Attached files
file | filename |
---|---|
EX-32 - EX-32 - Federal Home Loan Bank of Cincinnati | l37990exv32.htm |
EX-3.2 - EX-3.2 - Federal Home Loan Bank of Cincinnati | l37990exv3w2.htm |
EX-31.1 - EX-31.1 - Federal Home Loan Bank of Cincinnati | l37990exv31w1.htm |
EX-31.2 - EX-31.2 - Federal Home Loan Bank of Cincinnati | l37990exv31w2.htm |
Table of Contents
UNITED STATES 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 September 30, 2009
or
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to .
Commission File No. 000-51399
FEDERAL HOME LOAN BANK OF CINCINNATI
(Exact name of registrant as specified in its charter)
Federally chartered corporation | 31-6000228 | |
(State or other jurisdiction of | (I.R.S. Employer | |
incorporation or organization) | Identification No.) | |
1000 Atrium Two, P.O. Box 598, | ||
Cincinnati, Ohio | 45201-0598 | |
(Address of principal executive offices) | (Zip Code) |
Registrants telephone number, including area code
(513) 852-7500
(513) 852-7500
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.
þ Yes o No
Indicate by check mark whether the registrant has submitted electronically and
posted on its corporate Web site, if any, every Interactive Data File required to be submitted and
posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter
period that the registrant was required to submit and post such files).
o
Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of
large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act. (Check one):
Large accelerated filer o | Accelerated filer o | Non-accelerated filer þ | Smaller reporting company o | |||
(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 Act).
o Yes þ No
As of October 31, 2009, the registrant had 36,578,770 shares of capital stock
outstanding. The capital stock of the Federal Home Loan Bank of Cincinnati is not listed on any
securities exchange or quoted on any automated quotation system, only may be owned by members and
former members and is transferable only at its par value of $100 per share.
Page 1 of 100
Table of Contents
Item 1. | ||||||||
3 | ||||||||
4 | ||||||||
5 | ||||||||
6 | ||||||||
8 | ||||||||
Item 2. | 45 | |||||||
Item 3. | 97 | |||||||
Item 4. | 98 | |||||||
Item 1A. | 98 | |||||||
Item 2. | 98 | |||||||
Item 5. | 98 | |||||||
Item 6. | 98 | |||||||
Signatures | 99 | |||||||
EX-3.2 | ||||||||
EX-31.1 | ||||||||
EX-31.2 | ||||||||
EX-32 |
2
Table of Contents
PART
I FINANCIAL INFORMATION
Item 1.
Financial Statements.
FEDERAL HOME LOAN BANK OF CINCINNATI
STATEMENTS OF CONDITION
(In thousands, except par value)
(Unaudited)
STATEMENTS OF CONDITION
(In thousands, except par value)
(Unaudited)
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
ASSETS |
||||||||
Cash and due from banks |
$ | 2,733,228 | $ | 2,867 | ||||
Interest-bearing deposits |
166 | 19,906,234 | ||||||
Federal funds sold |
5,775,000 | - | ||||||
Trading securities |
2,252,568 | 2,985 | ||||||
Available-for-sale securities |
5,725,076 | 2,511,630 | ||||||
Held-to-maturity securities (includes $0 and $0 pledged as collateral at September 30, 2009
and December 31, 2008, respectively, that may be repledged) (a) |
12,471,895 | 12,904,200 | ||||||
Advances |
38,082,056 | 53,915,972 | ||||||
Mortgage loans held for portfolio, net |
9,736,249 | 8,631,873 | ||||||
Accrued interest receivable |
161,166 | 275,560 | ||||||
Premises, software, and equipment |
10,154 | 9,611 | ||||||
Derivative assets |
8,864 | 17,310 | ||||||
Other assets |
27,140 | 27,827 | ||||||
TOTAL ASSETS |
$ | 76,983,562 | $ | 98,206,069 | ||||
LIABILITIES |
||||||||
Deposits: |
||||||||
Interest bearing |
$ | 1,665,253 | $ | 1,192,593 | ||||
Non-interest bearing |
4,195 | 868 | ||||||
Total deposits |
1,669,448 | 1,193,461 | ||||||
Consolidated Obligations, net: |
||||||||
Discount Notes |
29,169,806 | 49,335,739 | ||||||
Bonds |
41,202,616 | 42,392,785 | ||||||
Total Consolidated Obligations, net |
70,372,422 | 91,728,524 | ||||||
Mandatorily redeemable capital stock |
87,415 | 110,909 | ||||||
Accrued interest payable |
290,706 | 394,346 | ||||||
Affordable Housing Program |
105,144 | 102,615 | ||||||
Payable to REFCORP |
15,372 | 14,054 | ||||||
Derivative liabilities |
269,842 | 286,476 | ||||||
Other liabilities |
113,587 | 93,815 | ||||||
Total liabilities |
72,923,936 | 93,924,200 | ||||||
Commitments and contingencies |
||||||||
CAPITAL |
||||||||
Capital stock Class B putable ($100 par value); 36,578 and 39,617 shares
issued and outstanding at September 30, 2009 and December 31, 2008, respectively |
3,657,848 | 3,961,698 | ||||||
Retained earnings |
406,895 | 326,446 | ||||||
Accumulated other comprehensive income: |
||||||||
Net unrealized gain (loss) on available-for-sale securities |
76 | (458 | ) | |||||
Pension and postretirement plans |
(5,193 | ) | (5,817 | ) | ||||
Total capital |
4,059,626 | 4,281,869 | ||||||
TOTAL LIABILITIES AND CAPITAL |
$ | 76,983,562 | $ | 98,206,069 | ||||
(a) | Fair values: $12,947,773 and $13,163,337 at September 30, 2009 and December 31, 2008, respectively. |
The accompanying notes are an integral part of these financial statements.
3
Table of Contents
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
INTEREST INCOME: |
||||||||||||||||
Advances |
$ | 108,429 | $ | 438,097 | $ | 488,048 | $ | 1,450,982 | ||||||||
Prepayment fees on Advances, net |
1,716 | 913 | 6,569 | 1,627 | ||||||||||||
Interest-bearing deposits |
207 | 1,222 | 8,597 | 5,713 | ||||||||||||
Securities purchased under agreements to resell |
514 | 2,395 | 979 | 13,794 | ||||||||||||
Federal funds sold |
2,906 | 33,325 | 9,130 | 136,406 | ||||||||||||
Trading securities |
1,341 | 43 | 1,440 | 138 | ||||||||||||
Available-for-sale securities |
3,944 | 32 | 14,187 | 32 | ||||||||||||
Held-to-maturity: |
||||||||||||||||
Securities |
147,242 | 183,293 | 437,840 | 507,187 | ||||||||||||
Securities of other FHLBanks |
- | - | 22 | - | ||||||||||||
Mortgage loans held for portfolio |
115,546 | 112,122 | 367,455 | 344,900 | ||||||||||||
Loans to other FHLBanks |
11 | 43 | 15 | 280 | ||||||||||||
Total interest income |
381,856 | 771,485 | 1,334,282 | 2,461,059 | ||||||||||||
INTEREST EXPENSE: |
||||||||||||||||
Consolidated
Obligations Discount Notes |
15,478 | 228,431 | 104,405 | 773,750 | ||||||||||||
Consolidated
Obligations Bonds |
271,561 | 443,016 | 910,220 | 1,388,784 | ||||||||||||
Deposits |
424 | 6,280 | 1,521 | 23,990 | ||||||||||||
Loans from other FHLBanks |
- | - | 1 | - | ||||||||||||
Mandatorily redeemable capital stock |
3,287 | 1,788 | 5,485 | 6,643 | ||||||||||||
Other borrowings |
- | 2 | - | 26 | ||||||||||||
Total interest expense |
290,750 | 679,517 | 1,021,632 | 2,193,193 | ||||||||||||
NET INTEREST INCOME |
91,106 | 91,968 | 312,650 | 267,866 | ||||||||||||
OTHER INCOME: |
||||||||||||||||
Service fees |
406 | 294 | 1,297 | 919 | ||||||||||||
Net gains (losses) on trading securities |
179 | (22 | ) | 401 | (35 | ) | ||||||||||
Net gains on held-to-maturity securities |
- | - | 5,943 | - | ||||||||||||
Net gains on derivatives and hedging activities |
4,846 | 9,893 | 12,797 | 9,391 | ||||||||||||
Other, net |
1,701 | 1,855 | 4,719 | 4,814 | ||||||||||||
Total other income |
7,132 | 12,020 | 25,157 | 15,089 | ||||||||||||
OTHER EXPENSE: |
||||||||||||||||
Compensation and benefits |
7,646 | 6,081 | 21,623 | 18,777 | ||||||||||||
Other operating |
3,926 | 3,398 | 10,844 | 9,800 | ||||||||||||
Finance Agency |
700 | 780 | 2,174 | 2,338 | ||||||||||||
Office of Finance |
596 | 476 | 2,258 | 1,791 | ||||||||||||
Other |
1,311 | 3,096 | 1,857 | 4,345 | ||||||||||||
Total other expense |
14,179 | 13,831 | 38,756 | 37,051 | ||||||||||||
INCOME BEFORE ASSESSMENTS |
84,059 | 90,157 | 299,051 | 245,904 | ||||||||||||
Affordable Housing Program |
7,197 | 7,543 | 24,972 | 20,752 | ||||||||||||
REFCORP |
15,373 | 16,522 | 54,816 | 45,030 | ||||||||||||
Total assessments |
22,570 | 24,065 | 79,788 | 65,782 | ||||||||||||
NET INCOME |
$ | 61,489 | $ | 66,092 | $ | 219,263 | $ | 180,122 | ||||||||
The accompanying notes are an integral part of these financial statements.
4
Table of Contents
FEDERAL HOME LOAN BANK OF CINCINNATI
STATEMENTS OF CAPITAL
Nine Months Ended September 30, 2009 and 2008
(In thousands)
(Unaudited)
STATEMENTS OF CAPITAL
Nine Months Ended September 30, 2009 and 2008
(In thousands)
(Unaudited)
Accumulated | ||||||||||||||||||||
Capital Stock | Other | |||||||||||||||||||
Class B* | Retained | Comprehensive | Total | |||||||||||||||||
Shares | Par Value | Earnings | Income | Capital | ||||||||||||||||
BALANCE, DECEMBER 31, 2007 |
34,734 | $ | 3,473,361 | $ | 286,428 | $ | (5,203 | ) | $ | 3,754,586 | ||||||||||
Proceeds from sale of capital stock |
3,558 | 355,817 | 355,817 | |||||||||||||||||
Net reclassified to mandatorily
redeemable capital stock |
(82 | ) | (8,222 | ) | (8,222 | ) | ||||||||||||||
Comprehensive income: |
||||||||||||||||||||
Net income |
180,122 | 180,122 | ||||||||||||||||||
Other comprehensive income: |
||||||||||||||||||||
Net unrealized loss on
available-for-sale securities |
(1,438 | ) | (1,438 | ) | ||||||||||||||||
Pension and postretirement benefits |
479 | 479 | ||||||||||||||||||
Total other comprehensive income |
(959 | ) | (959 | ) | ||||||||||||||||
Total comprehensive income |
179,163 | |||||||||||||||||||
Dividends on capital stock: |
||||||||||||||||||||
Cash |
(108 | ) | (108 | ) | ||||||||||||||||
Stock |
1,474 | 147,490 | (147,631 | ) | (141 | ) | ||||||||||||||
BALANCE, SEPTEMBER 30, 2008 |
39,684 | $ | 3,968,446 | $ | 318,811 | $ | (6,162 | ) | $ | 4,281,095 | ||||||||||
BALANCE, DECEMBER 31, 2008 |
39,617 | $ | 3,961,698 | $ | 326,446 | $ | (6,275 | ) | $ | 4,281,869 | ||||||||||
Proceeds from sale of capital stock |
869 | 86,948 | 86,948 | |||||||||||||||||
Net reclassified to mandatorily
redeemable capital stock |
(3,908 | ) | (390,798 | ) | (390,798 | ) | ||||||||||||||
Comprehensive income: |
||||||||||||||||||||
Net income |
219,263 | 219,263 | ||||||||||||||||||
Other comprehensive income: |
||||||||||||||||||||
Net unrealized gain (loss) on
available-for-sale securities |
534 | 534 | ||||||||||||||||||
Pension and postretirement benefits |
624 | 624 | ||||||||||||||||||
Total other comprehensive income |
1,158 | 1,158 | ||||||||||||||||||
Total comprehensive income |
220,421 | |||||||||||||||||||
Dividends on capital stock: |
||||||||||||||||||||
Cash |
(138,814 | ) | (138,814 | ) | ||||||||||||||||
BALANCE, SEPTEMBER 30, 2009 |
36,578 | $ | 3,657,848 | $ | 406,895 | $ | (5,117 | ) | $ | 4,059,626 | ||||||||||
* | Putable |
The accompanying notes are an integral part of these financial statements.
5
Table of Contents
Nine Months Ended September 30, | ||||||||
2009 | 2008 | |||||||
OPERATING ACTIVITIES: |
||||||||
Net income |
$ | 219,263 | $ | 180,122 | ||||
Adjustments to reconcile net income
to net cash provided by operating activities: |
||||||||
Depreciation and amortization |
(54,632 | ) | (5,034 | ) | ||||
Change in net fair value adjustment on derivative and
hedging activities |
119,981 | (158,744 | ) | |||||
Net fair value adjustment on trading securities |
(401 | ) | 35 | |||||
Other adjustments |
(5,913 | ) | 4,854 | |||||
Net change in: |
||||||||
Accrued interest receivable |
114,417 | 42,184 | ||||||
Other assets |
3,334 | 2,929 | ||||||
Accrued interest payable |
(103,643 | ) | (11,524 | ) | ||||
Other liabilities |
24,480 | 1,883 | ||||||
Total adjustments |
97,623 | (123,417 | ) | |||||
Net cash provided by operating activities |
316,886 | 56,705 | ||||||
INVESTING ACTIVITIES: |
||||||||
Net change in: |
||||||||
Interest-bearing deposits |
20,145,191 | (106,301 | ) | |||||
Federal funds sold |
(5,775,000 | ) | (370,000 | ) | ||||
Premises, software and equipment |
(2,539 | ) | (2,430 | ) | ||||
Trading securities: |
||||||||
Net increase in short-term |
(2,248,088 | ) | - | |||||
Proceeds from long-term |
246 | 474 | ||||||
Available-for-sale securities: |
||||||||
Net increase in short-term |
(3,213,220 | ) | - | |||||
Purchases of long-term |
- | (28,755 | ) | |||||
Held-to-maturity securities: |
||||||||
Net (increase) decrease in short-term |
(661 | ) | 754,893 | |||||
Net decrease in other FHLBanks |
6 | - | ||||||
Proceeds from long-term |
3,145,943 | 1,666,727 | ||||||
Purchases of long-term |
(2,706,091 | ) | (2,843,871 | ) | ||||
Advances: |
||||||||
Proceeds |
316,153,047 | 1,328,105,277 | ||||||
Made |
(300,605,516 | ) | (1,337,731,164 | ) | ||||
Mortgage loans held for portfolio: |
||||||||
Principal collected |
2,287,146 | 1,081,155 | ||||||
Purchases |
(3,390,764 | ) | (689,489 | ) | ||||
Net cash provided by (used in) investing activities |
23,789,700 | (10,163,484 | ) | |||||
The accompanying notes are an integral part of these financial statements.
6
Table of Contents
(continued from previous page)
FEDERAL HOME LOAN BANK OF CINCINNATI
STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended September 30, | ||||||||
2009 | 2008 | |||||||
FINANCING ACTIVITIES: |
||||||||
Net increase in deposits and pass-through reserves |
$ | 468,187 | $ | 320,855 | ||||
Net (payments) proceeds on derivative contracts with financing elements |
(112,730 | ) | 228,879 | |||||
Net proceeds from issuance of Consolidated Obligations: |
||||||||
Discount Notes |
493,773,421 | 719,677,329 | ||||||
Bonds |
26,541,073 | 29,537,672 | ||||||
Bonds transferred from other FHLBanks |
- | 271,988 | ||||||
Payments for maturing and retiring Consolidated Obligations: |
||||||||
Discount Notes |
(513,868,108 | ) | (712,084,138 | ) | ||||
Bonds |
(27,711,910 | ) | (28,239,184 | ) | ||||
Proceeds from issuance of capital stock |
86,948 | 355,817 | ||||||
Payments for redemption of mandatorily redeemable capital stock |
(414,292 | ) | (3 | ) | ||||
Cash dividends paid |
(138,814 | ) | (108 | ) | ||||
Net cash (used in) provided by financing activities |
(21,376,225 | ) | 10,069,107 | |||||
Net increase (decrease) in cash and cash equivalents |
2,730,361 | (37,672 | ) | |||||
Cash and cash equivalents at beginning of the period |
2,867 | 52,606 | ||||||
Cash and cash equivalents at end of the period |
$ | 2,733,228 | $ | 14,934 | ||||
Supplemental Disclosures: |
||||||||
Interest paid |
$ | 1,189,466 | $ | 2,214,574 | ||||
AHP payments, net |
$ | 22,443 | $ | 20,806 | ||||
REFCORP assessments paid |
$ | 53,498 | $ | 45,046 | ||||
The accompanying notes are an integral part of these financial statements.
7
Table of Contents
FEDERAL HOME LOAN BANK OF CINCINNATI
NOTES TO UNAUDITED FINANCIAL STATEMENTS
Background Information
The Federal Home Loan Bank of Cincinnati (the FHLBank), a federally chartered corporation, is one
of 12 District Federal Home Loan Banks (FHLBanks). The FHLBanks serve the public by enhancing the
availability of credit for residential mortgages and targeted community development. The FHLBank is
regulated by the Federal Housing Finance Agency (Finance Agency).
Note 1 Basis of Presentation
The accompanying interim financial statements of the FHLBank have been prepared in accordance with
accounting principles generally accepted in the United States of America (GAAP). The preparation of
financial statements in accordance with GAAP requires management to make assumptions and estimates.
These assumptions and estimates affect the reported amount of assets and liabilities, the
disclosure of contingent assets and liabilities, and the reported amounts of income and expenses.
Actual results could differ from these estimates. The interim financial statements presented are
unaudited, but they include all adjustments (consisting of only normal recurring adjustments) which
are, in the opinion of management, necessary for a fair statement of the financial condition,
results of operations, and cash flows for such periods. These financial statements do not include
all disclosures associated with annual financial statements and accordingly should be read in
conjunction with the audited financial statements and notes included in the FHLBanks annual report
on Form 10-K for the year ended December 31, 2008 filed with the Securities and Exchange Commission
(SEC). Results for the three and nine months ended September 30, 2009 are not necessarily
indicative of operating results for the full year.
The FHLBank has evaluated subsequent events for potential recognition or disclosure through the
issuance of these financial statements, which occurred on November 12, 2009, and believes there
have been no material subsequent events requiring additional disclosure or recognition in these
financial statements.
Note 2Recently Issued Accounting Standards and Interpretations
Fair Value Measurements and Disclosures Measuring Liabilities at Fair Value. On August 28,
2009, the Financial Accounting Standards Board (FASB) issued amended guidance for the fair value
measurement of liabilities. The update provides clarification that in circumstances in which a
quoted price in an active market for the identical liability is not available, a reporting entity
is required to measure fair value using one or more of the following techniques: (1) a valuation
technique that uses: (a) the quoted price of the identical liability when traded as an asset or (b)
quoted prices for similar liabilities or for similar liabilities when traded as assets; or (2)
another valuation technique that is consistent with the principles of fair value measurements. This
guidance is effective for the first reporting period (including interim periods) beginning after
issuance (October 1, 2009 for the FHLBank). The FHLBank does not believe that the adoption of
this guidance will have a material effect on its financial condition, results of operations or cash
flows.
Codification of Accounting Standards. On June 30, 2009, the FASB established the FASB Accounting
Standards Codification (ASC) as the single source of authoritative accounting principles
recognized by the FASB to be applied by nongovernmental entities in the preparation of financial
statements in conformity with GAAP. The ASC does not change current GAAP; rather, its intent
is to organize all accounting literature by topic in one place in order to enable users to quickly
identify appropriate GAAP. The ASC is effective for interim and annual periods ending after
September 15, 2009. The FHLBank adopted the ASC for the period ending September 30, 2009. The
FHLBanks adoption of the ASC did not have a material effect on its financial condition, results of
operations or cash flows.
Accounting for Transfers of Financial Assets. On June 12, 2009, the FASB issued guidance which is
intended to improve the relevance, representational faithfulness, and comparability of the
information that a reporting entity provides in its financial reports about a transfer of financial
assets; the effects of a transfer on its financial position, financial performance, and cash flows;
and a transferors continuing involvement in transferred financial assets. The guidance is
effective as of the beginning of each reporting entitys first annual reporting period that begins
after November 15, 2009 (January 1, 2010 for the FHLBank), for interim periods within that first
annual reporting period and for interim and annual reporting periods
8
Table of Contents
thereafter. Earlier application is prohibited. The FHLBank does not believe that the adoption of
this guidance will have a material effect on its financial condition, results of operations or cash
flows.
Recognition and Presentation of Other-Than-Temporary Impairments. On April 9, 2009, the FASB issued
guidance amending the other-than-temporary impairment guidance in U.S. GAAP for debt securities.
This other-than-temporary impairment guidance clarifies the interaction of the factors that
should be considered when determining whether a debt security is other-than-temporarily impaired
and changes the presentation and calculation of the other-than-temporary impairment on debt
securities recognized in earnings in the financial statements. The guidance does not amend existing
recognition and measurement guidance related to other-than-temporary impairment of equity
securities. However, it expands and increases the frequency of existing disclosures about
other-than-temporary impairment for both debt and equity securities and requires new disclosures to
help users of financial statements understand the significant inputs used in determining a credit
loss, as well as a rollforward of that amount each period.
If the fair value of a debt security is less than its amortized cost basis at the measurement date,
an entity is required to assess whether (a) it has the intent to sell the debt security, or (b) it
is more likely than not that it will be required to sell the debt security before its anticipated
recovery. If either of these conditions is met, an other-than-temporary impairment on the security
must be recognized.
In instances in which a determination is made that a credit loss (the difference between the
present value of the cash flows expected to be collected and the amortized cost basis) exists but
the entity does not intend to sell the debt security and it is not more likely than not that the
entity will be required to sell the debt security before the anticipated recovery of its remaining
amortized cost basis, this guidance changes the presentation and amount of the other-than-temporary
impairment recognized in the income statement. In these instances, the impairment is separated into
(a) the amount of the total impairment related to the credit loss, and (b) the amount of the total
impairment related to all other factors. The amount of the total other-than-temporary impairment
related to the credit loss is recognized in earnings. The amount of the total impairment related to
all other factors is recognized in other comprehensive income. Subsequent non-other-than-temporary
impairment related increases and decreases in the fair value of available-for-sale securities are
included in other comprehensive income. The other-than-temporary impairment recognized in other
comprehensive income for debt securities classified as held-to-maturity is amortized over the
remaining life of the debt security as an increase in the carrying value of the security (with no
effect on earnings unless the security is subsequently sold or there is additional
other-than-temporary impairment related to credit loss recognized).
This other-than-temporary impairment guidance is effective for interim and annual reporting
periods ending after June 15, 2009 with early adoption permitted. When adopting this guidance, an
entity is required to record a cumulative-effect adjustment as of the beginning of the period of
adoption to reclassify the non-credit component of any previously recognized other-than-temporary
impairment from retained earnings to accumulated other comprehensive income if the entity does not
intend to sell the security and it is not more likely than not that the entity will be required to
sell the security before recovery of its amortized cost basis.
The FHLBank elected to adopt this other-than-temporary impairment guidance as of January 1, 2009.
Adoption did not affect the FHLBanks financial condition, results of operations or cash flows, nor
did it require the FHLBank to record a cumulative effect adjustment, since the FHLBank did not
consider any investments to be other-than-temporarily impaired.
9
Table of Contents
Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not Orderly. On April 9, 2009, the
FASB issued guidance which clarifies the approach to and provides additional factors to consider in
estimating fair value when the volume and level of activity for an asset or liability have
significantly decreased. It also includes guidance on identifying circumstances that indicate a
transaction is not orderly. This guidance is effective for interim and annual reporting periods
ending after June 15, 2009, with early adoption permitted. As required, the FHLBank adopted this
guidance as of January 1, 2009 when it adopted the other-than-temporary impairment guidance. The
adoption of this guidance did not affect the FHLBanks financial condition, results of operations
or cash flows.
Interim Disclosures about Fair Value of Financial Instruments. On April 9, 2009, the FASB issued
guidance to require disclosures about the fair value of financial instruments, including disclosure
of the method(s) and significant assumptions used to estimate the fair value of financial
instruments, in interim financial statements as well as in annual financial statements. Previously,
these disclosures were required only in annual financial statements. This guidance is effective for
interim and annual reporting periods ending after June 15, 2009. Early adoption of this guidance
was permitted in conjunction with the early adoption of the other-than-temporary impairment
guidance and fair value measurement guidance. In periods after initial adoption, this guidance
requires comparative disclosures only for periods ending subsequent to initial adoption and does
not require earlier periods to be disclosed for comparative purposes at initial adoption. The
FHLBank elected to adopt this guidance as of January 1, 2009, which resulted in increased interim
financial statement disclosures.
10
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Note 3Trading Securities
Major Security Types. Trading securities as of September 30, 2009 and December 31, 2008 were as
follows (in thousands):
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
Estimated | Estimated | |||||||
Fair Value | Fair Value | |||||||
Government-sponsored enterprises* |
$ | 2,249,755 | $ | - | ||||
Mortgage-backed securities: |
||||||||
Other U.S. obligation residential mortgage-backed securities ** |
2,813 | 2,985 | ||||||
Total |
$ | 2,252,568 | $ | 2,985 | ||||
* | Consists of debt securities issued or guaranteed by Federal Home Loan Mortgage Corporation (Freddie Mac), which are not obligations of the U.S. government. | |
** | Consists of Government National Mortgage Association (Ginnie Mae) securities. |
Net gain (loss) on trading securities for the three months ended September 30, 2009 and 2008
included changes in net unrealized gain (loss) (in thousands) of $179 and $(22), respectively, for
securities held on September 30, 2009 and 2008. Net gain (loss) on trading securities for the nine
months ended September 30, 2009 and 2008 included changes in net unrealized gain (loss) (in
thousands) of $401 and $(35), respectively, for securities held on September 30, 2009 and 2008.
Note 4Available-for-Sale Securities
Major Security Types. Available-for-sale securities as of September 30, 2009 and December 31, 2008
were as follows (in thousands):
September 30, 2009 | ||||||||||||||||
Gross | Gross | Estimated | ||||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
Cost | Gains | (Losses) | Value | |||||||||||||
Certificates of deposit |
$ | 5,725,000 | $ | 146 | $ | (70 | ) | $ | 5,725,076 | |||||||
December 31, 2008 | ||||||||||||||||
Gross | Gross | Estimated | ||||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
Cost | Gains | (Losses) | Value | |||||||||||||
Certificates of deposit and bank notes |
$ | 2,512,088 | $ | 93 | $ | (551 | ) | $ | 2,511,630 | |||||||
All securities outstanding with gross unrealized losses at September 30, 2009 have been in a
continuous unrealized loss position for less than 12 months.
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Redemption Terms. The amortized cost and estimated fair value of available-for-sale securities by
contractual maturity at the dates indicated are shown below (in thousands).
September 30, 2009 | December 31, 2008 | |||||||||||||||
Estimated | Estimated | |||||||||||||||
Amortized | Fair | Amortized | Fair | |||||||||||||
Year of Maturity | Cost | Value | Cost | Value | ||||||||||||
Due in one year or less |
$ | 5,725,000 | $ | 5,725,076 | $ | 2,512,088 | $ | 2,511,630 | ||||||||
Interest Rate Payment Terms. The following table details additional interest rate payment terms for
investment securities classified as available-for-sale as of September 30, 2009 and December 31,
2008 (in thousands):
September 30, 2009 | December 31, 2008 | ||||||||
Amortized cost of available-for-sale securities: |
|||||||||
Fixed-rate |
$ | 5,725,000 | $ | 2,512,088 | |||||
Realized Gains and Losses. There were no sales of available-for-sale securities for the nine months
ended September 30, 2009 or 2008.
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Note 5Held-to-Maturity Securities
Major Security Types. Held-to-maturity securities as of September 30, 2009 and December 31, 2008
were as follows (in thousands):
September 30, 2009 | ||||||||||||||||
Gross | Gross | |||||||||||||||
Unrecognized | Unrecognized | |||||||||||||||
Amortized | Holding | Holding | Estimated | |||||||||||||
Cost (1) | Gains | (Losses) | Fair Value | |||||||||||||
Government-sponsored enterprises * |
$ | 26,668 | $ | 16 | $ | - | $ | 26,684 | ||||||||
State or local housing agency obligations |
11,185 | - | (413 | ) | 10,772 | |||||||||||
Mortgage-backed securities: |
||||||||||||||||
Other U.S. obligation residential
mortgage-backed securities ** |
2,617 | 4 | - | 2,621 | ||||||||||||
Government-sponsored enterprise residential
mortgage-backed securities *** |
12,220,789 | 482,595 | (4,025 | ) | 12,699,359 | |||||||||||
Private-label residential mortgage-backed
securities |
210,636 | - | (2,299 | ) | 208,337 | |||||||||||
Total mortgage-backed securities |
12,434,042 | 482,599 | (6,324 | ) | 12,910,317 | |||||||||||
Total |
$ | 12,471,895 | $ | 482,615 | $ | (6,737 | ) | $ | 12,947,773 | |||||||
December 31, 2008 | ||||||||||||||||
Gross | Gross | |||||||||||||||
Unrecognized | Unrecognized | |||||||||||||||
Amortized | Holding | Holding | Estimated | |||||||||||||
Cost (1) | Gains | (Losses) | Fair Value | |||||||||||||
Government-sponsored enterprises * |
$ | 26,012 | $ | 38 | $ | - | $ | 26,050 | ||||||||
State or local housing agency obligations |
12,080 | - | (536 | ) | 11,544 | |||||||||||
Mortgage-backed securities: |
||||||||||||||||
Other U.S. obligation residential
mortgage-backed securities ** |
9,103 | - | (3 | ) | 9,100 | |||||||||||
Government-sponsored enterprise residential
mortgage-backed securities *** |
12,552,810 | 301,671 | (1,138 | ) | 12,853,343 | |||||||||||
Private-label residential mortgage-backed
securities |
304,195 | - | (40,895 | ) | 263,300 | |||||||||||
Total mortgage-backed securities |
12,866,108 | 301,671 | (42,036 | ) | 13,125,743 | |||||||||||
Total |
$ | 12,904,200 | $ | 301,709 | $ | (42,572 | ) | $ | 13,163,337 | |||||||
(1) | Carrying value equals amortized cost. | |
* | Consists of debt securities issued or guaranteed by Freddie Mac and/or Federal National Mortgage Association (Fannie Mae), which are not obligations of the U.S. government. | |
** | Consists of Ginnie Mae securities. | |
*** | Consists of securities issued or guaranteed by Freddie Mac and/or Fannie Mae, which are not obligations of the U.S. government. |
The FHLBanks mortgage-backed security investments consist of senior classes of agency
guaranteed securities, government-sponsored enterprise securities, and private-label prime
residential mortgage-backed securities. The FHLBanks investments in mortgage-backed securities
must be triple-A rated at the time of purchase.
Investments in government-sponsored enterprise securities, specifically debentures issued by Fannie
Mae and Freddie Mac, have been affected by investor concerns regarding the adequacy of those
entities capital levels to offset expected credit losses from declining home prices and increasing
delinquencies. The Housing and Economic Recovery Act (HERA) contains provisions allowing the U.S.
Treasury Department to provide support to Fannie Mae and Freddie Mac. Additionally, in
13
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September 2008, the U.S. Treasury and the Finance Agency announced that Fannie Mae and Freddie Mac
had been placed into conservatorship, with the Finance Agency named as conservator. The Finance
Agency is acting as the conservator of Fannie Mae and Freddie Mac in an attempt to stabilize their
financial condition and their ability to support the secondary mortgage market.
The FHLBank has increased exposure to the risk of loss on its investments in mortgage-backed
securities when the loans backing the mortgage-backed securities exhibit high rates of delinquency
and foreclosure, and when there are losses on the sale of foreclosed properties. Credit safeguards
for the FHLBanks mortgage-backed securities consist of either payment guarantees of principal and
interest in the case of U.S. government-guaranteed mortgage-backed securities and
government-sponsored enterprise mortgage-backed securities, or credit enhancements for residential
mortgage-backed securities issued by entities other than government-sponsored enterprises
(private-label mortgage-backed securities) in the form of subordinate tranches in a security
structure that absorb the losses before the security purchased by the FHLBank takes a loss. Since
the surety of the FHLBanks private-label mortgage-backed securities holdings relies on credit
enhancements and the quality of the underlying loan collateral, the FHLBank analyzes these
investments on an ongoing basis in an effort to determine whether the credit enhancement associated
with each security is sufficient to protect against potential losses of principal and/or interest
on the underlying mortgage loans. The FHLBank has not historically used monoline insurance as a
form of credit enhancement for mortgage-backed securities.
The following table summarizes the par value of our six private-label mortgage-backed securities by
year of issuance, as well as the weighted-average credit enhancement on the applicable securities
as of September 30, 2009 (in thousands, except percentages). The weighted-average credit
enhancement is the percent of protection in place to absorb losses of principal that could occur
within the specified senior tranches.
As of September 30, 2009 | ||||||||||||||||||||
Percent | Serious | |||||||||||||||||||
Private-Label | Unrealized | Investment | Average Credit | Delinquency | ||||||||||||||||
Mortgage-Backed Securities | Par | (Losses) | Rating | Enhancement | Rate (2) | |||||||||||||||
Prime(1) Year of Securitization |
||||||||||||||||||||
2003 |
$ | 210,405 | $ | (2,299 | ) | AAA | 7.5% | 0.54% | ||||||||||||
Total |
$ | 210,405 | $ | (2,299 | ) | |||||||||||||||
(1) | As defined by the originator at the time of origination. | |
(2) | Seriously delinquent is defined as loans 60 days or more past due that underlie the securities, all bankruptcies, foreclosures, and real estate owned. |
14
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The following tables summarize the held-to-maturity securities with unrealized losses as of
September 30, 2009 and December 31, 2008. The unrealized losses are aggregated by major security
type and length of time that individual securities have been in a continuous unrealized loss
position (in thousands).
September 30, 2009 | ||||||||||||||||||||||||
Less than 12 Months | 12 Months or more | Total | ||||||||||||||||||||||
Estimated | Gross | Estimated | Gross | Estimated | Gross | |||||||||||||||||||
Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
Value | (Losses) | Value | (Losses) | Value | (Losses) | |||||||||||||||||||
State or local housing agency obligations |
$ | - | $ | - | $ | 10,772 | $ | (413 | ) | $ | 10,772 | $ | (413 | ) | ||||||||||
Mortgage-backed securities: |
||||||||||||||||||||||||
Government-sponsored enterprise
residential mortgage-backed securities * |
746,535 | (4,025 | ) | - | - | 746,535 | (4,025 | ) | ||||||||||||||||
Private-label residential mortgage-
backed securities |
- | - | 208,337 | (2,299 | ) | 208,337 | (2,299 | ) | ||||||||||||||||
Total |
$ | 746,535 | $ | (4,025 | ) | $ | 219,109 | $ | (2,712 | ) | $ | 965,644 | $ | (6,737 | ) | |||||||||
December 31, 2008 | ||||||||||||||||||||||||
Less than 12 Months | 12 Months or more | Total | ||||||||||||||||||||||
Estimated | Gross | Estimated | Gross | Estimated | Gross | |||||||||||||||||||
Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
Value | (Losses) | Value | (Losses) | Value | (Losses) | |||||||||||||||||||
State or local housing agency obligations |
$ | 11,544 | $ | (536 | ) | $ | - | $ | - | $ | 11,544 | $ | (536 | ) | ||||||||||
Mortgage-backed securities: |
||||||||||||||||||||||||
Other U.S. obligation residential
mortgage-backed securities ** |
9,100 | (3 | ) | - | - | 9,100 | (3 | ) | ||||||||||||||||
Government-sponsored enterprise
residential mortgage-backed
securities * |
171,811 | (1,138 | ) | - | - | 171,811 | (1,138 | ) | ||||||||||||||||
Private-label residential mortgage-
backed securities |
- | - | 263,300 | (40,895 | ) | 263,300 | (40,895 | ) | ||||||||||||||||
Total |
$ | 192,455 | $ | (1,677 | ) | $ | 263,300 | $ | (40,895 | ) | $ | 455,755 | $ | (42,572 | ) | |||||||||
* | Consists of securities issued or guaranteed by Freddie Mac and/or Fannie Mae, which are not obligations of the U.S. government. | |
** | Consists of Ginnie Mae securities. |
Redemption Terms. The amortized cost and estimated fair value of held-to-maturity securities
at the dates indicated by year of contractual maturity are shown below (in thousands). Expected
maturities of some securities may differ from contractual maturities because borrowers may have the
right to call or prepay obligations with or without call or prepayment fees.
September 30, 2009 | December 31, 2008 | |||||||||||||||
Amortized | Estimated | Amortized | Estimated | |||||||||||||
Year of Maturity | Cost (1) | Fair Value | Cost (1) | Fair Value | ||||||||||||
Other than mortgage-backed securities: |
||||||||||||||||
Due in 1 year or less |
$ | 26,668 | $ | 26,684 | $ | 26,012 | $ | 26,050 | ||||||||
Due after 1 year through 5 years |
- | - | - | - | ||||||||||||
Due after 5 years through 10 years |
8,020 | 7,765 | 5 | 5 | ||||||||||||
Due after 10 years |
3,165 | 3,007 | 12,075 | 11,539 | ||||||||||||
Total other |
37,853 | 37,456 | 38,092 | 37,594 | ||||||||||||
Mortgage-backed securities |
12,434,042 | 12,910,317 | 12,866,108 | 13,125,743 | ||||||||||||
Total |
$ | 12,471,895 | $ | 12,947,773 | $ | 12,904,200 | $ | 13,163,337 | ||||||||
(1) | Carrying value equals amortized cost. |
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Table of Contents
The amortized cost of the FHLBanks mortgage-backed securities classified as held-to-maturity
includes net discounts (in thousands) of $10,913 and $27,521 at September 30, 2009 and December 31,
2008.
Interest Rate Payment Terms. The following table details additional interest rate payment terms
for investment securities classified as held-to-maturity at September 30, 2009 and December 31,
2008 (in thousands):
September 30, 2009 | December 31, 2008 | ||||||||
Amortized cost of held-to-maturity securities
other than mortgage-backed securities: |
|||||||||
Fixed-rate |
$ | 34,688 | $ | 34,722 | |||||
Variable-rate |
3,165 | 3,370 | |||||||
Total other |
37,853 | 38,092 | |||||||
Amortized cost of held-to-maturity
mortgage-backed securities: |
|||||||||
Pass-through securities: |
|||||||||
Fixed-rate |
8,600,052 | 7,443,417 | |||||||
Collateralized mortgage obligations: |
|||||||||
Fixed-rate |
3,833,990 | 5,422,691 | |||||||
Total mortgage-backed securities |
12,434,042 | 12,866,108 | |||||||
Total |
$ | 12,471,895 | $ | 12,904,200 | |||||
The FHLBank did not sell any securities out of its held-to-maturity portfolio during the year ended
December 31, 2008.
The FHLBank sold securities out of its held-to-maturity portfolio during the nine months ended
September 30, 2009, each of which had less than 15 percent of the acquired principal outstanding at
the time of the sale. Such sales are considered as maturities for the purposes of security
classification. The FHLBank realized (in thousands) $5,943 in gross gains and no gross losses on
these sales during the nine months ended September 30, 2009.
Note 6Other-Than-Temporary Impairment Analysis
The FHLBank evaluates its individual available-for-sale and held-to-maturity investment securities
holdings in an unrealized loss position for other-than-temporary impairment on a quarterly basis.
As part of its securities evaluation for other-than-temporary impairment, the FHLBank considers
its intent to sell each debt security and whether it is more likely than not that the FHLBank will
be required to sell the security before its anticipated recovery. If either of these conditions is
met, the FHLBank recognizes an other-than-temporary impairment in earnings equal to the entire
difference between the securitys amortized cost basis and its fair value at the balance sheet
date. For securities in unrealized loss positions that meet neither of these conditions, the
FHLBank performs analyses to determine if any of these securities are other-than-temporarily
impaired.
For its government-sponsored enterprise residential mortgage-backed securities, the FHLBank
determined that the strength of the issuers guarantees through direct obligations or support from
the U.S. government is sufficient to protect the FHLBank from losses based on current expectations.
As a result, the FHLBank has determined that, as of September 30, 2009, all of the gross unrealized
losses on its government-sponsored enterprise mortgage-backed securities are temporary as the
declines in market value of these securities are not attributable to credit quality. Furthermore,
the FHLBank does not intend to sell the investments, and it is not more likely than not that the
FHLBank will be required to sell the investments before recovery of their amortized cost bases. As
a result, the FHLBank does not consider any of these investments to be other-than-temporarily
impaired at September 30, 2009.
Beginning with the third quarter of 2009, the FHLBank assessed whether the entire amortized cost
bases of the private-label residential mortgage-backed securities would be recovered by initially
selecting all private-label mortgage-backed securities in an unrealized loss position for cash flow
analysis. For certain private-label mortgage-backed securities where
underlying collateral data are
not available, alternative procedures, such as a screening process, are used to assess these
securities for other-than-temporary impairment. Prior to the third quarter of 2009, the FHLBank
only performed a cash flow analysis if an initial screening process revealed conditions (i.e., a
likely credit loss) suggesting that a detailed cash flow analysis was required. The FHLBank used a
screening process for two securities for which underlying collateral data was not available.
16
Table of Contents
The FHLBank performs cash flow analyses for securities in which underlying loan collateral data is
available by using two third-party models. The first model considers borrower characteristics and
the particular attributes of the loans underlying the FHLBanks 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 is
based upon an assessment of the individual housing markets. 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 with a
population of 10,000 or more people. The FHLBanks housing price forecast assumed CBSA level
current-to-trough home price declines ranging from 0 percent to 20 percent over the next 9 to 15
months. Thereafter, home prices are projected to remain flat in the first six months, before
increasing 0.5 percent in the next six months, 3 percent in the second year and 4 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. The projected cash flows are based on
a number of assumptions and expectations, and the results of these models can vary significantly
with changes in assumptions and expectations. The scenario of cash flows determined based on the
model approach described above reflects a best estimate of the present value of cash flows expected
to be collected.
As a result of the evaluation, the FHLBank believes that it will recover the entire amortized cost
basis in its private-label residential mortgage-backed securities. Additionally, because the
FHLBank does not intend to sell such securities nor is it more likely than not that the FHLBank
will be required to sell these securities before its anticipated recovery of the remaining
amortized cost basis, it did not consider the private-label residential mortgage-backed securities
to be other-than-temporarily impaired at September 30, 2009.
The FHLBank also reviewed its available-for-sale securities and the remainder of its
held-to-maturity securities that have experienced unrealized losses at September 30, 2009 and
determined that the unrealized losses were temporary, based on the creditworthiness of the issuers
and the related collateral characteristics and that the FHLBank will recover its entire amortized
cost basis. Additionally, because the FHLBank does not intend to sell its securities nor is it more
likely than not that the FHLBank will be required to sell the securities before recovery, it did
not consider the investments to be other-than-temporarily impaired at September 30, 2009.
17
Table of Contents
Note 7Advances
Redemption Terms. At September 30, 2009 and December 31, 2008, the FHLBank had Advances
outstanding, including Affordable Housing Program (AHP) Advances (see Note 12), at interest rates
ranging from 0.00 percent to 9.75 percent, as summarized below (dollars in thousands). Advances
with interest rates of 0.00 percent are AHP-subsidized Advances.
September 30, 2009 | December 31, 2008 | |||||||||||||||
Weighted | Weighted | |||||||||||||||
Average | Average | |||||||||||||||
Interest | Interest | |||||||||||||||
Year of Contractual Maturity | Amount | Rate | Amount | Rate | ||||||||||||
Overdrawn demand deposit accounts |
$ | 349 | 0.19 | % | $ | 82 | 0.46 | % | ||||||||
Due in 1 year or less |
10,021,156 | 1.89 | 19,453,340 | 2.66 | ||||||||||||
Due after 1 year through 2 years |
3,704,579 | 3.52 | 7,027,588 | 3.29 | ||||||||||||
Due after 2 years through 3 years |
9,550,936 | 2.38 | 5,759,670 | 2.51 | ||||||||||||
Due after 3 years through 4 years |
3,689,743 | 1.85 | 8,022,345 | 3.36 | ||||||||||||
Due after 4 years through 5 years |
1,135,118 | 2.88 | 2,955,172 | 2.95 | ||||||||||||
Thereafter |
9,152,252 | 2.33 | 9,580,509 | 3.50 | ||||||||||||
Total par value |
37,254,133 | 2.31 | 52,798,706 | 3.00 | ||||||||||||
Commitment fees |
(1,125 | ) | (1,160 | ) | ||||||||||||
Discount on AHP Advances |
(30,863 | ) | (33,316 | ) | ||||||||||||
Premiums |
4,477 | 4,664 | ||||||||||||||
Discount |
(7,934 | ) | (6,689 | ) | ||||||||||||
Hedging adjustments |
863,368 | 1,153,767 | ||||||||||||||
Total |
$ | 38,082,056 | $ | 53,915,972 | ||||||||||||
The FHLBank offers Advances to members that may be prepaid on specified dates (call dates) without
incurring prepayment or termination fees (callable Advances). Other Advances may only be prepaid
subject to a fee to the FHLBank (prepayment fee) that makes the FHLBank financially indifferent to
the prepayment of the Advance. At September 30, 2009 and December 31, 2008, the FHLBank had
callable Advances (in thousands) of $14,304,834 and $21,634,101.
The following table summarizes Advances at the dates indicated by year of contractual maturity or
next call date for callable Advances (in thousands):
Year of Contractual Maturity | September 30, | Percentage | December 31, | Percentage | ||||||||||||
or Next Call Date | 2009 | of Total | 2008 | of Total | ||||||||||||
Overdrawn demand deposit accounts |
$ | 349 | - | % | $ | 82 | - | % | ||||||||
Due in 1 year or less |
20,404,103 | 55 | 32,026,608 | 61 | ||||||||||||
Due after 1 year through 2 years |
3,397,005 | 9 | 6,434,692 | 12 | ||||||||||||
Due after 2 years through 3 years |
6,072,336 | 16 | 2,276,596 | 4 | ||||||||||||
Due after 3 years through 4 years |
1,468,998 | 4 | 6,019,345 | 11 | ||||||||||||
Due after 4 years through 5 years |
955,490 | 3 | 968,120 | 2 | ||||||||||||
Thereafter |
4,955,852 | 13 | 5,073,263 | 10 | ||||||||||||
Total par value |
$ | 37,254,133 | 100 | % | $ | 52,798,706 | 100 | % | ||||||||
The FHLBank also offers putable Advances. With a putable Advance, the FHLBank effectively purchases
a put option from the member that allows the FHLBank to terminate the Advance at predetermined
dates. The FHLBank normally would exercise its option when interest rates increase relative to
contractual rates. At September 30, 2009 and December 31, 2008, the FHLBank had putable Advances
outstanding totaling (in thousands) $7,045,350 and $6,981,250.
18
Table of Contents
Through
December 2005, the FHLBank offered convertible Advances. At September 30, 2009
and December 31, 2008, the FHLBank had convertible Advances outstanding totaling (in thousands)
$3,230,700 and $3,478,700.
The following table summarizes Advances at the dates indicated by year of contractual maturity or
next put/convert date for putable/convertible Advances (in thousands):
Year of Contractual Maturity | September 30, | Percentage | December 31, | Percentage | ||||||||||||
or Next Put/Convert Date | 2009 | of Total | 2008 | of Total | ||||||||||||
Overdrawn demand deposit accounts |
$ | 349 | - | % | $ | 82 | - | % | ||||||||
Due in 1 year or less |
18,582,606 | 49.9 | 28,142,090 | 53.3 | ||||||||||||
Due after 1 year through 2 years |
3,116,779 | 8.4 | 6,735,288 | 12.7 | ||||||||||||
Due after 2 years through 3 years |
6,008,036 | 16.1 | 5,153,270 | 9.8 | ||||||||||||
Due after 3 years through 4 years |
3,284,243 | 8.8 | 4,341,845 | 8.2 | ||||||||||||
Due after 4 years through 5 years |
911,418 | 2.4 | 2,788,772 | 5.3 | ||||||||||||
Thereafter |
5,350,702 | 14.4 | 5,637,359 | 10.7 | ||||||||||||
Total par value |
$ | 37,254,133 | 100.0 | % | $ | 52,798,706 | 100.0 | % | ||||||||
The FHLBank has never experienced a credit loss on an Advance to a member. Based upon the
collateral held as security for its Advances and the repayment history of the FHLBanks Advances,
management believes that an allowance for credit losses on Advances is unnecessary.
The following table shows Advance balances at the dates indicated to members holding five percent
or more of total Advances and includes any known affiliates of these members that are members of
the FHLBank (dollars in millions):
September 30, 2009 | December 31, 2008 | |||||||||||||||||||
Principal | % of Total | Principal | % of Total | |||||||||||||||||
U.S. Bank, N.A. |
$ | 10,315 | 28 | % | U.S. Bank, N.A. |
$ | 14,856 | 28 | % | |||||||||||
National City Bank |
4,409 | 12 | National City Bank |
6,435 | 12 | |||||||||||||||
Fifth Third Bank |
2,038 | 5 | Fifth Third Bank |
5,639 | 11 | |||||||||||||||
Total |
$ | 16,762 | 45 | % | Total |
$ | 26,930 | 51 | % | |||||||||||
Interest Rate Payment Terms. The following table details additional interest rate payment terms
for Advances at the dates indicated (in thousands):
September 30, 2009 | December 31, 2008 | |||||||||||||||
Amount | % of Total | Amount | % of Total | |||||||||||||
Par amount of Advances: |
||||||||||||||||
Fixed-rate |
$ | 18,452,950 | 50 | % | $ | 24,501,522 | 46 | % | ||||||||
Variable-rate |
18,801,183 | 50 | 28,297,184 | 54 | ||||||||||||
Total |
$ | 37,254,133 | 100 | % | $ | 52,798,706 | 100 | % | ||||||||
Prepayment Fees. The FHLBank records prepayment fees received from members on prepaid Advances net
of any associated fair-value hedging adjustments on those Advances. The net amount of prepayment
fees is reflected as interest income in the Statements of Income. Gross Advance prepayment fees
received from members (in thousands) were $4,791 and $293 for the three months ended September 30,
2009 and 2008, respectively, and $10,662 and $2,538 for the nine months ended September 30, 2009
and 2008, respectively.
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Note 8Mortgage Loans Held for Portfolio, Net
The following table presents information at the dates indicated on mortgage loans held for
portfolio (in thousands):
September 30, 2009 | December 31, 2008 | ||||||||
Real Estate: |
|||||||||
Fixed rate medium-term single-family mortgages (1) |
$ | 1,428,249 | $ | 1,177,689 | |||||
Fixed rate long-term single-family mortgages |
8,221,896 | 7,412,329 | |||||||
Subtotal fixed rate single-family mortgages |
9,650,145 | 8,590,018 | |||||||
Premiums |
99,946 | 61,390 | |||||||
Discounts |
(9,616 | ) | (9,934 | ) | |||||
Hedging basis adjustments |
(4,226 | ) | (9,601 | ) | |||||
Total |
$ | 9,736,249 | $ | 8,631,873 | |||||
(1) | Medium-term is defined as a term of 15 years or less. |
The following table details the par value of mortgage loans held for portfolio outstanding at
the dates indicated (in thousands):
September 30, 2009 | December 31, 2008 | ||||||||
Government-guaranteed/insured loans |
$ | 1,483,166 | $ | 1,396,411 | |||||
Conventional loans |
8,166,979 | 7,193,607 | |||||||
Total par value |
$ | 9,650,145 | $ | 8,590,018 | |||||
The conventional mortgage loans are supported by primary and supplemental mortgage insurance and
the Lender Risk Account in addition to the associated property as collateral. The following table
presents changes in the Lender Risk Account for the nine months ended September 30, 2009 (in
thousands):
Lender Risk Account at December 31, 2008 |
$ | 48,782 | ||
Additions |
12,272 | |||
Claims |
(1,094 | ) | ||
Scheduled distributions |
(2,760 | ) | ||
Lender Risk Account at September 30, 2009 |
$ | 57,200 | ||
The FHLBank had no nonaccrual loans at September 30, 2009 and December 31, 2008.
Mortgage loans, other than those included in large groups of smaller-balance homogeneous loans, are
considered impaired when, based on current information and events, it is probable that the FHLBank
will be unable to collect all principal and interest amounts due according to the contractual terms
of the mortgage loan agreement. At September 30, 2009 and December 31, 2008, the FHLBank had no
mortgage loans that were considered impaired.
The FHLBank has experienced no credit losses on mortgage loans to date and no event has occurred
that would cause the FHLBank to believe it will have to absorb any credit losses on these mortgage
loans. Accordingly, the FHLBank has not provided any allowances for losses on these mortgage loans.
The following table shows unpaid principal balances at the dates indicated to members supplying
five percent or more of total unpaid principal and includes any known affiliates that are members
of the FHLBank (dollars in millions):
September 30, 2009 | December 31, 2008 | |||||||||||||||
Principal | % of Total | Principal | % of Total | |||||||||||||
National City Bank |
$ | 3,763 | 39 | % | $ | 4,709 | 55 | % | ||||||||
Union Savings Bank |
3,078 | 32 | 1,995 | 23 | ||||||||||||
Guardian Savings Bank FSB |
809 | 8 | 544 | 6 | ||||||||||||
Total |
$ | 7,650 | 79 | % | $ | 7,248 | 84 | % | ||||||||
20
Table of Contents
Note 9Derivatives and Hedging Activities
Nature of Business Activity
The FHLBank is exposed to interest rate risk primarily from the effect of interest rate changes on
its interest-earning assets and its funding sources which finance these assets.
Consistent with Finance Agency policy, the FHLBank enters into derivatives to manage the interest
rate risk exposures inherent in otherwise unhedged assets and funding positions, to achieve the
FHLBanks risk management objectives and to act as an intermediary between its members and
counterparties. Finance Agency Regulations and the FHLBanks financial management policy prohibit
trading in or the speculative use of derivative instruments and limit credit risk arising from
these instruments. The FHLBank may only use derivatives to reduce funding costs for Consolidated
Obligations and to manage its interest rate risk, mortgage prepayment risk and foreign currency
risk positions. Derivatives are an integral part of the FHLBanks financial management strategy.
The most common ways in which the FHLBank uses derivatives are to:
§ | reduce the interest rate sensitivity and repricing gaps of assets, liabilities, and certain other derivative instruments; | ||
§ | manage embedded options in assets and liabilities; | ||
§ | reduce funding costs by combining a derivative with a Consolidated Obligation, as the cost of a combined funding structure can be lower than the cost of a comparable Consolidated Obligation Bond; | ||
§ | preserve a favorable interest rate spread between the yield of an asset (e.g., an Advance) and the cost of the related liability (e.g., the Consolidated Obligation Bond used to fund the Advance); without the use of derivatives, this interest rate spread could be reduced or eliminated when a change in the interest rate on the Advance does not match a change in the interest rate on the Bond; and | ||
§ | protect the value of existing asset or liability positions. |
Types of Derivatives
The FHLBanks financial management policy establishes guidelines for its use of derivatives. The
FHLBank may enter into interest rate swaps (including callable and putable swaps), swaptions,
interest rate cap and floor agreements, calls, puts, futures, and forward contracts to manage its
exposure to changes in interest rates.
The FHLBank may use these types of derivatives to adjust the effective maturity, repricing
frequency, or option characteristics of financial instruments (such as Advances, and Consolidated
Obligations) to achieve risk/return management objectives.
The FHLBank uses either derivative strategies or embedded options in its funding to minimize
hedging costs. Interest rate swaps are used to manage interest rate exposures. Swaptions, caps
and floors may be used to manage interest rate and volatility exposures.
An interest rate swap is an agreement between two entities to exchange cash flows in the future.
The agreement sets the dates on which the cash flows will be paid and the manner in which the cash
flows will be calculated. One of the simplest forms of an interest rate swap involves the promise
by one party to pay cash flows equivalent to the interest on a notional principal amount at a
predetermined fixed rate for a given period of time. In return for this promise, this party
receives cash flows equivalent to the interest on the same notional principal amount at a
variable-rate index for the same period of time. The variable-rate received by the FHLBank in its
interest rate swaps is LIBOR.
21
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Application of Interest Rate Swaps
The FHLBank generally uses derivatives as fair value hedges of underlying financial instruments.
However, because the FHLBank uses interest rate swaps when they are considered to be the most
cost-effective alternative to achieve the FHLBanks financial and risk management objectives, it
may enter into interest rate swaps that do not necessarily qualify for hedge accounting (economic
hedges). The FHLBank re-evaluates its hedging strategies from time to time and may change the
hedging techniques it uses or adopt new strategies.
Types of Assets and Liabilities Hedged
The FHLBank documents at inception all relationships between derivatives designated as hedging
instruments and the hedged items, its risk management objectives and strategies for undertaking
various hedge transactions, and its method of assessing effectiveness. This process includes
linking all derivatives that are designated as fair value hedges to assets and liabilities on the
Statements of Condition. The FHLBank also formally assesses (both at the hedges inception and at
least quarterly) whether the derivatives that are used in hedging transactions have been effective
in offsetting changes in the fair value of the hedged items and whether those derivatives may be
expected to remain effective in future periods. The FHLBank currently uses regression analyses to
assess the effectiveness of its hedges.
Consolidated
Obligations While Consolidated Obligations are the joint and several
obligations of the FHLBanks, each FHLBank has Consolidated Obligations for which it is the primary
obligor. To date, no FHLBank has ever had to assume or pay the Consolidated Obligations of another
FHLBank. The FHLBank enters into derivatives to hedge the interest rate risk associated with its
specific debt issuances.
The FHLBank manages the risk arising from changing market prices and volatility of a Consolidated
Obligation by matching the cash inflow on a derivative with the cash outflow on the Consolidated
Obligation. In addition, the FHLBank requires collateral on derivatives at specified levels
correlated to counterparty credit ratings and contractual terms.
For instance, in a typical transaction, fixed-rate Consolidated Obligations are issued for one or
more FHLBanks, and the FHLBank simultaneously enters into a matching interest rate swap in which
the counterparty pays fixed cash flows to the FHLBank designed to mirror in timing and amount the
cash outflows the FHLBank pays on the Consolidated Obligation. The FHLBank pays a variable cash
flow that closely matches the interest payments it receives on short-term or variable-rate
Advances, typically 3-month LIBOR. These transactions are treated as fair value hedges.
This strategy of issuing Bonds while simultaneously entering into derivatives enables the FHLBank
to offer a wider range of attractively priced Advances to its members and may allow the FHLBank to
reduce its funding costs. The continued attractiveness of such debt depends on yield relationships
between the Bond and the derivative markets. If conditions in these markets change, the FHLBank may
alter the types or terms of the Bonds that it issues. By acting in both the capital and the swap
markets, the FHLBank can raise funds at lower costs than through the issuance of simple fixed- or
variable-rate Consolidated Obligations in the capital markets alone.
Advances
The FHLBank offers a wide array of Advance structures to meet members funding
needs. These Advances may have maturities up to 30 years with variable or fixed rates and may
include early termination features or options. The FHLBank may use derivatives to adjust the
repricing and/or options characteristics of Advances in order to more closely match the
characteristics of the FHLBanks funding liabilities. In general, whenever a member executes a
fixed-rate Advance or a variable-rate Advance with embedded options, the FHLBank will
simultaneously execute a derivative with terms that offset the terms and embedded options, if any,
in the Advance. For example, the FHLBank may hedge a fixed-rate Advance with an interest rate swap
where the FHLBank pays a fixed-rate coupon and receives a floating-rate coupon, effectively
converting the fixed-rate Advance to a floating-rate Advance. These types of hedges are treated as
fair value hedges.
When issuing a putable Advance, the FHLBank effectively purchases a put option from the member that
allows the FHLBank to put or extinguish the fixed-rate Advance, which the FHLBank normally would
exercise when interest rates increase. The FHLBank may hedge these Advances by entering into a
cancelable derivative.
22
Table of Contents
Mortgage
Loans The FHLBank invests in fixed rate mortgage loans. The prepayment options
embedded in mortgage loans can result in extensions or contractions in the expected repayment of
these investments, depending on changes in estimated prepayment speeds. The FHLBank may manage the
interest rate and prepayment risks associated with mortgages through a combination of debt issuance
and derivatives. The FHLBank issues both callable and noncallable debt and prepayment linked
Consolidated Obligations to achieve cash flow patterns and liability durations similar to those
expected on the mortgage loans. The FHLBank is permitted to use derivatives to match the expected
prepayment characteristics of the mortgages, although to date it has not done so.
Firm Commitment Strategies Certain mortgage purchase commitments are considered derivatives. The FHLBank normally hedges these commitments by selling to-be-announced (TBA) mortgage-backed securities for forward settlement. A TBA represents a forward contract for the sale of mortgage-backed securities at a future agreed upon date for an established price. The mortgage purchase commitment and the TBA used in the firm commitment hedging strategy (economic hedge) are recorded as a derivative asset or derivative liability at fair value, with changes in fair value recognized in the current period earnings. When the mortgage purchase commitment derivative settles, the current market value of the commitment is included in the basis of the mortgage loan and amortized accordingly.
Firm Commitment Strategies Certain mortgage purchase commitments are considered derivatives. The FHLBank normally hedges these commitments by selling to-be-announced (TBA) mortgage-backed securities for forward settlement. A TBA represents a forward contract for the sale of mortgage-backed securities at a future agreed upon date for an established price. The mortgage purchase commitment and the TBA used in the firm commitment hedging strategy (economic hedge) are recorded as a derivative asset or derivative liability at fair value, with changes in fair value recognized in the current period earnings. When the mortgage purchase commitment derivative settles, the current market value of the commitment is included in the basis of the mortgage loan and amortized accordingly.
Investments
The FHLBank invests in certificates of deposit, bank notes, U.S. agency
obligations, government-sponsored enterprise debt securities, mortgage-backed securities, and the
taxable portion of state or local housing finance agency obligations, which may be classified as
held-to-maturity, available-for-sale or trading securities. The interest rate and prepayment risk
associated with these investment securities is managed through a combination of debt issuance and,
possibly, derivatives. The FHLBank may manage the prepayment and interest rate risk by funding
investment securities with Consolidated Obligations that have call features or by hedging the
prepayment risk with caps or floors, callable swaps or swaptions.
Managing Credit Risk on Derivatives
The FHLBank is subject to credit risk due to nonperformance by counterparties to its derivative
agreements. The degree of counterparty risk depends on the extent to which master netting
arrangements are included in the contracts to mitigate the risk. The FHLBank manages counterparty
credit risk through credit analysis, collateral requirements and adherence to the requirements set
forth in FHLBank policies and Finance Agency Regulations. Based on credit analyses and collateral
requirements at September 30, 2009, the management of the FHLBank does not expect any credit losses
on its derivative agreements.
The contractual or notional amount of derivatives reflects the involvement of the FHLBank in the
various classes of financial instruments. The notional amount of derivatives does not measure the
credit risk exposure of the FHLBank, and the maximum credit exposure of the FHLBank is
substantially less than the notional amount. The FHLBank requires collateral agreements on all
derivatives, which establish collateral delivery thresholds. The maximum credit risk is the
estimated cost of replacing interest rate swaps, forward rate agreements, and mandatory delivery
contracts for mortgage loans that have a net positive market value, assuming the counterparty
defaults and the related collateral, if any, is of no value to the FHLBank. The FHLBank has not
sold or repledged the collateral it received.
As of September 30, 2009 and December 31, 2008, the FHLBanks maximum credit risk, as defined
above, was approximately $44,066,000 and $60,317,000, respectively. These totals include
$28,189,000 and $16,145,000 of net accrued interest receivable. In determining maximum credit risk,
the FHLBank considers accrued interest receivables and payables, and the legal right to offset
derivative assets and liabilities, by counterparty. The FHLBank held $35,202,000 and $43,007,000 of
cash as collateral as of September 30, 2009 and December 31, 2008, for net uncollateralized
balances of $8,864,000 and $17,310,000, respectively. The FHLBank held no securities as collateral
as of September 30, 2009 or December 31, 2008. Additionally, collateral related to derivatives with
member institutions includes collateral assigned to the FHLBank, as evidenced by a written security
agreement, and held by the member institution for the benefit of the FHLBank.
23
Table of Contents
Certain of the FHLBanks interest rate swap contracts contain provisions that require the FHLBank
to post additional collateral with its counterparties if there is deterioration in the FHLBanks
credit rating. If the FHLBanks credit rating were lowered by a major credit rating agency, the
FHLBank could be required to deliver additional collateral. The aggregate fair value of all
interest rate swaps with credit-risk-related contingent features that were in a liability position
at September 30, 2009 was $802,582,000, for which the FHLBank has posted collateral of $532,753,000
in the normal course of business, resulting in a net balance of $269,829,000. If the FHLBanks
credit ratings had been lowered from its current rating to the next lower rating, the FHLBank would
have been required to deliver up to an additional $159,422,000 of collateral (at fair value) to its
derivatives counterparties at September 30, 2009. However, the FHLBanks credit ratings have not
changed during the previous 12 months.
The FHLBank transacts most of its derivatives with large banks and major broker-dealers. Some of
these banks and broker-dealers or their affiliates buy, sell, and distribute Consolidated
Obligations. The FHLBank is not a derivative dealer and thus does not trade derivatives for
short-term profit.
Financial Statement Effect and Additional Financial Information
The notional amount of derivatives serves as a factor in determining periodic interest payments or
cash flows received and paid. As indicated above, the notional amount represents neither the actual
amounts exchanged nor the overall exposure of the FHLBank to credit and market risk. Notional
values are not meaningful measures of the risks associated with derivatives. The risks of
derivatives only can be measured meaningfully on a portfolio basis that takes into account the
derivatives, the items being hedged and any offsets between the two.
24
Table of Contents
The following table summarizes the fair value of the FHLBanks derivative instruments without the
effect of netting arrangements or collateral (in thousands). For purposes of this disclosure, the
derivative values include accrued interest on the instruments.
September 30, 2009 | ||||||||||||
Notional | ||||||||||||
Amount of | Derivative | Derivative | ||||||||||
Derivatives | Assets | Liabilities | ||||||||||
Derivatives designated as fair value hedging
instruments: |
||||||||||||
Interest rate swaps |
$ | 27,055,050 | $ | 192,895 | $ | (951,893 | ) | |||||
Derivatives not designated as hedging
instruments: |
||||||||||||
Interest rate swaps |
396,800 | 9,019 | (9,802 | ) | ||||||||
Forward rate agreements |
- | - | - | |||||||||
Mortgage delivery commitments |
126,566 | 1,265 | (13 | ) | ||||||||
Total derivatives not designated as hedging
instruments |
523,366 | 10,284 | (9,815 | ) | ||||||||
Total derivatives before netting and
collateral adjustments |
$ | 27,578,416 | 203,179 | (961,708 | ) | |||||||
Netting adjustments |
(159,113 | ) | 159,113 | |||||||||
Cash collateral and related accrued interest |
(35,202 | ) | 532,753 | |||||||||
Total collateral and netting adjustments (1) |
(194,315 | ) | 691,866 | |||||||||
Derivative assets and derivative liabilities as
reported on the Statement of Condition |
$ | 8,864 | $ | (269,842 | ) | |||||||
December 31, 2008 | ||||||||||||
Notional | ||||||||||||
Amount of | Derivative | Derivative | ||||||||||
Derivatives | Assets | Liabilities | ||||||||||
Derivatives designated as fair value hedging
instruments: |
||||||||||||
Interest rate swaps |
$ | 25,830,900 | $ | 226,043 | $ | (1,221,004 | ) | |||||
Derivatives not designated as hedging
instruments: |
||||||||||||
Interest rate swaps |
1,976,300 | 7,632 | (13,191 | ) | ||||||||
Forward rate agreements |
386,000 | - | (3,670 | ) | ||||||||
Mortgage delivery commitments |
917,435 | 6,282 | (153 | ) | ||||||||
Total derivatives not designated as hedging
instruments |
3,279,735 | 13,914 | (17,014 | ) | ||||||||
Total derivatives before netting and
collateral adjustments |
$ | 29,110,635 | 239,957 | (1,238,018 | ) | |||||||
Netting adjustments |
(179,640 | ) | 179,640 | |||||||||
Cash collateral and related accrued interest |
(43,007 | ) | 771,902 | |||||||||
Total collateral and netting adjustments (1) |
(222,647 | ) | 951,542 | |||||||||
Derivative assets and derivative liabilities as
reported on the Statement of Condition |
$ | 17,310 | $ | (286,476 | ) | |||||||
(1) | Amounts represent the effects of legally enforceable master netting agreements that allow the FHLBank to settle positive and negative positions and of cash collateral held or placed with the same counterparties. |
25
Table of Contents
The following table presents the components of net gains (losses) on derivatives and hedging
activities as presented in the Statements of Income for the dates indicated (in thousands):
Three Months Ended September 30, | ||||||||
2009 | 2008 | |||||||
Derivatives and hedged items in fair
value hedging relationships: |
||||||||
Interest rate swaps |
$ | 3,291 | $ | 8,974 | ||||
Derivatives not designated as hedging instruments: |
||||||||
Economic Hedges: |
||||||||
Interest rate swaps |
(1,863 | ) | 1,204 | |||||
Forward rate agreements |
(2,807 | ) | 281 | |||||
Net interest settlements |
400 | (281 | ) | |||||
Mortgage delivery commitments |
5,825 | (285 | ) | |||||
Total net gain related to derivatives not
designated as hedging instruments |
1,555 | 919 | ||||||
Net gains on derivatives and
hedging activities |
$ | 4,846 | $ | 9,893 | ||||
Nine Months Ended September 30, | ||||||||
2009 | 2008 | |||||||
Derivatives and hedged items in fair
value hedging relationships: |
||||||||
Interest rate swaps |
$ | 10,643 | $ | 10,756 | ||||
Derivatives not designated as hedging instruments: |
||||||||
Economic Hedges: |
||||||||
Interest rate swaps |
2,169 | 445 | ||||||
Forward rate agreements |
339 | 2,830 | ||||||
Net interest settlements |
1,138 | (293 | ) | |||||
Mortgage delivery commitments |
(1,492 | ) | (4,347 | ) | ||||
Total net gain (loss) related to derivatives not
designated as hedging instruments |
2,154 | (1,365 | ) | |||||
Net gains on derivatives and
hedging activities |
$ | 12,797 | $ | 9,391 | ||||
26
Table of Contents
The following table presents, by type of hedged item, the gains (losses) on derivatives and the
related hedged items in fair value hedging relationships and the impact of those derivatives on the
FHLBanks net interest income for the dates indicated (in thousands):
Three Months Ended September 30, | ||||||||||||||||
Effect of | ||||||||||||||||
Gain/(Loss) | Gain/(Loss) | Net Fair | Derivatives on | |||||||||||||
on | on Hedged | Value Hedge | Net Interest | |||||||||||||
Derivative | Item | Ineffectiveness | Income | |||||||||||||
2009 |
||||||||||||||||
Hedged Item Type: |
||||||||||||||||
Advances |
$ | (53,110 | ) | $ | 56,469 | $ | 3,359 | $ | (135,551 | ) | ||||||
Consolidated Bonds |
18,881 | (18,949 | ) | (68 | ) | 40,330 | ||||||||||
$ | (34,229 | ) | $ | 37,520 | $ | 3,291 | $ | (95,221 | ) | |||||||
2008 |
||||||||||||||||
Hedged Item Type: |
||||||||||||||||
Advances |
$ | 11,730 | $ | (17,315 | ) | $ | (5,585 | ) | $ | (63,513 | ) | |||||
Consolidated Bonds |
(8,674 | ) | 23,233 | 14,559 | 23,280 | |||||||||||
$ | 3,056 | $ | 5,918 | $ | 8,974 | $ | (40,233 | ) | ||||||||
Nine Months Ended September 30, | ||||||||||||||||
Effect of | ||||||||||||||||
Gain/(Loss) | Gain/(Loss) | Net Fair | Derivatives on | |||||||||||||
on | on Hedged | Value Hedge | Net Interest | |||||||||||||
Derivative | Item | Ineffectiveness | Income | |||||||||||||
2009 |
||||||||||||||||
Hedged Item Type: |
||||||||||||||||
Advances |
$ | 296,853 | $ | (290,296 | ) | $ | 6,557 | $ | (376,466 | ) | ||||||
Consolidated Bonds |
(36,744 | ) | 40,830 | 4,086 | 111,927 | |||||||||||
$ | 260,109 | $ | (249,466 | ) | $ | 10,643 | $ | (264,539 | ) | |||||||
2008 |
||||||||||||||||
Hedged Item Type: |
||||||||||||||||
Advances |
$ | 2,887 | $ | (8,540 | ) | $ | (5,653 | ) | $ | (136,247 | ) | |||||
Consolidated Bonds |
(6,471 | ) | 22,880 | 16,409 | 58,583 | |||||||||||
$ | (3,584 | ) | $ | 14,340 | $ | 10,756 | $ | (77,664 | ) | |||||||
27
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Note 10Deposits
The FHLBank offers demand and overnight deposits to members and qualifying non-members. In
addition, the FHLBank offers short-term interest-bearing deposit programs to members. A member that
services mortgage loans may deposit in the FHLBank funds collected in connection with the mortgage
loans, pending disbursement of such funds to the owners of the mortgage loans; the FHLBank
classifies these items as other interest bearing deposits.
The following table details interest bearing and non-interest bearing deposits with the FHLBank at
the dates indicated (in thousands):
September 30, 2009 | December 31, 2008 | |||||||||
Interest bearing: |
||||||||||
Demand and overnight |
$ | 1,563,508 | $ | 1,074,138 | ||||||
Term |
78,050 | 94,150 | ||||||||
Other |
23,695 | 24,305 | ||||||||
Total interest bearing |
1,665,253 | 1,192,593 | ||||||||
Non-interest bearing: |
||||||||||
Other |
4,195 | 868 | ||||||||
Total non-interest bearing |
4,195 | 868 | ||||||||
Total deposits |
$ | 1,669,448 | $ | 1,193,461 | ||||||
The average interest rates paid on interest bearing deposits were 0.10 percent and 1.79 percent in
the three months ended September 30, 2009 and 2008, respectively, and 0.12 percent and 2.18 percent
in the nine months ended September 30, 2009 and 2008, respectively.
Aggregate time deposits with a denomination of $100 thousand or more were (in thousands) $77,950
and $94,050 as of September 30, 2009 and December 31, 2008.
28
Table of Contents
Note 11Consolidated Obligations
Redemption Terms. The following is a summary of the FHLBanks participation in Consolidated Bonds
outstanding at the dates indicated by year of contractual maturity (dollars in thousands):
September 30, 2009 | December 31, 2008 | |||||||||||||||
Weighted | Weighted | |||||||||||||||
Average | Average | |||||||||||||||
Interest | Interest | |||||||||||||||
Year of Contractual Maturity | Amount | Rate | Amount | Rate | ||||||||||||
Due in 1 year or less |
$ | 14,067,600 | 2.12 | % | $ | 17,162,400 | 3.02 | % | ||||||||
Due after 1 year through 2 years |
6,899,750 | 2.30 | 5,271,000 | 3.98 | ||||||||||||
Due after 2 years through 3 years |
5,767,000 | 3.22 | 5,316,750 | 4.03 | ||||||||||||
Due after 3 years through 4 years |
4,378,450 | 3.60 | 3,805,000 | 4.57 | ||||||||||||
Due after 4 years through 5 years |
2,534,000 | 3.85 | 3,090,450 | 4.40 | ||||||||||||
Thereafter |
7,197,000 | 4.53 | 7,317,000 | 5.15 | ||||||||||||
Index amortizing notes |
216,747 | 4.99 | 251,757 | 4.99 | ||||||||||||
Total par value |
41,060,547 | 3.01 | 42,214,357 | 3.89 | ||||||||||||
Premiums |
35,326 | 35,868 | ||||||||||||||
Discounts |
(29,712 | ) | (35,726 | ) | ||||||||||||
Deferred net loss on terminated hedges |
659 | 1,496 | ||||||||||||||
Hedging adjustments |
135,796 | 176,790 | ||||||||||||||
Total |
$ | 41,202,616 | $ | 42,392,785 | ||||||||||||
The FHLBanks Consolidated Bonds outstanding at the dates indicated included (in thousands):
September 30, 2009 | December 31, 2008 | |||||||||
Par amount of Consolidated Bonds: |
||||||||||
Non-callable |
$ | 28,588,947 | $ | 30,239,957 | ||||||
Callable |
12,471,600 | 11,974,400 | ||||||||
Total par value |
$ | 41,060,547 | $ | 42,214,357 | ||||||
The following table summarizes Consolidated Bonds outstanding at the dates indicated by year of
contractual maturity or next call date (in thousands):
Percent | Percent | |||||||||||||||
Year of Contractual Maturity or Next Call Date | September 30, 2009 | of Total | December 31, 2008 | of Total | ||||||||||||
Due in 1 year or less |
$ | 24,493,600 | 60 | % | $ | 28,372,400 | 67 | % | ||||||||
Due after 1 year through 2 years |
7,884,750 | 19 | 4,786,000 | 11 | ||||||||||||
Due after 2 years through 3 years |
3,112,000 | 8 | 2,396,750 | 6 | ||||||||||||
Due after 3 years through 4 years |
2,513,450 | 6 | 2,430,000 | 6 | ||||||||||||
Due after 4 years through 5 years |
1,193,000 | 3 | 1,815,450 | 4 | ||||||||||||
Thereafter |
1,647,000 | 4 | 2,162,000 | 5 | ||||||||||||
Index amortizing notes |
216,747 | - | 251,757 | 1 | ||||||||||||
Total par value |
$ | 41,060,547 | 100 | % | $ | 42,214,357 | 100 | % | ||||||||
29
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Interest Rate Payment Terms. The following table details Consolidated Bonds by interest rate
payment type (in thousands):
September 30, 2009 | December 31, 2008 | |||||||||
Par value of Consolidated Bonds: |
||||||||||
Fixed-rate |
$ | 39,289,947 | $ | 35,789,957 | ||||||
Variable-rate |
1,770,600 | 6,424,400 | ||||||||
Total par value |
$ | 41,060,547 | $ | 42,214,357 | ||||||
Consolidated Discount Notes. Consolidated Discount Notes are issued to raise short-term funds.
Discount Notes are Consolidated Obligations with original maturities up to one year. These notes
are issued at less than their face amount and redeemed at par value when they mature. The FHLBanks
participation in Consolidated Discount Notes was as follows (dollars in thousands):
Weighted Average | ||||||||||||
Book Value | Par Value | Interest Rate (1) | ||||||||||
September 30, 2009 |
$ | 29,169,806 | $ | 29,173,794 | 0.16 | % | ||||||
December 31, 2008 |
$ | 49,335,739 | $ | 49,388,776 | 0.79 | % | ||||||
(1) | Represents an implied rate. |
Note 12Affordable Housing Program (AHP)
The following table presents changes in the AHP liability for the nine months ended September 30,
2009 (in thousands):
Balance at December 31, 2008 |
$ | 102,615 | ||
Expense (current year additions) |
24,972 | |||
Subsidy uses, net |
(22,443 | ) | ||
Balance at September 30, 2009 |
$ | 105,144 | ||
Note 13Capital
The following table demonstrates the FHLBanks compliance with the Finance Agencys capital
requirements at the dates indicated (dollars in thousands):
September 30, 2009 | December 31, 2008 | |||||||||||||||
Required | Actual | Required | Actual | |||||||||||||
Regulatory capital requirements: |
||||||||||||||||
Risk-based capital |
$ | 580,517 | $ | 4,152,158 | $ | 542,630 | $ | 4,399,053 | ||||||||
Capital-to-assets ratio |
4.00% | 5.39% | 4.00% | 4.48% | ||||||||||||
Regulatory capital |
$ | 3,079,342 | $ | 4,152,158 | $ | 3,928,243 | $ | 4,399,053 | ||||||||
Leverage capital-to-assets ratio |
5.00% | 8.09% | 5.00% | 6.72% | ||||||||||||
Leverage capital |
$ | 3,849,178 | $ | 6,228,237 | $ | 4,910,303 | $ | 6,598,580 |
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As of September 30, 2009 and December 31, 2008, the FHLBank had (in thousands) $87,415 and $110,909
in capital stock classified as mandatorily redeemable capital stock on its Statements of Condition.
At the dates indicated, these balances were comprised as follows:
September 30, 2009 | December 31, 2008 | |||||||||||||||
Number of | Number of | |||||||||||||||
Stockholders | Amount | Stockholders | Amount | |||||||||||||
Capital stock subject to mandatory
redemption due to: |
||||||||||||||||
Withdrawals(1) |
17 | $ | 87,415 | 15 | $ | 110,679 | ||||||||||
Other redemptions |
- | - | 1 | 230 | ||||||||||||
Total |
17 | $ | 87,415 | 16 | $ | 110,909 | ||||||||||
(1) | Withdrawals primarily include members that attain non-member status by merger or acquisition, charter termination, or involuntary termination of membership. |
The following table provides the dollar amounts for activities recorded in mandatorily redeemable
capital stock for the noted period as follows (in thousands):
Balance, December 31, 2008 |
$ | 110,909 | ||
Capital stock subject to mandatory redemption reclassified
from equity: |
||||
Withdrawals |
15,182 | |||
Other redemptions |
375,616 | |||
Redemption (or other reduction) of mandatorily redeemable
capital stock: |
||||
Withdrawals |
(38,446 | ) | ||
Other redemptions |
(375,846 | ) | ||
Balance, September 30, 2009 |
$ | 87,415 | ||
The following table shows the amount of mandatorily redeemable capital stock by year of redemption
at the dates indicated (in thousands):
Contractual Year of Redemption | September 30, 2009 | December 31, 2008 | ||||||||
Due in 1 year or less |
$ | 5,268 | $ | 335 | ||||||
Due after 1 year through 2 years |
8,694 | 7,043 | ||||||||
Due after 2 years through 3 years |
48,896 | 7,524 | ||||||||
Due after 3 years through 4 years |
9,335 | 83,057 | ||||||||
Due after 4 years through 5 years |
15,222 | 12,950 | ||||||||
Total par value |
$ | 87,415 | $ | 110,909 | ||||||
Capital Concentration. The following table presents holdings of five percent or more of the
FHLBanks total Class B stock, including mandatorily redeemable capital stock, outstanding at the
dates indicated and includes stock held by any known affiliates that are members of the FHLBank
(dollars in millions):
September 30, 2009 | ||||||||
Percent | ||||||||
Name | Balance | of Total | ||||||
U.S. Bank, N.A. |
$ | 591 | 16 | % | ||||
National City Bank |
404 | 11 | ||||||
Fifth Third Bank |
401 | 11 | ||||||
The Huntington National Bank |
241 | 6 | ||||||
Total |
$ | 1,637 | 44 | % | ||||
December 31, 2008 | ||||||||
Percent | ||||||||
Name | Balance | of Total | ||||||
U.S. Bank, N.A. |
$ | 841 | 21 | % | ||||
National City Bank |
404 | 10 | ||||||
Fifth Third Bank |
394 | 10 | ||||||
The Huntington National Bank |
241 | 6 | ||||||
AmTrust Bank |
223 | 5 | ||||||
Total |
$ | 2,103 | 52 | % | ||||
31
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Note 14Comprehensive Income
The following table shows the FHLBanks comprehensive income for the three and nine months ended
September 30, 2009 and 2008 (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||
2009 | 2008 | 2009 | 2008 | ||||||||||||||
Net income |
$ | 61,489 | $ | 66,092 | $ | 219,263 | $ | 180,122 | |||||||||
Other comprehensive income: |
|||||||||||||||||
Net unrealized gain (loss) on
available-for-sale securities |
510 | (1,438 | ) | 534 | (1,438 | ) | |||||||||||
Pension and postretirement benefits |
311 | 129 | 624 | 479 | |||||||||||||
Total other comprehensive income |
821 | (1,309 | ) | 1,158 | (959 | ) | |||||||||||
Total comprehensive income |
$ | 62,310 | $ | 64,783 | $ | 220,421 | $ | 179,163 | |||||||||
Note 15Employee Retirement Plans
The FHLBank participates in the Pentegra Defined Benefit Plan for Financial Institutions (Pentegra
Defined Benefit Plan), a tax-qualified defined benefit pension plan. The Plan covers substantially
all officers and employees of the FHLBank. Funding and administrative costs of the Pentegra Defined
Benefit Plan charged to other operating expenses were $844,000 and $697,000 in the three months
ended September 30, 2009 and 2008, respectively, and $2,471,000 and $2,308,000 in the nine months
ended September 30, 2009 and 2008, respectively.
The FHLBank also participates in the Pentegra Defined Contribution Plan for Financial Institutions,
a tax-qualified defined contribution pension plan. The FHLBank contributes a percentage of the
participants compensation by making a matching contribution equal to a percentage of voluntary
employee contributions, subject to certain limitations. The FHLBank contributed $133,000 and
$125,000 to this Plan in the three months ended September 30, 2009 and 2008, respectively, and
$591,000 and $520,000 in the nine months ended September 30, 2009 and 2008, respectively.
The FHLBank has a Benefit Equalization Plan (BEP). The BEP is a non-qualified supplemental
retirement plan which restores those pension benefits that would be available under the qualified
plans (both defined benefit and defined contribution features) were it not for legal limitations on
such benefits. The FHLBank also sponsors a fully insured postretirement benefits program that
includes health care and life insurance benefits for eligible retirees.
The FHLBanks contributions to the defined contribution feature of the BEP use the same matching
rules as the qualified defined contribution plan discussed above as well as the market related
earnings. The FHLBanks contributions for the three and nine months ended September 30 were (in
thousands):
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Matching contributions |
$ | 25 | $ | 26 | $ | 92 | $ | 93 | ||||||||
Market related earnings (losses) |
514 | (225 | ) | 667 | (488 | ) | ||||||||||
Net |
$ | 539 | $ | (199 | ) | $ | 759 | $ | (395 | ) | ||||||
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Components of the net periodic benefit cost for the defined benefit feature of the BEP and the
postretirement benefits plan for the three and nine months ended September 30 were (in thousands):
Three Months Ended September 30, | ||||||||||||||||
Postretirement | ||||||||||||||||
BEP | Benefits Plan | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Net Periodic Benefit Cost |
||||||||||||||||
Service cost |
$ | 157 | $ | 130 | $ | 14 | $ | 12 | ||||||||
Interest cost |
337 | 259 | 48 | 46 | ||||||||||||
Amortization of unrecognized net loss |
311 | 129 | - | - | ||||||||||||
Net periodic benefit cost |
$ | 805 | $ | 518 | $ | 62 | $ | 58 | ||||||||
Nine Months Ended September 30, | ||||||||||||||||
Postretirement | ||||||||||||||||
BEP | Benefits Plan | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Net Periodic Benefit Cost |
||||||||||||||||
Service cost |
$ | 377 | $ | 296 | $ | 43 | $ | 37 | ||||||||
Interest cost |
884 | 748 | 144 | 136 | ||||||||||||
Amortization of unrecognized net loss |
624 | 479 | - | - | ||||||||||||
Net periodic benefit cost |
$ | 1,885 | $ | 1,523 | $ | 187 | $ | 173 | ||||||||
33
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Note 16Segment Information
The FHLBank has identified two primary operating segments based on its method of internal
reporting: Traditional Member Finance and the Mortgage Purchase Program. These segments reflect the
FHLBanks two primary Mission Asset Activities and the manner in which they are managed from the
perspective of development, resource allocation, product delivery, pricing, credit risk and
operational administration. The segments identify the primary ways the FHLBank provides services to
member stockholders.
The following tables set forth the FHLBanks financial performance by operating segment for the
three and nine months ended September 30, 2009 and 2008 (in thousands):
Three Months Ended September 30, | ||||||||||||||||
Traditional Member | Mortgage Purchase | |||||||||||||||
Finance | Program | Total | ||||||||||||||
2009 |
||||||||||||||||
Net interest income |
$ | 65,073 | $ | 26,033 | $ | 91,106 | ||||||||||
Other income |
4,112 | 3,020 | 7,132 | |||||||||||||
Other expenses |
12,007 | 2,172 | 14,179 | |||||||||||||
Income before assessments |
57,178 | 26,881 | 84,059 | |||||||||||||
Affordable Housing Program |
5,003 | 2,194 | 7,197 | |||||||||||||
REFCORP |
10,435 | 4,938 | 15,373 | |||||||||||||
Total assessments |
15,438 | 7,132 | 22,570 | |||||||||||||
Net income |
$ | 41,740 | $ | 19,749 | $ | 61,489 | ||||||||||
Average assets |
$ | 71,248,065 | $ | 9,807,156 | $ | 81,055,221 | ||||||||||
Total assets |
$ | 67,204,184 | $ | 9,779,378 | $ | 76,983,562 | ||||||||||
2008 |
||||||||||||||||
Net interest income |
$ | 73,758 | $ | 18,210 | $ | 91,968 | ||||||||||
Other income |
12,017 | 3 | 12,020 | |||||||||||||
Other expenses |
12,016 | 1,815 | 13,831 | |||||||||||||
Income before assessments |
73,759 | 16,398 | 90,157 | |||||||||||||
Affordable Housing Program |
6,205 | 1,338 | 7,543 | |||||||||||||
REFCORP |
13,510 | 3,012 | 16,522 | |||||||||||||
Total assessments |
19,715 | 4,350 | 24,065 | |||||||||||||
Net income |
$ | 54,044 | $ | 12,048 | $ | 66,092 | ||||||||||
Average assets |
$ | 86,100,391 | $ | 8,610,778 | $ | 94,711,169 | ||||||||||
Total assets |
$ | 88,714,455 | $ | 8,568,614 | $ | 97,283,069 | ||||||||||
34
Table of Contents
Nine Months Ended September 30, | |||||||||||||||||
Traditional Member | Mortgage Purchase | ||||||||||||||||
Finance | Program | Total | |||||||||||||||
2009 |
|||||||||||||||||
Net interest income |
$ | 218,257 | $ | 94,393 | $ | 312,650 | |||||||||||
Other income (loss) |
26,299 | (1,142 | ) | 25,157 | |||||||||||||
Other expenses |
33,033 | 5,723 | 38,756 | ||||||||||||||
Income before assessments |
211,523 | 87,528 | 299,051 | ||||||||||||||
Affordable Housing Program |
17,827 | 7,145 | 24,972 | ||||||||||||||
REFCORP |
38,739 | 16,077 | 54,816 | ||||||||||||||
Total assessments |
56,566 | 23,222 | 79,788 | ||||||||||||||
Net income |
$ | 154,957 | $ | 64,306 | $ | 219,263 | |||||||||||
Average assets |
$ | 77,593,865 | $ | 9,602,215 | $ | 87,196,080 | |||||||||||
Total assets |
$ | 67,204,184 | $ | 9,779,378 | $ | 76,983,562 | |||||||||||
2008 |
|||||||||||||||||
Net interest income |
$ | 203,871 | $ | 63,995 | $ | 267,866 | |||||||||||
Other income (loss) |
16,588 | (1,499 | ) | 15,089 | |||||||||||||
Other expenses |
31,693 | 5,358 | 37,051 | ||||||||||||||
Income before assessments |
188,766 | 57,138 | 245,904 | ||||||||||||||
Affordable Housing Program |
16,088 | 4,664 | 20,752 | ||||||||||||||
REFCORP |
34,535 | 10,495 | 45,030 | ||||||||||||||
Total assessments |
50,623 | 15,159 | 65,782 | ||||||||||||||
Net income |
$ | 138,143 | $ | 41,979 | $ | 180,122 | |||||||||||
Average assets |
$ | 84,503,576 | $ | 8,767,183 | $ | 93,270,759 | |||||||||||
Total assets |
$ | 88,714,455 | $ | 8,568,614 | $ | 97,283,069 | |||||||||||
35
Table of Contents
Note 17Fair Value Disclosures
The FHLBank records derivatives, trading securities and available-for-sale securities at fair value
on the Statements of Condition. Fair value is a market-based measurement and is defined as the
price that would be received to sell an asset, or paid to transfer a liability, in an orderly
transaction between market participants at the measurement date (an exit price). The transaction to
sell the asset or transfer the liability is a hypothetical transaction at the measurement date,
considered from the perspective of a market participant that holds the asset or owes the liability.
In order to determine whether a transaction price represents the fair value (or exit price) of an
asset or liability, the FHLBank must determine the unit of account, highest and best use, principal
or most advantageous market for the asset or liability, and the market participants with whom the
transaction would take place. These determinations allow the FHLBank to define the inputs for fair
value. In general, the transaction price will equal the exit price and, therefore, represent the
fair value of the asset or liability at initial recognition.
Fair Value Option. The fair value option provides an irrevocable option to elect fair value as an
alternative measurement for selected financial assets, financial liabilities, unrecognized firm
commitments, and written loan commitments not otherwise carried at fair value. It requires a
company to display the fair value of those assets and liabilities for which it has chosen to use
fair value on the face of the Statements of Condition. If the fair value option is elected, fair
value is used for both the initial and subsequent measurement of the designated assets, liabilities
and commitments, with the changes in fair value recognized in net income. The FHLBank did not elect
to record any financial assets or financial liabilities at fair value during the nine months ended
September 30, 2009.
Fair Value Hierarchy. The fair value hierarchy is used to prioritize the inputs of valuation
techniques used to measure fair value. The inputs are evaluated and an overall level for the
measurement is determined. This overall level is an indication of how market observable the fair
value measurement is and defines the level of disclosure. Outlined below is the application of the
fair value hierarchy to the FHLBanks financial assets and financial liabilities that were carried
at fair value at September 30, 2009.
Level
1 defined as those instruments for which inputs to the valuation methodology are quoted
prices (unadjusted) for identical assets or liabilities in active markets. An active market is a
market in which the transactions for the instrument occur with sufficient frequency and volume
to provide pricing information on an ongoing basis.
Level
2 defined as those instruments for which inputs to the valuation methodology include
quoted prices for similar instruments in active markets, and for which inputs are observable,
either directly or indirectly, for substantially the full term of the financial instrument. The
FHLBanks trading securities, available-for-sale securities and derivative instruments are
considered Level 2 instruments based on the inputs utilized to derive fair value.
Level
3 defined as those instruments for which inputs to the valuation methodology are
unobservable and significant to the fair value measurement. Unobservable inputs are those
supported by little or no market activity or by the entitys own assumptions.
36
Table of Contents
The FHLBank utilizes valuation techniques that maximize the use of observable inputs and minimize
the use of unobservable inputs. The valuation techniques, inputs, and validation processes (as
applicable) utilized by the FHLBank for the assets and liabilities carried at fair value at
September 30, 2009 and December 31, 2008 on the Statements of Condition were as follows:
Trading securities: The FHLBanks trading portfolio consists of discount notes issued by Freddie
Mac and mortgage-backed securities issued by Ginnie Mae. Quoted market prices in active markets are
not available for these securities. Therefore, the fair value of each discount note is determined
using indicative fair values derived from a discounted cash flow methodology using market-observed
inputs for the interest rate environment. For mortgage-backed securities, the FHLBank requests
prices from four specific third-party vendors, and, depending on the number of prices received for
each security, selects a median price as defined by the FHLBanks methodology. The methodology also
incorporates variance thresholds to assist in identifying prices that may require further review.
In certain limited instances (i.e., prices remain outside of variance thresholds or there is no
price available from the third-party services), the FHLBank could obtain a price from securities
dealers or internally model a price that is deemed most appropriate after consideration of all
relevant facts and circumstances that would be considered by market participants. The third-party
vendors use price indications, which generally utilize processes that could include, but are not
limited to, the following market observable components: trader inputs, calculated inputs, matrix
development, and evaluation models. The third-party vendors derive the fair value from an
option-adjusted spread or discounted cash flow methodology.
Available-for-sale securities: The FHLBanks available-for-sale portfolio consists of certificates
of deposit and bank notes. Quoted market prices in active markets are not available for these
securities. Therefore, the fair value of each security is determined using indicative fair values
derived from an option-adjusted discounted cash flow methodology using market-observed inputs for
the interest rate environment and similar instruments.
The FHLBank performs several validation steps in order to verify the accuracy and reasonableness of
these fair values. These steps may include, but are not limited to, a detailed review of
instruments with significant periodic price changes and a comparison of the fair values received
from multiple third-party sources.
Derivative assets/liabilities: The FHLBanks derivative assets/liabilities consist of interest rate
swaps, to-be-announced mortgage-backed securities and mortgage delivery commitments. The FHLBanks
interest rate swaps are not listed on an exchange. Therefore, the FHLBank determines the fair value
of each individual interest rate swap using market value models that use readily observable market
inputs as their basis (inputs that are actively quoted and can be validated to external sources).
The FHLBank uses a mid-market pricing convention as a practical expedient for fair value
measurements within a bid-ask spread. These models reflect the contractual terms of the interest
rate swaps, including the period to maturity, and estimate fair value based on the LIBOR swap curve
and forward rates at period end and, for agreements containing options, on market-based
expectations of future interest rate volatility implied from current market prices for similar
options. The estimated fair value uses the standard valuation technique of discounted cash flow
analysis.
The FHLBank performs several validation steps to verify the reasonableness of the fair value output
generated by the primary market value model. In addition to an annual model validation, the FHLBank
prepares a monthly reconciliation of the models fair values to estimates of fair values provided
by the derivative counterparties and to another third party model. The FHLBank believes these
processes have provided a reasonable basis for it to place continued reliance on the derivative
fair values generated by the primary model.
The fair value of to-be-announced mortgage-backed securities is based on independent indicative
and/or quoted prices generated by market transactions involving comparable instruments. The FHLBank
determines the fair value of mortgage delivery commitments using market prices from the
TBA/mortgage-backed security market or TBA/Ginnie Mae market and adjusts them to reflect the
contractual terms of the mortgage delivery commitments, similar to the mortgage loans held for
portfolio process. The adjustments to the market prices are market observable, or can be
corroborated with observable market data.
The FHLBank is subject to credit risk in derivatives transactions due to potential nonperformance
by the derivatives counterparties. To mitigate this risk, the FHLBank enters into derivatives with
highly-rated institutions and executes master netting agreements with its derivative
counterparties. In addition, to limit the FHLBanks net unsecured credit exposure to these
counterparties, the FHLBank has entered into bilateral security agreements with all active
derivatives dealer counterparties that provide for delivery of collateral at specified levels tied
to counterparty credit ratings. The FHLBank has
37
Table of Contents
evaluated the potential for the fair value of the instruments to be impacted by counterparty credit
risk and has determined that no adjustments were significant or necessary to the overall fair value
measurements at September 30, 2009.
Fair Value on a Recurring Basis. The following table presents for each hierarchy level, the
FHLBanks assets and liabilities that were measured at fair value on its Statements of Condition at
the dates indicated (in thousands):
Fair Value Measurements at September 30, 2009 Using:
Netting | ||||||||||||||||||||
Adjustment | ||||||||||||||||||||
and Cash | ||||||||||||||||||||
Level 1 | Level 2 | Level 3 | Collateral (1) | Total | ||||||||||||||||
Assets |
||||||||||||||||||||
Trading securities: |
||||||||||||||||||||
Non mortgage-backed securities
government-sponsored enterprise debt |
$ | - | $ | 2,249,755 | $ | - | $ | - | $ | 2,249,755 | ||||||||||
Other U.S. obligation residential
mortgage-backed securities |
- | 2,813 | - | - | 2,813 | |||||||||||||||
Available-for-sale securities: |
||||||||||||||||||||
Certificates of deposit |
- | 5,725,076 | - | - | 5,725,076 | |||||||||||||||
Derivative assets |
- | 203,179 | - | (194,315 | ) | 8,864 | ||||||||||||||
Total assets at fair value |
$ | - | $ | 8,180,823 | $ | - | $ | (194,315 | ) | $ | 7,986,508 | |||||||||
Liabilities |
||||||||||||||||||||
Derivative liabilities |
$ | - | $ | (961,708 | ) | $ | - | $ | 691,866 | $ | (269,842 | ) | ||||||||
Total liabilities at fair value |
$ | - | $ | (961,708 | ) | $ | - | $ | 691,866 | $ | (269,842 | ) | ||||||||
Fair Value Measurements at December 31, 2008 Using:
Netting | ||||||||||||||||||||
Adjustment | ||||||||||||||||||||
and Cash | ||||||||||||||||||||
Level 1 | Level 2 | Level 3 | Collateral (1) | Total | ||||||||||||||||
Assets |
||||||||||||||||||||
Trading securities: |
||||||||||||||||||||
Other U.S. obligation residential
mortgage-backed securities |
$ | - | $ | 2,985 | $ | - | $ | - | $ | 2,985 | ||||||||||
Available-for-sale securities: |
||||||||||||||||||||
Certificates of deposit
and bank notes |
- | 2,511,630 | - | - | 2,511,630 | |||||||||||||||
Derivative assets |
- | 239,957 | - | (222,647 | ) | 17,310 | ||||||||||||||
Total assets at fair value |
$ | - | $ | 2,754,572 | $ | - | $ | (222,647 | ) | $ | 2,531,925 | |||||||||
Liabilities |
||||||||||||||||||||
Derivative liabilities |
$ | - | $ | (1,238,018 | ) | $ | - | $ | 951,542 | $ | (286,476 | ) | ||||||||
Total liabilities at fair value |
$ | - | $ | (1,238,018 | ) | $ | - | $ | 951,542 | $ | (286,476 | ) | ||||||||
(1) | Amounts represent the effects of legally enforceable master netting agreements that allow the FHLBank to settle positive and negative positions and of cash collateral held or placed with the same counterparties. |
For instruments carried at fair value, the FHLBank reviews the fair value hierarchy classifications
on a quarterly basis. Changes in the observability of the valuation attributes may result in a
reclassification of certain financial assets or liabilities. Such reclassifications are reported as
transfers in/out of a level at fair value in the quarter in which the changes occur.
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Estimated Fair Values. The estimated fair value amounts shown on the following Fair Value Summary
Table have been determined by the FHLBank using available market information and the FHLBanks best
judgment of appropriate valuation methods. These estimates are based on pertinent information
available to the FHLBank as of September 30, 2009 and December 31, 2008. The estimated fair values
reflect the FHLBanks judgment of how a market participant would estimate the fair values. The Fair
Value Summary Table does not represent an estimate of the overall market value of the FHLBank as a
going concern, which would take into account future business opportunities and the net
profitability of assets versus liabilities. The valuation techniques, inputs, and validation
processes (as applicable) utilized by the FHLBank for the assets and liabilities at September 30,
2009 and December 31, 2008 on the Fair Value Summary Table were as follows:
Cash and due from banks: The estimated fair value approximates the recorded book balance.
Interest-bearing deposits and investment securities: The estimated fair value is determined based
on each securitys quoted prices, excluding accrued interest, as of the last business day of the
period.
Federal funds sold: The estimated fair value of overnight Federal funds approximates the recorded
book balance. The estimated fair value of term Federal funds is determined by calculating the
present value of the expected future cash flows. The discount rates used in these calculations are
the rates for Federal funds with similar terms, as approximated by adding an estimated current
spread to the LIBOR swap curve for Federal funds with similar terms. The estimated fair value
excludes accrued interest.
Held-to-maturity securities: The estimated fair value for each individual mortgage-backed security
and collateralized mortgage obligation is obtained by requesting prices from four specific
third-party vendors, and, depending on the number of prices received for each security, selecting a
median price as defined by the FHLBanks methodology. The methodology also incorporates variance
thresholds to assist in identifying prices that may require further review. In certain limited
instances (i.e., prices remain outside of variance thresholds or there is no price available from
the third-party services), the FHLBank could obtain a price from securities dealers or internally
model a price that is deemed most appropriate after consideration of all relevant facts and
circumstances that would be considered by market participants. The third-party vendors use price
indications, which generally utilize processes that could include, but are not limited to, the
following market observable components: trader inputs, calculated inputs, matrix development, and
evaluation models. The third-party vendors derive the fair value from an option-adjusted spread or
discounted cash flow methodology. The estimated fair value excludes accrued interest. The estimated
fair value for taxable municipal bonds is determined based on each securitys indicative market
price obtained from a third-party vendor excluding accrued interest. The FHLBank uses various
techniques to validate the fair values received from third-party vendors for accuracy and
reasonableness.
Advances: The FHLBank determines the estimated fair value of Advances by calculating the present
value of expected future cash flows from the Advances excluding accrued interest. The discount
rates used in these calculations are the replacement rates for Advances with similar terms, as
approximated either by adding an estimated current spread to the LIBOR swap curve or by using
current indicative market yields, as indicated by the FHLBanks Advance pricing methodologies for
Advances with similar current terms. Advance pricing is determined based on the FHLBanks rates on
Consolidated Obligations. In accordance with Finance Agency Regulations, Advances with a maturity
and repricing period greater than six months require a prepayment fee sufficient to make the
FHLBank financially indifferent to the borrowers decision to prepay the Advances. Therefore, the
estimated fair value of Advances does not assume prepayment risk.
For swapped option-based Advances, the estimated fair value is determined (independently of the
related derivative) by the discounted cash flow methodology based on the LIBOR swap curve and
forward rates at the end of the period adjusted for the estimated current spread on new swapped
Advances to the swap curve. For swapped Advances with a conversion option, the conversion option is
valued by taking into account the LIBOR swap curve and forward rates at the end of the period and
the markets expectations of future interest rate volatility implied from current market prices of
similar options.
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Mortgage loans held for portfolio, net: The estimated fair values of mortgage loans are determined
based on quoted market prices offered to approved members as indicated by the FHLBanks Mortgage
Purchase Program pricing methodologies for mortgage loans with similar current terms excluding
accrued interest. The quoted prices offered to members are based on Fannie Mae price indications on
to-be-announced mortgage-backed securities and FHA price indications on government-guaranteed
loans; the FHLBank then adjusts these indicative prices to account for particular features of the
FHLBanks Mortgage Purchase Program that differ from the Fannie Mae and FHA securities. These
features include, but may not be limited to:
§ | the Mortgage Purchase Programs credit enhancements; | ||
§ | marketing adjustments that reflect the FHLBanks cooperative business model, and preferences for particular kinds of loans and mortgage note rates. |
These prices, however, can change rapidly based upon market conditions and are highly dependent
upon the underlying prepayment assumptions.
Accrued interest receivable and payable: The estimated fair value approximates the recorded book
value.
Deposits: The FHLBank determines the estimated fair value of FHLBank deposits with fixed rates 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 the cost of
deposits with similar terms.
Consolidated Obligations: The FHLBank determines the estimated fair value of Discount Notes by
calculating the present value of expected future cash flows from the Discount Notes excluding
accrued interest. The discount rates used in these calculations are current replacement rates for
Discount Notes with similar current terms, as approximated by adding an estimated current spread to
the LIBOR swap curve. Each months cash flow is discounted at that months replacement rate.
The FHLBank determines the estimated fair value of non-callable Consolidated Obligation Bonds (both
unswapped and swapped) by calculating the present value of scheduled future cash flows from the
bonds excluding accrued interest. The discount rates used in these calculations are estimated
current market yields, as indicated by the Office of Finance, for bonds with similar current terms.
The FHLBank determines the estimated fair value of callable Consolidated Obligation Bonds (both
unswapped and swapped) by calculating the present value of expected future cash flows from the
bonds excluding accrued interest. The estimated fair value is determined by the discounted cash
flow methodology based on the LIBOR swap curve and forward rates adjusted for the estimated spread
on new callable bonds to the swap curve and based on the markets expectations of future interest
rate volatility implied from current market prices of similar options.
Adjustments may be necessary to reflect the 12 FHLBanks credit quality when valuing Consolidated
Obligation Bonds measured at fair value. Due to the joint and several liability of Consolidated
Obligations, the FHLBank monitors its own creditworthiness and the creditworthiness of the other
FHLBanks to determine whether any credit adjustments are necessary in its fair value measurement of
Consolidated Obligation Bonds. The credit ratings of the FHLBanks and any changes to these credit
ratings are the basis for the FHLBanks to determine whether the fair values of Consolidated
Obligation Bonds have been significantly affected during the reporting period by changes in the
instrument-specific credit risk. The FHLBank had no adjustment during the nine months ended
September 30, 2009.
Mandatorily redeemable capital stock: The fair value of capital subject to mandatory redemption is
par value for the dates indicated as indicated by member contemporaneous purchases and sales at par
value. FHLBank stock can only be acquired by members at par value and redeemed at par value.
FHLBank stock is not traded and no market mechanism exists for the exchange of stock outside the
cooperative structure.
Commitments: The estimated fair value of the FHLBanks commitments to extend credit is determined
using the fees currently charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the present creditworthiness of the counterparties. For
fixed-rate loan commitments, fair value also considers the difference between current levels of
interest rates and the committed rates. The estimated fair value of Standby Letters of Credit is
based on the present value of fees currently charged for similar agreements or on the estimated
cost to terminate them or otherwise settle the obligations with the counterparties. The estimated
fair value of standby bond purchase agreements is based on the present value of the estimated fees
taking into account the remaining terms of the agreements.
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Subjectivity of estimates. Estimates of the fair value of Advances with options, mortgage
instruments, derivatives with embedded options and bonds with options using the methods described
above and other methods are highly subjective and require judgments regarding significant matters
such as the amount and timing of future cash flows, prepayment speeds, interest rate volatility,
distributions of future interest rates used to value options, and discount rates that appropriately
reflect market and credit risks. The judgments also include the parameters, methods, and
assumptions used in models to value the options. Changes in these judgments often have a material
effect on the fair value estimates. Since these estimates are made as of a specific point in time,
they are susceptible to material near term changes.
The carrying values and estimated fair values of the FHLBanks financial instruments at September
30, 2009 and December 31, 2008 were as follows (in thousands):
FAIR VALUE SUMMARY TABLE
September 30, 2009 | December 31, 2008 | |||||||||||||||
Carrying | Estimated | Carrying | Estimated | |||||||||||||
Financial Instruments | Value | Fair Value | Value | Fair Value | ||||||||||||
Assets: |
||||||||||||||||
Cash and due from banks |
$ | 2,733,228 | $ | 2,733,228 | $ | 2,867 | $ | 2,867 | ||||||||
Interest-bearing deposits |
166 | 166 | 19,906,234 | 19,906,234 | ||||||||||||
Federal funds sold |
5,775,000 | 5,775,000 | - | - | ||||||||||||
Trading securities |
2,252,568 | 2,252,568 | 2,985 | 2,985 | ||||||||||||
Available-for-sale securities |
5,725,076 | 5,725,076 | 2,511,630 | 2,511,630 | ||||||||||||
Held-to-maturity securities |
12,471,895 | 12,947,773 | 12,904,200 | 13,163,337 | ||||||||||||
Advances |
38,082,056 | 38,298,971 | 53,915,972 | 54,150,919 | ||||||||||||
Mortgage loans held for portfolio, net |
9,736,249 | 10,062,477 | 8,631,873 | 8,888,577 | ||||||||||||
Accrued interest receivable |
161,166 | 161,166 | 275,560 | 275,560 | ||||||||||||
Derivative assets |
8,864 | 8,864 | 17,310 | 17,310 | ||||||||||||
Liabilities: |
||||||||||||||||
Deposits |
(1,669,448 | ) | (1,669,669 | ) | (1,193,461 | ) | (1,193,818 | ) | ||||||||
Consolidated Obligations: |
||||||||||||||||
Discount Notes |
(29,169,806 | ) | (29,171,619 | ) | (49,335,739 | ) | (49,383,752 | ) | ||||||||
Bonds |
(41,202,616 | ) | (42,042,752 | ) | (42,392,785 | ) | (43,298,966 | ) | ||||||||
Mandatorily redeemable capital stock |
(87,415 | ) | (87,415 | ) | (110,909 | ) | (110,909 | ) | ||||||||
Accrued interest payable |
(290,706 | ) | (290,706 | ) | (394,346 | ) | (394,346 | ) | ||||||||
Derivative liabilities |
(269,842 | ) | (269,842 | ) | (286,476 | ) | (286,476 | ) | ||||||||
Other: |
||||||||||||||||
Commitments to extend credit for Advances |
- | - | - | 284 | ||||||||||||
Standby bond purchase agreements |
- | 2,174 | - | 2,155 |
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Note 18Commitments and Contingencies
During the third quarter of 2008, the FHLBank entered into a Lending Agreement with the U.S.
Treasury in connection with the U.S. Treasurys establishment of the Government Sponsored
Enterprise Credit Facility (GSECF), as authorized by HERA. As of September 30, 2009, the FHLBank
had provided the U.S. Treasury with listings of Advance collateral amounting to $19.0 billion,
which provides for maximum borrowings of $16.8 billion. The 12 FHLBanks have joint and several
liability for any liquidity accessed by an FHLBank under the GSECF. Neither the FHLBank nor any of
the other FHLBanks had drawn on this available source of liquidity as of September 30, 2009.
The following table sets forth the FHLBanks commitments at the dates indicated (in thousands):
September 30, 2009 | December 31, 2008 | |||||||
Commitments to fund additional Advances |
$ | - | $ | 4,541 | ||||
Mandatory Delivery Contracts for mortgage loans |
126,566 | 917,435 | ||||||
Forward rate agreements |
- | 386,000 | ||||||
Outstanding Standby Letters of Credit |
5,564,203 | 7,916,613 | ||||||
Consolidated Obligations committed to, not settled (par value) (1) |
385,300 | 225,000 | ||||||
Standby bond purchase agreements (principal) |
411,965 | 413,125 |
(1) At September 30, 2009, $165 million of these commitments were hedged with associated
interest rate swaps.
In addition, the 12 FHLBanks have joint and several liability for the par amount of all of the
Consolidated Obligations issued on their behalves. The par amounts of the outstanding Consolidated
Obligations of all 12 FHLBanks were $973.6 billion and $1,251.5 billion at September 30, 2009 and
December 31, 2008, respectively.
Note 19Transactions with Other FHLBanks
The FHLBank notes all transactions with other FHLBanks on the face of its financial statements.
Occasionally, the FHLBank loans short-term funds to and borrows short-term funds from other
FHLBanks. These loans and borrowings are transacted at then current market rates when traded. There
were no such loans or borrowings outstanding at September 30, 2009 or December 31, 2008.
Additionally, the FHLBank occasionally invests in Consolidated Discount Notes issued on behalf of
another FHLBank. These investments are purchased in the open market from third parties and are
accounted for in the same manner as other similarly classified investments. There were no such
investments outstanding at September 30, 2009 or December 31, 2008. The following table details the
average daily balance of lending, borrowing and investing between the FHLBank and other FHLBanks
for the nine months ended September 30 (in thousands):
Average Daily Balances | ||||||||
2009 | 2008 | |||||||
Loans to other FHLBanks |
$ | 14,037 | $ | 14,792 | ||||
Borrowings from other FHLBanks |
1,832 | - | ||||||
Investments in other FHLBanks |
9,092 | - |
The FHLBank may, from time to time, assume the outstanding primary liability for Consolidated
Obligations of another FHLBank (at then current market rates on the day when the transfer is
traded) rather than issue new debt for which the FHLBank is the primary obligor. The FHLBank then
becomes the primary obligor on the transferred debt. There were no Consolidated Obligations
transferred to the FHLBank during the nine months ended September 30, 2009. During the nine months
ended September 30, 2008, the par amounts of the liability on Consolidated Obligations transferred
to the FHLBank totaled (in thousands) $265,000, being (in thousands) $150,000 transferred by the
FHLBank of Dallas and $115,000 transferred by the FHLBank of Chicago. The net premiums associated
with these transactions were (in thousands) $6,988 during the nine months ended September 30, 2008.
The FHLBank did not transfer any Consolidated Obligations to other FHLBanks during these periods.
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Note 20Transactions with Stockholders
Transactions with Directors Financial Institutions. In the ordinary course of its
business, the FHLBank may provide products and services to members whose officers or directors
serve as directors of the FHLBank (Directors Financial Institutions). Finance Agency regulations
require that transactions with Directors Financial Institutions be made on the same terms as those
with any other member. The following table reflects balances with Directors Financial Institutions
for the items indicated below at the dates indicated (dollars in millions):
September 30, 2009 | December 31, 2008 | |||||||||||||||
Balance | % of Total (1) | Balance | % of Total (1) | |||||||||||||
Advances |
$ | 1,210 | 3.2 | % | $ | 734 | 1.4 | % | ||||||||
Mortgage Purchase Program |
110 | 1.1 | 29 | 0.3 | ||||||||||||
Mortgage-backed securities |
- | - | - | - | ||||||||||||
Regulatory capital stock |
179 | 4.8 | 61 | 1.5 | ||||||||||||
Derivatives |
- | - | - | - |
(1) | Percentage of total principal (Advances), unpaid principal balance (Mortgage Purchase Program), principal balance (mortgage-backed securities), regulatory capital stock, and notional balances (derivatives). |
Concentrations. The following tables show regulatory capital stock balances,
outstanding Advance principal balances, and unpaid principal balances of Mortgage Loans Held for
Portfolio at the dates indicated to members and former members holding five percent or more of
regulatory capital stock and include any known affiliates that are members of the FHLBank (dollars
in millions):
Regulatory | Mortgage Purchase | |||||||||||||||
Capital Stock | Advance | Program Unpaid | ||||||||||||||
September 30, 2009 |
Balance | % of Total | Principal | Principal Balance | ||||||||||||
U. S. Bank, N.A. |
$ | 591 | 16 | % | $ | 10,315 | $ | 99 | ||||||||
National City Bank |
404 | 11 | 4,409 | 3,763 | ||||||||||||
Fifth Third Bank |
401 | 11 | 2,038 | 12 | ||||||||||||
The Huntington National Bank |
241 | 6 | 921 | 289 | ||||||||||||
Total |
$ | 1,637 | 44 | % | $ | 17,683 | $ | 4,163 | ||||||||
Regulatory | Mortgage Purchase | |||||||||||||||
Capital Stock | Advance | Program Unpaid | ||||||||||||||
December
31, 2008 |
Balance | % of Total | Principal | Principal Balance | ||||||||||||
U. S. Bank, N.A. |
$ | 841 | 21 | % | $ | 14,856 | $ | 116 | ||||||||
National City Bank |
404 | 10 | 6,435 | 4,709 | ||||||||||||
Fifth Third Bank |
394 | 10 | 5,639 | 15 | ||||||||||||
The Huntington National Bank |
241 | 6 | 2,590 | 310 | ||||||||||||
AmTrust Bank |
223 | 5 | 2,338 | - | ||||||||||||
Total |
$ | 2,103 | 52 | % | $ | 31,858 | $ | 5,150 | ||||||||
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Non-member Affiliates. The FHLBank has relationships with two non-member affiliates, the
Kentucky Housing Corporation and the Ohio Housing Finance Agency. The nature of these relationships
is twofold: one as an approved borrower from the FHLBank and one in which the FHLBank invests in
the purchase of these non-members bonds. The Kentucky Housing Corporation and the Ohio Housing
Finance Agency had no borrowings during the nine months ended September 30, 2009 or 2008. The
FHLBank had principal investments in the bonds of the Kentucky Housing Corporation of $11,185,000
and $12,075,000 as of September 30, 2009 and December 31, 2008, respectively. The FHLBank did not
have any investments in the bonds of the Ohio Housing Finance Agency as of September 30, 2009 and
December 31, 2008. Charles J. Ruma, a Director of the FHLBank, serves on the board of the Ohio
Housing Finance Agency. The FHLBank did not have any investments in or borrowings extended to any
other non-member affiliates during the nine months ended September 30, 2009 or 2008.
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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
This document contains forward-looking statements that describe the objectives, expectations,
estimates, and assessments of the FHLBank. These statements use words such as anticipates,
expects, believes, could, estimates, may, and should. By their nature, forward-looking
statements relate to matters involving risks or uncertainties, some of which we may not be able to
know, control, or completely manage. Actual future results could differ materially from those
expressed or implied in forward-looking statements or could affect the extent to which we are able
to realize an objective, expectation, estimate, or assessment. Some of the risks and uncertainties
that could affect our forward-looking statements include the following:
§ | the effects of economic, financial, credit, market, and member conditions on our financial condition and results of operations, including changes in economic growth, general liquidity conditions, interest rates, interest rate spreads, interest rate volatility, mortgage originations, prepayment activity, housing prices, asset delinquencies, and members mergers and consolidations, deposit flows, liquidity needs, and loan demand; | |
§ | political events, including legislative, regulatory, federal government, judicial or other developments that could affect us, our members, our counterparties, other FHLBanks and other government-sponsored enterprises, and/or investors in the FHLBank Systems Consolidated Obligations; | |
§ | competitive forces, including those related to other sources of funding available to members, to purchases of mortgage loans, and to our issuance of Consolidated Obligations; | |
§ | the financial results and actions of other FHLBanks that could affect our ability, in relation to the Systems joint and several liability for Consolidated Obligations, to access the capital markets on favorable terms or preserve our profitability, or could alter the regulations and legislation to which we are subject; | |
§ | changes in investor demand for Consolidated Obligations; | |
§ | the volatility of market prices, interest rates, credit quality, and other indices that could affect the value of investments and collateral we hold as security for member obligations and/or for counterparty obligations; | |
§ | the ability to attract and retain skilled individuals; | |
§ | the ability to sufficiently develop and support technology and information systems to effectively manage the risks we face; | |
§ | the ability to successfully manage new products and services; | |
§ | the risk of loss arising from litigation filed against us or one or more of the other FHLBanks; and | |
§ | inflation and deflation. |
The FHLBank does not undertake any obligation to update any forward-looking statements made in this
document.
In this filing, the interrelated disruptions in 2008s and 2009s financial, credit, housing,
capital, and mortgage markets are referred to generally as the financial crisis.
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EXECUTIVE OVERVIEW
Organizational Structure and Business Activities
The Federal Home Loan Bank of Cincinnati (FHLBank) is a regional wholesale bank that provides
financial products and services to our member financial institutions. We are one of 12 District
Banks in the Federal Home Loan Bank System (FHLBank System); our region, known as the Fifth
District, comprises Kentucky, Ohio and Tennessee. Each District Bank is a government-sponsored
enterprise (GSE) of the United States of America and operates as a separate entity with its own
stockholders, employees, and Board of Directors. A GSE combines private sector ownership with
public sector sponsorship. The FHLBanks are not government agencies but are exempt from federal,
state, and local taxation (except real property taxes). The U.S. government does not guarantee the
debt securities or other obligations of the FHLBank System. In addition to being GSEs, the FHLBanks
are cooperative institutions. This means that private-sector financial institutions voluntarily
become members of our FHLBank and purchase our capital stock in order to gain access to products
and services. Only members can purchase our capital stock.
Our FHLBanks mission is to provide financial intermediation between our member stockholders and
the capital markets in order to facilitate and expand the availability of financing for housing and
community lending throughout the Fifth District. We achieve our mission through a cooperative
business model. We raise private-sector capital from our member stockholders and issue high-quality
debt in the worldwide capital markets in conjunction with other FHLBanks to provide members with
competitive servicesprimarily a reliable, readily available, low-cost source of funds called
Advancesand a competitive return on their FHLBank capital investment through quarterly dividend
payments. An important component of our mission is supporting members in their efforts to assist
lower-income housing markets.
The FHLBank System also includes the Federal Housing Finance Agency (Finance Agency) and the Office
of Finance. The Finance Agency is an independent agency in the executive branch of the U.S.
government that regulates the FHLBanks, the Federal National Mortgage Association (Fannie Mae) and
the Federal Home Loan Mortgage Corporation (Freddie Mac). The Finance Agency also oversees the
conservatorships of Fannie Mae and Freddie Mac. The Office of Finance is a joint office of the
District Banks established by the Finance Agency to facilitate the issuing and servicing of the
FHLBank Systems debt securities (called Consolidated Obligations or Obligations).
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Financial Condition
Mission Asset Activity
The following table summarizes our financial condition.
Ending Balances | Average Balances | |||||||||||||||||||||||
Nine Months Ended | Year Ended | |||||||||||||||||||||||
September 30, | December 31, | September 30, | December 31, | |||||||||||||||||||||
(Dollars in millions) | 2009 | 2008 | 2008 | 2009 | 2008 | 2008 | ||||||||||||||||||
Advances (principal) |
$ | 37,254 | $ | 62,580 | $ | 52,799 | $ | 46,058 | $ | 60,441 | $ | 59,973 | ||||||||||||
Mortgage Purchase Program: |
||||||||||||||||||||||||
Mortgage loans held for portfolio (principal) |
9,650 | 8,462 | 8,590 | 9,489 | 8,661 | 8,621 | ||||||||||||||||||
Mandatory Delivery Contracts (notional) |
126 | 178 | 917 | 705 | 141 | 182 | ||||||||||||||||||
Total Mortgage Purchase
Program |
9,776 | 8,640 | 9,507 | 10,194 | 8,802 | 8,803 | ||||||||||||||||||
Letters of Credit (notional) |
5,564 | 8,023 | 7,917 | 6,057 | 7,824 | 7,894 | ||||||||||||||||||
Total Mission Asset Activity |
$ | 52,594 | $ | 79,243 | $ | 70,223 | $ | 62,309 | $ | 77,067 | $ | 76,670 | ||||||||||||
Retained earnings |
$ | 407 | $ | 319 | $ | 326 | $ | 398 | $ | 327 | $ | 335 | ||||||||||||
Capital-to-assets ratio |
5.27 | % | 4.40 | % | 4.36 | % | 4.98 | % | 4.36 | % | 4.37 | % | ||||||||||||
Regulatory capital-to-assets ratio (1) |
5.39 | 4.54 | 4.48 | 5.16 | 4.50 | 4.51 |
(1) See the Capital Resources section for further description of regulatory capital.
The trends in our financial condition that began in the fourth quarter of 2008 continued in
the first nine months of 2009. The ending and average balances of Mission Asset Activitycomprised
of Advances, Letters of Credit, and the Mortgage Purchase Programdecreased in each of the first
three quarters of 2009. Overall, Advances and Letters of Credit fell, while balances in the
Mortgage Purchase Program increased.
Comparing September 30, 2009 to December 31, 2008, the total principal balance of Mission Asset
Activity decreased $17,629 million (25 percent). The principal balance of Advances fell $15,545
million (29 percent), the notional principal of Letters of Credit fell $2,353 million (30 percent),
and aggregate balances and commitments in the Mortgage Purchase Program grew $269 million (3
percent). The decrease in Advances was even larger (a 40 percent reduction) from September 30, 2008
to September 30, 2009 because Advance balances began to decrease in the fourth quarter of 2008
after they had reached record highs in October 2008. The decrease in Advances occurred broadly
throughout our membership but was disproportionately represented by our larger members.
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We believe that Advance balances have decreased from their high point in 2008 for three reasons.
§ | The economic recession resulted in members slower loan growth in the second half of 2008 and a decrease in their loans outstanding in the first three quarters of 2009. | ||
§ | There was a substantial increase in members retail deposits. | ||
§ | The availability to members of new funding and liquidity options increased dramatically due to the various fiscal and monetary stimuli and financial guarantees initiated by the federal government, including most importantly the Federal Reserve System and Treasury Department, to combat the financial crisis and recession. In particular, new sources of government-induced liquidity through the Troubled Asset Relief Program (TARP) and the exponential increase in bank reserves initiated by the Federal Reserve have decreased demand for our Advances. |
We expect Advance demand to remain weak until monetary policy tightens and an economic recovery
begins with expansion of financial institutions lending.
Despite the decrease in Advance balances, we continued to fulfill our business role as an important
provider of reliable and attractively priced wholesale funding to our members. Although various
measures of market penetration have decreased this year, members overall continue to fund over five
percent of their assets with our Advances. Our Advance business is cyclical, and we expect slower
growth, if not a decrease, in an economic contraction, especially when combined with the
extraordinary liquidity that the federal government has provided.
The total principal balance of the Mortgage Purchase Program grew in the first nine months of 2009
due to accelerated refinancing activity in response to lower mortgage rates, especially in the
first quarter. The Program currently has strong member participation and interest. This was
evidenced this year by the 23 members approved for the Program, with a similar number of additional
applications currently being processed for approval, and an over 50 percent increase in regular
sellers.
Based on the strong earnings in the first nine months of 2009, we accrued an additional $25 million
for future use in the Affordable Housing Program, a $4 million increase over the same period in
2008. By regulation, we annually set aside 10 percent of net income before assessments for this
Program. In addition, in April 2009, our Board authorized $5 million in commitments for two
voluntary housing programs. We have disbursed more than $15 million of voluntary housing-related
funds since 2003, which are over and above the statutory Affordable Housing requirements.
Capital
Our capital adequacy continued to be strong in the first nine months of 2009 and we maintained
compliance with all of our regulatory and internal capital limits. Regulatory capital (which
includes capital stock accounted for as a liability under mandatorily redeemable stock) at
September 30, 2009 totaled $4,152 million, a $247 million (6 percent) decrease from year-end 2008.
The decrease in capital resulted from our repurchase of $415 million of stock, most of which had
been the subject of two members excess stock redemption requests. These repurchases were partially
offset by required stock purchases from other members and increases in retained earnings. The
regulatory capital-to-assets ratio at September 30 was 5.39 percent, well above the regulatory
minimum of 4.00 percent and at a sufficient level to enable us to effectively manage our financial
performance and risk exposures. Retained earnings, which totaled $407 million on September 30, grew
$81 million (25 percent) in the first nine months. The business and market environment generated
sufficient earnings for us to pay stockholders a competitive dividend return in each of the first
three quarters as well as to retain a substantial portion of earnings to bolster our
capitalization.
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Results of Operations
The table below summarizes our results for operations.
Three Months | Nine Months | Year Ended | ||||||||||||||||||
Ended September 30, | Ended September 30, | December 31, | ||||||||||||||||||
(Dollars in millions) | 2009 | 2008 | 2009 | 2008 | 2008 | |||||||||||||||
Net income |
$ | 61 | $ 66 | $ | 219 | $ 180 | $ 236 | |||||||||||||
Affordable Housing Program accrual |
7 | 8 | 25 | 21 | 27 | |||||||||||||||
Return on average equity (ROE) |
5.70 | % | 6.26% | 6.75 | % | 5.92% | 5.73% | |||||||||||||
Return on average assets |
0.30 | 0.28 | 0.34 | 0.26 | 0.25 | |||||||||||||||
Weighted average dividend rate |
5.00 | 5.50 | 4.67 | 5.42 | 5.31 | |||||||||||||||
Average 3-month LIBOR |
0.41 | 2.91 | 0.83 | 2.98 | 2.92 | |||||||||||||||
Average overnight Federal Funds effective rate |
0.15 | 1.94 | 0.17 | 2.40 | 1.92 | |||||||||||||||
ROE spread to 3-month LIBOR |
5.29 | 3.35 | 5.92 | 2.94 | 2.81 | |||||||||||||||
Dividend rate spread to 3-month LIBOR |
4.59 | 2.59 | 3.84 | 2.44 | 2.39 | |||||||||||||||
ROE spread to Federal Funds effective rate |
5.55 | 4.32 | 6.58 | 3.52 | 3.81 | |||||||||||||||
Dividend rate spread to Federal Funds effective rate |
4.85 | 3.56 | 4.50 | 3.02 | 3.39 |
When short-term interest rates decline dramatically, as occurred in 2009, net income normally
decreases. However, earnings in the nine months ended September 30, 2009 improved substantially
over the same period of 2008, as net income grew $39 million (22 percent) and ROE increased 0.83
percentage points. By contrast, in the third quarter of 2009 compared to the same period of 2008,
net income fell $5 million (7 percent) and ROE decreased 0.56 percentage points.
The ROE spreads to 3-month LIBOR and overnight Federal funds are two market benchmarks we believe
our stockholders use to assess the competitiveness of return on their capital investment in the
FHLBank, which, along with access to our products and services, is a key source of membership
value. These spreads in 2009 were significantly above those in the same periods of 2008.
There were four major reasons for the changes in earnings and profitability:
§ | Beginning in late 2008 and continuing in the first nine months of 2009, in response to the decline in intermediate- and long-term interest rates, we retired before their final maturities approximately $14 billion of high-cost long-term debt (i.e., Consolidated Bonds), which we had issued mostly to fund mortgage assets, and replaced them with new Bonds at substantially lower costs. | |
§ | Average portfolio spreads between short-term and adjustable-rate assets indexed to short-term LIBOR and their related funding costs were wider in the first nine months of 2009 than the same period in 2008 and wider than historical norms. The financial crisis raised the cost of inter-bank lending (represented by LIBOR) relative to other short-term interest costs such as our Discount Notes. We believe this cost differential indicated that, during the financial crisis, market participants viewed the Systems short-term debt as a lower risk investment than other short-term investments. Because we use Discount Notes to fund a large amount (normally between $10 billion and $20 billion) of our LIBOR-indexed Advances, earnings benefited from our relatively more favorable funding costs. | |
In the third quarter of 2009, short-term LIBOR decreased, causing the spread between LIBOR and Discount Notes to revert back to, and even go below, historical average levels. We believe this was due to market participants view that the financial disruptions had eased and to the effects of the massive amounts of liquidity injected into the financial system. As a result, the higher profits from the wider LIBOR to Discount Note spreads dissipated during the third quarter. |
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§ | Market yield curves became significantly steeper as short-term interest rates fell to historical lows of close to zero. This benefited earnings due to our modest utilization of short-term debt to fund long-term assets. In addition, due to mismatches of principal paydowns of long-term assets versus liabilities, including muted acceleration of mortgage prepayments, the amount of short funding increased in the first three quarters of 2009. | |
§ | There were other gains totaling approximately $14 million, most of which occurred in the first quarter of 2009, including: $6 million from the sale of $216 million of mortgage-backed securities; a $4 million increase in Advance prepayment fees; and a $4 million increase in net market value (primarily unrealized) relating to accounting for derivatives and hedging activities. |
Several factors partially offset the favorable earnings drivers. Most significant was the extremely
low short-term interest rate environment, which substantially decreased the amount of earnings
generated from funding assets with our interest-free capital. For example, the benchmark 3-month
LIBOR rate averaged 0.83 percent in the first nine months of 2009, compared to 2.98 percent for the
same period in 2008. The positive earnings factors also were partially offset by a reduction in
assets, especially Advances.
The lower earnings for the third quarter of 2009 compared to the third quarter of 2008 were
primarily the result of the narrowing of the LIBOR to Discount Note Spread discussed above, the
decrease in short-term interest rates, the reduction in Advances, and a $5 million reduction in
fair value gains from accounting for derivatives and hedging activity. We recognized substantial
fair value gains in the third quarter of 2008 due principally to the sharp increase in short-term
LIBOR as a result of the accelerating financial crisis.
Our Board authorized paying stockholders a cash dividend in each of the first two quarters of 2009
at a 4.50 percent annualized rate and in the third quarter at an annualized rate of 5.00 percent.
These dividend payouts represented historically wide spreads to the average 3-month LIBOR. The
difference between the 6.75 percent ROE in the first nine months of 2009 and the 4.67 percent
average dividend rate enabled us to increase retained earnings by $81 million. The $239 million
increase in retained earnings since year-end 2004 represents more than a doubling of retained
earnings as a percent of regulatory capital stock. We believe the increase in retained earnings as
a percent of capital stock has enhanced our ability to protect future dividends against earnings
volatility and members capital stock against impairment risk.
Risk Exposure
Funding and Liquidity Risk
We believe that in the first nine months of 2009, our liquidity position remained strong and
our overall ability to fund our operations through debt issuance at acceptable interest costs
remained sufficient. Although we can make no assurances, we expect this to continue to be the case
and we believe the possibility of a liquidity or funding crisis in the FHLBank System that would
impair our FHLBanks ability to issue new debt, service our outstanding debt or pay competitive
dividends is remote. The financial crisis significantly elevated our long-term funding costs,
compared to U.S. Treasury securities and LIBOR, in the first half of 2009 as in most of 2008. As
the financial crisis appeared to have eased, especially in the third quarter, our long-term funding
costs improved relative to these market benchmarks. As a result, late in the second quarter and
continuing in the third quarter, we determined it was acceptable from a risk perspective to
partially reduce the amount of asset liquidity held, which can be at a cost to earnings, from
funding short-term (mostly overnight) investments with longer-term Consolidated Obligation Discount
Notes.
Market Risk
Our residual exposures to market risk continued to be moderate, at levels consistent with
historical averages and with our cooperative business model. The current level of market risk
exposure should ensure that profitability would be competitive across a wide range of stressed
interest rate and business environments. We have historically emphasized strategies and tactics
aimed at providing a competitive earnings stream over a multitude of market and business
environments and a relative lack of earnings volatility. These strategies and tactics include
(among others): 1) conservative management of market risk exposure, 2) controlled growth in
mortgage assets, 3) holding a nominal amount of riskier types of mortgage-backed securities, 4)
accounting and hedging practices that attempt to minimize earnings volatility from use of
derivatives, and 5) limiting growth in operating expenses.
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Credit Risk
We continued to have limited credit risk exposure from offering Advances, purchasing mortgage
loans, making investments, and executing derivative transactions. We have robust policies,
strategies and processes designed to identify, manage and mitigate credit risk. Our Advances are
overcollateralized and we have a perfected first lien position on all pledged loan collateral. The
Mortgage Purchase Program is comprised only of conforming fixed-rate conventional loans and loans
fully insured by the Federal Housing Administration. Multiple layers of credit enhancements on the
Programs loans protect us against credit losses down to approximately a 50 percent loan-to-value
level (based on value at origination). Actual program delinquencies on conventional loans are well
below national averages on similar loans and any losses have been well below the amount of our
credit enhancements.
At September 30, 2009, 98 percent of our mortgage-backed securities were issued and guaranteed by
Fannie Mae or Freddie Mac, which we believe have the backing of the United States government. Only
2 percent ($211 million) of the holdings were in private-label mortgage-backed securities; these
securities are comprised of high-quality residential mortgage loans issued and purchased in 2003
and were rated triple-A at September 30, 2009. The underlying collateral has a de minimis level of
delinquencies and foreclosures as reflected in the average serious delinquency rate (loans at least
60 days past due) of 0.54 percent of total principal, while their average credit enhancement stood
at 7.5 percent.
Although most of our money market investments are unsecured, we invest in the debt securities of
highly rated, investment-grade institutions, have conservative limits on dollar and maturity
exposure to each institution, and believe we have strong credit underwriting practices. Finally, we
collateralize most of the credit risk exposure resulting from interest rate swap transactions; only
the uncollateralized portion of our derivative asset position ($8 million at September 30, 2009)
represents unsecured exposure. We continue to expect no credit losses on this source of unsecured
credit exposure.
Overall, we have never experienced a credit-related loss on, nor have we ever established a loss
reserve for any asset. In addition, we have not taken an impairment charge on any investment. Based
on our analysis of exposures and application of GAAP we continue to believe no loss reserves are
required for our Advances or mortgage assets, nor do we consider any of our investments to be
other-than-temporarily impaired. We expect that this will continue to be the case.
Business Related Developments and Update on Risk Factors
Many of the issues related to our financial condition, results of operations, and liquidity
discussed throughout this document relate directly to the financial crisis and economic recession,
and to the federal governments actions to attempt to mitigate their unfavorable effects. During
2009, these factors have resulted in sharply improved profitability relative to short-term interest
rates, substantially lower Advance balances, and a modest increase in Mortgage Purchase Program
balances. This section provides relevant updates on several risk factors identified in our annual
report on Form 10-K.
We continue to monitor several scenarios that could result in further reductions in Mission Asset
Activity and lower profitability. Although cyclicality of our Mission Asset Activity and
profitability relative to the state of the economy is expected, the effects from the recession and
the financial crisis could result in a longer and more severe reduction in our Mission Asset
Activity. The scenarios that could unfavorably affect Mission Asset Activity include:
§ | a continuation of the economic recession, which could further reduce Advance demand; | |
§ | a continuation of the financial crisis, which could result in additional measures to add even more liquidity to the financial markets; | |
§ | unfavorable effects on the competitiveness of our business model from current or future federal government actions to mitigate the recession and financial crisis; | |
§ | potentially unfavorable actions regarding the ultimate financial, legislative and regulatory disposition of issues involving the GSEs, especially actions related to Fannie Mae and Freddie Mac with whom the FHLBanks share a common regulator; and | |
§ | issues with earnings pressures and capital adequacy at other FHLBanks. |
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As
discussed above, our profitability relative to short-term interest
rates began to decrease in the third quarter of 2009. We expect our
profitability will further decrease in the fourth quarter of 2009
and beyond. The profitability in the first nine months of 2009 is
inconsistent with the sustained fundamental earnings generated by our business model. The following
are the major factors affecting earnings that we are experiencing or expect to experience in the
near-to intermediate-term future:
§ | extremely low short-term interest rates; | |
§ | the effects of the collapsing LIBOR to Discount Note spread back to, and even below, historically normal levels; | |
§ | replacing expected paydowns of mortgages earning wide net spreads with new mortgages assumed to earn lower net spreads; | |
§ | continued reductions in Advance balances; and | |
§ | because of the stressed mortgage markets and government purchases that are reducing acceptable mortgages to purchase, the possibility of not being able to fully utilize our mortgage-backed security regulatory authority at acceptable risk-adjusted returns. |
Notwithstanding these concerns, we expect our profitability and capacity to pay dividends to remain
competitive across a wide range of economic, business, and market rate environmentseven many
stressful ones. We believe that credit and operational risk will not affect our earnings
materially. Based on our earnings simulations, we believe that short-term interest rates would have
to increase dramatically, quickly, and last for a sustained period of time before ROE would not
exceed 3-month LIBOR. We also believe that a decrease in mortgage rates by 100 basis points that
lasted for three years, which would place the 30-year fixed mortgage note rate in a range of 4.00
to 4.50 percent, would not cause ROE to fall below 3-month LIBOR.
Our business model is able to absorb sharp changes in our Mission Asset Activity because we can
undertake commensurate reductions in our liability balances and capital and because of our low
operating expenses. However, if several large members were to withdraw from membership or otherwise
reduce activity with us, the decrease in Mission Asset Activity and/or capital could materially
reduce dividend rates available to our remaining members. On November 6, 2009, National City Bank,
which was acquired in January 2009 by PNC Financial Services Group, Inc., notified us of its
decision to withdraw from membership in our FHLBank. PNC Bank is not a member of our FHLBank
because it is chartered outside our District.
Although in the last several years, National City has been one of our largest stockholders and
Advance borrowers and our largest historical seller of loans in the Mortgage Purchase Program, we
believe that losing this member will have no material affect on our business model. We also believe
the membership loss will not materially affect the adequacy of our liquidity, our ability to make
timely principal and interest payments on our participations in Consolidated Obligations and other
liabilities, our ability to continue providing sufficient membership value to our members, or our
profitability. This assessment is similar to one made, and subsequently experienced, when we lost
one of our largest members (RBS Citizens, N.A.) in 2007 due to a consolidation of its charter
outside of the Fifth District.
The Mortgage Purchase Program has expanded this year due to lower mortgage rates, increased
refinancing activity and increased interest from our members. We continue to emphasize both
recruiting community financial institution members to the Program and increasing the number of
regular sellers. However, issues with our two Supplemental Mortgage Insurance providers could harm
the Programs sustainability. Due to the deterioration in the mortgage markets over the last two
years, the providers currently have ratings below the double-A rating required by a Finance Agency
Regulation, which means we are in technical violation of this Regulation. On August 11, 2009, the
Finance Agency, with certain stipulations, granted a one-year waiver of the double-A rating
requirement for existing loans and commitments and a six month waiver for new commitments. We have
submitted a proposal to the Finance Agency that, if approved, would replace the current reliance on
the credit enhancement provided by these insurers with increased use of the credit enhancement
provided by members. We believe this change in credit enhancement structure would maintain
compliance with the Programs legal, accounting, and other regulatory requirements, preserve the
Programs minimal credit risk profile, and enable the Program to continue as a beneficial business
activity for our member stockholders. We cannot provide at this time any assurance as to whether
the Finance Agency will approve the proposal.
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We cannot estimate the ultimate impact on the earnings and capital of other FHLBanks from the
market value and credit losses on their private-label securities. Therefore, we can provide no
assurance about the potential effects on us from System-wide earnings and capital issues identified
in this risk factor in our 2008 annual report on Form 10-K. These potential effects could include
1) requiring us to provide financial assistance to one or more other FHLBanks, 2) higher and more
volatile debt costs, 3) more difficulty in issuing debt, especially longer-term debt, at maturity
points we would prefer for our asset/liability management needs, and 4) decreases in our Mission
Asset Activity and profitability, which are the two key sources of membership value.
CONDITIONS IN THE ECONOMY AND FINANCIAL MARKETS
Economy
The primary external factors that affect our Mission Asset Activity and earnings are the
general state and trends of the economy and financial institutions, especially in the states of our
District; conditions in the financial, credit, and mortgage markets; and interest rates. The
economy entered a sharp recession in December 2007, which continued through 2008 and into 2009. As
measured by real Gross Domestic Product (GDP), the national economy contracted by 5.4 percent in
the fourth quarter of 2008, 6.4 percent in the first quarter of 2009, and 0.7 percent in the second
quarter, and expanded by an advance estimate of 3.5 percent in the third quarter (all rates are
annualized).
Although there are indicationsincluding the growth in third quarter GDP, reduction in credit
spreads, and unfreezing of some credit marketsthat the recession and financial crisis may have
subsided, or even ended, in the second and third quarters, it is premature to know if the positive
indications will be sustained. Contraindications against a robust pickup in economic activity are
that lending by financial institutions appears not to have accelerated in the third quarter,
unemployment appears to still be increasing (although unemployment is generally a lagging indicator
of economic growth), financial institutions continue having credit difficulties, interest rates
remain low, and most stock market indices remain well below the highs from earlier in the decade.
The residual effects on our members of the financial crisis and recession may continue to be
serious for some time. These continued effects may include diminished lending activity, credit risk
difficulties, strong deposit growth, and existence of substantial liquidity and funding
alternatives from the federal government. To the extent these effects continue to be realized, we
expect a continuation of subdued demand for our Advances.
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Interest Rates
Trends in market interest rates affect members demand for Mission Asset Activity, earnings,
spreads on assets, funding costs and decisions in managing the tradeoffs in our market risk/return
profile. The following table presents key market interest rates (obtained from Bloomberg L.P.).
Nine Months Ended Sept 30, | ||||||||||||||||||||||||||||||||||||||||
Quarter 3 2009 | Quarter 2 2009 | Quarter 1 2009 | 2009 | 2008 | Year 2008 | |||||||||||||||||||||||||||||||||||
Average | Ending | Average | Ending | Average | Ending | Average | Average | Average | Ending | |||||||||||||||||||||||||||||||
Federal Funds Target |
0.25 | % | 0.25 | % | 0.25 | % | 0.25 | % | 0.25 | % | 0.25 | % | 0.25 | % | 2.43 | % | 2.09 | % | 0.25 | % | ||||||||||||||||||||
Federal Funds Effective |
0.15 | 0.07 | 0.18 | 0.22 | 0.18 | 0.16 | 0.17 | 2.40 | 1.92 | 0.14 | ||||||||||||||||||||||||||||||
3-month LIBOR |
0.41 | 0.29 | 0.85 | 0.60 | 1.24 | 1.19 | 0.83 | 2.98 | 2.92 | 1.43 | ||||||||||||||||||||||||||||||
2-year LIBOR |
1.40 | 1.28 | 1.50 | 1.53 | 1.54 | 1.38 | 1.48 | 3.16 | 2.95 | 1.48 | ||||||||||||||||||||||||||||||
5-year LIBOR |
2.86 | 2.65 | 2.74 | 2.97 | 2.38 | 2.21 | 2.66 | 3.88 | 3.70 | 2.13 | ||||||||||||||||||||||||||||||
10-year LIBOR |
3.72 | 3.46 | 3.50 | 3.78 | 2.94 | 2.86 | 3.39 | 4.46 | 4.25 | 2.56 | ||||||||||||||||||||||||||||||
2-year U.S. Treasury |
1.01 | 0.95 | 1.01 | 1.11 | 0.89 | 0.80 | 0.97 | 2.26 | 2.00 | 0.77 | ||||||||||||||||||||||||||||||
5-year U.S. Treasury |
2.45 | 2.31 | 2.23 | 2.56 | 1.75 | 1.66 | 2.15 | 3.00 | 2.79 | 1.55 | ||||||||||||||||||||||||||||||
10-year U.S. Treasury |
3.50 | 3.31 | 3.31 | 3.54 | 2.71 | 2.67 | 3.18 | 3.79 | 3.64 | 2.21 | ||||||||||||||||||||||||||||||
15-year mortgage current coupon (1) |
3.82 | 3.57 | 3.84 | 4.01 | 3.75 | 3.59 | 3.80 | 5.03 | 4.97 | 3.64 | ||||||||||||||||||||||||||||||
30-year mortgage current coupon (1) |
4.50 | 4.26 | 4.31 | 4.63 | 4.13 | 3.89 | 4.31 | 5.58 | 5.47 | 3.93 | ||||||||||||||||||||||||||||||
15-year mortgage note rate (2) |
4.61 | 4.46 | 4.63 | 4.87 | 4.72 | 4.58 | 4.65 | 5.64 | 5.63 | 4.91 | ||||||||||||||||||||||||||||||
30-year mortgage note rate (2) |
5.16 | 5.04 | 5.01 | 5.42 | 5.06 | 4.85 | 5.08 | 6.09 | 6.05 | 5.14 |
(1) | Simple average of current coupon rates of Fannie Mae and Freddie Mac mortgage-backed securities. | ||
(2) | Simple weekly average of 125 national lenders mortgage rates surveyed and published by Freddie Mac. |
After decreasing sharply in 2008, the overnight Federal funds target and effective rates were
relatively stable in the first nine months of 2009. The Federal Reserve maintained the overnight
Federal funds target rate at a range of zero to 0.25 percent, which it had established by the end
of 2008. Short-term LIBOR decreased at a slower pace. By the third quarter of 2009, short-term
LIBOR had decreased to a level consistent with its historical relationship to Federal funds. The
slower pace of reduction in short-term LIBOR significantly improved our earnings in the first half
of 2009.
In the first three quarters of 2009, longer-term LIBOR and U.S. Treasury rates tended to rise.
However, spreads of our Consolidated Obligation Bonds to these indices narrowed, with the result
being relatively stable and even lower Bond rates. The combination of falling short-term rates and
more stable longer-term Bond rates resulted in a steeper funding yield curve, which improved
earnings. In addition, earnings benefited from the reduction in Bond spreads relative to market
indices. Likewise, mortgage note rates were more stable in 2009 than longer-term LIBOR and U.S.
Treasuries, which, along with falling home prices, the recession, and difficult mortgage
refinancing conditions, resulted in relatively small increases in mortgage prepayments.
More discussion of the effects on our earnings and market risk exposure from interest rate trends
are discussed above in Executive Overview and below in Results of Operations, as well as in the
Market Risk section of Quantitative and Qualitative Disclosures About Risk Management.
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ANALYSIS OF FINANCIAL CONDITION
Asset Composition Data
Mission Asset Activity includes the following components:
§ | the principal balance of Advances; | ||
§ | the notional principal amount of available lines in the Letters of Credit program; | ||
§ | the principal balance in the Mortgage Purchase Program (Mortgage Loans Held for Portfolio); and | ||
§ | the notional principal amount of Mandatory Delivery Contracts. |
The following two tables show the composition of our total assets, which support the discussions in
this section and in the Executive Overview.
Asset
Composition - Ending Balances (Dollars in millions)
September 30, 2009 | December 31, 2008 | September 30, 2008 | September 30, 2009 | ||||||||||||||||||||||||||||||||||||||
% of | % of | % of | Change From | Change From | |||||||||||||||||||||||||||||||||||||
Total | Total | Total | December 31, 2008 | September 30, 2008 | |||||||||||||||||||||||||||||||||||||
Balance | Assets | Balance | Assets | Balance | Assets | Amount | Pct | Amount | Pct | ||||||||||||||||||||||||||||||||
Advances |
|||||||||||||||||||||||||||||||||||||||||
Principal |
$ | 37,254 | 48 | % | $ | 52,799 | 54 | % | $ | 62,580 | 65 | % | $ | (15,545 | ) | (29 | )% | $ | (25,326 | ) | (40 | )% | |||||||||||||||||||
Other items (1) |
828 | 1 | 1,117 | 1 | 348 | - | (289 | ) | (26 | ) | 480 | 138 | |||||||||||||||||||||||||||||
Total book value |
38,082 | 49 | 53,916 | 55 | 62,928 | 65 | (15,834 | ) | (29 | ) | (24,846 | ) | (39 | ) | |||||||||||||||||||||||||||
Mortgage Loans Held for
Portfolio |
|||||||||||||||||||||||||||||||||||||||||
Principal |
9,650 | 13 | 8,590 | 9 | 8,462 | 9 | 1,060 | 12 | 1,188 | 14 | |||||||||||||||||||||||||||||||
Other items |
86 | - | 42 | - | 60 | - | 44 | 105 | 26 | 43 | |||||||||||||||||||||||||||||||
Total book value |
9,736 | 13 | 8,632 | 9 | 8,522 | 9 | 1,104 | 13 | 1,214 | 14 | |||||||||||||||||||||||||||||||
Investments |
|||||||||||||||||||||||||||||||||||||||||
Mortgage-backed
securities |
|||||||||||||||||||||||||||||||||||||||||
Principal |
12,448 | 16 | 12,897 | 13 | 13,357 | 14 | (449 | ) | (3 | ) | (909 | ) | (7 | ) | |||||||||||||||||||||||||||
Other items |
(11 | ) | - | (28 | ) | - | (37 | ) | - | 17 | 61 | 26 | 70 | ||||||||||||||||||||||||||||
Total book value |
12,437 | 16 | 12,869 | 13 | 13,320 | 14 | (432 | ) | (3 | ) | (883 | ) | (7 | ) | |||||||||||||||||||||||||||
Short-term money market |
13,777 | 18 | 22,444 | 23 | 12,142 | 12 | (8,667 | ) | (39 | ) | 1,635 | 13 | |||||||||||||||||||||||||||||
Other long-term investments |
11 | - | 12 | - | 40 | - | (1 | ) | (8 | ) | (29 | ) | (73 | ) | |||||||||||||||||||||||||||
Total investments |
26,225 | 34 | 35,325 | 36 | 25,502 | 26 | (9,100 | ) | (26 | ) | 723 | 3 | |||||||||||||||||||||||||||||
Loans to other FHLBanks |
- | - | - | - | - | - | - | - | - | - | |||||||||||||||||||||||||||||||
Total earning assets |
74,043 | 96 | 97,873 | 100 | 96,952 | 100 | (23,830 | ) | (24 | ) | (22,909 | ) | (24 | ) | |||||||||||||||||||||||||||
Other assets |
2,941 | 4 | 333 | - | 331 | - | 2,608 | 783 | 2,610 | 789 | |||||||||||||||||||||||||||||||
Total assets |
$ | 76,984 | 100 | % | $ | 98,206 | 100 | % | $ | 97,283 | 100 | % | $ | (21,222 | ) | (22 | ) | $ | (20,299 | ) | (21 | ) | |||||||||||||||||||
Other Business Activity
(Notional) |
|||||||||||||||||||||||||||||||||||||||||
Letters of Credit |
$ | 5,564 | $ | 7,917 | $ | 8,023 | $ | (2,353 | ) | (30 | ) | $ | (2,459 | ) | (31 | ) | |||||||||||||||||||||||||
Mandatory Delivery
Contracts |
$ | 126 | $ | 917 | $ | 178 | $ | (791 | ) | (86 | ) | $ | (52 | ) | (29 | ) | |||||||||||||||||||||||||
Total Mission Asset
Activity (Principal and Notional) |
$ | 52,594 | 68 | % | $ | 70,223 | 72 | % | $ | 79,243 | 81 | % | $ | (17,629 | ) | (25 | ) | $ | (26,649 | ) | (34 | ) | |||||||||||||||||||
(1) | The majority of these balances are hedging related adjustments. |
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Asset
Composition - Average Balances (Dollars in millions)
Nine Months Ended | Year Ended | Nine Months Ended | |||||||||||||||||||||||||||||||||||||||
September 30, 2009 | December 31, 2008 | September 30, 2008 | September 30, 2009 | ||||||||||||||||||||||||||||||||||||||
Change From | Change From | ||||||||||||||||||||||||||||||||||||||||
% of | % of | % of | Year Ended | Nine Months Ended | |||||||||||||||||||||||||||||||||||||
Total | Total | Total | December 31, 2008 | September 30, 2008 | |||||||||||||||||||||||||||||||||||||
Balance | Assets | Balance | Assets | Balance | Assets | Amount | Pct | Amount | Pct | ||||||||||||||||||||||||||||||||
Advances |
|||||||||||||||||||||||||||||||||||||||||
Principal |
$ | 46,058 | 53 | % | $ | 59,973 | 64 | % | $ | 60,441 | 65 | % | $ | (13,915 | ) | (23 | )% | $ | (14,383 | ) | (24 | )% | |||||||||||||||||||
Other items (1) |
895 | 1 | 526 | - | 503 | - | 369 | 70 | 392 | 78 | |||||||||||||||||||||||||||||||
Total book value |
46,953 | 54 | 60,499 | 64 | 60,944 | 65 | (13,546 | ) | (22 | ) | (13,991 | ) | (23 | ) | |||||||||||||||||||||||||||
Mortgage Loans Held for
Portfolio |
|||||||||||||||||||||||||||||||||||||||||
Principal |
9,489 | 11 | 8,621 | 9 | 8,661 | 10 | 868 | 10 | 828 | 10 | |||||||||||||||||||||||||||||||
Other items |
68 | - | 62 | - | 63 | - | 6 | 10 | 5 | 8 | |||||||||||||||||||||||||||||||
Total book value |
9,557 | 11 | 8,683 | 9 | 8,724 | 10 | 874 | 10 | 833 | 10 | |||||||||||||||||||||||||||||||
Investments |
|||||||||||||||||||||||||||||||||||||||||
Mortgage-backed
securities |
|||||||||||||||||||||||||||||||||||||||||
Principal |
12,166 | 14 | 12,623 | 14 | 12,448 | 13 | (457 | ) | (4 | ) | (282 | ) | (2 | ) | |||||||||||||||||||||||||||
Other items |
(20 | ) | - | (30 | ) | - | (28 | ) | - | 10 | 33 | 8 | 29 | ||||||||||||||||||||||||||||
Total book value |
12,146 | 14 | 12,593 | 14 | 12,420 | 13 | (447 | ) | (4 | ) | (274 | ) | (2 | ) | |||||||||||||||||||||||||||
Short-term money market |
18,221 | 21 | 12,206 | 13 | 10,814 | 12 | 6,015 | 49 | 7,407 | 68 | |||||||||||||||||||||||||||||||
Other long-term investments |
11 | - | 16 | - | 16 | - | (5 | ) | (31 | ) | (5 | ) | (31 | ) | |||||||||||||||||||||||||||
Total investments |
30,378 | 35 | 24,815 | 27 | 23,250 | 25 | 5,563 | 22 | 7,128 | 31 | |||||||||||||||||||||||||||||||
Loans to other FHLBanks |
14 | - | 18 | - | 15 | - | (4 | ) | (22 | ) | (1 | ) | (7 | ) | |||||||||||||||||||||||||||
Total earning assets |
86,902 | 100 | 94,015 | 100 | 92,933 | 100 | (7,113 | ) | (8 | ) | (6,031 | ) | (6 | ) | |||||||||||||||||||||||||||
Other assets |
294 | - | 342 | - | 338 | - | (48 | ) | (14 | ) | (44 | ) | (13 | ) | |||||||||||||||||||||||||||
Total assets |
$ | 87,196 | 100 | % | $ | 94,357 | 100 | % | $ | 93,271 | 100 | % | $ | (7,161 | ) | (8 | ) | $ | (6,075 | ) | (7 | ) | |||||||||||||||||||
Other Business Activity
(Notional) |
|||||||||||||||||||||||||||||||||||||||||
Letters of Credit |
$ | 6,057 | $ | 7,894 | $ | 7,824 | $ | (1,837 | ) | (23 | ) | $ | (1,767 | ) | (23 | ) | |||||||||||||||||||||||||
Mandatory Delivery
Contracts |
$ | 705 | $ | 182 | $ | 141 | $ | 523 | 287 | $ | 564 | 400 | |||||||||||||||||||||||||||||
Total Mission Asset Activity
(Principal and Notional) |
$ | 62,309 | 71 | % | $ | 76,670 | 81 | % | $ | 77,067 | 83 | % | $ | (14,361 | ) | (19 | ) | $ | (14,758 | ) | (19 | ) | |||||||||||||||||||
(1) | The majority of these balances are hedging related adjustments. |
To measure the extent of our success in achieving growth in Mission Asset Activity, we
consider changes in both period-end balances and period-average balances. There can be large
differences in the results of these two computations. Average data can provide more meaningful
information about the ongoing condition of and trends in Mission Asset Activity and earnings than
period-end data because day-to-day volatility can impact the latter.
On September 30, 2009, Advances represented just under half (49 percent) of our total assets, a
decrease of six percentage points from year-end 2008. The Mortgage Portfolio Program increased to
13 percent of total assets, due to growth in the Program and the decrease in total assets, led by
Advances. The large balance in other assets on September 30, 2009 was due to our decision to keep
funds at the Federal Reserve on that day instead of investing with traditional unsecured
counterparties because of the zero or negative interest rate available on overnight investments at
the end of the quarter.
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Credit Services
The principal balance of Advances decreased significantly in the first nine months of 2009.
The decrease began in the fourth quarter of 2008, after Advances had reached record highs in
October 2008. Available lines and member usage of the Letters of Credit program also fell
substantially. Most of our Letters of Credit support members public unit deposits. We earn fees on
the actual amount of the available lines members use, which can be substantially less than the
lines outstanding.
The following table presents Advance balances by major program.
(Dollars in millions) | September 30, 2009 | December 31, 2008 | September 30, 2008 | |||||||||||||||||||||
Balance | Percent(1) | Balance | Percent(1) | Balance | Percent(1) | |||||||||||||||||||
Short-Term and Adjustable-Rate |
||||||||||||||||||||||||
REPO/Cash Management |
$ | 1,770 | 5 | % | $ | 5,886 | 11 | % | $ | 11,161 | 18 | % | ||||||||||||
LIBOR |
15,354 | 41 | 24,225 | 46 | 29,619 | 47 | ||||||||||||||||||
Total |
17,124 | 46 | 30,111 | 57 | 40,780 | 65 | ||||||||||||||||||
Long-Term |
||||||||||||||||||||||||
Regular Fixed Rate |
7,830 | 21 | 9,722 | 18 | 9,332 | 15 | ||||||||||||||||||
Convertible (2) |
3,231 | 9 | 3,479 | 7 | 3,506 | 6 | ||||||||||||||||||
Putable (2) |
7,046 | 19 | 6,981 | 13 | 6,894 | 11 | ||||||||||||||||||
Mortgage Related |
1,740 | 4 | 1,815 | 4 | 1,860 | 3 | ||||||||||||||||||
Total |
19,847 | 53 | 21,997 | 42 | 21,592 | 35 | ||||||||||||||||||
Other Advances |
283 | 1 | 691 | 1 | 208 | - | ||||||||||||||||||
Total Advances Principal |
37,254 | 100 | % | 52,799 | 100 | % | 62,580 | 100 | % | |||||||||||||||
Other Items |
828 | 1,117 | 348 | |||||||||||||||||||||
Total Advances Book Value |
$ | 38,082 | $ | 53,916 | $ | 62,928 | ||||||||||||||||||
(1) | As a percentage of total Advances principal. | ||
(2) | Related interest rate swaps executed to hedge these Advances convert them to an adjustable-rate tied to LIBOR. |
Most of the reduction in balances occurred in the REPO, LIBOR, and Regular Fixed Rate Advance
programs. REPO and LIBOR programs normally have the most fluctuation in balances because larger
members tend to use them disproportionately more than smaller members do, they tend to have
shorter-term maturities than other programs and, in the case of LIBOR Advances, they can be prepaid
without a fee on repricing dates subject to pre-established prepayment lock out periods. Other
Advance programs experienced smaller changes.
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The following tables present the principal balances and related weighted average interest rates for
our top five Advance borrowers.
(Dollars in millions)
September 30, 2009 | December 31, 2008 | |||||||||||||||||||
Ending | Weighted Average | Ending | Weighted Average | |||||||||||||||||
Name | Balance | Interest Rate | Name | Balance | Interest Rate | |||||||||||||||
U.S. Bank, N.A. |
$ | 10,315 | 1.57 | % | U.S. Bank, N.A. | $ | 14,856 | 3.02 | % | |||||||||||
National City Bank |
4,409 | 1.00 | National City Bank | 6,435 | 2.83 | |||||||||||||||
Fifth Third Bank |
2,038 | 2.40 | Fifth Third Bank | 5,639 | 3.18 | |||||||||||||||
AmTrust Bank |
1,786 | 3.91 | The Huntington National Bank | 2,590 | 1.22 | |||||||||||||||
RBS Citizens, N.A. |
1,287 | 0.33 | AmTrust Bank | 2,338 | 3.75 | |||||||||||||||
Total of Top 5 |
$ | 19,835 | 1.66 | Total of Top 5 |
$ | 31,858 | 2.92 | |||||||||||||
Total Advances (Principal) |
$ | 37,254 | 2.31 | Total Advances (Principal) | $ | 52,799 | 3.00 | |||||||||||||
Top 5 Percent of Total |
53 | % | Top 5 Percent of Total | 60 | % | |||||||||||||||
RBS Citizens, N.A. and National City Bank are former members. The decrease in total weighted
average interest rates from the end of 2008 to September 30, 2009 was due to the reductions in
short-term interest rates during 2009, especially LIBOR.
As indicated above, our Advances are concentrated among a small number of members. Concentration
ratios have been relatively stable in the last several years. We believe that having large members
who actively use our Mission Asset Activity augments the value of membership to all members because
it enables us to improve operating efficiency, increase financial leverage, possibly enhance
dividend returns, obtain more favorable funding costs, and provide competitively priced Mission
Asset Activity.
Although Advance usage fell broadly across the membership, usage decreased disproportionately among
our largest borrowers. The top five borrowers accounted for 77 percent of the total decrease in
Advance balances, but they represented a smaller proportion (53 percent) of total Advances. In
addition, as shown in the following table, the unweighted average ratio of each members Advance
balance to its most-recently available total assets decreased more for larger members than smaller
members. Despite their decrease, we believe the level of these ratios and the fact that the number
of borrowing members has held steady at approximately 77 percent of total membership continue to
demonstrate that our members view Advances as important sources of funding and liquidity, even in
business conditions in which retail deposit growth exceeds loan growth and in which there are
abundant sources of liquidity.
September 30, 2009 | December 31, 2008 | |||||||
Average Advances-to-Assets for Members |
||||||||
Smaller members: assets less than $1.0 billion (681 members)
|
5.29 | % | 6.11 | % | ||||
Larger members: assets over $1.0 billion (58 members)
|
4.45 | % | 5.47 | % | ||||
All members
|
5.22 | % | 6.06 | % |
Mortgage Purchase Program (Mortgage Loans Held for Portfolio)
The expansion of the Mortgage Purchase Program in the first nine months of 2009 came after
several years in which the Programs balance was relatively stable. Significantly lower mortgage
interest rates in the fourth quarter of 2008 and the first quarter of 2009 increased refinancing
activity, which resulted in Program balances increasing. In addition, because of falling home
prices, the recession, and difficult mortgage refinancing conditions, mortgage prepayments did not
accelerate as much as would normally have been the case given the lower mortgage rates. The growth
in the Program helped offset a portion of the earnings lost from the lower balances in the Advance
portfolio. The Programs growth slowed in the second and third quarters, primarily due to
diminishing refinancing activity.
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Our focus continues to be on recruiting community-based members to participate in the Program and
on increasing the number of regular sellers. We approved 23 members to the Program in the first
nine months of 2009 and there is a similar number of members in the pipeline either interested in
joining the Program or in the process of joining. The number of regular sellers has doubled in the
last year. Through September 30, members transacted approximately 3,300 separate commitments to
sell us loans, 50 percent more than the amount in any prior full year. Because the recent increases
in the number of sellers and new approvals to the Program have come from our smaller
community-based members and because we have self-imposed constraints on growth, we expect that the
Program will not grow significantly.
The following table reconciles changes in the Programs principal balance (excluding Mandatory
Delivery Contracts) for the nine months ended September 30, 2009.
Mortgage Purchase | ||||
(In millions) | Program Principal | |||
Balance at December 31, 2008 |
$ | 8,590 | ||
Principal purchases |
3,347 | |||
Principal paydowns |
(2,287 | ) | ||
Balance at September 30, 2009 |
$ | 9,650 | ||
We closely track the refinancing incentives of all of our mortgage assets because the mortgage
prepayment option represents almost all of our market risk exposure. The principal paydowns in the
first three quarters equated to an annual constant prepayment rate of 29 percent, compared to 12
percent in all of 2008. The acceleration in prepayment rates reflected the significant drop in
mortgage rates in late 2008 and early 2009. However, as noted above, the refinancing response was
muted. The Programs composition of balances by loan type and original final maturity did not
change materially in the first nine months of 2009. However, the weighted average mortgage note
rate fell from 5.80 percent at year-end 2008 to 5.56 percent at September 30, 2009, reflecting the
prepayments of higher rate notes and the purchase of lower rate notes in the declining mortgage
rate environment.
As shown in the following table, the percentage of principal balances from members supplying five
percent or more of total principal decreased five percentage points from year-end 2008 to September
30, 2009.
September 30, 2009 | December 31, 2008 | |||||||||||||||
(Dollars in millions) | Unpaid Principal | % of Total | Unpaid Principal | % of Total | ||||||||||||
National City Bank |
$ 3,763 | 39 | % | $ 4,709 | 55 | % | ||||||||||
Union Savings Bank |
3,078 | 32 | 1,995 | 23 | ||||||||||||
Guardian Savings Bank FSB |
809 | 8 | 544 | 6 | ||||||||||||
Total |
$ 7,650 | 79 | % | $ 7,248 | 84 | % | ||||||||||
The decrease in the percentage of loans outstanding from National City Bank reflected its lack of
new activity with us since mid-2007, while the increase from Union Savings Bank and Guardian Saving
Bank FSB reflected refinancing activity in their portfolio that resulted in new loans sold to us.
As in prior years, in the first nine months of 2009, yields we earned on new mortgage loans in the
Program relative to funding costs continued to provide profitable risk-adjusted returns. The
federal governments actions to purchase mortgage-backed securities put upward pressure on mortgage
prices, which normally lowers yields, but the impact was not large enough to cause profitability on
new mortgages to decrease substantially. We cannot predict whether the effects on net spreads from
the governments purchase activities will continue to be modest.
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Investments
Money Market Investments
Short-term unsecured money market instruments consist of the following accounts on the Statements of Condition: interest-bearing deposits; Federal funds sold; GSE discount notes, most of which are in our trading portfolio; and certificates of deposit and bank notes in our available-for-sale portfolio. In the first nine months of 2009, our investment portfolio continued to provide liquidity and helped us manage market risk and capital adequacy.
Short-term unsecured money market instruments consist of the following accounts on the Statements of Condition: interest-bearing deposits; Federal funds sold; GSE discount notes, most of which are in our trading portfolio; and certificates of deposit and bank notes in our available-for-sale portfolio. In the first nine months of 2009, our investment portfolio continued to provide liquidity and helped us manage market risk and capital adequacy.
The composition of our money market investment portfolio varies over time based on relative value
considerations. Daily balances can fluctuate significantly, usually within a range of $8,000
million to $20,000 million, due to numerous factors, including changes in the actual and
anticipated amount of Mission Asset Activity, liquidity requirements, net spreads, opportunities to
warehouse debt at attractive rates for future use, and management of financial leverage. Money
market investments normally have one of the lowest net spreads of any of our assets, typically
ranging from 5 to 15 basis points.
In the nine months ended September 30, 2009, we maintained average money market balances at higher
than historical levels, with the portfolio having an average balance of $18,221 million. The
increase in balances, which mostly had overnight maturities, began in the fourth quarter of 2008
and occurred primarily because the financial crisis and the Finance Agencys guidance to target as
many as 15 days of liquidity required us to increase asset liquidity. We funded the increased asset
liquidity with longer-term Discount Notes. Because of the upward sloping yield curve, these actions
tended to negatively affect our earnings.
In the third quarter of 2009, we began to invest in the short-term Discount Note obligations of
Freddie Mac. These investments provide us a vehicle to diversify our short-term investments at
attractive yields, and we believe that there is less credit risk of delayed or nonrepayment of the
principal and interest on these obligations than of other unsecured short-term investments. On
September 30, 2009 our investment in Freddie Mac Discount Notes totaled $2,250 million.
Mortgage-Backed Securities
We invest in mortgage-backed securities in order to enhance profitability and to help support the housing market. Mortgage-backed securities currently comprise almost 100 percent of the held-to-maturity securities and $3 million of the trading securities on the Statements of Condition. Our current philosophy is to invest in the mortgage-backed securities of GSEs and government agencies. We have not purchased any mortgage-backed securities issued by other entities since 2003.
We invest in mortgage-backed securities in order to enhance profitability and to help support the housing market. Mortgage-backed securities currently comprise almost 100 percent of the held-to-maturity securities and $3 million of the trading securities on the Statements of Condition. Our current philosophy is to invest in the mortgage-backed securities of GSEs and government agencies. We have not purchased any mortgage-backed securities issued by other entities since 2003.
We historically have been permitted by Finance Agency Regulation to hold mortgage-backed securities
up to a multiple of three times our regulatory capital. In May 2008, the Finance Agency approved
our request, pursuant to a Finance Agency authorization permitting a higher multiple, to
temporarily expand our mortgage-backed security percentage by up to an additional 1.5 times
regulatory capital. In July 2008, we utilized a small portion of this authority. However, because
of the financial crisis and recession, in the last twelve months there has been a limited
availability of securities that fit our investment parameters, including offering an acceptable
risk/return tradeoff. On September 30, 2009, the principal balance of our mortgage-backed
securities was $12,448 million and regulatory capital was $4,152 million, for a multiple of 3.00.
We cannot predict if we will find attractive securities to again utilize the temporary expanded
authority before it expires on March 31, 2010.
As shown in the following table, throughout 2009 principal paydowns exceeded principal purchases of
mortgage-backed securities. The principal paydowns equated to an annual constant prepayment rate of
28 percent, compared to 16 percent in all of 2008.
Mortgage-backed | ||||
(In millions) | Securities Principal | |||
Balance at December 31, 2008 |
$ | 12,897 | ||
Principal purchases |
2,690 | |||
Principal paydowns |
(2,923 | ) | ||
Principal sales |
(216 | ) | ||
Balance at September 30, 2009 |
$ | 12,448 | ||
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The following table presents the composition of the principal balances of the mortgage-backed
securities portfolio by security type, collateral type, and issuer. Most purchases in the first
nine months of 2009 were 15-year pass-through collateral.
(In millions) | September 30, 2009 | December 31, 2008 | ||||||
Security Type |
||||||||
Collateralized mortgage obligations |
$ | 3,843 | $ | 5,433 | ||||
Pass-throughs (1) |
8,605 | 7,464 | ||||||
Total |
$ | 12,448 | $ | 12,897 | ||||
Collateral Type (2) |
||||||||
15-year collateral |
$ | 5,959 | $ | 5,169 | ||||
20-year collateral |
3,404 | 3,365 | ||||||
30-year collateral |
3,085 | 4,363 | ||||||
Total |
$ | 12,448 | $ | 12,897 | ||||
Issuer |
||||||||
GSE residential mortgage-backed securities |
$ | 12,232 | $ | 12,581 | ||||
Agency residential mortgage-backed securities |
6 | 12 | ||||||
Private-label residential mortgage-backed securities |
210 | 304 | ||||||
Total |
$ | 12,448 | $ | 12,897 | ||||
(1) | On each date, only $3 million of the pass-throughs were 30-year adjustable-rate mortgages. All others were 15-year or 20-year fixed-rate pass-throughs. | |
(2) | On each date, all but $3 million of principal were comprised of fixed-rate mortgages. |
Consolidated Obligations
Changes in Balances and Composition
Our primary source of funding and liquidity is through participating in the issuance of the Systems debt securitiesConsolidated Obligationsin the capital markets. The table below presents the ending and average balances of our participations in Consolidated Obligations. All of our Obligations issued and outstanding in 2009, as in the last several years, had plain-vanilla interest terms. None had step-up, inverse floating rate, convertible, range, or zero-coupon structures.
Our primary source of funding and liquidity is through participating in the issuance of the Systems debt securitiesConsolidated Obligationsin the capital markets. The table below presents the ending and average balances of our participations in Consolidated Obligations. All of our Obligations issued and outstanding in 2009, as in the last several years, had plain-vanilla interest terms. None had step-up, inverse floating rate, convertible, range, or zero-coupon structures.
Nine Months Ended | Year Ended | Nine Months Ended | ||||||||||||||||||||||
(In millions) | September 30, 2009 | December 31, 2008 | September 30, 2008 | |||||||||||||||||||||
Ending | Average | Ending | Average | Ending | Average | |||||||||||||||||||
Balance | Balance | Balance | Balance | Balance | Balance | |||||||||||||||||||
Consolidated Discount Notes: |
||||||||||||||||||||||||
Par |
$ | 29,174 | $ | 37,725 | $ | 49,389 | $ | 40,450 | $ | 43,134 | $ | 39,283 | ||||||||||||
Discount |
(4 | ) | (17 | ) | (53 | ) | (94 | ) | (127 | ) | (94 | ) | ||||||||||||
Total Consolidated Discount Notes |
29,170 | 37,708 | 49,336 | 40,356 | 43,007 | 39,189 | ||||||||||||||||||
Consolidated Bonds: |
||||||||||||||||||||||||
Unswapped fixed-rate |
25,822 | 25,383 | 25,650 | 25,468 | 27,737 | 24,788 | ||||||||||||||||||
Unswapped adjustable-rate |
1,771 | 4,380 | 6,424 | 9,638 | 7,525 | 10,486 | ||||||||||||||||||
Swapped fixed-rate |
13,467 | 11,979 | 10,140 | 11,969 | 12,485 | 11,966 | ||||||||||||||||||
Total Par Consolidated Bonds |
41,060 | 41,742 | 42,214 | 47,075 | 47,747 | 47,240 | ||||||||||||||||||
Other items (1) |
142 | 137 | 179 | 62 | - | 59 | ||||||||||||||||||
Total Consolidated Bonds |
41,202 | 41,879 | 42,393 | 47,137 | 47,747 | 47,299 | ||||||||||||||||||
Total Consolidated Obligations (2) |
$ | 70,372 | $ | 79,587 | $ | 91,729 | $ | 87,493 | $ | 90,754 | $ | 86,488 | ||||||||||||
(1) | Includes unamortized premiums/discounts, hedging and other basis adjustments. | |
(2) | The 12 FHLBanks have joint and several liability for the par amount of all of the Consolidated Obligations issued on their behalves. See Note 11 of the Notes to Unaudited Financial Statements for additional detail and discussion related to Consolidated Obligations. The par amount of the outstanding Consolidated Obligations of all 12 FHLBanks was (in millions) $973,579 and $1,251,542 at September 30, 2009 and December 31, 2008, respectively. |
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Balances of the various Obligation types can fluctuate significantly based on Advance demand, money
market investment balances, comparative changes in their cost levels relative to swapped
Consolidated Bonds, supply and demand conditions, and our balance sheet management strategies. In
the first nine months of 2009, the average balance of Discount Notes was similar to the average
balances for all of 2008 and the first nine months of 2008. Beginning in the second quarter of 2009
and continuing in the third quarter, we decreased our issuance of Discount Notes compared to the
first quarter of 2009 and all of 2008. The reduced reliance on Discount Notes reflected the
reduction in Advance balances in 2009 and our lower holdings of asset liquidity using money market
investments, which we normally fund with Discount Notes. By September 30, Discount Note balances
were down substantially from levels earlier in 2009 and in 2008.
The relatively stable balance of unswapped fixed-rate Bonds in the first nine months of 2009
compared to the 2008 periods reflected primarily the relatively modest growth in our mortgage
assets.
The following table shows the allocation on September 30, 2009 of unswapped fixed-rate Bonds
according to their final remaining maturity and next call date (for callable Bonds).
(In millions) | Year of Maturity | Year of Next Call | ||||||||||||||||||
Callable | Noncallable | Amortizing | Total | Callable | ||||||||||||||||
Due in 1 year or less |
$ | - | $ | 4,429 | $ | 4 | $ | 4,433 | $ | 8,791 | ||||||||||
Due after 1 year through 2 years |
445 | 3,005 | 4 | 3,454 | 1,695 | |||||||||||||||
Due after 2 years through 3 years |
1,580 | 2,672 | 54 | 4,306 | 125 | |||||||||||||||
Due after 3 years through 4 years |
1,695 | 2,339 | 14 | 4,048 | - | |||||||||||||||
Due after 4 years through 5 years |
1,366 | 1,168 | 3 | 2,537 | 25 | |||||||||||||||
Thereafter |
5,550 | 1,357 | 137 | 7,044 | - | |||||||||||||||
Total |
$ | 10,636 | $ | 14,970 | $ | 216 | $ | 25,822 | $ | 10,636 | ||||||||||
The allocations were consistent with those in the last several years. The Bonds were distributed
relatively smoothly throughout the maturity spectrum. Twenty-seven percent had final remaining
maturities greater than five years. These longer-term Bonds help us hedge the extension risk of
long-term mortgage assets. Forty-one percent provide us with call options, which help manage the
prepayment volatility of mortgage assets. Over 80 percent of the callable Bonds have next call
dates within the next 12 months and most of them are callable daily after an initial lockout
period. Daily call options provide considerable flexibility in managing market risk exposure to
lower mortgage rates.
Relative Cost of Funding
Consolidated Obligation Bonds normally have an interest cost at a spread above U.S. Treasury securities and below LIBOR. These spreads can be volatile, and in 2008 and the first quarter of 2009, they were significantly wider and more volatile than in prior years. The financial crisis caused investors to demand significantly more relative compensation for debt securities, especially longer-term securities, issued by non-government entities. We responded to the higher spreads on noncallable Bonds by issuing a greater percentage of callable Bonds and Discount Notes because callable Bond spreads did not widen as much as noncallable Bond spreads. Throughout 2009, both noncallable and callable Bonds spreads and volatility improved back towards historical norms compared to the previous distressed conditions. This reversion of spreads benefited our earnings to the extent we replaced called and matured Bonds.
Consolidated Obligation Bonds normally have an interest cost at a spread above U.S. Treasury securities and below LIBOR. These spreads can be volatile, and in 2008 and the first quarter of 2009, they were significantly wider and more volatile than in prior years. The financial crisis caused investors to demand significantly more relative compensation for debt securities, especially longer-term securities, issued by non-government entities. We responded to the higher spreads on noncallable Bonds by issuing a greater percentage of callable Bonds and Discount Notes because callable Bond spreads did not widen as much as noncallable Bond spreads. Throughout 2009, both noncallable and callable Bonds spreads and volatility improved back towards historical norms compared to the previous distressed conditions. This reversion of spreads benefited our earnings to the extent we replaced called and matured Bonds.
Deposits
Members deposits with us are a relatively minor source of low-cost funding. As shown on the
Average Balance Sheet and Yield/Rates table in the Results of Operations, the average balance
of interest-bearing deposits increased $206 million (14 percent) in the first nine months of 2009
compared to the same period of 2008. We believe the growth reflected members excess liquidity
available for investment. As shown on the Statements of Condition, comparing September 30, 2009 to
year-end 2008, interest-bearing deposit balances increased more substantially (by $473 million).
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Derivatives Hedging Activity and Liquidity
We discuss our use of and accounting for derivatives in the Use of Derivatives in Market Risk
Management section of Quantitative and Qualitative Disclosures About Risk Management. We discuss
our liquidity in Executive Overview and in the Liquidity Risk and Contractual Obligations
section of Quantitative and Qualitative Disclosures About Risk Management. Further information on
our use of derivatives is contained in our annual report on Form 10-K for year end 2008.
Capital Resources
Capital Leverage
The Gramm-Leach-Bliley Act of 1999 (GLB Act) and Finance Agency Regulations specify limits on how much we can leverage capital by requiring us to maintain at all times at least a 4.00 percent regulatory capital-to-assets ratio. A lower ratio indicates more leverage. We have adopted a more restrictive additional limit in our Financial Management Policy, which targets a floor on the regulatory quarterly average capital-to-assets ratio of 4.20 percent. If our financial leverage increases too much, or becomes too close to the regulatory limit, we have discretionary ability within our Capital Plan to enact changes to ensure our capitalization remains strong and in compliance with all regulatory limits. The following tables present our capital and capital-to-assets ratios, on both a GAAP and regulatory basis.
The Gramm-Leach-Bliley Act of 1999 (GLB Act) and Finance Agency Regulations specify limits on how much we can leverage capital by requiring us to maintain at all times at least a 4.00 percent regulatory capital-to-assets ratio. A lower ratio indicates more leverage. We have adopted a more restrictive additional limit in our Financial Management Policy, which targets a floor on the regulatory quarterly average capital-to-assets ratio of 4.20 percent. If our financial leverage increases too much, or becomes too close to the regulatory limit, we have discretionary ability within our Capital Plan to enact changes to ensure our capitalization remains strong and in compliance with all regulatory limits. The following tables present our capital and capital-to-assets ratios, on both a GAAP and regulatory basis.
GAAP and Regulatory Capital
Nine Months Ended | Year Ended | Nine Months Ended | ||||||||||||||||||||||
September 30, 2009 | December 31, 2008 | September 30, 2008 | ||||||||||||||||||||||
(In millions) | Period End | Average | Period End | Average | Period End | Average | ||||||||||||||||||
GAAP Capital Stock |
$ | 3,658 | $ | 3,949 | $ | 3,962 | $ | 3,798 | $ | 3,968 | $ | 3,745 | ||||||||||||
Mandatorily Redeemable
Capital Stock |
87 | 155 | 111 | 127 | 131 | 124 | ||||||||||||||||||
Regulatory Capital Stock |
3,745 | 4,104 | 4,073 | 3,925 | 4,099 | 3,869 | ||||||||||||||||||
Retained Earnings |
407 | 398 | 326 | 335 | 319 | 327 | ||||||||||||||||||
Regulatory Capital |
$ | 4,152 | $ | 4,502 | $ | 4,399 | $ | 4,260 | $ | 4,418 | $ | 4,196 | ||||||||||||
GAAP and Regulatory Capital-to-Assets Ratios
Nine Months Ended | Year Ended | Nine Months Ended | ||||||||||||||||||||||
September 30, 2009 | December 31, 2008 | September 30, 2008 | ||||||||||||||||||||||
Period End | Average | Period End | Average | Period End | Average | |||||||||||||||||||
GAAP |
5.27 | % | 4.98 | % | 4.36 | % | 4.37 | % | 4.40 | % | 4.36 | % | ||||||||||||
Regulatory |
5.39 | 5.16 | 4.48 | 4.51 | 4.54 | 4.50 |
The decrease in financial leverage in the first nine months of 2009 was due principally to the
decrease in Advance balances. Retained earnings increased from year-end 2008 to September 30, 2009
by $81 million because we paid shareholders an average annualized dividend rate of 4.67 percent
dividend in the first three quarters of 2009 while the ROE averaged 6.75 percent.
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Changes in Capital Stock Balances
The following table presents changes in our regulatory capital stock balances.
The following table presents changes in our regulatory capital stock balances.
(In millions) | ||||
Regulatory stock balance at December 31, 2008 |
$ | 4,073 | ||
Stock purchases: |
||||
Membership stock |
47 | |||
Activity stock |
40 | |||
Stock repurchases: |
||||
Excess stock redemption |
(376 | ) | ||
Other stock repurchases |
(39 | ) | ||
Regulatory stock balance at September 30, 2009 |
$ | 3,745 | ||
Regulatory capital stock balances decreased $328 million. The decrease resulted primarily from our
repurchase of $376 million of excess stock, most of it the subject of two members redemption
requests. Although total Advance balances decreased, Advance usage from several members increased,
resulting in the $40 million increase in activity stock purchases. The membership stock purchases
reflected the annual recalculation of the member capital investment requirement.
Excess Stock
The table below shows that, as our Advances fell in 2009, the amount of our excess capital stock outstanding increased and the amount of capital stock members cooperatively utilized within our Capital Plan decreased. A key component of our Capital Plan is cooperative utilization of capital stock, which, within constraints, permits members who have no excess stock of their own to capitalize additional Mission Asset Activity using excess stock owned by other members. Excess capital stock outstanding per our Capital Plan is reduced by the amount of cooperative utilization. If our Capital Plan did not have a cooperative capital feature, members would have been required to purchase up to $281 million of additional stock to capitalize the same total amount of Mission Asset Activity outstanding.
The table below shows that, as our Advances fell in 2009, the amount of our excess capital stock outstanding increased and the amount of capital stock members cooperatively utilized within our Capital Plan decreased. A key component of our Capital Plan is cooperative utilization of capital stock, which, within constraints, permits members who have no excess stock of their own to capitalize additional Mission Asset Activity using excess stock owned by other members. Excess capital stock outstanding per our Capital Plan is reduced by the amount of cooperative utilization. If our Capital Plan did not have a cooperative capital feature, members would have been required to purchase up to $281 million of additional stock to capitalize the same total amount of Mission Asset Activity outstanding.
(In millions) | September 30, 2009 | December 31, 2008 | ||||||
Excess capital stock (Capital Plan definition) |
$ | 907 | $ | 649 | ||||
Cooperative utilization of capital stock |
$ | 281 | $ | 406 | ||||
Mission Asset Activity capitalized with cooperative capital stock |
$ | 7,025 | $ | 10,150 | ||||
A Finance Agency Regulation prohibits us from paying stock dividends if the amount of our
regulatory excess stock (defined by the Finance Agency to include stock cooperatively used) exceeds
one percent of our total assets. Because of the recent reductions in Advance balances, at year-end
2008 and in each of the first three quarters of 2009, we were above the regulatory threshold and,
therefore, were required to pay cash dividends. Until Advances grow substantially again, we expect
to continue to be required to pay cash dividends.
Retained Earnings
On September 30, 2009, stockholders investment in our FHLBank was supported by $407 million of retained earnings. This represented 11 percent of total regulatory capital stock and 0.53 percent of total assets. When allocating earnings between dividends and retained earnings our Board of Directors considers the goals of paying stockholders a competitive dividend and having an adequate amount of retained earnings to mitigate impairment risk and potentially augment future dividend stability.
On September 30, 2009, stockholders investment in our FHLBank was supported by $407 million of retained earnings. This represented 11 percent of total regulatory capital stock and 0.53 percent of total assets. When allocating earnings between dividends and retained earnings our Board of Directors considers the goals of paying stockholders a competitive dividend and having an adequate amount of retained earnings to mitigate impairment risk and potentially augment future dividend stability.
Membership and Stockholders
On September 30, 2009, we had 738 member stockholders. In the first nine months of 2009, 17
institutions became new member stockholders while seven were lost, producing a net gain of ten
member stockholders. Of the seven members lost, three merged with other Fifth District members, two
merged outside of the Fifth District, one was subject to an FDIC seizure and subsequent purchase
and assumption agreement with another Fifth District member, and one relocated its charter outside
the Fifth District. The impact on Mission Asset Activity and earnings from these membership changes
was negligible. Modest fluctuations in Mission Asset Activity and earnings from membership changes
are a normal part of our business operations. More pronounced effects could result from the loss of
one or more of our largest users.
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The following tables list institutions holding five percent or more of outstanding Class B capital
stock. The amounts include stock held by any known affiliates that are members of our FHLBank.
(Dollars in millions)
September 30, 2009 | ||||||||
Percent | ||||||||
Name | Balance | of Total | ||||||
U.S. Bank, N.A. |
$ | 591 | 16 | % | ||||
National City Bank |
404 | 11 | ||||||
Fifth Third Bank |
401 | 11 | ||||||
The Huntington National Bank |
241 | 6 | ||||||
Total |
$ | 1,637 | 44 | % | ||||
December 31, 2008 | ||||||||
Percent | ||||||||
Name | Balance | of Total | ||||||
U.S. Bank, N.A. |
$ | 841 | 21 | % | ||||
National City Bank |
404 | 10 | ||||||
Fifth Third Bank |
394 | 10 | ||||||
The Huntington National Bank |
241 | 6 | ||||||
AmTrust Bank |
223 | 5 | ||||||
Total |
$ | 2,103 | 52 | % | ||||
The decrease in stock held by U.S. Bank, N.A. was due to its request for redemption of a portion of
its excess stock in order to reduce its total holdings of FHLBank System stock; we repurchased this
excess stock in September 2009. On November 6, 2009, National City Bank, which had been acquired in
January 2009 by PNC Financial Services Group, Inc., notified us of its membership withdrawal. See
the discussion in the Business Related Developments and Update on Risk Factors in the Executive
Overview for more information on this membership termination.
In the first nine months of 2009, there were no material changes in the percentage of members we
have from total eligible companies, in the composition of membership by state, or in the allocation
of member stockholders by their asset size. Because most existing eligible commercial banks and
thrift/savings and loan associations are already members, our recruitment of new members focuses on
credit unions, insurance companies, and de novo banks.
RESULTS OF OPERATIONS
Components of Earnings and Return on Equity
The following table is a summary income statement for the three and nine months ended September 30,
2009 and 2008. Each ROE percentage is computed as the annualized income or expense for the category
divided by the average amount of stockholders equity for the period.
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||||
(Dollars in millions) | 2009 | 2008 | 2009 | 2008 | ||||||||||||||||||||||||||||
Amount | ROE (a) | Amount | ROE (a) | Amount | ROE (a) | Amount | ROE (a) | |||||||||||||||||||||||||
Net interest income |
$ | 91 | 6.18 | % | $ | 92 | 6.38 | % | $ | 313 | 7.06 | % | $ | 268 | 6.44 | % | ||||||||||||||||
Net gains on derivatives
and hedging activities |
5 | 0.33 | 10 | 0.69 | 13 | 0.29 | 9 | 0.23 | ||||||||||||||||||||||||
Other non-interest income |
2 | 0.16 | 2 | 0.15 | 12 | 0.28 | 6 | 0.14 | ||||||||||||||||||||||||
Total non-interest income |
7 | 0.49 | 12 | 0.84 | 25 | 0.57 | 15 | 0.37 | ||||||||||||||||||||||||
Total revenue |
98 | 6.67 | 104 | 7.22 | 338 | 7.63 | 283 | 6.81 | ||||||||||||||||||||||||
Total other expense |
(14 | ) | (0.97 | ) | (14 | ) | (0.96 | ) | (39 | ) | (0.88 | ) | (37 | ) | (0.89 | ) | ||||||||||||||||
Assessments |
(23 | ) | (b | ) | (24 | ) | (b | ) | (80 | ) | (b | ) | (66 | ) | (b | ) | ||||||||||||||||
Net income |
$ | 61 | 5.70 | % | $ | 66 | 6.26 | % | $ | 219 | 6.75 | % | $ | 180 | 5.92 | % | ||||||||||||||||
(a) | The ROE amounts have been computed using dollars in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) in this table may produce nominally different results. | |
(b) | The effect on ROE of the REFCORP and Affordable Housing Program assessments is pro-rated within the other categories. |
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As is normally the case for our FHLBank, in both the three- and nine-months comparison, the largest
component of net income was net interest income, which is detailed in the next section.
Most of the income changes for derivatives and hedging activities in both periods represented
unrealized market value adjustments. The adjustments resulted primarily from interest rate changes
that affected the market values of derivatives differently from the market values of the hedged
risks. For the three-months comparison, the smaller gain in the derivatives market value
adjustment resulted from relatively large gains in the third quarter of 2008 due primarily to the
sharp increase in short-term LIBOR from the accelerating financial crisis in that quarter. Overall,
we consider the amount of volatility in these two periods to be moderate and consistent with the
close hedging relationships of our derivative transactions.
The $6 million increase in other non-interest income for the nine-months comparison period resulted
from a gain on the sales, in January 2009, of $216 million of mortgage-backed securities.
Net Interest Income
We manage net interest income within the context of managing the tradeoff between market risk and
return. Effective risk/return management requires us to focus principally on the relationships
among assets and liabilities that affect net interest income, rather than individual balance sheet
and income statement accounts in isolation. Our ROE normally tends to be low compared to many other
financial institutions because of our cooperative wholesale business model, our members desire to
have dividends correlate with short-term interest rates, and our modest overall risk profile.
Components of Net Interest Income
We generate net interest income from two components: 1) the net interest rate spread and 2) funding interest-earning assets with interest-free capital (earnings from capital). The sum of these, when expressed as a percentage of the average book balance of interest-earning assets, equals the net interest margin. Because of our relatively low net interest rate spread compared to other financial institutions, we normally derive a substantial proportion of net interest income from deploying our capital to fund assets.
We generate net interest income from two components: 1) the net interest rate spread and 2) funding interest-earning assets with interest-free capital (earnings from capital). The sum of these, when expressed as a percentage of the average book balance of interest-earning assets, equals the net interest margin. Because of our relatively low net interest rate spread compared to other financial institutions, we normally derive a substantial proportion of net interest income from deploying our capital to fund assets.
The following table shows the two major components of net interest income, as well as the three
major subcomponents of the net interest spread.
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||||
(Dollars in millions) | 2009 | 2008 | 2009 | 2008 | ||||||||||||||||||||||||||||
Pct of | Pct of | Pct of | Pct of | |||||||||||||||||||||||||||||
Earning | Earning | Earning | Earning | |||||||||||||||||||||||||||||
Amount | Assets | Amount | Assets | Amount | Assets | Amount | Assets | |||||||||||||||||||||||||
Components of net interest rate spread: |
||||||||||||||||||||||||||||||||
Other components of net interest rate spread |
$ | 77 | 0.38 | % | $ | 60 | 0.25 | % | $ | 263 | 0.41 | % | $ | 171 | 0.25 | % | ||||||||||||||||
Net (amortization)/accretion (1) (2) |
(9 | ) | (0.04 | ) | (6 | ) | (0.02 | ) | (25 | ) | (0.04 | ) | (26 | ) | (0.04 | ) | ||||||||||||||||
Prepayment fees on Advances, net (2) |
2 | 0.01 | 1 | - | 6 | 0.01 | 2 | - | ||||||||||||||||||||||||
Total net interest rate spread (3) |
70 | 0.35 | 55 | 0.23 | 244 | 0.38 | 147 | 0.21 | ||||||||||||||||||||||||
Earnings from funding assets with interest-free capital |
21 | 0.10 | 37 | 0.16 | 69 | 0.10 | 121 | 0.18 | ||||||||||||||||||||||||
Total net interest income/net interest margin |
$ | 91 | 0.45 | % | $ | 92 | 0.39 | % | $ | 313 | 0.48 | % | $ | 268 | 0.39 | % | ||||||||||||||||
(1) | Includes (amortization)/accretion of premiums/discounts on mortgage assets and Consolidated Obligations and deferred transaction costs (concession fees) for Consolidated Obligations. | |
(2) | These components of net interest rate spread have been segregated here to display their relative impact. | |
(3) | Total earning assets multiplied by the difference in the book yield on interest-earning assets and book cost of interest-bearing liabilities. |
Earnings From Capital. Earnings from capital decreased in both comparison periods because
of the significant reductions in short-term interest rates. We deploy much of our capital in
short-term and adjustable-rate assets in order to help ensure that our ROE moves with short-term
interest rates and to help control market risk exposure.
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Net Amortization/Accretion. Although volatility in net amortization of mortgage assets and
callable Bonds can be substantial, the total change in such amortization was relatively small
between the two comparison periods. The amortization of callable Bond concession expense was higher
in the first nine months of 2009 than in the same period of 2008 primarily because we called a
greater amount of Bonds in 2009.
Although changes in net amortization of purchase premiums and discounts on mortgage assets can be,
and in the past have been, significant, they were not significant in the two comparison periods.
Net amortization depends on actual and projected principal prepayments. Our mortgage assets
normally have a net premium balance, which results in higher net amortization when mortgage rates
fall and lower net amortization when mortgage rates rise. Although mortgage rates were generally
lower in 2009 than in 2008, changes in actual and projected prepayment speeds were smaller than
normally expected due to falling home prices, the recession, and difficult mortgage refinancing
conditions. This resulted in smaller than expected changes in net amortization.
Prepayment Fees on Advances. Although Advance prepayment fees can be, and in the past have
been, significant, they were relatively moderate in the 2009 and 2008. Prepayment fees depend
mostly on the actions and preferences of members to continue holding our Advances. Fees in one
period do not necessarily indicate a trend that will continue in future periods.
Other Components of Net Interest Spread. Excluding net amortization and Advance prepayment
fees, the other components of the net interest rate spread increased $92 million in the nine-months
comparison and $17 million in the three-months comparison. When short-term interest rates decline
dramatically, as occurred in 2009, net interest income normally decreases due to a reduction in the
earnings from capital. However, several material factors resulted in an overall increase in net
interest income for the nine-months comparison and a small $1 million decrease in the three-months
comparison. These factors are discussed below in estimated order of impact from largest to
smallest.
Nine-Months Comparison
§ | Re-issuing called Consolidated Bonds at lower debt costsFavorable: During the fourth quarter of 2008 and the first three quarters of 2009, the reductions in intermediate- and long-term interest rates enabled us to retire (call) approximately $14 billion of unswapped Bonds before their final maturities and replace them with new debt (both Bonds and Discount Notes) at significantly lower interest rates. By contrast, the amount of mortgage paydowns, which we reinvested in assets with lower rates, was substantially less than the amount of Bonds called. In addition, the large amount of Bonds called enabled us to favorably alter the distribution of liability maturities, which raised earnings given the sharply upward sloping yield curve, without materially impacting market risk exposure. | ||
§ | Wider portfolio spreads on short-term assets compared to funding costsFavorable: We use Discount Notes to fund a large amount (normally between $10 billion and $20 billion) of our LIBOR-indexed Advances. For 2008 and the first six months of 2009, average portfolio spreads on short-term and adjustable-rate assets indexed to short-term LIBOR relative to their funding costs were substantially wider than the 18 to 20 basis points historical average. Spreads were wider in the first nine months of 2009 than the same period in 2008 because the financial crisis raised the cost of inter-bank lending (represented by LIBOR) relative to other short-term interest costs such as our Discount Notes. In some months, LIBOR rose as other short-term market rates fell. The wider spreads were particularly acute in the fourth quarter of 2008 (which benefited 2009s earnings) and the first quarter of 2009. | ||
§ | Increase in benefit from short fundingFavorable: Market yield curves became significantly steeper in late 2008 and 2009 as short-term interest rates fell to historical lows of close to zero. This benefited earnings due to our modest utilization of short-term debt to fund long-term assets (short funding). In addition, differences in principal paydowns of long-term assets versus liabilities, including muted acceleration of mortgage prepayments, caused the amount of short funding to increase in the first three quarters of 2009. | ||
§ | Decrease in financial leverage due to lower Advance balanceUnfavorable: The average principal balance of Advances was $14.4 billion lower in the first nine months of 2009 compared to the same period of 2008, which reduced our financial leverage. Much of the reduction in leverage occurred from repayment and maturities of LIBOR Advances. Because, as explained above, we had funded many of these LIBOR Advances with Discount Notes at elevated spreads until the third quarter, the loss of these Advances decreased net interest income. We did not replace the lower Advance balances with sufficient increases in other asset balances to fully offset the lost income. |
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Three-Months Comparison
For the three-months comparison, the same factors affected the other components of net interest
rate spread as in the nine-months comparison and in approximately the same relative magnitude,
except as noted below.
In the third quarter of 2009, short-term LIBOR decreased, causing the spread between LIBOR and
Discount Notes to revert back to, and even go below, the levels in the third quarter of 2008 and
historical average levels. We believe this was due to market participants view that the
financial disruptions had eased and to the effects of the massive amounts of liquidity injected
into the financial system. As a result, the higher profits from the wider LIBOR to Discount Note
spreads dissipated during the third quarter, resulting in a slight decrease in net interest
income for the three-months comparison. Partially offsetting this trend was a favorable earnings
impact from the continuing calls of high-cost Consolidated Bonds; the impact of the Bond calls
increased as 2009 progressed.
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Average Balance Sheet and Yield/Rates
The following tables provide yields/rates and average balances for major balance sheet accounts. These tables provide details on the increases in the net interest rate spread. The average rate of each asset and liability category was lower in the 2009 periods than in the 2008 periods. The accounts with the largest reductions in average rates have short-term maturities or are adjustable rate, which means they repriced to lower rates in the first nine months of 2009, corresponding to the significant reductions in short-term market rates. All data include the impact of interest rate swaps, which we allocate to each asset and liability category according to their designated hedging relationship.
The following tables provide yields/rates and average balances for major balance sheet accounts. These tables provide details on the increases in the net interest rate spread. The average rate of each asset and liability category was lower in the 2009 periods than in the 2008 periods. The accounts with the largest reductions in average rates have short-term maturities or are adjustable rate, which means they repriced to lower rates in the first nine months of 2009, corresponding to the significant reductions in short-term market rates. All data include the impact of interest rate swaps, which we allocate to each asset and liability category according to their designated hedging relationship.
(Dollars in millions) | Three Months Ended | Three Months Ended | ||||||||||||||||||||||
September 30, 2009 | September 30, 2008 | |||||||||||||||||||||||
Average | Average | Average | Average | |||||||||||||||||||||
Balance | Interest | Rate (1) | Balance | Interest | Rate (1) | |||||||||||||||||||
Assets |
||||||||||||||||||||||||
Advances |
$ | 41,530 | $ | 110 | 1.05 | % | $ | 62,185 | $ | 439 | 2.81 | % | ||||||||||||
Mortgage loans held for portfolio (2) |
9,761 | 116 | 4.70 | 8,569 | 112 | 5.21 | ||||||||||||||||||
Federal funds sold and securities purchased under resale agreements |
9,070 | 4 | 0.15 | 7,329 | 36 | 1.94 | ||||||||||||||||||
Other short-term investments |
2,275 | 1 | 0.23 | 26 | - | 2.81 | ||||||||||||||||||
Interest-bearing deposits in banks (3) (4) |
5,847 | 4 | 0.28 | 2,898 | 19 | 2.60 | ||||||||||||||||||
Mortgage-backed securities |
12,260 | 147 | 4.76 | 13,337 | 166 | 4.93 | ||||||||||||||||||
Other long-term investments |
11 | - | 4.15 | 16 | - | 4.84 | ||||||||||||||||||
Loans to other FHLBanks |
29 | - | 0.15 | 10 | - | 1.62 | ||||||||||||||||||
Total earning assets |
80,783 | 382 | 1.88 | 94,370 | 772 | 3.25 | ||||||||||||||||||
Allowance for credit losses on mortgage loans |
- | - | ||||||||||||||||||||||
Other assets |
272 | 341 | ||||||||||||||||||||||
Total assets |
$ | 81,055 | $ | 94,711 | ||||||||||||||||||||
Liabilities and Capital |
||||||||||||||||||||||||
Term deposits |
$ | 176 | - | 0.61 | $ | 121 | 1 | 2.46 | ||||||||||||||||
Other interest bearing deposits (4) |
1,584 | - | 0.04 | 1,277 | 5 | 1.72 | ||||||||||||||||||
Short-term borrowings |
32,216 | 16 | 0.19 | 39,578 | 229 | 2.30 | ||||||||||||||||||
Unswapped fixed-rate Consolidated Bonds |
25,413 | 256 | 3.99 | 26,639 | 303 | 4.53 | ||||||||||||||||||
Unswapped adjustable-rate Consolidated Bonds |
2,853 | 4 | 0.54 | 9,239 | 60 | 2.59 | ||||||||||||||||||
Swapped Consolidated Bonds |
12,969 | 12 | 0.37 | 12,471 | 80 | 2.54 | ||||||||||||||||||
Mandatorily redeemable capital stock |
251 | 3 | 5.19 | 129 | 2 | 5.50 | ||||||||||||||||||
Other borrowings |
- | - | - | 2 | - | 0.49 | ||||||||||||||||||
Total interest-bearing liabilities |
75,462 | 291 | 1.53 | 89,456 | 680 | 3.02 | ||||||||||||||||||
Non-interest bearing deposits |
6 | 2 | ||||||||||||||||||||||
Other liabilities |
1,307 | 1,050 | ||||||||||||||||||||||
Total capital |
4,280 | 4,203 | ||||||||||||||||||||||
Total liabilities and capital |
$ | 81,055 | $ | 94,711 | ||||||||||||||||||||
Net interest rate spread |
0.35 | % | 0.23 | % | ||||||||||||||||||||
Net interest income and net interest margin |
$ | 91 | 0.45 | % | $ | 92 | 0.39 | % | ||||||||||||||||
Average interest-earning assets to interest-bearing liabilities |
107.05 | % | 105.49 | % | ||||||||||||||||||||
(1) | Amounts used to calculate average rates are based on dollars in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results. | |
(2) | Nonperforming loans are included in average balances used to determine average rate. There were none for the periods displayed. | |
(3) | Includes securities classified as available-for-sale, based on their amortized costs. The yield information does not give effect to changes in fair value that are reflected as a component of stockholders equity for available-for-sale securities. | |
(4) | Amounts include certificates of deposits and bank notes that are classified as available-for-sale or held-to-maturity securities in the Statements of Condition. Additionally, the average balance amounts include the rights or obligations to cash collateral, which are included in the fair value of derivative assets or derivative liabilities on the Statements of Condition at period end. |
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(Dollars in millions) | Nine Months Ended | Nine Months Ended | ||||||||||||||||||||||
September 30, 2009 | September 30, 2008 | |||||||||||||||||||||||
Average | Average | Average | Average | |||||||||||||||||||||
Balance | Interest | Rate (1) | Balance | Interest | Rate (1) | |||||||||||||||||||
Assets |
||||||||||||||||||||||||
Advances |
$ | 46,953 | $ | 495 | 1.41 | % | $ | 60,944 | $ | 1,453 | 3.18 | % | ||||||||||||
Mortgage loans held for portfolio (2) |
9,557 | 367 | 5.14 | 8,724 | 345 | 5.28 | ||||||||||||||||||
Federal funds sold and securities purchased under resale agreements |
8,396 | 10 | 0.16 | 8,451 | 150 | 2.37 | ||||||||||||||||||
Other short-term investments |
801 | 1 | 0.24 | 25 | 1 | 2.97 | ||||||||||||||||||
Interest-bearing deposits in banks (3) (4) |
9,024 | 23 | 0.34 | 2,338 | 55 | 3.17 | ||||||||||||||||||
Mortgage-backed securities |
12,146 | 438 | 4.82 | 12,420 | 456 | 4.91 | ||||||||||||||||||
Other long-term investments |
11 | - | 4.24 | 16 | 1 | 5.10 | ||||||||||||||||||
Loans to other FHLBanks |
14 | - | 0.14 | 15 | - | 2.53 | ||||||||||||||||||
Total earning assets |
86,902 | 1,334 | 2.06 | 92,933 | 2,461 | 3.54 | ||||||||||||||||||
Allowance for credit losses on mortgage loans |
- | - | ||||||||||||||||||||||
Other assets |
294 | 338 | ||||||||||||||||||||||
Total assets |
$ | 87,196 | $ | 93,271 | ||||||||||||||||||||
Liabilities and Capital |
||||||||||||||||||||||||
Term deposits |
$ | 140 | 1 | 0.93 | $ | 102 | 2 | 3.07 | ||||||||||||||||
Other interest bearing deposits (4) |
1,536 | 1 | 0.05 | 1,368 | 22 | 2.11 | ||||||||||||||||||
Short-term borrowings |
37,708 | 104 | 0.37 | 39,189 | 774 | 2.64 | ||||||||||||||||||
Unswapped fixed-rate Consolidated Bonds |
25,388 | 802 | 4.23 | 24,789 | 863 | 4.64 | ||||||||||||||||||
Unswapped adjustable-rate Consolidated Bonds |
4,380 | 32 | 0.98 | 10,486 | 247 | 3.15 | ||||||||||||||||||
Swapped Consolidated Bonds |
12,111 | 76 | 0.84 | 12,024 | 279 | 3.11 | ||||||||||||||||||
Mandatorily redeemable capital stock |
155 | 5 | 4.73 | 124 | 6 | 7.15 | ||||||||||||||||||
Other borrowings |
2 | - | 0.07 | 2 | - | 1.64 | ||||||||||||||||||
Total interest-bearing liabilities |
81,420 | 1,021 | 1.68 | 88,084 | 2,193 | 3.33 | ||||||||||||||||||
Non-interest bearing deposits |
5 | 4 | ||||||||||||||||||||||
Other liabilities |
1,429 | 1,115 | ||||||||||||||||||||||
Total capital |
4,342 | 4,068 | ||||||||||||||||||||||
Total liabilities and capital |
$ | 87,196 | $ | 93,271 | ||||||||||||||||||||
Net interest rate spread |
0.38 | % | 0.21 | % | ||||||||||||||||||||
Net interest income and net interest margin |
$ | 313 | 0.48 | % | $ | 268 | 0.39 | % | ||||||||||||||||
Average interest-earning assets to interest-bearing liabilities |
106.73 | % | 105.50 | % | ||||||||||||||||||||
(1) | Amounts used to calculate average rates are based on dollars in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results. | |
(2) | Nonperforming loans are included in average balances used to determine average rate. There were none for the periods displayed. | |
(3) | Includes securities classified as available-for-sale, based on their amortized costs. The yield information does not give effect to changes in fair value that are reflected as a component of stockholders equity for available-for-sale securities. | |
(4) | Amounts include certificates of deposits and bank notes that are classified as available-for-sale or held-to-maturity securities in the Statements of Condition. Additionally, the average balance amounts include the rights or obligations to cash collateral, which are included in the fair value of derivative assets or derivative liabilities on the Statements of Condition at period end. |
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Volume/Rate Analysis
Another way to consider the change in net interest income is through a standard volume/rate analysis, as presented in the following table. For purposes of this table, we have allocated changes due to the combined volume/rate variance to the rate category.
Another way to consider the change in net interest income is through a standard volume/rate analysis, as presented in the following table. For purposes of this table, we have allocated changes due to the combined volume/rate variance to the rate category.
Three Months Ended | Nine Months Ended | ||||||||||||||||||||||||
(In millions) |
September 30, 2009 over 2008 | September 30, 2009 over 2008 | |||||||||||||||||||||||
Volume | Rate | Total | Volume | Rate | Total | ||||||||||||||||||||
Increase (decrease) in interest income |
|||||||||||||||||||||||||
Advances |
$ | (146 | ) | $ | (183 | ) | $ | (329 | ) | $ | (333 | ) | $ | (625 | ) | $ | (958 | ) | |||||||
Mortgage loans held for portfolio |
16 | (12 | ) | 4 | 33 | (11 | ) | 22 | |||||||||||||||||
Federal funds sold and securities purchased under resale agreements |
9 | (41 | ) | (32 | ) | (1 | ) | (139 | ) | (140 | ) | ||||||||||||||
Other short-term investments |
16 | (15 | ) | 1 | 17 | (17 | ) | - | |||||||||||||||||
Interest-bearing deposits in banks |
19 | (34 | ) | (15 | ) | 159 | (191 | ) | (32 | ) | |||||||||||||||
Mortgage-backed securities |
(14 | ) | (5 | ) | (19 | ) | (10 | ) | (8 | ) | (18 | ) | |||||||||||||
Other long-term investments |
- | - | - | (1 | ) | - | (1 | ) | |||||||||||||||||
Loans to other FHLBanks |
- | - | - | - | - | - | |||||||||||||||||||
Total |
(100 | ) | (290 | ) | (390 | ) | (136 | ) | (991 | ) | (1,127 | ) | |||||||||||||
Increase (decrease) in interest expense |
|||||||||||||||||||||||||
Term deposits |
- | (1 | ) | (1 | ) | 1 | (2 | ) | (1 | ) | |||||||||||||||
Other interest-bearing deposits |
2 | (7 | ) | (5 | ) | 3 | (24 | ) | (21 | ) | |||||||||||||||
Short-term borrowings |
(43 | ) | (170 | ) | (213 | ) | (30 | ) | (640 | ) | (670 | ) | |||||||||||||
Unswapped fixed-rate Consolidated Bonds |
(13 | ) | (34 | ) | (47 | ) | 20 | (81 | ) | (61 | ) | ||||||||||||||
Unswapped adjustable-rate Consolidated Bonds |
(41 | ) | (15 | ) | (56 | ) | (144 | ) | (71 | ) | (215 | ) | |||||||||||||
Swapped Consolidated Bonds |
3 | (71 | ) | (68 | ) | 2 | (205 | ) | (203 | ) | |||||||||||||||
Mandatorily redeemable capital stock |
1 | - | 1 | 2 | (3 | ) | (1 | ) | |||||||||||||||||
Other borrowings |
- | - | - | - | - | - | |||||||||||||||||||
Total |
(91 | ) | (298 | ) | (389 | ) | (146 | ) | (1,026 | ) | (1,172 | ) | |||||||||||||
Increase (decrease) in net interest income |
$ | (9 | ) | $ | 8 | $ | (1 | ) | $ | 10 | $ | 35 | $ | 45 | |||||||||||
Because of the large reductions in interest rates from 2008 to 2009, changes in individual asset
and liability categories in the volume/rate table cannot be aggregated or netted to reflect the
changes in balances or spreads between various interest rates. For example, the earnings benefits
we have realized from the spread between LIBOR and Discount Notes (short-term borrowings) and from
calling high-cost Bonds cannot be distinguished in the table above.
Effect of the Use of Derivatives on Net Interest Income
As explained elsewhere, the primary reason we use derivatives, most of which are interest rate swaps, is to hedge the fixed interest rates of certain Advances and Consolidated Obligations as well as to manage certain embedded options in assets and liabilities. The following table shows the effect of derivatives on our net interest income.
As explained elsewhere, the primary reason we use derivatives, most of which are interest rate swaps, is to hedge the fixed interest rates of certain Advances and Consolidated Obligations as well as to manage certain embedded options in assets and liabilities. The following table shows the effect of derivatives on our net interest income.
(In millions) | Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Advances (1) |
$ | (135 | ) | $ | (63 | ) | $ | (377 | ) | $ | (136 | ) | ||||
Mortgage purchase commitments (2) |
- | - | 3 | 1 | ||||||||||||
Consolidated Obligations (1) |
40 | 23 | 112 | 59 | ||||||||||||
Decrease to net interest income |
$ | (95 | ) | $ | (40 | ) | $ | (262 | ) | $ | (76 | ) | ||||
(1) | Represents interest rate swap interest. | |
(2) | Represents the amortization of derivative fair value adjustments. |
Although our overall use of derivatives decreased net interest income more in the 2009 periods than
in the 2008 periods, the derivatives made our earnings and market risk profile significantly more
stable because they effectively created synthetic adjustable-rate LIBOR-based coupon rates for both
fixed-rate Advances and fixed-rate Obligations. We funded the synthetic adjustable-rate Advances
with short-term Discount Notes and the synthetic adjustable-rate swapped Obligations. Thus, the
derivatives provided a much closer match of interest rate cash flows between assets and liabilities
than would have occurred without their use.
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The effect on net interest income from derivatives activity primarily represents the net effects
of:
§ | the economic cost of hedging purchased options embedded in Advances; | ||
§ | converting fixed-rate Regular Advances and Advances with below-market coupons and purchased options to at-market coupons tied to adjustable-rate LIBOR; and | ||
§ | converting fixed-rate coupons to an adjustable-rate LIBOR coupon on swapped Consolidated Obligations. |
In general, the relative magnitude of each factor depends on changes in both short-term LIBOR and
in the notional principal amounts of swapped Advances versus swapped Obligations. The larger
reduction in net interest income in the 2009 periods from our use of derivatives was primarily due
to the lower short-term LIBOR in 2009 versus 2008, combined with a greater use of derivatives to
transform fixed-rate Advances to adjustable-rate LIBOR than of derivatives to transform fixed-rate
Obligations to adjustable-rate LIBOR. See the section Use of Derivatives in Market Risk
Management in Quantitative and Qualitative Disclosures About Risk Management for further
information.
Non-Interest Income and Non-Interest Expense
The following table presents non-interest income and non-interest expense for the three and nine
months ended September 30, 2009 and 2008.
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||
(Dollars in millions) | 2009 | 2008 | 2009 | 2008 | ||||||||||||||||
Other Income |
||||||||||||||||||||
Net gains on held-to-maturity securities |
$ | - | $ | - | $ | 6 | $ | - | ||||||||||||
Net gains on derivatives and hedging activities |
5 | 10 | 13 | 9 | ||||||||||||||||
Other non-interest income, net |
2 | 2 | 6 | 6 | ||||||||||||||||
Total other income |
$ | 7 | $ | 12 | $ | 25 | $ | 15 | ||||||||||||
Other Expense |
||||||||||||||||||||
Compensation and benefits |
$ | 8 | $ | 6 | $ | 22 | $ | 19 | ||||||||||||
Other operating expense |
4 | 3 | 11 | 10 | ||||||||||||||||
Finance Agency |
1 | 1 | 2 | 2 | ||||||||||||||||
Office of Finance |
- | 1 | 2 | 2 | ||||||||||||||||
Other expenses |
1 | 3 | 2 | 4 | ||||||||||||||||
Total other expense |
$ | 14 | $ | 14 | $ | 39 | $ | 37 | ||||||||||||
Average total assets |
$ | 81,055 | $ | 94,711 | $ | 87,196 | $ | 93,271 | ||||||||||||
Average regulatory capital |
4,537 | 4,337 | 4,502 | 4,196 | ||||||||||||||||
Total other expense to average total assets (1) |
0.07% | 0.06% | 0.06% | 0.05% | ||||||||||||||||
Total other expense to average regulatory capital (1) |
1.24% | 1.27% | 1.15% | 1.18% |
(1) | Amounts used to calculate percentages are based on dollars in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results. |
The net gain on held-to-maturity securities and the net gains on derivatives and hedging activities
are discussed above under Components of Earnings and Return on Equity. Total other expenses grew
less than $2 million, or 5 percent, in the nine-months comparison. Total other expense as a
percentage of average total assets and average regulatory capital continued to be one of the lowest
of the FHLBanks. We continue to maintain a sharp focus on controlling our operating costs.
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REFCORP and Affordable Housing Program Assessments
Currently, the combined assessments for REFCORP and the Affordable Housing Program equate to an
approximately 27 percent effective annualized net assessment rate. Depending on the level of the
FHLBank Systems earnings, the REFCORP assessment is currently expected to be statutorily retired
within the next several years. Lower FHLBank System earnings would extend the retirement date and
higher earnings would accelerate the date.
In the first three quarters of 2009, assessments totaled $80 million, which reduced ROE by 2.46
percentage points, compared to $66 million in the first three quarters of 2008, which reduced ROE
by 2.16 percentage points. The relative burden of assessments was higher in 2009 than in 2008
because net income before assessments rose by 22 percent while average capital rose by only 7
percent; this means a larger assessment was applied to a modestly larger capital base.
Segment Information
Note 16 of the Notes to Unaudited Financial Statements presents information on our two operating
business segments. It is important to note that we manage our financial operations and market risk
exposure primarily at the level, and within the context, of the entire balance sheet, rather than
exclusively at the level of individual operating business segments. Under this approach, the market
risk/return profile of each operating business segment may not match, or possibly even have the
same trends as, what would occur if we managed each segment on a stand-alone basis.
The table below summarizes each segments operating results for the three and nine months ended
September 30, 2009 and 2008.
Traditional |
Mortgage |
|||||||||||
(Dollars in millions) | Member |
Purchase |
||||||||||
Finance |
Program |
Total | ||||||||||
Three Months Ended September 30, 2009 |
||||||||||||
Net interest income |
$ | 65 | $ | 26 | $ | 91 | ||||||
Net income |
$ | 41 | $ | 20 | $ | 61 | ||||||
Average assets |
$ | 71,248 | $ | 9,807 | $ | 81,055 | ||||||
Assumed average capital allocation |
$ | 3,765 | $ | 515 | $ | 4,280 | ||||||
Return on Average Assets (1) |
0.23% | 0.80% | 0.30% | |||||||||
Return on Average Equity (1) |
4.40% | 15.23% | 5.70% | |||||||||
Three Months Ended September 30, 2008 |
||||||||||||
Net interest income |
$ | 74 | $ | 18 | $ | 92 | ||||||
Net income |
$ | 54 | $ | 12 | $ | 66 | ||||||
Average assets |
$ | 86,100 | $ | 8,611 | $ | 94,711 | ||||||
Assumed average capital allocation |
$ | 3,820 | $ | 383 | $ | 4,203 | ||||||
Return on Average Assets (1) |
0.25% | 0.56% | 0.28% | |||||||||
Return on Average Equity (1) |
5.63% | 12.53% | 6.26% | |||||||||
(1) | Amounts used to calculate returns are based on numbers in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results. |
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Traditional |
Mortgage |
|||||||||||
(Dollars in millions) | Member |
Purchase |
||||||||||
Finance |
Program |
Total | ||||||||||
Nine Months Ended September 30, 2009 |
||||||||||||
Net interest income |
$ | 218 | $ | 95 | $ | 313 | ||||||
Net income |
$ | 155 | $ | 64 | $ | 219 | ||||||
Average assets |
$ | 77,594 | $ | 9,602 | $ | 87,196 | ||||||
Assumed average capital allocation |
$ | 3,864 | $ | 478 | $ | 4,342 | ||||||
Return on Average Assets (1) |
0.27% | 0.90% | 0.34% | |||||||||
Return on Average Equity (1) |
5.36% | 17.98% | 6.75% | |||||||||
Nine Months Ended September 30, 2008 |
||||||||||||
Net interest income |
$ | 204 | $ | 64 | $ | 268 | ||||||
Net income |
$ | 138 | $ | 42 | $ | 180 | ||||||
Average assets |
$ | 84,504 | $ | 8,767 | $ | 93,271 | ||||||
Assumed average capital allocation |
$ | 3,685 | $ | 383 | $ | 4,068 | ||||||
Return on Average Assets (1) |
0.22% | 0.64% | 0.26% | |||||||||
Return on Average Equity (1) |
5.01% | 14.67% | 5.92% | |||||||||
(1) | Amounts used to calculate returns are based on numbers in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results. |
Traditional Member Finance Segment
For the three-month comparison, the lower net income and lower ROE reflected the unfavorable effects of the reduction in the earnings from capital, the decrease in Advance balances, the decrease in the gain from market value adjustments on derivatives, and the narrower LIBOR-Discount Note spread. These were offset only partially by our calls of Consolidated Bonds identified to fund mortgage-backed securities and the higher gain from short funding. For the nine-months comparison, the increase in net income and ROE reflected the wider portfolio spreads on short-term assets, the Bond calls, the higher gain from short funding, a $4 million increase in Advance prepayment fees, the gains from selling mortgage-backed securities, and the increase in the gain from market value adjustments on derivatives. The last three factors were particularly prevalent in the first quarter of 2009.
For the three-month comparison, the lower net income and lower ROE reflected the unfavorable effects of the reduction in the earnings from capital, the decrease in Advance balances, the decrease in the gain from market value adjustments on derivatives, and the narrower LIBOR-Discount Note spread. These were offset only partially by our calls of Consolidated Bonds identified to fund mortgage-backed securities and the higher gain from short funding. For the nine-months comparison, the increase in net income and ROE reflected the wider portfolio spreads on short-term assets, the Bond calls, the higher gain from short funding, a $4 million increase in Advance prepayment fees, the gains from selling mortgage-backed securities, and the increase in the gain from market value adjustments on derivatives. The last three factors were particularly prevalent in the first quarter of 2009.
Mortgage Purchase Program Segment
The net income and ROE increased in 2009 for both comparison periods. The unfavorable effects from lower earnings from capital were more than offset by replacing a large amount of called Bonds with lower cost debt. We believe the Mortgage Purchase Program will continue to provide competitive risk-adjusted returns and augment earnings available to pay member stockholders, although this segment can exhibit more volatility in profitability over time relative to short-term interest rates than the Traditional Member Finance segment. As discussed elsewhere, mortgage assets are the largest source of our market risk exposure. The effect of market risk exposure from the mortgage-backed securities in the Traditional Member Finance segment is diluted by that segments Advances and money market investments, which each have a small amount of residual market risk.
The net income and ROE increased in 2009 for both comparison periods. The unfavorable effects from lower earnings from capital were more than offset by replacing a large amount of called Bonds with lower cost debt. We believe the Mortgage Purchase Program will continue to provide competitive risk-adjusted returns and augment earnings available to pay member stockholders, although this segment can exhibit more volatility in profitability over time relative to short-term interest rates than the Traditional Member Finance segment. As discussed elsewhere, mortgage assets are the largest source of our market risk exposure. The effect of market risk exposure from the mortgage-backed securities in the Traditional Member Finance segment is diluted by that segments Advances and money market investments, which each have a small amount of residual market risk.
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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT RISK MANAGEMENT
Overview
Residual risk is defined as the risk exposure to our mission and corporate objectives remaining
after applying our policies, controls, decisions, and procedures to manage and mitigate risk.
Normally, our most significant residual risks are business/strategic risk and market risk.
Currently, we believe the most significant risk is business/strategic risk, which we define as the
potential adverse impact on corporate objectives from external factors and events over which we
have limited control or influence. Our current business/strategic risks arise primarily from:
§ | residual effects from the economic recession, especially in our Fifth District; | ||
§ | residual effects from the financial crisis; | ||
§ | the various other actual and potential actions of the Federal government, including the Federal Reserve, Treasury Department and FDIC, to attempt to mitigate the financial crisis and economic recession; | ||
§ | potentially unfavorable actions regarding the ultimate financial, legislative and regulatory disposition of issues involving the GSEs, especially actions related to Fannie Mae and Freddie Mac with whom the FHLBanks share a common regulator; and | ||
§ | the evolving concerns about some other FHLBanks capital adequacy and profitability. |
We believe that the residual exposures for our other riskscollectively market risk, capital
adequacy, credit risk, and operational riskcontinued to be modest in the first nine months of
2009. Market risk exposure continued to be moderate and at a level consistent with our cooperative
business model. We have always maintained compliance with our capital requirements and we believe
we hold a sufficient amount of retained earnings to protect our capital stock against earnings
losses and impairment risk. We continue to conclude that we do not need a loss reserve for any
asset class and that no assets are impaired. We did not experience any material operating risk
event.
We also believe the funding/liquidity risk eased as 2009 progressed. Although we can make no
assurances, we believe the possibility of a liquidity or funding crisis in the FHLBank System that
would impair our FHLBanks ability to service our debt or pay competitive dividends is remote. The
impact of the financial crisis on our debt issuance capabilities and funding costs lessened, as our
long-term funding costs relative to LIBOR and U.S. Treasuries showed a relative improvement and
less volatility.
Market Risk
Measurement and Management of Market Risk Exposure
Market risk exposure is the risk of fluctuations in both the economic value of our stockholders capital investment in the FHLBank and the level of future earnings from unexpected changes and volatility in the market environment (most importantly interest rates) and our business operating conditions. There is normally a tradeoff between our long-term market risk exposure and short-term earnings. We attempt to minimize long-term market risk exposure while earning a competitive return on members capital stock investment. Effective management of both components is important in order to attract and retain members and capital and to support growth in Mission Asset Activity.
Market risk exposure is the risk of fluctuations in both the economic value of our stockholders capital investment in the FHLBank and the level of future earnings from unexpected changes and volatility in the market environment (most importantly interest rates) and our business operating conditions. There is normally a tradeoff between our long-term market risk exposure and short-term earnings. We attempt to minimize long-term market risk exposure while earning a competitive return on members capital stock investment. Effective management of both components is important in order to attract and retain members and capital and to support growth in Mission Asset Activity.
The primary challenges in managing the level and volatility of long-term earnings exposurei.e.,
market risk exposurearise from 1) the tradeoff between earning a competitive return and
correlating profitability with short-term interest rates and 2) the market risk exposure of owning
mortgage assets on which we have sold prepayment options. We mitigate the market risk of mortgage
assets mostly with long-term unswapped fixed-rate callable and noncallable Consolidated Bonds. We
have not used derivatives to manage the market risk of mortgage assets, except for hedging a
portion of commitments in the Mortgage Purchase Program. Because it is normally cost-prohibitive to
completely mitigate mortgage prepayment risk, a residual amount of market risk typically remains
after funding and hedging activities.
Our Financial Management Policy established by our Board of Directors specifies five sets of limits
regarding market risk exposure, which primarily address long-term market risk exposure. The policy
limits address: 1) the sensitivity of the market value of equity to interest rate shocks; 2) the
sensitivity of the duration of equity to interest rate shocks; 3) the market capitalization ratio
(defined as the ratio of the market value of equity to the par value of regulatory stock) under two
interest rate shocks; 4) the market value sensitivity of the mortgage assets portfolio; and 5) the
amount of mortgage assets as a
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multiple of capital (this limit was implemented in October 2009). We determine compliance with
these policy limits at every month-end or more frequently if market or business conditions change
significantly. We complied with each of these policy limits in each of the first nine months of
2009, except one for which we had a minor temporary violation in March.
In addition, Finance Agency Regulations and our Financial Management Policy provide controls on
market risk exposure by restricting the types of mortgage loans, mortgage-backed securities and
other investments we can hold. We have a minimal amount of mortgage-backed securities of
private-label issuers, which can have more volatility in prepayment speeds and credit risk than GSE
mortgage-backed securities. We have tended to purchase the senior tranches of collateralized
mortgage obligations, which can have less prepayment volatility than other tranches. We also manage
market risk exposure by charging members prepayment fees on many Advance programs where an early
termination of an Advance would result in an economic loss to us.
Market Value of Equity and Duration of Equity Entire Balance Sheet
Two key measures of long-term market risk exposure are the sensitivities of the market value of equity and the duration of equity to changes in interest rates and other variables. The following table presents the sensitivity profiles for the market value of equity and the duration of equity for the entire balance sheet and interest rate shocks (in basis points). Average results are compiled using data for each month end.
Two key measures of long-term market risk exposure are the sensitivities of the market value of equity and the duration of equity to changes in interest rates and other variables. The following table presents the sensitivity profiles for the market value of equity and the duration of equity for the entire balance sheet and interest rate shocks (in basis points). Average results are compiled using data for each month end.
Market Value of Equity
(Dollars in millions) | Down 200 | Down 100 | Down 50 | Flat Rates | Up 50 | Up 100 | Up 200 | |||||||||||||||||||||
Average Results |
||||||||||||||||||||||||||||
2009 Year-to-Date |
||||||||||||||||||||||||||||
Market Value of Equity |
$ | 4,139 | $ | 4,245 | $ | 4,330 | $ | 4,424 | $ | 4,477 | $ | 4,480 | $ | 4,374 | ||||||||||||||
% Change from Flat Case |
(6.4 | )% | (4.0 | )% | (2.1 | )% | - | 1.2 | % | 1.3 | % | (1.1 | )% | |||||||||||||||
2008 Full Year |
||||||||||||||||||||||||||||
Market Value of Equity |
$ | 3,698 | $ | 3,907 | $ | 3,979 | $ | 4,010 | $ | 3,998 | $ | 3,956 | $ | 3,840 | ||||||||||||||
% Change from Flat Case |
(7.8 | )% | (2.6 | )% | (0.8 | )% | - | (0.3 | )% | (1.3 | )% | (4.2 | )% | |||||||||||||||
Month-End
Results |
||||||||||||||||||||||||||||
September 30, 2009 |
||||||||||||||||||||||||||||
Market Value of Equity |
$ | 4,016 | $ | 4,110 | $ | 4,188 | $ | 4,294 | $ | 4,322 | $ | 4,290 | $ | 4,137 | ||||||||||||||
% Change from Flat Case |
(6.5 | )% | (4.3 | )% | (2.5 | )% | - | 0.7 | % | (0.1 | )% | (3.7 | )% | |||||||||||||||
December 31, 2008 |
||||||||||||||||||||||||||||
Market Value of Equity |
$ | 3,831 | $ | 3,965 | $ | 4,060 | $ | 4,153 | $ | 4,180 | $ | 4,136 | $ | 3,924 | ||||||||||||||
% Change from Flat Case |
(7.8 | )% | (4.5 | )% | (2.2 | )% | - | 0.7 | % | (0.4 | )% | (5.5 | )% | |||||||||||||||
Duration of Equity |
||||||||||||||||||||||||||||
(In years) |
Down 200 | Down 100 | Down 50 | Flat Rates | Up 50 | Up 100 | Up 200 | |||||||||||||||||||||
Average Results |
||||||||||||||||||||||||||||
2009 Year-to-Date |
(2.6 | ) | (3.8 | ) | (4.4 | ) | (3.4 | ) | (1.2 | ) | 1.1 | 3.5 | ||||||||||||||||
2008 Full Year |
(5.7 | ) | (4.3 | ) | (2.4 | ) | (0.2 | ) | 1.6 | 2.6 | 3.1 | |||||||||||||||||
Month-End Results |
||||||||||||||||||||||||||||
September 30, 2009 |
(1.6 | ) | (3.4 | ) | (4.3 | ) | (3.9 | ) | 0.5 | 2.3 | 4.8 | |||||||||||||||||
December 31, 2008 |
(4.2 | ) | (4.5 | ) | (4.6 | ) | (3.1 | ) | 0.6 | 3.6 | 6.4 |
Our residual exposures to market risk continued to be moderate, at levels consistent with
historical averages and with our cooperative business model. As of September 30, 2009, for an up
200 basis points instantaneous and permanent interest rate shock, we estimated that the market
value of equity would decrease 3.7 percent, or $157 million. Likewise, market risk exposure to
lower long-term interest rates was also moderate on September 30, with an estimated loss in the
market value of equity of 4.3 percent, or $184 million, for a down 100 basis points interest rate
shock. Based on these long-term market risk metrics, which indicate the potential reduction in
future earnings over the whole life of asset cash flows, as well as based on
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analysis of cash flows and earnings simulations, we do not expect that profitability would decrease
to uncompetitive levels if interest rates were to change by a substantial amount.
Regarding lower mortgage rates, we called approximately $14 billion of unswapped Bonds in the
fourth quarter of 2008 and the first three quarters of 2009 and replaced them with new debt at
significantly lower interest costs. Mortgage prepayments did not increase proportionately to the
amount of the Bonds called, in part due to the credit conditionsespecially falling home
pricesthat have made refinancing difficult for many homeowners. The amount of Bonds we called will
substantially mitigatebut not completely offsetthe lower earnings resulting from a possible large
acceleration in mortgage prepayment speeds if mortgage rates decrease again substantially.
On September 30, 2009, the mortgage asset portfolio had a net premium balance of $79 million, which
was composed of a $90 million net premium balance on the Mortgage Purchase Program and an $11
million net discount balance on mortgage-backed securities. For a 1.00 percentage shock decrease to
the currently low mortgage rates, we project there would have been a $16 million immediate increase
in net amortization on mortgage asset net premiums (which would lower earnings), while for a 2.00
percentage shock increase to mortgage rates, there would have been a $6 million immediate decrease
in net amortization (which would raise earnings). This amount of volatility would not materially
affect our ongoing profitability.
Market Capitalization Ratios
The ratio of the market value of equity to the book value of regulatory capital indicates the theoretical net market value of portfolio assets after subtracting the theoretical net market cost of liabilities, as a percent of regulatory capital. To the extent the ratio is lower than 100 percent, it reflects a potential reduction in future earnings from the current balance sheet. The market values used in the ratio can represent potential real economic losses, unrealized opportunity losses, or temporary fluctuations. However, the ratio does not measure the market value of equity from the perspective of an ongoing business. We also track the ratio of the market value of equity to the par value of regulatory capital stock. This ratio excludes retained earnings in the denominator and therefore shows the ability of the market value of equity to protect the value of stockholders stock investment in our company.
The ratio of the market value of equity to the book value of regulatory capital indicates the theoretical net market value of portfolio assets after subtracting the theoretical net market cost of liabilities, as a percent of regulatory capital. To the extent the ratio is lower than 100 percent, it reflects a potential reduction in future earnings from the current balance sheet. The market values used in the ratio can represent potential real economic losses, unrealized opportunity losses, or temporary fluctuations. However, the ratio does not measure the market value of equity from the perspective of an ongoing business. We also track the ratio of the market value of equity to the par value of regulatory capital stock. This ratio excludes retained earnings in the denominator and therefore shows the ability of the market value of equity to protect the value of stockholders stock investment in our company.
The following table presents both of these ratios for the current (flat rate) interest rate
environment. Because both ratios are close to, or above, 100 percent, they support the assessment
that we have a moderate amount of market risk exposure.
September 30, 2009 | December 31, 2008 | |||||||
Market Value of Equity to Book Value of Regulatory Capital |
103 | % | 94 | % | ||||
Market Value of Equity to Par Value of Regulatory Capital Stock |
115 | % | 102 | % |
Both ratios have increased in 2009, due to a combination of generally lower mortgage rates,
narrower market spreads on new mortgage assets, the Bond calls discussed above and throughout this
filing, and our repurchase of a material amount of excess capital stock in September 2009.
Market Risk Exposure of the Mortgage Assets Portfolio
The mortgage assets portfolio accounts for almost all of our market risk exposure because of prepayment volatility that we cannot completely hedge while maintaining positive net spreads to funding costs for these assets. We closely analyze the mortgage assets portfolio both together with and separately from the entire balance sheet. The portfolio includes mortgage-backed securities; loans and commitments under the Mortgage Purchase Program; Consolidated Obligations we have issued to finance and hedge these assets; to-be-announced mortgage-backed securities we have sold short to hedge the market risk of Mandatory Delivery Contracts; overnight assets or funding for balancing the portfolio; and allocated capital.
The mortgage assets portfolio accounts for almost all of our market risk exposure because of prepayment volatility that we cannot completely hedge while maintaining positive net spreads to funding costs for these assets. We closely analyze the mortgage assets portfolio both together with and separately from the entire balance sheet. The portfolio includes mortgage-backed securities; loans and commitments under the Mortgage Purchase Program; Consolidated Obligations we have issued to finance and hedge these assets; to-be-announced mortgage-backed securities we have sold short to hedge the market risk of Mandatory Delivery Contracts; overnight assets or funding for balancing the portfolio; and allocated capital.
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The following table presents the sensitivities of the market value of equity of the mortgage assets
portfolio and interest rate shocks (in basis points). Average results are compiled using data for
each month end. We allocate equity to this portfolio using the entire balance sheets regulatory
capital-to-assets ratio. This allocation is not necessarily what would result from an economic
allocation of equity to the mortgage assets portfolio but, because it uses the same regulatory
capital-to-assets ratio as the entire balance sheet, the results are comparable to the sensitivity
results for the entire balance sheet.
% Change in Market Value of EquityMortgage Assets Portfolio
Down 200 | Down 100 | Down 50 | Flat Rates | Up 50 | Up 100 | Up 200 | ||||||||||||||||||||||
Average Results |
||||||||||||||||||||||||||||
2009 Year-to-Date |
(29.4 | )% | (17.9 | )% | (9.3 | )% | - | 5.4 | % | 6.2 | % | (2.5 | )% | |||||||||||||||
2008 Full Year |
(47.4 | )% | (16.5 | )% | (5.4 | )% | - | (0.4 | )% | (4.6 | )% | (17.7 | )% | |||||||||||||||
Month-End Results |
||||||||||||||||||||||||||||
September 30, 2009 |
(24.7 | )% | (15.9 | )% | (8.9 | )% | - | 3.1 | % | 1.6 | % | (8.3 | )% | |||||||||||||||
December 31, 2008 |
(49.4 | )% | (27.4 | )% | (13.4 | )% | - | 5.2 | % | 0.8 | % | (25.0 | )% |
The table shows that as of September 30, 2009 the market risk exposure of the mortgage assets
portfolio had similar directional trends across interest rate shocks as those of the entire balance
sheet, although the mortgage assets portfolio had substantially greater risk volatility than the
entire balance sheet.
Use of Derivatives in Market Risk Management
As with our participation in debt issuances, derivatives help us hedge market risk created by Advances and mortgage commitments. Derivatives related to Advances most commonly hedge:
As with our participation in debt issuances, derivatives help us hedge market risk created by Advances and mortgage commitments. Derivatives related to Advances most commonly hedge:
§ | the market risk exposure on Putable and Convertible Advances for which members have sold us options embedded within the Advances; | ||
§ | the market risk exposure of options we have sold that are embedded with Advances; or | ||
§ | Regular Fixed-Rate Advances when it may not be as advantageous to issue Obligations or when it may improve our market risk management. |
We also use derivatives to hedge the market risk created by commitment periods of Mandatory
Delivery Contracts in the Mortgage Purchase Program.
Derivatives help us intermediate between the normal preferences of capital market investors for
intermediate-and- long-term fixed-rate debt securities and the normal preferences of our members
for shorter-term or adjustable-rate Advances. We can satisfy the preferences of both groups by
issuing long-term fixed-rate Bonds and entering into an interest rate swap that synthetically
converts the Bonds to an adjustable-rate LIBOR funding basis that matches up with the short-term
and adjustable-rate Advances, thereby preserving a favorable interest rate spread.
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The following table presents the notional principal amounts of the derivatives used to hedge other
financial instruments. The allocation of our derivatives showed no significant trend or change in
the last year outside of normal variations. This is as expected given the lack of growth of the
types of Advances that we normally hedge with derivatives.
September 30, | December 31, | September 30, | ||||||||||||||
(In millions) | 2009 | 2008 | 2008 | |||||||||||||
Hedged Item |
Hedging Instrument | |||||||||||||||
Consolidated Obligations |
Interest rate swap | $ | 13,632 | $ | 10,140 | $ | 12,640 | |||||||||
Convertible Advances |
Interest rate swap | 3,231 | 3,478 | 3,506 | ||||||||||||
Putable Advances |
Interest rate swap | 7,046 | 6,981 | 6,894 | ||||||||||||
Advances with purchased caps and/or floors |
Interest rate swap |
- | 1,400 | 2,400 | ||||||||||||
Regular Fixed-Rate Advances |
Interest rate swap | 3,543 | 5,808 | 5,573 | ||||||||||||
Mandatory Delivery |
Commitments to sell to-be-announced | |||||||||||||||
Contracts |
mortgage-backed securities | - | 386 | 35 | ||||||||||||
Total based on Hedged Item (1) |
$ | 27,452 | $ | 28,193 | $ | 31,048 | ||||||||||
(1) | We enter into Mandatory Delivery Contracts (commitments to purchase loans) in the normal course of business and economically hedge them with interest rate forward agreements (commitments to sell to-be-announced mortgage-backed securities). Therefore, the Mandatory Delivery Contracts (which are derivatives) are the objects of the hedge (the Hedged Item) and are not listed as a Hedging Instrument in this table. |
The following table presents the notional principal amounts of derivatives according to their
accounting treatment and hedge relationship. This table differs from the one above in that it
displays all derivatives, including Mandatory Delivery Contracts (the hedged item) and
to-be-announced mortgage-backed securities (their hedging instrument).
September 30, | December 31, | September 30, | ||||||||||
(In millions) | 2009 | 2008 | 2008 | |||||||||
Shortcut (Fair Value) Treatment |
||||||||||||
Advances |
$ | 5,918 | $ | 8,246 | $ | 7,914 | ||||||
Consolidated Obligations |
449 | 860 | 1,020 | |||||||||
Total |
6,367 | 9,106 | 8,934 | |||||||||
Long-haul (Fair Value) Treatment |
||||||||||||
Advances |
7,705 | 7,790 | 10,228 | |||||||||
Consolidated Obligations |
12,983 | 8,935 | 11,620 | |||||||||
Total |
20,688 | 16,725 | 21,848 | |||||||||
Economic Hedges |
||||||||||||
Advances |
197 | 1,631 | 231 | |||||||||
Consolidated Obligations |
200 | 345 | - | |||||||||
Mandatory Delivery Contracts |
126 | 918 | 178 | |||||||||
To-be-announced mortgage-backed securities hedges |
- | 386 | 35 | |||||||||
Total |
523 | 3,280 | 444 | |||||||||
Total Derivatives |
$ | 27,578 | $ | 29,111 | $ | 31,226 | ||||||
Changes in the allocation of derivatives according to their accounting treatment reflected normal
variations. In particular, the increase in long-haul treatment of Consolidated Obligations
reflected greater use of these types of derivatives as a substitute for Discount Note funding. The
overall changes shown did not represent a new hedging or risk management strategy or a change in
accounting treatment of existing hedges. An economic hedge is defined as the use of a derivative
that economically hedges a financial instrument but that is deemed to not qualify for hedge
accounting treatment. The decrease in economic hedges from year-end 2008 to September 30, 2009 was
primarily due to the maturity of a large Advance hedged with an interest rate swap.
Effective July 1, 2009, in light of the continued evolution of more rigid accounting
interpretations surrounding shortcut accounting treatment and to minimize the related accounting
risk, we decided to account for all new derivatives hedging Advances using the long-haul treatment.
We expect this to result in some additional minor earnings volatility.
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Capital Adequacy
Capital Leverage
Prudent risk management dictates that we maintain effective financial leverage to minimize risk to our capital stock while preserving profitability and that we hold an adequate amount of retained earnings. Pursuant to these objectives, Finance Agency Regulations stipulate that we must comply with three limits on capital leverage and risk-based capital requirements.
Prudent risk management dictates that we maintain effective financial leverage to minimize risk to our capital stock while preserving profitability and that we hold an adequate amount of retained earnings. Pursuant to these objectives, Finance Agency Regulations stipulate that we must comply with three limits on capital leverage and risk-based capital requirements.
§ | We must maintain at least a 4.00 percent minimum regulatory capital-to-assets ratio. |
§ | We must maintain at least a 5.00 percent minimum leverage ratio of capital divided by total assets, which includes a 1.5 weighting factor applicable to permanent capital. Because all of our Class B stock is considered permanent capital, this requirement is met automatically if we satisfy the 4.00 percent unweighted capital requirement. |
§ | We are subject to a risk-based capital rule, as discussed below. |
We have always complied with each capital requirement. See the Capital Resources section of the
Analysis of Financial Condition for information on the most important requirement, the minimum
regulatory capital-to-assets ratio.
Retained Earnings
Our Retained Earnings Policy sets forth a range for the amount of retained earnings that we believe is needed to mitigate impairment risk and augment dividend stability in light of all the material risks we face. The current Retained Earnings Policy establishes a range of adequate retained earnings from $140 million to $285 million, with a target level of $170 million. We believe that our retained earnings assessment is conservative. Our methodology biases it towards calculation of a higher amount of retained earnings than we believe actually is needed to protect against impairment risk. In particular, we assume that all unfavorable scenarios and conditions occur simultaneously, implying that each dollar of retained earnings can serve as protection against only one risk event. This scenario is extremely unlikely to occur. On September 30, 2009, we had $407 million of retained earnings, which we believe is sufficient to protect our capital stock against impairment risk and to enhance our ability to protect dividends against earnings volatility.
Our Retained Earnings Policy sets forth a range for the amount of retained earnings that we believe is needed to mitigate impairment risk and augment dividend stability in light of all the material risks we face. The current Retained Earnings Policy establishes a range of adequate retained earnings from $140 million to $285 million, with a target level of $170 million. We believe that our retained earnings assessment is conservative. Our methodology biases it towards calculation of a higher amount of retained earnings than we believe actually is needed to protect against impairment risk. In particular, we assume that all unfavorable scenarios and conditions occur simultaneously, implying that each dollar of retained earnings can serve as protection against only one risk event. This scenario is extremely unlikely to occur. On September 30, 2009, we had $407 million of retained earnings, which we believe is sufficient to protect our capital stock against impairment risk and to enhance our ability to protect dividends against earnings volatility.
Risk-Based Capital Regulatory Requirement
We must hold sufficient capital to protect against exposure to market risk, credit risk, and operational risk. The GLB Act and Finance Agency Regulations require total permanent capital, which includes retained earnings and the regulatory amount of Class B capital stock, to at least equal the amount of risk-based capital. Risk-based capital is the sum of market risk, credit risk, and operational risk as specified by the Regulations. The following table shows the amount of risk-based capital required based on the measurements, the amount of permanent capital, and the amount of excess permanent capital.
We must hold sufficient capital to protect against exposure to market risk, credit risk, and operational risk. The GLB Act and Finance Agency Regulations require total permanent capital, which includes retained earnings and the regulatory amount of Class B capital stock, to at least equal the amount of risk-based capital. Risk-based capital is the sum of market risk, credit risk, and operational risk as specified by the Regulations. The following table shows the amount of risk-based capital required based on the measurements, the amount of permanent capital, and the amount of excess permanent capital.
(Dollars in millions) | ||||||||||||
Monthly Average | ||||||||||||
Quarter End | Nine Months Ended | Year End | ||||||||||
September 30, 2009 | September 30, 2009 | 2008 | ||||||||||
Total risk-based capital requirement |
$ 580 | $ 618 | $ 543 | |||||||||
Total permanent capital |
4,152 | 4,502 | 4,399 | |||||||||
Excess permanent capital |
$ 3,572 | $ 3,884 | $ 3,856 | |||||||||
Risk-based capital as a percent of permanent capital |
14% | 14% | 12% |
The risk-based capital calculation has historically not been a constraint on our operations. It has
ranged from 12 to 20 percent, which is significantly less than the amount of our permanent capital,
and has not changed materially during the financial crisis. We expect this to continue to be the
case. We do not use the requirement to actively manage our market risk exposure.
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Credit Risk
Overview
We assume a substantial amount of inherent credit risk exposure in our dealings with members, purchases of investments, and transactions of derivatives. Credit risk is the risk of monetary loss due to failure of any obligor to meet the terms of any contract with us. Most importantly, credit risk arises from delayed receipt, or no receipt, of principal and interest on assets lent to or purchased from members or investment counterparties, or due to counterparties nonpayment of interest due on derivative transactions. We focus on credit risk arising from Advances, loans in the Mortgage Purchase Program, investments, and derivative transactions. For the reasons detailed below, we believe we are exposed to a minimal amount of residual credit risk. Therefore, we have not established a loss reserve or taken an impairment charge on any financial instrument.
We assume a substantial amount of inherent credit risk exposure in our dealings with members, purchases of investments, and transactions of derivatives. Credit risk is the risk of monetary loss due to failure of any obligor to meet the terms of any contract with us. Most importantly, credit risk arises from delayed receipt, or no receipt, of principal and interest on assets lent to or purchased from members or investment counterparties, or due to counterparties nonpayment of interest due on derivative transactions. We focus on credit risk arising from Advances, loans in the Mortgage Purchase Program, investments, and derivative transactions. For the reasons detailed below, we believe we are exposed to a minimal amount of residual credit risk. Therefore, we have not established a loss reserve or taken an impairment charge on any financial instrument.
Credit Services
Overview. We have numerous policies and practices to manage credit risk exposure from our secured lending activities, which include Advances and Letters of Credit. The objective of our credit risk management is to equalize risk exposure across members and counterparties to a zero level of expected losses. Despite deterioration in the credit conditions of many of our members and in the value of some pledged collateral, we believe that we have a minimal residual amount of credit risk exposure in our secured lending activities. We base this assessment on the following factors:
Overview. We have numerous policies and practices to manage credit risk exposure from our secured lending activities, which include Advances and Letters of Credit. The objective of our credit risk management is to equalize risk exposure across members and counterparties to a zero level of expected losses. Despite deterioration in the credit conditions of many of our members and in the value of some pledged collateral, we believe that we have a minimal residual amount of credit risk exposure in our secured lending activities. We base this assessment on the following factors:
§ | a conservative approach to collateralizing credit that results in significant over-collateralization. This includes 1) systematically raising collateral margins and collateral status as the financial condition of a member or of the collateral pledged deteriorates, and 2) adjusting collateral margins for subprime and nontraditional mortgage loans that we have identified and determined are not properly underwritten; | |
§ | close monitoring of members financial conditions and repayment capacities; | |
§ | a risk focused process for reviewing and verifying the quality, documentation, and administration of pledged loan collateral; | |
§ | our belief that we have a moderate level of exposure to poorly performing subprime and nontraditional mortgages pledged as collateral; and | |
§ | a history of never experiencing a credit loss or delinquency on any Advance. |
Because of these factors, we have never established a loan loss reserve for Credit Services.
Collateral. We require each member to provide us a security interest in eligible collateral
before it can undertake any secured borrowing. One of our most important policy parameters is that
we require each members borrowings to be over-collateralized. This means that each member must
maintain borrowing capacity in excess of its credit outstanding and that its borrowing capacity is
less than estimated market value of the collateral pledged. As of September 30, 2009, the
over-collateralization resulted in total collateral pledged of $160.6 billion against a total
borrowing capacity of $101.6 billion. Over-collateralization by one member is not applied to
another member.
We assign each member one of four levels of collateral statusBlanket, Securities, Listing, and
Physical Deliverybased on our credit rating (described below) that reflects our view of the members current
financial condition, capitalization, level of problem assets, and other credit risk factors.
Blanket collateral status is the least restrictive and is available for lower risk institutions. We
assign it to approximately 85 percent of members. Under a Blanket status, the borrowing member is
not required to provide loan level detail on pledged loans. We monitor eligible collateral pledged
under Blanket status using quarterly regulatory financial reports or periodic collateral
Certification documents submitted by all significant borrowers. Lower risk members that choose
not to pledge loan collateral are assigned Securities status. Under Listing collateral status, a
member must pledge, and provide us information on, specifically identified individual loans that
meet certain minimum qualifications. Physical Delivery is the most restrictive collateral status,
which we assign to members experiencing significant financial difficulties, most insurance
companies pledging loans, and newly chartered institutions.
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In addition to requiring physical delivery of collateral, we apply more conservative collateral
requirements for insurance company members and for newly chartered institutions. The latter are
required to deliver collateral until they have developed a solid financial history that trends
strongly towards being profitable.
The table below shows the allocation of pledged collateral by collateral type as of September 30,
2009.
Percent of Total | Collateral Amount | |||||||
Pledged Collateral | ($ Billions) | |||||||
1-4 Family Residential |
62 | % | $ 99.8 | |||||
Home Equity Loans |
20 | 32.6 | ||||||
Commercial Real Estate |
9 | 14.3 | ||||||
Bond Securities |
7 | 11.4 | ||||||
Multi-Family |
1 | 2.0 | ||||||
Farm Real Estate |
(a | ) | 0.5 | |||||
Total |
100 | % | $ 160.6 | |||||
(a) | Less than one percent of total pledged collateral. |
Collateral is primarily 1-4 family whole first mortgages on residential property or securities
representing a whole interest in such mortgages. Compared to December 31, 2008, the percentage of
1-4 family residential collateral rose four percentage points while the percentage of home equity
collateral fell five percentage points. We value listed and physically delivered loan collateral at
the lesser of par or our internally estimated market value. Securities collateral is valued using
two third-party providers. The market value of loan collateral pledged under a Blanket status is
assumed to equal the outstanding unpaid principal balance.
We determine borrowing capacity against pledged collateral by applying Collateral Maintenance
Requirements (CMRs), which are informally referred to as over-collateralization rates or
haircuts. CMRs are percentage adjustments (i.e., discounts) applied to the estimated market value
of pledged collateral. The discounts are determined by dividing one by the CMR; for example, a CMR
of 150 percent translates into a discount of 66.7 percent, which means that 66.7 percent of the
market value is eligible for borrowing. CMRs, which are intended to capture market, credit,
liquidity, and prepayment risks that may affect the realizable value of each pledged asset in the
event we must liquidate collateral, result in borrowing capacity that is less than the amount of
pledged collateral. The table below shows the range of discounts resulting from the CMR process for
each major collateral type segregated by collateral status.
Discount Range | ||||
1-4 Family Residential |
57-80 | % | ||
Home Equity Loans |
25-67 | % | ||
Commercial Real Estate |
20-67 | % | ||
Bond Securities |
0-49 | % | ||
Multi-Family |
40-80 | % | ||
Farm Real Estate |
29-57 | % |
We believe our CMR process results in conservative adjustments of borrowing capacity for all
collateral types. Members and collateral with a higher risk profile, more risky credit quality,
and/or less favorable performance are generally subjected to higher CMRs. Loans pledged under a
Blanket status generally are haircut more aggressively than loans on which we have detailed loan
structure and underwriting information, due to unknown factors which may result in the market value
being significantly below the book value of the Blanket loans. In most cases, higher quality assets
such as 1-4 family residential mortgage loans must be pledged before we will accept lower quality
collateral such as commercial real estate loans.
At September 30, 2009, we had $1,478 million of Advances outstanding to nonmembers that had been acquired by
financial institutions who are members of other FHLBanks. The merger on November 6, 2009 of
National City Bank into PNC Bank, which is chartered in a different FHLBank district, increased the
amount of nonmember Advances and outstanding Letters of Credit, as of that date, by $4,433 million.
Our Advances to nonmembers are secured either by marketable securities held in our custody (which
totaled $269 million on September 30, 2009) or supported by subordination or other inter-FHLBank
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security agreements. In accordance with the terms of these agreements, each counterparty FHLBank is required
to maintain sufficient collateral to cover our extensions of credit in accordance with its
collateral policies and practices, all of which require overcollateralization and periodic
verification of collateral levels. Subordination agreements mitigate our risk in the event of
default by giving our claim to the value of collateral priority over the interests of the
subordinating FHLBank, thus providing an incentive to ensure pledged collateral values are
sufficient to cover all parties.
We also have an internal policy that, with certain exceptions granted on a case-by-case basis, we
will not extend additional credit to any member (except under the Affordable Housing or the
Community Investment and Economic Development Programs) that would result in total borrowings
exceeding 50 percent of its total assets.
Perfection. With certain unlikely statutory exceptions, the FHLBank Act affords any
security interest granted to us by a member, or by an affiliate of a member, priority over the
claims and rights of any party, including any receiver, conservator, trustee, or similar party
having rights of a lien creditor. As additional security for members indebtedness, we have a
statutory lien on their FHLBank capital stock. We perfect our security interest in collateral by 1)
filing financing statements on each member pledging loan collateral, 2) taking possession or
control of all pledged securities and cash collateral, and 3) taking physical possession of pledged
loan collateral when we deem it appropriate based on a members financial condition. In addition,
at our discretion and consistent with our Credit Policy, we are permitted to call on members to
pledge additional collateral at any time during the life of a borrowing.
Subprime and Nontraditional Mortgage Loan Collateral. We have policies and processes to
identify subprime loans pledged by members to which we have high credit risk exposure or have
extended significant credit. We perform on-site collateral reviews, sometimes engaging third
parties, of members we deem to have high credit risk exposure. The reviews include identification
of loans that meet our definitions of subprime and nontraditional. Our definitions of a subprime
and a nontraditional mortgage loan (NTM) are expansive and conservative. During the review process,
we estimate overall subprime and nontraditional mortgage exposure levels by performing random
statistical sampling of residential loans in the members pledged portfolio.
We have instituted a multi-year program to review all members for exposure to subprime and
nontraditional collateral. The members on which we have performed on-site credit reviews to date
have encompassed approximately half of the residential mortgage collateral pledged. Based on these
reviews, we estimate that approximately 20 to 25 percent of pledged residential loan collateral has
one or more subprime characteristics. Although we have estimated NTM exposure for some members, due
to the fact this is a relatively new process, we have not reviewed a sufficient number of members
to offer a statistically valid estimate of exposure.
We raise CMRs by up to 50 additional percentage points for the identified subprime and/or NTM
segment of each pledged loan portfolio. We also apply separate adjustments to CMRs for pledged
private-label residential mortgage-backed securities for which there is available information on
subprime loan collateral. No security known to have more than one-third subprime collateral is
eligible for pledge to support additional credit borrowings.
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Internal Credit Ratings of Members. We assign each borrower an internal credit rating,
based on a combination of internal credit analysis and consideration of available credit ratings
from independent credit rating organizations. Analysis focuses on asset quality, financial
performance and earnings quality, liquidity, and capital adequacy. In addition to the credit
ratings process, ongoing analyses are performed of institutions that pose elevated credit risk
including problem institutions, insurance companies, and large borrowers. The following tables show
the distribution of internal credit ratings we assigned to member and non-member borrowers.
September 30, 2009
(Dollars in billions)
All Members and Borrowing | ||||||||||||||||||||
Nonmembers | All Borrowers | |||||||||||||||||||
Collateral-Based | Credit | Collateral-Based | ||||||||||||||||||
Credit | Borrowing | Services | Borrowing | |||||||||||||||||
Rating | Number | Capacity | Number | Outstanding | Capacity | |||||||||||||||
1 |
73 | $ 2.0 | 43 | $ 0.3 | $ 1.2 | |||||||||||||||
2 |
125 | 40.2 | 76 | 16.8 | 39.5 | |||||||||||||||
3 |
169 | 11.5 | 136 | 5.8 | 11.0 | |||||||||||||||
4 |
201 | 27.8 | 174 | 7.7 | 27.4 | |||||||||||||||
5 |
73 | 12.7 | 65 | 7.1 | 12.6 | |||||||||||||||
6 |
66 | 2.8 | 59 | 2.0 | 2.5 | |||||||||||||||
7 |
45 | 4.6 | 42 | 3.1 | 4.6 | |||||||||||||||
Total |
752 | $ 101.6 | 595 | $ 42.8 | $ 98.8 | |||||||||||||||
December 31, 2008
(Dollars in billions)
All Members and Borrowing | ||||||||||||||||||||
Nonmembers | All Borrowers | |||||||||||||||||||
Collateral-Based | Credit | Collateral-Based | ||||||||||||||||||
Credit | Borrowing | Services | Borrowing | |||||||||||||||||
Rating | Number | Capacity | Number | Outstanding | Capacity | |||||||||||||||
1 |
103 | $ 32.7 | 69 | $ 22.1 | $ 31.8 | |||||||||||||||
2 |
149 | 5.8 | 107 | 2.4 | 5.2 | |||||||||||||||
3 |
223 | 23.9 | 196 | 15.3 | 23.4 | |||||||||||||||
4 |
165 | 23.5 | 142 | 9.0 | 23.2 | |||||||||||||||
5 |
35 | 10.1 | 26 | 7.2 | 10.0 | |||||||||||||||
6 |
49 | 2.6 | 46 | 1.8 | 2.5 | |||||||||||||||
7 |
16 | 4.5 | 14 | 2.9 | 4.5 | |||||||||||||||
Total |
740 | $ 103.1 | 600 | $ 60.7 | $ 100.6 | |||||||||||||||
The left table shows the borrowing capacity (Advances and Letters of Credit) of both members and
non-member borrowers. The right side includes only institutions with outstanding credit activity,
which includes Advances and Letter of Credit obligations, along with their total borrowing
capacity. The lower the numerical rating, the higher our assessment of the members credit quality.
A 4 rating is our assessment of the lowest level of satisfactory performance.
Although our members overall have satisfactory credit risk profiles, many of them have been
unfavorably affected by the financial crisis, which has resulted in a continuing significant
downward trend in our member credit ratings. This trend began in the second half of 2007 and
accelerated throughout 2008 and the first three quarters of 2009. As of September 30, 2009, 184
members and borrowing nonmembers (24 percent of the total) had credit ratings of 5 or below, with
$20.1 billion of borrowing capacity. Between the end of 2007, when the recession and financial
crisis began, and September 30, 2009, we moved a net of 141 institutions and $13.3 billion of
borrowing capacity into one of the three lowest credit rating categories, and there has been a
substantial movement (a net of 86) of members from the first three highest rating categories into
the fourth highest rating category. The small amount of borrowing capacity on September 30 for the
73 members and borrowing nonmembers with the highest credit rating reflects the fact that these are
all small financial institutions.
A lower internal credit rating can cause us to 1) decrease the institutions borrowing capacity via
a higher collateral maintenance requirement, 2) require it to provide an increased level of detail
on pledged collateral, 3) require it to deliver
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collateral to us in custody, and/or 4) prompt us to more closely and/or frequently monitor the
institution using several established processes. The underwriting is largely performed in advance
of individual extensions of credit and is reflected in an institutions maximum borrowing capacity
and, in some cases, maturity limits.
Mortgage Purchase Program
Overview. We believe that the residual amount of credit risk exposure to loans in the Mortgage Purchase Program is de minimis and that it is probable we will be able to collect all principal and interest amounts due according to contractual terms. We base this assessment on the following factors:
Overview. We believe that the residual amount of credit risk exposure to loans in the Mortgage Purchase Program is de minimis and that it is probable we will be able to collect all principal and interest amounts due according to contractual terms. We base this assessment on the following factors:
§ | the strong credit enhancements for conventional loans; | |
§ | the U.S. government insurance on FHA mortgage loans; | |
§ | no credit losses experienced on any purchased loan since inception of the Program; | |
§ | minimal delinquencies and defaults experienced in the Programs loan portfolio; | |
§ | underwriting and loan characteristics consistent with favorable expected credit performance; and | |
§ | no supplemental mortgage insurance provider having experienced a loss on any loan sold to us, other than one loss for only $16,000 on a partial claim. |
Because of these factors, we have not established a loan loss reserve for the Program and have
determined that none of our mortgage loans are impaired.
Credit Enhancements. We use similar credit underwriting standards and processes for
approving members to participate in the Mortgage Purchase Program as for members who borrow
Advances. Our primary management of credit risk for conventional loans involves the collateral
supporting the mortgage loans (i.e., homeowners equity) and several layers of credit enhancement.
The credit enhancements, listed in order of priority, include:
§ | primary mortgage insurance (when applicable); | |
§ | the Lender Risk Account; and | |
§ | supplemental mortgage insurance coverage on a loan-by-loan basis that the participating financial institution (PFI) purchases from one of our approved third party providers, naming us the beneficiary. |
The combination of homeowners equity and credit enhancements protect us down to approximately a 50
percent loan-to-value level (based on values at loan origination), subject, in certain cases, to an
aggregate stop-loss feature in the supplemental mortgage insurance policy. This means that the
loans value (observed from a sale price or appraisal) can fall to half of its value at the time
the loan was originated before we would be exposed to a potential loss.
Finance Agency Regulations require that the combination of mortgage loan collateral and credit
enhancements be sufficient to raise the implied credit ratings on pools of conventional mortgage
loans to at least an investment-grade rating of BBB, although our program internally requires an
implied credit rating of AA when each pool is closed. We analyze all pools using a credit
assessment model licensed from Standard & Poors.
If the implied rating falls below AA, risk-based capital Regulations require us to hold additional
risk-based capital to help mitigate the perceived additional credit risk. On September 30, 2009, we
had six pools totaling $1.3 billion that fell short of a AA rating, which resulted in an increase
of $7 million in our risk-based capital.
Lender Risk Account. The Lender Risk Account is a key feature that helps protect us against
credit losses on conventional mortgage loans. It is a purchase price holdback from the PFI on each
conventional loan the PFI sells to the FHLBank. Therefore, it provides members an incentive to sell
us high quality loans. These funds are available to cover credit losses in excess of the borrowers
equity and primary mortgage insurance on loans in the pool we have purchased. The Lender Risk
Account percentage ranges from 30 basis points to 50 basis points of the loans purchased principal
balance, based on our determination of expected loan losses. We use the Standard & Poors credit
model to determine the Lender Risk Account percentage to apply to each PFI and to manage the credit
risk of committed and purchased conventional loans.
If conventional loan losses, on a loan-by-loan basis, exceed homeowners equity and applicable
primary mortgage insurance, the Lender Risk Account is drawn on to cover our exposure to these
residual losses until the Account is exhausted. Any
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portion of the Account not needed to help cover actual loan losses in excess of homeowners equity
and any applicable primary mortgage insurance is distributed to the PFI over a pre-determined
schedule.
The following table presents changes in the Lender Risk Account. The amount of loss claims was
approximately $1 million for the nine months ended September 30, 2009. Since inception of the
Program, loss claims have only used approximately $2 million, or 3 percent, of the Lender Risk
Account.
(In millions) | Nine Months Ended | |||
September 30, 2009 | ||||
Lender Risk Account at December 31, 2008 |
$ 49 | |||
Additions |
12 | |||
Claims |
(1 | ) | ||
Scheduled distributions |
(3 | ) | ||
Lender Risk Account at September 30, 2009 |
$ 57 | |||
Loan Characteristics and Credit Performance. Two indications of credit quality are
loan-to-value ratios and credit scores provided by Fair Isaac and Company (FICO®).
FICO® provides a commonly used measure to assess a borrowers credit quality, with
scores ranging from a low of 300 to a high of 850. Our policy currently stipulates that we will not
purchase conventional loans with a FICO® score of less than 660. In current market
conditions, the mortgage industry generally considers a FICO® score of over 660, and a
loan-to-value ratio of 80 percent or lower, as benchmarks indicating a good credit risk. For
conventional loans with FICO® scores between 620 to 660, we also have risk-based pricing
adjustments and additional underwriting limitations to further mitigate risks. In addition, we
require higher FICOs for loans with loan-to-values that exceed 90 percent.
The following table shows FICO® scores at origination for the conventional loan portfolio. The
distributions were similar on September 30, 2009 as in the prior several years.
September 30, | December 31, | |||||||
FICO® Score | 2009 | 2008 | ||||||
< 620 |
0 | % | 0 | % | ||||
620 to < 660 |
4 | 5 | ||||||
660 to < 700 |
11 | 12 | ||||||
700 to < 740 |
19 | 21 | ||||||
>= 740 |
66 | 62 | ||||||
Weighted Average |
751 | 745 |
High loan-to-value ratios, especially those above 90 percent in which homeowners have little or no
equity at stake, are key drivers in potential mortgage delinquencies and defaults. The following
table shows loan-to-value ratios for conventional loans based on values at origination dates and
also values estimated as of September 30, 2009 based on original loan-to-values, principal paydowns
that have occurred since origination, and one estimated method of changes in historical home prices
for the metropolitan statistical area in which each loan resides. Both measures are weighted by
current unpaid principal.
Based on Origination Dates | Based On Estimated Current Value | |||||||||||||||||||
September 30, | December 31, | September 30, | December 31, | |||||||||||||||||
Loan-to-Value | 2009 | 2008 | Loan-to-Value | 2009 | 2008 | |||||||||||||||
<= 60% |
21 | % | 21 | % | <= 60% | 34 | % | 34 | % | |||||||||||
> 60% to 70% |
19 | 18 | > 60% to 70% | 22 | 19 | |||||||||||||||
> 70% to 80% |
52 | 53 | > 70% to 80% | 28 | 21 | |||||||||||||||
> 80% to 90% |
5 | 5 | > 80% to 90% | 9 | 16 | |||||||||||||||
> 90% |
3 | 3 | > 90% to 100% | 4 | 6 | |||||||||||||||
> 100% | 3 | 4 | ||||||||||||||||||
Weighted Average |
70 | % | 70 | % | Weighted Average |
65 | % | 67 | % |
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The relatively favorable original and estimated current loan-to-value ratios provide further
support for our conclusion that the Mortgage Purchase Program has a strong credit quality. Only 7
percent of loans are estimated to have current ratios above 90 percent. The reduction in home
prices since origination dates has been more than offset by regular principal amortization as well
as partial prepayments. In large part, this reflects the heavy concentration of our mortgage loans
from Ohio (discussed below), which several data sources indicate has had relatively modest decrease
in home prices. Although the estimated current loan-to-values have a range of uncertainty based on
sampling methods to determine current loan values, our research leads us to believe that the range
is not large enough to alter the conclusion that the current loan-to-value ratios are favorable,
despite the housing markets difficulties in the last three years. To help derive this assessment,
we evaluated two sources for estimates of current loan values.
The following tables provide additional detailed data on conventional loans with FICO® scores at origination below
660 and, separately, current estimated loan-to-value ratios above 90 percent. Some loans are in
both categories.
Conventional Loans with FICO® Scores Below 660
September 30, | December 31, | |||||||
Loan-to-Value | 2009 | 2008 | ||||||
<= 60% |
25 | % | 23 | % | ||||
> 60% to 70% |
25 | 23 | ||||||
> 70% to 80% |
27 | 25 | ||||||
> 80% to 90% |
12 | 16 | ||||||
> 90% to 100% |
5 | 7 | ||||||
> 100% |
6 | 6 |
Conventional Loans with Loan-to-Values Above 90%
September 30, | December 31, | |||||||
FICO® Score | 2009 | 2008 | ||||||
< 620 |
3 | % | 3 | % | ||||
620 to < 660 |
3 | 3 | ||||||
660 to < 700 |
7 | 7 | ||||||
700 to < 740 |
13 | 12 | ||||||
>= 740 |
74 | 75 |
For loans with FICO® scores below 660, only 11 percent are estimated to have loan-to-values above 90
percent and their combined 60-day or more delinquency and foreclosure rate, although above the
averages for the entire conventional portfolio, is below six percent, which we believe is less than
national statistics for loans with FICO® scores below 660. For loans with loan-to-value ratios above
90 percent, only six percent have FICO® scores below 660 and their combined 60-day delinquency or
more and foreclosure rate is below six percent.
Based on the available data, we believe we have little exposure to loans in the Program considered
to have individual characteristics of subprime or alternative/nontraditional loans. Further, we
do not knowingly purchase any loan that violates the terms of our Anti-Predatory Lending Policy.
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The geographical allocation of loans in the Program is concentrated in the Midwest, as shown on the
following table based on unpaid principal balance.
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
Midwest |
61 | % | 52 | % | ||||
Southeast |
21 | 24 | ||||||
Southwest |
9 | 11 | ||||||
West |
5 | 7 | ||||||
Northeast |
4 | 6 | ||||||
Total |
100 | % | 100 | % | ||||
Midwest includes the states of IA, IL, IN, MI, MN, ND, NE, OH, SD, and WI
Southeast includes the states of AL, DC, FL, GA, KY, MD, MS, NC, SC, TN, VA, and WV
Southwest includes the states of AR, AZ, CO, KS, LA, MO, NM, OK, TX, and UT
West includes the states of AK, CA, GU, HI, ID, MT, NV, OR, WA, and WY
Northeast includes the states of CT, DE, MA, ME, NH, NJ, NY, PA, PR, RI, VI, and VT
Southeast includes the states of AL, DC, FL, GA, KY, MD, MS, NC, SC, TN, VA, and WV
Southwest includes the states of AR, AZ, CO, KS, LA, MO, NM, OK, TX, and UT
West includes the states of AK, CA, GU, HI, ID, MT, NV, OR, WA, and WY
Northeast includes the states of CT, DE, MA, ME, NH, NJ, NY, PA, PR, RI, VI, and VT
After being relatively stable in recent years, loans became more concentrated in the Midwest in the
first nine months of 2009 due to an increase in loan purchase activity from our second largest
seller, which operates much of its business in Ohio. Our loan concentration in the Midwest may
further increase due to the loss of one of our historically largest sellers of loans outside of the
Midwest. Loans are less concentrated in the Northeast and West, regions that historically have had
the most exposure to credit problems including foreclosures and housing price declines. In
addition, less than two percent of total loans were originated in the depressed real-estate market
of Florida.
Conventional loans in Ohio represented 50 percent of unpaid principal as of September 30, 2009, an
increase from year-end 2008s 40 percent. No other state had more than ten percent of unpaid
principal. Our two largest current sellers operate much of their businesses in Ohio, which has had
one of the highest state foreclosure rates in the past few years. To mitigate this concentration
risk, we emphasize purchases of mortgage-backed securities in our investment portfolio whose
underlying loans are not heavily originated in Ohio. However, delinquency rates (loans past due 90
days or more or in foreclosure) on our Ohio loans (0.3 percent) continue to be significantly lower
than the overall delinquency rates (4.1 percent) for Ohios prime, fixed-rate mortgages.
The relatively low amount of delinquencies and foreclosures is another indication of the Programs
strong credit quality. An analysis of loans past due 90 days or more or in foreclosure is presented
below. For comparison, the table shows the same data nationally, based on a nationally recognized
delinquency survey. The 0.8 percent ratio translates into $62 million of principal balance.
Mortgage Purchase Program | National Averages | |||||||||||||||
September 30, | December 31, | September 30, (1) | December 31, | |||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Delinquencies past due 90 days or more, or in foreclosure: |
||||||||||||||||
Conventional mortgage loans |
0.8 | % | 0.5 | % | 3.5 | % | 2.3 | % | ||||||||
FHA mortgage loans |
3.7 | 2.9 | 7.4 | 6.6 |
(1) | September 30, 2009 national averages for conventional and FHA mortgage loans are based on the most recent national delinquency data, or June 30, 2009. |
During the financial crisis, our delinquency/foreclosure rates on both conventional and FHA loans
have continued to be well below the national averages. Because of the Programs credit
enhancements, we do not expect to have to pay claims on any loans that become foreclosed. For
government-insured (FHA) mortgages, the delinquency rate is generally higher than for the
conventional mortgages held in the Program. We rely on government insurance, which generally
provides a 100 percent guarantee, as well as quality control processes, to maintain the credit
quality of the FHA portfolio.
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We perform a credit risk analysis for conventional loans, on a loan-by-loan basis, to determine if
projected claims on loans 60 days or more delinquent would be significant enough to exhaust all the
credit enhancements. The analysis uses a third party prepayment and housing credit model, which
employs conservative assumptions on future home price trends. We also stress this model for an
extremely pessimistic assumptions of future home prices. As a result of the analysis, we continue
to expect no probable losses on these loans that would exceed the combined credit enhancements, and
few losses that would exceed the Lender Risk Account.
Credit Risk Exposure to Supplemental Insurance Providers. The following table presents
information on the concentration of supplemental mortgage insurance providers for our conventional
loans and their related credit ratings as of September 30, 2009.
Percent of | Credit Rating | |||||||||||||||
Portfolio | S&P | Moodys | Fitch | |||||||||||||
Mortgage Guaranty Insurance Corporation (MGIC) |
55 | % | BB | Ba2 | BBB- | |||||||||||
Genworth Residential Mortgage Insurance Corporation (Genworth) |
45 | % | BBB+ | Baa2 | N/A | |||||||||||
Total |
100 | % | ||||||||||||||
Genworth is our current sole provider of supplemental mortgage insurance for new business. We
discontinued committing new business with MGIC in 2008, although 55 percent of our loans
outstanding have supplemental mortgage insurance underwritten by MGIC. We subject both supplemental
mortgage insurance providers to standard credit underwriting analysis. As of September 30, 2009, a
stress test of potential exposure resulted in an estimated $13 million total gross credit exposure
from both providers and net exposure after consideration of the protection afforded by the Lender
Risk Account of $1 million. We believe this constitutes an acceptable amount of exposure under the
very extreme scenario of our entire conventional portfolio defaulting and the insurance providers
being financially unable to pay any of the resulting claims. Over its life, we have had only 78
claims paid in the Mortgage Purchase Program, all of which we funded from the Lender Risk Account
except for one partial claim paid by a supplemental mortgage insurance provider. Therefore, we
believe we have a very small amount of expected credit exposure to both providers. See the related
discussion in Business Related Developments and Update on Risk Factors of the Executive
Overview.
Investments
Money Market Investments. Most money market investments are unsecured and therefore present credit risk exposure. A credit event for an investment security could be triggered by its default, by delayed payments of principal or interest, or by a rating downgrade that results in a realized market value loss. We believe our conservative investment policies and practices result in a nominal amount of credit risk exposure in our investment portfolio. Our Financial Management Policy permits us to invest only in highly rated counterparties and stipulates restrictions on the amount of exposure we are permitted to have to an individual counterparty and affiliated counterparties.
Money Market Investments. Most money market investments are unsecured and therefore present credit risk exposure. A credit event for an investment security could be triggered by its default, by delayed payments of principal or interest, or by a rating downgrade that results in a realized market value loss. We believe our conservative investment policies and practices result in a nominal amount of credit risk exposure in our investment portfolio. Our Financial Management Policy permits us to invest only in highly rated counterparties and stipulates restrictions on the amount of exposure we are permitted to have to an individual counterparty and affiliated counterparties.
We supplement the formulaic limits on credit exposure with internal credit underwriting analysis
and aggressive trading room management of counterparties credit conditions, which could include:
1) suspending new activity, 2) putting them on a trading room watch list, 3) applying tighter
maturity or dollar limits, 4) liquidating securities holdings, and/or 5) steering investment
priorities away from particular counterparties or market segments. In the last year, because of the
financial crisis, we suspended activity with or applied tighter maturity or dollar limits on a
substantial number of our unsecured credit counterparties.
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The following table presents the par amount of deposits held at the Federal Reserve and unsecured
money market investments outstanding in relation to the counterparties long-term credit ratings
provided by Moodys, Standard & Poors, and/or Fitch Advisory Services.
(In millions) | September 30, 2009 | December 31, 2008 | ||||||
Federal Reserve deposits (1) |
$ 2,733 | $ 19,906 | ||||||
Aaa/AAA |
2,250 | - | ||||||
Aa/AA |
8,055 | 2,512 | ||||||
A |
3,445 | - | ||||||
Baa/BBB |
- | - | ||||||
Total |
$ 16,483 | $ 22,418 | ||||||
(1) | The September 30, 2009 Federal Reserve deposit balance is included in Cash and due from banks on the Statement of Condition. |
On September 30, 2009, the unsecured investments held with the Aaa/AAA counterparty were short-term
Discount Notes issued by Freddie Mac. In the fourth quarter of 2008 and the first three months of
2009, contrary to our historical practice of investing with private companies, we held on average a
majority of our short-term investments as overnight deposits at the Federal Reserve Bank. We
believed this was prudent during the height of the financial and credit crisis because these
deposits presented no credit risk exposure. Due to our perception that the credit crisis had eased
beginning at the end of the first quarter, we decreased our holding of Federal Reserve deposits to
smaller amounts. The balance on September 30 in this account resulted from our decision to keep
funds at the Federal Reserve instead of investing with traditional unsecured counterparties due to
the zero or negative interest rates available on overnight investments with those counterparties at
the end of the quarter.
Mortgage-Backed Securities. We have never held any asset-backed securities other than
mortgage-backed securities. Historically, almost all of our mortgage-backed securities have been
GSE securities issued by Fannie Mae and Freddie Mac, which provide credit safeguards by
guaranteeing either timely or ultimate payments of principal and interest, and agency securities
issued by Ginnie Mae, which the federal government guarantees. On September 30, 2009, we held six
private-label mortgage-backed securities with an outstanding principal balance of $210 million. We
have policies to limit, monitor and mitigate exposure to investments having collateral that could
be considered subprime or alternative/nontraditional.
As indicated in Note 5 of the Notes to Unaudited Financial Statements, on September 30, 2009, our
mortgage-backed securities issued by GSEs in the held-to-maturity securities portfolio had an
estimated net unrealized gain totaling $479 million, which was four percent of their amortized
cost. The gain reflects the lower overall level of mortgage rates on September 30 compared to when
the securities were originated. Most of these securities were issued by Fannie Mae or Freddie Mac.
In September 2008, the U.S. Treasury and the Finance Agency placed Fannie Mae and Freddie Mac into
conservatorship, with the Finance Agency named as conservator. These GSEs continue to receive the
highest senior debt ratings available from the NRSROs, which are based in part on their perceived
backing by the U.S. government, although the U.S. government does not guarantee Fannie Mae or
Freddie Mac securities, either directly or indirectly. Nonetheless, we believe the conservatorships
lower the chance that Fannie Mae and Freddie Mac would not be able to fulfill their credit
guarantees. In addition, based on the data available to us and our purchase practices, we believe
that most of the mortgage loans backing our GSE mortgage-backed securities are of high quality with
strong credit performance.
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Private-label mortgage-backed securities have more credit risk than GSE and agency mortgage-backed
securities because the issuers do not guarantee principal and interest payments. However, we
believe the private-label securities that we own are comprised of high quality mortgages and have,
and will continue to have, a minimal amount of credit risk. We base this assessment on the
following factors.
§ | Each carries increased credit subordination involving additional tranches that absorb the first credit losses beyond that required to receive the triple-A rating. See the table immediately below for information on credit subordination compared to delinquencies. | ||
§ | Each is collateralized primarily by prime, fixed-rate, first lien mortgages originated in 2003 or earlier, not in more recent years when the largest numbers of the mortgages with current and expected credit issues were issued. | ||
§ | Each has loan characteristics consistent with favorable expected credit performance. Only 2.5 percent of original principal balances had original FICO® scores below 650, the average original FICO® score was 740, and the average current estimated loan-to-value ratio at September 30, 2009 was 50 percent. | ||
§ | Each has a strong and seasoned credit performance experience. At September 30, 2009, the 60-day or more delinquency rate was only 0.20 percent and a de minimis amount (0.34 percent) of the loans backing the securities were in foreclosure or real-estate owned. | ||
§ | Each continues to receive a triple-A rating. |
The following table summarizes the credit support of our private-label mortgage-backed securities:
Original | Current | Weighted | ||||||||||||||
Weighted- | Weighted | Minimum | Average | |||||||||||||
Average | Average | Current | Collateral | |||||||||||||
Credit Support | Credit Support | Credit Support | Delinquency (1) | |||||||||||||
Private-label mortgage-backed securities |
||||||||||||||||
September 30, 2009
|
4.7 | % | 7.5 | % | 5.4 | % | 0.54 | % | ||||||||
December 31, 2008
|
4.7 | 6.7 | 5.1 | 0.33 |
(1) | Collateral delinquency includes loans 60 days or more past due that underlie the securities, all bankruptcies, foreclosures, and real estate owned. |
In addition, we perform a projected cash flow analysis that considers various factors that affect
credit risk exposure, including under stressful conditions for defaults. At September 30, 2009, the
analysis indicated that each security will continue to provide all contractual amounts of principal
and interest on a timely basis.
The following table presents the fair value of our private-label mortgage-backed securities as a
percent of unpaid principal balance:
(Dollars in millions) | Fair Value as | |||||||||||
a Percent of | ||||||||||||
Unpaid Principal | Unpaid Principal | |||||||||||
Fair Value | Balance | Balance | ||||||||||
September 30, 2009
|
$ | 208 | $ | 210 | 99.0 | % | ||||||
December 31, 2008
|
263 | 304 | 86.6 |
As of September 30, 2009, our private-label mortgage-backed securities had an estimated net
unrealized loss totaling $2 million, which was one percent of their amortized cost. On December 31,
2008, the same portfolio had an estimated unrealized loss totaling $41 million. The decrease in
unrealized loss was due to overall reductions in mortgage rates in 2009 and to recovery of a
portion of the illiquidity in the mortgage markets for these types of securities. As of September
30, 2009, our six private-label mortgage-backed securities had an average of 72 percent of their
original principal balances paid down.
Based on the analysis presented above, we have determined that the small amount of gross unrealized
losses on our private-label mortgage-backed securities as of September 30, 2009, as for all
previous periods, were temporary. We believe these losses were the result of interest rate changes
and/or illiquidity in the credit and mortgage markets, which has increased
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market yields for these securities, rather than an indication of a material deterioration in the
creditworthiness of the underlying collateral. We do not intend to sell these securities, and our
analysis of available evidence indicates that it is more likely than not that we will recover their
entire amortized cost basis. Therefore, we continue to believe that our private-label securities
are not other-than-temporarily impaired. See Note 6 of the Notes to Unaudited Financial Statements
for more detailed information supporting our assessment.
Derivatives
The credit exposure on an interest rate swap derivative transaction is the risk that the counterparty does not make timely interest payments, that it defaults, or that swaps are terminated before their maturity date, which could occur because of a failure of the counterparty or us. Any one of these events could result in us having to replace the derivative transaction with that from another counterparty on less favorable terms or could expose us to market risk during the time it takes to replace the transaction.
The credit exposure on an interest rate swap derivative transaction is the risk that the counterparty does not make timely interest payments, that it defaults, or that swaps are terminated before their maturity date, which could occur because of a failure of the counterparty or us. Any one of these events could result in us having to replace the derivative transaction with that from another counterparty on less favorable terms or could expose us to market risk during the time it takes to replace the transaction.
The gross amount of our credit risk exposure to a counterparty equals the positive net market value
of all derivatives outstanding with the counterparty. Each counterpartys total unsecured limit is
based on criteria similar to those we use for money market investments. Each counterparty is
required to deliver to us high quality collateral in a market value amount equal to our net market
value exposure to the counterparty that exceeds contractual threshold limits. Threshold amounts,
which are uncollateralized, vary by the perceived riskiness of the counterparty based on its credit
ratings. The residual amount of credit risk exposure is the estimated cost of replacing the
derivatives if the counterparty defaults on payments due, net of the value of collateral we hold.
The table below presents, as of September 30, 2009, the gross credit risk exposure (i.e., the
market value) of interest rate swap derivatives outstanding, as well as the net unsecured exposure.
(Dollars in millions) | ||||||||||||||||||||
Gross | Fair Value | Net | ||||||||||||||||||
Credit Rating | Number of | Notional | Credit | of Collateral | Unsecured | |||||||||||||||
Category (1) | Counterparties | Principal | Exposure | Held | Exposure | |||||||||||||||
Aaa/AAA |
- | $ | - | $ | - | $ | - | $ | - | |||||||||||
Aa/AA |
7 | 10,211 | 2 | - | 2 | |||||||||||||||
A |
8 | 17,241 | 41 | (35 | ) | 6 | ||||||||||||||
Total |
15 | $ | 27,452 | $ | 43 | $ | (35 | ) | $ | 8 | ||||||||||
(1) | Each category includes the related plus (+) and minus (-) ratings (i.e., A includes A+ and A- ratings). |
After collateral exchanges, we had net unsecured credit exposure of $8 million. Because of the
terms of our swap contracts, use of highly-rated institutions, and the collateralization process,
which limit our credit risk exposure to threshold amounts, we continue to expect no credit losses
from our derivative transactions.
The following table presents, as of September 30, 2009, counterparties that provided 10 percent or
more of the total notional amount of interest rate swap derivatives outstanding.
(In millions)
Credit | Net | |||||||||||
Rating | Notional | Unsecured | ||||||||||
Counterparty | Category | Principal | Exposure | |||||||||
Barclays Bank PLC |
Aa/AA | $ | 5,074 | $ | - | |||||||
Bank of America, N.A. |
A | 4,401 | - | |||||||||
Credit Suisse International |
A | 3,111 | 3 | |||||||||
All others (12 counterparties) |
A to Aa/AA | 14,866 | 5 | |||||||||
Total |
$ | 27,452 | $ | 8 | ||||||||
Although we cannot predict if we will realize credit or market risk losses from any of our
counterparties, we have no reason to believe any of them will be unable to continue making timely
interest payments or to more generally continue to satisfy the terms and conditions of their
derivative contracts.
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Liquidity Risk and Contractual Obligations
Liquidity Overview
Our operations require a continual and substantial amount of liquidity to provide members access to Advance funding and mortgage loan sales in all financial environments and to meet financial obligations as they come due in a timely and cost-efficient manner. Liquidity risk is the risk that we will be unable to satisfy these obligations or meet the Advance and Mortgage Purchase Program funding needs of members in a timely and cost-efficient manner. Our primary source of ongoing permanent liquidity is through our ability to participate in the issuance of FHLBank System Consolidated Obligations. As shown on the Statements of Cash Flows, in the first nine months of 2009, our share of participations in debt issuance totaled $493.8 billion of Discount Notes and $26.5 billion of Consolidated Bonds.
Our operations require a continual and substantial amount of liquidity to provide members access to Advance funding and mortgage loan sales in all financial environments and to meet financial obligations as they come due in a timely and cost-efficient manner. Liquidity risk is the risk that we will be unable to satisfy these obligations or meet the Advance and Mortgage Purchase Program funding needs of members in a timely and cost-efficient manner. Our primary source of ongoing permanent liquidity is through our ability to participate in the issuance of FHLBank System Consolidated Obligations. As shown on the Statements of Cash Flows, in the first nine months of 2009, our share of participations in debt issuance totaled $493.8 billion of Discount Notes and $26.5 billion of Consolidated Bonds.
We are exposed to two types of liquidity risk, for which Finance Agency Regulations and our
Financial Management Policy require us to hold ample liquidity:
§ | Operational liquidity risk is the potential inability to meet anticipated or unanticipated day-to-day liquidity needs through our normal sources of funding. | ||
§ | Contingency liquidity risk is the potential inability to meet liquidity needs because our access to the capital markets to issue Consolidated Obligations is restricted or suspended for a period of time due to a market disruption, operational failure, or real or perceived credit quality problems. |
We actively monitor our liquidity measures. Our operational liquidity must equal or exceed our
contingency liquidity. To meet the operational liquidity requirement, we are permitted to include
the sources of liquidity under the contingency liquidity requirement as well as our access to the
capital markets to issue Consolidated Obligations, purchase Federal funds, and borrow deposits. In
the first nine months of 2009, as in all of 2008, we satisfied the operational liquidity
requirement both as a function of meeting the contingency liquidity requirement and because we were
able to adequately access the capital markets to issue Obligations.
We believe that in the first nine months of 2009, our liquidity position remained strong and our
overall ability to fund our operations through debt issuance at acceptable interest costs remained
sufficient. We expect this to continue to be the case. The Systems triple-A debt ratings, the
implicit U.S. government backing of our debt, and our effective funding management were, and
continue to be, instrumental in ensuring satisfactory access to the capital markets.
Contingency Liquidity Requirement
To meet the contingency liquidity requirement, we must hold sources of liquidity to meet obligations in the event our access to the capital markets is impeded for seven business days. The liquidity obligations include maturing net liabilities in the next seven business days, assets traded not yet settled, Advance commitments outstanding, Advances maturing in the next seven business days, and a three percent hypothetical increase in Advances. Sources of liquidity for this requirement include, among others, cash, overnight Federal funds, overnight deposits, self-liquidating term Federal funds, 95 percent of the market value of available-for-sale negotiable securities, and 75 percent of the market value of held-to-maturity obligations of the United States, U.S. government agencies and mortgage-backed securities.
To meet the contingency liquidity requirement, we must hold sources of liquidity to meet obligations in the event our access to the capital markets is impeded for seven business days. The liquidity obligations include maturing net liabilities in the next seven business days, assets traded not yet settled, Advance commitments outstanding, Advances maturing in the next seven business days, and a three percent hypothetical increase in Advances. Sources of liquidity for this requirement include, among others, cash, overnight Federal funds, overnight deposits, self-liquidating term Federal funds, 95 percent of the market value of available-for-sale negotiable securities, and 75 percent of the market value of held-to-maturity obligations of the United States, U.S. government agencies and mortgage-backed securities.
The following table presents the components of our contingency liquidity reserves. We continued to
hold an adequate amount of liquidity reserves to protect against impaired access to the debt
markets for at least seven business days.
(In millions) | September 30, | December 31, | |||||||
2009 | 2008 | ||||||||
Total Contingency Liquidity Reserves |
$ | 25,181 | $ | 34,566 | |||||
Total Requirement |
(11,248 | ) | (15,125 | ) | |||||
Excess Contingency Liquidity Available |
$ | 13,933 | $ | 19,441 | |||||
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Deposit Reserve Requirement
To support our member deposits, we are required to meet a statutory deposit reserve requirement. The sum of our investments in obligations of the United States, deposits in eligible banks or trust companies, and Advances with a final maturity not exceeding five years must equal or exceed the current amount of member deposits. The following table presents the components of this liquidity requirement.
To support our member deposits, we are required to meet a statutory deposit reserve requirement. The sum of our investments in obligations of the United States, deposits in eligible banks or trust companies, and Advances with a final maturity not exceeding five years must equal or exceed the current amount of member deposits. The following table presents the components of this liquidity requirement.
(In millions) | September 30, | December 31, | |||||||
2009 | 2008 | ||||||||
Total Eligible Deposit Reserves |
$ | 39,967 | $ | 66,733 | |||||
Total Member Deposits |
(1,665 | ) | (1,193 | ) | |||||
Excess Deposit Reserves |
$ | 38,302 | $ | 65,540 | |||||
Contractual Obligations
The following table summarizes our contractual obligations and off-balance sheet commitments as of September 30, 2009. The allocations according to the expiration terms and payment due dates of these obligations were not materially different from those at year-end 2008, and changes reflected normal business variations. As discussed elsewhere in this filing, we believe that, as in the past, we will continue to have sufficient liquidity, including from access to the debt markets to issue Consolidated Obligations, to satisfy these obligations timely.
The following table summarizes our contractual obligations and off-balance sheet commitments as of September 30, 2009. The allocations according to the expiration terms and payment due dates of these obligations were not materially different from those at year-end 2008, and changes reflected normal business variations. As discussed elsewhere in this filing, we believe that, as in the past, we will continue to have sufficient liquidity, including from access to the debt markets to issue Consolidated Obligations, to satisfy these obligations timely.
(In millions) | < 1 year | 1<3 years | 3<5 years | > 5 years | Total | |||||||||||||||
Contractual Obligations |
||||||||||||||||||||
Long-term
debt (Consolidated Bonds) par |
$ | 14,067 | $ | 12,719 | $ | 6,924 | $ | 7,350 | $ | 41,060 | ||||||||||
Mandatorily redeemable capital stock |
5 | 58 | 24 | - | 87 | |||||||||||||||
Other
long-term obligations (term deposits) par |
64 | 14 | - | - | 78 | |||||||||||||||
Pension and other postretirement benefit obligations |
1 | 3 | 4 | 13 | 21 | |||||||||||||||
Capital lease obligations |
- | - | - | - | - | |||||||||||||||
Operating leases (include premises and equipment) |
1 | 2 | 2 | - | 5 | |||||||||||||||
Total Contractual Obligations before
off-balance sheet items |
14,138 | 12,796 | 6,954 | 7,363 | 41,251 | |||||||||||||||
Off-balance sheet items (1) |
||||||||||||||||||||
Commitments to fund additional Advances |
- | - | - | - | - | |||||||||||||||
Standby Letters of Credit |
5,409 | 60 | 17 | 78 | 5,564 | |||||||||||||||
Standby bond purchase agreements |
144 | 68 | 200 | - | 412 | |||||||||||||||
Commitments to fund mortgage loans |
126 | - | - | - | 126 | |||||||||||||||
Consolidated Obligations traded, not yet settled |
15 | 370 | - | - | 385 | |||||||||||||||
Other purchase obligations |
- | - | - | - | - | |||||||||||||||
Unused line of credits and other commitments (2) |
- | - | - | - | - | |||||||||||||||
Total off-balance sheet items |
5,694 | 498 | 217 | 78 | 6,487 | |||||||||||||||
Total Contractual Obligations and off-balance sheet items |
$ | 19,832 | $ | 13,294 | $ | 7,171 | $ | 7,441 | $ | 47,738 | ||||||||||
(1) | Represents notional amount of off-balance sheet obligations. | |
(2) | In September 2008, all 12 FHLBanks entered into an agreement with the United States Department of Treasury to establish a GSE secured lending credit facility. The facility is designed to serve as a contingent source of liquidity for the housing GSEs. The agreement terminates on December 31, 2009. The FHLBank does not currently expect to access funding under the facility. |
Operational Risk
Operational risk is defined as the risk of an unexpected loss resulting from human error, fraud,
unenforceability of legal contracts, or deficiencies in internal controls or information systems.
We mitigate operational risk through adherence to internal department procedures and controls, use
of tested information systems, disaster recovery provisions for those systems, acquisition of
insurance coverage to help protect us from financial exposure relating to errors or fraud by our
personnel, and comprehensive policies and procedures related to Human Resources. In addition, our
Internal Audit Department, which reports directly to the Audit Committee of our Board of Directors,
regularly monitors and tests compliance from a best practices perspective with all policies,
procedures, and applicable regulatory requirements.
We believe there were no material developments regarding our operational risk in the first nine
months of 2009.
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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Introduction
The preparation of financial statements in accordance with GAAP requires management to make a
number of judgments, estimates, and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities (if applicable), and the reported
amounts of income and expenses during the reported periods. Although management believes its
judgments, estimates, and assumptions are reasonably accurate, actual results may differ.
Our critical accounting policies and estimates are described in detail in our 2008 annual report on
Form 10-K. Below is a description of our fair value processes as a result of applying new fair
value measurement guidance. We have also provided an explanation of our other-than-temporary
impairment analysis for investment securities as a result of recent adoption of new
other-than-temporary impairment guidance. There have been no material changes during the period to
our other policies and estimates described in the 2008 annual report on Form 10-K.
Other-Than-Temporary Impairment Analysis for Investment Securities
Due to the decline in value of residential U.S. real estate and difficult conditions in the credit
and mortgage markets, we closely monitor the performance of our private-label mortgage-backed
securities portfolio to evaluate our exposure to the risk of loss of principal or interest on these
investments and to determine on a quarterly basis whether this risk of loss represents an
other-than-temporary impairment. The other-than-temporary impairment analysis considers all
available evidence and requires management to make a number of significant judgments, estimates,
and assumptions.
An investment security is deemed impaired if the fair value of the security is less than its
amortized cost. To determine whether an impairment is other-than-temporary, we assess whether the
amortized cost basis of the security will be recovered by considering numerous factors as described
in Note 6 of the Notes to Unaudited Financial Statements. We recognize impairment losses if we
intend to sell the security, or when available evidence indicates it is more likely than not we
will be required to sell the security before the recovery of its amortized cost basis. We also
recognize impairment losses when any credit losses are expected for the security. This requires
consideration of market conditions and projections of future results.
We use a detailed cash flow analysis to determine if likely credit losses exist for a security. The
cash flow analysis requires estimating the present value of cash flows expected to be collected
based on the structure of a security and certain assumptions, such as delinquency, default rates,
loss severity, and voluntary prepayment rates. These estimates of projected cash flows require
significant judgments, estimates and assumptions, especially considering the unprecedented
deterioration in the national housing market, the inability to readily determine the fair value of
all underlying properties and the uncertainty in other macroeconomic factors that make estimating
defaults and severity imprecise. Other parties could arrive at different conclusions as to the
likelihood of various default and severity outcomes throughout the life of a security.
In addition to the base case cash flow analysis described in Note 6 of the Notes to Unaudited
Financial Statements, we also performed a sensitivity test based on a different scenario that
reflects a plausible but more adverse than the base case current-to-trough housing price decline
with a more shallow and slower rate of housing price recovery. Specifically, the current-to-trough
forecast showed a decline of 5 percentage points more than the base case current-to-trough housing
price decline, and the housing price recovery path projected housing prices to remain unchanged
from trough levels in the first year, to increase 1 percent in the second year, to increase 2
percent in the third year and to increase 3 percent per year thereafter. Under each of these
scenarios, no shortfall of principal or interest is expected.
If we were to determine that an other-than-temporary impairment existed, the security would
initially be written down to current market value, with the loss recognized in non-interest income
if we intend to sell the security or it is more likely than not we will be required to sell the
security before recovery of the amortized cost basis. If we do not intend to sell the security and
it is not more likely than not we will be required to sell the security before recovery, the
security would be written down to current market value with a separate display of losses related to
credit deterioration and losses related to all other factors on the income statement. Any
non-credit loss related amounts would then be reclassified and recorded in other comprehensive
income, resulting in only net credit-related losses recorded on the income statement. As of
September 30, 2009, we did not consider any of our investment securities to be
other-than-temporarily impaired.
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Fair Values
Fair values play an important role in the valuation of certain assets, liabilities and derivative
transactions, which may be reflected in the Statements of Condition or related Notes to Unaudited
Financial Statements at fair value. We carry investments classified as available-for-sale and
trading, and all derivatives, on the Statements of Condition at fair value.
Fair value measurement guidance establishes a framework for measuring fair value, establishes a
fair value hierarchy based on the inputs used to measure fair value and requires additional
disclosures for instruments carried at fair value on the Statements of Condition. Fair value is
defined as the price the exit 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.
In April 2009, the FASB issued guidance addressing the determination of when a market for a
financial asset or a financial liability is not active and when a transaction is not distressed for
fair value measurements. We elected to adopt this guidance in the first quarter of 2009 and applied
it when determining the fair value of assets and liabilities.
We base our fair value amounts on actual quoted market prices in active markets for identical
assets or liabilities, if available, or indicative market-based prices. Our investments currently
do not have available quoted market prices. Therefore, we determine fair values based on 1) our
valuation models or 2) dealer indications, which may be based on the dealers own valuation models
and/or prices of similar instruments.
Valuation models and their underlying assumptions are based on the best estimates of management
with respect to discount rates, prepayments, market volatility, and other factors. These
assumptions may have a significant effect on the reported fair values of assets and liabilities,
including derivatives, and the income and expense related thereto. The use of different assumptions
or changes in the models and assumptions, as well as changes in market conditions, could result in
materially different net income and retained earnings.
We have control processes designed to ensure that fair value measurements are appropriate and
reliable, that they are based on observable inputs for orderly transactions wherever possible and
that our valuation approaches and assumptions are reasonable and consistently applied. Where
applicable, valuations are also compared to alternative external market data (e.g., quoted market
prices, broker or dealer indications, pricing services and comparative analyses to similar
instruments). For further discussion regarding how we measure financial assets and financial
liabilities at fair value, see Note 17 of the Notes to Unaudited Financial Statements.
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We categorize each of our financial instruments carried at fair value into one of three levels in
accordance with the fair value hierarchy. The hierarchy is based upon the transparency (observable
or unobservable) of inputs to the valuation of an asset or liability as of the measurement date.
Observable inputs reflect market data obtained from independent sources (Levels 1 and 2), while
unobservable inputs reflect our assumptions of market variables (Level 3). Management utilizes
valuation techniques that maximize the use of observable inputs and minimize the use of
unobservable inputs. Because items classified as Level 3 are valued using significant unobservable
inputs, the process for determining the fair value of these items is generally more subjective and
involves a high degree of management judgment and use of assumptions. The following table
summarizes our assets and liabilities measured at fair value on a recurring basis by level of
valuation hierarchy.
(Dollars
in millions)
At September 30, 2009 | |||||||||||||||||||||
Assets | Liabilities | ||||||||||||||||||||
Available- | |||||||||||||||||||||
Trading | for-sale | Derivative | Derivative | ||||||||||||||||||
Securities | Securities | Assets (1) | Total | Liabilities (1) | |||||||||||||||||
Level 1 |
- | % | - | % | - | % | - | % | - | % | |||||||||||
Level 2 |
100 | 100 | 100 | 100 | 100 | ||||||||||||||||
Level 3 |
- | - | - | - | - | ||||||||||||||||
Total |
100 | % | 100 | % | 100 | % | 100 | % | 100 | % | |||||||||||
Total GAAP Fair Value |
$ | 2,253 | $ | 5,725 | $ | 9 | $ | 7,987 | $ | 270 | |||||||||||
At December 31, 2008 | |||||||||||||||||||||
Assets | Liabilities | ||||||||||||||||||||
Available- | |||||||||||||||||||||
Trading | for-sale | Derivative | Derivative | ||||||||||||||||||
Securities | Securities | Assets (1) | Total | Liabilities (1) | |||||||||||||||||
Level 1 |
- | % | - | % | - | % | - | % | - | % | |||||||||||
Level 2 |
100 | 100 | 100 | 100 | 100 | ||||||||||||||||
Level 3 |
- | - | - | - | - | ||||||||||||||||
Total |
100 | % | 100 | % | 100 | % | 100 | % | 100 | % | |||||||||||
Total GAAP Fair Value |
$ | 3 | $ | 2,512 | $ | 17 | $ | 2,532 | $ | 286 | |||||||||||
(1) | Based on total fair value of derivative assets and liabilities after effect of counterparty netting and cash collateral netting. |
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Information required by this Item is set forth under the caption Quantitative and Qualitative
Disclosures About Risk Management in Part I, Item 2, of this filing.
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Item 4. Controls and Procedures.
DISCLOSURE CONTROLS AND PROCEDURES
As of September 30, 2009, the FHLBanks management, including its principal executive officer and
principal financial officer, evaluated the effectiveness of our disclosure controls and procedures
as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the Exchange Act). Based
upon that evaluation, these two officers each concluded that as of September 30, 2009, the FHLBank
maintained effective disclosure controls and procedures to ensure that information required to be
disclosed in the reports that it files under the Exchange Act is (1) accumulated and communicated
to management as appropriate to allow timely decisions regarding disclosure and (2) recorded,
processed, summarized and reported within the time periods specified in the rules and forms of the
Securities and Exchange Commission.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
As of September 30, 2009, the FHLBanks management, including its principal executive officer and
principal financial officer, evaluated the FHLBanks internal control over financial reporting.
Based upon that evaluation, these two officers each concluded that there were no changes in the
FHLBanks internal control over financial reporting that occurred during the quarter ended
September 30, 2009 that materially affected, or are reasonably likely to materially affect, the
FHLBanks internal control over financial reporting.
PART
II OTHER INFORMATION
Item 1A. Risk Factors.
Information relating to this Item is set forth under the caption Business Related Developments and
Update on Risk Factors in Part I, Item 2, of this filing.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
From time-to-time the FHLBank provides Letters of Credit in the ordinary course of business to
support members obligations issued in support of unaffiliated, third-party offerings of notes,
bonds or other securities. The FHLBank provided $190.1 million of such credit support during the
three months ended September 30, 2009. To the extent that these Letters of Credit are securities
for purposes of the Securities Act of 1933, their issuance is exempt from registration pursuant to
section 3(a)(2) thereof.
Item 5. Other Information.
(a) | On September 17, 2009, the Board of Directors of the FHLBank approved several amendments to the FHLBanks Bylaws. Article IV of the Bylaws was amended to reflect changes made by the Housing the Economic Recovery Act of 2008 (HERA) in the composition of the Board, the qualifications of its directors and the nomination and election of independent directors. Additionally, a new section on vacancies on the Board was added. Certain other technical and clarifying amendments also were made. | |
The foregoing description of the amendments to the Bylaws is qualified in its entirety by reference to the amended Bylaws, a copy of which is attached as Exhibit 3.2. |
Item 6. Exhibits.
(a) | Exhibits. | |
See Index of Exhibits |
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, as of the 12th day of November 2009.
FEDERAL HOME LOAN BANK OF CINCINNATI (Registrant) |
||||
By:
|
/s/ David H. Hehman
|
|||
President and Chief Executive Officer (principal executive officer) | ||||
By:
|
/s/ Donald R. Able
|
|||
Senior Vice President, Controller (principal financial officer) |
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INDEX OF EXHIBITS
Document incorporated | ||||
Exhibit | by reference, filed or | |||
Number (1) | Description of exhibit | furnished, as indicated below | ||
3.2
|
Bylaws, as amended through September 17, 2009 | Filed Herewith | ||
31.1
|
Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer | Filed Herewith | ||
31.2
|
Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer | Filed Herewith | ||
32
|
Section 1350 Certifications | Furnished Herewith |
(1) | Numbers coincide with Item 601 of Regulation S-K. |
100