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EX-31.3 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 - Federal Home Loan Bank of San Franciscodex313.htm
EX-31.1 - CERTIFICATION OF THE PRESIDENT AND CEO PURSUANT TO SECTION 302 - Federal Home Loan Bank of San Franciscodex311.htm
EX-99.1 - COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES - Federal Home Loan Bank of San Franciscodex991.htm
EX-32.4 - CERTIFICATION OF THE CONTROLLER AND OPERATIONS OFFICER PURSUANT TO SECTION 906 - Federal Home Loan Bank of San Franciscodex324.htm
EX-31.4 - CERTIFICATION OF THE CONTROLLER AND OPERATIONS OFFICER PURSUANT TO SECTION 302 - Federal Home Loan Bank of San Franciscodex314.htm
EX-32.3 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 906 - Federal Home Loan Bank of San Franciscodex323.htm
EX-31.2 - CERTIFICATION OF THE CHIEF OPERATING OFFICER PURSUANT TO SECTION 302 - Federal Home Loan Bank of San Franciscodex312.htm
EX-32.2 - CERTIFICATION OF THE CHIEF OPERATING OFFICER PURSUANT TO SECTION 906 - Federal Home Loan Bank of San Franciscodex322.htm
EX-32.1 - CERTIFICATION OF THE PRESIDENT AND CEO PURSUANT TO SECTION 906 - Federal Home Loan Bank of San Franciscodex321.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2010

OR

 

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

Commission File Number: 000-51398

 

 

FEDERAL HOME LOAN BANK OF SAN FRANCISCO

(Exact name of registrant as specified in its charter)

 

 

 

Federally chartered corporation

  94-6000630

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. employer

identification number)

600 California Street

San Francisco, CA

  94108

(Address of principal executive offices)

  (Zip code)

(415) 616-1000

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing for the past 90 days.    x  Yes    ¨  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ¨  Yes    ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

     Shares outstanding
as of July 30, 2010

Class B Stock, par value $100

   129,740,703

 

 

 


Table of Contents

Federal Home Loan Bank of San Francisco

Form 10-Q

Index

 

PART I.

  FINANCIAL INFORMATION   

Item 1.

  Financial Statements    1
 

Statements of Condition (Unaudited)

   1
 

Statements of Income (Unaudited)

   2
 

Statements of Capital Accounts (Unaudited)

   3
 

Statements of Cash Flows (Unaudited)

   4
 

Notes to Financial Statements (Unaudited)

   6

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   54
 

Quarterly Overview

   55
 

Financial Highlights

   58
 

Results of Operations

   59
 

Financial Condition

   71
 

Liquidity and Capital Resources

   85
 

Risk Management

   88
 

Critical Accounting Policies and Estimates

   105
 

Recently Issued Accounting Standards and Interpretations

   106
 

Recent Developments

   106
 

Off-Balance Sheet Arrangements, Guarantees, and Other Commitments

   109

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk    110

Item 4.

  Controls and Procedures    117

PART II.

  OTHER INFORMATION   

Item 1.

  Legal Proceedings    118

Item 1A.

  Risk Factors    118

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds    118

Item 3.

  Defaults Upon Senior Securities    118

Item 4.

  (Removed and Reserved)    119

Item 5.

  Other Information    119

Item 6.

  Exhibits    119
Signatures    120

 

i


Table of Contents

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

Federal Home Loan Bank of San Francisco

Statements of Condition

(Unaudited)

 

(In millions-except par value)    June 30,
2010
    December 31,
2009
 
   

Assets

    

Cash and due from banks

   $ 7,631      $ 8,280   

Federal funds sold

     14,470        8,164   

Trading securities(a)

     1,159        31   

Available-for-sale securities(a)

     1,932        1,931   

Held-to-maturity securities (fair values were $33,503 and $35,682, respectively)(b)

     33,563        36,880   

Advances (includes $12,819 and $21,616 at fair value under the fair value option, respectively)

     95,747        133,559   

Mortgage loans held for portfolio, net of allowance for credit losses on mortgage loans of $4 and $2, respectively

     2,788        3,037   

Loans to other Federal Home Loan Banks

     15          

Accrued interest receivable

     251        355   

Premises and equipment, net

     22        21   

Derivative assets

     476        452   

Other assets

     144        152   
                

Total Assets

   $ 158,198      $ 192,862   
   

Liabilities and Capital

    

Liabilities:

    

Deposits:

    

Interest-bearing:

    

Demand and overnight

   $ 144      $ 192   

Term

     29        29   

Other

     2        1   

Non-interest-bearing - other

     3        2   
                

Total deposits

     178        224   
                

Consolidated obligations, net:

    

Bonds (includes $21,148 and $37,022 at fair value under the fair value option, respectively)

     129,524        162,053   

Discount notes

     15,788        18,246   
                

Total consolidated obligations, net

     145,312        180,299   
                

Mandatorily redeemable capital stock

     4,690        4,843   

Accrued interest payable

     616        754   

Affordable Housing Program

     174        186   

Payable to REFCORP

     9        25   

Derivative liabilities

     173        205   

Other liabilities

     748        96   
                

Total Liabilities

     151,900        186,632   
                

Commitments and Contingencies (Note 13)

    

Capital:

    

Capital stock—Class B—Putable ($100 par value) issued and outstanding:

    

83 shares and 86 shares, respectively

     8,280        8,575   

Restricted retained earnings

     1,350        1,239   

Accumulated other comprehensive loss

     (3,332     (3,584
                

Total Capital

     6,298        6,230   
                

Total Liabilities and Capital

   $ 158,198      $ 192,862   
   

 

(a) At June 30, 2010, and at December 31, 2009, none of these securities were pledged as collateral that may be repledged.
(b) Includes $76 at June 30, 2010, and $40 at December 31, 2009, pledged as collateral that may be repledged.

The accompanying notes are an integral part of these financial statements.

 

1


Table of Contents

Federal Home Loan Bank of San Francisco

Statements of Income

(Unaudited)

 

     For the Three Months Ended June 30,     For the Six Months Ended June 30,  
(In millions)    2010     2009     2010     2009  
   

Interest Income:

        

Advances

   $ 285      $ 754      $ 606      $ 1,817   

Prepayment fees on advances, net

     28        18        39        20   

Federal funds sold

     8        6        13        13   

Trading securities

     1        1        1        1   

Available-for-sale securities

     1               2          

Held-to-maturity securities

     282        369        570        804   

Mortgage loans held for portfolio

     39        36        75        79   
                                

Total Interest Income

     644        1,184        1,306        2,734   
                                

Interest Expense:

        

Consolidated obligations:

        

Bonds

     269        588        558        1,448   

Discount notes

     9        112        22        368   

Mandatorily redeemable capital stock

     3               6          
                                

Total Interest Expense

     281        700        586        1,816   
                                

Net Interest Income

     363        484        720        918   
                                

Provision for credit losses on mortgage loans

     2        1        2        1   
                                

Net Interest Income After Mortgage Loan Loss Provision

     361        483        718        917   
                                

Other Loss:

        

Services to members

            1               1   

Net (loss)/gain on trading securities

     (1            (1     1   

Total other-than-temporary impairment loss on held-to-maturity securities

     (190     (1,283     (382     (2,439

Portion of impairment loss recognized in other comprehensive income

     48        1,195        180        2,263   
                                

Net other-than-temporary impairment loss on held-to-maturity securities

     (142     (88     (202     (176

Net loss on advances and consolidated obligation bonds held at fair value

     (21     (178     (121     (361

Net (loss)/gain on derivatives and hedging activities

     (123     224        (159     258   

Other

     2        2        3        2   
                                

Total Other Loss

     (285     (39     (480     (275
                                

Other Expense:

        

Compensation and benefits

     16        15        33        30   

Other operating expense

     13        13        25        24   

Federal Housing Finance Agency/Federal Housing Finance Board

     3        2        6        5   

Office of Finance

     1        1        3        3   

Other

     2               4          
                                

Total Other Expense

     35        31        71        62   
                                

Income Before Assessments

     41        413        167        580   
                                

REFCORP

     9        76        31        106   

Affordable Housing Program

     3        34        14        48   
                                

Total Assessments

     12        110        45        154   
                                

Net Income

   $ 29      $ 303      $ 122      $ 426   
   

The accompanying notes are an integral part of these financial statements.

 

2


Table of Contents

Federal Home Loan Bank of San Francisco

Statements of Capital Accounts

(Unaudited)

 

      Capital Stock
Class B—Putable
    Retained Earnings     Accumulated
Other
Comprehensive
Income/(Loss)
    Total
Capital
 
(In millions)    Shares     Par Value     Restricted    Unrestricted     Total      
           

Balance, December 31, 2008

   96      $ 9,616      $ 176    $      $ 176      $ (7   $ 9,785   

Adjustments to opening balance(a)

            570        570        (570       

Issuance of capital stock

   1        55                 55   

Capital stock reclassified from mandatorily redeemable capital stock, net

   6        582                 582   

Comprehensive income/(loss):

               

Net income

            426        426          426   

Other comprehensive income/(loss):

               

Other-than-temporary impairment loss related to all other factors

                (2,390     (2,390

Reclassified to income for previously impaired securities

                127        127   

Accretion of impairment loss

                123        123   
                     

Total comprehensive income/(loss)

                  (1,714
                     

Transfers to restricted retained earnings

         996      (996                
      

Balance, June 30, 2009

   103      $ 10,253      $ 1,172    $      $ 1,172      $ (2,717   $ 8,708   
   

Balance, December 31, 2009

   86      $ 8,575      $ 1,239    $      $ 1,239      $ (3,584   $ 6,230   

Issuance of capital stock

          42                 42   

Repurchase/redemption of capital stock

   (3     (307              (307

Capital stock reclassified to mandatorily redeemable capital stock, net

          (30              (30

Comprehensive income/(loss):

               

Net income

            122        122          122   

Other comprehensive income/(loss):

               

Net change in available-for-sale valuation

                4        4   

Other-than-temporary impairment loss related to all other factors

                (379     (379

Reclassified to income for previously impaired securities

                199        199   

Accretion of impairment loss

                428        428   
                     

Total comprehensive income/(loss)

                  374   
                     

Transfers to restricted retained earnings

         111      (111                

Dividends on capital stock (0.27%)

               

Cash dividends paid

                   (11     (11       (11
      

Balance, June 30, 2010

   83      $ 8,280      $ 1,350    $      $ 1,350      $ (3,332   $ 6,298   
   

 

(a) Adjustments to the opening balance consist of the effects of adopting guidance related to the recognition and presentation of other-than-temporary impairments. For more information, see Note 2 to the Financial Statements in the Bank’s 2009 Form 10-K.

The accompanying notes are an integral part of these financial statements.

 

3


Table of Contents

Federal Home Loan Bank of San Francisco

Statements of Cash Flows

(Unaudited)

 

     For the Six Months Ended June 30,  
(In millions)    2010     2009  

Cash Flows from Operating Activities:

    

Net Income

   $ 122      $ 426   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     (5     (238

Provision for credit losses on mortgage loans

     2        1   

Change in net fair value adjustment on trading securities

     1        (1

Change in net fair value adjustment on advances and consolidated obligation bonds held at fair value

     121        361   

Change in net fair value adjustment on derivatives and hedging activities

     68        (518

Net other-than-temporary impairment loss on held-to-maturity securities

     202        176   

Net change in:

    

Accrued interest receivable

     141        416   

Other assets

     (5     11   

Accrued interest payable

     (142     (456

Other liabilities

     224        116   
                

Total adjustments

     607        (132
                

Net cash provided by operating activities

     729        294   
                

Cash Flows from Investing Activities:

    

Net change in:

    

Federal funds sold

     (6,306     (7,227

Loans to other Federal Home Loan Banks

     (15       

Premises and equipment

     (4     (3

Trading securities:

    

Proceeds from maturities

     3        3   

Purchases

     (1,132       

Held-to-maturity securities:

    

Net (increase)/decrease in short-term

     (940     2,799   

Proceeds from maturities of long-term

     5,109        3,827   

Purchases of long-term

     (412       

Advances:

    

Principal collected

     116,246        596,074   

Made to members

     (78,626     (535,969

Mortgage loans held for portfolio:

    

Principal collected

     249        345   
                

Net cash provided by investing activities

     34,172        59,849   
                

 

4


Table of Contents

Federal Home Loan Bank of San Francisco

Statements of Cash Flows (continued)

(Unaudited)

 

     For the Six Months Ended June 30,  
(In millions)    2010     2009  

Cash Flows from Financing Activities:

    

Net change in:

    

Deposits

     (107     (830

Net payments on derivative contracts with financing elements

     33        32   

Net proceeds from consolidated obligations:

    

Bonds issued

     49,510        34,210   

Discount notes issued

     61,780        89,224   

Payments for consolidated obligations:

    

Bonds matured or retired

     (82,107     (69,861

Discount notes matured or retired

     (64,200     (131,794

Proceeds from issuance of capital stock

     42        55   

Payments for repurchase/redemption of mandatorily redeemable capital stock

     (183       

Payments for repurchase of capital stock

     (307       

Cash dividends paid

     (11       
                

Net cash used in financing activities

     (35,550     (78,964
                

Net decrease in cash and cash equivalents

     (649     (18,821

Cash and cash equivalents at beginning of the period

     8,280        19,632   
                

Cash and cash equivalents at end of the period

   $ 7,631      $ 811   

Supplemental Disclosures:

    

Interest paid during the period

   $ 655      $ 2,816   

Affordable Housing Program payments during the period

     26        25   

REFCORP payments during the period

     47          

Transfers of mortgage loans to real estate owned

     3        1   

The accompanying notes are an integral part of these financial statements.

 

5


Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements

(Unaudited)

(Dollars in millions)

Note 1 – Summary of Significant Accounting Policies

The information about the Federal Home Loan Bank of San Francisco (Bank) included in these unaudited financial statements reflects all adjustments that, in the opinion of management, are necessary for a fair statement of results for the periods presented. These adjustments are of a normal recurring nature, unless otherwise disclosed. The results of operations in these interim statements are not necessarily indicative of the results to be expected for any subsequent period or for the entire year ending December 31, 2010. These unaudited financial statements should be read in conjunction with the Bank’s Annual Report on Form 10-K for the year ended December 31, 2009 (2009 Form 10-K).

Use of Estimates. The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America (U.S. 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, expenses, gains, and losses during the reporting period. The most significant of these estimates include the fair value of derivatives, investments classified as other-than-temporarily impaired, certain advances, certain investment securities, and certain consolidated obligations that are reported at fair value in the Statements of Condition. In addition, significant judgments, estimates, and assumptions were made in the determination of other-than-temporarily impaired securities. Changes in judgments, estimates, and assumptions could potentially affect the Bank’s financial position and results of operations significantly. Although management believes these judgments, estimates, and assumptions to be reasonable, actual results may differ.

Descriptions of the Bank’s significant accounting policies are included in Note 1 (Summary of Significant Accounting Policies) to the Financial Statements in the Bank’s 2009 Form 10-K. Other changes to these policies as of June 30, 2010, are discussed in Note 2 to the Financial Statements.

Note 2 – Recently Issued and Adopted Accounting Guidance

Disclosures About the Credit Quality of Financing Receivables and the Allowance for Credit Losses. On July 21, 2010, the Financial Accounting Standards Board (FASB) issued amended guidance to enhance disclosures about an entity’s allowance for credit losses and the credit quality of its financing receivables. The amended guidance requires all public and nonpublic entities with financing receivables, including loans, lease receivables, and other long-term receivables, to provide disclosure of the following: (i) the nature of the credit risk inherent in the financing receivables, (ii) how that risk is analyzed and assessed in arriving at the allowance for credit losses, and (iii) the changes in the allowance of credit losses and reasons for those changes. Both new and existing disclosures must be disaggregated by portfolio segment or class of financing receivable. A portfolio segment is defined as the level at which an entity develops and documents a systematic method for determining its allowance for credit losses. Short-term accounts receivable, receivables measured at fair value or at the lower of cost or fair value, and debt securities are exempt from this amended guidance. For public entities, the required disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010 (December 31, 2010, for the Bank). The required disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010 (January 1, 2011, for the Bank). The adoption of this amended guidance will likely result in increased financial statement disclosures, but will not affect the Bank’s financial condition, results of operations, or cash flows.

 

6


Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Scope Exception Related to Embedded Credit Derivative. On March 5, 2010, the FASB issued amended guidance to clarify that the only type of embedded credit derivative feature related to the transfer of credit risk that is exempt from derivative bifurcation requirements is one that is in the form of subordination of one financial instrument to another. As a result, entities that have contracts containing an embedded credit derivative feature in a form other than such subordination will need to assess those embedded credit derivatives to determine whether bifurcation and separate accounting as a derivative are required. Upon adoption, entities are permitted to irrevocably elect the fair value option for any investment in a beneficial interest in a securitized financial asset. Any impairment would be recognized prior to applying the fair value option election. This amended guidance became effective at the beginning of the first interim reporting period beginning after June 15, 2010 (July 1, 2010, for the Bank). The Bank adopted this amended guidance as of July 1, 2010, and the adoption has not had a material effect on the Bank’s financial condition, results of operations, or cash flows.

Fair Value Measurements and Disclosures – Improving Disclosures about Fair Value Measurements. On January 21, 2010, the FASB issued amended guidance for fair value measurements and disclosures. The update requires a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. Furthermore, this update requires a reporting entity to present separately information about purchases, sales, issuances, and settlements in the reconciliation of fair value measurements using significant unobservable inputs; clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value; and amends guidance on employers’ disclosures about postretirement benefit plan assets to require that disclosures be provided by classes of assets instead of by major categories of assets. The amended guidance became effective for interim and annual reporting periods beginning after December 15, 2009 (January 1, 2010, for the Bank), except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 (January 1, 2011, for the Bank), and for interim periods within those fiscal years. In the period of initial adoption, entities will not be required to provide the amended disclosures for any previous periods presented for comparative purposes. Early adoption is permitted. The Bank adopted this amended guidance as of January 1, 2010, with the exception of the required changes noted above related to the reconciliation of Level 3 fair values. Its adoption resulted in increased financial statement disclosures but did not have any effect on the Bank’s financial condition, results of operations, or cash flows.

Accounting for Consolidation of Variable Interest Entities. On June 12, 2009, the FASB issued guidance for amending certain requirements of consolidation of variable interest entities (VIEs). This guidance was to improve financial reporting by enterprises involved with VIEs and to provide more relevant and reliable information to users of financial statements. This guidance amended the manner in which entities evaluate whether consolidation is required for VIEs. An entity must first perform a qualitative analysis in determining whether it must consolidate a VIE, and if the qualitative analysis is not determinative, the entity must perform a quantitative analysis. This guidance also required that an entity continually evaluate VIEs for consolidation, rather than making such an assessment based on the occurrence of triggering events. In addition, the guidance requires enhanced disclosures about how an entity’s involvement with a VIE affects its financial statements and its exposure to risks. The Bank evaluated its investments in VIEs, which are limited to the Bank’s private-label residential mortgage-backed securities (PLRMBS), and determined that as of January 1, 2010, and June 30, 2010, consolidation accounting is not required under the new accounting guidance because the Bank is not the primary beneficiary. The Bank does not have the power to significantly affect the economic performance of any of these investments because it does not act as a key decision maker nor does it have the unilateral ability to replace a key decision maker. In addition, the Bank does not design, sponsor, transfer, service, or provide credit or liquidity support in any of its investments in VIEs. The Bank’s maximum loss exposure for these investments is limited to the carrying value. The Bank adopted this guidance as of January 1, 2010, and the adoption did not have a material impact on the Bank’s financial condition, results of operations, or cash flows.

Accounting for Transfers of Financial Assets. On June 12, 2009, the FASB issued guidance intended to improve the relevance, representational faithfulness, and comparability of the information a reporting entity provides in its financial reports about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement in transferred financial assets. Key provisions of the guidance included (i) the removal of the concept of qualifying special purpose entities; (ii) the introduction of the concept of a participating interest, in circumstances in which a

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

portion of a financial asset has been transferred; and (iii) the requirement that to qualify for sale accounting, the transferor must evaluate whether it maintains effective control over transferred financial assets either directly or indirectly. The guidance also required enhanced disclosures about transfers of financial assets and a transferor’s continuing involvement. The Bank adopted this guidance as of January 1, 2010, and the adoption did not have a material impact on the Bank’s financial condition, results of operations, or cash flows.

Note 3 – Trading Securities

Trading securities as of June 30, 2010, and December 31, 2009, were as follows:

 

     June 30, 2010     December 31, 2009  
      Estimated
Fair Value
   Weighted
Average
Interest
Rate
    Estimated
Fair Value
   Weighted
Average
Interest
Rate
 

Government-sponsored enterprises (GSEs):

          

Federal Farm Credit Bank (FFCB) bonds

   $ 1,132    0.36   $   

Mortgage-backed securities (MBS):

          

Other U.S. obligations:

          

Ginnie Mae

     21    3.61        23    4.11   

GSEs:

          

Fannie Mae

     6    4.77        8    4.77   
             

Total

   $ 1,159    0.44   $ 31    4.28
                     

Redemption Terms. The contractual maturity (based on contractual final principal payment) of the FFCB bonds is from one year through five years as of June 30, 2010. Expected maturities of MBS will differ from contractual maturities because borrowers generally have the right to prepay the underlying obligations without prepayment fees.

Interest Rate Payment Terms. Interest rate payment terms for trading securities at June 30, 2010, and December 31, 2009, are detailed in the following table:

 

      June 30, 2010    December 31, 2009

Estimated fair value of trading securities other than MBS:

     

Adjustable rate

   $ 1,132    $

Subtotal

     1,132     

Estimated fair value of trading MBS:

     

Passthrough securities:

     

Adjustable rate

     21      23

Collateralized mortgage obligations:

     

Fixed rate

     6      8

Subtotal

     27      31

Total

   $ 1,159    $ 31

The net unrealized loss on trading securities was $1 and $1 for the three and six months ended June 30, 2010, respectively. The net unrealized gain on trading securities was immaterial for the three months ended June 30, 2009, and $1 for the six months ended June 30, 2009, respectively. These amounts represent the changes in the fair value of the securities during the reported periods.

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Note 4 – Available-for-Sale Securities

Available-for-sale securities as of June 30, 2010, and December 31, 2009, were as follows:

June 30, 2010

 

     

Amortized

Cost(1)

   Other-Than-
Temporary
Impairment
(OTTI)
Recognized  in
Accumulated
Other
Comprehensive
Income/(Loss)
(AOCI)
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   

Estimated

Fair
Value

   Weighted
Average
Interest
Rate
 

TLGP(2)

   $ 1,929    $    $ 3    $      $ 1,932    0.62
December 31, 2009                 
     

Amortized

Cost(1)

   OTTI
Recognized in
AOCI
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   

Estimated

Fair
Value

   Weighted
Average
Interest
Rate
 

TLGP(2)

   $ 1,932    $    $    $ (1   $ 1,931    0.41

 

(1) Amortized cost includes unpaid principal balance and unamortized premiums and discounts.
(2) Temporary Liquidity Guarantee Program (TLGP) securities represent corporate debentures of the issuing party that are guaranteed by the Federal Deposit Insurance Corporation (FDIC) and backed by the full faith and credit of the U.S. government.

The following table summarizes the available-for-sale securities with unrealized losses as of December 31, 2009. The unrealized losses are aggregated by major security type and the length of time that individual securities have been in a continuous unrealized loss position.

December 31, 2009

     Less than 12 months    12 months or more    Total
      Estimated
Fair Value
   Unrealized
Losses
   Estimated
Fair Value
   Unrealized
Losses
   Estimated
Fair Value
   Unrealized
Losses

TLGP

   $ 1,281    $ 1    $    $    $ 1,281    $ 1

Redemption Terms. The contractual maturity (based on contractual final principal payment) of the Bank’s TLGP securities is from one year through five years as of June 30, 2010, and December 31, 2009.

The amortized cost of the TLGP securities, which are classified as available-for-sale, included net premiums of $6 at June 30, 2010, and net premiums of $8 at December 31, 2009.

Interest Rate Payment Terms. Available-for-sale securities at June 30, 2010, and December 31, 2009, had adjustable rate interest payment terms.

Other-Than-Temporary Impairment. On a quarterly basis, the Bank evaluates its individual available-for-sale investment securities in an unrealized loss position for OTTI. As part of this evaluation, the Bank considers whether it intends to sell each debt security and whether it is more likely than not that it will be required to sell the security before its anticipated recovery of the amortized cost basis. If either of these conditions is met, the Bank recognizes an OTTI charge to earnings equal to the entire difference between the

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

security’s amortized cost basis and its fair value at the balance sheet date. For securities in an unrealized loss position that meet neither of these conditions, the Bank considers whether it expects to recover the entire amortized cost basis of the security by comparing its best estimate of the present value of the cash flows expected to be collected from the security with the amortized cost basis of the security. If the Bank’s best estimate of the present value of the cash flows expected to be collected is less than the amortized cost basis, the difference is considered the credit loss.

For all the securities in its available-for-sale portfolio, the Bank does not intend to sell any security and it is not more likely than not that the Bank will be required to sell any security before its anticipated recovery of the remaining amortized cost basis.

As of June 30, 2010, the Bank’s available-for-sale portfolio had gross unrealized gains. As a result, the Bank expects to recover the entire amortized cost basis of these securities.

Note 5 – Held-to-Maturity Securities

The Bank classifies the following securities as held-to-maturity because the Bank has the positive intent and ability to hold these securities to maturity:

June 30, 2010

 

     

Amortized

Cost(1)

  

OTTI

Recognized
in AOCI(1)

    Carrying
Value(1)
   Gross
Unrecognized
Holding
Gains(2)
   Gross
Unrecognized
Holding
Losses(2)
   

Estimated

Fair Value

Interest-bearing deposits

   $ 6,594    $      $ 6,594    $ 1    $      $ 6,595

Commercial paper

     2,357             2,357                  2,357

Housing finance agency bonds

     758             758           (143     615

TLGP

     303             303                  303

Subtotal

     10,012             10,012      1      (143     9,870

MBS:

               

Other U.S. obligations:

               

Ginnie Mae

     14             14                  14

GSEs:

               

Freddie Mac

     2,268             2,268      117             2,385

Fannie Mae

     6,614             6,614      291      (11     6,894

Subtotal GSEs

     8,882             8,882      408      (11     9,279

PLRMBS:

               

Prime

     5,167      (389     4,778      139      (315     4,602

Alt-A, option ARM

     1,894      (799     1,095      39      (11     1,123

Alt-A, other

     10,921      (2,139     8,782      585      (752     8,615

Subtotal PLRMBS

     17,982      (3,327     14,655      763      (1,078     14,340

Total MBS

     26,878      (3,327     23,551      1,171      (1,089     23,633

Total

   $ 36,890    $ (3,327   $ 33,563    $ 1,172    $ (1,232   $ 33,503

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

December 31, 2009

 

     

Amortized

Cost(1)

  

OTTI

Recognized
in AOCI(1)

    Carrying
Value(1)
   Gross
Unrecognized
Holding
Gains(2)
   Gross
Unrecognized
Holding
Losses(2)
   

Estimated

Fair Value

Interest-bearing deposits

   $ 6,510    $      $ 6,510    $    $      $ 6,510

Commercial paper

     1,100             1,100                  1,100

Housing finance agency bonds

     769             769           (138     631

TLGP

     304             304           (1     303

Subtotal

     8,683             8,683           (139     8,544

MBS:

               

Other U.S. obligations:

               

Ginnie Mae

     16             16                  16

GSEs:

               

Freddie Mac

     3,423             3,423      150      (1     3,572

Fannie Mae

     8,467             8,467      256      (13     8,710

Subtotal GSEs

     11,890             11,890      406      (14     12,282

PLRMBS:

               

Prime

     5,999      (407     5,592      72      (554     5,110

Alt-A, option ARM

     2,086      (908     1,178      37      (104     1,111

Alt-A, other

     11,781      (2,260     9,521      385      (1,287     8,619

Subtotal PLRMBS

     19,866      (3,575     16,291      494      (1,945     14,840

Total MBS

     31,772      (3,575     28,197      900      (1,959     27,138

Total

   $ 40,455    $ (3,575   $ 36,880    $ 900    $ (2,098   $ 35,682

 

(1) Amortized cost includes unpaid principal balance, unamortized premiums and discounts, and previous other-than-temporary impairments recognized in earnings (less any cumulative-effect adjustments recognized). The carrying value of held-to-maturity securities represents amortized cost after adjustment for impairment related to all other factors recognized in AOCI.
(2) Gross unrecognized holding gains/(losses) represent the difference between estimated fair value and carrying value, while gross unrealized gains/(losses) represent the difference between estimated fair value and amortized cost.

As of June 30, 2010, all of the interest-bearing deposits, commercial paper, and housing finance agency bonds had a credit rating of at least A. The TLGP securities are guaranteed by the FDIC and backed by the full faith and credit of the U.S. government. In addition, as of June 30, 2010, 36% of the PLRMBS, based on amortized cost, were rated above investment grade (13% had a credit rating of AAA), and the remaining 64% were rated below investment grade. Credit ratings of BB and lower are below investment grade. The credit ratings used by the Bank are based on the lowest of Moody’s Investors Service (Moody’s), Standard & Poor’s Rating Services (Standard & Poor’s), or comparable Fitch ratings.

At June 30, 2010, PLRMBS labeled Alt-A by the issuer represented 48% of the amortized cost of the Bank’s MBS portfolio. Alt-A PLRMBS are generally collateralized by mortgage loans that are considered less risky than subprime loans, but more risky than prime loans. These loans are generally made to borrowers who have sufficient credit ratings to qualify for a conforming mortgage loan, but the loans may not meet all standard guidelines for documentation requirements, property type, or loan-to-value ratios.

The following tables summarize the held-to-maturity securities with unrealized losses as of June 30, 2010, and December 31, 2009. The unrealized losses are aggregated by major security type and the length of time that individual securities have been in a continuous unrealized loss position.

 

11


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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

June 30, 2010

 

     Less than 12 months    12 months or more    Total
      Estimated
Fair Value
   Unrealized
Losses
   Estimated
Fair Value
   Unrealized
Losses
   Estimated
Fair Value
   Unrealized
Losses

Interest-bearing deposits

   $ 4,722    $    $    $    $ 4,722    $

Commercial paper

     1,258                     1,258     

Housing finance agency bonds

               615      143      615      143

Subtotal

     5,980           615      143      6,595      143

MBS:

                 

Other U.S. obligations:

                 

Ginnie Mae

               5           5     

GSEs:

                 

Freddie Mac

     2           33           35     

Fannie Mae

     220      5      108      6      328      11

Subtotal GSEs

     222      5      141      6      363      11

PLRMBS(1) :

                 

Prime

     14           4,313      704      4,327      704

Alt-A, option ARM

               1,115      810      1,115      810

Alt-A, other

               8,615      2,891      8,615      2,891

Subtotal PLRMBS

     14           14,043      4,405      14,057      4,405

Total MBS

     236      5      14,189      4,411      14,425      4,416

Total

   $ 6,216    $ 5    $ 14,804    $ 4,554    $ 21,020    $ 4,559
December 31, 2009         
      Less than 12 months    12 months or more    Total
      Estimated
Fair Value
   Unrealized
Losses
   Estimated
Fair Value
   Unrealized
Losses
   Estimated
Fair Value
   Unrealized
Losses

Interest-bearing deposits

   $ 6,510         $    $    $ 6,510    $

Housing finance agency bonds

     30      7      600      131      630      138

TLGP

     303      1                303      1

Subtotal

     6,843      8      600      131      7,443      139

MBS:

                 

Other U.S. obligations:

                 

Ginnie Mae

   $    $    $ 13    $    $ 13    $

GSEs:

                 

Freddie Mac

               40      1      40      1

Fannie Mae

     1,037      10      172      3      1,209      13

Subtotal GSEs

     1,037      10      212      4      1,249      14

PLRMBS(1):

                 

Prime

               5,110      961      5,110      961

Alt-A, option ARM

               1,111      1,012      1,111      1,012

Alt-A, other

               8,619      3,547      8,619      3,547

Subtotal PLRMBS

               14,840      5,520      14,840      5,520

Total MBS

     1,037      10      15,065      5,524      16,102      5,534

Total

   $ 7,880    $ 18    $ 15,665    $ 5,655    $ 23,545    $ 5,673

 

(1)

Includes securities with gross unrecognized holding losses of $1,078 and $1,945 at June 30, 2010, and December 31, 2009, respectively, and securities with OTTI charges of $3,327 and $3,575 that have been recognized in AOCI at June 30, 2010, and December 31, 2009, respectively.

As indicated in the tables above, as of June 30, 2010, the Bank’s investments classified as held-to-maturity had gross unrealized losses totaling $4,559, primarily relating to PLRMBS. The gross unrealized losses associated with the PLRMBS were primarily due to illiquidity in the MBS market, uncertainty about the future condition of the housing and mortgage markets and the economy, and continued deterioration in the credit performance of loan collateral underlying these securities, which caused these assets to be valued at significant discounts to their acquisition cost.

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Redemption Terms. The amortized cost, carrying value, and estimated fair value of non-MBS securities by contractual maturity (based on contractual final principal payment) and of MBS as of June 30, 2010, and December 31, 2009, are shown below. Expected maturities of MBS will differ from contractual maturities because borrowers generally have the right to prepay the underlying obligations without prepayment fees.

June 30, 2010

 

Year of Contractual Maturity

   Amortized
Cost(1)
   Carrying
Value(1)
   Estimated
Fair
Value
   Weighted
Average
Interest
Rate
 

Held-to-maturity securities other than MBS:

           

Due in 1 year or less

   $ 9,254    $ 9,254    $ 9,255    0.33

Due after 1 year through 5 years

     9      9      8    0.49   

Due after 5 years through 10 years

     27      27      23    0.46   

Due after 10 years

     722      722      584    0.56   
    

Subtotal

     10,012      10,012      9,870    0.34   
    

MBS:

           

Other U.S. obligations:

           

Ginnie Mae

     14      14      14    1.25   

GSEs:

           

Freddie Mac

     2,268      2,268      2,385    4.75   

Fannie Mae

     6,614      6,614      6,894    4.13   
    

Subtotal GSEs

     8,882      8,882      9,279    4.29   
    

PLRMBS:

           

Prime

     5,167      4,778      4,602    3.71   

Alt-A, option ARM

     1,894      1,095      1,123    0.61   

Alt-A, other

     10,921      8,782      8,615    4.03   
    

Subtotal PLRMBS

     17,982      14,655      14,340    3.55   
    

Total MBS

     26,878      23,551      23,633    3.78   
    

Total

   $ 36,890    $ 33,563    $ 33,503    2.87
   

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

December 31, 2009

 

Year of Contractual Maturity

   Amortized
Cost(1)
   Carrying
Value(1)
   Estimated
Fair
Value
   Weighted
Average
Interest
Rate
 

Held-to-maturity securities other than MBS:

           

Due in 1 year or less

   $ 7,610    $ 7,610    $ 7,610    0.15

Due after 1 year through 5 years

     316      316      314    1.75   

Due after 5 years through 10 years

     27      27      23    0.40   

Due after 10 years

     730      730      597    0.53   
    

Subtotal

     8,683      8,683      8,544    0.24   
    

MBS:

           

Other U.S. obligations:

           

Ginnie Mae

     16      16      16    1.26   

GSEs:

           

Freddie Mac

     3,423      3,423      3,572    4.83   

Fannie Mae

     8,467      8,467      8,710    4.15   
    

Subtotal GSEs

     11,890      11,890      12,282    4.35   
    

PLRMBS:

           

Prime

     5,999      5,592      5,110    3.91   

Alt-A, option ARM

     2,086      1,178      1,111    0.49   

Alt-A, other

     11,781      9,521      8,619    4.25   
    

Subtotal PLRMBS

     19,866      16,291      14,840    3.73   
    

Total MBS

     31,772      28,197      27,138    3.95   
    

Total

   $ 40,455    $ 36,880    $ 35,682    3.17
   

 

(1) Amortized cost includes unpaid principal balance, unamortized premiums and discounts, and previous other-than-temporary impairments recognized in earnings (less any cumulative-effect adjustments recognized). The carrying value of held-to-maturity securities represents amortized cost after adjustment for impairment related to all other factors recognized in AOCI.

At June 30, 2010, the carrying value of the Bank’s MBS classified as held-to-maturity included net discounts of $9, OTTI related to credit loss of $861 (including interest accretion adjustments of $31), and OTTI related to all other factors of $3,327. At December 31, 2009, the carrying value of the Bank’s MBS classified as held-to-maturity included net discounts of $16, OTTI related to credit loss of $652 (including interest accretion adjustments of $24), and OTTI related to all other factors of $3,575.

Interest Rate Payment Terms. Interest rate payment terms for held-to-maturity securities at June 30, 2010, and December 31, 2009, are detailed in the following table:

 

      June 30, 2010    December 31, 2009

Amortized cost of held-to-maturity securities other than MBS:

     

Fixed rate

   $ 9,254    $ 7,914

Adjustable rate

     758      769

Subtotal

     10,012      8,683

Amortized cost of held-to-maturity MBS:

     

Passthrough securities:

     

Fixed rate

     2,317      3,326

Adjustable rate

     109      87

Collateralized mortgage obligations:

     

Fixed rate

     13,244      16,619

Adjustable rate

     11,208      11,740

Subtotal

     26,878      31,772

Total

   $ 36,890    $ 40,455

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Certain MBS classified as fixed rate passthrough securities and fixed rate collateralized mortgage obligations have an initial fixed interest rate that subsequently converts to an adjustable interest rate on a specified date as follows:

 

      June 30, 2010    December 31, 2009

Passthrough securities:

     

Converts in 1 year or less

   $ 109    $ 158

Converts after 1 year through 5 years

     1,478      2,061

Converts after 5 years through 10 years

     702      1,076

Total

   $ 2,289    $ 3,295

Collateralized mortgage obligations:

     

Converts in 1 year or less

   $ 508    $ 1,216

Converts after 1 year through 5 years

     4,546      6,167

Converts after 5 years through 10 years

     1,252      1,652

Total

   $         6,306    $     9,035

The Bank does not own MBS that are backed by mortgage loans purchased by another Federal Home Loan Bank (FHLBank) from either (i) members of the Bank or (ii) members of other FHLBanks.

Other-Than-Temporary Impairment. On a quarterly basis, the Bank evaluates its individual held-to-maturity investment securities in an unrealized loss position for OTTI. As part of this evaluation, the Bank considers whether it intends to sell each debt security and whether it is more likely than not that it will be required to sell the security before its anticipated recovery of the amortized cost basis. If either of these conditions is met, the Bank recognizes an OTTI charge to earnings equal to the entire difference between the security’s amortized cost basis and its fair value at the balance sheet date. For securities in an unrealized loss position that meet neither of these conditions, the Bank considers whether it expects to recover the entire amortized cost basis of the security by comparing its best estimate of the present value of the cash flows expected to be collected from the security with the amortized cost basis of the security. If the Bank’s best estimate of the present value of the cash flows expected to be collected is less than the amortized cost basis, the difference is considered the credit loss.

For all the securities in its held-to-maturity portfolio, the Bank does not intend to sell any security and it is not more likely than not that the Bank will be required to sell any security before its anticipated recovery of the remaining amortized cost basis.

The Bank determined that, as of June 30, 2010, the immaterial gross unrealized losses on its interest-bearing deposits and commercial paper are temporary because the gross unrealized losses were caused by movements in interest rates and not by the deterioration of the issuers’ creditworthiness. The interest-bearing deposits and commercial paper were all with issuers that had credit ratings of at least A at June 30, 2010, and all of the securities had maturity dates within 45 days of June 30, 2010. As a result, the Bank expects to recover the entire amortized cost basis of these securities.

As of June 30, 2010, the Bank’s investments in housing finance agency bonds, which were issued by the California Housing Finance Agency (CalHFA), had gross unrealized losses totaling $143. These gross unrealized losses were mainly due to an illiquid market, causing these investments to be valued at a discount to their acquisition cost. In addition, the Bank independently modeled cash flows for the underlying collateral, using assumptions for default rates and loss severity that management deemed reasonable, and concluded that the available credit support within the CalHFA structure more than offset the projected losses on the underlying collateral. The Bank determined that, as of June 30, 2010, all of the gross unrealized losses on these bonds are temporary because the underlying collateral and credit enhancements were sufficient to protect the Bank from losses based on current expectations and because CalHFA had a credit rating of A at June 30, 2010 (based on the lower of Moody’s or Standard & Poor’s ratings). As a result, the Bank expects to recover the entire amortized cost basis of these securities.

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

For its agency MBS, the Bank expects to recover the entire amortized cost basis of these securities because it determined that the strength of the issuers’ guarantees through direct obligations or support from the U.S. government is sufficient to protect the Bank from losses based on current expectations. As a result, the Bank determined that, as of June 30, 2010, all of the gross unrealized losses on its agency MBS are temporary.

To assess whether it expects to recover the entire amortized cost basis of its PLRMBS, the Bank performed a cash flow analysis for all of its PLRMBS as of June 30, 2010. In performing the cash flow analysis for each security, the Bank used two third-party models. The first model considers borrower characteristics and the particular attributes of the loans underlying the Bank’s securities, in conjunction with assumptions about future changes in home prices, interest rates, and other assumptions, to project prepayments, default rates, 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) based on an assessment of the relevant 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 of 10,000 or more people. The Bank’s housing price forecast as of June 30, 2010, assumed CBSA-level current-to-trough housing price declines ranging from 0% to 12% over the 3- to 9-month periods beginning April 1, 2010 (average price decline for all areas during their current-to-trough period equaled 4.5%). For each area, after the current-to-trough period, home prices are projected to increase 0% in the first six months, 0.5% in the next six months, 3% in the second year, and 4% in each subsequent year. The month-by-month projections of future loan performance derived from the first model, which reflect projected prepayments, default rates, 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 each securitization structure in accordance with the structure’s prescribed cash flow and loss allocation rules. When the credit enhancement for the senior securities in a securitization is derived from the presence of subordinated securities, losses are generally allocated first to the subordinated 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 scenario and includes a base case current-to-trough housing price forecast and a base case housing price recovery path.

At each quarter end, the Bank compares the present value of the cash flows expected to be collected on its PLRMBS to the amortized cost basis of the securities to determine whether a credit loss exists. For the Bank’s variable rate and hybrid PLRMBS, the Bank uses a forward interest rate curve to project the future estimated cash flows. The Bank then uses the effective interest rate for the security prior to impairment for determining the present value of the future estimated cash flows. For securities previously identified as other-than-temporarily impaired, the Bank updates its estimate of future estimated cash flows on a quarterly basis.

For securities determined to be other-than-temporarily impaired as of June 30, 2010 (that is, securities for which the Bank determined that it does not expect to recover the entire amortized cost basis), the following table presents a summary of the significant inputs used in measuring the amount of credit loss recognized in earnings in the second quarter of 2010.

Credit enhancement is defined as the subordinated tranches and over-collateralization, if any, in a security structure that will generally absorb losses before the Bank will experience a loss on the security, expressed as a percentage of the underlying collateral balance. The calculated averages represent the dollar-weighted averages of all the PLRMBS investments in each category shown. The classification (prime or Alt-A) is based on the model used to run the estimated cash flows for the CUSIP, which may not necessarily be the same as the classification at the time of origination.

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

June 30, 2010

 

     Significant Inputs    Current
     Prepayment Rates    Default Rates    Loss Severities    Credit Enhancement
Year of Securitization    Weighted
Average %
   Range %    Weighted
Average %
   Range %    Weighted
Average %
   Range %    Weighted
Average %
   Range %

Prime

                       

2008

   8.8    5.9 – 9.6    62.0    61.6 – 63.4    41.5    41.3 – 42.1    30.8    30.8

2006

   6.7    6.1 – 7.5    19.9    18.7 – 23.5    35.8    33.9 – 41.0    7.6    7.1 – 9.3

2005

   7.3    7.3    25.3    25.3    37.3    37.3    17.6    17.6

2004 and earlier

   10.8    10.8    3.7    3.7    28.4    28.4    11.3    11.3

Total Prime

   8.2    5.9 – 10.8    44.9    3.7 – 63.4    38.9    28.4 – 42.1    22.2    7.1 – 30.8

Alt-A

                       

2007

   8.8    4.4 – 13.7    63.5    22.9 – 89.3    48.7    40.5 – 60.4    28.2    9.1 – 46.4

2006

   10.2    5.3 – 13.7    52.0    28.5 – 88.4    49.0    39.4 – 62.0    24.8    10.0 – 40.5

2005

   11.3    6.5 – 15.7    38.8    15.5 – 77.7    45.7    31.8 – 59.5    15.7    5.4 – 32.0

2004 and earlier

   12.3    11.8 – 12.6    42.9    34.6 – 50.8    48.0    41.7 – 55.0    20.6    14.3 – 29.6

Total Alt-A

   9.9    4.4 – 15.7    52.7    15.5 – 89.3    47.8    31.8 – 62.0    23.3    5.4 – 46.4

Total

   9.8    4.4 – 15.7    52.3    3.7 – 89.3    47.3    28.4 – 62.0    23.2    5.4 – 46.4

The Bank recorded OTTI related to credit loss of $142 and $88 that was recognized in “Other Loss” for the second quarter of 2010 and 2009, respectively, and recognized OTTI related to all other factors of $48 and $1,195 in “Other comprehensive income/(loss)” for the second quarter of 2010 and 2009, respectively. The Bank recorded OTTI related to credit loss of $202 and $176 that was recognized in “Other Loss” for the first six months of 2010 and 2009, respectively, and recognized OTTI related to all other factors of $180 and $2,263 in “Other comprehensive income/(loss)” for the first six months of 2010 and 2009, respectively. For each security, the estimated impairment related to all other factors for each security is accreted prospectively, based on the amount and timing of future estimated cash flows, over the remaining life of the security as an increase in the carrying value of the security (with no effect on earnings unless the security is subsequently sold or there are additional decreases in the cash flows expected to be collected). The Bank accreted $213 and $93 from AOCI to increase the carrying value of the respective PLRMBS for the second quarter of 2010 and 2009, respectively. The Bank accreted $428 and $123 from AOCI to increase the carrying value of the respective PLRMBS for the first six months of 2010 and 2009, respectively. The Bank does not intend to sell these securities and it is not more likely than not that the Bank will be required to sell these securities before its anticipated recovery of the remaining amortized cost basis. At June 30, 2010, the estimated weighted average life of these securities was approximately four years.

For certain other-than-temporarily impaired securities that had previously been impaired and subsequently incurred additional OTTI related to credit loss, the additional credit-related OTTI, up to the amount in AOCI, was reclassified out of non-credit-related OTTI in AOCI and charged to earnings. This amount was $140 and $77 for the second quarter of 2010 and 2009, respectively. This amount was $199 and $127 for the first six months of 2010 and 2009, respectively.

The following tables present the OTTI related to credit loss, which is recognized in earnings, and the OTTI related to all other factors, which is recognized in “Other comprehensive income/(loss),” for the three and six months ended June 30, 2010 and 2009.

 

     Three Months Ended June 30, 2010     Three Months Ended June 30, 2009  
                
    

OTTI

Related to

Credit Loss

  

OTTI

Related to
All Other

Factors

    Total
OTTI
   

OTTI

Related to

Credit Loss

  

OTTI

Related to
All Other

Factors

    Total
OTTI
 
   

Balance, beginning of the period

   $ 688    $ 3,492      $ 4,180      $ 108    $ 1,608      $ 1,716   

Charges on securities for which OTTI was not previously recognized

     2      175        177        48      1,196        1,244   

Additional charges on securities for which OTTI was previously recognized(1)

     140      (127     13        40      (1     39   

Accretion of impairment related to all other factors

          (213     (213          (93     (93
   

Balance, end of the period

   $     830    $     3,327      $     4,157      $     196    $     2,710      $     2,906   
   

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

     Six Months Ended June 30, 2010     Six Months Ended June 30, 2009  
                
    

OTTI

Related to

Credit Loss

  

OTTI

Related to
All Other

Factors

    Total
OTTI
   

OTTI

Related to

Credit Loss

  

OTTI

Related to
All Other

Factors

    Total
OTTI
 
   

Balance, beginning of the period(2)

   $     628    $ 3,575      $ 4,203      $ 20    $ 570      $ 590   

Charges on securities for which OTTI was not previously recognized

     5      289        294        86      2,211        2,297   

Additional charges on securities for which OTTI was previously recognized(1)

     197      (109     88        90      52        142   

Accretion of impairment related to all other factors

          (428     (428          (123     (123
   

Balance, end of the period

   $     830    $     3,327      $     4,157      $     196    $     2,710      $     2,906   
   

 

(1) For the three months ended June 30, 2010, “securities for which OTTI was previously recognized” represents all securities that were also other-than-temporarily impaired prior to April 1, 2010. For the three months ended June 30, 2009, “securities for which OTTI was previously recognized” represents all securities that were also previously other-than-temporarily impaired prior to April 1, 2009. For the six months ended June 30, 2010, “securities for which OTTI was previously recognized” represents all securities that were also other-than-temporarily impaired prior to January 1, 2010. For the six months ended June 30, 2009, “securities for which OTTI was previously recognized” represents all securities that were also previously other-than-temporarily impaired prior to January 1, 2009.
(2) The Bank adopted the OTTI guidance as of January 1, 2009, and recognized the cumulative effect of initially applying the OTTI guidance, totaling $570, as an increase in the retained earnings balance at January 1, 2009, with a corresponding change in AOCI.

The following tables present the Bank’s other-than-temporarily impaired PLRMBS that incurred an OTTI charge during the three months ended June 30, 2010, and 2009, by loan collateral type:

 

June 30, 2010    Unpaid
Principal
Balance
   Amortized
Cost
  

Carrying

Value

   Estimated
Fair Value
 

Other-than-temporarily impaired PLRMBS backed by loans classified at origination as:

           

Prime

   $ 1,265    $ 1,180    $ 825    $ 950

Alt-A, option ARM

     2,004      1,734      998      1,031

Alt-A, other

     6,139      5,729      3,982      4,416
 

Total

   $ 9,408    $ 8,643    $ 5,805    $ 6,397
 

 

June 30, 2009    Unpaid
Principal
Balance
   Amortized
Cost
  

Carrying

Value

   Estimated
Fair Value
 

Other-than-temporarily impaired PLRMBS backed by loans classified at origination as:

           

Prime

   $ 1,203    $ 1,190    $ 824    $ 824

Alt-A, option ARM

     4,318      4,203      2,554      2,596

Alt-A, other

     1,165      1,114      515      531
 

Total

   $ 6,686    $ 6,507    $ 3,893    $ 3,951
 

The following tables present the Bank’s other-than-temporarily impaired PLRMBS that incurred an OTTI charge anytime during the life of the securities at June 30, 2010, and December 31, 2009, by loan collateral type:

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

June 30, 2010    Unpaid
Principal
Balance
   Amortized
Cost
  

Carrying

Value

   Estimated
Fair Value
 

Other-than-temporarily impaired PLRMBS backed by loans classified at origination as:

           

Prime

   $ 1,438    $ 1,345    $ 956    $ 1,092

Alt-A, option ARM

     2,146      1,865      1,066      1,105

Alt-A, other

     7,745      7,265      5,126      5,711
 

Total

   $ 11,329    $ 10,475    $ 7,148    $ 7,908
 

 

December 31, 2009    Unpaid
Principal
Balance
   Amortized
Cost
  

Carrying

Value

   Estimated
Fair Value
 

Other-than-temporarily impaired PLRMBS backed by loans classified at origination as:

           

Prime

   $ 1,392    $ 1,333    $ 927    $ 998

Alt-A, option ARM

     2,084      1,873      964      1,001

Alt-A, other

     7,410      7,031      4,771      5,150
 

Total

   $ 10,886    $ 10,237    $ 6,662    $ 7,149
 

The following tables present the Bank’s OTTI related to credit loss and OTTI related to all other factors on its other-than-temporarily impaired PLRMBS during the three and six months ended June 30, 2010 and 2009:

 

     Three Months Ended June 30, 2010    Three Months Ended June 30, 2009
             
     OTTI
Related to
Credit Loss
   OTTI
Related to
All Other
Factors
   

Total

OTTI

   OTTI
Related to
Credit Loss
   OTTI
Related to
All Other
Factors
   Total
OTTI
 

Other-than-temporarily impaired PLRMBS backed by loans classified at origination as:

                

Prime

   $ 28    $ (24   $ 4    $ 15    $ 312    $ 327

Alt-A, option ARM

     56      28        84      25      139      164

Alt-A, other

     58      44        102      48      744      792
 

Total

   $ 142    $ 48      $ 190    $   88    $ 1,195    $ 1,283
 
     Six Months Ended June 30, 2010    Six Months Ended June 30, 2009
             
     OTTI
Related to
Credit Loss
   OTTI
Related to
All Other
Factors
   

Total

OTTI

   OTTI
Related to
Credit Loss
   OTTI
Related to
All Other
Factors
   Total
OTTI
 

Other-than-temporarily impaired PLRMBS backed by loans classified at origination as:

                

Prime

   $ 34    $ 29      $ 63    $ 15    $ 312    $ 327

Alt-A, option ARM

     71      14        85      50      556      606

Alt-A, other

     97      137        234      111      1,395      1,506
 

Total

   $ 202    $ 180      $ 382    $ 176    $ 2,263    $ 2,439
 

The following tables present the other-than-temporarily impaired PLRMBS for the three and six months ended June 30, 2010 and 2009, by loan collateral type and the length of time that the individual securities were in a continuous loss position prior to the current period write-down:

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

     Three Months Ended June 30, 2010
      
    

Gross Unrealized Losses

Related to Credit

  

Gross Unrealized Losses

Related to All Other Factors

             
     Less than
12 months
  

12 months

or more

   Total    Less than
12 months
    12 months
or more
    Total     
 

Other-than-temporarily impaired PLRMBS backed by loans classified at origination as:

               

Prime

   $    $ 28    $ 28    $      $ (24     $(24)   

Alt-A, option ARM

     1      55      56      (1     29        28    

Alt-A, other

          58      58             44        44    
 

Total

   $ 1    $ 141    $ 142    $ (1   $ 49      $ 48    
 
     Three Months Ended June 30, 2009
      
    

Gross Unrealized Losses

Related to Credit

  

Gross Unrealized Losses

Related to All Other Factors

             
     Less than
12 months
  

12 months

or more

   Total    Less than
12 months
    12 months
or more
    Total     
 

Other-than-temporarily impaired PLRMBS backed by loans classified at origination as:

               

Prime

   $ 9    $ 6    $ 15    $      $ 312      $ 312    

Alt-A, option ARM

          25      25             139        139    

Alt-A, other

          48      48             744        744    
 

Total

   $ 9    $ 79    $ 88    $      $ 1,195      $ 1,195    
 
     Six Months Ended June 30, 2010
      
    

Gross Unrealized Losses

Related to Credit

  

Gross Unrealized Losses

Related to All Other Factors

             
     Less than
12 months
  

12 months

or more

   Total    Less than
12 months
    12 months
or more
    Total     
 

Other-than-temporarily impaired PLRMBS backed by loans classified at origination as:

               

Prime

   $    $ 34    $ 34    $      $ 29      $ 29    

Alt-A, option ARM

     1      70      71      (1     15        14    

Alt-A, other

          97      97             137        137    
 

Total

   $ 1    $ 201    $ 202    $ (1   $ 181      $ 180    
 
     Six Months Ended June 30, 2009
      
    

Gross Unrealized Losses

Related to Credit

  

Gross Unrealized Losses

Related to All Other Factors

             
     Less than
12 months
  

12 months

or more

   Total    Less than
12 months
    12 months
or more
    Total     
 

Other-than-temporarily impaired PLRMBS backed by loans classified at origination as:

               

Prime

   $ 9    $ 6    $ 15    $      $ 312      $ 312    

Alt-A, option ARM

          50      50             556        556    

Alt-A, other

          111      111             1,395        1,395    
 

Total

   $ 9    $ 167    $ 176    $      $ 2,263      $ 2,263    
 

For the Bank’s PLRMBS that were not other-than-temporarily impaired as of June 30, 2010, the Bank has experienced net unrealized losses and a decrease in fair value primarily because of illiquidity in the MBS market, uncertainty about the future condition of the housing and mortgage markets and the economy, and continued deterioration in the credit performance of loan collateral underlying these securities, which caused these assets to be valued at significant discounts to their acquisition cost. The Bank does not intend to sell these securities, it is not more likely than not that the Bank will be required to sell these securities before its anticipated recovery of the remaining amortized cost basis, and the Bank expects to recover the entire

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

amortized cost basis of these securities. As a result, the Bank determined that, as of June 30, 2010, the gross unrealized losses on these remaining PLRMBS are temporary. Seventy-three percent of the PLRMBS, based on amortized cost, that were not other-than-temporarily impaired were rated investment grade (31% were rated AAA), and the remaining 27% were rated below investment grade. These securities were included in the securities that the Bank reviewed and analyzed for OTTI as discussed above, and the analyses performed indicated that these securities were not other-than-temporarily impaired. The credit ratings used by the Bank are based on the lowest of Moody’s, Standard & Poor’s, or comparable Fitch ratings.

Note 6 – Advances

Redemption Terms. The Bank had advances outstanding, excluding overdrawn demand deposit accounts, at interest rates ranging from 0.04% to 8.57% at June 30, 2010, and 0.01% to 8.57% at December 31, 2009, as summarized below.

 

     June 30, 2010     December 31, 2009  
                
Contractual Maturity    Amount
Outstanding
  

Weighted

Average

Interest Rate

    Amount
Outstanding
  

Weighted

Average

Interest Rate

 

Within 1 year

   $ 46,427    1.60   $ 76,854    1.54

After 1 year through 2 years

     24,176    1.41        30,686    1.69   

After 2 years through 3 years

     10,003    1.85        7,313    2.85   

After 3 years through 4 years

     5,572    2.42        9,211    1.77   

After 4 years through 5 years

     1,774    3.31        1,183    4.12   

After 5 years

     6,737    2.12        7,066    2.12   
             

Total par amount

     94,689    1.70     132,313    1.72
                  

Valuation adjustments for hedging activities

     476        524   

Valuation adjustments under fair value option

     523        616   

Net unamortized premiums

     59        106   
             

Total

   $ 95,747      $ 133,559   
             

The following table summarizes advances at June 30, 2010, and December 31, 2009, by the earlier of the year of contractual maturity or next call date for callable advances.

 

Earlier of Contractual

Maturity or Next Call Date

   June 30, 2010    December 31, 2009
 

Within 1 year

   $ 46,492    $ 76,864

After 1 year through 2 years

     24,180      30,686

After 2 years through 3 years

     10,000      7,318

After 3 years through 4 years

     5,572      9,201

After 4 years through 5 years

     1,766      1,183

After 5 years

     6,679      7,061
 

Total par amount

   $ 94,689    $ 132,313
 

The following table summarizes advances at June 30, 2010, and December 31, 2009, by the earlier of the year of contractual maturity or next put date for putable advances.

 

21


Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Earlier of Contractual

Maturity or Next Put Date

   June 30, 2010    December 31, 2009
 

Within 1 year

   $ 49,054    $ 79,552

After 1 year through 2 years

     23,651      30,693

After 2 years through 3 years

     9,452      6,385

After 3 years through 4 years

     5,394      8,933

After 4 years through 5 years

     1,551      942

After 5 years

     5,587      5,808
 

Total par amount

   $ 94,689    $ 132,313
 

Security Terms. The Bank lends to member financial institutions that have a principal place of business in Arizona, California, or Nevada. The Bank is required by the Federal Home Loan Bank Act of 1932, as amended (FHLBank Act), to obtain sufficient collateral for advances to protect against losses and to accept as collateral for advances only certain U.S. government or government agency securities, residential mortgage loans or MBS, other eligible real estate-related assets, and cash or deposits in the Bank. The capital stock of the Bank owned by each borrowing member is pledged as additional collateral for the member’s indebtedness to the Bank. The Bank may also accept small business, small farm, and small agribusiness loans that are fully secured by collateral (such as real estate, equipment and vehicles, accounts receivable, and inventory) or securities representing a whole interest in such loans as eligible collateral from members that qualify as community financial institutions. The Housing and Economic Recovery Act of 2008 (Housing Act) added secured loans for community development activities as collateral that the Bank may accept from community financial institutions. The Housing Act defines community financial institutions as FDIC-insured depository institutions with average total assets over the preceding three-year period of $1,000 or less. The Federal Housing Finance Agency (Finance Agency) adjusts the average total asset cap for inflation annually. Effective January 1, 2010, the cap was $1,029. In addition, the Bank has advances outstanding to former members and member successors, which are also subject to these security terms. For more information on security terms, see Note 7 to the Financial Statements in the Bank’s 2009 Form 10-K.

Credit and Concentration Risk. The Bank’s potential credit risk from advances is concentrated in four institutions whose advances outstanding represented 63% of the Bank’s total par amount of advances outstanding at June 30, 2010. The following tables present the concentration in advances to these four institutions as of June 30, 2010, and December 31, 2009. The tables also present the interest income from these advances before the impact of interest rate exchange agreements associated with these advances for the second quarter of 2010 and 2009 and for the first six months of 2010 and 2009.

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Concentration of Advances

 

     June 30, 2010     December 31, 2009  
Name of Borrower    Advances
Outstanding(1)
  

Percentage of
Total

Advances
Outstanding

    Advances
Outstanding(1)
  

Percentage of

Total

Advances
Outstanding

 

Citibank, N.A.

   $ 30,003    32   $ 46,544    35

Bank of America California, N.A.

     13,904    15        9,304    7   

JPMorgan Chase Bank, National Association

     8,609    9        20,622    16   

Wells Fargo Bank, N.A.(2)

     6,387    7        14,695    11   

Subtotal

     58,903    63        91,165    69   

Others(3)

     35,786    37        41,148    31   

Total par amount

   $ 94,689    100   $ 132,313    100

Concentration of Interest Income from Advances

 

  

     Three Months Ended  
     June 30, 2010     June 30, 2009  
Name of Borrower   

Interest

Income from
Advances(4)

  

Percentage of
Total Interest

Income from
Advances

    Interest
Income  from
Advances(4)
   Percentage of
Total Interest
Income from
Advances
 

Citibank, N.A.

   $ 25    6   $ 124    12

Bank of America California, N.A.

     34    8        31    3   

JPMorgan Chase Bank, National Association

     89    20        344    34   

Wells Fargo Bank, N.A.(2)

     25    6        61    6   

Subtotal

     173    40        560    55   

Others(5)

     268    60        447    45   

Total

   $ 441    100   $ 1,007    100
     Six Months Ended  
     June 30, 2010     June 30, 2009  
Name of Borrower   

Interest

Income from
Advances(4)

   Percentage of
Total Interest
Income from
Advances
    Interest
Income  from
Advances(4)
   Percentage of
Total Interest
Income from
Advances
 

Citibank, N.A.

   $ 47    5   $ 357    16

Bank of America California, N.A.

     63    6        95    4   

JPMorgan Chase Bank, National Association

     226    24        741    32   

Wells Fargo Bank, N.A.(2)

     56    6        163    7   

Subtotal

     392    41        1,356    59   

Others(5)

     555    59        932    41   

Total

   $ 947    100   $ 2,288    100

 

(1) Borrower advance amounts and total advance amounts are at par value, and total advance amounts will not agree to carrying value amounts shown in the Statements of Condition. The differences between the par and carrying value amounts primarily relate to unrealized gains or losses associated with hedged advances resulting from valuation adjustments related to hedging activities and the fair value option.
(2) On December 31, 2008, Wells Fargo & Company, a nonmember, acquired Wachovia Corporation, the parent company of Wachovia Mortgage, FSB. Wachovia Mortgage, FSB, operated as a separate entity and continued to be a member of the Bank until its merger into Wells Fargo Bank, N.A., a subsidiary of Wells Fargo & Company, on November 1, 2009. Effective November 1, 2009, Wells Fargo Financial National Bank, an affiliate of Wells Fargo & Company, became a member of the Bank, and the Bank allowed the transfer of excess capital stock totaling $5 from Wachovia Mortgage, FSB, to Wells Fargo Financial National Bank to enable Wells Fargo Financial National Bank to satisfy its initial membership stock requirement. As a result of the merger, Wells Fargo Bank, N.A., assumed all outstanding Bank advances and the remaining Bank capital stock of Wachovia Mortgage, FSB. The Bank reclassified the capital stock transferred to Wells Fargo Bank, N.A., to mandatorily redeemable capital stock (a liability).
(3) Includes advances outstanding totaling $5,000 to JPMorgan Bank and Trust Company, National Association, an affiliate of JPMorgan Chase Bank, National Association, at June 30, 2010, and December 31, 2009.
(4) Interest income amounts exclude the interest effect of interest rate exchange agreements with derivatives counterparties; as a result, the total interest income amounts will not agree to the Statements of Income. The amount of interest income from advances can vary depending on the amount outstanding, terms to maturity, interest rates, and repricing characteristics.
(5) Includes interest income from advances totaling $4 and $3 from JPMorgan Bank and Trust Company, National Association, an affiliate of JPMorgan Chase Bank, National Association, for the three months ended June 30, 2010 and 2009, respectively. Includes interest income from advances totaling $6 and $3 from JPMorgan Bank and Trust Company, National Association, an affiliate of JPMorgan Chase Bank, National Association, for the six months ended June 30, 2010 and 2009, respectively.

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

The Bank held a security interest in collateral from each of its four largest advances borrowers sufficient to support their respective advances outstanding, and the Bank does not expect to incur any credit losses on these advances. As of June 30, 2010, and December 31, 2009, three of the four largest advances borrowers (Citibank, N.A.; JPMorgan Chase Bank, National Association; and Wells Fargo Bank, N.A.) each owned more than 10% of the Bank’s outstanding capital stock, including mandatorily redeemable capital stock.

During the first six months of 2010, eleven member institutions were placed into receivership or liquidation. Ten of these institutions had advances outstanding at the time they were placed into receivership or liquidation. The advances outstanding to these ten institutions were either repaid prior to June 30, 2010, or assumed by other institutions, and no losses were incurred by the Bank. The eleventh institution had no advances outstanding at the time it was placed into receivership or liquidation. Bank capital stock held by six of the eleven institutions totaling $30 was classified as mandatorily redeemable capital stock (a liability). The capital stock of the other five institutions was transferred to other member institutions.

The Bank has policies and procedures in place to manage the credit risk of advances. Based on the collateral pledged as security for advances, the Bank’s credit analyses of members’ financial condition, and the Bank’s credit extension and collateral policies, the Bank expects to collect all amounts due according to the contractual terms of the advances. Therefore, no allowance for losses on advances was deemed necessary by management. The Bank has never experienced any credit losses on advances.

From July 1, 2010, to July 30, 2010, two member institutions were placed into receivership. The outstanding advances and capital stock of one institution were assumed by another member institution. The advances outstanding to the second institution were assumed by a nonmember institution, and the Bank capital stock held by the institution totaling $3 was classified as mandatorily redeemable capital stock (a liability). Because the estimated fair value of the collateral exceeds the carrying amount of the advances outstanding, and the Bank expects to collect all amounts due according to the contractual terms of the advances, no allowance for loan losses on the advances outstanding was deemed necessary by management.

Interest Rate Payment Terms. Interest rate payment terms for advances at June 30, 2010, and December 31, 2009, are detailed below:

 

      June 30, 2010    December 31, 2009

Par amount of advances:

     

Fixed rate

   $ 52,152    $ 68,411

Adjustable rate

     42,537      63,902

Total par amount

   $ 94,689    $ 132,313

 

24


Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Prepayment Fees, Net. The Bank charges borrowers prepayment fees or pays borrowers prepayment credits when the principal on certain advances is paid prior to original maturity. The Bank records prepayment fees net of any associated fair value adjustments related to prepaid advances that were hedged. The net amount of prepayment fees is reflected as interest income in the Statements of Income, as follows:

 

     Three Months Ended          Six Months Ended  
       June 30, 2010        June 30, 2009             June 30, 2010        June 30, 2009   

Prepayment fees received

   $ 59      $ 32         $ 78      $ 52   

Fair value adjustments

     (11     (14        (19     (32

Other basis adjustments

     (20                 (20       

Net

   $ 28      $ 18           $ 39      $ 20   

Advance principal prepaid

   $ 8,146      $ 11,376         $ 14,551      $ 14,067   

Note 7 – Mortgage Loans Held for Portfolio

Under the Mortgage Partnership Finance® (MPF®) Program, the Bank purchased conventional conforming fixed rate residential mortgage loans directly from its participating members from May 2002 through October 2006. (“Mortgage Partnership Finance” and “MPF” are registered trademarks of the Federal Home Loan Bank of Chicago.) The mortgage loans are held-for-portfolio loans. Participating members originated or purchased the mortgage loans, credit-enhanced them and sold them to the Bank, and generally retained the servicing of the loans.

The following table presents information as of June 30, 2010, and December 31, 2009, on mortgage loans, all of which are secured by one- to four-unit residential properties and single-unit second homes.

 

      June 30, 2010     December 31, 2009  

Fixed rate medium-term mortgage loans

   $ 823      $ 927   

Fixed rate long-term mortgage loans

     1,984        2,130   

Subtotal

     2,807        3,057   

Net unamortized discounts

     (15     (18

Mortgage loans held for portfolio

     2,792        3,039   

Less: Allowance for credit losses

     (4     (2

Total mortgage loans held for portfolio, net

   $ 2,788      $ 3,037   

Medium-term loans have original contractual terms of 15 years or less, and long-term loans have contractual terms of more than 15 years.

For taking on the credit enhancement obligation, the Bank pays the participating member or any successor a credit enhancement fee, which is calculated on the remaining unpaid principal balance of the mortgage loans. The Bank records credit enhancement fees as a reduction to interest income. For the three and six months ended June 30, 2010, the credit enhancement fees were immaterial. For the three and six months ended June 30, 2009, the credit enhancement fees totaled $1 and $2, respectively.

Concentration Risk. The Bank had the following concentration in MPF loans with institutions whose outstanding total of mortgage loans sold to the Bank represented 10% or more of the Bank’s total outstanding mortgage loans at June 30, 2010, and December 31, 2009.

 

25


Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Concentration of Mortgage Loans

June 30, 2010

 

Name of Institution    Mortgage
Loan Balances
Outstanding
   Percentage of
Total
Mortgage
Loan Balances
Outstanding
    Number of
Mortgage Loans
Outstanding
   Percentage of
Total Number
of Mortgage
Loans
Outstanding
 

JPMorgan Chase Bank, National Association

   $ 2,211    79   17,575    73

OneWest Bank, FSB

     366    13      4,610    19   

Subtotal

     2,577    92      22,185    92   

Others

     230    8      1,947    8   

Total

   $ 2,807    100   24,132    100

 

December 31, 2009

 

    
Name of Institution    Mortgage
Loan Balances
Outstanding
   Percentage of
Total
Mortgage
Loan Balances
Outstanding
    Number of
Mortgage Loans
Outstanding
   Percentage of
Total Number
of Mortgage
Loans
Outstanding
 

JPMorgan Chase Bank, National Association

   $ 2,391    78   18,613    73

OneWest Bank, FSB

     409    13      4,893    19   

Subtotal

     2,800    91      23,506    92   

Others

     257    9      2,109    8   

Total

   $ 3,057    100   25,615    100

Credit Risk. A mortgage loan is considered to be impaired when it is reported 90 days or more past due (nonaccrual) or when it is probable, based on current information and events, that the Bank will be unable to collect all principal and interest amounts due according to the contractual terms of the mortgage loan agreement.

The following table presents information on delinquent mortgage loans as of June 30, 2010, and December 31, 2009.

 

     June 30, 2010          December 31, 2009  
Days Past Due    Number
of Loans
  

Mortgage

Loan Balance

          Number
of Loans
  

Mortgage

Loan Balance

 

30 – 59 days delinquent

   205    $ 22         243    $ 29   

60 – 89 days delinquent

   60      8         81      10   

90 days or more delinquent

   115      15         97      13   

In process of foreclosure(1)

   104      13           80      9   

Total

   484    $ 58           501    $ 61   

Nonaccrual loans(2)

   219    $ 28         177    $ 22   

Loans past due 90 days or more and still accruing interest

                       

Real estate owned inventory

   43    $ 4         26    $ 3   

Serious delinquency rate(3)

        0.98           0.70

 

(1) Includes loans for which the servicer has reported a decision to foreclose or to pursue a similar alternative, such as deed-in-lieu.
(2) Nonaccrual loans at June 30, 2010, included 22 loans, totaling $3, for which the borrower was in bankruptcy. Nonaccrual loans at December 31, 2009, included 23 loans, totaling $2, for which the borrower was in bankruptcy.
(3) Loans that are 90 days or more past due or in the process of foreclosure expressed as a percentage of the total conventional loan portfolio principal balance.

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

The Bank’s average recorded investment in impaired loans totaled $28 for the second quarter of 2010 and $15 for the second quarter of 2009. The Bank’s average recorded investment in impaired loans totaled $26 and $12 for the six months ended June 30, 2010 and 2009, respectively. The Bank did not recognize any interest income for impaired loans in the second quarter of 2010 and 2009 and in the first six months of 2010 and 2009.

The allowance for credit losses on the mortgage loan portfolio was as follows:

 

                               
     Three Months Ended          Six Months Ended  
       June 30, 2010        June 30, 2009             June 30, 2010        June 30, 2009   

Balance, beginning of the period

   $ 2.0      $ 1.1         $ 2.0      $ 1.0   

Chargeoffs – transferred to real estate owned

     (0.3               (0.7       

Recoveries

                               

Provision for credit losses

     1.9        0.9             2.3        1.0   

Balance, end of the period

   $ 3.6      $ 2.0           $ 3.6      $ 2.0   

Ratio of net charge-offs during the period to average loans outstanding during the period

     (0.01 )%             (0.02 )%     

For more information on how the Bank determines its estimated allowance for credit losses on mortgage loans, see Note 8 to the Financial Statements in the Bank’s 2009 Form 10-K.

Note 8 – Consolidated Obligations

Consolidated obligations, consisting of consolidated obligation bonds and discount notes, are jointly issued by the FHLBanks through the Office of Finance, which serves as the FHLBanks’ agent. As provided by the FHLBank Act or by regulations governing the operations of the FHLBanks, all FHLBanks have joint and several liability for all FHLBank consolidated obligations. For a discussion of the joint and several liability regulation, see Note 18 to the Financial Statements in the Bank’s 2009 Form 10-K. In connection with each debt issuance, each FHLBank specifies the type, term, and amount of debt it requests to have issued on its behalf. The Office of Finance tracks the amount of debt issued on behalf of each FHLBank. In addition, the Bank separately tracks and records as a liability its specific portion of the consolidated obligations issued and is the primary obligor for that portion of the consolidated obligations issued. The Finance Agency, the successor agency to the Federal Housing Finance Board (Finance Board), and the U.S. Secretary of the Treasury have oversight over the issuance of FHLBank debt through the Office of Finance.

Redemption Terms. The following is a summary of the Bank’s participation in consolidated obligation bonds at June 30, 2010, and December 31, 2009.

 

27


Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

     June 30, 2010     December 31, 2009  
                
Contractual Maturity    Amount
Outstanding
  

Weighted

Average

Interest Rate

    Amount
Outstanding
   

Weighted

Average

Interest Rate

 
   

Within 1 year

   $ 59,565    1.59   $ 75,865      1.29

After 1 year through 2 years

     34,609    2.08        42,745      2.40   

After 2 years through 3 years

     14,360    2.36        11,589      2.12   

After 3 years through 4 years

     7,467    4.05        12,855      3.86   

After 4 years through 5 years

     2,415    3.02        5,308      3.11   

After 5 years

     8,913    4.43        11,561      4.38   

Index amortizing notes

     6    4.61        6      4.61   
              

Total par amount

     127,335    2.18     159,929      2.14
                 

Unamortized premiums/(discounts)

     217        251     

Valuation adjustments for hedging activities

     1,953        1,926     

Fair value option valuation adjustments

     19        (53  
              

Total

   $ 129,524      $ 162,053     
              

The Bank’s participation in consolidated obligation bonds outstanding includes callable bonds of $19,172 at June 30, 2010, and $32,185 at December 31, 2009. Contemporaneous with the issuance of a callable bond for which the Bank is the primary obligor, the Bank routinely enters into an interest rate swap (in which the Bank pays a variable rate and receives a fixed rate) with a call feature that mirrors the call option embedded in the bond (a sold callable swap). The Bank had notional amounts of interest rate exchange agreements hedging callable bonds of $14,939 at June 30, 2010, and $25,530 at December 31, 2009. The combined sold callable swap and callable bond enable the Bank to meet its funding needs at costs not otherwise directly attainable solely through the issuance of non-callable debt, while effectively converting the Bank’s net payment to an adjustable rate.

The Bank’s participation in consolidated obligation bonds was as follows:

 

     June 30, 2010    December 31, 2009
 

Par amount of consolidated obligation bonds:

     

Non-callable

   $ 108,163    $ 127,744

Callable

     19,172      32,185
 

Total par amount

   $ 127,335    $ 159,929
 

The following is a summary of the Bank’s participation in consolidated obligation bonds outstanding at June 30, 2010, and December 31, 2009, by the earlier of the year of contractual maturity or next call date.

 

Earlier of Contractual

Maturity or Next Call Date

   June 30, 2010    December 31, 2009
 

Within 1 year

   $ 74,592    $ 103,215

After 1 year through 2 years

     32,249      36,750

After 2 years through 3 years

     10,210      5,494

After 3 years through 4 years

     5,787      9,480

After 4 years through 5 years

     210      593

After 5 years

     4,281      4,391

Index amortizing notes

     6      6
 

Total par amount

   $ 127,335    $ 159,929
 

Consolidated obligation discount notes are consolidated obligations issued to raise short-term funds; discount notes have 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 Bank’s participation in consolidated obligation discount notes, all of which are due within one year, was as follows:

 

28


Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

         June 30, 2010          December 31, 2009  
           Amount
Outstanding
    Weighted
Average
Interest Rate
          Amount
Outstanding
    Weighted
Average
Interest Rate
 

Par amount

     $ 15,800      0.22      $ 18,257      0.35

Unamortized discounts

         (12          (11  

Total

       $ 15,788           $ 18,246     

Interest Rate Payment Terms. Interest rate payment terms for consolidated obligations at June 30, 2010, and December 31, 2009, are detailed in the following table. For information on the general terms and types of consolidated obligations outstanding, see Note 10 to the Financial Statements in the Bank’s 2009 Form 10-K.

 

     June 30, 2010    December 31, 2009
 

Par amount of consolidated obligations:

     

Bonds:

     

Fixed rate

   $ 89,345    $ 98,619

Adjustable rate

     30,900      49,244

Step-up

     5,522      10,433

Step-down

     200      350

Fixed rate that converts to adjustable rate

     1,042      915

Adjustable rate that converts to fixed rate

     285      250

Range bonds

     35      112

Index amortizing notes

     6      6
 

Total bonds, par

     127,335      159,929

Discount notes, par

     15,800      18,257
 

Total consolidated obligations, par

   $ 143,135    $ 178,186
 

Note 9 – Capital

Capital Requirements. Under the Housing Act, the director of the Finance Agency is responsible for setting the risk-based capital standards for the FHLBanks. The FHLBank Act and regulations governing the operations of the FHLBanks require that the minimum stock requirement for members must be sufficient to enable the Bank to meet its regulatory requirements for total capital, leverage capital, and risk-based capital. The Bank must maintain (i) total regulatory capital in an amount equal to at least 4% of its total assets, (ii) leverage capital in an amount equal to at least 5% of its total assets, and (iii) permanent capital in an amount at least equal to its regulatory risk-based capital requirement. Regulatory capital and permanent capital are defined as retained earnings and Class B stock, which includes mandatorily redeemable capital stock that is classified as a liability for financial reporting purposes. Regulatory capital and permanent capital do not include AOCI. Leverage capital is defined as the sum of permanent capital, weighted by a 1.5 multiplier, plus non-permanent capital. (Non-permanent capital consists of Class A capital stock, which is redeemable upon six months’ notice. The Bank’s capital plan does not provide for the issuance of Class A capital stock.)

The risk-based capital requirements must be met with permanent capital, which must be at least equal to the sum of the Bank’s credit risk, market risk, and operations risk capital requirements, all of which are calculated in accordance with the rules and regulations of the Finance Agency. The Finance Agency may require an FHLBank to maintain a greater amount of permanent capital than is required by the risk-based capital requirements as defined.

The following table shows the Bank’s compliance with the Finance Agency’s capital requirements at June 30, 2010, and December 31, 2009.

 

29


Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Regulatory Capital Requirements

 

     

 

June 30, 2010

    December 31, 2009  
   Required     Actual     Required     Actual  

Risk-based capital

   $ 5,468      $ 14,320      $ 6,207      $ 14,657   

Total regulatory capital

   $ 6,328      $ 14,320      $ 7,714      $ 14,657   

Total regulatory capital ratio

     4.00     9.05     4.00     7.60

Leverage capital

   $ 7,910      $ 21,479      $ 9,643      $ 21,984   

Leverage ratio

     5.00     13.58     5.00     11.40

The Bank’s total regulatory capital ratio increased to 9.05% at June 30, 2010, from 7.60% at December 31, 2009, primarily because of increased excess capital stock resulting from the decline in advances outstanding, coupled with the Bank’s decision not to repurchase excess capital stock in 2009 and the first quarter of 2010.

Mandatorily Redeemable Capital Stock. The Bank had mandatorily redeemable capital stock totaling $4,690 at June 30, 2010, and $4,843 at December 31, 2009. The change in mandatorily redeemable capital stock for the three and six months ended June 30, 2010 and 2009, was as follows:

 

     Three Months Ended  
     June 30, 2010     June 30, 2009  
     

Number of

Institutions

   Amount    

Number of

Institutions

    Amount  

Balance at the beginning of the period

   45    $ 4,858      33      $ 3,145   

Reclassified from/(to) capital during the period:

         

Merger with or acquisition by nonmember institution

             (1       

Termination of membership(1)

   2      12      2        20   

Repurchase of excess mandatorily redeemable capital stock

        (180            

Balance at the end of the period

   47    $ 4,690      34      $ 3,165   

 

     Six Months Ended  
     June 30, 2010     June 30, 2009  
     

Number of

Institutions

   Amount    

Number of

Institutions

   Amount  

Balance at the beginning of the period

   42    $ 4,843      30    $ 3,747   

Reclassified from/(to) capital during the period:

          

Merger with or acquisition by nonmember institution

   1                  

Termination of membership(1)

   4      30      4      36   

Acquired by/transferred to members(2)(3)

                  (618

Redemption of mandatorily redeemable capital stock

        (3          

Repurchase of excess mandatorily redeemable capital stock

        (180          

Balance at the end of the period

   47    $ 4,690      34    $ 3,165   

 

(1) For the three and six months ended June 30, 2010, the capital stock of three and six institutions, respectively, was reclassified to mandatorily redeemable capital stock as a result of termination of membership. Because the capital stock of one institution in the three-month period and two institutions in the six-month period was acquired by nonmembers that were already included in the table, those institutions are not included in the number of institutions listed, while the capital stock transferred to mandatorily redeemable capital stock is reflected in the table.

 

(2) During 2008, JPMorgan Chase Bank, National Association, a nonmember, assumed Washington Mutual Bank’s outstanding Bank advances and acquired the associated Bank capital stock. The Bank reclassified the capital stock transferred to JPMorgan Chase Bank, National Association, totaling $3,208, to mandatorily redeemable capital stock (a liability). JPMorgan Bank and Trust Company, National Association, an affiliate of JPMorgan Chase Bank, National Association, became a member of the Bank. During the first quarter of 2009, the Bank allowed the transfer of excess stock totaling $300 from JPMorgan Chase Bank, National Association, to JPMorgan Bank and Trust Company, National Association, to enable JPMorgan Bank and Trust Company, National Association, to satisfy its activity-based stock requirement. The capital stock transferred is no longer classified as mandatorily redeemable capital stock (a liability). However, the capital stock remaining with JPMorgan Chase Bank, National Association, remains classified as mandatorily redeemable capital stock (a liability).

 

(3) On March 19, 2009, OneWest Bank, FSB, became a member of the Bank, assumed the outstanding advances of IndyMac Federal Bank, FSB, a nonmember, and acquired the associated Bank capital stock totaling $318. Bank capital stock acquired by OneWest Bank, FSB, is no longer classified as mandatorily redeemable capital stock (a liability). However, the capital stock remaining with IndyMac Federal Bank, FSB, remains classified as mandatorily redeemable capital stock (a liability).

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Cash dividends on mandatorily redeemable capital stock in the amount of $3 and $6 were recorded as interest expense for the three and six months ended June 30, 2010. There were no dividends on mandatorily redeemable capital stock recorded as interest expense for the three and six months ended June 30, 2009.

The Bank’s mandatorily redeemable capital stock is discussed more fully in Note 13 to the Financial Statements in the Bank’s 2009 Form 10-K.

The following table presents mandatorily redeemable capital stock amounts by contractual redemption period at June 30, 2010, and December 31, 2009.

 

Contractual Redemption Period    June 30, 2010    December 31, 2009

Within 1 year

   $ 29    $ 3

After 1 year through 2 years

     41      63

After 2 years through 3 years

     81      91

After 3 years through 4 years

     2,878      2,955

After 4 years through 5 years

     1,661      1,731

Total

   $ 4,690    $ 4,843

Retained Earnings and Dividend Policy. The Bank’s Retained Earnings and Dividend Policy establishes amounts to be retained in restricted retained earnings, which are not made available for dividends in the current dividend period.

Retained Earnings Related to Valuation Adjustments – In accordance with the Retained Earnings and Dividend Policy, the Bank retains in restricted retained earnings any cumulative net gains in earnings (net of applicable assessments) resulting from gains or losses on derivatives and associated hedged items and financial instruments carried at fair value (valuation adjustments). As the cumulative net gains are reversed by periodic net losses and settlements of contractual interest cash flows, the amount of cumulative net gains decreases. The amount of retained earnings required by this provision of the policy is therefore decreased, and that portion of the previously restricted retained earnings becomes unrestricted and may be made available for dividends. Retained earnings restricted in accordance with these provisions totaled $79 at June 30, 2010, and $181 at December 31, 2009. In accordance with this provision, the amount decreased by $102 in the first six months of 2010 as a result of net unrealized losses resulting from valuation adjustments during this period.

Other Retained Earnings–Targeted Buildup – In addition to any cumulative net gains resulting from valuation adjustments, the Bank holds an additional amount in restricted retained earnings intended to protect members’ paid-in capital from the effects of an extremely adverse credit event, an extremely adverse operations risk event, an extremely high level of quarterly losses related to the Bank’s derivatives and associated hedged items and financial instruments carried at fair value, and the risk of higher-than-anticipated OTTI related to credit loss on PLRMBS, especially in periods of extremely low net income resulting from an adverse interest rate environment.

The Board of Directors has set the targeted amount of restricted retained earnings at $1,800. The retained earnings restricted in accordance with this provision of the Retained Earnings and Dividend Policy totaled $1,271 at June 30, 2010, and $1,058 at December 31, 2009.

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

For more information on these two categories of restricted retained earnings and the Bank’s Retained Earnings and Dividend Policy, see Note 13 to the Financial Statements in the Bank’s 2009 Form 10-K.

Dividend Payments – Finance Agency rules state that FHLBanks may declare and pay dividends only from previously retained earnings or current net earnings, and may not declare or pay dividends based on projected or anticipated earnings. There is no requirement that the Board of Directors declare and pay any dividend. A decision by the Board of Directors to declare a dividend is a discretionary matter and is subject to the requirements and restrictions of the FHLBank Act and applicable requirements under the regulations governing the operations of the FHLBanks.

On July 29, 2010, the Bank’s Board of Directors declared a cash dividend for the second quarter of 2010 at an annualized dividend rate of 0.44%. The Bank recorded the second quarter dividend on July 29, 2010, the day it was declared by the Board of Directors. The Bank expects to pay the second quarter dividend (including dividends on mandatorily redeemable capital stock), which will total $14, on or about August 12, 2010. On April 29, 2010, the Bank’s Board of Directors declared a cash dividend for the first quarter of 2010 at an annualized rate of 0.26%. The Bank recorded the first quarter dividend during the second quarter of 2010. The total amount of the dividend was $9 and was recorded and paid during the second quarter of 2010. On July 30, 2009, the Bank’s Board of Directors declared a cash dividend for the second quarter of 2009 at an annualized rate of 0.84%. The total amount of the dividend was $28 and was recorded and paid during the third quarter of 2009.

The Bank expects to pay the second quarter 2010 dividend in cash rather than stock form to comply with Finance Agency rules, which do not permit the Bank to pay dividends in the form of capital stock if the Bank’s excess stock (defined as any stock holdings in excess of a member’s minimum capital stock requirement, as established by the Bank’s capital plan) exceeds 1% of its total assets. As of June 30, 2010, the Bank’s excess capital stock totaled $7,654, or 4.84% of total assets.

The Bank will continue to monitor the condition of its PLRMBS portfolio, its overall financial performance and retained earnings, developments in the mortgage and credit markets, and other relevant information as the basis for determining the status of dividends in future quarters.

Excess and Surplus Capital Stock. The Bank may repurchase some or all of a member’s excess capital stock and any excess mandatorily redeemable capital stock, at the Bank’s discretion and subject to certain statutory and regulatory requirements. The Bank must give the member 15 days’ written notice; however, the member may waive this notice period. The Bank may also repurchase some or all of a member’s excess capital stock at the member’s request, at the Bank’s discretion and subject to certain statutory and regulatory requirements. Excess capital stock is defined as any stock holdings in excess of a member’s minimum capital stock requirement, as established by the Bank’s capital plan.

The Bank’s surplus capital stock repurchase policy provides for the Bank to repurchase excess stock that constitutes surplus stock, at the Bank’s discretion and subject to certain statutory and regulatory requirements, if a member has surplus capital stock as of the last business day of the quarter. A member’s surplus capital stock is defined as any stock holdings in excess of 115% of the member’s minimum capital stock requirement, generally excluding stock dividends earned and credited for the current year.

On a quarterly basis, the Bank determines whether it will repurchase excess capital stock, including surplus capital stock. The Bank did not repurchase excess stock in 2009 and in the first quarter of 2010 to preserve the Bank’s capital.

In the second quarter of 2010, the Bank repurchased excess capital stock totaling $487. The amount of excess capital stock repurchased from any shareholder was based on the shareholder’s pro rata ownership share of total capital stock outstanding as of the repurchase date, up to the amount of the shareholder’s excess capital stock.

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

On July 29, 2010, the Bank announced that it plans to repurchase up to $500 in excess capital stock on August 13, 2010. The amount of excess capital stock to be repurchased from any shareholder will be based on the shareholder’s pro rata ownership share of total capital stock outstanding as of the repurchase date, up to the amount of the shareholder’s excess capital stock.

The Bank will continue to monitor the condition of its PLRMBS portfolio, its overall financial performance and retained earnings, developments in the mortgage and credit markets, and other relevant information as the basis for determining the status of capital stock repurchases in future quarters.

Excess capital stock totaled $7,654 as of June 30, 2010, which included surplus capital stock of $7,138.

For more information on excess and surplus capital stock, see Note 13 to the Financial Statements in the Bank’s 2009 Form 10-K.

Concentration. The following table presents the concentration in capital stock held by institutions whose capital stock ownership represented 10% or more of the Bank’s outstanding capital stock, including mandatorily redeemable capital stock, as of June 30, 2010, and December 31, 2009.

Concentration of Capital Stock

Including Mandatorily Redeemable Capital Stock

 

     June 30, 2010     December 31, 2009  
Name of Institution   

Capital Stock

Outstanding

  

Percentage

of Total

Capital Stock

Outstanding

   

Capital Stock

Outstanding

  

Percentage

of Total

Capital Stock

Outstanding

 

Citibank, N.A.

   $ 3,732    29   $ 3,877    29

JPMorgan Chase Bank, National Association(1)

     2,595    20        2,695    20   

Wells Fargo Bank, N.A.(1)

     1,509    12        1,567    12   

Subtotal

     7,836    61        8,139    61   

Others(2)

     5,134    39        5,279    39   

Total

   $ 12,970    100   $ 13,418    100

 

(1) The capital stock held by these institutions is classified as mandatorily redeemable capital stock.
(2) Includes capital stock totaling $289 and $300 held by JPMorgan Bank and Trust Company, National Association, an affiliate of JPMorgan Chase Bank, National Association, at June 30, 2010, and December 31, 2009, respectively.

Note 10 – Segment Information

The Bank uses an analysis of financial performance based on the balances and adjusted net interest income of two operating segments, the advances-related business and the mortgage-related business, as well as other financial information, to review and assess financial performance and to determine the allocation of resources to these two major business segments. For purposes of segment reporting, adjusted net interest income includes interest income and expense associated with economic hedges that are recorded in “Net (loss)/gain on derivatives and hedging activities” in other income and excludes interest expense that is recorded in “Mandatorily redeemable capital stock.” Other key financial information, such as any OTTI loss on the Bank’s held-to-maturity PLRMBS, other expenses, and assessments, are not included in the segment reporting analysis, but are incorporated into management’s overall assessment of financial performance.

For more information on these operating segments, see Note 15 to the Financial Statements in the Bank’s 2009 Form 10-K.

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

The following table presents the Bank’s adjusted net interest income by operating segment and reconciles total adjusted net interest income to income before assessments for the three and six months ended June 30, 2010 and 2009.

Reconciliation of Adjusted Net Interest Income and Income Before Assessments

 

     

Advances-

Related

Business

  

Mortgage-

Related

Business(1)

  

Adjusted

Net

Interest

Income

  

Amortization of

Deferred

Losses(2)

   

Net Interest

Expense on

Economic

Hedges(3)

   

Interest

Expense on

Mandatorily

Redeemable

Capital

Stock(4)

  

Net

Interest

Income

  

Other

Loss

   

Other

Expense

  

Income

Before

Assessments

Three months ended:

                          

June 30, 2010

   $ 145    $ 154    $ 299    $ (22   $ (43   $ 3    $ 361    $ (285   $ 35    $ 41

June 30, 2009

     189      118      307      (36     (140          483      (39     31      413

Six months ended:

                          

June 30, 2010

   $ 283    $ 292    $ 575    $ (42   $ (107   $ 6    $ 718    $ (480   $ 71    $ 167

June 30, 2009

     393      254      647      (45     (225          917      (275     62      580

 

(1) Does not include credit-related OTTI charges of $142 and $88 for the three months ended June 30, 2010 and 2009, respectively. Does not include credit-related OTTI charges of $202 and $176 for the six months ended June 30, 2010 and 2009, respectively.

 

(2) Represents amortization of amounts deferred for adjusted net interest income purposes only in accordance with the Bank’s Retained Earnings and Dividend Policy.

 

(3) The Bank includes interest income and interest expense associated with economic hedges in adjusted net interest income in its analysis of financial performance for its two operating segments. For financial reporting purposes, the Bank does not include these amounts in net interest income in the Statements of Income, but instead records them in other income in “Net (loss)/gain on derivatives and hedging activities.”

 

(4) The Bank excludes interest expense on mandatorily redeemable capital stock from adjusted net interest income in its analysis of financial performance for its two operating segments.

The following table presents total assets by operating segment at June 30, 2010, and December 31, 2009.

Total Assets

 

     

Advances-

Related Business

  

Mortgage-

Related Business

  

Total

Assets

June 30, 2010

   $ 131,666    $ 26,532    $ 158,198

December 31, 2009

     161,406      31,456      192,862

Note 11 – Derivatives and Hedging Activities

General. The Bank may enter into interest rate swaps (including callable, putable, and basis swaps); swaptions; and cap, floor, corridor, and collar agreements (collectively, interest rate exchange agreements or derivatives). Most of the Bank’s interest rate exchange agreements are executed in conjunction with the origination of advances and the issuance of consolidated obligation bonds to create variable rate structures. The interest rate exchange agreements are generally executed at the same time the advances and bonds are transacted and generally have the same maturity dates as the related advances and bonds.

Additional active uses of interest rate exchange agreements include: (i) offsetting interest rate caps, floors, corridors, or collars embedded in adjustable rate advances made to members, (ii) hedging the anticipated issuance of debt, (iii) matching against consolidated obligation discount notes or bonds to create the equivalent of callable fixed rate debt, (iv) modifying the repricing intervals between variable rate assets and variable rate liabilities, and (v) exactly offsetting other derivatives executed with members (with the Bank serving as an intermediary). The Bank’s use of interest rate exchange agreements results in one of the following classifications: (i) a fair value hedge of an underlying financial instrument, (ii) a forecasted transaction, (iii) a cash flow hedge of an underlying financial instrument, (iv) an economic hedge for specific asset and liability management purposes, or (v) an intermediary transaction for members.

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Interest Rate Swaps – An interest rate swap is an agreement between two entities to exchange cash flows in the future. The agreement sets the dates on which the cash flows will be paid and the manner in which the cash flows will be calculated. One of the simplest forms of an interest rate swap involves the promise by one party to pay cash flows equivalent to the interest on a notional principal amount at a predetermined fixed rate for a given period of time. In return for this promise, the 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 or paid by the Bank in most interest rate exchange agreements is the London Inter-Bank Offered Rate (LIBOR).

Swaptions – A swaption is an option on a swap that gives the buyer the right to enter into a specified interest rate swap at a certain time in the future. When used as a hedge, a swaption can protect the Bank against future interest rate changes when it is planning to lend or borrow funds in the future. The Bank purchases receiver swaptions. A receiver swaption is the option to receive fixed interest rate payments at a later date.

Interest Rate Caps and Floors – In a cap agreement, a cash flow is generated if the price or rate of an underlying variable rate rises above a certain threshold (or cap) price. In a floor agreement, a cash flow is generated if the price or rate of an underlying variable rate falls below a certain threshold (or floor) price. Caps may be used in conjunction with liabilities and floors may be used in conjunction with assets. Caps and floors are designed as protection against the interest rate on a variable rate asset or liability rising above or falling below a certain level.

Hedging Activities. The Bank documents all relationships between derivative hedging instruments and hedged items, its risk management objectives and strategies for undertaking various hedge transactions, and its method of assessing effectiveness. This process includes linking all derivatives that are designated as fair value or cash flow hedges to (i) assets and liabilities on the balance sheet, (ii) firm commitments, or (iii) forecasted transactions. The Bank also formally assesses (both at the hedge’s inception and at least quarterly on an ongoing basis) whether the derivatives that are used in hedging transactions have been effective in offsetting changes in the fair value or cash flows of hedged items and whether those derivatives may be expected to remain effective in future periods. The Bank typically uses regression analyses or other statistical analyses to assess the effectiveness of its hedges. When it is determined that a derivative has not been or is not expected to be effective as a hedge, the Bank discontinues hedge accounting prospectively.

The Bank discontinues hedge accounting prospectively when (i) it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item (including hedged items such as firm commitments or forecasted transactions); (ii) the derivative and/or the hedged item expires or is sold, terminated, or exercised; (iii) it is no longer probable that the forecasted transaction will occur in the originally expected period; (iv) a hedged firm commitment no longer meets the definition of a firm commitment; (v) management determines that designating the derivative as a hedging instrument is no longer appropriate; or (vi) management decides to use the derivative to offset changes in the fair value of other derivatives or instruments carried at fair value.

Intermediation – As an additional service to its members, the Bank enters into offsetting interest rate exchange agreements, acting as an intermediary between exactly offsetting derivatives transactions with members and other counterparties. This intermediation allows members indirect access to the derivatives market.

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Derivatives in which the Bank is an intermediary may also arise when the Bank enters into derivatives to offset the economic effect of other derivatives that are no longer designated to advances, investments, or consolidated obligations. The offsetting derivatives used in intermediary activities do not receive hedge accounting treatment and are separately marked to market through earnings. The net result of the accounting for these derivatives does not significantly affect the operating results of the Bank. These amounts are recorded in other income and presented as “Net (loss)/gain on derivatives and hedging activities.”

The notional principal of the interest rate exchange agreements associated with derivatives with members and offsetting derivatives with other counterparties was $920 at June 30, 2010, and $616 at December 31, 2009. The Bank did not have any interest rate exchange agreements outstanding at June 30, 2010, and December 31, 2009, that were used to offset the economic effect of other derivatives that were no longer designated to advances, investments, or consolidated obligations.

Investments – The Bank may invest in U.S. Treasury and agency obligations, MBS rated AAA at the time of acquisition, and the taxable portion of highly rated state or local housing finance agency obligations. The interest rate and prepayment risk associated with these investment securities is managed through a combination of debt issuance and derivatives. The Bank may manage prepayment risk and interest rate risk by funding investment securities with consolidated obligations that have call features or by hedging the prepayment risk with a combination of consolidated obligations and callable swaps or swaptions. The Bank executes callable swaps and purchases swaptions in conjunction with the issuance of certain liabilities to create funding equivalent to fixed rate callable debt. Although these derivatives are economic hedges against prepayment risk and are designated to individual liabilities, they do not receive either fair value or cash flow hedge accounting treatment. The derivatives are marked to market through earnings and provide modest income volatility. Investment securities may be classified as trading or held-to-maturity.

The Bank may also manage the risk arising from changing market prices or cash flows of investment securities classified as trading by entering into interest rate exchange agreements (economic hedges) that offset the changes in fair value or cash flows of the securities. The market value changes of both the trading securities and the associated interest rate exchange agreements are included in other income in the Statements of Income.

Advances – The Bank offers a wide array of advance structures to meet members’ funding needs. These advances may have maturities up to 30 years with fixed or adjustable rates and may include early termination features or options. The Bank may use derivatives to adjust the repricing and/or options characteristics of advances to more closely match the characteristics of the Bank’s funding liabilities. In general, whenever a member executes a fixed rate advance or a variable rate advance with embedded options, the Bank will simultaneously execute an interest rate exchange agreement with terms that offset the terms and embedded options, if any, in the advance. The combination of the advance and the interest rate exchange agreement effectively creates a variable rate asset. This type of hedge is treated as a fair value hedge.

Mortgage Loans – The Bank’s investment portfolio includes 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 Bank manages the interest rate risk and prepayment risk associated with fixed rate mortgage loans through a combination of debt issuance and derivatives. The Bank uses both callable and non-callable debt to achieve cash flow patterns and market value sensitivities for liabilities similar to those expected on the mortgage loans. Net income could be reduced if the Bank replaces prepaid mortgages with lower-yielding assets and the Bank’s higher funding costs are not reduced accordingly.

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

The Bank executes callable swaps and purchases swaptions in conjunction with the issuance of certain consolidated obligations to create funding equivalent to fixed rate callable bonds. Although these derivatives are economic hedges against the prepayment risk of specific loan pools and are referenced to individual liabilities, they do not receive either fair value or cash flow hedge accounting treatment. The derivatives are marked to market through earnings and are presented as “Net (loss)/gain on derivatives and hedging activities.”

Consolidated Obligations – Although the joint and several liability regulation authorizes the Finance Agency to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor, FHLBanks individually are counterparties to interest rate exchange agreements associated with specific debt issues. The Office of Finance acts as agent of the FHLBanks in the debt issuance process. In connection with each debt issuance, each FHLBank specifies the terms and the amount of debt it requests to have issued on its behalf. The Office of Finance tracks the amount of debt issued on behalf of each FHLBank. In addition, the Bank separately tracks and records as a liability its specific portion of consolidated obligations and is the primary obligor for its specific portion of consolidated obligations issued. Because the Bank knows the amount of consolidated obligations issued on its behalf, it has the ability to structure hedging instruments to match its specific debt. The hedge transactions may be executed upon or after the issuance of consolidated obligations and are accounted for based on the accounting for derivative instruments and hedging activities.

Consolidated obligation bonds are structured to meet the Bank’s and/or investors’ needs. Common structures include fixed rate bonds with or without call options and adjustable rate bonds with or without embedded options. In general, when bonds with these structures are issued, the Bank will simultaneously execute an interest rate exchange agreement with terms that offset the terms and embedded options, if any, of the consolidated obligation bond. This combination of the consolidated obligation bond and the interest rate exchange agreement effectively creates an adjustable rate bond. The cost of this funding combination is generally lower than the cost that would be available through the issuance of just an adjustable rate bond. These transactions generally receive fair value hedge accounting treatment.

The Bank did not have any consolidated obligations denominated in currencies other than U.S. dollars outstanding during the six months ended June 30, 2010, or the twelve months ended December 31, 2009.

Firm Commitments – A firm commitment for a forward starting advance hedged through the use of an offsetting forward starting interest rate swap is considered a derivative. In this case, the interest rate swap functions as the hedging instrument for both the firm commitment and the subsequent advance. When the commitment is terminated and the advance is made, the current market value associated with the firm commitment is included with the basis of the advance. The basis adjustment is then amortized into interest income over the life of the advance.

Anticipated Debt Issuance – The Bank may enter into interest rate swaps for the anticipated issuances of fixed rate bonds to hedge the cost of funding. These hedges are designated and accounted for as cash flow hedges. The interest rate swap is terminated upon issuance of the fixed rate bond, with the effective portion of the realized gain or loss on the interest rate swap recorded in other comprehensive income. Realized gains and losses reported in AOCI are recognized as earnings in the periods in which earnings are affected by the cash flows of the fixed rate bonds.

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Credit Risk – The Bank is subject to credit risk as a result of the risk of nonperformance by counterparties to the derivative agreements. All of the Bank’s derivative agreements contain master netting provisions to help mitigate the credit risk exposure to each counterparty. The Bank manages counterparty credit risk through credit analyses and collateral requirements and by following the requirements of the Bank’s risk management policies and credit guidelines. Based on the master netting provisions in each agreement, credit analyses, and the collateral requirements in place with each counterparty, the Bank does not expect to incur any credit losses on derivative agreements.

The notional amount of an interest rate exchange agreement serves as a basis for calculating periodic interest payments or cash flows and is not a measure of the amount of credit risk from that transaction. The Bank had notional amounts outstanding of $197,969 and $235,014 at June 30, 2010, and December 31, 2009, respectively. The notional amount does not represent the exposure to credit loss. The amount potentially subject to credit loss is the estimated cost of replacing an interest rate exchange agreement that has a net positive market value if the counterparty defaults; this amount is substantially less than the notional amount.

Maximum credit risk is defined as the estimated cost of replacing all interest rate exchange agreements the Bank has transacted with counterparties where the Bank is in a net favorable position (has a net unrealized gain) if the counterparties all defaulted and the related collateral proved to be of no value to the Bank. At June 30, 2010, the Bank’s maximum credit risk, as defined above, was estimated at $1,847, including $347 of net accrued interest and fees receivable. At December 31, 2009, the Bank’s maximum credit risk was estimated at $1,827, including $399 of net accrued interest and fees receivable. Accrued interest and fees receivable and payable and the legal right to offset assets and liabilities by counterparty (under which amounts recognized for individual transactions may be offset against amounts recognized for other derivatives transactions with the same counterparty) are considered in determining the maximum credit risk. The Bank held cash, investment grade securities, and mortgage loans valued at $1,839 and $1,868 as collateral from counterparties as of June 30, 2010, and December 31, 2009, respectively. This collateral has not been sold or repledged. A significant number of the Bank’s interest rate exchange agreements are transacted with financial institutions such as major banks and highly rated derivatives dealers. Some of these financial institutions or their broker-dealer affiliates buy, sell, and distribute consolidated obligations. Assets pledged as collateral by the Bank to these counterparties are more fully discussed in Note 13 to the Financial Statements.

Certain of the Bank’s derivatives agreements contain provisions that link the Bank’s credit rating from each of the major credit rating agencies to various rights and obligations. In several of the Bank’s derivatives agreements, if the Bank’s debt rating falls below A, the Bank’s counterparty would have the right, but not the obligation, to terminate all of its outstanding derivatives transactions with the Bank. In addition, the amount of collateral that the Bank is required to deliver to a counterparty depends on the Bank’s credit rating. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a net derivative liability position (before cash collateral and related accrued interest) at June 30, 2010, was $160, for which the Bank had posted collateral of $77 in the normal course of business. If the credit rating of the Bank’s debt had been lowered to AAA/Aa, then the Bank would have been required to deliver up to an additional $50 of collateral (at fair value) to its derivatives counterparties at June 30, 2010. At June 30, 2010, the Bank’s credit ratings continued to be AAA/Aaa.

The following table summarizes the fair value of derivative instruments without the effect of netting arrangements or collateral as of June 30, 2010, and December 31, 2009. For purposes of this disclosure, the derivatives values include the fair value of derivatives and related accrued interest.

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Fair Values of Derivative Instruments

 

     June 30, 2010     December 31, 2009  
     Notional
Amount  of
Derivatives
   Derivative
Assets
    Derivative
Liabilities
    Notional
Amount  of
Derivatives
   Derivative
Assets
    Derivative
Liabilities
 

Derivatives designated as hedging instruments:

              

Interest rate swaps

   $ 94,316    $ 2,382      $ 555      $ 104,211    $ 2,476      $ 699   
                

Total

     94,316      2,382        555        104,211      2,476        699   
                

Derivatives not designated as hedging instruments:

              

Interest rate swaps

     101,652      554        679        129,108      684        756   

Interest rate caps, floors, corridors, and/or collars

     2,001      13        23        1,695      16        22   
                

Total

     103,653      567        702        130,803      700        778   
                

Total derivatives before netting and collateral adjustments

   $ 197,969      2,949        1,257      $ 235,014      3,176        1,477   
                      

Netting adjustments by counterparty

        (1,102     (1,102        (1,349     (1,349

Cash collateral and related accrued interest

        (1,371     18           (1,375     77   
                      

Total collateral and netting adjustments(1)

        (2,473     (1,084        (2,724     (1,272
                      

Derivative assets and derivative liabilities as reported on the Statements of Condition

      $ 476      $ 173         $ 452      $ 205   
                      

 

(1) Amounts represent the effect of legally enforceable master netting agreements that allow the Bank to settle positive and negative positions and also cash collateral held or placed with the same counterparty.

The following table presents the components of net (loss)/gain on derivatives and hedging activities as presented in the Statements of Income for the three and six months ended June 30, 2010 and 2009.

 

     Three Months Ended         Six Months Ended  
     June 30, 2010     June 30, 2009         June 30, 2010     June 30, 2009  
       Gain/(Loss)        Gain/(Loss)          Gain/(Loss)        Gain/(Loss)   

Derivatives and hedged items in fair value hedging relationships – hedge ineffectiveness by derivative type:

          

Interest rate swaps

   $ 1      $ 8          $ 5      $ 24   

Total net gain related to fair value hedge ineffectiveness

     1        8            5        24   

Derivatives not designated as hedging instruments:

          

Economic hedges:

          

Interest rate swaps

     (80     348          (54     449   

Interest rate caps, floors, corridors, and/or collars

     (1     8          (3     10   

Net interest settlements

     (43     (140         (107     (225

Total net (loss)/gain related to derivatives not designated as hedging instruments

     (124     216            (164     234   

Net (loss)/gain on derivatives and hedging activities

   $ (123   $ 224          $ (159   $ 258   

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

The following table presents, by type of hedged item, the gains and losses on derivatives and the related hedged items in fair value hedging relationships and the impact of those derivatives on the Bank’s net interest income for the three and six months ended June 30, 2010 and 2009.

 

     Three Months Ended  
     June 30, 2010     June 30, 2009  
Hedged Item Type   

Gain/

(Loss) on
Derivative

   

Gain/

(Loss) on
Hedged
Item

   

Net Fair

Value Hedge
Ineffectiveness

  

Effect of
Derivatives

on Net

Interest

Income(1)

   

Gain/

(Loss) on

Derivative

   

Gain/

(Loss) on
Hedged

Item

   

Net Fair

Value Hedge
Ineffectiveness

  

Effect of
Derivatives

on Net

Interest
Income(1)

 
   

Advances

   $ (2   $ 3      $ 1    $ (143   $ 261      $ (253   $ 8    $ (237

Consolidated obligation bonds

     31        (31          468        (772     772             532   
   

Total

   $ 29      $ (28   $ 1    $ 325      $ (511   $ 519      $ 8    $ 295   
   

 

     Six Months Ended  
     June 30, 2010     June 30, 2009  
Hedged Item Type   

Gain/

(Loss) on
Derivative

  

Gain/

(Loss) on
Hedged
Item

   

Net Fair

Value Hedge
Ineffectiveness

  

Effect of
Derivatives

on Net

Interest

Income(1)

   

Gain/

(Loss) on

Derivative

   

Gain/

(Loss) on
Hedged

Item

   

Net Fair

Value Hedge
Ineffectiveness

   

Effect of
Derivatives

on Net

Interest
Income(1)

 
   

Advances

   $ 36    $ (36   $    $ (311   $ 393      $ (421   $ (28   $ (428

Consolidated obligation bonds

     39      (34     5      979        (1,175     1,227        52        1,022   
   

Total

   $ 75    $ (70   $ 5    $ 668      $ (782   $ 806      $ 24      $ 594   
   

 

(1) The net interest on derivatives in fair value hedge relationships is presented in the interest income/expense line item of the respective hedged item.

For the three and six months ended June 30, 2010 and 2009, there were no reclassifications from other comprehensive income/(loss) into earnings as a result of the discontinuance of cash flow hedges because the original forecasted transactions occurred by the end of the originally specified time period or within a two-month period thereafter.

As of June 30, 2010, the amount of unrecognized net losses on derivative instruments accumulated in other comprehensive income expected to be reclassified to earnings during the next 12 months was immaterial. The maximum length of time over which the Bank is hedging its exposure to the variability in future cash flows for forecasted transactions, excluding those forecasted transactions related to the payment of variable interest on existing financial instruments, is less than three months.

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

The following table presents outstanding notional balances and estimated fair values of the derivatives outstanding at June 30, 2010, and December 31, 2009.

 

     June 30, 2010     December 31, 2009  
Type of Derivative and Hedge Classification    Notional
Amount of
Derivatives
   Estimated
Fair Value
    Notional
Amount of
Derivatives
   Estimated
Fair Value
 
   

Interest rate swaps:

          

Fair value

   $ 94,316    $ 1,479      $ 104,211    $ 1,392   

Economic

     101,652      (120     129,108      (78

Interest rate caps, floors, corridors, and/or collars:

          

Economic

     2,001      (10     1,695      (6
   

Total

   $ 197,969    $ 1,349      $ 235,014    $ 1,308   
   

Total derivatives excluding accrued interest

      $ 1,349         $ 1,308   

Accrued interest, net

        343           391   

Cash collateral held from counterparties – liabilities(1)

        (1,389        (1,452
   

Net derivative balances

      $ 303         $ 247   
   

Derivative assets

      $ 476         $ 452   

Derivative liabilities

        (173        (205
   

Net derivative balances

      $ 303         $ 247   
   

 

(1) Amounts represent the amount receivable or payable related to cash collateral arising from derivative instruments recognized at fair value executed with the same counterparty under a master netting arrangement.

Embedded derivatives are bifurcated, and their estimated fair values are accounted for in accordance with the accounting for derivative instruments and hedging activities. The estimated fair values of the embedded derivatives are included as valuation adjustments to the host contract and are not included in the table above. The estimated fair values of these embedded derivatives were immaterial as of June 30, 2010, and December 31, 2009.

Note 12 – Fair Values

The following fair value amounts have been determined by the Bank using available market information and the Bank’s best judgment of appropriate valuation methods. These estimates are based on pertinent information available to the Bank at June 30, 2010, and December 31, 2009. Although the Bank uses its best judgment in estimating the fair value of these financial instruments, there are inherent limitations in any estimation technique or valuation methodology. For example, because an active secondary market does not exist for a portion of the Bank’s financial instruments, in certain cases fair values are not subject to precise quantification or verification and may change as economic and market factors and evaluation of those factors change. Therefore, these fair values are not necessarily indicative of the amounts that would be realized in current market transactions, although they do reflect the Bank’s judgment of how a market participant would estimate the fair values. The fair value summary table does not represent an estimate of the overall market value of the Bank as a going concern, which would take into account future business opportunities and the net profitability of total assets and liabilities on a combined basis.

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Fair Value of Financial Instruments

 

     June 30, 2010    December 31, 2009
     Carrying
Value
   Estimated
Fair Value
   Carrying
Value
   Estimated
Fair Value
 

Assets

           

Cash and due from banks

   $ 7,631    $ 7,631    $ 8,280    $ 8,280

Federal funds sold

     14,470      14,470      8,164      8,164

Trading securities

     1,159      1,159      31      31

Available-for-sale securities

     1,932      1,932      1,931      1,931

Held-to-maturity securities

     33,563      33,503      36,880      35,682

Advances (includes $12,819 and $21,616 at fair value under the fair value option, respectively)

     95,747      96,111      133,559      133,778

Mortgage loans held for portfolio, net of allowance for
credit losses on mortgage loans

     2,788      2,954      3,037      3,117

Loans to other FHLBanks

     15      15          

Accrued interest receivable

     251      251      355      355

Derivative assets(1)

     476      476      452      452

Liabilities

           

Deposits

     178      178      224      224

Consolidated obligations:

           

Bonds (includes $21,148 and $37,022 at fair value under the fair value option, respectively)

     129,524      130,061      162,053      162,220

Discount notes

     15,788      15,789      18,246      18,254

Mandatorily redeemable capital stock

     4,690      4,690      4,843      4,843

Accrued interest payable

     616      616      754      754

Derivative liabilities(1)

     173      173      205      205

Other

           

Standby letters of credit

     29      29      27      27

 

(1) Amounts include the netting of derivative assets and liabilities by counterparty, including cash collateral, where the Bank has the legal right to do so under its master netting agreement with each counterparty.

Fair Value Methodologies and Techniques and Significant Inputs. The valuation methodologies and techniques and significant inputs used in estimating the fair values of the Bank’s financial instruments are discussed below.

Cash and Due from Banks – The estimated fair value approximates the recorded carrying value.

Federal Funds Sold – The estimated fair value of overnight Federal funds sold approximates the recorded carrying value. The estimated fair value of term Federal funds sold has been determined by calculating the present value of expected cash flows for the instruments excluding accrued interest. The discount rates used in these calculations are the replacement rates for comparable instruments with similar terms.

Investment Securities – Non-MBS – The estimated fair value of non-MBS investments is determined (i) based on each security’s quoted price; (ii) based on prices obtained from pricing services, excluding accrued interest, as of the last business day of the period; or, (iii) when quoted prices are not available, by calculating the present value of expected cash flows, excluding accrued interest, using market-observable inputs as of the last business day of the period or using industry standard analytical models and certain actual and estimated market information. The discount rates used in these calculations are the replacement rates for comparable instruments with similar terms. Non-MBS investments classified as trading or available-for-sale are recorded at fair value on a recurring basis.

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Investment Securities – MBS – During 2009, in an effort to achieve consistency among all the FHLBanks in applying a fair value methodology to their MBS investments, the FHLBanks formed the MBS Pricing Governance Committee with the responsibility for developing a fair value methodology that all FHLBanks could adopt. Under the methodology approved by the MBS Pricing Governance Committee and adopted by the Bank, the Bank requests prices for all MBS from four specific third-party vendors, when available. These pricing vendors use methods that generally employ, but are not limited to, benchmark yields, recent trades, dealer estimates, valuation models, benchmarking of like securities, sector groupings, and/or matrix pricing. The Bank establishes a price for each of its MBS using a formula that is based on the number of prices received. If four prices are received, the average of the two middle prices is used; if three prices are received, the middle price is used; if two prices are received, the average of the two prices is used; and if one price is received, it is used subject to validation as described below. The computed prices are tested for reasonableness based on differences among pricing vendors using specified tolerance thresholds. Prices within the established thresholds are generally accepted unless strong evidence suggests that using the formula-driven price would not be appropriate. Preliminary estimated fair values that are outside the tolerance thresholds, or that management believes may not be appropriate based on all available information (including those limited instances in which only one price is received), are subject to further analysis, including but not limited to a price challenge of pricing vendors, a comparison to the prices for similar securities and/or to non-binding dealer estimates, or use of an internal model that is deemed most appropriate after consideration of all relevant facts and circumstances that a market participant would consider. The relative proximity of the vendor prices for each MBS, as defined by the tolerance thresholds, supports the Bank’s conclusion that the final assigned prices are reasonable estimates of fair value. MBS investments classified as trading are recorded at fair value on a recurring basis.

Advances – Because quoted prices are not available for advances, the fair values are measured using model-based valuation techniques (such as the present value of future cash flows excluding the amount of the accrued interest receivable), creditworthiness of members, advance collateral types, prepayment assumptions, and other factors, such as credit loss assumptions, as necessary.

Because no principal market exists for the sale of advances, the Bank has defined the most advantageous market as a hypothetical market in which an advance sale could occur with a hypothetical financial institution. The Bank’s primary inputs for measuring the fair value of advances are market-based consolidated obligation yield curve (CO Curve) inputs obtained from the Office of Finance and provided to the Bank. The Bank prices advances using the CO Curve because it represents the Bank’s cost of funds. The CO Curve is then adjusted to reflect the rates on replacement advances with similar terms and collateral. These spread adjustments are not market-observable and are evaluated for significance in the overall fair value measurement and the fair value hierarchy level of the advance. As of June 30, 2010, the spread adjustment to the CO Curve ranged from 5 to 13 basis points for advances carried at fair value. The Bank obtains market-observable inputs from derivatives dealers for complex advances. These inputs may include volatility assumptions, which are market-based expectations of future interest rate volatility implied from current market prices for similar options (swaptions volatilities). The discount rates used in these calculations are the replacement advance rates for advances with similar terms. Pursuant to the Finance Agency’s advances regulation, advances with an original term to maturity or repricing period greater than six months generally require a prepayment fee sufficient to make the Bank financially indifferent to the borrower’s decision to prepay the advances, and the Bank determined that no adjustment is required to the fair value measurement of advances for prepayment fees.

Mortgage Loans Held for Portfolio – The estimated fair value for mortgage loans represents modeled prices based on observable market spreads for agency passthrough MBS adjusted for differences in credit, coupon, average loan rate, and seasoning. Market prices are highly dependent on the underlying prepayment assumptions. Changes in the prepayment speeds often have a material effect on the fair value estimates. These underlying prepayment assumptions are susceptible to material changes in the near term because they are made at a specific point in time.

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Loans to Other FHLBanks – Because these are overnight transactions, the estimated fair value approximates the recorded carrying value.

Accrued Interest Receivable and Payable – The estimated fair value approximates the recorded carrying value of accrued interest receivable and accrued interest payable.

Derivative Assets and Liabilities – In general, derivative instruments held by the Bank for risk management activities are traded in over-the-counter markets where quoted market prices are not readily available. These derivatives are interest-rate related. For these derivatives, the Bank measures fair value using internally developed discounted cash flow models that use primarily market-observable inputs, such as the LIBOR swap yield curve, option volatilities adjusted for counterparty credit risk, as necessary, and prepayment assumptions.

The Bank is subject to credit risk in derivatives transactions due to potential nonperformance by the derivatives counterparties. To mitigate this risk, the Bank only executes transactions with highly rated derivatives dealers and major banks (derivatives dealer counterparties) that meet the Bank’s eligibility criteria. In addition, the Bank has entered into master netting agreements and bilateral security agreements with all active derivatives dealer counterparties that provide for delivery of collateral at specified levels tied to counterparty credit ratings to limit the Bank’s net unsecured credit exposure to these counterparties. Under these policies and agreements, the amount of unsecured credit exposure to an individual derivatives dealer counterparty is limited to the lesser of (i) a percentage of the counterparty’s capital or (ii) an absolute dollar credit exposure limit, both according to the counterparty’s credit rating, as determined by rating agency long-term credit ratings of the counterparty’s debt securities or deposits. All credit exposure from derivatives transactions entered into by the Bank with member counterparties that are not derivatives dealers must be fully secured by eligible collateral. The Bank evaluated the potential for the fair value of the instruments to be affected by counterparty credit risk and determined that no adjustments to the overall fair value measurements were required.

Deposits and Other Borrowings – For deposits and other borrowings, the estimated fair value has been determined by calculating the present value of expected future cash flows from the deposits and other borrowings excluding accrued interest. The discount rates used in these calculations are the cost of deposits and borrowings with similar terms.

Consolidated Obligations – Because quoted prices in active markets are not generally available for identical liabilities, the Bank measures fair values using internally developed models that use primarily market-observable inputs. The Bank’s primary inputs for measuring the fair value of consolidated obligation bonds are market-based CO Curve inputs obtained from the Office of Finance and provided to the Bank. The Office of Finance constructs a market observable curve, referred to as the CO Curve, using the Treasury yield curve as a base curve, which may be adjusted by indicative spreads obtained from market observable sources. These market indications are generally derived from pricing indications from dealers, historical pricing relationships, market activity for similar liabilities such as recent GSE trades or secondary market activity. For consolidated obligation bonds with embedded options, the Bank also obtains market-observable quotes and inputs from derivatives dealers. The Bank uses these swaption volatilities as significant inputs for measuring the fair value of consolidated obligations.

Adjustments may be necessary to reflect the Bank’s credit quality or the credit quality of the FHLBank System when valuing consolidated obligation bonds measured at fair value. The Bank monitors its own creditworthiness, the creditworthiness of the other 11 FHLBanks, and the FHLBank System to determine whether any adjustments are necessary for creditworthiness in its fair value measurement of consolidated obligation bonds. The credit ratings of the FHLBank System and any changes to the credit ratings are the basis for the Bank to determine whether the fair values of consolidated obligations have been significantly affected during the reporting period by changes in the instrument-specific credit risk.

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Mandatorily Redeemable Capital Stock – The estimated fair value of capital stock subject to mandatory redemption is generally at par value as indicated by member contemporaneous purchases and sales at par value. Fair value includes estimated dividends earned at the time of reclassification from capital to liabilities, until such amount is paid, and any subsequently declared stock dividend. The Bank’s stock can only be acquired by members at par value and redeemed or repurchased at par value, subject to statutory and regulatory requirements. The Bank’s stock is not traded, and no market mechanism exists for the exchange of Bank stock outside the cooperative ownership structure.

Commitments – The estimated fair value of the Bank’s commitments to extend credit was immaterial at June 30, 2010, and December 31, 2009. The estimated fair value of standby letters of credit is based on the present value of fees currently charged for similar agreements. The value of the Bank’s standby letters of credit is recorded in other liabilities.

Subjectivity of Estimates Related to Fair Values of Financial Instruments. Estimates of the fair value of advances with embedded options, mortgage instruments, derivatives with embedded options, and consolidated obligation bonds with embedded options using the methods described below and other methods are highly subjective and require judgments regarding significant matters such as the amount and timing of future cash flows, prepayment speed assumptions, expected interest rate volatility, methods to determine possible distributions of future interest rates used to value options, and the selection of discount rates that appropriately reflect market and credit risks. Changes in these judgments often have a material effect on the fair value estimates. Since these estimates are made as of a specific date, they are susceptible to material near term changes.

Fair Value Hierarchy. The fair value hierarchy is used to prioritize the fair value methodologies and valuation techniques as well as the inputs to the valuation techniques used to measure fair value for assets and liabilities carried at fair value on the Statements of Condition. The inputs are evaluated and an overall level for the fair value measurement is determined. This overall level is an indication of market observability of the fair value measurement for the asset or liability. The fair value hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are as follows:

 

   

Level 1 – Inputs to the valuation methodology are quoted prices for identical assets or liabilities in active markets. An active market for the asset or liability is a market in which the transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.

 

   

Level 2 – Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

 

   

Level 3 – Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Unobservable inputs are supported by little or no market activity or by the Bank’s own assumptions.

A financial instrument’s categorization within the valuation hierarchy is based on the lowest level of input that is significant to the fair value measurement.

The following assets and liabilities, including those for which the Bank has elected the fair value option, are carried at fair value on the Statements of Condition as of June 30, 2010:

 

   

Trading securities

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

   

Available-for-sale securities

 

   

Certain advances

 

   

Derivative assets and liabilities

 

   

Certain consolidated obligation bonds

For instruments carried at fair value, the Bank 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 or out at fair value as of the beginning of the quarter in which the changes occur. For the periods presented, the Bank did not have any reclassifications for transfers in or out of the fair value hierarchy levels.

 

46


Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Fair Value on a Recurring Basis. These assets and liabilities are measured at fair value on a recurring basis and are summarized in the following table by fair value hierarchy (as described above).

June 30, 2010

 

     Fair Value Measurement Using:   

Netting

     
      Level 1    Level 2    Level 3    Adjustments(1)     Total

Assets:

             

Trading securities:

             

GSEs:

             

FFCB bonds

   $    $ 1,132    $    $      $ 1,132

MBS:

             

Other U.S. obligations:

             

Ginnie Mae

          21                  21

GSEs:

             

Fannie Mae

          6                  6

Total trading securities

          1,159                  1,159

Available-for-sale securities (TLGP)

          1,932                  1,932

Advances(2)

          13,829                  13,829

Derivative assets (interest-rate related)

          2,949           (2,473     476

Total assets

   $    $ 19,869    $    $ (2,473   $ 17,396

Liabilities:

             

Consolidated obligation bonds(3)

   $    $ 21,672    $    $      $ 21,672

Derivative liabilities (interest-rate related)

          1,257           (1,084     173

Total liabilities

   $    $ 22,929    $    $ (1,084   $ 21,845

December 31, 2009

 

     Fair Value Measurement Using:   

Netting

     
      Level 1    Level 2    Level 3    Adjustments(1)     Total

Assets:

             

Trading securities:

             

MBS:

             

Other U.S. obligations:

             

Ginnie Mae

   $    $ 23    $    $      $ 23

GSEs:

             

Fannie Mae

          8                  8

Total trading securities

          31                  31

Available-for-sale securities (TLGP)

          1,931                  1,931

Advances(2)

          22,952                  22,952

Derivative assets (interest-rate related)

          3,176           (2,724     452

Total assets

   $    $ 28,090    $    $ (2,724   $ 25,366

Liabilities:

             

Consolidated obligation bonds(3)

   $    $ 38,173    $    $      $ 38,173

Derivative liabilities (interest-rate related)

          1,477           (1,272     205

Total liabilities

   $    $ 39,650    $    $ (1,272   $ 38,378

 

(1) Amounts represent the netting of derivative assets and liabilities by counterparty, including cash collateral, where the Bank has the legal right to do so under its master netting agreement with each counterparty.

 

(2) Includes $12,819 and $21,616 of advances recorded under the fair value option at June 30, 2010, and December 31, 2009, respectively, and $1,010 and $1,336 of advances recorded at fair value in accordance with the accounting for derivative instruments and hedging activities at June 30, 2010, and December 31, 2009, respectively.

 

(3) Includes $21,148 and $37,022 of consolidated obligation bonds recorded under the fair value option at June 30, 2010, and December 31, 2009, respectively, and $524 and $1,151 of consolidated obligation bonds recorded at fair value in accordance with the accounting for derivatives instruments and hedging activities at June 30, 2010, and December 31, 2009, respectively.

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

Fair Value on a Nonrecurring Basis. Certain assets are measured at fair value on a nonrecurring basis—that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustment in certain circumstances (for example, when there is evidence of impairment). At June 30, 2010, and December 31, 2009, the Bank measured certain of its held-to-maturity investment securities at fair value on a nonrecurring basis. The following tables present the investment securities as of June 30, 2010, and December 31, 2009, for which a nonrecurring change in fair value was recorded at June 30, 2010, and December 31, 2009, by level within the fair value hierarchy.

June 30, 2010

 

      Fair Value Measurement Using:
      Level 1    Level 2    Level 3

Assets:

        

Held-to-maturity securities – PLRMBS

   $    $    $ 808

PLRMBS with a carrying value of $998 were written down to their fair value of $808.

December 31, 2009

 

      Fair Value Measurement Using:
      Level 1    Level 2    Level 3

Assets:

        

Held-to-maturity securities – PLRMBS

   $    $    $ 1,880

PLRMBS with a carrying value of $2,177 were written down to their fair value of $1,880.

Based on the current lack of significant market activity for PLRMBS, the non-recurring fair value measurements for such securities as of December 31, 2009, and June 30, 2010, fell within Level 3 of the fair value hierarchy.

Fair Value Option. The fair value option provides an entity 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 previously carried at fair value. It requires an entity to display the fair value of those assets and liabilities for which the entity has chosen to use fair value on the face of the statement of condition. 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. Interest income and interest expense carried on advances and consolidated bonds at fair value are recognized solely on the contractual amount of interest due or unpaid. Any transaction fees or costs are immediately recognized into other non-interest income or other non-interest expense.

The Bank elected the fair value option for certain financial instruments on January 1, 2008, as follows.

 

   

Adjustable rate credit advances with embedded options

 

   

Callable fixed rate credit advances

 

   

Putable fixed rate credit advances

 

   

Putable fixed rate credit advances with embedded options

 

   

Fixed rate credit advances with partial prepayment symmetry

 

   

Callable or non-callable capped floater consolidated obligation bonds

 

   

Convertible consolidated obligation bonds

 

   

Floating or fixed rate range accrual consolidated obligation bonds

 

   

Ratchet consolidated obligation bonds

 

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Table of Contents

Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

In addition to the items transitioned to the fair value option on January 1, 2008, the Bank has elected that any new transactions in these categories will be accounted for under the fair value option. In general, transactions for which the Bank has elected the fair value option are in economic hedge relationships. The Bank has also elected the fair value option for the following additional categories for all new transactions entered into starting on January 1, 2008:

 

   

Adjustable rate credit advances indexed to the following: Prime Rate, U.S. Treasury Bill, Federal funds, Constant Maturity Treasury (CMT), Constant Maturity Swap (CMS), and 12-month Moving Treasury Average of one-year CMT (12MTA)

 

   

Adjustable rate consolidated obligation bonds indexed to the following: Prime Rate, U.S. Treasury Bill, Federal funds, CMT, CMS, and 12MTA

The Bank elected the fair value option for the following financial instruments on October 1, 2009:

 

   

Step-up callable bonds, which pay interest at increasing fixed rates for specified intervals over the life of the bond and can generally be called at the Bank’s option on the step-up dates

 

   

Step-down callable bonds, which pay interest at decreasing fixed rates for specified intervals over the life of the bond and can generally be called at the Bank’s option on the step-down dates

The Bank has elected these items for the fair value option to assist in mitigating potential income statement volatility that can arise from economic hedging relationships. The risk associated with using fair value only for the derivative is the Bank’s primary reason for electing the fair value option for financial assets and liabilities that do not qualify for hedge accounting or that have not previously met or may be at risk for not meeting the hedge effectiveness requirements.

The following table summarizes the activity related to financial assets and liabilities for which the Bank elected the fair value option during the three and six months ended June 30, 2010 and 2009:

 

     Three Months Ended  
     June 30, 2010     June 30, 2009  
      Advances     Consolidated
Obligation Bonds
    Advances     Consolidated
Obligation Bonds
 

Balance, beginning of the period

   $ 17,459      $ 24,241      $ 35,676      $ 36,262   

New transactions elected for fair value option

     127        6,574        150        4,925   

Maturities and terminations

     (4,781     (9,709     (828     (6,075

Net gain/(loss) on advances and net loss on consolidated obligation bonds held at fair value

     35        56        (130     48   

Change in accrued interest

     (21     (14     1        (3

Balance, end of the period

   $ 12,819      $ 21,148      $ 34,869      $ 35,157   

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

     Six Months Ended  
     June 30, 2010     June 30, 2009  
      Advances     Consolidated
Obligation Bonds
    Advances     Consolidated
Obligation Bonds
 

Balance, beginning of the period

   $ 21,616      $ 37,022      $ 38,573      $ 30,286   

New transactions elected for fair value option

     200        14,325        193        18,585   

Maturities and terminations

     (8,915     (30,271     (3,563     (13,746

Net loss on advances and net loss on consolidated obligation bonds held at fair value

     (45     76        (321     40   

Change in accrued interest

     (37     (4     (13     (8

Balance, end of the period

   $ 12,819      $ 21,148      $ 34,869      $ 35,157   

For advances and consolidated obligations recorded under the fair value option, the estimated impact of changes in credit risk for the three and six months ended June 30, 2010 and 2009, was immaterial.

The following table presents the changes in fair value included in the Statements of Income for each item for which the fair value option has been elected for the three and six months ended June 30, 2010 and 2009:

 

     Three Months Ended  
     June 30, 2010     June 30, 2009  
     

Interest

Income on

Advances

  

Interest

Expense on

Consolidated

Obligation

Bonds

   

Net Gain/

(Loss) on

Advances and

Consolidated

Obligation

Bonds Held

at Fair Value

   

Total Changes

in Fair Value

Included in

Current Period

Earnings

   

Interest

Income on
Advances

  

Interest

Expense on

Consolidated

Obligation

Bonds

   

Net Gain/

(Loss) on

Advances and

Consolidated

Obligation

Bonds Held at

Fair Value

   

Total Changes

in Fair Value

Included in

Current Period
Earnings

 

Advances

   $ 130    $      $ 35      $ 165      $ 302    $      $ (130   $ 172   

Consolidated obligation bonds

          (49     (56     (105          (49     (48     (97

Total

   $ 130    $ (49   $ (21   $ 60      $ 302    $ (49   $ (178   $ 75   

 

     Six Months Ended  
     June 30, 2010     June 30, 2009  
     

Interest

Income on

Advances

  

Interest

Expense on

Consolidated

Obligation

Bonds

   

Net Gain/
(Loss) on

Advances and

Consolidated

Obligation

Bonds Held

at Fair Value

   

Total Changes

in Fair Value

Included in

Current Period

Earnings

   

Interest

Income on

Advances

  

Interest

Expense on

Consolidated

Obligation

Bonds

   

Net Gain/

(Loss) on

Advances and

Consolidated

Obligation

Bonds Held

at Fair Value

   

Total Changes

in Fair Value

Included in

Current Period

Earnings

 

Advances

   $ 296    $      $ (45   $ 251      $ 621    $      $ (321   $ 300   

Consolidated obligation bonds

          (110     (76     (186          (95     (40     (135

Total

   $ 296    $ (110   $ (121   $ 65      $ 621    $ (95   $ (361   $ 165   

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

The following table presents the difference between the aggregate fair value and aggregate remaining contractual principal balance outstanding of advances and consolidated obligation bonds for which the fair value option has been elected at June 30, 2010, and December 31, 2009:

 

     At June 30, 2010    At December 31, 2009  
      Principal Balance    Fair Value   

Fair Value

Over/(Under)

Principal Balance

   Principal Balance    Fair Value   

Fair Value

Over/(Under)

Principal Balance

 

Advances(1)

   $ 12,296    $ 12,819    $ 523    $ 21,000    $ 21,616    $ 616   

Consolidated obligation bonds

     21,129      21,148      19      37,075      37,022      (53

 

  (1)

At June 30, 2010, and December 31, 2009, none of these advances were 90 days or more past due or had been placed on nonaccrual status.

Note 13 – Commitments and Contingencies

As provided by the FHLBank Act or regulations governing the operations of the FHLBanks, all FHLBanks have joint and several liability for all FHLBank consolidated obligations, which are backed only by the financial resources of the FHLBanks. The joint and several liability regulation authorizes the Finance Agency to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor. The Bank has never been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank, and as of June 30, 2010, and through the filing date of this report, does not believe that is probable that it will be asked to do so. The par amount of the outstanding consolidated obligations of all 12 FHLBanks was $846,481 at June 30, 2010, and $930,617 at December 31, 2009. The par value of the Bank’s participation in consolidated obligations was $143,135 at June 30, 2010, and $178,186 at December 31, 2009. For more information on the joint and several liability regulation, see Note 18 to the Financial Statements in the Bank’s 2009 Form 10-K.

At June 30, 2010, there were no commitments that legally obligated the Bank for additional advances. At December 31, 2009, commitments that legally obligated the Bank for additional advances totaled $32. Advance commitments are generally for periods up to 12 months. Advances funded under advance commitments are fully collateralized at the time of funding (see Note 6 to the Financial Statements). Based on the Bank’s credit analyses of members’ financial condition and collateral requirements, no allowance for losses was deemed necessary by the Bank on the advance commitments outstanding as of December 31, 2009. The estimated fair value of advance commitments was immaterial to the balance sheet as of December 31, 2009.

Standby letters of credit are generally issued for a fee on behalf of members to support their obligations to third parties. If the Bank is required to make payment for a beneficiary’s drawing under a letter of credit, the amount is charged to the member’s demand deposit account with the Bank. The Bank’s outstanding standby letters of credit at June 30, 2010, and December 31, 2009, were as follows:

 

      June 30, 2010    December 31, 2009

Outstanding notional

   $ 6,200    $ 5,269

Original terms

     42 days to 10 years      23 days to 10 years

Final expiration year

     2020      2019

The value of the Bank’s obligations related to standby letters of credit is recorded in other liabilities and amounted to $29 at June 30, 2010, and $27 at December 31, 2009. Letters of credit are fully collateralized at the time of issuance. Based on the Bank’s credit analyses of members’ financial condition and collateral requirements, no allowance for losses was deemed necessary by the Bank on the letters of credit outstanding as of June 30, 2010, and December 31, 2009.

The Bank executes interest rate exchange agreements with major banks and derivatives entities affiliated with broker-dealers that have, or are supported by guarantees from related entities that have, long-term unsecured, unsubordinated debt or deposit ratings from Standard & Poor’s, Moody’s, and/or Fitch, where the lowest rating is A-/A3 or better. The Bank also executes interest rate exchange agreements with its members. The Bank enters into master agreements with netting provisions with all counterparties and into bilateral security agreements with all active derivatives dealer counterparties. All member counterparty master agreements,

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

excluding those with derivatives dealers, are subject to the terms of the Bank’s Advances and Security Agreement with members, and all member counterparties (except for those that are derivatives dealers) must fully collateralize the Bank’s net credit exposure. As of June 30, 2010, the Bank had pledged as collateral securities with a carrying value of $76, all of which could be sold or repledged, to counterparties that have market risk exposure to the Bank related to derivatives. As of December 31, 2009, the Bank had pledged as collateral securities with a carrying value of $40, all of which could be sold or repledged, to counterparties that had market risk exposure to the Bank related to derivatives.

The Bank may be subject to various pending legal proceedings that may arise in the normal course of business. After consultation with legal counsel, management does not anticipate that the ultimate liability, if any, arising out of these matters will have a material effect on the Bank’s financial condition or results of operations.

At June 30, 2010, the Bank had committed to the issuance of $720 in consolidated obligation bonds, all of which were hedged with associated interest rate swaps. At December 31, 2009, the Bank had committed to the issuance of $1,090 in consolidated obligation bonds, of which $1,000 were hedged with associated interest rate swaps.

The Bank entered into interest rate exchange agreements that had traded but not yet settled with notional amounts totaling $1,303 at June 30, 2010, and $1,110 at December 31, 2009.

Other commitments and contingencies are discussed in Notes 6, 7, 8, 9, and 11 to the Financial Statements.

Note 14 – Transactions with Certain Members, Certain Nonmembers, and Other FHLBanks

Transactions with Certain Members and Certain Nonmembers. The following tables set forth information at the dates and for the periods indicated with respect to transactions with (i) members and nonmembers holding more than 10% of the outstanding shares of the Bank’s capital stock, including mandatorily redeemable capital stock, at each respective period end, (ii) members that had an officer or director serving on the Bank’s Board of Directors at any time during the periods indicated, and (iii) affiliates of the foregoing members and nonmembers. All transactions with members, the nonmembers described in the preceding sentence, and their respective affiliates are entered into in the normal course of business.

 

      June 30, 2010    December 31, 2009

Assets:

     

Held-to-maturity securities(1)

   $ 2,209    $ 2,638

Advances

     50,648      87,701

Mortgage loans held for portfolio

     2,212      2,391

Accrued interest receivable

     82      150

Derivative assets

     948      956

Total

   $ 56,099    $ 93,836

Liabilities:

     

Deposits

   $ 949    $ 993

Mandatorily redeemable capital stock

     4,150      4,311

Total

   $ 5,099    $ 5,304

Notional amount of derivatives

   $ 47,760    $ 55,152

Standby letters of credit

     4,250      3,885

 

  (1) Held-to-maturity securities include MBS issued by and/or purchased from the members or nonmembers described in this section or their affiliates.

 

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Federal Home Loan Bank of San Francisco

Notes to Financial Statements (continued)

 

     Three Months Ended     Six Months Ended  
        
     June 30, 2010     June 30, 2009     June 30, 2010     June 30, 2009  
   

Interest Income:

        

Federal funds sold

   $ 1      $ 1      $ 1      $ 1   

Held-to-maturity securities

     23        38        49        82   

Advances(1)

     163        526        333        1,250   

Mortgage loans held for portfolio

     28        33        57        68   

Total

   $ 215      $ 598      $ 440      $ 1,401   

Interest Expense:

        

Mandatorily redeemable capital stock

   $ 2      $      $ 5      $   

Consolidated obligations(1)

     (168     (161     (353     (305

Total

   $ (166   $ (161   $ (348   $ (305

Other Income/(Loss):

        

Net gain/(loss) on derivatives and hedging activities

   $ 11      $ (249   $ 14      $ (322

Other income

     1        1        2        2   

Total

   $ 12      $ (248   $ 16      $ (320

 

  (1) Includes the effect of associated derivatives with the members or nonmembers described in this section or their affiliates.

Transactions with Other FHLBanks. Transactions with other FHLBanks are identified on the face of the Bank’s financial statements, which begin on page 1.

Note 15 – Subsequent Events

The Bank evaluated events subsequent to June 30, 2010, until the time of the Form 10-Q filing with the SEC, and no material subsequent events were identified, other than those discussed below.

On July 29, 2010, the Bank announced that it plans to repurchase up to $500 in excess capital stock on August 13, 2010. The amount of excess capital stock to be repurchased from any shareholder will be based on the shareholder’s pro rata ownership share of total capital stock outstanding as of the repurchase date, up to the amount of the shareholder’s excess capital stock.

On July 29, 2010, the Bank’s Board of Directors declared a cash dividend for the second quarter of 2010 at an annualized dividend rate of 0.44%. The Bank recorded the second quarter dividend on July 29, 2010, the day it was declared by the Board of Directors. The Bank expects to pay the second quarter dividend (including dividends on mandatorily redeemable capital stock), which will total $14, on or about August 12, 2010. The Bank expects to pay the dividend in cash rather than stock form to comply with Finance Agency rules.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Statements contained in this quarterly report on Form 10-Q, including statements describing the objectives, projections, estimates, or predictions of the future of the Federal Home Loan Bank of San Francisco (Bank) or the Federal Home Loan Bank System, are “forward-looking statements.” These statements may use forward-looking terms, such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “likely,” “may,” “probable,” “project,” “should,” “will,” or their negatives or other variations on these terms, and include statements related to gains and losses on derivatives, plans to pay dividends and repurchase excess capital stock, future other-than-temporary impairment charges, and reform legislation. The Bank cautions that by their nature, forward-looking statements involve risk or uncertainty that could cause actual results to differ materially from those expressed or implied in these forward-looking statements or could affect the extent to which a particular objective, projection, estimate, or prediction is realized. These risks and uncertainties include, among others, the following:

 

   

changes in economic and market conditions, including conditions in the mortgage, housing, and capital markets;

 

   

the volatility of market prices, rates, and indices;

 

   

political events, including legislative, regulatory, judicial, or other developments that affect the Bank, its members, counterparties, or investors in the consolidated obligations of the Federal Home Loan Banks (FHLBanks), such as changes in the Federal Home Loan Bank Act of 1932 as amended (FHLBank Act), changes in applicable sections of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, or regulations applicable to the FHLBanks;

 

   

changes in the Bank’s capital structure;

 

   

the ability of the Bank to pay dividends or redeem or repurchase capital stock;

 

   

membership changes, including changes resulting from mergers or changes in the principal place of business of Bank members;

 

   

soundness of other financial institutions, including Bank members, nonmember borrowers, and the other FHLBanks;

 

   

changes in the demand by Bank members for Bank advances;

 

   

changes in the value or liquidity of collateral underlying advances to Bank members or nonmember borrowers or collateral pledged by the Bank’s derivatives counterparties;

 

   

changes in the fair value and economic value of, impairments of, and risks associated with the Bank’s investments in mortgage loans and mortgage-backed securities (MBS) or other assets and the related credit enhancement protections;

 

   

changes in the Bank’s ability or intent to hold MBS and mortgage loans to maturity;

 

   

competitive forces, including the availability of other sources of funding for Bank members;

 

   

the willingness of the Bank’s members to do business with the Bank whether or not the Bank is paying dividends or repurchasing excess capital stock;

 

   

changes in investor demand for consolidated obligations and/or the terms of interest rate exchange or 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;

 

   

the pace of technological change and the Bank’s ability to develop and support technology and information systems sufficient to manage the risks of the Bank’s business effectively;

 

   

the timing and volume of market activity.

 

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Readers of this report should not rely solely on the forward-looking statements and should consider all risks and uncertainties addressed throughout this report, as well as those discussed under “Item 1A. Risk Factors” in the Bank’s Annual Report on
Form 10-K for the year ended December 31, 2009 (2009 Form 10-K).

This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Bank’s interim financial statements and notes, which begin on page 1, and the Bank’s 2009 Form 10-K.

On July 30, 2008, the Housing and Economic Recovery Act of 2008 (Housing Act) was enacted. The Housing Act created a new federal agency, the Federal Housing Finance Agency (Finance Agency), which became the new federal regulator of the FHLBanks effective on the date of enactment of the Housing Act. On October 27, 2008, the Federal Housing Finance Board (Finance Board), the federal regulator of the FHLBanks prior to the creation of the Finance Agency, merged into the Finance Agency. Pursuant to the Housing Act, all regulations, orders, determinations, and resolutions that were issued, made, prescribed, or allowed to become effective by the Finance Board will remain in effect until modified, terminated, set aside, or superseded by the Director of the Finance Agency, any court of competent jurisdiction, or operation of law. References throughout this report to regulations of the Finance Agency also include the regulations of the Finance Board where they remain applicable.

Quarterly Overview

Challenging economic and mortgage and credit market conditions continued to affect the Bank’s business and results of operations as well as its members’ operations during the second quarter of 2010. Although the U.S. economy continued to exhibit signs of recovery during the quarter, as more regions throughout the nation experienced moderate growth, unemployment remained high and consumers generally remained cautious. Home sales slowed during the quarter, coinciding with the end of the popular federal tax credit program. The level of home foreclosures remained high, and members continued to maintain high levels of liquidity.

Net income for the second quarter of 2010 was $29 million, compared with net income of $303 million for the second quarter of 2009. The decrease primarily reflected a decline in net interest income; an increase in net losses associated with derivatives, hedged items, and financial instruments carried at fair value; and an increase in other-than-temporary impairment (OTTI) charges on some of the private-label residential mortgage-backed securities (PLRMBS) in the Bank’s held-to-maturity securities portfolio.

Net interest income for the second quarter of 2010 was $363 million, compared with net interest income of $484 million for the second quarter of 2009. Several factors contributed to the decline in net interest income. Net interest income on economically hedged assets and liabilities, which is generally offset by net interest expense on derivative instruments used in economic hedges (reflected in other income), was lower in the second quarter of 2010 relative to the year-earlier period. In addition, the net interest spread on advances was lower in the second quarter of 2010, as favorably priced short-term debt issued in the fourth quarter of 2008 matured by yearend 2009, and the volume of advances was lower. The effect of these factors on net interest income was partially offset by an increase in advance prepayment fees and higher net interest spreads on the mortgage portfolio and other investments.

Members and nonmember borrowers prepaid $8.2 billion of advances in the second quarter of 2010, increasing interest income by net prepayment fees of $28 million. In the second quarter of 2009, members and nonmember borrowers prepaid $11.4 billion of advances, increasing interest income by $18 million in net prepayment fees. The increased net prepayment fees in the second quarter of 2010 were primarily due to a significant decline in the interest rate environment since the advances were originated and to longer remaining terms for several large advances that were prepaid during the second quarter of 2010.

Other income for the second quarter of 2010 was a net loss of $285 million, compared to a net loss of $39 million for the second quarter of 2009. The net loss associated with derivatives, hedged items, and financial

 

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instruments carried at fair value totaled $102 million for the second quarter of 2010, compared to a net gain of $186 million for the second quarter of 2009. In addition, the losses in other income for the second quarter of 2010 reflected a credit-related OTTI charge of $142 million on certain PLRMBS, compared to a credit-related OTTI charge of $88 million for the second quarter of 2009. Net interest expense on derivative instruments used in economic hedges, which was generally offset by net interest income on the economically hedged assets and liabilities, totaled $43 million in the second quarter of 2010, compared to $140 million in the second quarter of 2009.

The $102 million net loss associated with derivatives, hedged items, and financial instruments carried at fair value for the second quarter of 2010 reflected a significant decrease relative to the $186 million net gain for the second quarter of 2009. This decrease was primarily driven by large reversals of prior period gains and by changes in interest rates and swaption volatilities. Net gains and losses on these financial instruments are primarily a matter of timing and will generally reverse through changes in future valuations and settlements of contractual interest cash flows over the remaining contractual terms to maturity, or by the exercised call or put dates. As of June 30, 2010, the Bank had a cumulative net gain of $79 million associated with derivatives, hedged items, and financial instruments carried at fair value.

The credit-related OTTI charges of $142 million for the second quarter of 2010 reflected the impact of additional projected credit losses on loan collateral underlying certain of the Bank’s PLRMBS. Each quarter, the Bank updates its OTTI analysis to reflect current and anticipated housing market conditions, observed and anticipated borrower behavior, and updated information on the loans supporting the Bank’s PLRMBS. This process includes updating key aspects of the Bank’s loss projection models. For the second quarter of 2010, the update reflected the ongoing pressure on housing prices from persistently high inventories of unsold properties and the impacts on anticipated borrower behavior of continued high unemployment and the increased likelihood of default by borrowers with mortgage loan balances that exceed the value of their homes. As a result, the Bank recorded additional credit losses on PLRMBS backed by Alt-A and prime collateral, with the greatest impact on PLRMBS backed by Alt-A collateral.

The non-credit-related OTTI charges on the affected PLRMBS recorded in other comprehensive income were $48 million for the second quarter of 2010 and $1.2 billion for the second quarter of 2009. For each security, the amount of the non-credit-related impairment is accreted prospectively, based on the amount and timing of future estimated cash flows, over the remaining life of the security as an increase in the carrying value of the security, with no effect on earnings unless the security is subsequently sold or there are additional decreases in the cash flows expected to be collected. The Bank does not intend to sell these securities and it is not more likely than not that the Bank will be required to sell these securities before its anticipated recovery of the remaining amortized cost basis. At June 30, 2010, the estimated weighted average life of the affected securities was approximately four years.

Additional information about investments and OTTI charges associated with the Bank’s PLRMBS is provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Investments” and in Note 5 to the Financial Statements. Additional information about the Bank’s PLRMBS is also provided in “Part II. Item 1. Legal Proceedings.”

On July 29, 2010, the Bank’s Board of Directors declared a cash dividend for the second quarter of 2010 at an annualized rate of 0.44%. The Bank recorded the second quarter dividend on July 29, 2010, the day it was declared by the Board of Directors. The Bank expects to pay the dividend (including dividends on mandatorily redeemable capital stock), which will total $14 million, on or about August 12, 2010. The Bank expects to pay the dividend in cash rather than stock form to comply with Finance Agency rules, which do not permit the Bank to pay dividends in the form of capital stock if the Bank’s excess capital stock exceeds 1% of its total assets. As of June 30, 2010, the Bank’s excess capital stock totaled $7.7 billion, or 4.84% of total assets.

 

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As of June 30, 2010, the Bank was in compliance with all of its regulatory capital requirements. The Bank’s total regulatory capital ratio was 9.05%, exceeding the 4.00% requirement. The Bank had $14.3 billion in regulatory capital, exceeding its risk-based capital requirement of $5.5 billion.

In light of the Bank’s strengthened regulatory capital position, the Bank plans to repurchase up to $500 million in excess capital stock on August 13, 2010. The amount of excess capital stock to be repurchased from any shareholder will be based on the shareholder’s pro rata ownership share of total capital stock outstanding as of the repurchase date, up to the amount of the shareholder’s excess capital stock.

The Bank will continue to monitor the condition of the Bank’s PLRMBS portfolio, its overall financial performance and retained earnings, developments in the mortgage and credit markets, and other relevant information as the basis for determining the status of dividends and excess capital stock repurchases in future quarters.

During the first six months of 2010, total assets decreased $34.7 billion, or 18%, to $158.2 billion at June 30, 2010, from $192.9 billion at December 31, 2009. Total advances declined $37.9 billion, or 28%, to $95.7 billion at June 30, 2010, from $133.6 billion at December 31, 2009. The continued decline in member advance demand reflected general economic conditions and conditions in the mortgage and credit markets. Member liquidity remained high and lending activity remained low. Held-to-maturity securities decreased to $33.6 billion at June 30, 2010, from $36.9 billion at December 31, 2009, primarily because of principal payments, prepayments, and maturities in the MBS portfolio and OTTI charges recognized on certain PLRMBS. During the first six months of 2010, Federal funds sold increased $6.3 billion, to $14.5 billion at June 30, 2010, from $8.2 billion at December 31, 2009. The Bank increased its use of Federal funds sold to invest the proceeds from advance prepayments.

All advances made by the Bank are required to be fully collateralized in accordance with the Bank’s credit and collateral requirements. The Bank monitors the creditworthiness of its members on an ongoing basis. In addition, the Bank has a comprehensive process for assigning values to collateral and determining how much it will lend against the collateral pledged. During the second quarter of 2010, the Bank continued to review and adjust its lending parameters based on market conditions and to require additional collateral, when necessary, to ensure that advances remained fully collateralized. Based on the Bank’s risk assessments of housing and mortgage market conditions and of individual members and their collateral, the Bank also continued to adjust collateral terms for individual members during the second quarter of 2010.

Seven member institutions were placed into receivership or liquidation during the second quarter of 2010. Six of these institutions had advances outstanding at the time they were placed into receivership or liquidation. The advances outstanding to these six institutions were either repaid prior to June 30, 2010, or assumed by other institutions, and no losses were incurred by the Bank. The seventh institution had no advances outstanding at the time it was placed into receivership or liquidation. The Bank capital stock held by three of the seven institutions totaling $12 million was classified as mandatory redeemable capital stock (a liability). The capital stock of the other four institutions was transferred to other member institutions.

From July 1, 2010, to July 30, 2010, two member institutions were placed into receivership. The outstanding advances and capital stock of one institution were assumed by another member institution. The advances outstanding to the second institution were assumed by a nonmember institution, and the Bank capital stock held by the institution totaling $3 million was classified as mandatorily redeemable capital stock (a liability).

 

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Financial Highlights

The following table presents a summary of certain financial information for the Bank for the periods indicated.

Financial Highlights

(Unaudited)

(Dollars in millions)   

June 30,

2010

   

March 31,

2010

   

December 31,

2009

   

September 30,

2009

   

June 30,

2009

 

Selected Balance Sheet Items at Quarter End

          

Total Assets

   $ 158,198      $ 173,851      $ 192,862      $ 211,212      $ 238,924   

Advances

     95,747        112,139        133,559        154,962        174,732   

Mortgage Loans Held for Portfolio, Net

     2,788        2,909        3,037        3,172        3,357   

Investments(1)

     51,139        54,383        47,006        45,943        58,933   

Consolidated Obligations:(2)

          

Bonds

     129,524        136,588        162,053        154,869        176,200   

Discount Notes

     15,788        24,764        18,246        43,901        49,009   

Mandatorily Redeemable Capital Stock

     4,690        4,858        4,843        3,159        3,165   

Capital Stock – Class B – Putable

     8,280        8,561        8,575        10,244        10,253   

Retained Earnings

     1,350        1,326        1,239        1,065        1,172   

Accumulated Other Comprehensive Loss

     (3,332     (3,501     (3,584     (3,601     (2,717

Total Capital

     6,298        6,386        6,230        7,708        8,708   

Selected Operating Results for the Quarter

          

Net Interest Income

   $ 363      $ 357      $ 406      $ 458      $ 484   

Provision for Credit Losses on Mortgage Loans

     2                             1   

Other Loss

     (285     (195     (130     (543     (39

Other Expense

     35        36        39        31        31   

Assessments

     12        33        63        (31     110   

Net Income/(Loss)

   $ 29      $ 93      $ 174      $ (85   $ 303   

Selected Other Data for the Quarter

          

Net Interest Margin(3)(4)

     0.87     0.78     0.79     0.80     0.76

Operating Expenses as a Percent of Average Assets

     0.07        0.06        0.06        0.05        0.04   

Return on Average Assets

     0.07        0.20        0.34        (0.15     0.47   

Return on Average Equity

     1.87        5.96        10.30        (3.84     12.49   

Annualized Dividend Rate(5)

     0.44        0.26        0.27               0.84   

Dividend Payout Ratio(6)

     31.25        5.92        3.57               7.08   

Selected Other Data at Quarter End

          

Regulatory Capital Ratio(7)

     9.05        8.48        7.60        6.85        6.11   

Average Equity to Average Assets Ratio

     3.76        3.41        3.29        3.88        3.77   

Duration Gap (in months)

     6        4        4        4        2   

 

(1) Investments consist of Federal funds sold, trading securities, available-for-sale securities, held-to-maturity securities, securities purchased under agreements to resell, and loans to other Federal Home Loan Banks (FHLBanks).
(2) As provided by the FHLBank Act or regulations governing the operations of the FHLBanks, all of the FHLBanks have joint and several liability for FHLBank consolidated obligations, which are backed only by the financial resources of the FHLBanks. The joint and several liability regulation authorizes the Finance Agency to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor. The Bank has never been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank, and as of June 30, 2010, and through the filing date of this report, does not believe that it is probable that it will be asked to do so. The par amount of the outstanding consolidated obligations of all 12 FHLBanks at the dates indicated was as follows:
      Par amount

June 30, 2010

   $ 846,481

March 31, 2010

     870,928

December 31, 2009

     930,617

September 30, 2009

     973,579

June 30, 2009

     1,055,863

 

(3) Net interest margin is net interest income (annualized) divided by average interest-earning assets.
(4) For the purpose of calculating the net interest margin, on a retroactive basis, the Bank included in interest-earning assets fair value adjustments resulting from hedging relationships and fair value option adjustments. The Bank made this change to achieve consistency among all the FHLBanks in reporting interest-earning assets. This change did not materially affect average interest-earning assets and had no effect on reported assets, net interest income, or net income. Prior to this change, the net interest margins for the three months ended June 30, September 30, and December 31, 2009, were reported as 0.77%, 0.81% and 0.80%, respectively. For more information see Second Quarter of 2010 Compared to Second Quarter of 2009 – Average Balance Sheets below.
(5) On July 29, 2010, the Bank’s Board of Directors declared a cash dividend for the second quarter of 2010 at an annualized dividend rate of 0.44%. The Bank will record and pay the second quarter dividend during the third quarter of 2010. On April 29, 2010, the Bank’s Board of Directors declared a cash dividend for the first quarter of 2010, which was recorded and paid during the second quarter of 2010. On February 22, 2010, the Bank’s Board of Directors declared a cash dividend for the fourth quarter of 2009, which was recorded and paid during the first quarter of 2010. On July 30, 2009, the Bank’s Board of Directors declared a cash dividend for the second quarter of 2009, which was recorded and paid during the third quarter of 2009.
(6) This ratio is calculated as dividends per share divided by net income per share.
(7) This ratio is calculated as regulatory capital divided by total assets. Regulatory capital includes mandatorily redeemable capital stock (which is classified as a liability) and excludes accumulated other comprehensive income.

 

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Results of Operations

The primary source of Bank earnings is net interest income, which is the interest earned on advances, mortgage loans, and investments, less interest paid on consolidated obligations, deposits, and other borrowings. The following Average Balance Sheets table presents average balances of earning asset categories and the sources that fund those earning assets (liabilities and capital) for the three and six months ended June 30, 2010 and 2009, together with the related interest income and expense. It also presents the average rates on total earning assets and the average costs of total funding sources. The Change in Net Interest Income table details the changes in interest income and interest expense for the second quarter of 2010 compared to the second quarter of 2009 and for the first six months of 2010 compared to the first six months of 2009. Changes in both volume and interest rates influence changes in net interest income and the net interest margin.

 

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Second Quarter of 2010 Compared to Second Quarter of 2009

Average Balance Sheets

 

     Three Months Ended  
        
     June 30, 2010     June 30, 2009  
                
(Dollars in millions)    Average
Balance
    Interest
Income/
Expense
   Average
Rate
    Average
Balance
    Interest
Income/
Expense
   Average
Rate
 

Assets

              

Interest-earning assets:

              

Federal funds sold

   $ 17,162      $ 8    0.20   $ 12,702      $ 6    0.19

Trading securities:

              

MBS

     28        1    3.77        34        1    4.61   

Other investments

     396           0.34                    

Available-for-sale securities:

              

Other investments

     1,933        1    0.29                    

Held-to-maturity securities:

              

MBS

     27,966        275    3.95        36,557        361    3.96   

Other investments

     10,864        7    0.26        9,633        8    0.33   

Mortgage loans held for portfolio, net

     2,849        39    5.48        3,485        36    4.14   

Advances(1)(2)

     106,962        313    1.17        192,683        772    1.61   

Loans to other FHLBanks

     4           0.15        366           0.12   
                                  

Total interest-earning assets

     168,164        644    1.54        255,460        1,184    1.86   

Other assets(2)(3)(4)(5)

     60                  2,472             
                                  

Total Assets

   $ 168,244      $ 644    1.54   $ 257,932      $ 1,184    1.84

Liabilities and Capital

              

Interest-bearing liabilities:

              

Consolidated obligations:

              

Bonds(1)(2)

   $ 136,327      $ 269    0.79   $ 180,271      $ 588    1.31

Discount notes

     17,709        9    0.21        60,502        112    0.74   

Deposits(3)

     1,586           0.06        1,954           0.05   

Borrowings from other FHLBanks

                      15           0.14   

Mandatorily redeemable capital stock

     4,771        3    0.26        3,160             

Other borrowings

                      7           0.11   
                                  

Total interest-bearing liabilities

     160,393        281    0.70        245,909        700    1.14   

Other liabilities(2)(3)(4)

     1,511                  2,290             
                                  

Total Liabilities

     161,904        281    0.70        248,199        700    1.13   

Total Capital

     6,320                  9,733             
                                  

Total Liabilities and Capital

   $ 168,224      $ 281    0.67   $ 257,932      $ 700    1.09

Net Interest Income

     $ 363        $ 484   
                      

Net Interest Spread(2)(6)

        0.84        0.72
                      

Net Interest Margin(2)(7)

        0.87        0.76
                      

Interest-earning Assets/Interest-bearing Liabilities(2)

     104.84          103.88     
                          

 

(1) Interest income/expense and average rates include the effect of associated interest rate exchange agreements. Interest income on advances includes net interest expense on interest rate exchange agreements of $143 million and $237 million for the second quarter of 2010 and 2009, respectively. Interest expense on consolidated obligation bonds includes net interest income on interest rate exchange agreements of $468 million and $532 million for the second quarter of 2010 and 2009, respectively.
(2) For the purpose of calculating the net interest margin, on a retroactive basis, the Bank included in interest-earning assets and interest-bearing liabilities fair value adjustments resulting from hedging relationships and fair value option adjustments that had been included in other assets and other liabilities prior to the first quarter of 2010. The Bank made these changes to achieve consistency among all the FHLBanks in reporting interest-earning assets and interest-bearing liabilities. These changes did not materially affect average rates, net interest spread, or net interest margin, and had no effect on reported assets, liabilities, net interest income or net income.
(3) Average balances do not reflect the effect of reclassifications of cash collateral.
(4) Includes forward settling transactions and valuation adjustments for certain cash items.
(5) Includes OTTI charges on held-to-maturity securities related to all other factors.
(6) Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities.
(7) Net interest margin is net interest income (annualized) divided by average interest-earning assets.

 

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Change in Net Interest Income: Rate/Volume Analysis

Three Months Ended June 30, 2010, Compared to Three Months Ended June 30, 2009

 

     Increase/     Attributable to Changes in(1)  
(In millions)    (Decrease)     Average Volume     Average Rate  

Interest-earning assets:

      

Federal funds sold

   $ 2      $ 2      $   

Trading securities:

      

MBS

                     

Available-for-sale securities:

      

Other investments

     1        1          

Held-to-maturity securities:

      

MBS

     (86     (85     (1

Other investments

     (1     1        (2

Mortgage loans held for portfolio

     3        (7     10   

Advances(2)

     (459     (285     (174

Total interest-earning assets

     (540     (373     (167

Interest-bearing liabilities:

      

Consolidated obligations:

      

Bonds(2)

     (319     (121     (198

Discount notes

     (103     (51     (52

Deposits

                     

Mandatorily redeemable capital stock

     3               3   

Total interest-bearing liabilities

     (419     (172     (247

Net interest income

   $ (121   $ (201   $ 80   

 

(1) Combined rate/volume variances, a third element of the calculation, are allocated to the rate and volume variances based on their relative sizes.

 

(2) Interest income/expense and average rates include the interest effect of associated interest rate exchange agreements.

Net Interest Income

Net interest income in the second quarter of 2010 was $363 million, a 25% decrease from $484 million in the second quarter of 2009. This decrease was driven primarily by the following:

 

   

Interest income on non-MBS investments increased $2 million in the second quarter of 2010 compared to the second quarter of 2009. The increase consisted of a $4 million increase attributable to a 36% increase in average non-MBS investment balances offset by a $2 million decrease attributable to lower average yields on non-MBS investments.

 

   

Interest income from the mortgage portfolio decreased $83 million in the second quarter of 2010 compared to the second quarter of 2009. The decrease consisted of an $85 million decrease attributable to a 23% decrease in average MBS outstanding, a $1 million decrease attributable to lower average yields on MBS investments, and a $7 million decrease attributable to an 18% decrease in average mortgage loans outstanding, partially offset by a $10 million increase attributable to higher

 

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average yields on mortgage loans outstanding. Interest income from the mortgage portfolio includes the impact of cumulative retrospective adjustments for the amortization of net purchase discounts from the acquisition dates of the MBS and mortgage loans, which increased interest income by $15 million in the second quarter of 2010 and decreased interest income by $32 million in the second quarter of 2009. This increase was primarily due to faster projected prepayment speeds during the second quarter of 2010.

 

   

Interest income from advances decreased $459 million in the second quarter of 2010 compared to the second quarter of 2009. The decrease consisted of a $174 million decrease attributable to lower average yields and a $285 million decrease attributable to a 44% decrease in average advances outstanding, reflecting lower member demand during the second quarter of 2010 relative to the second quarter of 2009. In addition, members and nonmember borrowers prepaid $8.2 billion of advances in the second quarter of 2010 and $11.4 billion in the second quarter of 2009. As a result, interest income was increased by net prepayment fees of $28 million in the second quarter of 2010 and $18 million in the second quarter of 2009. The increased prepayment fees were primarily due to a significant decline in the interest rate environment since the advances were originated and to longer remaining terms for several large advances that were prepaid during the second quarter of 2010.

 

   

Interest expense on consolidated obligations (bonds and discount notes) decreased $422 million in the second quarter of 2010 compared to the second quarter of 2009. The decrease consisted of a $250 million decrease attributable to lower interest rates on consolidated obligations and a $172 million decrease attributable to lower average consolidated obligation balances, which paralleled the decline in advances and MBS investments. Lower interest rates enabled the Bank to refinance matured or called debt at lower rates.

The net interest margin for the second quarter of 2010 was 87 basis points, 11 basis points higher than the net interest margin for the second quarter of 2009, which was 76 basis points. The net interest spread for the second quarter of 2010 was 84 basis points, 12 basis points higher than the net interest spread for the second quarter of 2009, which was 72 basis points. These improvements were primarily due to an increase in advance prepayment fees and a higher net interest spread on the mortgage portfolio.

The decrease in net interest income was partially offset by the decrease in net interest expense on derivative instruments used in economic hedges, recognized in “Other Loss.” The decrease in net interest expense was primarily due to the impact of lower interest rates throughout the second quarter of 2010 on the floating leg of the interest rate swaps.

Member demand for wholesale funding from the Bank can vary greatly depending on a number of factors, including economic and market conditions, competition from other wholesale funding sources, member deposit inflows and outflows, the activity level of the primary and secondary mortgage markets, and strategic decisions made by individual member institutions. As a result, Bank asset levels and operating results may vary significantly from period to period.

Other Loss

The following table presents the components of “Other Loss” for the three months ended June 30, 2010 and 2009.

 

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     Three Months Ended  
        
(In millions)    June 30, 2010     June 30, 2009  
   

Other Loss:

    

Services to members

   $      $ 1   

Net loss on trading securities

     (1       

Total other-than-temporary impairment loss on held-to-maturity securities

     (190     (1,283

Portion of loss recognized in other comprehensive income/(loss)

     48        1,195   
   

Net other-than-temporary impairment loss on held-to-maturity securities

     (142     (88

Net loss on advances and consolidated obligation bonds held at fair value

     (21     (178

Net (loss)/gain on derivatives and hedging activities

     (123     224   

Other

     2        2   
   

Total Other Loss

   $ (285   $ (39
   

Net Other-Than-Temporary Impairment Loss on Held-to-Maturity Securities – The Bank recognized a $142 million credit-related OTTI charge on PLRMBS during the second quarter of 2010, compared to an $88 million credit-related OTTI charge on PLRMBS during the second quarter of 2009. The credit-related OTTI charge of $142 million for the second quarter of 2010 reflected the impact of additional projected credit losses on loan collateral underlying certain of the Bank’s PLRMBS. Each quarter, the Bank updates its OTTI analysis to reflect current and anticipated housing market conditions, observed and anticipated borrower behavior, and updated information on the loans supporting the Bank’s PLRMBS. This process includes updating key aspects of the Bank’s loss projection models. For the second quarter of 2010, the update reflected the ongoing pressure on housing prices from persistently high inventories of unsold properties and the impacts on anticipated borrower behavior of continued high unemployment and the increased likelihood of default by borrowers with mortgage loan balances that exceed the value of their homes. As a result, the Bank recorded additional credit losses on PLRMBS backed by Alt-A and prime collateral, with the greatest impact on PLRMBS backed by Alt-A collateral.

Additional information about the OTTI charge is provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Investments” and in Note 5 to the Financial Statements.

Net Loss on Advances and Consolidated Obligation Bonds Held at Fair Value – The following table presents the net loss on advances and consolidated obligation bonds held at fair value, for which the Bank elected the fair value option for the three months ended June 30, 2010 and 2009.

 

     Three Months Ended  
        
(In millions)    June 30, 2010     June 30, 2009  
   

Advances

   $ 35      $ (130

Consolidated obligation bonds

     (56     (48
   

Total

   $ (21   $ (178
   

For the second quarter of 2010, the unrealized net fair value gains on advances were primarily driven by the decreased long-term interest rate environment relative to the actual coupon rates on the Bank’s advances. The unrealized net fair value losses on consolidated obligation bonds were primarily driven by the decreased long-term interest rate environment relative to the actual coupon rates on the consolidated obligation bonds.

For the second quarter of 2009, the unrealized net fair value losses on advances were primarily driven by increased interest rates on newly issued, longer term advances and from increased swaption volatilities used in pricing fair value option putable advances during the second quarter of 2009. The unrealized net fair value losses on consolidated obligation bonds were primarily driven by the decreased short-term interest rate environment relative to the actual coupon rates on the Bank’s consolidated obligation bonds and higher swaption volatilities used in pricing fair value option callable bonds during the second quarter of 2009.

Net (Loss)/Gain on Derivatives and Hedging Activities – The following table shows the accounting classification of hedges and the categories of hedged items that contributed to the gains and losses on derivatives and hedged items that were recorded in “Net (loss)/gain on derivatives and hedging activities” in the second quarter of 2010 and 2009.

 

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Sources of Gains/(Losses) Recorded in Net (Loss)/Gain on Derivatives and Hedging Activities

Three Months Ended June 30, 2010, Compared to Three Months Ended June 30, 2009

 

(In millions)    June 30, 2010     June 30, 2009
     Gain/(Loss)    

Net Interest
Income/

(Expense) on

          Gain/(Loss)    

Net Interest
Income/

(Expense) on

     
Hedged Item    Fair Value
Hedges, Net
   Economic
Hedges
   

Economic
Hedges

    Total     Fair Value
Hedges, Net
   Economic
Hedges
   

Economic
Hedges

    Total
 

Advances:

                  

Elected for fair value option

   $    $ (28   $ (112   $ (140   $    $ 220      $ (193   $ 27

Not elected for fair value option

     1      (9     (11     (19     8      60        (39     29

Consolidated obligations:

                  

Elected for fair value option

          (5     43        38             88        (29     59

Not elected for fair value option

          (39     37        (2          (12     121        109
 

Total

   $ 1    $ (81   $ (43   $ (123   $ 8    $ 356      $ (140   $ 224
 

During the second quarter of 2010, net losses on derivatives and hedging activities totaled $123 million compared to net gains of $224 million in the second quarter of 2009. These amounts included net interest expense on derivative instruments used in economic hedges of $43 million in the second quarter of 2010, compared to net interest expense on derivative instruments used in economic hedges of $140 million in the second quarter of 2009. The decrease in net interest expense was primarily due to the impact of lower interest rates throughout the second quarter of 2010 on the floating leg of the interest rate swaps.

Excluding the $43 million impact from net interest expense on derivative instruments used in economic hedges, net losses for the second quarter of 2010 totaled $80 million as detailed above. The $80 million in net losses were primarily attributable to a decrease in interest rates during the second quarter of 2010.

Excluding the $140 million impact from net interest expense on derivative instruments used in economic hedges, net gains for the second quarter of 2009 totaled $364 million as detailed above. The $364 million in net gains were primarily attributable to an increase in interest rates and an increase in swaption volatilities during the second quarter of 2009.

The gains or losses on derivatives and associated hedged items and financial instruments carried at fair value (valuation adjustments) during the second quarter of 2010 were primarily driven by changes in overall interest rate spreads and the reversal of prior period gains and losses.

The ongoing impact of these valuation adjustments on the Bank cannot be predicted, and the Bank’s retained earnings in the future may not be sufficient to fully offset the impact of these valuation adjustments. The effects of these valuation adjustments may lead to significant volatility in future earnings, including earnings available for dividends.

 

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Six Months Ended June 30, 2010, Compared to Six Months Ended June 30, 2009

Average Balance Sheets

 

     Six Months Ended  
     June 30, 2010     June 30, 2009  
(Dollars in millions)    Average
Balance
    Interest
Income/
Expense
   Average
Rate
    Average
Balance
    Interest
Income/
Expense
   Average
Rate
 
   

Assets

              

Interest-earning assets:

              

Federal funds sold

   $ 15,908      $ 13    0.17   $ 14,226      $ 13    0.18

Trading securities:

              

MBS

     29        1    3.92        34        1    4.75   

Other investments

     199           0.34                    

Available-for-sale securities:

              

Other investments

     1,933        2    0.26                    

Held-to-maturity securities:

              

MBS

     29,200        559    3.86        37,640        783    4.19   

Other investments

     10,486        11    0.23        11,452        21    0.37   

Mortgage loans held for portfolio, net

     2,909        75    5.16        3,573        79    4.46   

Advances(1)(2)

     115,962        645    1.12        208,344        1,837    1.78   

Deposits with other FHLBanks

     1           0.03                    

Loans to other FHLBanks

     8           0.11        341           0.11   
                                  

Total interest-earning assets

     176,635        1,306    1.49        275,610        2,734    2.00   

Other assets(2)(3)(4)(5)

     81                  4,142             
                                  

Total Assets

   $ 176,716      $ 1,306    1.49   $ 279,752      $ 2,734    1.97
   

Liabilities and Capital

              

Interest-bearing liabilities:

              

Consolidated obligations:

              

Bonds(1)(2)

   $ 142,016      $ 558    0.79   $ 192,160      $ 1,448    1.52

Discount notes

     20,415        22    0.22        69,485        368    1.07   

Deposits(3)

     1,652           0.04        2,286           0.06   

Borrowings from other FHLBanks

     1           0.13        10           0.16   

Mandatorily redeemable capital stock

     4,810        6    0.27        3,358             

Other borrowings

     1           0.10        13           0.08   
                                  

Total interest-bearing liabilities

     168,895        586    0.70        267,312        1,816    1.37   

Other liabilities(2)(3)(4)

     1,505                  2,537             
                                  

Total Liabilities

     170,400        586    0.69        269,849        1,816    1.36   

Total Capital

     6,316                  9,903             
                                  

Total Liabilities and Capital

   $ 176,716      $ 586    0.67   $ 279,752      $ 1,816    1.31
   

Net Interest Income

     $ 720        $ 918   
                      

Net Interest Spread(2)(6)

        0.79        0.63
                      

Net Interest Margin(2)(7)

        0.82        0.67
                      

Interest-earning Assets/Interest-bearing Liabilities(2)

     104.58          103.10     
                          

 

(1) Interest income/expense and average rates include the effect of associated interest rate exchange agreements. Interest income on advances includes net interest expense on interest rate exchange agreements of $311 million and $428 million for the first six months of 2010 and 2009, respectively. Interest expense on consolidated obligation bonds includes net interest income on interest rate exchange agreements of $979 million and $1,022 million for the first six months of 2010 and 2009, respectively.
(2) For the purpose of calculating the net interest margin, on a retroactive basis, the Bank included in interest-earning assets and interest-bearing liabilities fair value adjustments resulting from hedging relationships and fair value option adjustments that had been included in other assets and other liabilities prior to the first quarter of 2010. The Bank made these changes to achieve consistency among all the FHLBanks in reporting interest-earning assets and interest-bearing liabilities. These changes did not materially affect average rates, net interest spread, or net interest margin, and had no effect on reported assets, liabilities, net interest income or net income.
(3) Average balances do not reflect the effect of reclassifications of cash collateral.
(4) Includes forward settling transactions and valuation adjustments for certain cash items.
(5) Includes OTTI charges on held-to-maturity securities related to all other factors.
(6) Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities.
(7) Net interest margin is net interest income (annualized) divided by average interest-earning assets.

 

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Change in Net Interest Income: Rate/Volume Analysis

Six Months Ended June 30, 2010, Compared to Six Months Ended June 30, 2009

 

    

Increase/

(Decrease)

    Attributable to Changes in(1)  
          
(In millions)      Average Volume     Average Rate  
   

Interest-earning assets:

      

Federal funds sold

   $      $ 1      $ (1

Trading securities:

      

MBS

                     

Other investments

                     

Available-for-sale securities:

      

Other investments

     2        2          

Held-to-maturity securities:

      

MBS

     (224     (165     (59

Other investments

     (10     (2     (8

Mortgage loans held for portfolio

     (4     (16     12   

Advances(2)

     (1,192     (650     (542
   

Total interest-earning assets

     (1,428     (830     (598
   

Interest-bearing liabilities:

      

Consolidated obligations:

      

Bonds(2)

     (890     (314     (576

Discount notes

     (346     (163     (183

Deposits

                     

Mandatorily redeemable capital stock

     6               6   
   

Total interest-bearing liabilities

     (1,230     (477     (753
   

Net interest income

   $ (198   $ (353   $ 155   
   

 

(1) Combined rate/volume variances, a third element of the calculation, are allocated to the rate and volume variances based on their relative sizes.

 

(2) Interest income/expense and average rates include the interest effect of associated interest rate exchange agreements.

Net Interest Income

Net interest income in the first six months of 2010 was $720 million, a 22% decrease from $918 million in the first six months of 2009. This decrease was driven primarily by the following:

 

   

Interest income on non-MBS investments decreased $8 million in the first six months of 2010 compared to the first six months of 2009. The decrease consisted of a $9 million decrease attributable to lower average yields on non-MBS investments and a $1 million increase attributable to an 11% increase in average non-MBS investment balances.

 

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Interest income from the mortgage portfolio decreased $228 million in the first six months of 2010 compared to the first six months of 2009. The decrease consisted of a $59 million decrease attributable to lower average yields on MBS investments, a $165 million decrease attributable to a 22% decrease in average MBS outstanding, and a $16 million decrease attributable to a 19% decrease in average mortgage loans outstanding, partially offset by a $12 million increase attributable to higher average yields on mortgage loans outstanding. Interest income from the mortgage portfolio includes the impact of cumulative retrospective adjustments for the amortization of net purchase discounts from the acquisition dates of the MBS and mortgage loans, which increased interest income by $4 million in the first six months of 2010 and decreased interest income by $23 million in the first six months of 2009. This increase was primarily due to faster projected prepayment speeds during the first six months of 2010.

 

   

Interest income from advances decreased $1.2 billion in the first six months of 2010 compared to the first six months of 2009. The decrease consisted of a $542 million decrease attributable to lower average yields and a $650 million decrease attributable to a 44% decrease in average advances outstanding, reflecting lower member demand during the first six months of 2010 relative to the first six months of 2009. In addition, members and nonmember borrowers prepaid $14.6 billion of advances in the first six months of 2010 compared to $14.1 billion in the first six months of 2009. As a result, interest income was increased by net prepayment fees of $39 million in the first six months of 2010 and $20 million in the first six months of 2009. The increased prepayment fees were primarily due to a significant decline in the interest rate environment since the advances were originated and to longer remaining terms for several large advances that were prepaid during the first six months of 2010.

 

   

Interest expense on consolidated obligations (bonds and discount notes) decreased $1.2 billion in the first six months of 2010 compared to the first six months of 2009. The decrease consisted of a $759 million decrease attributable to lower interest rates on consolidated obligations and a $477 million decrease attributable to lower average consolidated obligation balances, which paralleled the decline in advances and MBS investments. Lower interest rates enabled the Bank to refinance matured or called debt at lower rates.

The net interest margin was 82 basis points for the first six months of 2010, 15 basis points higher than the net interest margin for the first six months of 2009, which was 67 basis points. The net interest spread was 79 basis points for the first six months of 2010, 16 basis points higher than the net interest spread for the first six months of 2009, which was 63 basis points. These improvements were primarily due to an increase in advance prepayment fees and a higher net interest spread on the mortgage portfolio.

The decrease in net interest income was partially offset by the decrease in net interest expense on derivative instruments used in economic hedges, recognized in “Other Loss.” The decrease in net interest expense was primarily due to the impact of lower interest rates throughout the first six months of 2010 on the floating leg of the interest rate swaps.

Member demand for wholesale funding from the Bank can vary greatly depending on a number of factors, including economic and market conditions, competition from other wholesale funding sources, member deposit inflows and outflows, the activity level of the primary and secondary mortgage markets, and strategic decisions made by individual member institutions. As a result, Bank asset levels and operating results may vary significantly from period to period.

 

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Other Loss

The following table presents the components of “Other Loss” for the six months ended June 30, 2010 and 2009.

 

     Six Months Ended  
        
(In millions)    June 30, 2010     June 30, 2009  
   

Other Loss:

    

Services to members

   $      $ 1   

Net (loss)/gain on trading securities

     (1     1   

Total other-than-temporary impairment loss on held-to-maturity securities

     (382     (2,439

Portion of loss recognized in other comprehensive income/(loss)

     180        2,263   
   

Net other-than-temporary impairment loss on held-to-maturity securities

     (202     (176

Net loss on advances and consolidated obligation bonds held at fair value

     (121     (361

Net (loss)/gain on derivatives and hedging activities

     (159     258   

Other

     3        2   
   

Total Other Loss

   $ (480   $ (275
   

Net Other-Than-Temporary Impairment Loss on Held-to-Maturity Securities – The Bank recognized a $202 million credit-related OTTI charge on PLRMBS during the first six months of 2010, compared to a $176 million credit-related OTTI charge on PLRMBS during the first six months of 2009. Additional information about the OTTI charge is provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Investments” and in Note 5 to the Financial Statements.

Net Loss on Advances and Consolidated Obligation Bonds Held at Fair Value – The following table presents the net loss on advances and consolidated obligation bonds held at fair value, for which the Bank elected the fair value option for the six months ended June 30, 2010 and 2009.

 

     Six Months Ended  
        
(In millions)    June 30, 2010     June 30, 2009  
   

Advances

   $ (45   $ (321

Consolidated obligation bonds

     (76     (40
   

Total

   $ (121   $ (361
   

For the first six months of 2010, the unrealized net fair value losses on advances were primarily driven by the increased short-term interest rate environment relative to the actual coupon rates on the Bank’s advances. The unrealized net fair value losses on consolidated obligation bonds were primarily driven by the decreased long-term interest rate environment relative to the actual coupon rates on the consolidated obligation bonds.

For the first six months of 2009, the unrealized net fair value losses on advances were primarily driven by the increased long-term interest rate environment relative to the actual coupon rates on the Bank’s advances. The unrealized net fair value losses on consolidated obligation bonds were primarily driven by the decreased short-term interest rate environment relative to the actual coupon rates on the consolidated obligation bonds.

Net (Loss)/Gain on Derivatives and Hedging Activities – The following table shows the accounting classification of hedges and the categories of hedged items that contributed to the gains and losses on derivatives and hedged items that were recorded in “Net (loss)/gain on derivatives and hedging activities” in the first six months of 2010 and 2009.

 

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Sources of Gains/(Losses) Recorded in Net (Loss)/Gain on Derivatives and Hedging Activities

Six Months Ended June 30, 2010, Compared to Six Months Ended June 30, 2009

 

(In millions)   June 30, 2010     June 30, 2009  
    Gain/(Loss)    

Net Interest
Income/

(Expense) on

          Gain/(Loss)    

Net Interest
Income/

(Expense) on

       
Hedged Item   Fair Value
Hedges, Net
  Economic
Hedges
   

Economic
Hedges

    Total     Fair Value
Hedges, Net
    Economic
Hedges
   

Economic
Hedges

    Total  
   

Advances:

               

Elected for fair value option

  $   $ 33      $ (258   $ (225   $      $ 353      $ (342   $ 11   

Not elected for fair value option

        (8     (25     (33     (28     102        (86     (12

Consolidated obligations:

               

Elected for fair value option

        19        97        116               130        (109     21   

Not elected for fair value option

    5     (101     79        (17     52        (126     312        238   
   

Total

  $ 5   $ (57   $ (107   $ (159   $ 24      $ 459      $ (225   $ 258   
   

During the first six months of 2010, net losses on derivatives and hedging activities totaled $159 million compared to net gains of $258 million in the first six months of 2009. These amounts included net interest expense on derivative instruments used in economic hedges of $107 million in the first six months of 2010, compared to net interest expense on derivative instruments used in economic hedges of $225 million in the first six months of 2009. The decrease in net interest expense was primarily due to the impact of lower interest rates throughout the first six months of 2010 on the floating leg of the interest rate swaps.

Excluding the $107 million impact from net interest expense on derivative instruments used in economic hedges, net losses for the first six months of 2010 totaled $52 million as detailed above. The $52 million in net losses were primarily attributable to a decrease in interest rates during the first six months of 2010.

Excluding the $225 million impact from net interest expense on derivative instruments used in economic hedges, net gains for the first six months of 2009 totaled $483 million as detailed above. The $483 million in net gains were primarily attributable to a decrease in interest rates during the first six months of 2009.

The gains or losses on derivatives and associated hedged items and financial instruments carried at fair value (valuation adjustments) during the first six months of 2010 were primarily driven by changes in overall interest rate spreads and the reversal of prior period gains and losses.

The ongoing impact of these valuation adjustments on the Bank cannot be predicted, and the Bank’s retained earnings in the future may not be sufficient to fully offset the impact of these valuation adjustments. The effects of these valuation adjustments may lead to significant volatility in future earnings, including earnings available for dividends.

Return on Average Equity

Return on average equity (ROE) was 1.87% (annualized) for the second quarter of 2010, compared to 12.49% (annualized) for the second quarter of 2009. This decrease reflected the decrease in net income in the second quarter of 2010, partially offset by the decline in average equity, which decreased 35%, to $6.3 billion in the second quarter of 2010 from $9.7 billion in the second quarter of 2009.

ROE was 3.90% (annualized) for the first six months of 2010, compared to 8.68% (annualized) for the first six months of 2009. This decrease reflected the decrease in net income in the first six months of 2010, partially offset by the decline in average equity, which decreased 36%, to $6.3 billion in the first six months of 2010 from $9.9 billion in the first six months of 2009.

Dividends and Retained Earnings

By regulations governing the operations of the FHLBanks, dividends may be paid only out of current net earnings or previously retained earnings. As required by the regulations, the Bank has a formal Retained Earnings and Dividend Policy that is reviewed at least annually by the Bank’s Board of Directors. The Board

 

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of Directors may amend the Retained Earnings and Dividend Policy from time to time. The Bank’s Retained Earnings and Dividend Policy establishes amounts to be retained in restricted retained earnings, which are not made available for dividends in the current dividend period. The Bank may be restricted from paying dividends if it is not in compliance with any of its minimum capital requirements or if payment would cause the Bank to fail to meet any of its minimum capital requirements. In addition, the Bank may not pay dividends if any principal or interest due on any consolidated obligation has not been paid in full or is not expected to be paid in full, or, under certain circumstances, if the Bank fails to satisfy certain liquidity requirements under applicable regulations.

The regulatory liquidity requirements state that each FHLBank must (i) maintain eligible high quality assets (advances with a maturity not exceeding five years, U.S. Treasury securities investments, and deposits in banks or trust companies) in an amount equal to or greater than the deposits received from members, and (ii) hold contingency liquidity in an amount sufficient to meet its liquidity needs for at least five business days without access to the consolidated obligations markets. At June 30, 2010, advances maturing within five years totaled $88.0 billion, significantly in excess of the $0.2 billion of member deposits on that date. At December 31, 2009, advances maturing within five years totaled $125.2 billion, also significantly in excess of the $0.2 billion of member deposits on that date. In addition, as of June 30, 2010, and December 31, 2009, the Bank’s estimated total sources of funds obtainable from liquidity investments, repurchase agreement borrowings collateralized by the Bank’s marketable securities, and advance repayments would have allowed the Bank to meet its liquidity needs for more than 90 days without access to the consolidated obligations markets.

Retained Earnings Related to Valuation Adjustments – In accordance with the Bank’s Retained Earnings and Dividend Policy, the Bank retains in restricted retained earnings any cumulative net gains in earnings (net of applicable assessments) resulting from valuation adjustments. As the cumulative net gains are reversed by periodic net losses and settlements of contractual interest cash flows, the amount of the cumulative net gains decreases. The amount of retained earnings required by this provision of the policy is therefore decreased, and that portion of the previously restricted retained earnings becomes unrestricted and may be made available for dividends. The retained earnings restricted in accordance with this provision of the Bank’s Retained Earnings and Dividend Policy totaled $79 million at June 30, 2010, and $181 million at December 31, 2009.

Other Retained Earnings – Targeted Buildup – In addition to any cumulative net gains resulting from valuation adjustments, the Bank holds an additional amount in restricted retained earnings intended to protect members’ paid-in capital from the effects of an extremely adverse credit event, an extremely adverse operations risk event, an extremely high level of quarterly losses related to the Bank’s derivatives and associated hedged items and financial instruments carried at fair value, and the risk of higher-than-anticipated credit losses related to OTTI of PLRMBS, especially in periods of extremely low net income resulting from an adverse interest rate environment.

The Board of Directors has set the targeted amount of restricted retained earnings at $1.8 billion. The retained earnings restricted in accordance with this provision of the Retained Earnings and Dividend Policy totaled $1.3 billion at June 30, 2010, and $1.1 billion at December 31, 2009.

For more information on these two categories of restricted retained earnings, see Note 13 to the Financial Statements in the Bank’s 2009 Form 10-K.

Dividends – On July 29, 2010, the Bank’s Board of Directors declared a cash dividend for the second quarter of 2010 at an annualized rate of 0.44%. The Bank recorded the second quarter dividend on July 29, 2010, the day it was declared by the Board of Directors. The Bank expects to pay the second quarter dividend (including dividends on mandatorily redeemable capital stock), which will total $14 million, on or about

 

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August 12, 2010. On July 30, 2009, the Bank’s Board of Directors declared a cash dividend for the second quarter of 2009 at an annualized rate of 0.84%. The total amount of the dividend was $28 million and was recorded and paid during the third quarter of 2009.

The Bank’s dividend rate decreased to 0.35% (annualized) for the first six months of 2010, compared to 0.42% (annualized) for the first six months of 2009. The Bank did not pay a dividend for the first quarter of 2009.

The Bank expects to pay the second quarter 2010 dividend in cash rather than stock form to comply with Finance Agency rules, which do not permit the Bank to pay dividends in the form of capital stock if the Bank’s excess stock exceeds 1% of its total assets. As of June 30, 2010, the Bank’s excess capital stock totaled $7.7 billion, or 4.84% of total assets.

The Bank will continue to monitor the condition of its PLRMBS portfolio, its overall financial performance and retained earnings, developments in the mortgage and credit markets, and other relevant information as the basis for determining the status of dividends in future quarters.

For more information on the Bank’s Retained Earnings and Dividend Policy, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations – Comparison of 2009 to 2008 – Dividends and Retained Earnings” in the Bank’s 2009 Form 10-K.

Financial Condition

Total assets were $158.2 billion at June 30, 2010, an 18% decrease from $192.9 billion at December 31, 2009, primarily as a result of a decline in advances, which decreased by $37.9 billion, or 28%, to $95.7 billion at June 30, 2010, from $133.6 billion at December 31, 2009. In addition, held-to-maturity securities decreased to $33.6 billion at June 30, 2010, from $36.9 billion at December 31, 2009, while Federal funds sold increased to $14.5 billion at June 30, 2010, from $8.2 billion at December 31, 2009. Average total assets were $168.2 billion for the second quarter of 2010, a 35% decrease compared to $257.9 billion for the second quarter of 2009. Average total assets were $176.7 billion for the first six months of 2010, a 37% decrease compared to $279.8 billion for the first six months of 2009. Average advances were $107.0 billion for the second quarter of 2010, a 44% decrease from $192.7 billion for the second quarter of 2009. Average advances were $116.0 billion for the first six months of 2010, a 44% decrease from $208.3 billion for the first six months of 2009.

The continued decline in member advance demand reflected general economic conditions and conditions in the mortgage and credit markets. Member liquidity remained high and lending activity remained low. Held-to-maturity securities decreased primarily because of principal payments, prepayments, and maturities in the MBS portfolio and OTTI charges recognized on certain PLRMBS. The Bank increased its use of Federal funds sold to invest the proceeds from advance prepayments.

Advances outstanding at June 30, 2010, included unrealized gains of $1.0 billion, of which $476 million represented unrealized gains on advances hedged in accordance with the accounting for derivative instruments and hedging activities and $523 million represented unrealized gains on economically hedged advances that are carried at fair value in accordance with the fair value option. Advances outstanding at December 31, 2009, included unrealized gains of $1.1 billion, of which $524 million represented unrealized gains on advances hedged in accordance with the accounting for derivative instruments and hedging activities and $616 million represented unrealized gains on economically hedged advances that are carried at fair value in accordance with the fair value option. The overall decrease in the unrealized gains of the hedged advances and advances carried at fair value from December 31, 2009, to June 30, 2010, was primarily attributable to a reversal of prior period gains, partially offset by the decreased long-term interest rate environment relative to the actual coupon rates on the Bank’s advances.

 

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Total liabilities were $151.9 billion at June 30, 2010, a 19% decrease from $186.6 billion at December 31, 2009, reflecting decreases in consolidated obligations outstanding from $180.3 billion at December 31, 2009, to $145.3 billion at June 30, 2010. The decrease in consolidated obligations outstanding paralleled the decrease in assets during the first six months of 2010. Average total liabilities were $161.9 billion for the second quarter of 2010, a 35% decrease compared to $248.2 billion for the second quarter of 2009. Average total liabilities were $170.4 billion for the first six months of 2010, a 37% decrease compared to $269.8 billion for the first six months of 2009. The decrease in average liabilities reflects decreases in average consolidated obligations, paralleling the decline in average assets. Average consolidated obligations were $154.0 billion in the second quarter of 2010 and $240.8 billion in the second quarter of 2009. Average consolidated obligations were $162.4 billion in the first six months of 2010 and $261.6 billion in the first six months of 2009.

Consolidated obligations outstanding at June 30, 2010, included unrealized losses of $2.0 billion on consolidated obligation bonds hedged in accordance with the accounting for derivative instruments and hedging activities and unrealized losses of $19 million on economically hedged consolidated obligation bonds that are carried at fair value in accordance with the fair value option. Consolidated obligations outstanding at December 31, 2009, included unrealized losses of $1.9 billion on consolidated obligation bonds hedged in accordance with the accounting for derivative instruments and hedging activities and unrealized gains of $53 million on economically hedged consolidated obligation bonds that are carried at fair value in accordance with the fair value option. The overall increase in the unrealized losses on the hedged consolidated obligation bonds and the consolidated obligation bonds carried at fair value from December 31, 2009, to June 30, 2010, was primarily attributable to the reversal of prior period gains.

As provided by the FHLBank Act or regulations governing the operations of the FHLBanks, all FHLBanks have joint and several liability for all FHLBank consolidated obligations. The joint and several liability regulation authorizes the Finance Agency to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor. The Bank has never been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank, and as of June 30, 2010, and through the filing date of this report, does not believe that it is probable that it will be asked to do so. The par amount of the outstanding consolidated obligations of all 12 FHLBanks was $846.5 billion at June 30, 2010, and $930.6 billion at December 31, 2009.

As of June 30, 2010, Standard & Poor’s Rating Services (Standard & Poor’s) rated the FHLBanks’ consolidated obligations
AAA/A-1+, and Moody’s Investors Service (Moody’s) rated them Aaa/P-1. As of June 30, 2010, Standard & Poor’s assigned ten FHLBanks, including the Bank, a long-term credit rating of AAA and assigned the FHLBank of Seattle and the FHLBank of Chicago a long-term credit rating of AA+. On July 2, 2010, Standard & Poor’s revised the FHLBank of Seattle’s outlook to negative. As of June 30, 2010, Moody’s continued to assign all the FHLBanks a long-term credit rating of Aaa. Changes in the long-term credit ratings of individual FHLBanks do not necessarily affect the credit rating of the consolidated obligations issued on behalf of the FHLBanks. Rating agencies may change a rating from time to time because of various factors, including operating results or actions taken, business developments, or changes in their opinion regarding, among other factors, the general outlook for a particular industry or the economy.

The Bank evaluated the publicly disclosed FHLBank regulatory actions and long-term credit ratings of other FHLBanks as of June 30, 2010, and as of each period end presented, and determined that they have not materially increased the likelihood that the Bank will be required to repay any principal or interest associated with consolidated obligations for which the Bank is not the primary obligor.

Financial condition is further discussed under “Segment Information.”

 

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Segment Information

The Bank uses an analysis of financial performance based on the balances and adjusted net interest income of two operating segments, the advances-related business and the mortgage-related business, as well as other financial information, to review and assess financial performance and to determine the allocation of resources to these two major business segments. For purposes of segment reporting, adjusted net interest income includes interest income and expense associated with economic hedges that are recorded in “Net (loss)/gain on derivatives and hedging activities” in other income and excludes interest expense that is recorded in “Mandatorily redeemable capital stock.” Other key financial information, such as any OTTI loss on the Bank’s held-to-maturity PLRMBS, other expenses, and assessments, are not included in the segment reporting analysis, but are incorporated into management’s overall assessment of financial performance. For a reconciliation of the Bank’s operating segment adjusted net interest income to the Bank’s total net interest income, see Note 10 to the Financial Statements.

Advances-Related Business. The advances-related business consists of advances and other credit products, related financing and hedging instruments, liquidity and other non-MBS investments associated with the Bank’s role as a liquidity provider, and capital stock.

Assets associated with this segment decreased to $131.7 billion (83% of total assets) at June 30, 2010, from $161.4 billion (84% of total assets) at December 31, 2009, representing a decrease of $29.7 billion, or 18%. The continued decline in member advance demand reflected general economic conditions and conditions in the mortgage and credit markets. Member liquidity remained high and lending activity remained low.

Adjusted net interest income for this segment is derived primarily from the difference, or spread, between the yield on advances and non-MBS investments and the cost of the consolidated obligations funding these assets, including the cash flows from associated interest rate exchange agreements.

Adjusted net interest income for this segment was $145 million in the second quarter of 2010, a decrease of $44 million, or 23%, compared to $189 million in the second quarter of 2009. In the first six months of 2010, adjusted net interest income for this segment was $283 million, a decrease of $110 million, or 28%, compared to $393 million in the first six months of 2009. The declines were primarily attributable to a lower net interest spread on advances, as favorably priced short-term debt issued in the fourth quarter of 2008 matured by yearend 2009, and a lower volume of advances. In addition, adjusted net interest income for the first six months of 2010 reflected a lower yield on capital because of the lower interest rate environment during the first six months of 2010.

Members and nonmember borrowers prepaid $8.2 billion of advances in the second quarter of 2010 compared to $11.4 billion in the second quarter of 2009. Members and nonmember borrowers prepaid $14.6 billion of advances in the first six months of 2010 compared to $14.1 billion in the first six months of 2009. As a result, interest income was increased by net prepayment fees of $28 million in the second quarter of 2010 and $18 million in the second quarter of 2009. Interest income was increased by net prepayment fees of $39 million in the first six months of 2010 and $20 million in the first six months of 2009. The increased net prepayment fees were primarily due to a significant decline in the interest rate environment since the advances were originated and to longer remaining terms for several large advances that were prepaid during the first six months of 2010.

Adjusted net interest income for this segment represented 48% and 62% of total adjusted net interest income for the second quarter of 2010 and 2009, respectively, and 49% and 61% of total adjusted net interest income for the first six months of 2010 and 2009, respectively.

 

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Advances – The par amount of advances outstanding decreased by $37.6 billion, or 28%, to $94.7 billion at June 30, 2010, from $132.3 billion at December 31, 2009. The decrease reflects a $16.3 billion decrease in fixed rate advances, a $20.7 billion decrease in adjustable rate advances, and a $0.6 billion decrease in daily variable rate advances.

Advances outstanding to the Bank’s four largest borrowers totaled $58.9 billion at June 30, 2010, a net decrease of $32.3 billion from $91.2 billion at December 31, 2009. The decrease was primarily attributable to lower advance borrowings by three of the four largest borrowers. The remaining $5.3 billion decrease in total advances outstanding was attributable to a net decrease in advances to other members of varying asset sizes and charter types. In total, 42 institutions increased their advances during the first six months of 2010, while 155 institutions decreased their advances.

Average advances were $107.0 billion in the second quarter of 2010, a 44% decrease from $192.7 billion in the second quarter of 2009. Average advances were $116.0 billion in the first six months of 2010, a 44% decrease from $208.3 billion in the first six months of 2009. The decline in member advance demand reflected general economic conditions and conditions in the mortgage and credit markets. Member liquidity remained high and lending activity remained low.

The components of the advances portfolio at June 30, 2010, and December 31, 2009, are presented in the following table.

Advances Portfolio by Product Type

 

(In millions)    June 30, 2010    December 31, 2009
 

Standard advances:

     

Adjustable – London Inter-Bank Offered Rate (LIBOR)

   $ 40,262    $ 60,993

Adjustable – other indices

     283      288

Fixed

     41,139      48,606

Daily variable rate

     867      1,496
 

Subtotal

     82,551      111,383
 

Customized advances:

     

Adjustable – LIBOR, with caps and/or floors and PPS(1)

     1,125      1,125

Fixed – amortizing

     437      485

Fixed with PPS(1)

     7,202      15,688

Fixed with caps and PPS(1)

     200      200

Fixed – callable at member’s option

     8      19

Fixed – callable at Bank’s option with PPS(1)

     61     

Fixed – putable at Bank’s option

     2,657      2,910

Fixed – putable at Bank’s option with PPS(1)

     448      503
 

Subtotal

     12,138      20,930
 

Total par value

     94,689      132,313

Hedging valuation adjustments

     476      524

Fair value option valuation adjustments

     523      616

Net unamortized premiums

     59      106
 

Total

   $ 95,747    $ 133,559
 

 

(1) Partial prepayment symmetry (PPS) means that the Bank may charge the borrower a prepayment fee or pay the borrower a prepayment credit, depending on certain circumstances, such as movements in interest rates, when the advance is prepaid. Any prepayment credit on an advance with PPS would be limited to the lesser of 10% of the par value of the advance or the gain recognized on the termination of the associated interest rate swap, which may also include a similar contractual gain limitation.

Non-MBS Investments – The Bank’s non-MBS investment portfolio consists of financial instruments that are used primarily to facilitate the Bank’s role as a cost-effective provider of credit and liquidity to members. These investments are also used as a source of liquidity to meet the Bank’s financial obligations on a timely basis, which may supplement or reduce earnings. The Bank’s total non-MBS investment portfolio was $27.5 billion as of June 30, 2010, an increase of $8.7 billion, or 47%, from $18.8 billion as of December 31, 2009, primarily due to an increase in Federal funds sold.

 

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Cash and Due from Banks – Cash and due from banks decreased to $7.6 billion at June 30, 2010, from $8.3 billion at December 31, 2009. A significant portion of the cash and due from banks at June 30, 2010, was due to advance prepayments, which resulted in cash held at the Federal Reserve Bank of San Francisco.

Borrowings – Consistent with the decrease in advances, total liabilities (primarily consolidated obligations) funding the advances-related business decreased $29.8 billion, or 19%, from $155.2 billion at December 31, 2009, to $125.4 billion at June 30, 2010. For further information and discussion of the Bank’s joint and several liability for FHLBank consolidated obligations, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition.”

To meet the specific needs of certain investors, fixed and adjustable rate consolidated obligation bonds may contain embedded call options or other features that result in complex coupon payment terms. When these consolidated obligation bonds are issued on behalf of the Bank, typically the Bank simultaneously enters into interest rate exchange agreements with features that offset the complex features of the bonds and, in effect, convert the bonds to adjustable rate instruments tied to an index, primarily LIBOR. For example, the Bank uses fixed rate callable bonds that are typically offset with interest rate exchange agreements with call features that offset the call options embedded in the callable bonds. This combined financing structure enables the Bank to meet its funding needs at costs not generally attainable solely through the issuance of comparable term non-callable debt.

At June 30, 2010, the notional amount of interest rate exchange agreements associated with the advances-related business totaled $182.1 billion, of which $44.2 billion were hedging advances, $135.9 billion were hedging consolidated obligations, $1.1 billion were hedging FFCB investments, and $0.9 billion were interest rate exchange agreements that the Bank entered into as an intermediary between exactly offsetting derivatives transactions with members and other counterparties. At December 31, 2009, the notional amount of interest rate exchange agreements associated with the advances-related business totaled $220.8 billion, of which $53.7 billion were hedging advances, $166.5 billion were hedging consolidated obligations, and $0.6 billion were interest rate exchange agreements that the Bank entered into as an intermediary between exactly offsetting derivatives transactions with members and other counterparties. The hedges associated with advances and consolidated obligations were primarily used to convert the fixed rate cash flows and non-LIBOR-indexed cash flows of the advances and consolidated obligations to adjustable rate LIBOR-indexed cash flows or to manage the interest rate sensitivity and net repricing gaps of assets, liabilities, and interest rate exchange agreements.

FHLBank System consolidated obligation bonds and discount notes, along with similar debt securities issued by other government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac, are generally referred to as agency debt. The agency debt market is a large sector of the debt capital markets. The costs of fixed rate debt issued by the FHLBanks and the other GSEs generally rise and fall with increases and decreases in general market interest rates. For more information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Overview – Funding and Liquidity” in the Bank’s 2009 Form 10-K.

 

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Since December 16, 2008, the Federal Open Market Committee has not changed the target Federal funds rate. During the first six months of 2010, yields on long-term U.S. Treasury securities declined because of increased investor demand for U.S. Treasury securities as a result of higher European sovereign risks and lower inflation expectations. Since December 31, 2009, 3-month LIBOR increased from 0.25% to 0.53% as credit and liquidity conditions in the short-term interbank lending market deteriorated. The following table provides selected market interest rates as of the dates shown.

 

Market Instrument   June 30, 2010     December 31, 2009     June 30, 2009     December 31, 2008  
   

Federal Reserve target rate for overnight Federal funds

  0-0.25   0-0.25   0-0.25   0-0.25

3-month Treasury bill

  0.18      0.06      0.19      0.13   

3-month LIBOR

  0.53      0.25      0.60      1.43   

2-year Treasury note

  0.61      1.14      1.12      0.77   

5-year Treasury note

  1.78      2.68      2.56      1.55   

The following table presents a comparison of the average cost of FHLBank System consolidated obligation bonds relative to 3-month LIBOR and discount notes relative to comparable term LIBOR in the first six months of 2010 and 2009. With respect to consolidated obligation bonds, the decision by the Federal Reserve to end its program to purchase term GSE debt on March 31, 2010, had very little impact on relative borrowing costs. In the first six months of 2010, the Bank experienced a higher cost on discount notes relative to LIBOR compared to a year ago. The higher relative cost was primarily a result of a decline in LIBOR.

 

     Spread to LIBOR of Average Cost of
Consolidated Obligations  for the

Six Months Ended
(In basis points)    June 30, 2010    June 30, 2009
 

Consolidated obligation bonds

   –15.7    –16.4

Consolidated obligation discount notes (one month and greater)

   –17.7    –61.5

At June 30, 2010, the Bank had $112.5 billion of swapped non-callable bonds and $14.9 billion of swapped callable bonds that primarily funded advances and non-MBS investments. The swapped non-callable and callable bonds combined represented 98% of the Bank’s total consolidated obligation bonds outstanding. At December 31, 2009, the Bank had $130.7 billion of swapped non-callable bonds and $25.4 billion of swapped callable bonds that primarily funded advances and non-MBS investments. These swapped non-callable and callable bonds combined represented 96% of the Bank’s total consolidated obligation bonds outstanding.

These swapped callable and non-callable bonds are used in part to fund the Bank’s advances portfolio. In general, the Bank does not match-fund advances with consolidated obligations. Instead, the Bank uses interest rate exchange agreements, in effect, to convert the advances to floating rate LIBOR-indexed assets (except overnight advances and adjustable rate advances that are already indexed to LIBOR) and, in effect, to convert the consolidated obligation bonds to floating rate LIBOR-indexed liabilities.

Mortgage-Related Business. The mortgage-related business consists of MBS investments, mortgage loans acquired through the Mortgage Partnership Finance® (MPF®) Program, and the related financing and hedging instruments. (“Mortgage Partnership Finance” and “MPF” are registered trademarks of the Federal Home Loan Bank of Chicago.) Adjusted net interest income for this segment is derived primarily from the difference, or spread, between the yield on the MBS and mortgage loans and the cost of the consolidated obligations funding those assets, including the cash flows from associated interest rate exchange agreements.

At June 30, 2010, assets associated with this segment were $26.5 billion (17% of total assets), a decrease of $5.0 billion, or 16%, from $31.5 billion at December 31, 2009 (16% of total assets). The decrease was

 

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primarily due to principal payments, prepayments, and maturities in the MBS portfolio and OTTI charges recognized on certain PLRMBS. The MBS portfolio decreased $4.6 billion to $23.6 billion at June 30, 2010, from $28.2 billion at December 31, 2009, and mortgage loan balances decreased $0.2 billion to $2.8 billion at June 30, 2010, from $3.0 billion at December 31, 2009. In the second quarter of 2010, average MBS investments were $28.0 billion, a decrease of $8.6 billion compared to $36.6 billion in the second quarter of 2009. In the first six months of 2010, average MBS investments decreased $8.5 billion to $29.2 billion compared to $37.7 billion in the first six months of 2009. Average mortgage loans were $2.8 billion in the second quarter of 2010, a decrease of $0.7 billion from $3.5 billion in the second quarter of 2009. Average mortgage loans decreased $0.7 billion to $2.9 billion in the first six months of 2010 from $3.6 billion in the first six months of 2009.

Adjusted net interest income for this segment was $154 million in the second quarter of 2010, an increase of $36 million, or 31%, from $118 million in the second quarter of 2009. In the first six months of 2010, adjusted net interest income for this segment was $292 million, an increase of $38 million, or 15%, from $254 million in the first six months of 2009. The increases for the second quarter of 2010 and the first six months of 2010 were both primarily due to a rise in the average profit spread on the mortgage portfolio, reflecting favorable cumulative retrospective adjustments for the amortization of net purchase discounts from the acquisition dates of the MBS and mortgage loans and the favorable impact of lower interest rates, which enabled the Bank to refinance matured or called debt at lower rates.

Adjusted net interest income for this segment represented 52% and 38% of total adjusted net interest income for the second quarter of 2010 and 2009, respectively, and 51% and 39% of total adjusted net interest income for the first six months of 2010 and 2009, respectively.

MPF Program – Under the MPF Program, the Bank purchased conventional fixed rate conforming residential mortgage loans directly from eligible members. Participating members originated or purchased the mortgage loans, credit-enhanced them and sold them to the Bank, and generally retained the servicing of the loans. The Bank manages the interest rate risk, prepayment risk, and liquidity risk of each loan in its portfolio. The Bank and the member that sold the loan share in the credit risk of the loan. The Bank has not purchased any new loans since October 2006. For more information regarding credit risk, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – MPF Program” in the Bank’s 2009 Form 10-K.

At June 30, 2010, and December 31, 2009, the Bank held conventional fixed rate conforming mortgage loans purchased under one of two MPF products, MPF Plus or Original MPF, which are described in greater detail in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – MPF Program” in the Bank’s 2009 Form 10-K. Mortgage loan balances at June 30, 2010, and December 31, 2009, were as follows:

 

(In millions)    June 30, 2010     December 31, 2009  
   

MPF Plus

   $ 2,576      $ 2,800   

Original MPF

     231        257   
   

Subtotal

     2,807        3,057   

Net unamortized discounts

     (15     (18
   

Mortgage loans held for portfolio

     2,792        3,039   

Less: Allowance for credit losses

     (4     (2
   

Mortgage loans held for portfolio, net

   $ 2,788      $ 3,037   
   

 

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The Bank periodically reviews its mortgage loan portfolio to identify probable credit losses in the portfolio and to determine the likelihood of collection of the loans in the portfolio. The Bank maintains an allowance for credit losses, net of credit enhancements, on mortgage loans acquired under the MPF Program at levels management believes to be adequate to absorb estimated probable losses inherent in the total mortgage loan portfolio. The allowance for credit losses on the mortgage loan portfolio was as follows:

 

     Three Months Ended     Six Months Ended  
(Dollars in millions)    June 30, 2010     June 30, 2009     June 30, 2010     June 30, 2009  
   

Balance, beginning of the period

   $ 2.0      $ 1.1      $ 2.0      $ 1.0   

Chargeoffs – transferred to real estate owned

     (0.3            (0.7       

Recoveries

                            

Provision for credit losses

     1.9        0.9        2.3        1.0   
   

Balance, end of the period

   $ 3.6      $ 2.0      $ 3.6      $ 2.0   
   

Ratio of net charge-offs during the period to average loans outstanding during the period

     (0.01 )%          (0.02 )%     

The increase in the estimated allowance for credit losses as of June 30, 2010, arises primarily from the decline in the external ratings of the supplemental mortgage insurance (SMI) providers for three MPF Plus master commitments. Because the relevant participating financial institution (PFIs) have elected not to assume the credit enhancement obligations as their own, the Bank has discontinued paying the associated performance credit enhancement fees, in accordance with the terms of the applicable agreements. Formerly, upon a realized loss, the Bank would have withheld credit enhancement fees up to the amount of the SMI deductible to offset the loss. Because these fees are no longer owed to the PFI, they cannot be withheld to offset a loss. Instead, the Bank has now begun to directly recognize the potential loan losses in the related loss allowance account, in the amount of the foregone credit enhancement fees.

For more information on how the Bank determines its estimated allowance for credit losses on mortgage loans, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates – Allowance for Credit Losses – Mortgage Loans Acquired Under the MPF Program” in the Bank’s 2009 Form 10-K.

A mortgage loan is considered to be impaired when it is reported 90 days or more past due (nonaccrual) or when it is probable, based on current information and events, that the Bank will be unable to collect all principal and interest amounts due according to the contractual terms of the mortgage loan agreement.

The following table presents information on delinquent mortgage loans as of June 30, 2010, and December 31, 2009.

 

(Dollars in millions)    June 30, 2010     December 31, 2009  
Days Past Due    Number
of Loans
  

Mortgage

Loan Balance

    Number
of Loans
  

Mortgage

Loan Balance

 
   

30 – 59 days delinquent

   205    $ 22      243    $ 29   

60 – 89 days delinquent

   60      8      81      10   

90 days or more delinquent

   115      15      97      13   

In process of foreclosure(1)

   104      13      80      9   
   

Total

   484    $ 58      501    $ 61   
   

Nonaccrual loans(2)

   219    $ 28      177    $ 22   

Loans past due 90 days or more and still accruing interest

                    

Real estate owned inventory

   43    $ 4      26    $ 3   

Serious delinquency rate(3)

        0.98        0.70

 

(1) Includes loans for which the servicer has reported a decision to foreclose or to pursue a similar alternative, such as deed-in-lieu.
(2) Nonaccrual loans at June 30, 2010, included 22 loans, totaling $3 million, for which the borrower was in bankruptcy. Nonaccrual loans at December 31, 2009, included 23 loans, totaling $2 million, for which the borrower was in bankruptcy.
(3) Loans that are 90 days or more past due or in the process of foreclosure expressed as a percentage of the total conventional loan portfolio principal balance.

 

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The Bank manages the interest rate risk and prepayment risk of the mortgage loans by funding these assets with callable and non-callable debt and by limiting the size of the fixed rate mortgage loan portfolio.

MBS Investments – The Bank’s MBS portfolio was $23.6 billion, or 165% of Bank capital (as determined in accordance with regulations governing the operations of the FHLBanks), at June 30, 2010, compared to $28.2 billion, or 193% of Bank capital, at December 31, 2009. During the first six months of 2010, the Bank’s MBS portfolio decreased primarily because of principal payments, prepayments, and maturities in the MBS portfolio and OTTI charges recognized on certain PLRMBS. For a discussion of the composition of the Bank’s MBS portfolio and the Bank’s OTTI analysis of that portfolio, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management –Investments.”

Intermediate-term and long-term fixed rate MBS investments are subject to prepayment risk, and long-term adjustable rate MBS investments are subject to interest rate cap risk. The Bank has managed these risks by predominately purchasing intermediate-term fixed rate MBS (rather than long-term fixed rate MBS), funding the fixed rate MBS with a mix of non-callable and callable debt, and using interest rate exchange agreements with interest rate risk characteristics similar to callable debt.

Borrowings – Total consolidated obligations funding the mortgage-related business decreased $5.0 billion, or 16%, to $26.5 billion at June 30, 2010, from $31.5 billion at December 31, 2009, paralleling the decrease in mortgage portfolio assets. For further information and discussion of the Bank’s joint and several liability for FHLBank consolidated obligations, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition.”

At June 30, 2010, the notional amount of interest rate exchange agreements associated with the mortgage-related business totaled $15.9 billion, almost all of which hedged or was associated with consolidated obligations funding the mortgage portfolio.

At December 31, 2009, the notional amount of interest rate exchange agreements associated with the mortgage-related business totaled $14.2 billion, almost all of which hedged or was associated with consolidated obligations funding the mortgage portfolio.

Interest Rate Exchange Agreements

A derivatives transaction or interest rate exchange agreement is a financial contract whose fair value is generally derived from changes in the value of an underlying asset or liability. The Bank uses interest rate swaps; options to enter into interest rate swaps (swaptions); interest rate cap, floor, corridor, and collar agreements; and callable and putable interest rate swaps (collectively, interest rate exchange agreements) to manage its exposure to interest rate risks inherent in its normal course of business – lending, investment, and funding activities. For more information on the primary strategies that the Bank employs for using interest rate exchange agreements and the associated market risks, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Market Risk – Interest Rate Exchange Agreements” in the Bank’s 2009 Form 10-K.

 

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The following table summarizes the Bank’s interest rate exchange agreements by type of hedged item, hedging instrument, associated hedging strategy, accounting designation as specified under the accounting for derivative instruments and hedging activities, and notional amount as of June 30, 2010, and December 31, 2009.

 

(In millions)              
              Notional Amount
Hedging Instrument    Hedging Strategy  

Accounting

Designation

  

June 30,

2010

   December 31,
2009

Hedged Item: Advances

                      
Pay fixed, receive floating interest rate swap    Fixed rate advance converted to a LIBOR floating rate   Fair Value Hedge    $ 25,561    $ 28,859
Basis swap    Adjustable rate advance converted to a LIBOR floating rate   Economic Hedge(1)      2,000      2,000
Receive fixed, pay floating interest rate swap    LIBOR floating rate advance converted to a fixed rate   Economic Hedge(1)      150      150
Basis swap    Floating rate advance converted to another floating rate index to reduce interest rate sensitivity and repricing gaps   Economic Hedge(1)      153      158
Pay fixed, receive floating interest rate swap    Fixed rate advance converted to a LIBOR floating rate   Economic Hedge(1)      4,137      1,708
Pay fixed, receive floating interest rate swap; swap may be callable at the Bank’s option or putable at the counterparty’s option    Fixed rate advance (with or without an embedded cap) converted to a LIBOR floating rate; advance and swap may be callable or putable; matched to advance accounted for under the fair value option   Economic Hedge(1)      11,012      19,717
Interest rate cap, floor, corridor, and/or collar    Interest rate cap, floor, corridor, and/or collar embedded in an adjustable rate advance; matched to advance accounted for under the fair value option   Economic Hedge(1)      1,131      1,125

Subtotal Economic Hedges(1)

         18,583      24,858
Total               44,144      53,717

Hedged Item: Non-Callable Bonds

                 
Receive fixed or structured, pay floating interest rate swap    Fixed rate or structured rate non-callable bond converted to a LIBOR floating rate   Fair Value Hedge      61,525      62,317
Receive fixed or structured, pay floating interest rate swap    Fixed rate or structured rate non-callable bond converted to a LIBOR floating rate   Economic Hedge(1)      24,985      23,034
Receive fixed or structured, pay floating interest rate swap    Fixed rate or structured rate non-callable bond converted to a LIBOR floating rate; matched to non-callable bond accounted for under the fair value option   Economic Hedge(1)      45      505
Basis swap    Non-LIBOR floating rate non-callable bond converted to a LIBOR floating rate; matched to non-callable bond accounted for under the fair value option   Economic Hedge(1)      14,925      28,130
Basis swap    Floating rate non-callable bond converted to another floating rate index to reduce interest rate sensitivity and repricing gaps   Economic Hedge(1)      18,170      24,261
Pay fixed, receive floating interest rate swap    Floating rate bond converted to fixed rate non-callable debt that offsets the interest rate risk of mortgage assets   Economic Hedge(1)      3,635      2,980

 

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(In millions)              
              Notional Amount
Hedging Instrument    Hedging Strategy  

Accounting

Designation

  

June 30,

2010

   December 31,
2009

Subtotal Economic Hedges(1)

         61,760      78,910

Total

              123,285      141,227

Hedged Item: Callable Bonds

                 
Receive fixed or structured, pay floating interest rate swap with an option to call at the counterparty’s option    Fixed or structured rate callable bond converted to a LIBOR floating rate; swap is callable   Fair Value Hedge      7,230      13,035
Pay fixed, receive floating interest rate swap with an option to call at the counterparty’s option    Fixed rate callable bond converted to a LIBOR floating rate; swap is callable   Economic Hedge(1)           110
Receive fixed or structured, pay floating interest rate swap with an option to call at the counterparty’s option    Fixed or structured rate callable bond converted to a LIBOR floating rate; swap is callable   Economic Hedge(1)      1,380      3,280
Receive fixed or structured, pay floating interest rate swap with an option to call at the counterparty’s option    Fixed or structured rate callable bond converted to a LIBOR floating rate; swap is callable; matched to callable bond accounted for under the fair value option   Economic Hedge(1)      6,329      9,105

Subtotal Economic Hedges(1)

     7,709      12,495
Total      14,939      25,530

Hedged Item: Discount Notes

                 
Pay fixed, receive floating callable interest rate swap    Discount note converted to fixed rate callable debt that offsets the prepayment risk of mortgage assets   Economic Hedge(1)      1,502      1,685
Basis swap or receive fixed, pay floating interest rate swap    Discount note converted to one-month LIBOR or other short-term floating rate to hedge repricing gaps   Economic Hedge(1)      11,730      12,231
Pay fixed, receive floating non-callable interest rate swap    Discount note converted to fixed rate non-callable debt that offsets the interest rate risk of mortgage assets   Economic Hedge(1)      310     
Total               13,542      13,916

Hedged Item: Trading Securities

                 
Pay MBS rate, receive floating interest rate swap    MBS rate converted to a LIBOR floating rate   Economic Hedge(1)      6      8
Basis swap    Basis swap hedging floating rate Federal Farm Credit Bank (FFCB) bonds   Economic Hedge(1)      1,133     
Total               1,139      8

Hedged Item: Intermediary Positions

                 
Pay fixed, receive floating interest rate swap, and receive fixed, pay floating interest rate swap    Interest rate swaps executed with members offset by executing interest rate swaps with derivatives dealer counterparties   Economic Hedge(1)      50      46
Interest rate cap/floor    Stand-alone interest rate cap and/or floor executed with a member offset by executing an interest rate cap and/or floor with derivatives dealer counterparties   Economic Hedge(1)      870      570
Total               920      616
Total Notional Amount        $ 197,969    $ 235,014

 

(1) Economic hedges are derivatives that are matched to balance sheet instruments or other derivatives that do not meet the requirements for hedge accounting under the accounting for derivative instruments and hedging activities.

 

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At June 30, 2010, the total notional amount of interest rate exchange agreements outstanding was $198.0 billion, compared with $235.0 billion at December 31, 2009. The $37.0 billion decrease in the notional amount of derivatives during the first six months of 2010 was primarily due to a net $28.5 billion decrease in interest rate exchange agreements hedging consolidated obligation bonds and a net $9.6 billion decrease in interest rate exchange agreements hedging the market risk of fixed rate advances, partially offset by $1.1 billion in interest rate exchange agreements hedging FFCB bonds. The decrease in interest rate exchange agreements hedging consolidated obligation bonds reflects decreased use of interest rate exchange agreements that effectively converted the repricing frequency from three months to one month, and is consistent with the decline in the amount of bonds outstanding at June 30, 2010, relative to December 31, 2009. The notional amount serves as a basis for calculating periodic interest payments or cash flows received and paid.

The following tables categorize the notional amounts and estimated fair values of the Bank’s interest rate exchange agreements, unrealized gains and losses from the related hedged items, and estimated fair value gains and losses from financial instruments carried at fair value by product and type of accounting treatment as of June 30, 2010, and December 31, 2009.

 

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(In millions)                              

June 30, 2010

           
    

Notional
Amount

  

Fair Value of

Derivatives

    Unrealized
Gain/(Loss)
on Hedged
Items
    Financial
Instruments
Carried at
Fair Value
    Difference  
   

Fair value hedges:

           

Advances

   $ 25,561    $ (476   $ 476      $      $   

Non-callable bonds

     61,525      1,886        (1,895            (9

Callable bonds

     7,230      69        (58            11   
   

Subtotal

     94,316      1,479        (1,477            2   
   

Not qualifying for hedge accounting (economic hedges):

           

Advances

     18,583      (525            473        (52

Non-callable bonds

     61,710      388               7        395   

Non-callable bonds with embedded derivatives

     50                             

Callable bonds

     7,709      17               (3     14   

Discount notes

     13,542      (10                   (10

MBS – trading

     6                             

FFCB bonds

     1,133                             

Intermediated

     920                             
   

Subtotal

     103,653      (130            477        347   
   

Total excluding accrued interest

     197,969      1,349        (1,477     477        349   

Accrued interest

          343        (388     27        (18
   

Total

   $ 197,969    $ 1,692      $ (1,865   $ 504      $ 331   
   

 

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(In millions)                              
December 31, 2010                              
     Notional
Amount
   Fair Value of
Derivatives
    Unrealized
Gain/(Loss)
on Hedged
Items
    Financial
Instruments
Carried at
Fair Value
    Difference  
   

Fair value hedges:

           

Advances

   $ 28,859    $ (523   $ 524      $      $ 1   

Non-callable bonds

     62,317      1,883        (1,893            (10

Callable bonds

     13,035      32        (32              
   

Subtotal

     104,211      1,392        (1,401            (9
   

Not qualifying for hedge accounting (economic hedges):

           

Advances

     24,858      (560            529        (31

Non-callable bonds

     78,826      457               (20     437   

Non-callable bonds with embedded derivatives

     84      1                      1   

Callable bonds

     12,495      (41            100        59   

Discount notes

     13,916      60                      60   

MBS – trading

     8      (1                   (1

Intermediated

     616                             
   

Subtotal

     130,803      (84            609        525   
   

Total excluding accrued interest

     235,014      1,308        (1,401     609        516   

Accrued interest

          391        (395     60        56   
   

Total

   $ 235,014    $ 1,699      $ (1,796   $ 669      $ 572   
   

Embedded derivatives are bifurcated, and their estimated fair values are accounted for in accordance with the accounting for derivative instruments and hedging activities. The estimated fair values of the embedded derivatives are included as valuation adjustments to the host contract and are not included in the above table. The estimated fair values of these embedded derivatives were immaterial as of June 30, 2010, and December 31, 2009.

Because the periodic and cumulative net gains or losses on the Bank’s derivatives, hedged instruments, and certain assets and liabilities that are carried at fair value are primarily a matter of timing, the net gains or losses will generally reverse through changes in future valuations and settlements of contractual interest cash flows over the remaining contractual term to maturity, call date, or put date of the hedged financial instruments, associated interest rate exchange agreements, and financial instruments carried at fair value. However, the Bank may have instances in which the financial instruments or hedging relationships are terminated prior to maturity or prior to the call or put date. Terminating the financial instruments or hedging relationships may result in a realized gain or loss. In addition, the Bank may have instances in which it may sell trading securities prior to maturity, which may also result in a realized gain or loss.

The hedging and fair value option valuation adjustments during the first six months of 2010 were primarily driven by changes in overall interest rate spreads and the reversal of prior period gains and losses.

The ongoing impact of these valuation adjustments on the Bank cannot be predicted, and the Bank’s retained earnings in the future may not be sufficient to offset the impact of these valuation adjustments. The effects of these valuation adjustments may lead to significant volatility in future earnings, including earnings available for dividends.

 

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Credit Risk. For a discussion of derivatives credit exposure, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Derivatives Counterparties.”

Concentration Risk. The following table presents the concentration in derivatives with derivatives counterparties whose outstanding notional balances represented 10% or more of the Bank’s total notional amount of derivatives outstanding as of June 30, 2010, and December 31, 2009.

Concentration of Derivatives Counterparties

 

(Dollars in millions)         June 30, 2010     December 31, 2009  
Derivatives Counterparty    Credit  
Rating(1)  
   Notional
Amount
   Percentage of
Total
Notional Amount
    Notional
Amount
   Percentage of
Total
Notional Amount
 
   

Deutsche Bank AG

   A    $ 37,619    19   $ 36,257    15

JPMorgan Chase Bank, National Association

   AA      31,443    16        34,297    15   

Barclays Bank PLC

   AA      23,458    12        35,060    15   

BNP Paribas

   AA      20,509    10        25,388    11   

UBS AG

   A      20,007    10        13,759    6   
   

Subtotal

        133,036    67        144,761    62   

Others

   At least A      64,933    33        90,253    38   
   

Total

      $ 197,969    100   $ 235,014    100
   

 

(1) The credit ratings used by the Bank are based on the lowest of Moody’s, Standard & Poor’s, or comparable Fitch ratings.

Liquidity and Capital Resources

The Bank’s financial strategies are designed to enable the Bank to expand and contract its assets, liabilities, and capital in response to changes in membership composition and member credit needs. The Bank’s liquidity and capital resources are designed to support these financial strategies. The Bank’s primary source of liquidity is its access to the capital markets through consolidated obligation issuance. The Bank’s equity capital resources are governed by its capital plan.

The Federal Reserve concluded its program to purchase GSE debt on March 31, 2010. In total, the Federal Reserve purchased $172 billion of GSE debt, including $38 billion in FHLBank consolidated obligation bonds. The combination of declining FHLBank funding needs and continued investor demand for FHLBank debt has generally improved the FHLBanks’ ability to issue debt at reasonable costs. During the first six months of 2010, the FHLBanks issued $30 billion in global bonds and over $392 billion in auctioned discount notes.

Liquidity

The Bank strives to maintain the liquidity necessary to meet member credit demands, repay maturing consolidated obligations for which it is the primary obligor, meet other obligations and commitments, and respond to significant changes in membership composition. The Bank monitors its financial position in an effort to ensure that it has ready access to sufficient liquid funds to meet normal transaction requirements, take advantage of appropriate investment opportunities, and cover unforeseen liquidity demands.

The Bank maintains contingency liquidity plans to meet its obligations and the liquidity needs of members in the event of short-term operational disruptions at the Bank or the Office of Finance or short-term disruptions of the capital markets. In 2009, the Finance Agency established liquidity guidelines that require each FHLBank to maintain sufficient liquidity, through short-term investments, in an amount at least equal to its anticipated cash outflows under two different scenarios. One scenario assumes that the FHLBank cannot access the capital markets for a targeted period of 15 days and that during that time members do not renew

 

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any maturing, prepaid, and called advances. The second scenario assumes that the FHLBank cannot access the capital markets for a targeted period of five days and that during that period the Bank will automatically renew maturing and called advances for all members except very large, highly rated members.

Prior to establishing liquidity guidelines, the Finance Agency had issued a regulation on contingency liquidity that required each FHLBank to maintain at least five days of liquidity to enable it to meet its obligations without issuance of new consolidated obligations. This regulatory requirement does not stipulate that the Bank renew any maturing advances during the five-day timeframe. In addition to the Finance Agency’s regulatory requirement and guidelines on contingency liquidity, the Bank’s asset-liability management committee has established an operational guideline to maintain at least 90 days of liquidity to enable the Bank to meet its obligations in the event of a longer-term consolidated obligations market disruption. The Bank’s operational guideline assumes that mortgage assets can be used as a source of funds with the expectation that those assets can be used as collateral in the repurchase agreement markets. Under this guideline, the Bank maintained at least 90 days of liquidity at all times during the first six months of 2010 and during 2009. On a daily basis, the Bank models its cash commitments and expected cash flows for the next 90 days to determine its projected liquidity position.

The following table shows the Bank’s principal financial obligations due, estimated sources of funds available to meet those obligations, and the net difference between funds available and funds needed for the five-business-day and 90-day periods following June 30, 2010, and December 31, 2009. Also shown are additional contingent sources of funds from on-balance sheet collateral available for repurchase agreement borrowings.

 

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Principal Financial Obligations Due and Funds Available for Selected Periods

 

     As of June 30, 2010    As of December 31, 2009
(In millions)    5 Business
Days
   90 Days    5 Business
Days
   90 Days
 

Obligations due:

           

Commitments for new advances

   $    $    $ 32    $ 32

Commitments to purchase investments

     650      650          

Demand deposits

     1,538      1,538      1,647      1,647

Maturing member term deposits

     3      29      16      28

Discount note and bond maturities and expected exercises of bond call options

     1,950      28,846      7,830      52,493
 

Subtotal obligations

     4,141      31,063      9,525      54,200
 

Sources of available funds:

           

Maturing investments

     10,921      23,422      9,185      15,774

Cash at Federal Reserve Bank of San Francisco

     7,631      7,631      8,280      8,280

Proceeds from scheduled settlements of discount notes and bonds

     550      720      30      1,090

Loans to other FHLBanks

     15      15          

Maturing advances and scheduled prepayments

     1,412      18,727      4,762      36,134
 

Subtotal sources

     20,529      50,515      22,257      61,278
 

Net funds available

     16,388      19,452      12,732      7,078
 

Additional contingent sources of funds:(1)

           

Estimated borrowing capacity of securities available for repurchase agreement borrowings:

           

MBS

          17,173           19,457

Marketable money market investments

     6,299           3,339     

Temporary Liquidity Guarantee Program (TLGP) investments

     2,188      2,188      2,186      2,186

FFCB bonds

     1,132      1,132          
 

Subtotal contingent sources

     9,619      20,493      5,525      21,643
 

Total contingent funds available

   $ 26,007    $ 39,945    $ 18,257    $ 28,721
 

 

(1) The estimated amount of repurchase agreement borrowings obtainable from authorized securities dealers is subject to market conditions and the ability of securities dealers to obtain financing for the securities and transactions entered into with the Bank. The estimated maximum amount of repurchase agreement borrowings obtainable is based on the current par amount and estimated market value of MBS and other investments (not included in above figures) that are not pledged at the beginning of the period and subject to estimated collateral discounts taken by securities dealers.

For more information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Overview – Funding and Liquidity,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources – Liquidity,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Liquidity Risk” in the Bank’s 2009 Form 10-K.

 

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Regulatory Capital

The FHLBank Act and Finance Agency regulations specify that each FHLBank must meet certain minimum regulatory capital standards. The Bank must maintain (i) total regulatory capital in an amount equal to at least 4% of its total assets, (ii) leverage capital in an amount equal to at least 5% of its total assets, and (iii) permanent capital in an amount at least equal to its regulatory risk-based capital requirement. Regulatory capital and permanent capital are both defined as total capital stock outstanding, including mandatorily redeemable capital stock, and retained earnings. Regulatory capital and permanent capital do not include accumulated other comprehensive income/(loss). Leverage capital is defined as the sum of permanent capital weighted by a 1.5 multiplier plus non-permanent capital. (Non-permanent capital consists of Class A capital stock, which is redeemable upon six months’ notice. The Bank’s capital plan does not provide for the issuance of Class A capital stock.) The risk-based capital requirements must be met with permanent capital, which must be at least equal to the sum of the Bank’s credit risk, market risk, and operations risk capital requirements, all of which are calculated in accordance with the rules of the Finance Agency.

The following table shows the Bank’s compliance with the Finance Agency’s capital requirements at June 30, 2010, and December 31, 2009. During the first six months of 2010, the Bank’s risk-based capital required decreased from $6.2 billion at December 31, 2009, to $5.5 billion at June 30, 2010. The decrease was due to lower market risk capital requirements, reflecting the improvement in the Bank’s market value of capital relative to its book value of capital.

Regulatory Capital Requirements

 

     June 30, 2010     December 31, 2009  
(Dollars in millions)    Required     Actual     Required     Actual  
   

Risk-based capital

   $ 5,468      $ 14,320      $ 6,207      $ 14,657   

Total regulatory capital

   $ 6,328      $ 14,320      $ 7,714      $ 14,657   

Total capital-to-assets ratio

     4.00     9.05     4.00     7.60

Leverage capital

   $ 7,910      $ 21,479      $ 9,643      $ 21,984   

Leverage ratio

     5.00     13.58     5.00     11.40

The Bank’s total regulatory capital ratio increased to 9.05% at June 30, 2010, from 7.60% at December 31, 2009, primarily because of increased excess capital stock resulting from the decline in advances outstanding, coupled with the Bank’s decision not to repurchase excess capital stock in 2009 and the first quarter of 2010.

In light of the Bank’s strengthened regulatory capital position, the Bank plans to repurchase up to $500 million in excess capital stock on August 13, 2010. The amount of excess capital stock to be repurchased from any shareholder will be based on the shareholder’s pro rata ownership share of total capital stock outstanding as of the repurchase date, up to the amount of the shareholder’s excess capital stock.

The Bank’s capital requirements are more fully discussed in the Bank’s 2009 Form 10-K in Note 13 to the Financial Statements.

Risk Management

The Bank has an integrated corporate governance and internal control framework designed to support effective management of the Bank’s business activities and the risks inherent in these activities. As part of this framework, the Bank’s Board of Directors has adopted a Risk Management Policy and a Member Products Policy, which are reviewed regularly and reapproved at least annually. The Risk Management Policy establishes risk guidelines, limits (if applicable), and standards for credit risk, market risk, liquidity risk, operations risk, concentration risk, and business risk in accordance with Finance Agency regulations, the risk profile established by the Board of Directors, and other applicable guidelines in connection with the Bank’s

 

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capital plan and overall risk management. For more detailed information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management” in the Bank’s 2009 Form 10-K.

Advances. The Bank manages the credit risk associated with lending to members by monitoring the creditworthiness of the members and the quality and value of the assets they pledge as collateral. The Bank assigns credit quality ratings to each member and nonmember to identify the credit strength of each borrower. These ratings are based on results from the Bank’s credit model, which considers financial, regulatory, and other qualitative information, including regulatory examination reports. The internal ratings are reviewed on an ongoing basis using current available information, and are revised, if necessary, to reflect the borrower’s current financial position. Advance and collateral terms may be adjusted based on the results of this credit analysis. The Bank assigns each member and nonmember borrower an internal rating from one to ten, with one as the highest rating. During the first six months of 2010, the Bank’s internal member credit ratings reflected continued financial deterioration of some members and nonmember borrowers resulting from market conditions and other factors.

Pursuant to the Bank’s lending agreements with its members, the Bank limits the amount it will lend to a percentage of the market value or unpaid principal balance of pledged collateral, known as the borrowing capacity. The borrowing capacity percentage varies according to several factors, including the collateral type, the value assigned to the collateral, the results of the Bank’s collateral field review of the member’s collateral, the pledging method used for loan collateral (specific identification or blanket lien), data reporting frequency (monthly or quarterly), the member’s financial strength and condition, and the concentration of collateral type. Under the terms of the Bank’s lending agreements, the aggregate borrowing capacity of a member’s pledged eligible collateral must meet or exceed the total amount of the member’s outstanding advances, other extensions of credit, and certain other member obligations and liabilities. The Bank monitors each member’s aggregate borrowing capacity and collateral requirements on a daily basis, by comparing the member’s borrowing capacity to its obligations to the Bank, as required.

When a nonmember financial institution acquires some or all of the assets and liabilities of a member, including outstanding advances and Bank capital stock, the Bank may allow the advances to remain outstanding, at its discretion. The nonmember borrower is required to meet all the Bank’s credit and collateral requirements, including requirements regarding creditworthiness and collateral borrowing capacity.

The following tables present a summary of the status of the credit outstanding and overall collateral borrowing capacity of the Bank’s member and nonmember borrowers as of June 30, 2010, and December 31, 2009.

 

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Member and Nonmember Credit Outstanding and Collateral Borrowing Capacity

by Credit Quality Rating

 

(Dollars in millions)

 

June 30, 2010

  

  

      All Members and
Nonmembers
   Members and Nonmembers with Credit Outstanding  
                    Collateral Borrowing  Capacity(2)  

Member or Nonmember

Credit Quality Rating

   Number    Number    Credit
Outstanding(1)
   Total    Used  
   

1-3

   64    45    $ 9,196    $ 16,376    56

4-6

   205    136      86,784      194,656    45   

7-10

   134    92      4,914      10,100    49   
    

Total

   403    273    $ 100,894    $ 221,132    46
   
December 31, 2009   
     All Members and
Nonmembers
   Members and Nonmembers with Credit Outstanding  
                    Collateral Borrowing  Capacity(2)(3)  

Member or Nonmember

Credit Quality Rating

   Number    Number    Credit
Outstanding(1)
   Total    Used  
   

1-3

   68    52    $ 23,374    $ 36,202    65

4-6

   204    143      107,273      185,845    58   

7-10

   149    107      6,940      12,589    55   
    

Total

   421    302    $ 137,587    $ 234,636    59
   

 

  (1) Includes advances, letters of credit, the market value of swaps, estimated prepayment fees for certain borrowers, and the credit enhancement obligation on MPF loans.  
  (2) Collateral borrowing capacity does not represent any commitment to lend on the part of the Bank.
  (3) The collateral borrowing capacity for members and nonmembers with a credit quality rating of 1-3 and the total collateral borrowing capacity, as of December 31, 2009, have been revised.

 

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Member and Nonmember Credit Outstanding and Collateral Borrowing Capacity

by Unused Borrowing Capacity

(Dollars in millions)

June 30, 2010

 

Unused Borrowing Capacity    Number of
Members and
Nonmembers
with Credit
Outstanding
   Credit
Outstanding(1)
  

Collateral
Borrowing

Capacity(2)

 

0% - 10%

   14    $ 14,328    $ 15,862

11% - 25%

   32      8,592      10,378

26% - 50%

   60      52,039      95,036

More than 50%

   167      25,935      99,856
 

Total

   273    $ 100,894    $ 221,132
 

December 31, 2009

 

        
Unused Borrowing Capacity    Number of
Members and
Nonmembers
with Credit
Outstanding(3)
   Credit
Outstanding(1)(3)
  

Collateral
Borrowing

Capacity(2)(3)

 

0% - 10%

   24    $ 1,957    $ 2,136

11% - 25%

   43      33,154      42,353

26% - 50%

   80      94,026      145,466

More than 50%

   155      8,450      44,681
 

Total

   302    $ 137,587    $ 234,636
 

 

  (1) Includes advances, letters of credit, the market value of swaps, estimated prepayment fees for certain borrowers, and the credit enhancement obligation on MPF loans.  
  (2) Collateral borrowing capacity does not represent any commitment to lend on the part of the Bank.
  (3) Data as of December 31, 2009, have been revised.

Securities pledged as collateral are assigned borrowing capacities that reflect the securities’ pricing volatility and market liquidity risks. Securities are delivered to the Bank’s custodian when they are pledged. The Bank prices securities collateral on a daily basis or twice a month, depending on the availability and reliability of external pricing sources. Securities that are normally priced twice a month may be priced more frequently in volatile market conditions. The Bank benchmarks the borrowing capacities for securities collateral to the market on a periodic basis and may review and change the borrowing capacity for any security type at any time. As of June 30, 2010, the borrowing capacities assigned to U.S. Treasury securities and most agency securities ranged from 95% to 99.5% of their market value. The borrowing capacities assigned to private-label MBS, which must be rated AAA or AA when initially pledged, generally ranged from 50% to 85% of their market value, depending on the underlying collateral (residential mortgages, home equity loans, or commercial real estate).

The following table presents the securities collateral pledged by all members and by nonmembers with credit outstanding at June 30, 2010, and December 31, 2009.

 

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Composition of Securities Collateral Pledged

by Members and by Nonmembers with Credit Outstanding

 

(In millions)
     June 30, 2010    December 31, 2009
Securities Type with Current Credit Ratings    Current Par    Borrowing
Capacity
   Current Par    Borrowing
Capacity
 

U.S. Treasury (bills, notes, bonds)

   $ 956    $ 986    $ 1,284    $ 1,280

Agency (notes, subordinate debt, structured notes, indexed amortization notes, and Small Business Administration pools)

     5,289      5,307      7,366      7,298

Agency pools and collateralized mortgage obligations

     19,128      18,955      23,348      22,738

PLRMBS – publicly registered AAA-rated senior tranches

     422      295      535      379

Private-label home equity MBS – publicly registered AAA-rated senior tranches

               1     

Private-label commercial MBS – publicly registered AAA-rated senior tranches

     52      42      89      68

PLRMBS – publicly registered AA-rated senior tranches

     57      24      197      84

PLRMBS – publicly registered A-rated senior tranches

     110      18      189      30

PLRMBS – publicly registered BBB-rated senior tranches

     86      11      185      21

PLRMBS – publicly registered AAA- or AA-rated subordinate tranches

               2      1

Private-label home equity MBS – publicly registered AAA- or AA-rated subordinate tranches

     12      2      16      3

Private-label commercial MBS – publicly registered AAA-rated subordinate tranches

               13      8

Term deposits with the Bank

     30      30      29      29
 

Total

   $ 26,142    $ 25,670    $ 33,254    $ 31,939
 

With respect to loan collateral, most members may choose to pledge loan collateral using a specific identification method or a blanket lien method. Members pledging under the specific identification method must provide a detailed listing of all the loans pledged to the Bank on a monthly or quarterly basis. Under the blanket lien method, a member generally pledges the following loan types, whether or not the individual loans are eligible to receive borrowing capacity: all loans secured by real estate; all loans made for commercial, corporate, or business purposes; and all participations in these loans. Members pledging under the blanket lien method may provide a detailed listing of loans or may use a summary reporting method, which entails a quarterly review by the Bank of certain data regarding the member and its pledged collateral.

The Bank may require certain members to deliver pledged loan collateral to the Bank for one or more reasons, including the following: the member is a de novo institution (chartered within the last three years), the Bank is concerned about the member’s creditworthiness, or the Bank is concerned about the maintenance of its collateral or the priority of its security interest. Members required to deliver loan collateral must pledge those loans under the blanket lien method with detailed reporting. The Bank’s largest borrowers are required to report detailed data on a monthly basis and may pledge loan collateral using either the specific identification method or the blanket lien method with detailed reporting.

As of June 30, 2010, 69% of the loan collateral pledged to the Bank was pledged by 36 institutions under specific identification, 23% was pledged by 188 institutions under blanket lien with detailed reporting, and 8% was pledged by 107 institutions under blanket lien with summary reporting.

 

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As of June 30, 2010, the Bank’s maximum borrowing capacities for loan collateral ranged from 20% to 95% of the unpaid principal balance. For example, the maximum borrowing capacities for collateral pledged under blanket lien with detailed reporting were as follows: 95% for first lien residential mortgage loans, 66% for multifamily mortgage loans, 58% for commercial mortgage loans, 50% for small business, small farm, and small agribusiness loans, and 20% for second lien residential mortgage loans. The highest borrowing capacities are available to members that pledge under blanket lien with detailed reporting because the detailed loan information allows the Bank to assess the value of the collateral more precisely and because additional collateral is pledged under the blanket lien that may not receive borrowing capacity but may be liquidated to repay advances in the event of default. The Bank may review and change the maximum borrowing capacity for any type of loan collateral at any time.

The table below presents the mortgage loan collateral pledged by all members and by nonmembers with credit outstanding at June 30, 2010, and December 31, 2009.

Composition of Loan Collateral Pledged

by Members and by Nonmembers with Credit Outstanding

 

(In millions)                    
     June 30, 2010    December 31, 2009
Loan Type   

Unpaid Principal

Balance

  

Borrowing

Capacity

  

Unpaid Principal

Balance

  

Borrowing

Capacity

 

First lien residential mortgage loans(1)

   $ 184,283    $ 114,038    $ 208,845    $ 120,245

Second lien residential mortgage loans and home equity lines of credit(1)

     74,078      13,820      81,806      17,602

Multifamily mortgage loans

     36,704      21,655      37,011      21,216

Commercial mortgage loans

     54,679      29,568      58,783      30,550

Loan participations

     23,521      15,714      21,389      12,097

Small business, small farm, and small agribusiness loans

     2,738      531      3,422      672

Other

     1,067      330      1,055      314
 

Total

   $ 377,070    $ 195,656    $ 412,311    $ 202,696
 

 

(1) The unpaid principal balance and borrowing capacity for first lien residential mortgage loans and for second lien residential mortgage loans and home equity lines of credit at December 31, 2009, have been revised.

The Bank holds a security interest in subprime residential mortgage loans (defined as loans with a borrower FICO score of 660 or less) pledged as collateral. At June 30, 2010, and December 31, 2009, the amount of these loans totaled $36 billion and $38 billion, respectively. The Bank reviews and assigns borrowing capacities to subprime mortgage loans as it does for all other types of loan collateral, taking into account the known credit attributes in assigning the appropriate secondary market discounts. In addition, members with concentrations in nontraditional and subprime mortgage loans are subject to more frequent analysis to assess the credit quality and value of the loans. All advances, including those made to members pledging subprime mortgage loans, are required to be fully collateralized.

Investments. The Bank has adopted credit policies and exposure limits for investments that promote risk diversification and liquidity. These policies restrict the amounts and terms of the Bank’s investments with any given counterparty according to the Bank’s own capital position as well as the capital and creditworthiness of the counterparty.

 

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The Bank monitors its investments for substantive changes in relevant market conditions and any declines in fair value. For securities in an unrealized loss position because of factors other than movements in interest rates, such as widening of mortgage asset spreads, the Bank considers whether it expects to recover the entire amortized cost basis of the security by comparing the best estimate of the present value of the cash flows expected to be collected from the security with the amortized cost basis of the security. If the Bank’s best estimate of the present value of the cash flows expected to be collected is less than the amortized cost basis, the difference is considered the credit loss.

When the fair value of an individual investment security falls below its amortized cost, the Bank evaluates whether the decline is other than temporary. The Bank recognizes an other-than-temporary impairment when it determines that it will be unable to recover the entire amortized cost basis of the security and the fair value of the investment security is less than its amortized cost. The Bank considers its intent to hold the security and whether it is more likely than not that the Bank will be required to sell the security before its anticipated recovery of the remaining cost basis, and other factors. The Bank generally views changes in the fair value of the securities caused by movements in interest rates to be temporary.

The following tables present the Bank’s investment credit exposure at the dates indicated, based on the lowest of the long-term credit ratings provided by Moody’s, Standard & Poor’s, or comparable Fitch ratings.

Investment Credit Exposure

(In millions)

June 30, 2010

 

     Carrying Value
     Credit Rating(1)     
Investment Type    AAA    AA    A    BBB    BB    B    CCC    CC    C    Total
 

Federal funds sold

   $    $ 9,508    $ 4,962    $    $    $    $    $    $    $ 14,470

Trading securities:

                             

GSEs:

                             

FFCB bonds

     1,132                                              1,132

MBS:

                             

Other U.S. obligations:

                             

Ginnie Mae

     21                                              21

GSEs:

                             

Fannie Mae

     6                                              6
 

Total trading securities

     1,159                                              1,159
 

Available-for-sale securities:

                             

TLGP(2)

     1,932                                              1,932

Held-to-maturity securities:

                             

Interest-bearing deposits

          3,659      2,935                                    6,594

Commercial paper(3)

          1,499      858                                    2,357

Housing finance agency bonds

     26      203      529                                    758

TLGP(2)

     303                                              303

MBS:

                             

Other U.S. obligations:

                             

Ginnie Mae

     14                                              14

GSEs:

                             

Freddie Mac

     2,268                                              2,268

Fannie Mae

     6,614                                              6,614

Other:

                             

PLRMBS

     2,350      1,421      1,327      1,104      1,180      1,771      4,358      1,082      62      14,655
 

Total held-to-maturity securities

     11,575      6,782      5,649      1,104      1,180      1,771      4,358      1,082      62      33,563
 

Total investments

   $ 14,666    $ 16,290    $ 10,611    $ 1,104    $ 1,180    $ 1,771    $ 4,358    $ 1,082    $ 62    $ 51,124
 

 

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Investment Credit Exposure

(In millions)

December 31, 2009

 

     Carrying Value
     Credit Rating(1)     
Investment Type    AAA    AA    A    BBB    BB    B    CCC    CC    C    Total
 

Federal funds sold

   $    $ 5,374    $ 2,790    $    $    $    $    $    $    $ 8,164

Trading securities:

                             

MBS:

                             

Other U.S. obligations:

                             

Ginnie Mae

     23                                              23

GSEs:

                             

Fannie Mae

     8                                              8
 

Total trading securities

     31                                              31
 

Available-for-sale securities:

                             

TLGP(2)

     1,931                                              1,931

Held-to-maturity securities:

                             

Interest-bearing deposits

          2,340      4,170                                    6,510

Commercial paper(3)

          1,000      100                                    1,100

Housing finance agency bonds

     28      741                                         769

TLGP(2)

     304                                              304

MBS:

                             

Other U.S. obligations:

                             

Ginnie Mae

     16                                              16

GSEs:

                             

Freddie Mac

     3,423                                              3,423

Fannie Mae

     8,467                                              8,467

Other:

                             

PLRMBS

     2,790      1,670      2,290      2,578      2,151      1,412      2,546      793      61      16,291
 

Total held-to-maturity securities

     15,028      5,751      6,560      2,578      2,151      1,412      2,546      793      61      36,880
 

Total investments

   $ 16,990    $ 11,125    $ 9,350    $ 2,578    $ 2,151    $ 1,412    $ 2,546    $ 793    $ 61    $ 47,006
 

 

(1) Credit ratings of BB and lower are below investment grade.

 

(2) TLGP securities represent corporate debentures of the issuing party that are guaranteed by the FDIC and backed by the full faith and credit of the U.S. government.

 

(3)

The Bank’s investment in commercial paper also had a short-term credit rating of A-1/P-1.

For all the securities in its available-for-sale and held-to-maturity portfolios and Federal funds sold, the Bank does not intend to sell any security and it is not more likely than not that the Bank will be required to sell any security before its anticipated recovery of the remaining amortized cost basis.

The Bank invests in short-term unsecured Federal funds sold, negotiable certificates of deposit (interest-bearing deposits), and commercial paper with member and nonmember counterparties. The Bank determined that, as of June 30, 2010, all of the gross unrealized losses on its short-term unsecured Federal funds sold, interest-bearing deposits, and commercial paper are temporary because the gross unrealized losses were caused by movements in interest rates and not by the deterioration of the issuers’ creditworthiness; the short-term unsecured Federal funds sold, interest-bearing deposits, and commercial paper were all with issuers that had credit ratings of at least A at June 30, 2010; and all of the securities had maturity dates within 45 days of June 30, 2010. As a result, the Bank expects to recover the entire amortized cost basis of these securities.

The Bank’s investments may also include housing finance agency bonds issued by housing finance agencies located in Arizona, California, and Nevada, the three states that make up the Bank’s district, which is the Eleventh District of the FHLBank System. These bonds are mortgage revenue bonds (federally taxable) and are collateralized by pools of first lien residential mortgage loans and credit-enhanced by bond insurance. The bonds held by the Bank are issued by the California Housing Finance Agency (CalHFA) and insured by either

 

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Ambac Assurance Corporation (Ambac), MBIA Insurance Corporation (MBIA), or Assured Guaranty Municipal Corporation (formerly Financial Security Assurance Incorporated). At June 30, 2010, all of the bonds were rated at least A by Moody’s or Standard & Poor’s. There were no rating downgrades to the Bank’s housing finance agency bonds from July 1, 2010, to July 30, 2010. As of July 30, 2010, $529 million of the A-rated housing finance agency bonds issued by CalHFA and insured by Ambac or MBIA were on negative watch according to Moody’s or Standard & Poor’s.

At June 30, 2010, the Bank’s investments in housing finance agency bonds had gross unrealized losses totaling $143 million. These gross unrealized losses were mainly due to an illiquid market, causing these investments to be valued at a discount to their acquisition cost. In addition, the Bank independently modeled cash flows for the underlying collateral, using assumptions for default rates and loss severity that management deemed reasonable, and concluded that the available credit support within the CalHFA structure more than offset the projected underlying collateral losses. The Bank determined that, as of June 30, 2010, all of the gross unrealized losses on its housing finance agency bonds are temporary because the underlying collateral and credit enhancements were sufficient to protect the Bank from losses based on current expectations and because CalHFA had a credit rating of A at June 30, 2010 (based on the lower of Moody’s or Standard & Poor’s ratings). As a result, the Bank expects to recover the entire amortized cost basis of these securities.

The Bank’s investments also include agency residential MBS, which are backed by Fannie Mae, Freddie Mac, or Ginnie Mae, and PLRMBS, some of which were issued by and/or purchased from members, former members, or their respective affiliates. At June 30, 2010, PLRMBS representing 48% of the amortized cost of the Bank’s MBS portfolio were labeled Alt-A by the issuer. Alt-A MBS are generally collateralized by mortgage loans that are considered less risky than subprime loans but more risky than prime loans. These loans are generally made to borrowers who have sufficient credit ratings to qualify for a conforming mortgage loan but the loans may not meet all standard guidelines for documentation requirements, property type, or loan-to-value ratios.

As of June 30, 2010, the Bank’s investment in MBS classified as held-to-maturity had gross unrealized losses totaling $4,416 million, most of which were related to PLRMBS. These gross unrealized losses were primarily due to illiquidity in the MBS market, uncertainty about the future condition of the housing and mortgage markets and the economy, and continued deterioration in the credit performance of loan collateral underlying these securities, causing these assets to be valued at significant discounts to their acquisition cost.

For its agency residential MBS, the Bank expects to recover the entire amortized cost basis of these securities because it determined that the strength of the issuers’ guarantees through direct obligations or support from the U.S. government is sufficient to protect the Bank from losses based on current expectations. As a result, the Bank determined that, as of June 30, 2010, all of the gross unrealized losses on its agency residential MBS are temporary.

In 2009, the 12 FHLBanks formed the OTTI Governance Committee (OTTI Committee), which consists of one representative from each FHLBank. The OTTI Committee is responsible for reviewing and approving the key modeling assumptions, inputs, and methodologies to be used by the FHLBanks to generate the cash flow projections used in analyzing credit losses and determining OTTI for all PLRMBS and for certain home equity loan investments, including home equity asset-backed securities. For certain PLRMBS for which underlying collateral data is not available, alternative procedures as determined by each FHLBank are expected to be used to assess these securities for OTTI. Certain private-label MBS backed by multifamily and commercial real estate loans, home equity lines of credit, and manufactured housing loans are outside the

 

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scope of the FHLBanks’ OTTI Committee and are analyzed for OTTI by each individual FHLBank owning securities backed by such collateral. The Bank does not have any home equity loan investments or any private-label MBS backed by multifamily or commercial real estate loans, home equity lines of credit, or manufactured housing loans.

The Bank’s evaluation includes estimating projected cash flows that the Bank is likely to collect based on an assessment of all available information about the applicable security on an individual basis, the structure of the security, and certain assumptions as proposed by the FHLBanks’ OTTI Committee and approved by the Bank, such as the remaining payment terms for the security, prepayment speeds, default rates, loss severity on the collateral supporting the security based on underlying loan-level borrower and loan characteristics, expected housing price changes, and interest rate assumptions, to determine whether the Bank will recover the entire amortized cost basis of the security. In performing a detailed cash flow analysis, the Bank identifies the best estimate of the cash flows expected to be collected. If this estimate results in a present value of expected cash flows (discounted at the security’s effective yield) that is less than the amortized cost basis of the security, an OTTI is considered to have occurred.

To assess whether it expects to recover the entire amortized cost basis of its PLRMBS, the Bank performed a cash flow analysis for all of its PLRMBS as of June 30, 2010. In performing the cash flow analysis for each security, the Bank used two third-party models. The first model considers borrower characteristics and the particular attributes of the loans underlying the Bank’s securities, in conjunction with assumptions about future changes in home prices, interest rates, and other assumptions, to project prepayments, default rates, 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) based on an assessment of the relevant 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 of 10,000 or more people. The Bank’s housing price forecast as of June 30, 2010, assumed CBSA-level current-to-trough home price declines ranging from 0% to 12% over the 3- to 9-month periods beginning April 1, 2010 (average price decline for all areas during their current-to-trough period equaled 4.5%). For each area, after the current-to-trough period, home prices are projected to increase 0% in the first six months, 0.5% in the next six months, 3% in the second year, and 4% in each subsequent year. The month-by-month projections of future loan performance derived from the first model, which reflect projected prepayments, default rates, 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 each securitization structure in accordance with the structure’s prescribed cash flow and loss allocation rules. When the credit enhancement for the senior securities in a securitization is derived from the presence of subordinated securities, losses are generally allocated first to the subordinated 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 scenario and includes a base case current-to-trough housing price forecast and a base case housing price recovery path.

In addition to the cash flow analysis of the Bank’s PLRMBS under a base case (best estimate) housing price scenario, a cash flow analysis was also performed based on a housing price scenario that is more adverse than the base case (adverse case housing price scenario). The adverse case housing price scenario was based on a projection of housing prices that was 5 percentage points lower at the trough compared to the base case scenario followed by a flatter recovery path. Under the adverse case housing price scenario, current-to-trough housing price declines were projected to range from 5% to 17% over the 3- to 9-month periods beginning April 1, 2010. For each area, after the current-to-trough period, home prices were projected to increase 0% in the first year, 1% in the second year, 2% in the third and fourth year, and 3% in each subsequent year.

 

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The following table shows the base case scenario and what the OTTI charges would have been under the more stressful housing price scenario at June 30, 2010:

 

     Three Months Ended June 30, 2010  
     Housing Price Scenario  
     Base Case     Adverse Case  
(Dollars in millions)    Number of
Securities
   Unpaid
Principal
Balance
   OTTI Related
to Credit Loss
   OTTI
Related to
All Other
Factors
    Number of
Securities
   Unpaid
Principal
Balance
   OTTI Related
to Credit Loss
   OTTI
Related to
All Other
Factors
 
   

Other-than-temporarily impaired PLRMBS backed by loans classified at origination as:

                      

Prime

   9    $ 1,265    $ 28    $ (24   15    $ 1,573    $ 86    $ (63

Alt-A

   99      8,143      114      72      143      10,826      474      4   
   

Total

   108    $ 9,408    $ 142    $ 48      158    $ 12,399    $ 560    $ (59
   

The Bank uses models in projecting the cash flows for all PLRMBS for its analysis of OTTI. 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.

For more information on the Bank’s OTTI analysis and reviews, see Note 5 to the Financial Statements.

The following table presents the ratings of the Bank’s PLRMBS investments as of June 30, 2010, by year of issuance and by collateral type classified at origination.

 

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Unpaid Principal Balance of PLRMBS by Year of Issuance and Credit Rating

June 30, 2010

(In millions)

 

     Unpaid Principal Balance
     Credit Rating(1)     
Year of Issuance    AAA    AA    A    BBB    BB    B    CCC    CC    C    Total
 

Prime

                             

2008

   $    $    $    $ 41    $    $    $ 249    $ 72    $    $ 362

2007

                    96           23      286      494           899

2006

     220           196           221      89      100                826

2005

     71      27      28                74      66                266

2004 and earlier

     1,804      640      356      88           22                     2,910
 

Total Prime

     2,095      667      580      225      221      208      701      566           5,263
 

Alt-A

                             

2008

                              271                     271

2007

                         805      1,329      1,822      417      107      4,480

2006

                    101      287      39      776      503           1,706

2005

     18      207      199      772      263      586      3,313      178           5,536

2004 and earlier

     233      598      605      89           42                     1,567
 

Total Alt-A

     251      805      804      962      1,355      2,267      5,911      1,098      107      13,560
 

Total par amount

   $ 2,346    $ 1,472    $ 1,384    $ 1,187    $ 1,576    $ 2,475    $ 6,612    $ 1,664    $ 107    $ 18,823
 

 

(1) The credit ratings used by the Bank are based on the lowest of Moody’s, Standard & Poor’s, or comparable Fitch ratings. Credit ratings of BB and lower are below investment grade.

The following table presents the ratings of the Bank’s other-than-temporarily impaired PLRMBS at June 30, 2010, by year of issuance and by collateral type classified at origination.

Unpaid Principal Balance of Other-Than-Temporarily Impaired PLRMBS

by Year of Issuance and Credit Rating

June 30, 2010

(In millions)

 

     Unpaid Principal Balance
     Credit Rating(1)     
Year of Issuance    AA    A    BBB    BB    B    CCC    CC    C    Total
 

Prime

                          

2008

   $    $    $    $    $    $ 249    $ 72    $    $ 321

2007

                              286      494           780

2006

                    135      29      100                264

2005

                       51                     51

2004 and earlier

                         22                     22
 

Total Prime

                    135      102      635      566           1,438
 

Alt-A

                          

2007

                    580      1,329      1,823      417      107      4,256

2006

               101      252      39      775      503           1,670

2005

     162      163      257      194      165      2,677      93           3,711

2004 and earlier

          158      54           42                     254
 

Total Alt-A

     162      321      412      1,026      1,575      5,275      1,013      107      9,891
 

Total par amount

   $ 162    $ 321    $ 412    $ 1,161    $ 1,677    $ 5,910    $ 1,579    $ 107    $ 11,329
 

 

(1) The credit ratings used by the Bank are based on the lowest of Moody’s, Standard & Poor’s, or comparable Fitch ratings. Credit ratings of BB and lower are below investment grade.

 

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For the Bank’s PLRMBS, the following table shows the amortized cost, estimated fair value, OTTI charges, performance of the underlying collateral based on the classification at the time of origination, and credit enhancement statistics by type of collateral and year of issuance. Credit enhancement is defined as the percentage of subordinated tranches and over-collateralization, if any, in a security structure that will absorb losses before the Bank will experience a loss on the security. The credit enhancement figures include the additional credit enhancement required by the Bank (above the amounts required for an AAA rating by the credit rating agencies) for selected securities starting in late 2004, and for all securities starting in late 2005. The calculated original, average, and current credit enhancement amounts represent the dollar-weighted averages of all the MBS in each category shown.

PLRMBS Credit Characteristics

June 30, 2010

(Dollars in millions)

 

             For the Six Months Ended
June 30, 2010
  Underlying Collateral Performance and
Credit Enhancement Statistics
 
Year of Issuance   Amortized
Cost
  Gross
Unrealized
Losses
  Estimated
Fair
Value
  OTTI
Related to
Credit
Loss
  OTTI
Related to
All Other
Factors
    Total
OTTI
 

Weighted-
Average

60+ Days

Collateral
Delinquency
Rate

    Original
Weighted
Average
Credit
Support
    Current
Weighted
Average
Credit
Support
    Minimum
Current
Credit
Support
 
   

Prime

                   

2008

  $ 345   $ 76   $ 305   $ 14   $ (13   $ 1   26.41   30.00   30.83   30.83

2007

    832     310     610     18     36        54   21.12      22.93      19.99      7.27   

2006

    812     51     766     2     2        4   9.04      9.46      9.98      6.87   

2005

    265     45     227                  13.60      11.79      16.69      6.82   

2004 and earlier

    2,913     222     2,694         4        4   6.51      4.04      8.79      4.23   
         

Total Prime

    5,167     704     4,602     34     29        63   11.13      10.29      12.80      4.23   
         

Alt-A

                   

2008

    271     66     205                  16.56      31.80      32.57      32.57   

2007

    4,179     1,519     2,922     72     20        92   33.67      32.95      31.23      9.08   

2006

    1,494     417     1,212     35     (16     19   33.14      22.65      19.75      9.31   

2005

    5,293     1,479     4,035     59     131        190   20.92      14.05      16.48      5.40   

2004 and earlier

    1,578     220     1,364     2     16        18   13.66      7.92      16.55      8.65   
         

Total Alt-A

    12,815     3,701     9,738     168     151        319   25.75      21.02      22.10      5.40   
         

Total

  $ 17,982   $ 4,405   $ 14,340   $ 202   $ 180      $ 382   21.66   18.02   19.50   4.23
   

The following table presents the weighted average delinquency of the collateral underlying the Bank’s PLRMBS by collateral type classified at origination and by current credit rating.

 

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Credit Ratings of PLRMBS as of June 30, 2010

 

(Dollars in millions)    Unpaid
Principal
Balance
   Amortized
Cost
   Carrying
Value
   Gross
Unrealized
Losses
   Weighted-
Average
60+ Days
Collateral
Delinquency
Rate
 
   

Prime

              

AAA-rated

   $ 2,095    $ 2,097    $ 2,097    $ 119    4.79

AA-rated

     667      665      665      74    9.06   

A-rated

     580      576      576      49    8.32   

BBB-rated

     225      226      226      44    11.80   

BB-rated

     221      220      217      5    7.44   

B-rated

     208      206      190      29    13.71   

CCC-rated

     701      672      446      240    23.72   

CC-rated

     566      505      361      144    24.55   
    

Total Prime

     5,263      5,167      4,778      704    11.13   
   

Alt-A

              

AAA-rated

     251      253      253      31    14.03   

AA-rated

     805      812      755      150    15.04   

A-rated

     804      808      752      112    12.73   

BBB-rated

     962      960      877      223    16.59   

BB-rated

     1,355      1,285      963      439    29.15   

B-rated

     2,267      2,160      1,581      756    28.35   

CCC-rated

     5,911      5,495      3,913      1,699    27.33   

CC-rated

     1,098      944      721      255    36.31   

C-rated

     107      98      62      36    19.88   
    

Total Alt-A

     13,560      12,815      9,877      3,701    25.75   
   

Total PLRMBS

   $ 18,823    $ 17,982    $ 14,655    $ 4,405    21.66
   

Unpaid Principal Balance of PLRMBS by Collateral Type Classified at Origination

 

     June 30, 2010    December 31, 2009
(In millions)    Fixed Rate    Adjustable
Rate
   Total    Fixed Rate    Adjustable
Rate
   Total
 

PLRMBS:

                 

Prime

   $ 2,465    $ 2,798    $ 5,263    $ 3,083    $ 2,983    $ 6,066

Alt-A

     6,399      7,161      13,560      7,544      6,890      14,434
 

Total

   $ 8,864    $ 9,959    $ 18,823    $ 10,627    $ 9,873    $ 20,500
 

PLRMBS in a Loss Position

at June 30, 2010, and Credit Ratings as of July 30, 2010

(Dollars in millions)

 

     June 30, 2010     July 30, 2010  

PLRMBS

backed by

loans

classified at

origination as:

   Unpaid
Principal
Balance
   Amortized
Cost
   Carrying
Value
   Gross
Unrealized
Losses
  

Weighted-
Average

60+ Days
Collateral
Delinquency
Rate

    %
Rated
AAA
    %
Rated
AAA
    % Rated
Investment
Grade
    % Rated
Below
Investment
Grade
    % on
Watchlist
 
   

Prime

   $ 4,990    $ 4,895    $ 4,506    $ 704    11.62   37.07   36.59   66.01   33.99   44.78

Alt-A

     13,536      12,807      9,869      3,701    25.72      1.85      1.85      18.98      81.02      32.16   
              

Total

   $ 18,526    $ 17,702    $ 14,375    $ 4,405    21.92   11.33   11.20   31.64   68.36   35.56
   

 

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The following table presents the fair value of the Bank’s PLRMBS as a percentage of the unpaid principal balance by collateral type and year of securitization.

Fair Value of PLRMBS as a Percentage of Unpaid Principal Balance by Year of Securitization

 

Collateral Type at Origination and Year of Securitization   

June 30,

2010

   

March 31,

2010

   

December 31,

2009

   

September 30,

2009

   

June 30,

2009

 
   

Prime

          

2008

   84.19   80.87   77.59   74.55   80.25

2007

   67.93      62.44      67.64      62.69      64.78   

2006

   92.68      90.88      85.40      85.95      80.03   

2005

   85.25      83.73      82.15      78.16      70.43   

2004 and earlier

   92.56      90.87      89.57      89.79      85.02   

Weighted average of all Prime

   87.43      85.17      84.23      83.41      80.14   
   

Alt-A

          

2008

   75.78      75.21      51.17      49.16      58.72   

2007

   65.23      63.53      60.96      59.48      56.36   

2006

   71.03      68.76      66.74      64.48      58.69   

2005

   72.89      70.87      69.34      67.55      64.85   

2004 and earlier

   87.08      84.79      82.56      81.27      72.98   

Weighted average of all Alt-A

   71.82      69.89      67.41      65.73      62.14   

Weighted average of all PLRMBS

   76.19   74.28   72.39   71.09   67.80
   

The following table summarizes rating agency downgrade actions on PLRMBS that occurred from July 1, 2010, to July 30, 2010. The credit ratings used by the Bank are based on the lowest of Moody’s, Standard & Poor’s, or comparable Fitch ratings.

PLRMBS Downgraded from July 1, 2010, to July 30, 2010

Dollar Amounts as of June 30, 2010

 

     To AA    To BBB    To BB    To CCC    To CC    To C    Total
(In millions)    Carrying
Value
   Fair
Value
   Carrying
Value
   Fair
Value
   Carrying
Value
   Fair
Value
   Carrying
Value
   Fair
Value
   Carrying
Value
   Fair
Value
   Carrying
Value
   Fair
Value
   Carrying
Value
   Fair
Value
 

PLRMBS:

                                         

Downgrade from AAA

   $ 24    $ 23    $    $    $    $    $    $    $    $    $    $    $ 24    $ 23

Downgrade from AA

               45      38                11      16                          56      54

Downgrade from BBB

                         53      35      137      140                          190      175

Downgrade from CCC

                                             204      220      321      359      525      579

Downgrade from CC

                                                       603      696      603      696
 

Total

   $ 24    $ 23    $ 45    $ 38    $ 53    $ 35    $ 148    $ 156    $ 204    $ 220    $ 924    $ 1,055    $ 1,398    $ 1,527
 

The securities that were downgraded from July 1, 2010, to July 30, 2010, were included in the Bank’s OTTI analysis performed as of June 30, 2010, and no additional OTTI charges were required as a result of these downgrades.

 

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The Bank believes that, as of June 30, 2010, the gross unrealized losses on the remaining PLRMBS that did not have an OTTI charge are primarily due to unusually wide mortgage asset spreads, generally resulting from an illiquid market, which caused these assets to be valued at significant discounts to their acquisition costs. The Bank does not intend to sell these securities, it is not more likely than not that the Bank will be required to sell these securities before its anticipated recovery of the remaining amortized cost basis, and the Bank expects to recover the entire amortized cost basis of these securities. As a result, the Bank determined that, as of June 30, 2010, all of the gross unrealized losses on these securities are temporary. The Bank will continue to monitor and analyze the performance of these securities to assess the likelihood of the recovery of the entire amortized cost basis of these securities as of each balance sheet date.

If conditions in the housing and mortgage markets and general business and economic conditions remain stressed or deteriorate further, the fair value of MBS may decline further and the Bank may experience OTTI of additional PLRMBS in future periods, as well as further impairment of PLRMBS that were identified as other-than-temporarily impaired as of June 30, 2010. Additional future OTTI credit charges could adversely affect the Bank’s earnings and retained earnings and its ability to pay dividends and repurchase capital stock. The Bank cannot predict whether it will be required to record additional OTTI charges on its PLRMBS in the future.

Federal and state government authorities, as well as private entities, such as financial institutions and the servicers of residential mortgage loans, have begun or promoted implementation of programs designed to provide homeowners with assistance in avoiding residential mortgage loan foreclosures. These loan modification programs, as well as future legislative, regulatory, or other actions, including amendments to the bankruptcy laws, that result in the modification of outstanding mortgage loans, may adversely affect the value of, and the returns on, these mortgage loans or MBS related to these mortgage loans.

Derivatives Counterparties. The Bank has also adopted credit policies and exposure limits for derivatives credit exposure. All credit exposure from derivatives transactions entered into by the Bank with member counterparties that are not derivatives dealers (including interest rate swaps, caps, floors, corridors, and collars), for which the Bank serves as an intermediary, must be fully secured by eligible collateral, and all such derivatives transactions are subject to both the Bank’s Advances and Security Agreement and a master netting agreement.

For all derivatives dealer counterparties, the Bank selects only highly rated derivatives dealers and major banks that meet the Bank’s eligibility criteria. In addition, the Bank has entered into master netting agreements and bilateral security agreements with all active derivatives dealer counterparties that provide for delivery of collateral at specified levels tied to counterparty credit ratings to limit the Bank’s net unsecured credit exposure to these counterparties.

Under these policies and agreements, the amount of unsecured credit exposure to an individual derivatives dealer counterparty is limited to the lesser of (i) a percentage of the counterparty’s capital, or (ii) an absolute dollar credit exposure limit, both according to the counterparty’s credit rating, as determined by rating agency long-term credit ratings of the counterparty’s debt securities or deposits. The following table presents the Bank’s credit exposure to its derivatives counterparties at the dates indicated.

 

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Credit Exposure to Derivatives Counterparties

(In millions)

June 30, 2010

 

Counterparty Credit Rating(1)    Notional
Balance
   Gross Credit
Exposure
   Collateral    Net Unsecured
Exposure

AA

   $ 79,046    $ 1,158    $ 1,134    $ 24

A(2)

     118,463      688      682      6

Subtotal

     197,509      1,846      1,816      30

Member institutions( 3)

     460      1      1     

Total derivatives

   $ 197,969    $ 1,847    $ 1,817    $ 30
December 31, 2009   
Counterparty Credit Rating(1)    Notional
Balance
   Gross Credit
Exposure
   Collateral    Net Unsecured
Exposure

AA

   $ 101,059    $ 1,129    $ 1,101    $ 28

A(2)

     133,647      698      690      8

Subtotal

     234,706      1,827      1,791      36

Member institutions( 3)

     308               

Total derivatives

   $ 235,014    $ 1,827    $ 1,791    $ 36

 

(1) The credit ratings used by the Bank are based on the lowest of Moody’s, Standard & Poor’s, or comparable Fitch ratings.
(2) Includes notional amounts of derivatives contracts outstanding totaling $13.8 billion at June 30, 2010, and $16.6 billion at December 31, 2009, with Citibank, N.A., a member that is a derivatives dealer counterparty.
(3) Collateral held with respect to interest rate exchange agreements with members represents either collateral physically held by or on behalf of the Bank or collateral assigned to the Bank, as evidenced by an Advances and Security Agreement, and held by the members for the benefit of the Bank. These amounts do not include those related to Citibank, N.A., which are included in the A-rated derivatives dealer counterparty amounts above at June 30, 2010, and at December 31, 2009.

At June 30, 2010, the Bank had a total of $198.0 billion in notional amounts of derivatives contracts outstanding. Of this total:

 

   

$197.5 billion represented notional amounts of derivatives contracts outstanding with 17 derivatives dealer counterparties. Eight of these counterparties made up 87% of the total notional amount outstanding with these derivatives dealer counterparties, individually ranging from 5% to 19% of the total. The remaining counterparties each represented less than 5% of the total. Six of these counterparties, with $72.0 billion of derivatives outstanding at June 30, 2010, were affiliates of members, and one counterparty, with $13.8 billion outstanding at June 30, 2010, was a member of the Bank.

 

   

$460 million represented notional amounts of derivatives contracts with three member counterparties that are not derivatives dealers. The Bank entered into these derivatives contracts as an intermediary and entered into the same amount of exactly offsetting transactions with derivatives dealer counterparties. The Bank’s intermediation in this manner allows members indirect access to the derivatives market.

Gross credit exposure on derivatives contracts at June 30, 2010, was $1.8 billion, which consisted of:

 

   

$1.8 billion of gross credit exposure on open derivatives contracts with 13 derivatives dealer counterparties. After consideration of collateral held by the Bank, the amount of net unsecured exposure from these contracts totaled $30 million.

 

   

$1 million of gross credit exposure on open derivatives contracts, in which the Bank served as an intermediary, with one member counterparty that is not a derivatives dealer, all of which was secured with eligible collateral.

 

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At December 31, 2009, the Bank had a total of $235.0 billion in notional amounts of derivatives contracts outstanding. Of this total:

 

   

$234.7 billion represented notional amounts of derivatives contracts outstanding with 18 derivatives dealer counterparties. Seven of these counterparties made up 78% of the total notional amount outstanding with these derivatives dealer counterparties, individually ranging from 6% to 15% of the total. The remaining counterparties each represented less than 5% of the total. Six of these counterparties, with $95.9 billion of derivatives outstanding at December 31, 2009, were affiliates of members, and one counterparty, with $16.6 billion outstanding at December 31, 2009, was a member of the Bank.

 

   

$308 million represented notional amounts of derivatives contracts with three member counterparties that are not derivatives dealers. The Bank entered into these derivatives contracts as an intermediary and entered into the same amount of exactly offsetting transactions with derivatives dealer counterparties. The Bank’s intermediation in this manner allows members indirect access to the derivatives market.

Gross credit exposure on derivatives contracts at December 31, 2009, was $1.8 billion, which consisted of:

 

   

$1.8 billion of gross credit exposure on open derivatives contracts with 12 derivatives dealer counterparties. After consideration of collateral held by the Bank, the amount of net unsecured exposure from these contracts totaled $36 million.

 

   

$0.3 million of gross credit exposure on open derivatives contracts, in which the Bank served as an intermediary, with one member counterparty that is not a derivatives dealer, all of which was secured with eligible collateral.

The Bank’s gross credit exposure with derivatives dealer counterparties, representing net gain amounts due to the Bank, was $1.8 billion at June 30, 2010, and $1.8 billion at December 31, 2009. The gross credit exposure reflects the fair value of derivatives contracts, including interest amounts accrued through the reporting date, and is netted by counterparty because the Bank has the legal right to do so under its master netting agreement with each counterparty.

The Bank’s gross credit exposure remained the same from December 31, 2009, to June 30, 2010, even though the notional amount outstanding decreased from $235.0 billion at December 31, 2009, to $198.0 billion at June 30, 2010. In general, the Bank is a net receiver of fixed interest rates and a net payer of floating interest rates under its derivatives contracts with counterparties. From December 31, 2009, to June 30, 2010, interest rates decreased, causing interest rate swaps in which the Bank is a net receiver of fixed interest rates to increase in value.

An increase or decrease in the notional amounts of derivatives contracts may not result in a corresponding increase or decrease in gross credit exposure because the fair values of derivatives contracts are generally zero at inception.

Based on the master netting arrangements, its credit analyses, and the collateral requirements in place with each counterparty, the Bank does not expect to incur any credit losses on its derivatives agreements.

For more information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – Derivatives Counterparties” in the Bank’s 2009 Form 10-K.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) requires management to make a number of judgments, estimates, and

 

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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, expenses, gains, and losses during the reporting period. Changes in these judgments, estimates, and assumptions could potentially affect the Bank’s financial position and results of operations significantly. Although management believes these judgments, estimates, and assumptions to be reasonably accurate, actual results may differ.

In the Bank’s 2009 Form 10-K, the following accounting policies and estimates were identified as critical because they require management to make subjective or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies and estimates are: estimating the allowance for credit losses on the advances and mortgage loan portfolios; accounting for derivatives; estimating fair values of investments classified as trading and available-for-sale, derivatives and associated hedged items carried at fair value in accordance with the accounting for derivative instruments and associated hedging activities, and financial instruments carried at fair value under the fair value option, and accounting for other-than-temporary impairment for investment securities; and estimating the prepayment speeds on MBS and mortgage loans for the accounting of amortization of premiums and accretion of discounts on MBS and mortgage loans.

There have been no significant changes in the judgments and assumptions made during the first six months of 2010 in applying the Bank’s critical accounting policies. These policies and the judgments, estimates, and assumptions are described in greater detail in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” and Note 1 to the Financial Statements in the Bank’s 2009 Form 10-K and in Note 12 to the Financial Statements.

Recently Issued Accounting Standards and Interpretations

See Note 2 to the Financial Statements for a discussion of recently issued accounting standards and interpretations.

Recent Developments

Financial Reform Legislation. On July 21, 2010, the Wall Street Reform and Consumer Protection Act (Reform Act) was signed into law. The Reform Act, among other effects: (1) creates a consumer financial protection agency; (2) creates an inter-agency oversight council to identify and regulate systemically important financial institutions; (3) regulates the over-the-counter derivatives market; (4) reforms the credit rating agencies; (5) provides shareholders of entities that are subject to the proxy rules under the Securities Exchange Act of 1934, as amended, with an advisory vote on the entities’ compensation practices, including executive compensation and golden parachutes; (6) establishes new requirements, including a risk retention requirement, for mortgage-backed securities; (7) makes a number of changes to the federal deposit insurance system; and (8) creates a federal insurance office to monitor the insurance industry.

The Bank’s business operations, funding costs, rights and obligations, and the manner in which the Bank carries out its housing finance mission are all likely to be affected by the passage of the Reform Act and implementing regulations. For example, under the derivatives regulation portion of the Reform Act, if determined to be a “major swap participant,” the Bank could be required to execute certain of its standardized derivatives transactions through an exchange and clear those transactions through a centralized clearing house, and be subject to additional capital and margin requirements. In addition, derivatives transactions not subject to exchange trading or centralized clearing could also be subject to additional margin requirements, and all derivatives transactions could be subject to new reporting requirements. Such additional requirements would likely increase the cost of the Bank’s hedging activities and may adversely affect the Bank’s ability to hedge its interest rate risk exposure, to achieve its risk management objectives, and to act as an intermediary between its members and counterparties.

 

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In addition, if identified by the Federal Reserve Board (Federal Reserve) as a systemically important financial institution, the Bank could be subject to additional prudential standards established by the Federal Reserve. These standards could include risk-based capital, liquidity, and risk management requirements. Other standards could encompass such matters as a requirement to issue contingent capital instruments, additional required public disclosures, and limits on short-term debt. The Reform Act also requires systemically important financial institutions to report to the Federal Reserve on the nature and extent of their credit exposures to other significant companies and to undergo semiannual stress tests.

The Reform Act also makes a number of changes to the federal deposit insurance program that could impact the Bank’s members. Among the changes, it requires the Federal Deposit Insurance Corporation (FDIC) to base future assessments for deposit insurance on the amount of assets held by an institution instead of on the amount of deposits it holds; it permanently increases deposit insurance coverage for insured banks, savings associations, and credit unions to $250,000; it increases the reserve ratio for the FDIC insurance fund, which is likely to cause an increase in the assessments imposed on federally insured institutions; and it requires insured depository institutions with assets of $10 billion or more to pay an additional deposit insurance assessment. The Reform Act may provide an incentive for some of the Bank’s members to hold more deposits than they would if non-deposit liabilities were not a factor in determining an institution’s deposit insurance assessments.

It is not possible to predict the full impact of the Reform Act on the Bank or its members.

FHLBank Conservatorship and Receivership Proposed Rule. On July 9, 2010, the Finance Agency issued a proposed rule implementing the conservatorship and receivership provisions of the Housing Act, which apply to Fannie Mae, Freddie Mac and the FHLBanks. The proposed rule addresses the status and priority of claims, the relationships among various classes of creditors and equity holders, and the priorities for contract parties and other claimants with regard to the resolution of an FHLBank that is put into conservatorship or receivership by the Finance Agency. Comments on the proposed rule must be submitted to the Finance Agency by September 7, 2010.

Annual Designation of Member Director and Independent Director Positions. On June 21, 2010, the Finance Agency redesignated one of the Bank’s eight member director positions from Nevada to California, effective January 1, 2011. This will result in four member director positions for California, three for Nevada, and one for Arizona for 2011. The member director position redesignated from Nevada to California, which has a current term ending December 31, 2010, is currently open and is to be filled through an election of the members located in California to be held in the fourth quarter of 2010, for a four-year term beginning January 1, 2011.

In addition, the Finance Agency designated six independent director positions for the Bank for 2011, the same as for 2010. The Bank will hold an election for two of these positions for terms beginning January 1, 2011. One of these positions is designated as a public interest director position and will have a four-year term ending December 31, 2014. To implement staggering of director terms over four years, the Finance Agency has assigned a one-year term to the other position, which will expire December 31, 2011.

FHLBank Mortgage Purchases and Affordable Housing Goals Proposed Rule. On May 28, 2010, the Finance Agency issued a proposed rule that would implement the requirement in the Housing Act for the Finance Agency to impose affordable housing goals on an FHLBank’s mortgage purchases. Under the

 

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proposed rule, if an FHLBank’s mortgage purchases under the Acquired Member Assets program exceed $2.5 billion in a given year, the FHLBank would be subject to three single-family, owner-occupied, purchase-money mortgage goals and one single-family refinancing mortgage goal. If an FHLBank fails to meet one of these housing goals, the proposed rule would allow the Finance Agency to require the FHLBank to submit a housing plan for future compliance with appropriate housing goals. Comments on the proposed rule were due July 12, 2010.

Finance Agency Proposed Rule Regarding FHLBank Investments. On May 4, 2010, the Finance Agency issued a proposed rule regarding FHLBank investments. Among other effects, the proposed rule would incorporate the current limitations on MBS investments and derivatives activities that are applicable to an FHLBank as a matter of Finance Agency financial management policy and order (including without limitation the provision limiting the level of MBS investments to no more than 300% of an FHLBank’s capital). The Finance Agency requested comment on whether additional limitations on an FHLBank’s MBS investments should be adopted as part of a final regulation and whether with respect to private-label MBS investments such limitations should be based on an FHLBank’s level of retained earnings, the underlying collateral characteristics, or other criteria. Comments on the proposed rule were due July 6, 2010.

FDIC Deposit Insurance and Risk-Based Assessment Rates Proposed Rule. On May 3, 2010, the FDIC issued a proposed rule that would use performance and loss severity measurement scores to determine the risk-based assessment rates for large FDIC-insured institutions. Under one of the measurements used in calculating the proposed performance score, large institutions with a lower ratio of core deposits to total liabilities would be subject to higher assessment rates. Under one of the measurements used in calculating the proposed loss severity score, institutions with a higher ratio of secured liabilities to domestic deposits would be considered more costly to resolve and would also be subject to higher assessment rates. The use of both these ratios in determining an institution’s deposit insurance assessment rate may provide an incentive for large member institutions to seek and hold more core deposits, which could reduce their need for access to advances from the Bank. This incentive could have the effect of reducing certain members’ use of Bank advances to meet their liquidity needs.

Board of Directors of the Federal Home Loan Bank System Office of Finance. On April 26, 2010, the Finance Agency adopted a final rule to increase the size of the Board of Directors of the Office of Finance to consist of the 12 FHLBank presidents and five independent directors. The final rule provides that the independent directors will serve as the audit committee of the Office of Finance and will be charged with the oversight of the Office of Finance’s preparation of combined financial reports. The final rule also gives responsibilities to the audit committee to ensure that the FHLBanks adopt consistent accounting policies and procedures to the extent necessary for information submitted by the FHLBanks to the Office of Finance to be combined to create accurate and meaningful combined financial reports. If the FHLBanks are not able to agree on consistent accounting policies and procedures, the audit committee, in consultation with the Finance Agency, may require them. In accordance with the final rule, the Finance Agency appointed the following independent directors: H Ronald Weissman (five-year term), J. Michael Davis (one-year term), Kathleen Crum McKinney (two-year term), Walter H. Morris, Jr. (four-year term), and Jonathan A. Scott (three-year term). On July 20, 2010, the Board of Directors of the Office of Finance held an organizational meeting at which the Board of Directors was reconstituted in accordance with the terms of the final rule. Once the terms of the independent directors initially appointed by the Finance Agency expire or the positions otherwise become vacant, the independent directors subsequently will be elected by a majority vote of the Board of Directors of the Office of Finance, subject to the Finance Agency’s review of, and non-objection to, each independent director.

 

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Off-Balance Sheet Arrangements, Guarantees, and Other Commitments

In accordance with regulations governing the operations of the FHLBanks, each FHLBank, including the Bank, is jointly and severally liable for the FHLBank System’s consolidated obligations issued under Section 11(a) of the FHLBank Act, and in accordance with the FHLBank Act, each FHLBank, including the Bank, is jointly and severally liable for consolidated obligations issued under Section 11(c) of the FHLBank Act. The joint and several liability regulation authorizes the Finance Agency to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor.

The Bank’s joint and several contingent liability is a guarantee, but is excluded from initial recognition and measurement provisions because the joint and several obligations are mandated by the FHLBank Act or Finance Agency regulation and are not the result of arms-length transactions among the FHLBanks. The Bank has no control over the amount of the guaranty or the determination of how each FHLBank would perform under the joint and several obligations. The valuation of this contingent liability is therefore not recorded on the balance sheet of the Bank. The par amount of the outstanding consolidated obligations of all 12 FHLBanks was $846.5 billion at June 30, 2010, and $930.6 billion at December 31, 2009. The par value of the Bank’s participation in consolidated obligations was $143.1 billion at June 30, 2010, and $178.2 billion at December 31, 2009. At June 30, 2010, the Bank had committed to the issuance of $0.7 billion in consolidated obligation bonds, all of which were hedged with associated interest rate swaps. At December 31, 2009, the Bank had committed to the issuance of $1.1 billion in consolidated obligation bonds, of which $1.0 billion were hedged with associated interest rate swaps. For additional information on the Bank’s joint and several liability contingent obligation, see Notes 10 and 18 to the Financial Statements in the Bank’s 2009 Form 10-K.

In addition, in the ordinary course of business, the Bank engages in financial transactions that, in accordance with U.S. GAAP, are not recorded on the Bank’s balance sheet or may be recorded on the Bank’s balance sheet in amounts that are different from the full contract or notional amount of the transactions. For example, the Bank routinely enters into commitments to extend advances and issues standby letters of credit. These commitments and standby letters of credit may represent future cash requirements of the Bank, although the standby letters of credit usually expire without being drawn upon. Standby letters of credit are subject to the same underwriting and collateral requirements as advances made by the Bank. At June 30, 2010, the Bank did not have any advance commitments and had $6.2 billion in standby letters of credit outstanding. At December 31, 2009, the Bank had $32 million of advance commitments and $5.3 billion in standby letters of credit outstanding. The estimated fair value of the advance commitments was immaterial to the balance sheet at December 31, 2009. The estimated fair value of the letters of credit was $29 million and $27 million at June 30, 2010, and at December 31, 2009, respectively.

The Bank’s financial statements do not include a liability for future statutorily mandated payments from the Bank to the Resolution Funding Corporation (REFCORP). No liability is recorded because each FHLBank must pay 20% of net earnings (after its Affordable Housing Program obligation) to REFCORP to support the payment of part of the interest on the bonds issued by the REFCORP, and each FHLBank is unable to estimate its future required payments because the payments are based on the future earnings of that FHLBank and the other FHLBanks and are not estimable under the accounting for contingencies. Accordingly, the REFCORP payments are disclosed as a long-term statutory payment requirement and, for accounting purposes, are treated, accrued, and recognized like an income tax.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Federal Home Loan Bank of San Francisco’s (Bank) market risk management objective is to maintain a relatively low exposure of the value of capital and future earnings (excluding the impact of any cumulative net gains or losses on derivatives and associated hedged items and on financial instruments carried at fair value) to changes in interest rates. This profile reflects the Bank’s objective of maintaining a conservative asset-liability mix and its commitment to providing value to its members through products and dividends without subjecting their investments in Bank capital stock to significant interest rate risk.

In May 2008, the Bank’s Board of Directors modified the market risk management objective in the Bank’s Risk Management Policy to maintaining a relatively low exposure of the net portfolio value of capital and future earnings (excluding the impact of any cumulative net gains or losses on derivatives and associated hedged items and on financial instruments carried at fair value) to changes in interest rates. See “Total Bank Market Risk” below for a discussion of the modification.

Market risk identification and measurement are primarily accomplished through market value of capital sensitivity analyses, net portfolio value of capital sensitivity analyses, and net interest income sensitivity analyses. The Risk Management Policy approved by the Bank’s Board of Directors establishes market risk policy limits and market risk measurement standards at the total Bank level. Additional guidelines approved by the Bank’s asset-liability management committee (ALCO) apply to the Bank’s two business segments, the advances-related business and the mortgage-related business. These guidelines provide limits that are monitored at the segment level and are consistent with the total Bank policy limits. Interest rate risk is managed for each business segment on a daily basis, as discussed below in “Segment Market Risk.” At least monthly, compliance with Bank policies and management guidelines is presented to the ALCO or the Board of Directors, along with a corrective action plan if applicable.

Total Bank Market Risk

Market Value of Capital Sensitivity and Net Portfolio Value of Capital Sensitivity

The Bank uses market value of capital sensitivity (the interest rate sensitivity of the net fair value of all assets, liabilities, and interest rate exchange agreements) as an important measure of the Bank’s exposure to changes in interest rates. As presented below, the Bank continues to measure, monitor, and report on market value of capital sensitivity, but no longer has a policy limit as of May 2008.

In May 2008, the Board of Directors approved a modification to the Bank’s Risk Management Policy to use net portfolio value of capital sensitivity as the primary market value metric for measuring the Bank’s exposure to changes in interest rate risk and to establish a policy limit on net portfolio value of capital sensitivity. This approach uses valuation methods that estimate the value of mortgage-backed securities (MBS) and mortgage loans in alternative interest rate environments based on valuation spreads that existed at the time the Bank acquired the MBS and mortgage loans (acquisition spreads), rather than valuation spreads implied by the current market prices of MBS and mortgage loans (market spreads). Risk metrics based on spreads existing at the time of acquisition of mortgage assets better reflect the interest rate risk of the Bank, since the Bank’s mortgage asset portfolio is primarily classified as held-to-maturity, while the use of market spreads calculated from estimates of current market prices (which include large embedded liquidity spreads) would not reflect the actual risks faced by the Bank. Because the Bank intends to and is able to hold its MBS and mortgage loans to maturity, the risks of value loss implied by current market prices of MBS and mortgage loans are not likely to be faced by the Bank. Prior to the third quarter of 2009, in the case where specific PLRMBS were classified as other-than-temporarily impaired, market spreads were used from the date of impairment for the purpose of estimating net portfolio of capital. Beginning in the third quarter of 2009, in the case of PLRMBS for which management expects loss of principal in future periods, the par amount of the other-than-temporarily impaired security is reduced by the amount of the projected principal shortfall and the asset price is calculated based on the acquisition spread. This approach directly takes into consideration the impact of

 

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projected principal (credit) losses from PLRMBS on the net portfolio value of capital, but eliminates the impact of large liquidity spreads inherent in the prior treatment of other-than-temporarily impaired securities. The Bank continues to monitor both the market value of capital sensitivity and the net portfolio value of capital sensitivity.

The Bank’s net portfolio value of capital sensitivity policy limits the potential adverse impact of an instantaneous parallel shift of a plus or minus 100-basis-point change in interest rates from current rates (base case) to no worse than –3% of the estimated net portfolio value of capital. In addition, the policy limits the potential adverse impact of an instantaneous plus or minus 100-basis-point change in interest rates measured from interest rates that are 200 basis points above or below the base case to no worse than –4% of the estimated net portfolio value of capital. The Bank’s measured net portfolio value of capital sensitivity was within the policy limit as of June 30, 2010.

To determine the Bank’s estimated risk sensitivities to interest rates for both the market value of capital sensitivity and net portfolio value of capital sensitivity, the Bank uses a third-party proprietary asset and liability system to calculate estimated net portfolio values under alternative interest rate scenarios. The system analyzes all of the Bank’s financial instruments, including derivatives, on a transaction-level basis using sophisticated valuation models with consistent and appropriate behavioral assumptions and current position data. The system also includes a mortgage prepayment model.

At least annually, the Bank reexamines the major assumptions and methodologies used in the model, including interest rate curves, spreads for discounting, and prepayment assumptions. The Bank also compares the prepayment assumptions in the third-party model to other sources, including actual prepayment history.

The Market Value of Capital Sensitivity table below presents the sensitivity of the market value of capital (the market value of all of the Bank’s assets, liabilities, and hedges, with mortgage assets valued using market spreads) to changes in interest rates. The table presents the estimated percentage change in the Bank’s market value of capital that would be expected to result from changes in interest rates under different interest rate scenarios, using market spread assumptions.

Market Value of Capital Sensitivity

Estimated Percentage Change in Market Value of Bank Capital

for Various Changes in Interest Rates

 

Interest Rate Scenario(1)    June 30, 2010     December 31, 2009  

+200 basis-point change above current rates

   –11.3   –9.0

+100 basis-point change above current rates

   –6.9      –5.3   

–100 basis-point change below current rates(2)

   +14.5      +12.1   

–200 basis-point change below current rates(2)

   +18.9      +21.6   

 

  (1) Instantaneous change from actual rates at dates indicated.
  (2) Interest rates for each maturity are limited to non-negative interest rates.

The Bank’s estimates of the sensitivity of the market value of capital to changes in interest rates as of June 30, 2010, show similar sensitivity compared to the estimates as of December 31, 2009. Compared to interest rates as of December 31, 2009, interest rates as of June 30, 2010, were 19 basis points higher for terms of 1 year, 93 basis points lower for terms of 5 years, and 97 basis points lower for terms of 10 years. As indicated by the table above, the market value of capital sensitivity is adversely affected when rates increase. In general, mortgage assets, including MBS, are expected to remain outstanding for a longer period of time when interest rates increase and prepayment speeds decline as a result of reduced incentives to refinance. Because most of the Bank’s MBS were purchased when mortgage asset spreads to pricing benchmarks were significantly lower than what is currently required by investors, the adverse spread difference gives rise to an embedded negative

 

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impact on the market value of MBS, which directly reduces the estimated market value of Bank capital. If interest rates increase and MBS consequently remain outstanding for a longer period of time, the adverse spread difference will exist for a longer period of time, giving rise to an even larger embedded negative market value impact than exists at current interest rate levels. This creates additional downward pressure on the measured market value of capital. As a result, the Bank’s measured market value of capital sensitivity to changes in rates is higher than it would be if it were measured based on the fundamental underlying repricing and option risks (a greater decline in the market value of capital when rates increase and a greater increase in the market value of capital when rates decrease). Based on the liquidity premium investors require for these assets and the Bank’s held-to-maturity classification, the Bank determined that the market value of capital sensitivity is not the best indication of risk from a held-to-maturity perspective, and the Bank has therefore developed an alternative way to measure that risk, based on estimates of the sensitivity of the net portfolio value of capital.

The Net Portfolio Value of Capital Sensitivity table below presents the sensitivity of the net portfolio value of capital (the net value of the Bank’s assets, liabilities, and hedges, with mortgage assets valued using acquisition valuation spreads) to changes in interest rates. The table presents the estimated percentage change in the Bank’s net portfolio value of capital that would be expected to result from changes in interest rates under different interest rate scenarios based on pricing mortgage assets at spreads that existed at the time of purchase rather than current market spreads. The Bank’s estimates of the net portfolio value of capital sensitivity to changes in interest rates as of June 30, 2010, show substantially the same sensitivity compared to the estimates as of December 31, 2009.

Net Portfolio Value of Capital Sensitivity

Estimated Percentage Change in Net Portfolio Value of Bank Capital

for Various Changes in Interest Rates Based on Acquisition Spreads

 

Interest Rate Scenario(1)    June 30, 2010     December 31, 2009  

+200 basis-point change above current rates

   –2.9   –4.4

+100 basis-point change above current rates

   –0.9      –1.8   

–100 basis-point change below current rates(2)

   –0.2      +0.2   

–200 basis-point change below current rates(2)

   –0.2      +0.1   

 

  (1) Instantaneous change from actual rates at dates indicated.
  (2) Interest rates for each maturity are limited to non-negative interest rates.

Potential Dividend Yield

The potential dividend yield is a measure used by the Bank to assess financial performance. The potential dividend yield is based on current period economic earnings that exclude the effects of unrealized net gains or losses resulting from the Bank’s derivatives and associated hedged items and from financial instruments carried at fair value, which will generally reverse through changes in future valuations and settlements of contractual interest cash flows over the remaining contractual terms to maturity or by the call or put date of the assets and liabilities held at fair value, hedged assets and liabilities, and derivatives. Economic earnings also exclude the interest expense on mandatorily redeemable stock.

The Bank limits the sensitivity of projected financial performance through a Board of Directors’ policy limit on projected adverse changes in the potential dividend yield. The Bank’s potential dividend yield sensitivity policy limits the potential adverse impact of an instantaneous parallel shift of a plus or minus 200-basis-point change in interest rates from current rates (base case) to no worse than –120 basis points from the base case projected potential dividend yield. In the downward shift, interest rates were limited to non-negative rates. With the indicated interest rate shifts, the potential dividend yield for the projected period July 2010 through June 2011 would be expected to decrease by 69 basis points, well within the policy limit of –120 basis points.

 

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Duration Gap

Duration gap is the difference between the estimated durations (market value sensitivity) of assets and liabilities (including the impact of interest rate exchange agreements) and reflects the extent to which estimated maturity and repricing cash flows for assets and liabilities are matched. The Bank monitors duration gap analysis at the total Bank level but does not have a policy limit. The Bank’s duration gap was six months at June 30, 2010, and four months at December 31, 2009.

Total Bank Duration Gap Analysis

 

     June 30, 2010    December 31, 2009
     

Amount

(In millions)

  

Duration Gap(1)

(In months)

  

Amount

(In millions)

  

Duration Gap(1)

(In months)

Assets

   $ 158,198    10    $ 192,862    9

Liabilities

     151,900    4      186,632    5

Net

   $ 6,298    6    $ 6,230    4

 

(1) Duration gap values include the impact of interest rate exchange agreements.

The duration gap as of June 30, 2010, was slightly longer than the duration gap as of December 31, 2009. Since duration gap is a measure of market value sensitivity, the impact of the extraordinarily wide mortgage asset spreads on duration gap is the same as described in the analysis in “Market Value of Capital Sensitivity” above. As a result of the liquidity premium investors require for these assets and the Bank’s held-to-maturity classification, management does not believe that market value-based sensitivity risk measures provide a fundamental indication of risk.

Segment Market Risk

The financial performance and interest rate risks of each business segment are managed within prescribed guidelines, which, when combined, are consistent with the policy limits for the total Bank.

Advances-Related Business

Interest rate risk arises from the advances-related business primarily through the use of member-contributed capital to fund fixed rate investments of targeted amounts and maturities. In general, advances result in very little net interest rate risk for the Bank because most fixed rate advances with original maturities greater than three months and advances with embedded options are hedged contemporaneously with an interest rate swap or option with terms offsetting the advance. The interest rate swap or option generally is maintained as a hedge for the life of the advance. These hedged advances effectively create a pool of variable rate assets, which, in combination with the strategy of raising debt swapped to variable rate liabilities, creates an advances portfolio with low net interest rate risk.

Non-MBS investments used for liquidity management generally have maturities of less than three months or are variable rate investments. These investments effectively match the interest rate risk of the Bank’s variable rate funding. The Bank also invests in agency or TLGP investments with terms of less than two years to leverage the Bank’s excess capital stock. These investments may be variable rate or fixed rate, and the interest rate risk resulting from the fixed rate coupon is hedged with an interest rate swap or fixed rate debt.

The interest rate risk in the advances-related business is primarily associated with the Bank’s strategy for investing the members’ contributed capital. The Bank’s general strategy is to invest 50% of member capital in short-term investments (maturities of 3 months or less) and 50% in intermediate-term investments (laddered portfolio of investments with maturities of up to four years). Because of the Federal Reserve’s actions to stimulate the economy, short-term interest rates are exceptionally low, resulting in lower returns on the Bank’s capital. In order to improve the return on the Bank’s capital, while not materially affecting the Bank’s risk profile, effective January 2010 the Bank temporarily modified its invested capital strategy to invest 50% of the capital currently invested in investments with maturities of 3 months or less (25% of total member capital) in a portfolio of investments with maturities of 12 to 24 months, and as those investments mature, to reinvest the capital back into short-term investments.

 

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The strategy to invest 50% of member capital in short-term assets is intended to mitigate the market value of capital risks associated with the potential repurchase or redemption of members’ excess capital stock. The strategy to invest 50% of member capital in a laddered portfolio of instruments with short to intermediate maturities is intended to take advantage of the higher earnings available from a generally positively sloped yield curve, when intermediate-term investments generally have higher yields than short-term investments. Excess capital stock primarily results from a decline in a member’s advances. Under the Bank’s capital plan, capital stock, when repurchased or redeemed, is required to be repurchased or redeemed at its par value of $100 per share, subject to certain regulatory and statutory limits.

Management updates the repricing and maturity gaps for actual asset, liability, and derivatives transactions that occur in the advances-related segment each day. Management regularly compares the targeted repricing and maturity gaps to the actual repricing and maturity gaps to identify rebalancing needs for the targeted gaps. On a weekly basis, management evaluates the projected impact of expected maturities and scheduled repricings of assets, liabilities, and interest rate exchange agreements on the interest rate risk of the advances-related segment. The analyses are prepared under base case and alternate interest rate scenarios to assess the effect of put options and call options embedded in the advances, related financing, and hedges. These analyses are also used to measure and manage potential reinvestment risk (when the remaining term of advances is shorter than the remaining term of the financing) and potential refinancing risk (when the remaining term of advances is longer than the remaining term of the financing).

Because of the short-term and variable rate nature of the assets, liabilities, and derivatives of the advances-related business, the Bank’s interest rate risk guidelines address the amounts of net assets that are expected to mature or reprice in a given period. Net market value sensitivity analysis and net interest income simulations are also used to identify and measure risk and variances to the target interest rate risk exposure in the advances-related segment.

Mortgage-Related Business

The Bank’s mortgage assets include MBS, most of which are classified as held-to-maturity and a small amount of which are classified as trading, and mortgage loans held for portfolio purchased under the MPF Program. The Bank is exposed to interest rate risk from the mortgage-related business because the principal cash flows of the mortgage assets and the liabilities that fund them are not exactly matched through time and across all possible interest rate scenarios, given the uncertainty of mortgage prepayments and the existence of interest rate caps on certain adjustable rate MBS.

The Bank purchases a mix of intermediate-term fixed rate and floating rate MBS. Generally, purchases of long-term fixed rate MBS have been relatively small; any MPF loans that have been acquired are medium- or long-term fixed rate mortgage assets. This results in a mortgage portfolio that has a diversified set of interest rate risk attributes.

The estimated market risk of the mortgage-related business is managed both at the time an individual asset is purchased and on a total portfolio level. At the time of purchase (for all significant mortgage asset acquisitions), the Bank analyzes the estimated earnings sensitivity and estimated net market value sensitivity, taking into consideration the estimated prepayment sensitivity of the mortgage assets and anticipated funding and hedging under various interest rate scenarios. The related funding and hedging transactions are executed at or close to the time of purchase of a mortgage asset.

At least monthly, management reviews the estimated market risk of the entire portfolio of mortgage assets and related funding and hedges. Rebalancing strategies to modify the estimated mortgage portfolio market risks are then considered. Periodically, management performs more in-depth analyses, which include the

 

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impacts of non-parallel shifts in the yield curve and assessments of unanticipated prepayment behavior. Based on these analyses, management may take actions to rebalance the mortgage portfolio’s estimated market risk profile. These rebalancing strategies may include entering into new funding and hedging transactions, forgoing or modifying certain funding or hedging transactions normally executed with new mortgage purchases, or terminating certain funding and hedging transactions for the mortgage asset portfolio.

The Bank manages the estimated interest rate risk associated with mortgage assets, including prepayment risk, through a combination of debt issuance and derivatives. The Bank may obtain funding through callable and non-callable FHLBank System debt and may execute derivatives transactions to achieve principal cash flow patterns and market value sensitivities for the liabilities and derivatives that provide a significant offset to the interest rate and prepayment risks associated with the mortgage assets. Debt issued to finance mortgage assets may be fixed rate debt, callable fixed rate debt, or adjustable rate debt. Derivatives may be used as temporary hedges of anticipated debt issuance or long-term hedges of debt used to finance the mortgage assets. The derivatives used to hedge the interest rate risk of fixed rate mortgage assets generally may be options to enter into interest rate swaps (swaptions) or callable and non-callable pay-fixed interest rate swaps. Derivatives used to hedge the periodic cap risks of adjustable rate mortgages may be receive-adjustable, pay-adjustable swaps with embedded caps that offset the periodic caps in the mortgage assets.

In May 2008, the Board of Directors approved a modification to the Bank’s Risk Management Policy to use net portfolio value of capital sensitivity as a primary metric for measuring the Bank’s exposure to interest rate risk and to establish a policy limit on net portfolio value of capital sensitivity. This new approach uses valuation methods that estimate the value of MBS and mortgage loans in alternative interest rate environments based on valuation spreads that existed at the time the Bank acquired the MBS and mortgage loans (acquisition spreads), rather than valuation spreads implied by the current market prices of MBS and mortgage loans (market spreads). Risk metrics based on spreads existing at the time of acquisition of mortgage assets better reflect the interest rate risk of the Bank, since the Bank’s mortgage asset portfolio is primarily classified as held-to-maturity, while the use of market spreads calculated from estimates of current market prices (which include large embedded liquidity spreads) would not reflect the actual risks faced by the Bank. Beginning in the third quarter of 2009, in the case of specific mortgage assets for which the Bank expects loss of principal in future periods, the par amount of the other-than-temporarily impaired security is reduced by the amount of the projected principal shortfall and the asset price is calculated based on the acquisition spread. This approach directly takes into consideration the impact of projected principal (credit) losses from PLRMBS on the net portfolio value of capital, but eliminates the impact of large liquidity spreads inherent in the prior treatment of other-than-temporarily impaired securities. The Bank continues to monitor both the market value of capital sensitivity and the net portfolio value of capital sensitivity attributable to the mortgage-related business.

The following table presents results of the estimated market value of capital sensitivity analysis attributable to the mortgage-related business as of June 30, 2010, and December 31, 2009.

 

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Market Value of Capital Sensitivity

Estimated Percentage Change in Market Value of Bank Capital

Attributable to the Mortgage-Related Business for Various Changes in Interest Rates

 

Interest Rate Scenario(1)    June 30, 2010     December 31, 2009  

+200 basis-point change

   –9.5   –6.2

+100 basis-point change

   –6.0      –4.0   

–100 basis-point change(2)

   +13.3      +11.1   

–200 basis-point change(2)

   +17.2      +19.8   

 

  (1) Instantaneous change from actual rates at dates indicated.
  (2) Interest rates for each maturity are limited to non-negative interest rates.

The Bank’s estimates of the sensitivity of the market value of capital to changes in interest rates as of June 30, 2010, show similar sensitivity compared to the estimates as of December 31, 2009. Compared to interest rates as of December 31, 2009, interest rates as of June 30, 2010, were 19 basis points higher for terms of 1 year, 93 basis points lower for terms of 5 years, and 97 basis points lower for terms of 10 years. As indicated by the table above, the market value of capital sensitivity is adversely affected when rates increase. In general, mortgage assets, including MBS, are expected to remain outstanding for a longer period of time when interest rates increase and prepayment speeds decline as a result of reduced incentives to refinance. Because most of the Bank’s MBS were purchased when mortgage asset spreads to pricing benchmarks were significantly lower than what is currently required by investors, the adverse spread difference gives rise to an embedded negative impact on the market value of MBS, which directly reduces the estimated market value of Bank capital. If interest rates increase and MBS consequently remain outstanding for a longer period of time, the adverse spread difference will exist for a longer period of time, giving rise to an even larger embedded negative market value impact than exists at current interest rate levels. This creates additional downward pressure on the measured market value of capital. As a result, the Bank’s measured market value of capital sensitivity to changes in rates is higher than it would be if it were measured based on the fundamental underlying repricing and option risks (a greater decline in the market value of capital when rates increase and a greater increase in the market value of capital when rates decrease). Based on the liquidity premium investors require for these assets and the Bank’s held-to-maturity classification, the Bank determined that the market value of capital sensitivity is not the best indication of risk from a held-to-maturity perspective, and the Bank has therefore developed an alternative way to measure that risk, based on estimates of the sensitivity of the net portfolio value of capital.

The Bank’s interest rate risk guidelines for the mortgage-related business address the net portfolio value of capital sensitivity of the assets, liabilities, and derivatives of the mortgage-related business. The following table presents the estimated percentage change in the value of Bank capital attributable to the mortgage-related business that would be expected to result from changes in interest rates under different interest rate scenarios based on pricing mortgage assets at spreads that existed at the time of purchase rather than current market spreads. The Bank’s estimates of the net portfolio value of capital sensitivity to changes in interest rates as of June 30, 2010, show similar sensitivity compared to the estimates as of December 31, 2009.

 

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Net Portfolio Value of Capital Sensitivity

Estimated Percentage Change in Net Portfolio Value of Bank Capital

Attributable to the Mortgage-Related Business for Various Changes in

Interest Rates Based on Acquisition Spreads

 

Interest Rate Scenario(1)    June 30, 2010     December 31, 2009  

+200 basis-point change above current rates

   –1.6   –2.5

+100 basis-point change above current rates

   –0.2      –1.0   

–100 basis-point change below current rates(2)

   –1.1      –0.4   

–200 basis-point change below current rates(2)

   –1.4      –1.0   

 

  (1) Instantaneous change from actual rates at dates indicated.
  (2) Interest rates for each maturity are limited to non-negative interest rates.

 

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

The senior management of the Federal Home Loan Bank of San Francisco (Bank) is responsible for establishing and maintaining a system of disclosure controls and procedures designed to ensure that information required to be disclosed by the Bank in the reports filed or submitted under the Securities Exchange Act of 1934 (1934 Act) is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. The Bank’s disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Bank in the reports that it files or submits under the 1934 Act is accumulated and communicated to the Bank’s management, including its principal executive officer or officers and principal financial officer or officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the Bank’s disclosure controls and procedures, the Bank’s management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and the Bank’s management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of controls and procedures.

Management of the Bank has evaluated the effectiveness of the design and operation of its disclosure controls and procedures with the participation of the president and chief executive officer, executive vice president and chief operating officer, senior vice president and chief financial officer, and senior vice president, controller and operations officer, as of the end of the quarterly period covered by this report. Based on that evaluation, the Bank’s president and chief executive officer, executive vice president and chief operating officer, senior vice president and chief financial officer, and senior vice president, controller and operations officer, have concluded that the Bank’s disclosure controls and procedures were effective at a reasonable assurance level as of the end of the fiscal quarter covered by this report.

Internal Control Over Financial Reporting

During the three months ended June 30, 2010, there were no changes in the Bank’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Bank’s internal control over financial reporting.

 

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Consolidated Obligations

The Bank’s disclosure controls and procedures include controls and procedures for accumulating and communicating information in compliance with the Bank’s disclosure and financial reporting requirements relating to the joint and several liability for the consolidated obligations of other Federal Home Loan Banks (FHLBanks). Because the FHLBanks are independently managed and operated, the Bank’s management relies on information that is provided or disseminated by the Federal Housing Finance Agency (Finance Agency), the Office of Finance, and the other FHLBanks, as well as on published FHLBank credit ratings, in determining whether the joint and several liability regulation is reasonably likely to result in a direct obligation for the Bank or whether it is reasonably possible that the Bank will accrue a direct liability.

The Bank’s management also relies on the operation of the joint and several liability regulation, which is located in Section 966.9 of Title 12 of the Code of Federal Regulations. The joint and several liability regulation requires that each FHLBank file with the Finance Agency a quarterly certification that it will remain capable of making full and timely payment of all of its current obligations, including direct obligations, coming due during the next quarter. In addition, if an FHLBank cannot make such a certification or if it projects that it may be unable to meet its current obligations during the next quarter on a timely basis, it must file a notice with the Finance Agency. Under the joint and several liability regulation, the Finance Agency may order any FHLBank to make principal and interest payments on any consolidated obligations of any other FHLBank, or allocate the outstanding liability of an FHLBank among all remaining FHLBanks on a pro rata basis in proportion to each FHLBank’s participation in all consolidated obligations outstanding or on any other basis.

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

The Federal Home Loan Bank of San Francisco (Bank) may be subject to various legal proceedings arising in the normal course of business. On March 15, 2010, the Bank filed two complaints in the Superior Court of the State of California, County of San Francisco, relating to the purchase of private-label residential mortgage-backed securities. The Bank’s complaints are actions for rescission and damages and assert claims for violations of state and federal securities laws, negligent misrepresentation, and rescission of contract. On June 10, 2010, the Bank filed amended complaints to, among other things, add as defendants: WaMu Capital Corp. as the securities dealer that sold the Bank five certificates in the amount paid of approximately $637 million, and Washington Mutual Mortgage Securities Corp. as the issuer of those five certificates. For a discussion of this litigation, see “Part I. Item 3. Legal Proceedings” in the Bank’s Annual Report on Form 10-K for the year ended December 31, 2009. After consultation with legal counsel, management is not aware of any other legal proceedings that may have a material effect on the Bank’s financial condition or results of operations or that are otherwise material to the Bank.

 

ITEM 1A. RISK FACTORS

For a discussion of risk factors, see “Part I. Item 1A. Risk Factors” in the Federal Home Loan Bank of San Francisco’s (Bank’s) Annual Report on Form 10-K for the year ended December 31, 2009 (2009 Form 10-K). There have been no material changes from the risk factors disclosed in the “Risk Factors” section of the Bank’s 2009 Form 10-K.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

 

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ITEM 4. (REMOVED AND RESERVED)

 

ITEM 5. OTHER INFORMATION

None.

 

ITEM 6. EXHIBITS

 

31.1    Certification of the President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2    Certification of the Chief Operating Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.3    Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.4    Certification of the Controller and Operations Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1    Certification of the President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2    Certification of the Chief Operating Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.3    Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.4    Certification of the Controller and Operations Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.1    Computation of Ratio of Earnings to Fixed Charges – Three and Six Months Ended June 30, 2010

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on August 12, 2010.

 

Federal Home Loan Bank of San Francisco

/S/ STEVEN T. HONDA

Steven T. Honda

Senior Vice President and Chief Financial Officer

(Principal Financial Officer)

/S/ VERA MAYTUM

Vera Maytum

Senior Vice President, Controller and Operations Officer

(Chief Accounting Officer)

 

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