UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

[√] 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

 

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ­ ­ to ­ ­

 

Commission File Number: 000-51395

 

FEDERAL HOME LOAN BANK OF PITTSBURGH

(Exact name of registrant as specified in its charter)

 

 

(412) 288-3400

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  x 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 definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  o Yes  x No

 

There were 40,134,228 shares of common stock with a par value of $100 per share outstanding at October 31, 2009.

 

FEDERAL HOME LOAN BANK OF PITTSBURGH

 

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION
­ ­

 

This Overview should be read in conjunction with the Bank’s unaudited financial statements and footnotes to financial statements in this report filed on Form 10-Q as well as the Bank’s 2008 Annual Report filed on Form 10-K.

 

Overview

 

The Federal Home Loan Bank of Pittsburgh (Bank) is one of twelve Federal Home Loan Banks (FHLBanks). The FHLBanks operate as separate entities with their own managements, employees and boards of directors. The twelve FHLBanks, along with the Office of Finance (OF - the FHLBanks’ fiscal agent) and the Federal Housing Finance Agency (Finance Agency - the FHLBanks’ regulator) make up the Federal Home Loan Bank System (FHLBank System). The FHLBanks were organized under the authority of the Federal Home Loan Bank Act of 1932, as amended (Act). The FHLBanks are commonly referred to as government-sponsored enterprises (GSEs), which generally means they are a combination of private capital and public sponsorship. The public sponsorship attributes include: (1) being exempt from federal, state and local taxation, except real estate taxes; (2) being exempt from registration under the Securities Act of 1933 (1933 Act) (although the FHLBanks are required by Finance Agency regulation and the Housing and Economic Recovery Act of 2008 (the Housing Act) to register a class of their equity securities under the Securities Exchange Act of 1934 (1934 Act)); and (3) having a line of credit with the U.S. Treasury.

 

The Bank is a cooperative institution, owned by financial institutions that are also its primary customers. Any building and loan association, savings and loan association, commercial bank, homestead association, insurance company, savings bank, credit union or insured depository institution that maintains its principal place of business in Delaware, Pennsylvania or West Virginia and that meets varying requirements can apply for membership in the Bank. The Housing Act expanded membership to include Community Development Financial Institutions (CDFIs). Pursuant to the Housing Act, the Finance Agency has proposed to amend its membership regulations to authorize non-federally insured CDFIs to become members of an FHLBank. The newly eligible CDFIs would include community development loan funds, venture capital funds and state-chartered credit unions without federal insurance. The proposed regulation sets out the eligibility and procedural requirements for CDFIs that wish to become members of an FHLBank. The comment period for the proposed regulation expired July 14, 2009. Management is evaluating the proposed regulation and its potential effect on the Bank. All members are required to purchase capital stock in the Bank as a condition of membership. The capital stock of the Bank can be purchased only by members.

 

The Bank’s primary mission is to intermediate between the capital markets and the housing market through member financial institutions. The Bank provides credit for housing and community development through two primary programs. First, it provides members with loans against the security of residential mortgages and other types of high-quality collateral; second, the Bank purchases residential mortgage loans originated by or through member institutions. The Bank also offers other types of credit and noncredit products and services to member institutions. These include letters of credit, interest rate exchange agreements (interest rate swaps, caps, collars, floors, swaptions and similar transactions), affordable housing grants, securities safekeeping, and deposit products and services. The Bank issues debt to the public (consolidated obligation bonds and discount notes) in the capital markets through the OF and uses these funds to provide its member financial institutions with a reliable source of credit for these programs. The U.S. government does not guarantee the debt securities or other obligations of the Bank or the FHLBank System.

 

The Bank is a GSE, chartered by Congress to assure the flow of liquidity through its member financial institutions into the American housing market. As a GSE, the Bank’s principal strategic position has historically been derived from its ability to raise funds in the capital markets at narrow spreads to the U.S. Treasury yield curve. Typically, this fundamental competitive advantage, coupled with the joint and several cross-guarantee on FHLBank System debt, has distinguished the Bank in the capital markets and has enabled it to provide attractively priced funding to members. However, as the financial crisis worsened in 2008, the spread between FHLBank System debt

and Treasury debt widened, making it more difficult for the Bank to provide term funding to members at attractive rates. During the third quarter of 2009, spreads narrowed, allowing the Bank to offer more attractive pricing.

 

Though chartered by Congress, the Bank is privately capitalized by its member institutions, which are voluntary participants in its cooperative structure. The characterization of the Bank as a voluntary cooperative with the status of a federal instrumentality differentiates the Bank from a traditional banking institution in three principal ways.

 

First, members voluntarily commit capital required for membership principally in order to gain access to the funding and other services provided by the Bank. The value in membership may be derived from the access to liquidity and the availability of favorably priced liquidity, as well as the potential for dividend on the capital investment. Management recognizes that financial institutions choose membership in the Bank principally for access to attractively priced liquidity, dividends, and the value of the products offered within this cooperative.

 

Second, because the Bank’s customers and shareholders are predominantly the same group of 317, normally there is a need to balance the pricing expectations of customers with the dividend expectations of shareholders, although both are the same institutions. This is a challenge in the current economic environment. By charging wider spreads on loans to customers, the Bank could potentially generate higher earnings and potentially dividends for shareholders. Yet these same shareholders viewed as customers would generally prefer narrower loan spreads. In normal market conditions, the Bank strives to achieve a balance between the goals of providing liquidity and other services to members at advantageous prices and potentially generating a market-based dividend. The Bank typically does not strive to maximize the dividend yield on the stock, but to produce an earned dividend that compares favorably to short-term interest rates, compensating members for the cost of the capital they have invested in the Bank. As previously announced on December 23, 2008, the Bank has voluntarily suspended dividend payments until the Bank believes it is prudent to restore them, in an effort to build retained earnings.

 

Third, the Bank is different from a traditional banking institution because its GSE charter is based on a public policy purpose to assure liquidity for housing and to enhance the availability of affordable housing for lower-income households. In upholding its public policy mission, the Bank offers a number of programs that consume a portion of earnings that might otherwise become available to its shareholders. The cooperative GSE character of this voluntary membership organization leads management to strive to optimize the primary purpose of membership, access to funding, as well as the overall value of Bank membership.

 

In November 2008, the Bank experienced a significant increase in its risk-based capital requirements due to deterioration in the market values of the Bank’s private label mortgage-backed securities (MBS). The Bank was narrowly in compliance with its risk-based capital requirement. As a result, the Bank submitted a Capital Restoration Plan (CRP) to the Finance Agency on February 27, 2009.

 

Since then, many changes have occurred in the environment affecting the Bank. The Financial Accounting Standards Board (FASB) changed the guidance for how to account for other-than-temporary impairment. There have been multiple and significant downgrades of the Bank’s private label MBS securities, especially those private label MBS of 2007 or 2006 vintage, which have impacted the credit risk-based capital requirement for the Bank. Macroeconomic conditions have not improved at the rate originally expected. The Bank has also implemented significant elements of action plans, including completing its initial analysis on modifying the funding and hedging of the Bank’s balance sheet, simplifying the menu of advance products, and completing its analysis on the Bank’s capital structure. In addition, loans to members balances have decreased more than expected. Collectively, these developments merited an update of the CRP. On September 28, 2009, management submitted a revised CRP to the Bank’s regulator. The plan submitted to the Finance Agency requests that the Bank not be required to increase member capital requirements unless it becomes significantly undercapitalized, which by definition would mean the Bank meets less than 75% of its risk-based, total or leverage capital requirements. As part of that effort, the Bank has reviewed its risk governance structure, risk management practices and expertise. An outside consultant was engaged to assist in this review; management is reviewing the consultant’s report.

 

On August 4, 2009, the Finance Agency issued its final Prompt Corrective Action Regulation (PCA Regulation) incorporating the terms of the Interim Final Regulation issued on January 30, 2009. See also the “Legislative and Regulatory Developments” discussion in Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (Management’s Discussion and Analysis) in the Bank’s 2008 Annual Report filed on Form 10-K for additional information regarding the terms of the Interim Final Regulation.

 

The Bank was in compliance with its risk-based, total and leverage capital requirements at September 30, 2009. On September 30, 2009, the Bank received final notification that it was considered adequately capitalized for the quarter ended June 30, 2009; however, the Finance Agency did express concern regarding the ratio of the Bank’s level of AOCI (accumulated other comprehensive income) to retained earnings, the decline in excess permanent capital over risk-based capital requirements and the potential impact of redemption of excess capital stock.

 

Loans to Members

 

The Bank makes loans to members and eligible nonmember housing associates based upon the security of pledged mortgages and other eligible types of collateral. The Act requires the Bank to obtain and maintain a security interest in eligible collateral at the time it originates or renews a loan.

 

Loan Products.  The Bank offers a number of various loan products to its members. These products are discussed in detail in the “Loans to Members” discussion in Item 1. Business in the Bank’s 2008 Annual Report filed on Form 10-K. The Bank has revised the extensive product line in an attempt to simplify the list of options available to customers and provide those products used most by members. These changes became effective August 3, 2009.

 

Collateral.  There are two types of collateral agreements under which members pledge collateral: a blanket collateral pledge agreement and a specific collateral pledge agreement. These agreements require one of three types of collateral status: undelivered, detailed listing or delivered status. All collateral securing loans to members is discounted to help protect the Bank from losses resulting from a decline in the values of the collateral in adverse market conditions. Eligible collateral value represents either book value or fair value of pledged collateral multiplied by the applicable discounts. These discounts, also referred to as collateral weightings, vary by collateral type and whether the calculation is based on book value or fair value of the collateral. They also typically include consideration for estimated costs to sell or liquidate collateral and the risk of a decline in the collateral value due to market or credit volatility. As additional security for each member’s indebtedness, the Bank has a statutory lien on the member’s capital stock in the Bank.

 

The Bank determines the type and amount of collateral each member has available to pledge as security for Bank loans by reviewing, on a quarterly basis, the call reports the members file with their primary banking regulators. Depending on a member’s credit product usage and current financial condition, that member may also be required to file a Qualifying Collateral Report (QCR) on a quarterly or monthly basis. At September 30, 2009, the principal form of eligible collateral to secure loans made by the Bank was single-family residential mortgage loans, which included a very low amount of manufactured housing loans. Securities, including U.S. Treasuries, U.S. agency securities, GSE MBS, and private label MBS with a credit rating of AAA are also accepted as collateral. FHLBank deposits and multi-family residential mortgages, as well as other real estate related collateral (ORERC), comprised a portion of qualifying collateral. See the “Credit and Counterparty Risk” discussion in the Risk Management section of this Item 2. Management’s Discussion and Analysis in this report filed on Form 10-Q for details regarding amounts and percentages of eligible collateral securing loans as of September 30, 2009.

 

On July 20, 2009, the Bank implemented several collateral policy changes affecting the Bank’s members. These changes addressed delivery of securities pledged as collateral, accepting Temporary Liquidity Guaranty Program (TLGP) debt as eligible collateral and accepting limited amounts of private label MBS rated AA for certain members. Details of these changes were discussed in the Overview section of Item 2. Management’s Discussion and Analysis in the Bank’s Second Quarter 2009 report filed on Form 10-Q. As of September 30, 2009, the Bank’s collateral included an immaterial amount of AA-rated securities. On December 21, 2009, several additional collateral policy changes will become effective for the Bank’s members. These changes include: (1) removal of the ORERC cap and various associated collateral weighting changes; (2) adjustments to Total Borrowing Limits set for members; and (3) other changes to collateral weightings based on Second Quarter and Third Quarter 2009 analyses. The details on these policy changes have been communicated to the Bank’s members.

 

Although subprime mortgages are not considered an eligible collateral asset class by the Bank, it is possible that the Bank may have subprime mortgages pledged as collateral through the blanket-lien pledge.

At September 30, 2009 and December 31, 2008, on a borrower-by-borrower basis, the Bank maintained a security interest in collateral with an eligible collateral value (after collateral weightings) in excess of the book value of all loans. Management believes that adequate policies and procedures are in place to effectively manage the Bank’s credit risk associated with lending to members and nonmember housing associates.

 

From January 1, 2009 through September 30, 2009, nationally 95 Federal Deposit Insurance Corporation (FDIC)–insured institutions have failed. None of the FHLBanks has incurred any losses on loans outstanding to these institutions. Although the majority of these institutions were members of the System, only one was a member of the Bank. The Bank had no loans or other credit products outstanding to this member at the time of the closure.

 

Investments

 

The Bank maintains a portfolio of investments for two main purposes: liquidity and additional earnings. For liquidity purposes, the Bank invests in shorter-term instruments such as overnight Federal funds and securities sold under agreement to repurchase to ensure the availability of funds to meet member credit needs. The Bank also invests in other short-term investments, including term Federal funds, interest-earning certificates of deposit and commercial paper. The Bank also maintains a secondary liquidity portfolio, which may include TLGP investments, U.S. Treasury and agency securities and other GSE securities that can be financed under normal market conditions in securities repurchase agreement transactions to raise additional funds. The Bank further enhances interest income by maintaining a long-term investment portfolio, including securities issued by GSEs and state and local government agencies and MBS.

 

See the “Credit and Counterparty Risk” discussion in the Risk Management section of this Item 2. Management’s Discussion and Analysis in this report filed on Form 10-Q for further discussion of the investment portfolio and related credit risk, including other-than-temporary impairment (OTTI) charges.

 

Mortgage Partnership Finance (MPF^®) Program

 

The Bank participates in the Mortgage Partnership Finance (MPF^®) Program under which the Bank invests in qualifying 5- to 30-year conventional conforming and government-insured fixed-rate mortgage loans secured by one-to-four family residential properties.

 

The Bank currently offers two products under the MPF Program that are differentiated primarily by their credit risk structures: Original MPF and MPF Government. Further details regarding the credit risk structure for each of the products, as well as additional information regarding the MPF Program and the products offered by the Bank, is provided in the “Mortgage Partnership Finance Program” section in Item 7. Management’s Discussion and Analysis in the Bank’s 2008 Annual Report filed on Form 10-K.

 

The Bank held approximately $5.3 billion and $6.1 billion in mortgage loans at par under the MPF Program at September 30, 2009 and December 31, 2008, respectively. These balances represented approximately 8.0% and 6.7% of total assets at September 30, 2009 and December 31, 2008, respectively. Mortgage loans contributed approximately 22% and 10% of total interest income for the third quarters of 2009 and 2008, respectively. For the nine months ended September 30, 2009 and 2008, the contribution was approximately 18% and 9%, respectively. While interest income on mortgage loans dropped 8.9% in the year-over-year comparison, the Bank’s total interest income decreased 55.1%. This sharp decline in total interest income resulted in the increase in the ratio of mortgage interest income to total interest income.

 

In February 2009 the Bank announced plans to offer a third product, MPF Xtra, to members. MPF Xtra allows Participating Financial Institutions (PFIs) to sell residential, conforming fixed-rate mortgages to FHLBank of Chicago, which concurrently sells them to Fannie Mae on a nonrecourse basis. MPF Xtra does not have the credit enhancement structure of the traditional MPF Program and these loans are not reported on the Bank’s balance sheet. In the MPF Xtra product, there is no credit obligation assumed by the PFI or the Bank and no credit enhancement fees are paid. PFIs which have completed all required documentation and training are eligible to participate in the program. As of September 30, 2009, 30 PFIs were eligible to participate in the program. Of these, nine have sold $12.0 million of mortgage loans through the MPF Xtra program.

Effective July 15, 2009, the Bank introduced a temporary loan payment modification plan (modification plan) for participating PFIs, which will be available until December 31, 2011 unless further extended by the MPF Program. Borrowers with conventional loans secured by their primary residence, which were closed prior to January 1, 2009 are eligible for the modification plan. This modification plan pertains to borrowers currently in default or in imminent danger of default. In addition, there are specific eligibility requirements that must be met and procedures that the PFIs must follow to participate in the modification plan. As of October 31, 2009, there has been no activity under this modification plan.

 

“Mortgage Partnership Finance,” “MPF,” and “MPF Xtra” are registered trademarks of the FHLBank of Chicago.

 

Debt Financing – Consolidated Obligations

 

The primary source of funds for the Bank is the sale of debt securities, known as consolidated obligations. These consolidated obligations are issued as both bonds and discount notes, depending on maturity. Consolidated obligations are the joint and several obligations of the FHLBanks, backed by the financial resources of the twelve FHLBanks. Consolidated obligations are not obligations of the U.S. government, and the U.S. government does not guarantee them. The OF has responsibility for issuing and servicing consolidated obligations on behalf of the FHLBanks. On behalf of the Bank, the OF issues bonds that the Bank uses primarily to provide loans to members. The Bank also uses bonds to fund the MPF Program and its investment portfolio. Typically, the maturity of these bonds ranges from one year to ten years, but the maturity is not subject to any statutory or regulatory limit. The OF also sells discount notes to provide short-term funds to the FHLBanks. The Bank uses these funds to provide loans to members for seasonal and cyclical fluctuations in savings flows and mortgage financing, short-term investments, and other funding needs. Discount notes are sold at a discount and mature at par. These securities have maturities of up to 365 days.

 

See the “Liquidity and Funding Risk” discussion in the Risk Management section of this Item 2. Management’s Discussion and Analysis in this report filed on Form 10-Q and the “Current Financial and Mortgage Market Events and Trends” discussion below for further information regarding consolidated obligations and related liquidity risk.

 

Current Financial and Mortgage Market Events and Trends

 

Market Actions and Reactions.  Housing and financial markets have been in tremendous turmoil since the middle of 2007, with repercussions throughout the U.S. and global economies, and the U.S. economy is in a recession. Limited liquidity in the credit markets, increasing mortgage delinquencies and foreclosures, falling real estate values, the collapse of the secondary market for MBS, loss of investor confidence, a highly volatile stock market, interest rate fluctuations, and the failure of a number of large and small financial institutions are all indicators of the severe economic crisis facing the U.S. and the rest of the world. These economic conditions, particularly in the housing and financial markets, combined with ongoing uncertainty about the depth and duration of the financial crisis and the recession, continued to affect the Bank’s business and results of operations, as well as its members, during the first nine months of 2009 and may continue to have adverse effects in the future. Specifically, the weakness in the U.S. economy has continued to affect the credit quality of the loan collateral underlying all types of private label MBS in the Bank’s investment portfolio, resulting in OTTI charges on more securities. To continue building retained earnings and preserve the Bank’s capital, the Bank has maintained its suspension of dividend payments and excess capital stock repurchases through the third quarter 2009 and has no current expectation that this will change in the foreseeable future.

 

While the significant deterioration in economic conditions that followed the disruptive financial market events of September 2008 has not reversed, and the economy has remained weak since that time, there is indication that the pace of economic decline may have started to slow. There have been signs that the financial condition of large financial institutions has begun to stabilize. However, despite these early signs of improvement, the prospects for and potential timing of renewed economic growth (employment growth in particular) remain very uncertain. The ongoing weak economic outlook, along with continued uncertainty regarding those conditions, will extend future losses at many financial institutions to a wider range of asset classes, and the nature and extent of the ongoing need for the government to support the banking industry, have combined to maintain market participants’ somewhat cautious approach to the credit markets.

The ongoing impact of several government programs that were either introduced or expanded during the fourth quarter of 2008 appears to have supported a greater degree of stability in the capital markets. Those programs include the implementation of the Troubled Asset Relief Program (TARP) authorized by Congress in October 2008 and the Federal Reserve’s purchases of commercial paper, agency debt securities (including FHLBank debt) and MBS. In addition, the Federal Reserve’s discount window lending and Term Auction Facility (TAF) for auctions of short-term liquidity and the expansion of insured deposit limits and the Temporary Liquidity Guarantee Program (TLGP) provided by the Federal Deposit Insurance Corporation (FDIC) have provided additional liquidity support for depository institutions.

 

During the third quarter of 2009, the Federal Reserve Bank of New York (FRBNY) continued to support the capital markets through the purchase of GSE term debt, agency MBS, and Treasuries. As such, FRBNY purchased approximately $34.3 billion in GSE term debt, including $6.0 billion of FHLBank mandated global bullets during the quarter. By the end of September 2009, FRBNY purchases of agency debt were up to $131.2 billion, or almost 66% of the $200.0 billion allocated to the program at that time.

 

During the third quarter of 2009, the Federal Reserve made two announcements regarding its agency debt purchase programs. First, it announced that certain securities would be included in the list of CUSIPs eligible for purchase through its agency debt purchase programs. Second, the Federal Reserve announced that it would slow the purchasing of agency debt and MBS, extending those operations into the first quarter of 2010.

 

From July 2 to September 30, the FRBNY purchased approximately $330.4 billion in agency MBS, including approximately $47.2 billion in purchases related to dollar rolls, which, similar to repurchase agreements, provide holders of MBS with a form of short-term financing. Finally, FRBNY purchases of U.S. Treasury securities also continued with the FRBNY buying an additional $105.0 billion in Treasuries during the quarter. With the planned end date for the FRBNY’s U.S. Treasury purchase program set for October 31, 2009, the FRBNY had purchased 95% of the allocated $300 billion by the end of the third quarter of 2009.

 

The FHLBanks continued to maintain access to debt funding at desirable levels during the third quarter of 2009. The FHLBanks had ready access to term debt funding, pricing slightly fewer bonds than in the second quarter of 2009. However, the increase in FHLBank TAP volume during the third quarter of 2009 demonstrated an increased willingness by dealers to assume risk positions in the sector. Meanwhile, agency discount note spreads deteriorated considerably during the third quarter of 2009, making discount notes a less desirable funding option for the FHLBanks. A continued decline in money market fund assets, coupled with proposed changes to the rules that govern money market funds, could further weaken the agency discount note market in the near term.

 

During the third quarter of 2009, as the FHLBanks’ consolidated obligations outstanding continued to shrink, redemptions resulting from both scheduled maturities and exercised calls outpaced FHLBank debt issuance. Consolidated obligations outstanding declined an additional $82 billion during the third quarter of 2009, with consolidated discount notes decreasing significantly more than consolidated bonds. Consolidated obligations outstanding closed the third quarter of 2009 at levels last seen in late July 2007.

 

On a stand-alone basis, discount notes accounted for 19.0% and 27.1% of total Bank consolidated obligations at September 30, 2009 and December 31, 2008, respectively. Total bonds decreased $12.4 billion, or 20.2%, in the same comparison, but comprised a greater percentage of the total debt portfolio, increasing from 72.9% at December 31, 2008 to 81.0% at September 30, 2009.

 

The volume of FHLBank consolidated bonds priced during the third quarter of 2009 was slightly less than during the second quarter of 2009. During the third quarter of 2009, the mix of bonds priced by the FHLBanks changed slightly, with the FHLBanks relying less on negotiated bullet bonds and floating-rate securities and relying more on negotiated callable bonds and step-up bonds. Furthermore, TAP issuance has been on the rise since June 2009, indicating dealers’ willingness to commit balance sheet resources to the agency sector. The FHLBanks priced $4.1 billion in TAPs during the third quarter of 2009, compared to only $30 million during the second quarter of 2009. In terms of FHLBank bond funding costs, while weighted-average consolidated bond funding costs during the third quarter of 2009 deteriorated slightly compared to those of the second quarter of 2009, they were still above the average for the previous twelve months. In July 2009, the FHLBanks priced $4 billion of a new, three-year mandated Global bullet bond. In August 2009, the FHLBanks priced a $1.25 billion re-opening of its most recent two-year mandated Global bullet bond using a Dutch auction process. In September 2009, the FHLBanks priced $3 billion of a new, three-year mandated Global bullet bond.

 

Primary securities dealer inventories of agency debt securities, as reported by the FRBNY, were virtually unchanged at the close of the third quarter of 2009 when compared to levels at the end of the second quarter of 2009. However, the mix of securities within these inventories shifted dramatically from discount notes to bonds; dealer inventories of agency discount notes dropped $12.5 billion during the third quarter of 2009, while dealer inventories of agency bonds increased almost $12 billion.

 

Foreign official holdings of agency debt and MBS securities, as reported by the Federal Reserve, continued to fall during the third quarter of 2009, dropping $39 billion during this quarter to levels last seen in August 2007. Meanwhile, during the third quarter of 2009, taxable money market fund assets fell another $148 billion, with assets allocated to “U.S. other agency” securities dropping $49 billion during this time period. In September 2009, the FHLBanks Office of Finance submitted a comment letter to the SEC on proposed rule changes for money market funds; such changes may be detrimental to agency discount note pricing.

 

The Bank’s net interest income is affected by several external factors, including market interest rate levels and volatility, credit spreads and the general state of the economy. Interest rates prevailing during any reporting period affect the Bank’s profitability for that reporting period, due primarily to the short-term structure of earning assets and the effect of interest rates on invested capital. A portion of the Bank’s loans to members has been hedged with interest-rate exchange agreements in which a short-term, variable rate is received. Interest rates also directly affect the Bank through earnings on invested capital. Generally, due to the Bank’s cooperative structure, the Bank earns relatively narrow net spreads between the yield on assets and the cost of corresponding liabilities.

 

The following table presents key market interest rates for the periods indicated (obtained from Bloomberg L.P.).

 

 

Notes:

 

 

The Bank is also heavily affected by the residential mortgage market through the collateral securing member loans and holdings of mortgage-related assets. As of September 30, 2009, 60.4% of the Bank’s eligible collateral value, after collateral weightings, was concentrated in 1-4 single family residential mortgage loans or multi-family residential mortgage loans, compared with 45.5% at December 31, 2008. The remaining 39.6% at September 30, 2009 was concentrated in other real estate-related collateral and high quality investment securities, compared to 54.5% at December 31, 2008. For the top ten borrowers, 1-4 single family residential mortgage loans or multi-family residential mortgage loans accounted for 66.6% of total eligible collateral, after collateral weightings, at September 30, 2009, compared to 47.3% at December 31, 2008. The remaining 33.4% at September 30, 2009 was concentrated in other real estate-related collateral and high quality investment securities, compared to 52.7% at December 31, 2008. Due to collateral policy changes implemented in third quarter 2009, the mix of collateral types within the total portfolio shifted. The new requirement to deliver all securities pledged as collateral, as well as refinements in collateral reporting and tracking made through the QCR process, impacted the concentration of collateral types by category. As of September 30, 2009, the Bank’s private label MBS portfolio represented 9.5% of total assets, while net mortgage loans held for portfolio represented 8.0% of total assets. At December 31, 2008, the comparable percentages were 9.4% and 6.8%, respectively.

The Bank continues to have high concentrations of its loans to members portfolio outstanding to its top ten borrowers. The Bank’s loans to members portfolio declined from December 31, 2008 to September 30, 2009, decreasing $20.8 billion, or 33.4%, due to a slowing of new loan growth and increased access by members to other government funding sources. Also, many of the Bank’s members have reacted to the Bank’s temporary actions of not paying dividends and not repurchasing excess capital stock by limiting their use of the Bank’s loans to members products. As well, the recession has decreased the Bank’s members’ need for funding from the Bank.

 

In addition, see the “Credit and Counterparty Risk” and “Market Risk” discussions in the Risk Management section of this Item 2. Management’s Discussion and Analysis in this report filed on Form 10-Q for information related to derivative counterparty risk and overall market risk of the Bank.

 

Lehman Brothers Holding, Inc. (Lehman) and Lehman Brothers Special Financing, Inc.  On September 15, 2008, Lehman filed for bankruptcy. At that time, Lehman’s subsidiary, Lehman Brothers Special Financing, Inc. (LBSF) was the Bank’s largest derivatives counterparty, with a total of 595 outstanding derivative trades having a total notional value of $16.3 billion. Lehman was a guarantor under the Bank’s agreement with LBSF such that Lehman’s bankruptcy filing triggered an event of default. The Bank posted cash collateral to secure its exposure to Lehman on its derivative transactions. As a result of the bankruptcy filing, the Bank evaluated the outstanding trades it had with LBSF to assess which individual derivatives were most important to the Bank’s overall risk position. Of the 595 trades, 63 represented approximately half of the total LBSF notional value and almost 100% of the base case duration impact of the LBSF portfolio. Therefore, the Bank elected to enter into 63 identical new trades with different counterparties on September 18, 2008.

 

Management determined that it was in the Bank’s best interest to declare an event of default and designate September 19, 2008 as the early termination date of the Bank’s agreement with LBSF, as provided for in the agreement. Accordingly, all LBSF derivatives were legally terminated at that time and the Bank began the process of obtaining third party quotes for all of the derivatives in order to settle its position with LBSF in accordance with the International Swaps Dealers Association, Inc. (ISDA) Master Agreement (Master Agreement). The Bank sent a final settlement notice to LBSF and demanded return of the balance of posted Bank collateral, which, including dealer quotes for all trades, the collateral position, and the applicable accrued interest netted to an approximate $41.5 million receivable from LBSF.

 

The Bank filed an adversary proceeding against LBSF and J.P. Morgan Chase Bank, N.A. (JP Morgan) to return the cash collateral posted by the Bank associated with the derivative contracts. See discussion within Item 3. Legal Proceedings in the Bank’s 2008 Annual Report filed on Form 10-K for more information with respect to the proceeding. In its Third Quarter 2008 Form 10-Q and its 2008 Annual Report filed on Form 10-K, the Bank disclosed that it was probable that a loss has been incurred with respect to this receivable. However, the Bank had not recorded a reserve with respect to the receivable from LBSF because the Bank was unable to reasonably estimate the amount of loss that had been incurred. There have been continuing developments in the adversary proceeding, that have occurred since the filing of the Bank’s Form 10-K. The discovery phase of the adversary proceeding is now underway, which has provided management information related to its claim. Based on this information, management’s most probable estimated loss is $35.3 million and a reserve was recorded in first quarter 2009. As of September 30, 2009, the Bank maintained a $35.3 million reserve on this receivable as this remains the most probable estimated loss.

 

During discovery in the Bank’s adversary proceeding against LBSF, the Bank learned that LBSF had failed to keep the Bank’s posted collateral in a segregated account in violation of the Master Agreement between the Bank and LBSF. In fact, the posted collateral was held in a general operating account of LBSF the balances of which were routinely swept to other Lehman Brother entities, including Lehman Brothers Holdings, Inc. among others. After discovering that the Bank’s posted collateral was transferred to other Lehman entities and not held by JP Morgan, the Bank agreed to discontinue the LBSF adversary proceeding against JP Morgan. JP Morgan was dismissed from the Bank’s proceeding on June 26, 2009. In addition, the Bank discontinued its LBSF adversary proceeding and pursued its claim in the LBSF bankruptcy through the proof of claim process, which made continuing the adversary proceeding against LBSF unnecessary.

 

The Bank has filed a new complaint against Lehman Brothers Holding Inc., Lehman Brothers, Inc., Lehman Brothers Commercial Corporation, Woodlands Commercial Bank, formerly known as Lehman Brothers Commercial Bank, and Aurora Bank FSB (Aurora), formerly known as Lehman Brothers Bank FSB, alleging unjust enrichment, constructive trust, and conversion claims. Aurora is a member of the Bank. Aurora did not hold more than five percent of the Bank’s capital stock as of September 30, 2009.

Financial Highlights

 

The Statement of Operations data for the three and nine months ended September 30, 2009 and 2008 and the Condensed Statement of Condition data as of September 30, 2009 are unaudited and were derived from the financial statements included in this report. The Condensed Statement of Condition data as of December 31, 2008 was derived from the audited financial statements in the Bank’s 2008 Annual Report filed on Form 10-K.

 

Statement of Operations

 

n/a - not applicable

Notes:

 

 

Condensed Statement of Condition

 

Notes:

 

 

Forward-Looking Information

 

Statements contained in this quarterly report on Form 10-Q, including statements describing the objectives, projections, estimates, or predictions of the future of the Bank, may be “forward-looking statements.” These statements may use forward-looking terms, such as “anticipates,” “believes,” “could,” “estimates,” “may,” “should,” “will,” or their negatives or other variations on these terms. The Bank cautions that by their nature, forward-looking statements involve risk or uncertainty and that actual results could differ materially from those expressed or implied in these forward-looking statements or could affect the extent to which a particular objective, projection, estimate, or prediction is realized. These forward-looking statements involve risks and uncertainties including, but not limited to, the following: economic and market conditions, including, but not limited to, real estate, credit and mortgage markets; volatility of market prices, rates, and indices; political, legislative, regulatory, litigation, or judicial events or actions; changes in the Bank’s capital structure; changes in the Bank’s capital requirements; membership changes; changes in the demand by Bank members for Bank loans to members; an increase in loans to members prepayments; competitive forces, including the availability of other sources of funding for Bank members; changes in investor demand for consolidated obligations and/or the terms of interest rate exchange agreements and similar agreements; the ability of the Bank to introduce new products and services to meet market demand and to manage successfully the risks associated with new products and services; the ability of each of the other FHLBanks to repay the principal and interest on consolidated obligations for which it is the primary obligor and with respect to which the Bank has joint and several liability; and timing and volume of market activity. This Management’s Discussion and Analysis should be read in conjunction with the Bank’s unaudited interim financial statements and notes and Risk Factors included in Part II, Item 1A of the Bank’s quarterly report filed on Form 10-Q for the First, Second and Third Quarters of 2009, as well as Risk Factors in Item 1A of the Bank’s 2008 Annual Report filed on Form 10-K.

Earnings Performance

 

The following is Management’s Discussion and Analysis of the Bank’s earnings performance for the three and nine months ended September 30, 2009 compared to the three and nine months ended September 30, 2008. This discussion should be read in conjunction with the unaudited interim financial statements and notes included in this report filed on Form 10-Q as well as the audited financial statements and analysis for the year ended December 31, 2008, included in the Bank’s 2008 Annual Report filed on Form 10-K.

 

Summary of Financial Results

 

Net Income and Return on Capital.  The Bank recorded a net loss of $40.4 million for third quarter 2009, compared to net income of $96.8 million in third quarter 2008. This decrease was primarily due to $93.3 million of OTTI credit loss charges taken on the Bank’s MBS investment portfolio in the third quarter of 2009, lower net interest income, and a nonrecurring gain in the third quarter of 2008. The increase in the credit portion of OTTI charges for the third quarter of 2009 was primarily due to continued stress in the housing markets. The Bank’s return on average capital was (4.39)% in the third quarter of 2009, compared to 8.99% in the same year-ago period.

 

For the nine months ended September 30, 2009, the Bank recorded a net loss of $31.9 million, compared to net income of $207.3 million in the same prior year period. This significant decline was due to OTTI credit losses of $163.1 million, a first quarter 2009 contingency reserve of $35.3 million, lower net interest income, and a nonrecurring gain in the third quarter of 2008. The Bank’s return on average capital for the nine months ended September 30, 2009 was (1.09)%, compared to 6.36% in the same year-ago period.

 

Both the third quarter 2008 and nine months ended September 30, 2008 results included significant net gains on derivatives and hedging activities related to the termination and replacement of LBSF derivatives as discussed in the Bank’s Third Quarter 2008 quarterly report filed on Form 10-Q on November 12, 2008. This gain did not recur in 2009.

 

Details of the Statement of Operations are presented more fully below.

 

Dividend Rate.  Management regards quarterly dividend payments as an important vehicle through which a direct investment return is provided to the Bank’s members. On December 23, 2008, the Bank announced its decision to voluntarily suspend payment of dividends for the foreseeable future. Therefore, there were no dividends declared or paid in the first nine months of 2009. The Bank’s weighted average dividend rate was 3.50% for third quarter 2008 and 4.07% for the nine months ended September 30, 2008. See additional discussion regarding dividends and retained earnings levels in the “Financial Condition” section of this Item 2. Management’s Discussion and Analysis in this report filed on Form 10-Q.

Net Interest Income

 

The following table summarizes the rate of interest income or interest expense, the average balance for each of the primary balance sheet classifications and the net interest margin for the three and nine months ended September 30, 2009 and 2008.

 

Average Balances, Interest Income/Expense and Yields/Rates Paid

 

Notes:

 

Net interest income was $67.5 million for third quarter 2009, a decline of $6.6 million, or 8.9%, from the same year-ago period. Lower interest rates and lower volumes were factors driving the decline. Total average interest-earning assets were $69.0 billion for the third quarter 2009, declining $25.8 billion, or 27.2%, from the same year-ago period. Total average loans to members declined $25.6 billion, or 38.6%, to $40.8 billion in the third quarter 2009 and were the primary driver of lower overall total average assets. The loans to members portfolio declined significantly as members reduced risk, de-levered, increased deposits and utilized government programs aimed at improving liquidity. Also, many of the Bank’s members have reacted to the Bank’s temporary actions of not paying dividends and not repurchasing excess capital stock by limiting their use of the Bank’s loans to members products. As well, the recession has decreased the Bank’s members’ need for funding from the Bank.

 

Net interest margin improved 8 basis points to 39 basis points in the third quarter 2009 compared to the third quarter 2008. Lower funding costs and increased funding of the investment securities portfolio with short-term debt, particularly discount notes, were the factors that drove the improvement. The rates paid on discount notes declined 211 basis points to 18 basis points in third quarter 2009. Partially offsetting the improved cost of funds was the drastic decline in yields on interest-free funds (capital) which are typically invested in short-term assets, generally Federal funds sold. The yield on Federal funds sold was 13 basis points for third quarter 2009, 168 basis points lower than the same year-ago period. Earlier in 2009, the Bank shifted much of its overnight investments to interest-earning FRB accounts, as the yield was higher than Federal funds sold. Beginning in July 2009, the FRB stopped paying interest on these excess balances it holds on the Bank’s behalf, and consequently the Bank shifted its investments back to Federal funds sold at a lower yield.

Average Balances, Interest Income/Expense and Yields/Rates Paid

 

Notes:

 

 

Net interest income was $199.8 million for the nine months ended September 30, 2009, a decline of $52.6 million, or 20.8%, from the same year-ago period. Lower interest rates combined with lower volumes were the drivers of the decline. Total average interest-earning assets were $77.1 billion for the nine months ended September 30, 2009 compared to $98.0 billion for the same year-ago period, declining $20.9 billion, or 21.4%. The primary driver of the decline was lower total average loans which decreased $21.0 billion, or 30.7%, to $47.4 billion for the nine months ended September 30, 2009 compared to the same year-ago period. The loans to member portfolio declined significantly as members reduced risk, de-levered, increased deposits and utilized government

programs aimed at improving liquidity. Also, many of the Bank’s members have reacted to the Bank’s temporary actions of not paying dividends and not repurchasing excess capital stock by limiting their use of the Bank’s loans to members products. As well, the recession has decreased the Bank’s members’ need for funding from the Bank. Average investments in short-term assets increased generally in response to regulatory demands, and largely offset the reductions in the MBS and mortgage loan portfolios.

 

Net interest margin improved 1 basis point to 35 basis points, compared to 34 basis points a year ago. Favorable funding costs, partially offset by the lower yields on interest-free funds (capital), contributed to the slight improvement. Yields on interest-earning assets fell 153 basis points in the year-over-year comparison, while rates paid on interest-bearing liabilities fell 157 basis points. The impact of favorable funding was most evident within the investment securities portfolio. The improvement in cost of funds associated with this portfolio combined with the increased use of short-term debt has greatly improved spreads. Offsetting this improvement was the lower yield on interest-free funds (capital), typically invested in short-term assets, as evidenced by the 220 basis point and 219 basis point decline in yields on Federal funds sold and interest-bearing deposits, respectively. Over the past year, as the yields on Federal funds sold declined, the Bank shifted its investments to higher-yield interest-bearing FRB accounts. Beginning in July 2009, the Federal Reserve stopped paying interest on these excess balances that it holds on the Bank’s behalf and the Bank shifted its investments back to Federal funds sold. Additional details and analysis regarding the shift in the mix of these categories is included in the “Rate/Volume Analysis” discussion below.

 

Rate/Volume Analysis.  Changes in both volume and interest rates influence changes in net interest income and net interest margin. The following table summarizes changes in interest income and interest expense between 2009 and 2008.

 

Note:

 

 

Net interest income decreased $6.6 million from third quarter 2008 to third quarter 2009, driven by the volume of interest-earning assets and interest-bearing liabilities. This decline was slightly offset by a nominal rate benefit in the quarter-over-quarter comparison. Total interest income decreased $444.6 million in the quarter-over-quarter comparison. This decline included a decrease of $239.8 million due to rate and $204.8 million due to volume, driven primarily by the loans to members portfolio and, to a lesser extent, the investment securities portfolio, as discussed below. Total interest expense decreased $438.0 million in the same comparison, including a rate impact of

$241.6 million and a volume impact of $196.4 million, both due to the consolidated obligation bonds and discount notes portfolios, discussed in more detail below.

 

For the nine months ended September 30, 2009, net interest income decreased $52.6 million, also driven by both volume of and rates on interest-earning assets and interest-bearing liabilities. Total interest income decreased $1.4 billion in the year-over-year comparison, including $884.7 million due to rate and $563.4 million due to volume, both primarily related to the loans to members portfolio and, to a lesser extent, the investment securities portfolio, as discussed below. Total interest expense also decreased $1.4 billion in the same comparison, including $854.3 million driven by rate and $541.2 million driven by volume. Both decreases were driven by the consolidated obligation bonds and discount notes portfolios, which are discussed in more detail below.

 

Federal funds sold increased $1.3 billion from third quarter 2008 to third quarter 2009; however, interest income on the portfolio decreased $18.1 million primarily due to a decline in yield of 168 basis points. Interest-earning deposits increased $265.9 million quarter-over-quarter; however, interest income on the portfolio decreased $1.7 million in the same comparison primarily due to a decline in yield of 174 basis points. For the nine months ended September 30, 2009, Federal funds sold decreased $2.2 billion from the same prior year period, reflecting a shift in the first part of 2009 to interest-earning deposits due to favorable rates paid on FRB balances, as previously discussed. Related interest income declined $71.1 million, driven in large part by a 220 basis point decline in yield on the portfolio. For the nine months ended September 30, 2009, interest-earning deposits increased $5.6 billion, although related interest income only increased $3.0 million due to the relatively low yields on short-term investments.

 

The decrease in yields on both Federal funds sold and interest-earning deposits in the quarter-over-quarter and year-over-year comparisons reflects the significant downward change in overall short-term rates. These decreases are evidenced in the interest rate trend presentation in the “Current Financial and Mortgage Market Events and Trends” discussion in the Overview Section of this Item 2. Management’s Discussion and Analysis in this report filed on Form 10-Q. The net $1.6 billion and $3.4 billion increases in balances between these two categories in the quarter-over-quarter and year-over-year comparisons, respectively, reflect the Bank’s continued strategy in part to maintain a strong liquidity position in short-term investments in order to meet members’ loan demand under conditions of market stress and to maintain adequate liquidity in accordance with Finance Agency guidance and Bank policies.

 

The decrease in the third quarter 2009 average investment securities portfolio balance compared to third quarter 2008 was $1.2 billion, or 6.8%. Correspondingly, the interest income on this portfolio decreased $60.1 million, driven by both volume and rate. Yields on the portfolio fell 116 basis points, also contributing to the decline. The average investment securities portfolio balance for the nine months ended September 30, 2009 decreased $3.0 billion, or 16.1%, from the same prior year period. In the same year-over-year comparison, interest income decreased $204.5 million, driven by the decrease in volume and an 87 basis point decline in yields.

 

The investment securities portfolio includes trading, available-for-sale and held-to-maturity securities, the majority of which are held-to-maturity. The decrease in investments quarter-over-quarter was due to declining certificates of deposit balances and run-off of the held-to-maturity MBS portfolio as well as credit-related OTTI recorded on certain private label MBS. The Bank has been cautious toward investments linked to the U.S. housing market, including MBS. The Bank purchased only $260.0 million and $735.0 million of agency MBS in the three and nine months ended September 30, 2009, respectively.

 

The average loans to members portfolio decreased significantly from third quarter 2008 to third quarter 2009, declining $25.6 billion, or 38.6%, in the comparison. This decline in volume, coupled with a 169 basis point decrease in the yield, resulted in a $354.0 million decline in interest income on this portfolio quarter-over-quarter. For the nine months ended September 30, 2009, the average loans to members portfolio declined $21.0 billion, or 30.7%, over the same prior year period. This volume decrease, as well as a 179 basis point decline in the yield on the portfolio, resulted in a $1.2 billion decline in interest income year-over-year.

 

During the second half of 2007 and continuing into the first half of 2008, the Bank experienced unprecedented growth in the loans to members portfolio due to instability in the credit market, which resulted in increased demand from members for liquidity. This demand leveled off in the second and third quarters of 2008. Loan demand began

to decline in the fourth quarter of 2008 and continued through the first nine months of 2009, as members grew core deposits and gained access to additional liquidity from the FRB and other government programs that only became available in the second half of 2008. The interest income on this portfolio was significantly impacted by the decline in short-term rates, the decrease of which is presented in the interest rate trend presentation in the “Current Financial and Mortgage Market Events and Trends” discussion in this Item 2. Management’s Discussion and Analysis in this report filed on Form 10-Q. Specific mix changes within the portfolio are discussed more fully below under “Loans to Members Portfolio Detail.”

 

The mortgage loans held for portfolio balance declined $575.1 million, or 9.5%, from third quarter 2008 to third quarter 2009. The related interest income on this portfolio declined $10.7 million quarter-over-quarter. For the nine months ended September 30, 2009, the mortgage loans held for portfolio balance decreased $318.9 million, or 5.2%, from the same prior year period. The corresponding interest income declined $20.8 million in the same comparison. The volume of mortgages purchased from members was steady from quarter-to-quarter and year-over-year, but was outpaced by acceleration in the run-off of the existing portfolio. The decline in interest income was due primarily to lower average portfolio balances in both comparisons although yields on the portfolio also declined 26 basis points and 19 basis points quarter-over-quarter and year-over-year, respectively.

 

Interest-bearing deposits decreased $20.2 million, or 1.1%, from third quarter 2008 to third quarter 2009, with a corresponding decrease in interest expense of $7.9 million, driven primarily by the 171 basis point decline in rates paid. For the nine months ended September 30, 2009, interest-bearing deposits decreased $168.7 million, or 8.6%, from the same prior year period. Interest expense on interest-bearing deposits decreased $32.4 million in the year-over-year comparison driven by a 220 basis point decline in rates paid. Average interest-bearing deposit balances fluctuate periodically and are driven by member activity.

 

The consolidated obligations portfolio balance decreased in both the quarter-over-quarter and year-over-year comparisons. The third quarter 2009 discount notes average balance decreased $12.1 billion, or 50.6%, compared to the third quarter 2008 average balance, while the average bonds balance for third quarter 2009 decreased $14.1 billion, or 21.7%, compared to third quarter 2008. For the nine months ended September 30, 2009, average discount notes decreased $13.3 billion, or 46.8%, compared to the same prior year period, while average bonds decreased $7.9 billion, or 12.4%, in the same comparison. The declines in discount notes were consistent with the decline in short-term loan demand from members as noted above. Interest expense on discount notes decreased $132.7 million from third quarter 2008 to third quarter 2009. For the nine months ended September 30, 2009, interest expense on discount notes decreased $551.5 million from the same year-ago period. These decreases were partially attributable to the volume decline and partially due to the 211 and 243 basis point declines in rates paid in the quarter-over-quarter and year-over-year, respectively. The declines in rates paid were consistent with the general decline in short-term rates as previously mentioned. Interest expense on bonds decreased $297.4 million quarter-over-quarter and $811.4 million year-over-year. These decreases were due in part to volume decline as well as decreases in rates paid on bonds of 141 and 142 basis points quarter-over-quarter and year-over-year, respectively.

 

A portion of the bond portfolio is swapped to 3-month LIBOR; therefore, as the LIBOR rate (decreases) increases, interest expense on swapped bonds, including the impact of swaps, (decreases) increases. Market conditions continued to impact spreads on the Bank’s consolidated obligations. Bond spreads were volatile in the beginning of 2009 and the Bank had experienced some obstacles in attempting to issue longer-term debt as investors had been reluctant to buy longer-term GSE obligations. However, investor demand for shorter-term GSE debt has been strong during the first nine months of 2009 and the Bank continued to be able to issue discount notes at attractive rates as needed. The Bank has also experienced an increase in demand for debt with maturities ranging from one to three years during the second and third quarters of 2009. See details regarding the impact of swaps on the quarterly rates paid in the “Net Interest Income Derivatives Effects” discussion below.

 

For additional information, see the “Liquidity and Funding Risk” discussion in Risk Management in this Item 2. Management’s Discussion and Analysis in this report filed on Form 10-Q.

Average Loans to Members Portfolio Detail

 

 

The par value of the Bank’s average loans to members portfolio decreased 38.6% in third quarter 2009 from third quarter 2008 and 30.8% in the nine months ended September 30, 2009 from the same prior year period. The most significant percentage decrease in both the quarter-over-quarter and year-over-year comparisons was in the Repo product, which decreased $20.5 billion, or 50.7%, and $19.0 billion, or 44.3%, respectively. In addition, the Returnable product decreased $3.0 billion, or 83.0%, and $1.2 billion, or 33.3%, in the quarter-over-quarter and year-over-year comparisons, respectively. The most significant dollar decrease in both comparisons was in the Mid-Term RepoPlus product which decreased $13.0 billion, or 40.7%, and $11.8 billion, or 35.1%, respectively.

 

Average balances for the Repo product decreased in 2009 reflecting the impact of members’ access to additional liquidity from government programs as well as members’ reactions to the Bank’s pricing of short-term loans to members products. Members have also taken other actions during the credit crisis, such as raising core deposits and reducing the size of their balance sheets. Also, many of the Bank’s members have reacted to the Bank’s temporary actions of not paying dividends and not repurchasing excess capital stock by limiting their use of the Bank’s loans to members products. As well, the recession has decreased the Bank’s members’ need for funding from the Bank. The majority of the decline was driven by decreases in average loans to members of the Bank’s larger borrowers, with five banks reducing their total average loans outstanding by $15.8 billion. The decline in Returnable product loans in both the quarter-over-quarter and year-over-year comparisons was due to significant paydowns by one of the Bank’s largest borrowers. To a much lesser extent, the decrease in interest rates also contributed to the decline in these balances.

 

The year-over-year increase in the average balance of Term Loans was driven primarily by a decline in interest rates; members elected to lock in lower rates on longer-term funding when possible. In addition, certain members had funding needs for term liquidity.

 

As of September 30, 2009, 42.8% of the par value of loans in the portfolio had a remaining maturity of one year or less, compared to 37.0% at December 31, 2008. Details of the portfolio components are included in Note 7 to the unaudited financial statements in this report filed on Form 10-Q.

 

The ability to grow the loans to members portfolio may be affected by, among other things, the following: (1) the liquidity demands of the Bank’s borrowers; (2) the composition of the Bank’s membership itself; (3) the Bank’s liquidity position and how management chooses to fund the Bank; (4) current, as well as future, credit market conditions and the Bank’s pricing levels on loans to members; (5) member reaction to the Bank’s voluntary decision to suspend dividend payments and excess capital stock repurchases until further notice; (6) actions of the U.S. government which have created additional competition; (7) housing market trends; and (8) the shape of the yield curve.

 

During 2008, the Federal Reserve took a series of unprecedented actions that have made it more attractive for eligible financial institutions to borrow directly from the FRBs, creating increased competition for the Bank. See the “Legislative and Regulatory Actions” discussion in Item 7. Management’s Discussion and Analysis in the Bank’s 2008 Annual Report filed on Form 10-K for additional information regarding these government actions.

 

The Bank accepts various forms of collateral including, but not limited to, AAA-rated investment securities and residential mortgage loans. In light of recent market conditions, the Bank recognizes that there is the potential for an increase in the credit risk of the portfolio. However, the Bank continues to monitor its collateral position and the related policies and procedures, to help ensure adequate collateral coverage. The Bank believes it was fully secured as of September 30, 2009. For more information on collateral, see the “Loan Products” discussion in Overview and the “Credit and Counterparty Risk” discussion in Risk Management both in this Item 2. Management’s Discussion and Analysis in this report filed on Form 10-Q.

 

Net Interest Income Derivative Effects.  The following tables separately quantify the effects of the Bank’s derivative activities on its interest income and interest expense for the three and nine months ended September 30, 2009 and 2008. Derivative and hedging activities are discussed below in the “Other Income (Loss)” section.

 

Note: