, 2010, respectively. The Bank’s average outstanding capital stock (excluding mandatorily redeemable capital stock) decreased from $2.1 billion for the year ended December 31, 2010 to $1.5 billion for the three months ended March 31, 2011. The decrease in outstanding capital stock from December 31, 2010 to March 31, 2011 was attributable primarily to a decline in members’ activity-based investment requirements resulting from the decline in outstanding advances balances.
Mandatorily redeemable capital stock outstanding at March 31, 2011 and December 31, 2010 was $18.1 million and $8.1 million, respectively. Although mandatorily redeemable capital stock is excluded from capital (equity) for financial reporting purposes, such stock is considered capital for regulatory purposes.
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At March 31, 2011 and December 31, 2010, the Bank’s five largest shareholders (all but one of which was among the Bank’s five largest borrowers) held $0.4 billion and $0.5 billion, respectively, of capital stock, which represented 27.5 percent and 28.8 percent, respectively, of the Bank’s total outstanding capital stock (including mandatorily redeemable capital stock) as of those dates. The following table presents the Bank’s five largest shareholders as of March 31, 2011.
FIVE LARGEST SHAREHOLDERS AS OF MARCH 31, 2011
(Par value, dollars in millions)
(Par value, dollars in millions)
Percent of | ||||||||
Par Value of | Total Par Value | |||||||
Name | Capital Stock | of Capital Stock | ||||||
Wells Fargo Bank South Central, National Association | $ | 147,533 | 10.2 | % | ||||
Comerica Bank | 127,621 | 8.8 | ||||||
Beal Bank Nevada(1) | 62,075 | 4.3 | ||||||
International Bank of Commerce | 31,410 | 2.2 | ||||||
Southside Bank | 29,216 | 2.0 | ||||||
$ | 397,855 | 27.5 | % | |||||
(1) | Beal Bank Nevada is chartered in Nevada, but maintains its home office in Plano, TX. |
As of March 31, 2011, all of the stock held by the five institutions shown in the table above was classified as capital in the statement of condition.
Members are required to maintain an investment in Class B stock equal to the sum of a membership investment requirement and an activity-based investment requirement. There were no changes in the investment requirement percentages during the three months ended March 31, 2011. Effective April 18, 2011, the membership investment requirement was reduced from 0.06 percent to 0.05 percent of each member’s total assets as of the previous calendar year-end, subject to a minimum of $1,000 and a maximum of $10,000,000. The activity-based investment requirement remains unchanged at 4.10 percent of outstanding advances.
Periodically, the Bank repurchases a portion of members’ 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 investment requirement. The portion of members’ excess capital stock subject to repurchase is known as surplus stock. The Bank generally repurchases surplus stock on the last business day of the month following the end of each calendar quarter (e.g., January 31, April 30, July 31 and October 31). For the quarterly repurchases that occurred on January 31, 2011 and April 29, 2011, surplus stock was defined as the amount of stock held by a member in excess of 105 percent of the member’s minimum investment requirement. The Bank’s practice has been that a member’s surplus stock will not be repurchased if the amount of that member’s surplus stock is $250,000 or less or if, subject to certain exceptions, the member is on restricted collateral status. From time to time, the Bank may modify the definition of surplus stock or the timing and/or frequency of surplus stock repurchases.
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The following table sets forth the repurchases of surplus stock that have occurred since December 31, 2010.
SURPLUS STOCK REPURCHASED UNDER QUARTERLY REPURCHASE PROGRAM
(dollars in thousands)
(dollars in thousands)
Amount Classified as | ||||||||||||
Mandatorily Redeemable | ||||||||||||
Date of Repurchase | Shares | Amount of | Capital Stock at Date of | |||||||||
by the Bank | Repurchased | Repurchase | Repurchase | |||||||||
January 31, 2011 | 1,024,586 | $ | 102,459 | $ | — | |||||||
April 29, 2011 | 1,470,359 | 147,036 | 119 |
At March 31, 2011, the Bank’s excess stock totaled $210.7 million, which represented 0.6 percent of the Bank’s total assets as of that date.
The following table presents outstanding capital stock, by type of institution, as of March 31, 2011 and December 31, 2010.
CAPITAL STOCK OUTSTANDING BY INSTITUTION TYPE
(dollars in millions)
(dollars in millions)
March 31, 2011 | December 31, 2010 | |||||||||||||||
Amount | Percent | Amount | Percent | |||||||||||||
Commercial banks | $ | 1,091 | 75 | % | $ | 1,256 | 78 | % | ||||||||
Thrifts | 212 | 15 | 218 | 14 | ||||||||||||
Credit unions | 99 | 7 | 101 | 6 | ||||||||||||
Insurance companies | 26 | 2 | 26 | 2 | ||||||||||||
Total capital stock classified as capital | 1,428 | 99 | 1,601 | 100 | ||||||||||||
Mandatorily redeemable capital stock | 18 | 1 | 8 | — | ||||||||||||
Total regulatory capital stock | $ | 1,446 | 100 | % | $ | 1,609 | 100 | % | ||||||||
During the three months ended March 31, 2011, the Bank’s retained earnings increased by $10.0 million, from $452.2 million to $462.2 million. During this same period, the Bank paid dividends on capital stock totaling $1.5 million, which represented an annualized dividend rate of 0.375 percent. The Bank’s first quarter 2011 dividend rate exceeded the upper end of the Federal Reserve’s target for the federal funds rate for the fourth quarter of 2010 by 12.5 basis points. The first quarter dividend, applied to average capital stock held during the period from October 1, 2010 through December 31, 2010, was paid on March 31, 2011.
The Bank has had a long-standing practice of benchmarking the dividend rate that it pays on capital stock to the average federal funds rate. Consistent with that practice, the Bank manages its balance sheet so that its returns (attributable to core earnings) generally track short-term interest rates.
While there can be no assurances, taking into consideration its current earnings expectations and anticipated market conditions, the Bank currently expects to pay dividends for the remainder of 2011 at or slightly above the upper end of the Federal Reserve’s target for the federal funds rate for the applicable dividend period (i.e., for each calendar quarter during this period, the upper end of the Federal Reserve’s target for the federal funds rate for the preceding quarter). Consistent with its long-standing practice, the Bank expects to pay these dividends in the form of capital stock with any fractional shares paid in cash.
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The Bank is required to maintain at all times permanent capital (defined under the Finance Agency’s rules as retained earnings and amounts paid in for Class B stock, regardless of its classification as equity or liabilities for financial reporting purposes) in an amount at least equal to its risk-based capital requirement, which is the sum of its credit risk capital requirement, its market risk capital requirement, and its operations risk capital requirement, as further described in the Bank’s 2010 10-K. At March 31, 2011, the Bank’s total risk-based capital requirement was $404 million, comprised of credit risk, market risk and operations risk capital requirements of $145 million, $166 million and $93 million, respectively.
In addition to the risk-based capital requirement, the Bank is subject to two other capital requirements. First, the Bank must, at all times, maintain a minimum total capital-to-assets ratio of 4.0 percent. For this purpose, total capital is defined by Finance Agency rules and regulations as the Bank’s permanent capital and the amount of any general allowance for losses (i.e., those reserves that are not held against specific assets). Second, the Bank is required to maintain at all times a minimum leverage capital-to-assets ratio in an amount at least equal to 5.0 percent of its total assets. In applying this requirement to the Bank, leverage capital includes the Bank’s permanent capital multiplied by a factor of 1.5 plus the amount of any general allowance for losses. The Bank did not have any general reserves at March 31, 2011 or December 31, 2010. Under the regulatory definitions, total capital and permanent capital exclude accumulated other comprehensive income (loss). At all times during the three months ended March 31, 2011, the Bank was in compliance with all of its regulatory capital requirements. For a summary of the Bank’s compliance with the Finance Agency’s capital requirements as of March 31, 2011 and December 31, 2010, see “Item 1. Financial Statements” (specifically, Note 9 on page 26 of this report).
The Bank’s Risk Management Policy contains a minimum total regulatory capital-to-assets target ratio of 4.1 percent, which is higher than the 4.0 percent ratio required under the Finance Agency’s capital rules. At all times during the three months ended March 31, 2011, the Bank was in compliance with its target capital-to-assets ratio.
Derivatives and Hedging Activities
The Bank enters into interest rate swap, swaption, cap and forward rate agreements (collectively, interest rate exchange agreements) with highly rated financial institutions to manage its exposure to changes in interest rates and/or to adjust the effective maturity, repricing index and/or frequency or option characteristics of financial instruments. This use of derivatives is integral to the Bank’s financial management strategy, and the impact of these interest rate exchange agreements permeates the Bank’s financial statements. For additional discussion, see “Item 1. Financial Statements” (specifically, Note 8 beginning on page 19 of this report). As a result of using interest rate exchange agreements extensively to fulfill its role as a financial intermediary, the Bank has a large notional amount of interest rate exchange agreements relative to its size. As of March 31, 2011 and December 31, 2010, the Bank’s notional balance of interest rate exchange agreements was $34.1 billion and $36.4 billion, respectively, while its total assets were $33.2 billion and $39.7 billion, respectively.
The following table provides the notional balances of the Bank’s derivative instruments, by balance sheet category and accounting designation, as of March 31, 2011 and December 31, 2010.
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COMPOSITION OF DERIVATIVES BY BALANCE SHEET CATEGORY AND ACCOUNTING DESIGNATION
(In millions of dollars)
(In millions of dollars)
Short-Cut | Long-Haul | Economic | ||||||||||||||
Method | Method | Hedges | Total | |||||||||||||
March 31, 2011 | ||||||||||||||||
Advances | $ | 6,449 | $ | 1,776 | $ | 223 | $ | 8,448 | ||||||||
Investments | — | — | 3,700 | 3,700 | ||||||||||||
Consolidated obligation bonds | — | 14,572 | 1,600 | 16,172 | ||||||||||||
Balance sheet | — | — | 5,700 | 5,700 | ||||||||||||
Intermediary positions | — | — | 87 | 87 | ||||||||||||
Total notional balance | $ | 6,449 | $ | 16,348 | $ | 11,310 | $ | 34,107 | ||||||||
December 31, 2010 | ||||||||||||||||
Advances | $ | 6,786 | $ | 1,835 | $ | 169 | $ | 8,790 | ||||||||
Investments | — | — | 3,700 | 3,700 | ||||||||||||
Consolidated obligation bonds | — | 14,650 | 1,600 | 16,250 | ||||||||||||
Consolidated obligation discount notes | — | — | 913 | 913 | ||||||||||||
Balance sheet | — | — | 6,700 | 6,700 | ||||||||||||
Intermediary positions | — | — | 44 | 44 | ||||||||||||
Total notional balance | $ | 6,786 | $ | 16,485 | $ | 13,126 | $ | 36,397 | ||||||||
The following table presents the earnings impact of derivatives and hedging activities, and the changes in fair value of any hedged items recorded at fair value during the three months ended March 31, 2011 and 2010.
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NET EARNINGS IMPACT OF DERIVATIVES AND HEDGING ACTIVITIES
(Dollars in millions)
(Dollars in millions)
Consolidated | Consolidated | Optional | ||||||||||||||||||||||||||
Obligation | Obligation | Advance | Balance | |||||||||||||||||||||||||
Advances | Investments | Bonds | Discount Notes | Commitments | Sheet | Total | ||||||||||||||||||||||
Three months ended March 31, 2011 | ||||||||||||||||||||||||||||
Amortization/accretion of hedging activities in net interest income (1) | $ | 1 | $ | — | $ | (8 | ) | $ | — | $ | — | $ | — | $ | (7 | ) | ||||||||||||
Net interest settlements included in net interest income(2) | (59 | ) | — | 78 | — | — | — | 19 | ||||||||||||||||||||
Net gain (loss) on derivatives and hedging activities | ||||||||||||||||||||||||||||
Net gains (losses) on economic hedges | — | (4 | ) | (1 | ) | (1 | ) | 1 | (4 | ) | (9 | ) | ||||||||||||||||
Net interest settlements on economic hedges | — | — | 1 | 1 | — | — | 2 | |||||||||||||||||||||
Total net gain (loss) on derivatives and hedging activities | — | (4 | ) | — | — | 1 | (4 | ) | (7 | ) | ||||||||||||||||||
Net impact of derivatives and hedging activities | (58 | ) | (4 | ) | 70 | — | 1 | (4 | ) | 5 | ||||||||||||||||||
Net loss on hedged financial instruments carried at fair value | — | — | — | — | (1 | ) | — | (1 | ) | |||||||||||||||||||
$ | (58 | ) | $ | (4 | ) | $ | 70 | $ | — | $ | — | $ | (4 | ) | $ | 4 | ||||||||||||
Three months ended March 31, 2010 | ||||||||||||||||||||||||||||
Amortization/accretion of hedging activities in net interest income (1) | $ | — | $ | — | $ | (7 | ) | $ | — | $ | — | $ | — | $ | (7 | ) | ||||||||||||
Net interest settlements included in net interest income(2) | (80 | ) | — | 140 | — | — | — | 60 | ||||||||||||||||||||
Net gain (loss) on derivatives and hedging activities | ||||||||||||||||||||||||||||
Net gains on fair value hedges | — | — | 2 | — | — | — | 2 | |||||||||||||||||||||
Net losses on economic hedges | — | (29 | ) | (6 | ) | (2 | ) | — | (1 | ) | (38 | ) | ||||||||||||||||
Net interest settlements on economic hedges | — | — | 7 | 2 | — | — | 9 | |||||||||||||||||||||
Total net gain (loss) on derivatives and hedging activities | — | (29 | ) | 3 | — | — | (1 | ) | (27 | ) | ||||||||||||||||||
Net impact of derivatives and hedging activities | $ | (80 | ) | $ | (29 | ) | $ | 136 | $ | — | $ | — | $ | (1 | ) | $ | 26 | |||||||||||
(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. |
By entering into interest rate exchange agreements with highly rated financial institutions (with which it has in place master swap agreements and credit support addendums), the Bank generally exchanges a defined market risk for the risk that the counterparty will not be able to fulfill its obligation in the future. The Bank manages this credit risk by spreading its transactions among as many highly rated counterparties as is practicable, by entering into collateral exchange agreements with all counterparties that include minimum collateral thresholds, and by monitoring its exposure to each counterparty at least monthly and as often as daily. In addition, all of the Bank’s collateral exchange agreements include master netting arrangements whereby the fair values of all interest rate derivatives (including accrued interest receivables and payables) with each counterparty are offset for purposes of measuring credit exposure. The collateral exchange agreements require the delivery of collateral consisting of cash or very liquid, highly rated securities (generally consisting of U.S. government guaranteed or agency debt securities) if credit risk exposures rise above the minimum thresholds. As of March 31, 2011 and December 31, 2010, only cash collateral had been delivered under the terms of these collateral exchange agreements.
The notional amount of interest rate exchange agreements does not reflect the Bank’s credit risk exposure, which is much less than the notional amount. The maximum credit risk exposure is the estimated cost, on a present value basis, of replacing at current market rates all interest rate exchange agreements with a counterparty with which the Bank is in a net gain position, if the counterparty were to default. Maximum credit risk exposure also considers the existence of any cash collateral held or remitted by the Bank. The Bank’s collateral exchange agreements with its counterparties generally establish maximum unsecured credit exposure thresholds (typically ranging from $100,000 to $500,000) that one party may have to the other party. Once the counterparties agree to the valuations of the interest rate exchange agreements, and if it is determined that the unsecured credit exposure exceeds the threshold, then, upon a request made by the unsecured counterparty, the party that has the unsecured obligation to the counterparty bearing the risk of the unsecured credit exposure generally must deliver sufficient collateral to reduce the unsecured credit exposure to zero.
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The following table provides information regarding the Bank’s derivative counterparty credit exposure as of March 31, 2011 and December 31, 2010.
DERIVATIVES COUNTERPARTY CREDIT EXPOSURE
(Dollars in millions)
(Dollars in millions)
Maximum | Cash | |||||||||||||||||||
Credit | Number of | Notional | Credit | Collateral | Net Credit | |||||||||||||||
Rating(1) | Counterparties | Principal(2) | Exposure | Due(3) | Exposure | |||||||||||||||
March 31, 2011 | ||||||||||||||||||||
Aaa | 1 | $ | 230.0 | $ | 0.6 | $ | 0.6 | $ | — | |||||||||||
Aa(4) | 10 | 27,246.0 | 22.1 | 20.2 | 1.9 | |||||||||||||||
A(5) | 3 | 6,587.3 | — | — | — | |||||||||||||||
14 | 34,063.3 | $ | 22.7 | $ | 20.8 | $ | 1.9 | |||||||||||||
Member institutions (6) | 7 | 43.4 | ||||||||||||||||||
Total | 21 | $ | 34,106.7 | |||||||||||||||||
December 31, 2010 | ||||||||||||||||||||
Aaa | 1 | $ | 234.0 | $ | 3.8 | $ | 3.8 | $ | — | |||||||||||
Aa(4) | 10 | 28,790.3 | 29.2 | 28.1 | 1.1 | |||||||||||||||
A(5) | 3 | 7,350.7 | 1.2 | 1.1 | 0.1 | |||||||||||||||
14 | 36,375.0 | $ | 34.2 | $ | 33.0 | $ | 1.2 | |||||||||||||
Member institutions (6) | 5 | 22.1 | ||||||||||||||||||
Total | 19 | $ | 36,397.1 | |||||||||||||||||
(1) | Credit ratings shown in the table are obtained from Moody’s and are as of March 31, 2011 and December 31, 2010, respectively. | |
(2) | Includes amounts that had not settled as of March 31, 2011 and December 31, 2010. | |
(3) | Amount of collateral to which the Bank had contractual rights under counterparty credit agreements based on March 31, 2011 and December 31, 2010 credit exposures. Cash collateral totaling $20.8 million and $33.0 million was delivered under these agreements in early April 2011 and early January 2011, respectively. | |
(4) | The figures for Aa-rated counterparties as of March 31, 2011 and December 31, 2010 include transactions with a counterparty that is affiliated with a member institution. Transactions with this counterparty had an aggregate notional principal of $1.5 billion and $1.8 billion as of March 31, 2011 and December 31, 2010, respectively. These transactions represented a maximum credit exposure of $2.1 million and $4.9 million to the Bank as of March 31, 2011 and December 31, 2010, respectively. | |
(5) | The figures for A-rated counterparties as of March 31, 2011 and December 31, 2010 include transactions with one counterparty that is affiliated with a non-member shareholder of the Bank. Transactions with that counterparty had an aggregate notional principal of $4.6 billion and $4.5 billion as of March 31, 2011 and December 31, 2010, respectively. These transactions did not represent a credit exposure to the Bank at March 31, 2011 and represented a maximum credit exposure of $1.1 million to the Bank as of December 31, 2010. | |
(6) | This product offering and the collateral provisions associated therewith are discussed in the paragraph below. |
The Bank offers interest rate swaps, caps and floors to its members to assist them in meeting their risk management objectives. In derivative transactions with its members, the Bank acts as an intermediary by entering into an interest rate exchange agreement with the member and then entering into an offsetting interest rate exchange agreement with one of the Bank’s derivative counterparties discussed above. When entering into interest rate exchange agreements with its members, the Bank requires the member to post eligible collateral in an amount equal to the sum of the net market value of the member’s derivative transactions with the Bank (if the value is positive to the Bank) plus a percentage of the notional amount of any interest rate swaps, with market values determined on at least a monthly basis. Eligible collateral for derivative transactions consists of collateral that is eligible to secure advances and other obligations under the member’s Advances and Security Agreement with the Bank.
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On July 21, 2010, the President of the United States signed into law the Dodd-Frank Act, which provides for new statutory and regulatory requirements for derivative transactions, including those used by the Bank to hedge its interest rate risk. 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 swap execution facilities. Cleared trades are expected to be subject to initial and variation margin requirements established by the clearinghouse and its clearing members. While clearing derivatives through a central clearinghouse may or may not reduce the counterparty credit risk typically associated with bilateral transactions, certain requirements, including margin provisions, for cleared trades have the potential to make derivative transactions more costly for the Bank. The Dodd-Frank Act will also change the regulatory landscape for derivative transactions that are not subject to mandatory clearing requirements (uncleared trades). While the Bank expects to be able to continue to enter into uncleared trades on a bilateral basis, those transactions are expected to be subject to new regulatory requirements, including minimum margin and capital requirements imposed by regulators on one or both counterparties to the transactions. Any changes to the margin or capital requirements associated with uncleared trades could adversely affect the pricing of certain uncleared derivative transactions entered into by the Bank, thereby increasing the costs of managing the Bank’s interest rate risk.
Because the Dodd-Frank Act calls for a number of regulations, orders, determinations and reports to be issued, the impact of this legislation on our hedging activities and the costs associated with those activities will become known only after the required regulations, orders, determinations, and reports are issued and implemented. For further information regarding the Dodd-Frank Act, see the Bank’s 2010 10-K (specifically, “Business — Legislative and Regulatory Developments” beginning on page 20 of that report).
Market Value of Equity
The ratio of the Bank’s estimated market value of equity to its book value of equity was approximately 109 percent at March 31, 2011. In comparison, this ratio was approximately 110 percent as of December 31, 2010. For additional discussion, see “Part I / Item 3 — Quantitative and Qualitative Disclosures About Market Risk.”
Results of Operations
Net Income
Net income for the three months ended March 31, 2011 and 2010 was $11.5 million and $15.6 million, respectively. The Bank’s net income for the three months ended March 31, 2011 represented an annualized return on average capital stock (“ROCS”) of 3.10 percent, which was 295 basis points above the average effective federal funds rate for the quarter. In comparison, the Bank’s ROCS was 2.58 percent for the three months ended March 31, 2010, which exceeded the average effective federal funds rate for that quarter by 245 basis points. To derive the Bank’s ROCS, net income is divided by average capital stock outstanding excluding stock that is classified as mandatorily redeemable capital stock. The factors contributing to the increase in ROCS compared to the average effective federal funds rate are discussed below.
While the Bank is exempt from all federal, state and local taxation (except for real property taxes), it is obligated to set aside amounts for its Affordable Housing Program (“AHP”) and to make quarterly payments to the Resolution Funding Corporation (“REFCORP”). Assessments for AHP and REFCORP, which are more fully described below, equate to a minimum 26.5 percent effective assessment rate for the Bank. Because interest expense on mandatorily redeemable capital stock is not deductible for purposes of computing the Bank’s AHP assessment, the effective rate may exceed 26.5 percent. During both the three months ended March 31, 2011 and 2010, the effective rate was 26.5 percent. During these periods, the combined AHP and REFCORP assessments were $4.2 million and $5.6 million, respectively.
Income Before Assessments
During the three months ended March 31, 2011 and 2010, the Bank’s income before assessments was $15.7 million and $21.2 million, respectively. As discussed in more detail below, the $5.5 million decrease in income before assessments from period to period was attributable to a $22.1 million decrease in net interest income and a $2.3
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million increase in other expense, offset by an $18.9 million improvement in other income/loss. The improvement in other income/loss was due largely to a $20.2 million decrease in net losses on derivatives and hedging activities.
The components of income before assessments (net interest income, other income/loss and other expense) are discussed in more detail in the following sections.
Net Interest Income
For the three months ended March 31, 2011 and 2010, the Bank’s net interest income was $42.1 million and $64.2 million, respectively. As described further below, the Bank’s net interest income does not include net interest payments on economic hedge derivatives, which also contributed to the Bank’s overall income before assessments for both periods. If these net interest payments had been included, net interest income would have declined by $28.9 million period to period. The decrease in net interest income was due primarily to a decrease in the average balance of earning assets from $61.7 billion for the three months ended March 31, 2010 to $36.3 billion for the corresponding period in 2011.
For the three months ended March 31, 2011 and 2010, the Bank’s net interest margin was 46 basis points and 41 basis points, respectively. Net interest margin, or net interest income as a percent of average earning assets, is a function of net interest spread and the rates of return on assets funded by the investment of the Bank’s capital. Net interest spread is the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities. Due to slightly higher short-term interest rates period-to-period, the contribution of earnings from the Bank’s invested capital to the net interest margin (the impact of non-interest bearing funds) increased from 2 basis points for the three months ended March 31, 2010 to 3 basis points for the comparable period in 2011. The Bank’s net interest spread improved from 39 basis points during the first three months of 2010 to 43 basis points during the first three months of 2011.
As noted above, the Bank’s net interest income excludes net interest payments on economic hedge derivatives. During the three months ended March 31, 2011, the Bank used approximately $5.8 billion (average notional balance) of interest rate basis swaps to hedge the risk of changes in spreads between one-month and three-month LIBOR, approximately $0.4 billion (average notional balance) of fixed-for-floating interest rate swaps to hedge some of its longer-term discount notes and approximately $1.6 billion (average notional balance) of interest rate swaps to convert variable-rate consolidated obligations from the daily federal funds rate to three-month LIBOR (“federal funds floater swaps”). During the comparable period in 2010, the Bank used approximately $9.5 billion (average notional balance) of interest rate basis swaps to hedge the risk of changes in spreads between one-month and three-month LIBOR, approximately $3.4 billion (average notional balance) of fixed-for-floating interest rate swaps to hedge some of its longer-term discount notes and approximately $5.3 billion (average notional balance) of federal funds floater swaps to convert variable-rate consolidated obligations from the daily federal funds rate to three-month LIBOR. These swaps are accounted for as economic hedges. Net interest income associated with economic hedge derivatives is recorded in other income (loss) in the statements of income and therefore excluded from net interest income, net interest margin and net interest spread. Net interest income on the Bank’s economic hedge derivatives totaled $1.7 million and $8.5 million for the three months ended March 31, 2011 and 2010, respectively. If this interest income on economic hedge derivatives had been included in net interest income, the Bank’s net interest income for the three months ended March 31, 2011 and 2010 would have been $1.7 million and $8.5 million higher, respectively. For the three months ended March 31, 2011 and 2010, the Bank’s net interest margin would have been 48 basis points and 47 basis points, respectively, and its net interest spread would have been 45 basis points and 45 basis points, respectively.
The Bank’s net interest income for the first quarter of 2010 was positively impacted by higher yields on the Bank’s CMO portfolio. During the first quarter of 2010, Fannie Mae and Freddie Mac announced plans to purchase loans that are at least 120 days delinquent from the mortgage pools underlying the CMOs guaranteed by those institutions. The initial purchases, which included delinquent loans that had accumulated up to that point in time, occurred during the period from February 2010 through May 2010, with additional purchases of delinquent loans occurring thereafter as needed. During the first quarter of 2010, Freddie Mac repurchased delinquent loans from the pools underlying its guaranteed CMOs that are owned by the Bank. The repayments resulting from these repurchases resulted in approximately $6.6 million of accelerated accretion of the purchase discounts associated with the Bank’s investments in certain of these securities. Such repurchases by Fannie Mae and Freddie Mac did not significantly
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affect the Bank’s net interest income during the three months ended March 31, 2011. The decline in the yield on the Bank’s CMO portfolio in 2011 was offset by increased yields on the Bank’s advances (which were due to the maturity of shorter-term advances bearing lower yields) and more favorable costs related to the Bank’s discount notes.
The following table presents average balance sheet amounts together with the total dollar amounts of interest income and expense and the weighted average interest rates of major earning asset categories and the funding sources for those earning assets for the three months ended March 31, 2011 and 2010.
YIELD AND SPREAD ANALYSIS
(Dollars in millions)
(Dollars in millions)
For the three months ended March 31, | ||||||||||||||||||||||||
2011 | 2010 | |||||||||||||||||||||||
Interest | Interest | |||||||||||||||||||||||
Average | Income/ | Average | Average | Income/ | Average | |||||||||||||||||||
Balance | Expense(c) | Rate(a)(c) | Balance | Expense(c) | Rate(a)(c) | |||||||||||||||||||
Assets | ||||||||||||||||||||||||
Interest-bearing deposits(b) | $ | 186 | $ | — | 0.17 | % | $ | 125 | $ | — | 0.15 | % | ||||||||||||
Securities purchased under agreements to resell | 323 | — | 0.13 | % | — | — | — | |||||||||||||||||
Federal funds sold | 3,574 | 1 | 0.14 | % | 4,256 | 1 | 0.11 | % | ||||||||||||||||
Investments | ||||||||||||||||||||||||
Trading | 5 | — | — | 4 | — | — | ||||||||||||||||||
Held-to-maturity(d) | 8,253 | 24 | 1.17 | % | 11,433 | 38 | 1.34 | % | ||||||||||||||||
Advances(e) | 23,790 | 61 | 1.02 | % | 45,653 | 84 | 0.74 | % | ||||||||||||||||
Mortgage loans held for portfolio | 201 | 3 | 5.54 | % | 254 | 4 | 5.55 | % | ||||||||||||||||
Total earning assets | 36,332 | 89 | 0.98 | % | 61,725 | 127 | 0.82 | % | ||||||||||||||||
Cash and due from banks | 76 | 509 | ||||||||||||||||||||||
Other assets | 161 | 332 | ||||||||||||||||||||||
Derivatives netting adjustment(b) | (242 | ) | (335 | ) | ||||||||||||||||||||
Adjustment for net non-credit portion of other-than-temporary impairments on held-to-maturity securities(d) | (62 | ) | (65 | ) | ||||||||||||||||||||
Total assets | $ | 36,265 | 89 | 0.98 | % | $ | 62,166 | 127 | 0.82 | % | ||||||||||||||
Liabilities and Capital | ||||||||||||||||||||||||
Interest-bearing deposits(b) | $ | 1,275 | — | 0.04 | % | $ | 1,607 | — | 0.04 | % | ||||||||||||||
Consolidated obligations | ||||||||||||||||||||||||
Bonds | 29,620 | 46 | 0.61 | % | 50,713 | 59 | 0.47 | % | ||||||||||||||||
Discount notes | 3,297 | 1 | 0.15 | % | 6,603 | 4 | 0.22 | % | ||||||||||||||||
Mandatorily redeemable capital stock and other borrowings | 18 | — | 0.41 | % | 9 | — | 0.60 | % | ||||||||||||||||
Total interest-bearing liabilities | 34,210 | 47 | 0.55 | % | 58,932 | 63 | 0.43 | % | ||||||||||||||||
Other liabilities | 387 | 819 | ||||||||||||||||||||||
Derivatives netting adjustment(b) | (242 | ) | (335 | ) | ||||||||||||||||||||
Total liabilities | 34,355 | 47 | 0.55 | % | 59,416 | 63 | 0.42 | % | ||||||||||||||||
Total capital | 1,910 | 2,750 | ||||||||||||||||||||||
Total liabilities and capital | $ | 36,265 | 0.52 | % | $ | 62,166 | 0.41 | % | ||||||||||||||||
Net interest income | $ | 42 | $ | 64 | ||||||||||||||||||||
Net interest margin | 0.46 | % | 0.41 | % | ||||||||||||||||||||
Net interest spread | 0.43 | % | 0.39 | % | ||||||||||||||||||||
Impact of non-interest bearing funds | 0.03 | % | 0.02 | % | ||||||||||||||||||||
(a) | Percentages are annualized figures. Amounts used to calculate average rates are based on whole dollars. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results. | |
(b) | The Bank offsets the fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral against the fair value amounts recognized for derivative instruments executed with the same counterparty under a master netting arrangement. The average balances of interest-bearing deposit assets for the three months ended March 31, 2011 and 2010 in the table above include $186 million and $125 million, respectively, which are classified as derivative assets/liabilities on the statements of condition. In addition, the average balances of the interest-bearing deposit liabilities for the three months ended March 31, 2011 and 2010 in the table above include $56 million and $210 million, respectively, which are classified as derivative assets/liabilities on the statements of condition. | |
(c) | Interest income/expense and average rates include the effects of associated interest rate exchange agreements to the extent such agreements qualify for fair value hedge accounting. If the agreements do not qualify for hedge accounting or were not designated in a hedging relationship for accounting purposes, the net interest income/expense associated with such agreements is recorded in other income (loss) in the statements of income and therefore excluded from the Yield and Spread Analysis. Net interest income on economic hedge derivatives totaled $1.7 million and $8.5 million for the three months ended March 31, 2011 and 2010, respectively, the components of which are presented below in the sub-section entitled “Other Income (Loss).” | |
(d) | Average balances for held-to-maturity securities are calculated based upon amortized cost. | |
(e) | Interest income and average rates include prepayment fees on advances. |
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Changes in both volume (i.e., average balances) and interest rates influence changes in net interest income and net interest margin. The following table summarizes changes in interest income and interest expense between the three-month periods in 2011 and 2010 and excludes net interest income on economic hedge derivatives, as discussed above. Changes in interest income and interest expense that cannot be attributed to either volume or rate have been allocated to the volume and rate categories based upon the proportion of the absolute value of the volume and rate changes.
RATE AND VOLUME ANALYSIS
(In millions of dollars)
(In millions of dollars)
Three Months Ended | ||||||||||||
March 31, 2011 vs. 2010 | ||||||||||||
Volume | Rate | Total | ||||||||||
Interest income | ||||||||||||
Interest-bearing deposits | $ | — | $ | — | $ | — | ||||||
Securities purchased under agreements to resell | — | — | — | |||||||||
Federal funds sold | — | — | — | |||||||||
Investments | ||||||||||||
Trading | — | — | — | |||||||||
Held-to-maturity | (10 | ) | (4 | ) | (14 | ) | ||||||
Advances | (48 | ) | 25 | (23 | ) | |||||||
Mortgage loans held for portfolio | (1 | ) | — | (1 | ) | |||||||
Total interest income | (59 | ) | 21 | (38 | ) | |||||||
Interest expense | ||||||||||||
Interest-bearing deposits | — | — | — | |||||||||
Consolidated obligations | ||||||||||||
Bonds | (28 | ) | 15 | (13 | ) | |||||||
Discount notes | (2 | ) | (1 | ) | (3 | ) | ||||||
Mandatorily redeemable capital stock and other borrowings | — | — | — | |||||||||
Total interest expense | (30 | ) | 14 | (16 | ) | |||||||
Changes in net interest income | $ | (29 | ) | $ | 7 | $ | (22 | ) | ||||
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Other Income (Loss)
The following table presents the various components of other income (loss) for the three months ended March 31, 2011 and 2010. The significant components are discussed in the narrative following the table.
OTHER INCOME (LOSS)
(In thousands of dollars)
(In thousands of dollars)
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Net interest income (expense) associated with: | ||||||||
Economic hedge derivatives related to consolidated obligation federal funds floater bonds | $ | 1,052 | $ | 7,049 | ||||
Economic hedge derivatives related to consolidated obligation discount notes | 485 | 1,746 | ||||||
Stand-alone economic hedge derivatives (basisswaps) | 204 | (278 | ) | |||||
Member/offsetting swaps | 1 | 1 | ||||||
Economic hedge derivatives related to advances | (74 | ) | (23 | ) | ||||
Total net interest income associated with economic hedge derivatives | 1,668 | 8,495 | ||||||
Gains (losses) related to economic hedge derivatives | ||||||||
Losses related to stand-alone derivatives (basis swaps) | (3,909 | ) | (554 | ) | ||||
Losses on federal funds floater swaps | (1,109 | ) | (6,520 | ) | ||||
Losses on interest rate caps related to held-to-maturity securities | (4,326 | ) | (28,953 | ) | ||||
Losses on discount note swaps | (497 | ) | (1,622 | ) | ||||
Net gains on member/offsetting swaps | 95 | — | ||||||
Gains on swaptions related to optional advance commitments | 1,102 | — | ||||||
Gains (losses) related to other economic hedge derivatives (advance swaps and caps) | 60 | (6 | ) | |||||
Total fair value losses related to economic hedge derivatives | (8,584 | ) | (37,655 | ) | ||||
Gains (losses) related to fair value hedge ineffectiveness | ||||||||
Net gains on advances and associated hedges | 403 | 224 | ||||||
Net gains (losses) on consolidated obligationbonds and associated hedges | (2 | ) | 2,230 | |||||
Total fair value hedge ineffectiveness | 401 | 2,454 | ||||||
Net gains on unhedged trading securities | 129 | 119 | ||||||
Credit component of other-than-temporary impairment losses on held-to-maturity securities | (1,378 | ) | (568 | ) | ||||
Losses on other liabilities carried at fair value under the fair value option (optional advance commitments) | (861 | ) | — | |||||
Gains on early extinguishment of debt | 369 | — | ||||||
Service fees | 570 | 563 | ||||||
Letter of credit fees | 1,429 | 1,432 | ||||||
Other, net | (10 | ) | 27 | |||||
Total other | 248 | 1,573 | ||||||
Total other loss | $ | (6,267 | ) | $ | (25,133 | ) | ||
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The Bank has issued a number of consolidated obligation bonds that are indexed to the daily federal funds rate. The Bank uses federal funds floater swaps to convert its interest payments with respect to these bonds from the daily federal funds rate to three-month LIBOR. As of March 31, 2011, the Bank’s federal funds floater swaps had an aggregate notional amount of $1.6 billion. As economic hedge derivatives, the changes in the fair values of the federal funds floater swaps are recorded in earnings with no offsetting changes in the fair values of the hedged items (i.e., the consolidated obligation federal funds floater bonds) and therefore can be a source of considerable volatility in the Bank’s earnings. The fair values of federal funds floater swaps generally fluctuate based on the timing of the interest rate reset dates, the relationship between the federal funds rate and three-month LIBOR at the time of measurement, the projected relationship between the federal funds rate and three-month LIBOR for the remaining term of the interest rate swap and the relationship between the current coupons for the interest rate swap and the prevailing market rates at the valuation date. At March 31, 2011, the carrying values of the Bank’s federal funds floater swaps totaled $0.8 million, excluding net accrued interest receivable.
From time to time, the Bank hedges some of its longer-term consolidated obligation discount notes using fixed-for-floating interest rate swaps. As stand-alone derivatives, the changes in the fair values of the Bank’s discount note swaps are recorded in earnings with no offsetting changes in the fair values of the hedged items (i.e., the consolidated obligation discount notes) and therefore can be a source of volatility in the Bank’s earnings. As of March 31, 2011, the Bank did not have any hedged discount notes.
From time to time, the Bank also enters into interest rate basis swaps to reduce its exposure to changing spreads between one-month and three-month LIBOR. Under these agreements, the Bank generally receives three-month LIBOR and pays one-month LIBOR. As of March 31, 2011, the Bank was a party to 7 interest rate basis swaps with an aggregate notional amount of $5.7 billion. The Bank accounts for interest rate basis swaps as stand-alone derivatives and, as such, the fair value changes associated with these instruments can be a source of considerable volatility in the Bank’s earnings, particularly when one-month and/or three-month LIBOR, or the spreads between these two indices, are or are projected to be volatile. The fair values of one-month LIBOR to three-month LIBOR basis swaps generally fluctuate based on the timing of the interest rate reset dates, the relationship between one-month LIBOR and three-month LIBOR at the time of measurement, the projected relationship between one-month LIBOR and three-month LIBOR for the remaining term of the interest rate basis swap and the relationship between the current coupons for the interest rate swap and the prevailing LIBOR rates at the valuation date. During the three months ended March 31, 2010, the Bank sold a portion of an interest rate basis swap ($1.0 billion notional balance); proceeds from this sale totaled $3.1 million, which reflected the cumulative life-to-date gain (excluding net interest settlements) realized on this transaction. There were no sales of interest rate basis swaps during the three months ended March 31, 2011; during the period, one interest rate basis swap with a $1.0 billion notional balance matured. At March 31, 2011, the carrying values of the Bank’s stand-alone interest rate basis swaps totaled $9.7 million, excluding net accrued interest receivable.
If the Bank holds its federal funds floater swaps and interest rate basis swaps to maturity, the cumulative life-to-date unrealized gains associated with these instruments aggregating $10.5 million will ultimately reverse in future periods in the form of unrealized losses. The timing of this reversal will depend upon a number of factors including, but not limited to, the level and volatility of short-term interest rates. Occasionally, in response to changing balance sheet and market conditions, the Bank may terminate one or more interest rate basis swaps (or portions thereof) prior to their scheduled maturity. The Bank typically holds its federal funds floater swaps to maturity.
As discussed previously in the section entitled “Financial Condition — Long-Term Investments,” to hedge a portion of the risk associated with a significant increase in interest rates, the Bank had (as of March 31, 2011) entered into 14 interest rate cap agreements having a total notional amount of $3.7 billion. The premiums paid for these caps totaled $37.3 million. The fair values of interest rate cap agreements are dependent upon the level of interest rates, volatilities and remaining term to maturity. In general (assuming constant volatilities and no erosion in value attributable to the passage of time), interest rate caps will increase in value as market interest rates rise and will diminish in value as market interest rates decline. The value of interest rate caps will increase as volatilities increase and will decline as volatilities decrease. Absent changes in volatilities or interest rates, the value of interest rate caps will decline with the passage of time. As stand-alone derivatives, the changes in the fair values of the Bank’s interest rate cap agreements are recorded in earnings with no offsetting changes in the fair values of the hedged CMO LIBOR floaters with embedded caps and therefore can also be a source of considerable volatility in the Bank’s earnings.
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At March 31, 2011, the carrying values of the Bank’s stand-alone interest rate cap agreements totaled $15.3 million. If these agreements are held to maturity, the value of the caps will ultimately decline to zero and be recorded as a loss in net gains (losses) on derivatives and hedging activities in future periods.
The Bank uses interest rate swaps to hedge the risk of changes in the fair value of some of its advances and consolidated obligation bonds. These hedging relationships are designated as fair value hedges. To the extent these relationships qualify for hedge accounting, changes in the fair values of both the derivative (the interest rate swap) and the hedged item (limited to changes attributable to the hedged risk) are recorded in earnings. For those relationships that qualified for hedge accounting, the differences between the change in fair value of the hedged items and the change in fair value of the associated interest rate swaps (representing hedge ineffectiveness) were net gains of $0.4 million and $2.5 million for the three months ended March 31, 2011 and 2010, respectively. To the extent these hedging relationships do not qualify for hedge accounting, or cease to qualify because they are determined to be ineffective, only the change in fair value of the derivative is recorded in earnings (in this case, there is no offsetting change in fair value of the hedged item). During the three months ended March 31, 2011 and 2010, the net gains (losses) relating to derivatives associated with specific advances that were not in qualifying hedging relationships totaled $60,000 and ($6,000), respectively.
For a discussion of the other-than-temporary impairment losses on certain of the Bank’s held-to-maturity securities, see “Item 1. Financial Statements” (specifically, Note 3 beginning on page 6 of this report).
As of March 31, 2011, the Bank had entered into optional advance commitments with a par value totaling $200,000,000, excluding commitments to fund Community Investment Program and Economic Development Program advances. Under each of these commitments, the Bank sold an option to a member that provides the member with the right to enter into an advance at a specified fixed rate and term on a specified future date, provided the member has satisfied all of the customary requirements for such advance. The Bank hedged these commitments through the use of interest rate swaptions, which are treated as economic hedges. The Bank has irrevocably elected to carry these optional advance commitments at fair value under the fair value option.
During the first three months of 2011, market conditions were such that the Bank was able to extinguish certain consolidated obligation bonds and simultaneously terminate the associated interest rate exchange agreements at net amounts that were profitable for the Bank, while new consolidated obligations could be issued and then converted (through the use of interest rate exchange agreements) to a floating rate that approximated the cost of the extinguished debt including any associated interest rate swaps. As a result, during the three months ended March 31, 2011, the Bank repurchased $262.8 million (par value) of its consolidated obligations in the secondary market and terminated the related interest rate exchange agreements. The gains on these debt extinguishments totaled $369,000. No consolidated obligations were extinguished during the three months ended March 31, 2010.
Other Expense
Total other expense, which includes the Bank’s compensation and benefits, other operating expenses and its proportionate share of the costs of operating the Finance Agency and the Office of Finance, totaled $20.2 million and $17.8 million for the three months ended March 31, 2011 and 2010, respectively.
Compensation and benefits were $11.6 million for the three months ended March 31, 2011, compared to $10.0 million for the corresponding period in 2010. The increase was attributable in large part to three factors: (1) the timing of contributions to the Bank’s Special Non-Qualified Deferred Compensation Plan (contributions were made during the first quarter in 2011 versus the second quarter in 2010); (2) an increase in the costs associated with the Bank’s participation in the Pentegra Defined Benefit Plan for Financial Institutions; and (3) cost-of-living and merit increases. At March 31, 2011, the Bank employed 201 people, an increase of 2 people from March 31, 2010.
Other operating expenses for the three months ended March 31, 2011 were $6.7 million compared to $6.6 million for the corresponding period in 2010.
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The Bank, together with the other FHLBanks, is assessed for the cost of operating the Finance Agency and the Office of Finance. The Bank’s share of these expenses totaled $1.9 million and $1.2 million for the three months ended March 31, 2011 and 2010, respectively.
AHP and REFCORP Assessments
As required by statute, each year the Bank contributes 10 percent of its earnings (after the REFCORP assessment discussed below and as adjusted for interest expense on mandatorily redeemable capital stock) to its AHP. The AHP provides grants that members can use to support affordable housing projects in their communities. Generally, the Bank’s AHP assessment is derived by adding interest expense on mandatorily redeemable capital stock to income before assessments and then subtracting the REFCORP assessment; the result of this calculation is then multiplied by 10 percent. For the three months ended March 31, 2011 and 2010, the Bank’s AHP assessments totaled $1.3 million and $1.7 million, respectively.
Also as required by statute, the Bank contributes 20 percent of its reported earnings (after its AHP contribution) toward the payment of interest on REFCORP bonds that were issued to provide funding for the resolution of failed thrifts following the savings and loan crisis in the 1980s. To compute the REFCORP assessment, the Bank’s AHP assessment is subtracted from reported income before assessments and the result is multiplied by 20 percent. During the three months ended March 31, 2011 and 2010, the Bank charged $2.9 million and $3.9 million, respectively, of REFCORP assessments to earnings.
The Bank currently expects that its obligation to REFCORP will be fully satisfied in 2011 and that subsequent to 2011 the Bank’s earnings will no longer be reduced by this assessment. Effective February 28, 2011, the Bank entered into an agreement with the other 11 FHLBanks that will require the Bank to begin allocating (after the FHLBanks’ REFCORP obligations are fully satisfied) at least 20 percent of its quarterly net income to a separate restricted retained earnings account. Depending upon the earnings of the 12 FHLBanks, it is possible that this allocation could begin as early as the third quarter of 2011. For additional discussion, see “Item 1. Financial Statements” (specifically, Note 9 beginning on page 26 of this report) and the Bank’s 2010 10-K.
Critical Accounting Policies and Estimates
A discussion of the Bank’s critical accounting policies and the extent to which management uses judgment and estimates in applying those policies is provided in the Bank’s 2010 10-K. There were no substantial changes to the Bank’s critical accounting policies, or the extent to which management uses judgment and estimates in applying those policies, during the three months ended March 31, 2011.
The Bank evaluates its non-agency RMBS holdings for other-than-temporary impairment on a quarterly basis. The procedures used in this analysis, together with the results thereof as of March 31, 2011, are summarized in “Item 1. Financial Statements” (specifically, Note 3 beginning on page 6 of this report). In addition to evaluating its non-agency RMBS holdings under a base case (or best estimate) scenario, a cash flow analysis was also performed for each of these securities under a more stressful housing price scenario to determine the impact that such a change would have on the credit losses recorded in earnings at March 31, 2011. The results of that more stressful analysis are presented on page 48 of this report.
Liquidity and Capital Resources
In order to meet members’ credit needs and the Bank’s financial obligations, the Bank maintains a portfolio of money market instruments typically consisting of overnight federal funds issued by highly rated domestic banks. From time-to-time, the Bank also invests in reverse repurchase agreements, short-term commercial paper (all of which is issued by highly rated entities) and U.S. Treasury Bills. Beyond those amounts that are required to meet members’ credit needs and its own obligations, the Bank typically holds additional balances of short-term investments that fluctuate as the Bank invests the proceeds of debt issued to replace maturing and called liabilities, as the balance of deposits changes, as the returns provided by short-term investments vary relative to the costs of the Bank’s discount notes, and as the level of liquidity needed to satisfy Finance Agency requirements changes. Overnight federal funds typically comprise the large majority of the portfolio. At March 31, 2011, the Bank’s short-term liquidity portfolio was comprised of $2.3 billion of overnight federal funds sold to domestic bank
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counterparties, $0.5 billion of non-interest bearing excess cash balances held at the Federal Reserve Bank of Dallas and a $0.4 billion overnight reverse repurchase agreement.
The Bank’s primary source of funds is the proceeds it receives from the issuance of consolidated obligation bonds and discount notes in the capital markets. Historically, the FHLBanks have issued debt throughout the business day in the form of discount notes and bonds with a wide variety of maturities and structures. Generally, the Bank has access to this market as needed during the business day to acquire funds to meet its needs.
In addition to the liquidity provided from the proceeds of the issuance of consolidated obligations, the Bank also maintains access to wholesale funding sources such as federal funds purchased and securities sold under agreements to repurchase (e.g., borrowings secured by its MBS investments). Furthermore, the Bank has access to borrowings (typically short-term) from the other FHLBanks.
As discussed more fully in the Bank’s 2010 10-K, the 12 FHLBanks and the Office of Finance entered into the Federal Home Loan Banks P&I Funding and Contingency Plan Agreement (the “Contingency Agreement”) on June 23, 2006. The Contingency Agreement and related procedures were entered into in order to facilitate the timely funding of principal and interest payments on FHLBank System consolidated obligations in the event that a FHLBank is not able to meet its funding obligations in a timely manner. The Contingency Agreement and related procedures provide for the issuance of overnight consolidated obligations directly to one or more FHLBanks that provide funds to avoid a shortfall in the timely payment of principal and interest on any consolidated obligations for which another FHLBank is the primary obligor. Specifically, in the event that a FHLBank does not fund its principal and interest payments under a consolidated obligation by deadlines agreed upon by the FHLBanks and the Office of Finance (for purposes of the Contingency Agreement, a “Delinquent Bank”), the non-Delinquent Banks will be obligated to fund any shortfall in funding to the extent that any of the non-Delinquent Banks has a net positive settlement balance (i.e., the amount by which end-of-day proceeds received by such non-Delinquent Bank from the sale of consolidated obligations on one day exceeds payments by such non-Delinquent Bank on consolidated obligations on the same day) in its account with the Office of Finance on the day the shortfall occurs. A FHLBank that funds the shortfall of a Delinquent Bank is referred to in the Contingency Agreement as a “Contingency Bank.” The non-Delinquent Banks would fund the shortfall of the Delinquent Bank sequentially in accordance with an agreed-upon funding matrix as provided in the Contingency Agreement. Additionally, a non-Delinquent Bank could choose to voluntarily fund any shortfall not funded on a mandatory basis by another non-Delinquent Bank. To fund the shortfall of a Delinquent Bank, the Office of Finance will issue to the Contingency Bank on behalf of the Delinquent Bank a consolidated obligation with a maturity of one business day in the amount of the shortfall funded by the Contingency Bank (a “Plan CO”). Through the date of this report, no Plan COs have been issued pursuant to the terms of the Contingency Agreement.
On occasion, and as an alternative to issuing new debt, the Bank may assume the outstanding consolidated obligations for which other FHLBanks are the original primary obligors. This occurs in cases where the original primary obligor may have participated in a large consolidated obligation issue to an extent that exceeded its immediate funding needs in order to facilitate better market execution for the issue. The original primary obligor might then warehouse the funds until they were needed, or make the funds available to other FHLBanks. Transfers may also occur when the original primary obligor’s funding needs change, and that FHLBank offers to transfer debt that is no longer needed to other FHLBanks. Transferred debt is typically fixed rate, fixed term, non-callable debt, and may be in the form of discount notes or bonds.
The Bank participates in such transfers of funding from other FHLBanks when the transfer represents favorable pricing relative to a new issue of consolidated obligations with similar features. During the three months ended March 31, 2011, the Bank assumed consolidated obligations from the FHLBank of New York with par amounts totaling $150,000,000. The Bank did not assume any consolidated obligations from other FHLBanks during the three months ended March 31, 2010.
The Bank manages its liquidity to ensure that, at a minimum, it has sufficient funds to meet operational and contingent liquidity requirements. When measuring its liquidity for these purposes, the Bank includes only contractual cash flows and the amount of funds it estimates would be available in the event the Bank were to use securities held in its long-term investment portfolio as collateral for repurchase agreements. While it believes
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purchased federal funds might be available as a source of funds, it does not include this potential source of funds in its calculations of available liquidity.
The Bank’s operational liquidity requirement stipulates that it have sufficient funds to meet its obligations due on any given day plus an amount equal to the statistically estimated (at the 99-percent confidence level) cash and credit needs of its members and associates for one business day without accessing the capital markets for the sale of consolidated obligations. As of March 31, 2011, the Bank’s estimated operational liquidity requirement was $2.0 billion. At that date, the Bank estimated that its operational liquidity exceeded this requirement by approximately $7.7 billion.
The Bank’s contingent liquidity requirement further requires that it maintain adequate balance sheet liquidity and access to other funding sources should it be unable to issue consolidated obligations for five business days. The combination of funds available from these sources must be sufficient for the Bank to meet its obligations as they come due and the cash and credit needs of its members, with the potential needs of members statistically estimated at the 99-percent confidence level. As of March 31, 2011, the Bank’s estimated contingent liquidity requirement was $3.4 billion. At that date, the Bank estimated that its contingent liquidity exceeded this requirement by approximately $6.2 billion.
In addition to the liquidity measures described above, the Bank is required, pursuant to guidance issued by the Finance Agency on March 6, 2009, to meet two daily liquidity standards, each of which assumes that the Bank is unable to access the market for consolidated obligations during a prescribed period. The first standard requires the Bank to maintain sufficient funds to meet its obligations for 15 days under a scenario in which it is assumed that members do not renew any maturing, prepaid or called advances. The second standard requires the Bank to maintain sufficient funds to meet its obligations for 5 days under a scenario in which it is assumed that members renew all maturing and called advances, with certain exceptions for very large, highly rated members. These requirements are more stringent than the 5-day contingent liquidity requirement discussed above. The Bank has been in compliance with both of these liquidity requirements since March 6, 2009.
The Bank’s access to the capital markets has never been interrupted to an extent that the Bank’s ability to meet its obligations was compromised and the Bank does not currently believe that its ability to issue consolidated obligations will be impeded to that extent in the future. If, however, the Bank were unable to issue consolidated obligations for an extended period of time, the Bank would eventually exhaust the availability of purchased federal funds (including borrowings from other FHLBanks) and repurchase agreements as sources of funds. It is also possible that an event (such as a natural disaster) that might impede the Bank’s ability to raise funds by issuing consolidated obligations would also limit the Bank’s ability to access the markets for federal funds purchased and/or repurchase agreements.
Under those circumstances, to the extent that the balance of principal and interest that came due on the Bank’s debt obligations and the funds needed to pay its operating expenses exceeded the cash inflows from its interest-earning assets and proceeds from maturing assets, and if access to the market for consolidated obligations was not again available, the Bank would seek to access funding under the Contingency Agreement to repay any principal and interest due on its consolidated obligations. However, if the Bank were unable to raise funds by issuing consolidated obligations, it is likely that the other FHLBanks would have similar difficulties issuing debt. If funds were not available under the Contingency Agreement, the Bank’s ability to conduct its operations would be compromised even earlier than if this funding source was available.
A summary of the Bank’s contractual cash obligations and off-balance-sheet lending-related financial commitments by due date or remaining maturity as of December 31, 2010 is provided in the Bank’s 2010 10-K. There have been no substantial changes in the Bank’s contractual obligations outside the normal course of business during the three months ended March 31, 2011.
Recently Issued Accounting Guidance
For a discussion of recently issued accounting guidance, see “Item 1. Financial Statements” (specifically, Note 2 beginning on page 5 of this report).
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following quantitative and qualitative disclosures about market risk should be read in conjunction with the quantitative and qualitative disclosures about market risk that are included in the Bank’s 2010 10-K. The information provided herein is intended to update the disclosures made in the Bank’s 2010 10-K.
As a financial intermediary, the Bank is subject to interest rate risk. Changes in the level of interest rates, the slope of the interest rate yield curve, and/or the relationships (or spreads) between interest yields for different instruments have an impact on the Bank’s estimated market value of equity and its net earnings. This risk arises from a variety of instruments that the Bank enters into on a regular basis in the normal course of its business.
The terms of member advances, investment securities and consolidated obligations may present interest rate risk and/or embedded option risk. As discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations, the Bank makes extensive use of interest rate derivative instruments, primarily interest rate swaps, swaptions and caps, to manage the risk arising from these sources.
The Bank has investments in residential mortgage-related assets, primarily CMOs and, to a much smaller extent, MPF mortgage loans, both of which present prepayment risk. This risk arises from the mortgagors’ option to prepay their mortgages, making the effective maturities of these mortgage-based assets relatively more sensitive to changes in interest rates and other factors that affect the mortgagors’ decisions to repay their mortgages as compared to other long-term investment securities that do not have prepayment features. Historically, a decline in interest rates has generally resulted in accelerated mortgage refinancing activity, thus increasing prepayments and thereby shortening the effective maturity of the mortgage-related assets. Conversely, rising rates generally slow prepayment activity and lengthen a mortgage-related asset’s effective maturity. Recent economic and credit market conditions appear to have had an impact on mortgage prepayment activity, as borrowers whose mortgage rates are above current market rates and who might otherwise refinance or repay their mortgages more rapidly may not be able to obtain new mortgage loans at current lower rates due to reductions in their incomes, declines in the values of their homes, tighter lending standards, a general lack of credit availability, and/or delays in obtaining approval of new loans.
Historically, the Bank has managed the potential prepayment risk embedded in mortgage assets by purchasing almost exclusively floating rate securities, by purchasing highly structured tranches of mortgage securities that substantially limit the effects of prepayment risk, and/or by using interest rate derivative instruments to offset prepayment risk specific both to particular securities and to the overall mortgage portfolio. Because the Bank generally purchases mortgage-backed securities with the intent and expectation of holding them to maturity, the Bank’s risk management activities related to these securities are focused on those interest rate factors that pose a risk to the Bank’s future earnings. As recent liquidity discounts in the prices for some of these securities have indicated, these interest rate factors may not necessarily be the same factors that are driving the market prices of the securities.
The Bank’s Risk Management Policy provides a risk management framework for the financial management of the Bank consistent with the strategic principles outlined in its Strategic Business Plan. The Bank develops its funding and hedging strategies to manage its interest rate risk within the risk limits established in its Risk Management Policy.
The Risk Management Policy articulates the Bank’s tolerance for the amount of overall interest rate risk the Bank will assume by limiting the maximum estimated loss in market value of equity that the Bank would incur under simulated 200 basis point changes in interest rates to 15 percent of the estimated base case market value. As reflected in the table below, the Bank was in compliance with this limit at each month end during the quarter ended March 31, 2011.
As part of its ongoing risk management process, the Bank calculates an estimated market value of equity for a base case interest rate scenario and for interest rate scenarios that reflect parallel interest rate shocks. These calculations are made primarily for the purpose of analyzing and managing the Bank’s interest rate risk and, accordingly, have been designed for that purpose rather than for purposes of fair value disclosure under generally accepted accounting principles. The base case market value of equity is calculated by determining the estimated fair value of each instrument on the Bank’s balance sheet, and subtracting the estimated aggregate fair value of the Bank’s liabilities from the estimated aggregate fair value of the Bank’s assets. For purposes of these calculations, mandatorily
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redeemable capital stock is treated as equity rather than as a liability. The fair values of the Bank’s financial instruments (both assets and liabilities) are determined using vendor prices, dealer estimates or a pricing model. These calculations include values for MBS based on current estimated market prices, some of which reflect discounts that the Bank believes are largely related to credit concerns and a lack of market liquidity rather than the level of interest rates. For those instruments for which a pricing model is used, the calculations are based upon parameters derived from market conditions existing at the time of measurement, and are generally determined by discounting estimated future cash flows at the replacement (or similar) rate for new instruments of the same type with the same or very similar characteristics. The market value of equity calculations include non-financial assets and liabilities, such as premises and equipment, other assets, payables for AHP and REFCORP, and other liabilities at their recorded carrying amounts.
For purposes of compliance with the Bank’s Risk Management Policy limit on estimated losses in market value, market value of equity losses are defined as the estimated net sensitivity of the value of the Bank’s equity (the net value of its portfolio of assets, liabilities and interest rate derivatives) to 200 basis point parallel shifts in interest rates. The following table provides the Bank’s estimated base case market value of equity and its estimated market value of equity under up and down 200 basis point interest rate shock scenarios (and, for comparative purposes, its estimated market value of equity under up and down 100 basis point interest rate shock scenarios) for each month-end during the period from December 2010 through March 2011. In addition, the table provides the percentage change in estimated market value of equity under each of these shock scenarios for the indicated periods.
MARKET VALUE OF EQUITY
(dollars in billions)
(dollars in billions)
Up 200 Basis Points(1) | Down 200 Basis Points(2) | Up 100 Basis Points(1) | Down 100 Basis Points(2) | |||||||||||||||||||||||||||||||||
Base Case | Estimated | Percentage | Estimated | Percentage | Estimated | Percentage | Estimated | Percentage | ||||||||||||||||||||||||||||
Market | Market | Change | Market | Change | Market | Change | Market | Change | ||||||||||||||||||||||||||||
Value | Value | from | Value | from | Value | from | Value | from | ||||||||||||||||||||||||||||
of Equity | of Equity | Base Case(3) | of Equity | Base Case(3) | of Equity | Base Case(3) | of Equity | Base Case(3) | ||||||||||||||||||||||||||||
December 2010 | $ | 2.187 | $ | 1.991 | -8.96 | % | $ | 2.324 | 6.26 | % | $ | 2.099 | -4.02 | % | $ | 2.261 | 3.38 | % | ||||||||||||||||||
January 2011 | 2.058 | 1.868 | -9.23 | % | 2.184 | 6.12 | % | 1.973 | -4.13 | % | 2.126 | 3.30 | % | |||||||||||||||||||||||
February 2011 | 2.042 | 1.850 | -9.40 | % | 2.123 | 3.97 | % | 1.960 | -4.02 | % | 2.092 | 2.45 | % | |||||||||||||||||||||||
March 2011 | 2.016 | 1.834 | -9.03 | % | 2.088 | 3.57 | % | 1.938 | -3.87 | % | 2.058 | 2.08 | % |
(1) | In the up 100 and 200 scenarios, the estimated market value of equity is calculated under assumed instantaneous +100 and +200 basis point parallel shifts in interest rates. | |
(2) | Pursuant to guidance issued by the Finance Agency, the estimated market value of equity is calculated under assumed instantaneous -100 and -200 basis point parallel shifts in interest rates, subject to a floor of 0.35 percent. | |
(3) | Amounts used to calculate percentage changes are based on numbers in the thousands. Accordingly, recalculations based upon the disclosed amounts (billions) may not produce the same results. |
A related measure of interest rate risk is duration of equity. Duration is the weighted average maturity (typically measured in months or years) of an instrument’s cash flows, weighted by the present value of those cash flows. As such, duration provides an estimate of an instrument’s sensitivity to small changes in market interest rates. The duration of assets is generally expressed as a positive figure, while the duration of liabilities is generally expressed as a negative number. The change in value of a specific instrument for given changes in interest rates will generally vary in inverse proportion to the instrument’s duration. As market interest rates decline, instruments with a positive duration are expected to increase in value, while instruments with a negative duration are expected to decrease in value. Conversely, as interest rates rise, instruments with a positive duration are expected to decline in value, while instruments with a negative duration are expected to increase in value.
The values of instruments having relatively longer (or higher) durations are more sensitive to a given interest rate movement than instruments having shorter durations; that is, risk increases as the absolute value of duration lengthens. For instance, the value of an instrument with a duration of three years will theoretically change by three percent for every one percentage point change in interest rates, while the value of an instrument with a duration of five years will theoretically change by five percent for every one percentage point change in interest rates.
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The duration of individual instruments may be easily combined to determine the duration of a portfolio of assets or liabilities by calculating a weighted average duration of the instruments in the portfolio. Such combinations provide a single straightforward metric that describes the portfolio’s sensitivity to interest rate movements. These additive properties can be applied to the assets and liabilities on the Bank’s balance sheet. The difference between the combined durations of the Bank’s assets and the combined durations of its liabilities is sometimes referred to as duration gap and provides a measure of the relative interest rate sensitivities of the Bank’s assets and liabilities.
Duration gap is a useful measure of interest rate sensitivity but does not account for the effect of leverage, or the effect of the absolute duration of the Bank’s assets and liabilities, on the sensitivity of its estimated market value of equity to changes in interest rates. The inclusion of these factors results in a measure of the sensitivity of the value of the Bank’s equity to changes in market interest rates referred to as the duration of equity. Duration of equity is the market value weighted duration of assets minus the market value weighted duration of liabilities divided by the market value of equity.
The significance of an entity’s duration of equity is that it can be used to describe the sensitivity of the entity’s market value of equity to movements in interest rates. A duration of equity equal to zero would mean, within a narrow range of interest rate movements, that the Bank had neutralized the impact of changes in interest rates on the market value of its equity.
A positive duration of equity would mean, within a narrow range of interest rate movements, that for each one year of duration the estimated market value of the Bank’s equity would be expected to decline by about 0.01 percent for every positive 0.01 percent change in the level of interest rates. A positive duration generally indicates that the value of the Bank’s assets is more sensitive to changes in interest rates than the value of its liabilities (i.e., that the duration of its assets is greater than the duration of its liabilities).
Conversely, a negative duration of equity would mean, within a narrow range of interest rate movements, that for each one year of negative duration the estimated market value of the Bank’s equity would be expected to increase by about 0.01 percent for every positive 0.01 percent change in the level of interest rates. A negative duration generally indicates that the value of the Bank’s liabilities is more sensitive to changes in interest rates than the value of its assets (i.e., that the duration of its liabilities is greater than the duration of its assets).
The following table provides information regarding the Bank’s base case duration of equity as well as its duration of equity in up and down 100 and 200 basis point interest rate shock scenarios for each month-end during the period from December 2010 through March 2011.
DURATION ANALYSIS
(Expressed in Years)
(Expressed in Years)
Base Case Interest Rates | ||||||||||||||||||||||||||||||||
Asset | Liability | Duration | Duration | Duration of Equity | ||||||||||||||||||||||||||||
Duration | Duration | Gap | of Equity | Up 100(1) | Up 200(1) | Down 100(2) | Down 200(2) | |||||||||||||||||||||||||
December 2010 | 0.56 | (0.39 | ) | 0.17 | 3.62 | 4.77 | 5.84 | 3.03 | 3.55 | |||||||||||||||||||||||
January 2011 | 0.56 | (0.38 | ) | 0.18 | 3.75 | 4.99 | 6.00 | 3.08 | 3.80 | |||||||||||||||||||||||
February 2011 | 0.63 | (0.44 | ) | 0.19 | 3.73 | 5.01 | 6.86 | 3.45 | 4.27 | |||||||||||||||||||||||
March 2011 | 0.65 | (0.48 | ) | 0.17 | 3.43 | 4.78 | 6.62 | 2.76 | 3.75 |
(1) | In the up 100 and 200 scenarios, the duration of equity is calculated under assumed instantaneous +100 and +200 basis point parallel shifts in interest rates. | |
(2) | Pursuant to guidance issued by the Finance Agency, the duration of equity is calculated under assumed instantaneous -100 and -200 basis point parallel shifts in interest rates, subject to a floor of 0.35 percent. |
Duration of equity measures the impact of a parallel shift in interest rates on an entity’s market value of equity but may not be a good metric for measuring changes in value related to non-parallel rate shifts. An alternative measure for that purpose uses key rate durations, which measure portfolio sensitivity to changes in interest rates at particular points on a yield curve. Key rate duration is a specialized form of duration. It is calculated by estimating the change
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in value due to changing the market rate for one specific maturity point on the yield curve while holding all other variables constant. The sum of the key rate durations across an applicable yield curve is approximately equal to the overall portfolio duration.
The duration of equity measure represents the expected percentage change in the Bank’s market value of equity for a one percentage point (100 basis point) parallel change in interest rates. The key rate duration measure represents the expected percentage change in the Bank’s market value of equity for a one percentage point (100 basis point) parallel change in interest rates for a given maturity point on the yield curve, holding all other rates constant. The Bank has established a key rate duration limit of 7.5 years, measured as the difference between the maximum and minimum key rate durations calculated for seven defined individual maturity points on the yield curve. In addition, during 2010, the Bank had a separate limit of 15 years for the 10-year maturity point key rate duration. In February 2011, the Bank eliminated the separate key rate duration limit for the 10-year maturity point and now includes the 10-year maturity point in its overall key rate duration limit. The Bank calculates these metrics monthly and was in compliance with these policy limits at each month-end during the first quarter of 2011.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The Bank’s management, under the supervision and with the participation of its Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the Bank’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of the end of the period covered by this report. Based upon that evaluation, the Bank’s Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Bank’s disclosure controls and procedures were effective in: (1) recording, processing, summarizing and reporting information required to be disclosed by the Bank in the reports that it files or submits under the Exchange Act within the time periods specified in the SEC’s rules and forms and (2) ensuring that information required to be disclosed by the Bank in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Bank’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.
Changes in Internal Control Over Financial Reporting
There were no changes in the Bank’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended March 31, 2011 that have materially affected, or are reasonably likely to materially affect, the Bank’s internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS
10.1 | Joint Capital Enhancement Agreement, dated February 28, 2011 (filed as Exhibit 99.1 to the Bank’s Current Report on Form 8-K dated February 28, 2011 and filed with the Securities and Exchange Commission on March 1, 2011, which exhibit is incorporated herein by reference). | |
31.1 | Certification of principal executive officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Certification of principal financial officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | Certification of principal executive officer and principal financial officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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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 Dallas | ||||
May 12, 2011 | By | /s/ Michael Sims | ||
Date | Michael Sims | |||
Chief Operating Officer, Executive Vice President - Finance and Chief Financial Officer (Principal Financial Officer) | ||||
May 12, 2011 | By | /s/ Tom Lewis | ||
Date | Tom Lewis | |||
Senior Vice President and Chief Accounting Officer (Principal Accounting Officer) | ||||
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EXHIBIT INDEX
Exhibit No.
10.1 | Joint Capital Enhancement Agreement, dated February 28, 2011 (filed as Exhibit 99.1 to the Bank’s Current Report on Form 8-K dated February 28, 2011 and filed with the Securities and Exchange Commission on March 1, 2011, which exhibit is incorporated herein by reference). | |
31.1 | Certification of principal executive officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Certification of principal financial officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | Certification of principal executive officer and principal financial officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |